Johnson & Johnson (JNJ) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Johnson & Johnson Second Quarter 2012 Earnings Conference Call. All participants will be able to listen-only until the question-and-answer session of the conference. This call is being recorded. (Operator Instructions) I will now turn the conference over to Johnson & Johnson, you may begin.

Good morning and welcome. I am Louise Mehrotra, Vice President of Investor Relations for Johnson & Johnson and it is my pleasure this morning to review our business results for the second quarter of 2012. Joining me on the call today are Alex Gorsky, Chief Executive Officer of Johnson & Johnson; and Dominic Caruso, Vice President, Finance and Chief Financial Officer. A few logistics before we get into the details. This call is being made available to a broader audience via a webcast accessible through the investor relations section of the Johnson & Johnson website. I will begin by briefly reviewing highlights of the second quarter for the corporation and highlights for our three business segments. Following my remarks, Alex will discuss his near term and strategic priorities for Johnson & Johnson. Following Alex’s remarks, Dominic will provide some additional commentary on the second quarter financial results and discuss guidance for the full year of 2012. We will then open the call to your questions. We expect the call to last approximately 90 minutes. Included with the press release that was sent to the investment community earlier this morning is the schedule showing sales for key products and/or businesses to facilitate updating your models. These are also available on the Johnson & Johnson website as is the press release. Before I get into the results, let me remind you that some of the statements made during this review may be considered forward-looking statements. The 10-K for the fiscal year 2011 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…

Thank you, Louise, and thanks to all of you for participating on the call today. You know it’s a real pleasure for me to join you, this being the first earnings announcement since I have assumed my responsibility as the CEO. This kind of dialogue with the investment community is something I consider important and mutually valuable. During the past couple of months I have done a lot of travelling and a lot of listening. This has allowed me to refine my understanding of the many opportunities we have across Johnson & Johnson and our plans to capitalize on them in the future. So I would like to spent a few minutes right upfront conveying my excitement for the future of Johnson & Johnson, and give you a sense of our priorities. Nothing is more important than the health and well being of those we care about. That’s why the Johnson & Johnson family of companies for more than 125 years has committed itself to caring for patients and consumers. Going forward, we will build on Johnson & Johnson’s long, proud legacy of strong performance, trust, esteem, high reputation and many accomplishments. Our commitment, a legacy of our founders and a very real motivating force among our 128,000 employees, is embodied in our credo which speaks to our first responsibility to the doctors, nurses, patients, the mothers and fathers and all who use our products. I am resolute in my determination to keep our credo as the foundation of Johnson & Johnson. Our credo has long been and must continue to be the defining feature of our organization because it reflects our core value systems, our beliefs and our aspirations. Science will evolve, our environment markets will change, but who we are and what we believe as described so well…

Thank you, Alex, and good morning, everyone. I’d like to provide some comments this morning about our second quarter financial results, discuss briefly the Synthes transaction, and provide guidance for you to consider in refining your models for 2012. Our second quarter performance was solid despite the continuing marketplace and economic pressures. Although healthcare utilization trends are still below prerecession levels, we saw continuing stabilization of the trends based on first quarter data with some signs of improvement in the rate of growth in hospital admissions and surgeries, including joint replacement. But while positive, these signs are still too early and minor to single any meaningful sustained recovery especially in light of the continued uncertainties in the macroeconomic environment. Sales results for the quarter were impacted significantly by the weakening euro but were positively enhanced by the closing of the Synthes transaction. Second quarter sales on an operational basis excluding the impact of currency grew at 3.5%. With two weeks of sales related to the completion of the Synthes acquisition contributed just over 1% to the operational growth for this quarter. From an earnings perspective earnings per share excluding special items were $1.30. Louise provided some information already regarding the special items we recorded in the second quarter. Let me take a few minutes now to provide some additional background regarding those items. First, regarding Crucell, as many of you remember historically the rules for acquired in-process research and development or IPR&D require that such cost be expensed at the time of acquisition. In 2009, however, the accounting rules changed to require that acquired in-process research and development be capitalized as an asset. Periodic evaluations for changes in the status of the related research projects are performed as the research projects progress. In the second quarter the company recorded as…

Thank you, Dominic. Before we open the Q&A session, I’d please ask you to keep your questions at the strategic level because we have Alex with us today. Felicia, could you give the instructions for the Q&A please?

(Operator Instructions) And your first question comes from the line of Mike Weinstein with JPMorgan.

Alex, you talked about a bunch of items in your prepared comments and I think probably the one that I think people should focus on and probably got our attention was your comments about. The goal of accelerating J&J’s sales and earnings growth, over the next several years not necessarily a short-term goal but a longer-term goal and within that you talked about innovation, globalization and other initiatives to try and accomplish that. Can you just talk a little about the portfolio today in that context, you talked about being more disciplined on strategic decisions regarding what goes into the portfolio and what comes out. Do you have the portfolio and do you have the R&D pipeline say to drive that acceleration and what do you think you need to do strategically to make that growth acceleration happen?

As I commented earlier in my comments, I think overall, we believe that our diversified portfolio does better position us for the healthcare market that we are likely to experience ahead. Let’s start with our pharmaceutical group, I believe the transformation that has occurred over the past several years when you consider the fact that we went through a very significant period of generic entries and patent expirations and you look at not only the fact the major changes that we made in our organization. But also if you look at the focus that Paul, Joaquin and their teams have put on specific therapeutic areas and frankly the success rates that we have had with our clinical development programs in getting new products to the market, we think it's really significant and has positioned us very well. We think by being focused in these areas not only does it give us an advantage in terms of our scientific insights in clinical development but it also enables us to leverage our commercial organization and really be focused on the right customers. So while we are very pleased with the uptick that we are seeing across that portfolio right now, with products like ZYTIGA, XARELTO, INCIVO, STELARA and SIMPONI. We’re also investing for the future and we’re excited about some of the new compounds that we have whether it's canagliflozin, bapineuzumab, things further out such as ibrutinib as well as TMC 435. And we’re continuing to invest even longer term as you heard in our announcement this week with our new cyclic peptide in heart failure recognizing that its earlier. So, I think there we got a strong portfolio of very differentiated drugs that the market's demanding, but clearly we're also investing for the future. Now if I can step over to…

Let me just take one quick follow-up with Dominic and maybe just to clarify a couple of items. One, Dominic, you referenced in your comments supply disruptions in certain of your MD&D businesses, I don’t think I caught that earlier in your prepared remarks so could you just identify where those are occurring? And then second, Dominic, if we look at the operational EPS guidance my numbers had on the last call, your guidance for the year was $5.18 to $5.28 ex-currency and today you said $5.25 to $5.32 ex-currency, did I get that right?

Yes. Let me take the last one first. You are exactly right. Our previous ex-currency guidance was $5.18 to $5.28. We increased the guidance to $5.25 to $5.32. Two things have happened there, we have added Synthes which we described as $0.03 to $0.05, so obviously the upper end of the range is up about $0.04. And we tightened the range a little bit because at this stage and again, we feel more comfortable with our earnings for the balance of the year. With respect to supply disruption, I’ll ask Alex, if he wants to add some additional comments. Two areas in particular in our energy business, we have had some supply disruptions and in our endovascular business with respect to endovascular stents. Alex, I don’t know if you want to add any more to that?

Yes, Mike. We had two supply interruptions again in our energy and in our cardiovascular stents. We are in the process of resolving those as we speak and we are confident that in the back end of this year we will see that return to a normal flow.

Your next question comes from the line of Matthew Dodds with Citigroup.

Alex, I guess first for you. If you look at where Europe is heading, I think Europe, you were flat when you take out Synthes roughly. Looks like it's a little worse than it's been. Where do we think we are today and can you align the costs with some of the pressures you are seeing in Europe?

Yes, Matt. Matt are you talking across the portfolio or in a specific segment?

Well, I think the overall looked flat. I was wondering if any segments you’re being hurt more than others in Europe broadly as well?

Yes. Matt, your observation is right that overall I think we are up about 1.5% and again there is puts and takes across that. But what we are seeing is obviously some additional pressure with price as well as volumes and price being regulated mostly to tendering and some of the contract things that we would see in our pharmaceutical group. What we are seeing is consistent with around 2011 with perhaps slightly more in Southern Europe. If you look at MD&D, we are also seeing pressures, some in price, but some just in extended queues, longer wait times for certain procedures. So we are watching it very closely. We have not seen a dramatic change over what we saw in 2011, but obviously we still think that there are a lot of macroeconomic conditions and dynamics that may impact that going forward.

And pharma on the pricing side has that also been more of an impact?

Again, we are seeing some impact in pharma on the pricing side mostly related to tenders and other austerity measures, but not to a significantly greater degree than what we have commented around 2011 so far this year.

Dominic, one quick one for you. When you look at the operating margin leverage both this quarter and the back half, can you roughly say how much of that might be due to local currency in the lower cost from the FX as an offset to the top line?

Yes, I think that one of the things that bear in mind is, we typically hedge our foreign currency commitments at about 18 months. So, our operations ex-translation, are not significantly impacted by changes in foreign currency, Matt. So, really what you're looking at is sort of a reasonably equal mix of changes in simply translating the top line and the expenses from the local currencies to the U.S. dollars. So, I don’t think there is a pronounced difference between those two factors.

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

Dominic, could you help us bridge the current top line guidance versus the prior, the prior was 4 to 5%, the current I think you said was 5.5 to 6.5%, and there was a lot of moving parts that you mentioned, but how much was it the increase due to Synthes and some of the offset? That’s my first question.

Sure, Larry. Let me just try to give you a general order of magnitude on that. So, the addition of Synthes and I think you have to bear in mind that with the Synthes impact I’m going to give you there’s two other factors to bear in mind. The impact of the divestiture of the trauma business and we've taken into consideration some disruption in the overall business as a result of the integration and planning, etcetera. So, we’ve increased our guidance about 2.5 points or thereabouts for the net of all that related to the Synthes integration and divesture of trauma, etcetera, and we have decreased the guidance about a little more than 1 point, maybe 1.2 points related to the supply disruptions we talked about earlier and having a better estimate now on the resupply of products in the OTC business. So, those two factors up 2.5, down 1.2 or thereabouts hopefully reconcile the change for you.

Then just two quick product questions. INCIVO was a little bit lighter than our expectations. Can you talk about what’s happening in Europe there? And then just lastly on CONCERTA, does your guidance assume that any change to generic competition in 2012? Thanks.

Sure. Let me take the last question first. On CONCERTA, we have not assumed any change with respect to the current generic competition, so status quo there for this year. And with respect to INCIVO I’ll start by just commenting that we did see as Louise mentioned in her script discussion that in fact we saw some seasonal adjustments in the rate of treatment patterns throughout Europe. And maybe I’ll ask Alex to comment some more as we have been through with the team to understand what’s happening there with INCIVO.

Overall, I’d say we are really pleased with the launch of INCIVO. As we look at it starting I believe in about the fourth quarter of last year, it's uptake in terms of share as well as volume has been very impressive. A lot of the volume obviously coming out of France and Germany and so overall we are very pleased with it. We did see some deceleration of that as we went into the second quarter. A part of that we think is just due to the bullish or new urgent patients that you see in the larger markets when we got out there early in the year. Second we think there's probably some seasonality related to it. So if we combine all of that we are still very confident in what we think the future prospects for that drug look like.

Your next question comes from the line of Ian Sanderson with Cowen. Ian Sanderson - Cowen & Company: If I could get an update on the XARELTO ACS regulatory process? In other words, at this point do you know what the FDA is looking for and if you have any rough guidance on when you may might be able to resubmit the NDA?

We are in an ongoing dialog right now with the Agency. We remain very confident in our file. You are obviously familiar with some of the comments that were made at the review committee. We are working our way through those and so again if we think if we look at the overall data set, we are confident that we are going to be able with the agency towards a positive resolution of that in the future. Ian Sanderson - Cowen & Company: Also if I could ask a quick follow-up on the OTC, maybe this is better for Dominic, can you give us some sense of when we should see this spending ramp related to the relaunches? Would it be late this year or is most of that going to ‘12 and ‘13?

As we said before, it's awfully difficult to predict the pace at which we will ramp up, but we will obviously not be spending on the relaunch of those products until we are confident that the supply situation is stabilized and we can provide a consistent supply to the market. So, I think we are going to monitor that and not get too far ahead of that quite frankly, because we want to ensure that there is first a consistent supply of product and then of course, we will invest significantly behind that once we achieve that. As we said before, we think the return of the products at the market will continue for the balance of 2012 and into 2013.

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

Alex, first, congratulations on your new appointment as CEO. In your prepared remarks and committing the Company to remaining a broad-based healthcare company, it sounds like you are coming out and rejecting some other strategies that your peers such as Abbott and Pfizer have embraced, in which the market has rewarded. So, I’m wondering if you could comment on that. And then secondly, I guess this question is for Dominic. On the pharmaceutical side, it looks like international revenues slowed sequentially quite a bit despite much easier year-over-year comps because of the Merck agreement plus obviously increased sales from ZYTIGA and INCIVO you didn’t have a year ago. So, maybe you could tie that with what you are seeing with the macro environment in Europe? I know sort of Alex touched upon the environment being worse, but not dramatically worse than you would expect it, but if you could parse out what you are seeing in terms of price declines, volumes, you had mentioned tenders, but if you could be a little bit more specific in what you are seeing in terms of receivables? Thanks.

Thanks a lot for the question, and also we always appreciate the challenge and some of the background and comments that you have written about. What I’d say and as you heard in my earlier comments, we do believe that based upon the evolving marketplace going forward, that our diversified portfolio gives us additional strength and will help us achieve further growth. That being said, we think that there are components of that model that are going to need to be ramped up to make us even more competitive. So, let me start with first the marketplace. As we look at their marketplace going forward, and particularly for example in the hospital space, we believe there will be further consolidation, further aggregation of some of those customers and as a result, we believe that they are going to be looking for more comprehensive offerings and greater solutions as well as outcomes versus just products. And in that case, when you have a very large portfolio depth and breadth of scale we think that that's going to be an important source of competitive advantage. Again, a good example of that may be with an ACO in the United States or frankly with some of the governments particularly in emerging markets where critical mass is particularly important and where we see a greater opportunity for growth. Next, we also think it’s going to be important in terms of what we are actually offering. If we look at products, we think a great opportunity for differentiation is going to be combining and bringing convergent products or offerings forward. So in pharmaceutical, that may relate to biomarkers and diagnostics along with some of our therapeutics, in MD&D that may relate to things like the Fibrin Pad, or frankly things that we have done with our VICRYL Plus line, anti-infective suture devices and we think the scientific, the clinical, the regulatory as well as the commercial differentiation that that provides, is a real opportunity for us. That being said, we also realized that we are going to have to be likely more selective and more decisive in what areas we are going to be and where we are not going to be. So, we are going in fact through a strategic planning process as we speak and we are committed to making sure that we make those decisions and are putting our resources and energy in our effort behind the areas that we think are going to drive the greatest growth opportunities for us going forward. Dominic?

Yes. Jamie, in Europe, just a couple of comments, I think our overall growth in the pharmaceutical business internationally did grow, of course, second quarter versus first quarter sequentially, but we did see some impacts. I think pricing has in fact been an impact. The tender process has been an impact and in particular what we saw in Southern Europe it's much, much more difficult in the new tenders to get any sort of price increase, in fact they usually come with significant price decreases. So, we have seen that in the low single-digit rates that seems to be just accelerating maybe a little bit but not that pronounced. The real difference in the period is really just the timing of various tenders. I mean one example is, with respect to VELCADE, the timing of the tender in Russia is such that you don't see much of an impact this quarter and they will get that impact as the tender gets approved in the future. With respect to receivables, I will tell you that either it varies by different countries, so we just look at Southern Europe, our receivables continue to build in countries like Italy and a little bit in Greece, but in other countries such as Spain, our receivables have significantly decreased. We recently received a very significant payment from the Government of Spain. So, what we are doing is working very closely with all the governments with respect to payment terms, etcetera, but overall our second quarter receivables and days sales outstanding at the end of the second quarter are much better in Southern Europe than they were at the end of the first quarter.

Your next question comes from the line of Rajeev Jashnani with UBS.

I had a question, first returning to the topic of the portfolio and it sounds like there is some potential for an accelerating pace of divestitures. I was just wondering if that's a reasonable expectation as you come out of this strategic review.

What I’d say and we have been very clear about it with our management team is that, our goal is to be very decisive about what businesses we're in and that we are not in. We realized that when there are areas, where frankly we don't think we are going to make the difference for patients or we are not as competitive as we should be as we were in drug eluting stents, but we should divest or be out of those businesses and reallocate our resources elsewhere. And where we think there is a greater opportunity, Synthes, in those areas we think we should put additional resources and make the right investments to make us even more competitive. So, we are going to be very disciplined. We are going to be also very decisive in how we are going to go forward, recognizing dynamics in the healthcare marketplace.

I did have one follow-up for Dominic, just regarding the operating margin expansion, 100 to 150 basis points this year. Now, I think a lot of us are looking for accelerating growth next year. And I’m just wondering as we think about the operating margin expansion this year, are there elements in there that we should think of as not coming back in 2013, just to help us kind of gauge where our expectation should be?

Rajeev, I think one of the things that point out about the 100 to 150 basis points expansion is, it’s what we called for at the beginning of the year and despite the inclusion now and the guidance of the Synthes, with the Synthes amortization expense, we still think we’re going to achieve 100 to 150 basis points expansion. So obviously, the underlying business at Synthes is performing in a more efficient manner than even we thought at the beginning of the year. How that continues for the balance of 2012 and into ‘13, I don’t want to project into 2013 too much because obviously we want to make sure that we balance out the appropriate investments we want to make in the business as we go forward. The only thing I’d say that's of any significant consequence in the current year and as we progress throughout the balance of ‘12 and into ‘13 is the remediation costs related to the consumer business are in fact higher than we thought this year, and hopefully as we go through that process, they should then tail off as we move into 2013, but we will see how the progress is and we will update you on that when we do the 2013 guidance.

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

I wanted to start with a couple of questions on the Synthes acquisition. Alex, I think that when you announced the deal over a year ago, you were talking about expectations for the trauma market growing 7% and since then it seems like the trauma market and nearly Synthes sales in particular have slowed. So I was wondering, what your expectations moving forward now were for the trauma market and Synthes sales in particular? And secondly, maybe you could talk a little bit about how you will be integrating the spine sales forces for Synthes and DePuy given the direct and indirect distributor models that you have? And then lastly maybe Dominic, what is your accretion guidance for Synthes assuming in terms of synergies?

You are right. If we go back to the announcement and the discussion that we had, again the announcement of the Synthes deal, at that time if you looked historically at the trauma market I believe you saw historical growth rates that were very consistent in the 7% plus range. If you look about over the last 18 months, we have seen that come down probably reduced in about half consistent with what we have seen in a lot of the other MD&D markets. We think there is a number of factors that are driving that and at this point it's difficult to predict whether or not they are secular or cyclical. But some of them or as the macroeconomic environment has had an impact although it's a bit lagging relative to some of the other markets such as general surgery, in particularly that need kind of the discretionary procedures. We also believe there's been some seasonality issues, but just as you look at overall macroeconomic ranging from construction to weather to a lot of other things that may be impacting it. As we project going forward, we think likely the next couple of years, we are likely to see growth in the lower to mid single-digits versus what we had seen previously, but we would expect that to return to more robust levels as the economy picks up. We are also seeing obviously stronger growth in the emerging markets particularly in Asia-Pacific and some of the areas over there. So that gives you a little bit of background on what we think is going to happen overall with the trauma market. If we look at the integration with spines, first of all, we think the portfolios are very complementary. If you look at the two organizations coming together and…

I mean one of the things that I mentioned, Derrick, about our guidance, which we gave as $0.03 to $0.05 for 2012 and $0.10 to $0.15 accretion in 2013, is that, it’s largely based on growth and not primarily based on expense synergies, right. There are some expense synergies in those numbers but as we announced when we did the acquisition announcement early on, we said our primary focus here was going to be on growth of the businesses together. So on top line synergies and not so much of a focus on expense synergies. There will be some. I think it's important to note that the business is already a very profitable business that we are adding all into the Johnson & Johnson business and in fact, there are pre-tax operating margins. Excluding this impact of amortization, we’re healthier than the overall Johnson & Johnson pre-tax operating margins. So, there will be some, we have included those in the estimates that we gave you for ‘12 and ’13, but I don’t see them as the major driver of the accretion.

Louise, just a quick housekeeping, can you repeat the INCIVO sales, I just missed that?

It contributed about 3.5% to the pharmaceutical international sales.

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

With the Synthes acquisition now completed, can you talk about, Alex, the change in strategy for use of cash over the next 12 to 24 months? Was the deal structured with ASR to make it accretive to give you more flexibility on the acquisition front going forward and if so what healthcare assets would make the most strategic sense for J&J?

Yes. Alex, let me take that on the overall use of cash. I think many of you have heard me discuss this, the answer to this question in the past. So just to reiterate, our primary focus is to generate, sustainable long-term free cash flow generation in the business, which we are very proud of our ability to do that and then we have prioritized and I think we will continue to prioritize our use of cash as first to dividends as a primary return to shareholders. Secondly, an investment in value creating acquisitions that enhance our ability to generate free cash flow in the future, and thirdly, any future returns of shareholders in the form of share buybacks. I don’t think that the impact of the Synthes transaction changes our philosophy there in any significant way. We are also maintaining our AAA credit rating, which gives us enormous flexibility in our ability to fund our operations going forward or any particular investment we want to make. With respect to the accelerated share repurchase program, you are correct that, that is a factor in providing immediate accretion as opposed to a longer term accretion value and it's basically a result of needing to have the shares necessary to complete the acquisition in a relatively short period of time. After the regulatory approvals were received, we needed to close in a couple days obviously and rather than issue shares and buy them back over extended period of times, we elected to do what many companies have done before us to do an accelerated share repurchase program and obviously we had the financial strength to able to do that. So, we are very pleased with that.

And then just on the point as far as acquisitions go, would healthcare assets that exist today make strategic sense for J&J?

Alex, I don't have my list handy, I don't know if you have.

No Danielle, what I’d say is, look we are looking for areas that, where we think first of all, there is a lot of unmet medical need, so it could be a new technology and new platform that just makes a big difference and that we think offers a real growth opportunity. The other areas are where there's an obvious complement to maybe something that we already have and we've got a number of examples of those. Some of the things where we have gone out in oncology, some of the recent things that we have done in other areas of our business represent those. And then sometimes it could be for vertical integration where we want to be able to become to more effective and more efficient about what we're doing. So, those are some of the strategic drivers that we look at, but obviously it's always done in the context of what the competitive environment is and other dynamics.

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

Two questions. First on bapineuzumab, it’s probably one of the most anticipated trial results of the year. I think most investors in the street expect the primary endpoint to be missed. But let's assume that some of the secondary endpoints or some of the sub-group analysis is favorable. What does the company do at that point? Do you submit or you go back and do another clinical trial? That's my first question and then I had a follow-up for Alex as well.

You know I don't think it's really appropriate for us at this point to speculate on it. Louise went through in pretty good detail. Our thoughts about bapineuzumab, in her comments and about where we are. So really until we get a look at the data it’s difficult for us to speculate on it going forward. Obviously Alzheimer's is an area that we remain very excited about when you just consider the sheer unmet need and the opportunity for patients as well as for our business that it represents.

And then just a second question on the hospital purchasing environment. In your prepared comments, you said utilization was stable, but it appears that Obama care is here to stay and this is going to add increased cost to hospitals. So, Alex, as you travel, what’s your sense as you talk to hospital executives, CEOs, CFOs, on the CapEx side? Is this something that’s going to flow here in the near-term or are we thinking about big ticket items that may get pushed off as the implementation of healthcare reform goes forward?

Now it’s a good follow-up, Glenn. Overall, look obviously we think that there are going to be opportunities as well as challenges associated with healthcare reform and how it ultimately gets rolled out. Certainly, if we look at some of the data, for example in the first quarter of this year what we have seen, hospital admissions up just about 2%. We saw some surgical procedures up around 4%. We saw lab procedures up at around 3%, ortho procedures up around 3%, offset with office visits actually down about 3%, the only caveat. That’s first quarter data. That’s the most recent data that we have. And, frankly, we believe that the hospitals are going to be looking for ways to become more efficient and more effective across the board. And that's what we hear from our customers and again that’s here in the United States as well as abroad. The offset of course in the United States is the increased volumes that the hospitals will be getting from the newly covered patients that will be coming into the system under healthcare reform. But clearly we would expect there to be additional challenges in the pricing environment and therefore all the more important, to my earlier statements as we look at our portfolio as we look at our capabilities, having a broad base, having offerings that go beyond the product, building on our relationships, building on our scale are going to be more and more important.

Your next question comes from the line of Matt Miksic with Piper Jaffray.

Thanks for taking my questions. A couple for Alex. And I appreciate the preamble and the reference to the credo on your long-term strategy. You mentioned emerging markets and so to the breadth of the products and technology that you can bring to those markets. I'm wondering, how do you expect to match some of the economic parameters of these emerging economies with some of the advanced top-tier products and brands you deliver. Really what some of your strengths are in developed markets? And maybe if you could put your recent China medical device acquisition, albeit small, into that strategic context? Then I have one follow-up.

Sure. Matt, thanks a lot for the question. What I have seen having just recently been over to Russia and made a number of visits over to China as well as to Brazil and to some of the other emerging markets is, most importantly that the customer in those markets is the government. And what we've found is that the government is very interested as they are building their healthcare systems in the developing markets of not just replicating what's been done in the developed markets, but looking for ways to expand access and, frankly, also to expand and accelerate their access to some of the new technologies in a cost effective way. So, what we're doing is, first of all making sure that we're trying to work closely with them, and again this is where I think our breadth and depth and our scale is very important as Johnson & Johnson in those and if you look at our share position in a lot of those emerging markets, it remains very strong and competitive. Second, it entails new offerings. And that's why we put R&D centers in many of these locations and we continue to invest in them. We're pleased with the rollout of products such as absorbable suture, linear cutters and staplers, that I would say are of very high quality yet more appropriate for those particular markets, both in terms of their actual construction as well as their pricing model. And some of our other things that we're working on right now, again, to take smart application of technology for those markets where we think there is a big opportunity. The other areas that we're focusing on frankly is training and education. And in many of those areas it's a case of trying to get more physicians trained on things like minimally-invasive surgery, on getting the right treatment paradigms for diabetes and cardiovascular procedures. So, we're working closely, again, in many cases directly with the governments in China and Russia on extensive training programs to help them train their physicians. So, that's why we think that there, again, it's a significant opportunity. Related to our most recent acquisition in China, we're very excited about it. As we stated on a number of occasions, we think our biosurgicals area is one of our most exciting in terms of new science and technologies, they are really going to make a difference for patients as well as represent a significant growth opportunity for our business. And in China we’ve been very limited in what we’ve been able to do so far and with this most recent acquisition it's going to give us a source of a porcine based biologic that we’ll be able to use there and roll out a significantly broader line of products to help patients and again grow our business. So we’re very excited about that.

And then the one follow-up is a subject that’s kind of emerged over the past several years, developed market question, specifically for the U.S., given the more challenging pricing and regulatory environment in the U.S. You speak about innovation. We know that that's important for J&J and for the industry, particularly in medical technology and medical devices though, maybe how should we think about what that means going forward? Are you placing longer duration bets on earlier stage technologies or do the shorter-term opportunities become tougher, more pricing, more commoditized, maybe help us understand what the path for innovations is for devices going forward in the U.S.?

Sure. What I would say, Matt, it’s going to take a combination and it really starts with innovation but different kinds of innovation. Now in some areas this is going to mean better technology that overall delivers better results for patients. So, some examples I would have of that is what we’re doing with Biosense Webster and the great progress that they've made with so many of their products and the treatment of AFib. And just what you see is a huge difference for patients and for systems. We’re also excited about a higher technology plan, something like the fibrin pad which we think can truly transform the way you treat moderate to severe bleeding intra-operatively and longer-term potentially for a trauma application. So, areas like that, we see technology still being very, very important. But we also think it's going to be important in how we relate with our customers. And what I'm talking about there is innovating with the way that we work with them, that we partner with them, that we truly leverage our overall portfolio in working together. And obviously, it may include new services, new approaches, new partnerships with them in unique ways as they try to not only manage their increased patient volume but also try to manage their costs going forward as well. And we also see an opportunity longer term to take some of these simplified approaches actually that we would develop in developing markets and basically bring them back to developed markets. We are already seeing some signs of that with things that we are doing in the diabetes space and potentially some others. So, we think even in developed markets people are going to be looking for very effective, but lower cost opportunities as well.

Our next question comes from the line of Bob Hopkins with Bank of America.

So, Alex, just a quick question to follow-up on some of the earlier ones on your perspective on utilization and I know your comments were as of Q1, but I'm just curious from, you look at the Q2 results and what you are hearing from the field. Is there anything different going on in the second quarter versus the first as far as you're concerned as it relates to surgical procedure volumes?

No, we haven't seen significant changes. I have got to say we're encouraged by what we are seeing in orthopedics. If we look at overall worldwide joints against Q1, but as we look at the results we saw Q1 results around 3%, hips up about 1.5%, knees up about 3%, spine down slightly, although I think a slight improvement on a quarter-to-quarter basis. So, again we don't have second quarter, I think we're the first large orthopedics company coming out so we're going to have to wait and see with everyone else. That's our current view on it.

Okay. And then a question on Synthes, in terms of some of the opportunities for you in the United States. I guess I'm curious as to how quickly you think you can benefit from the new scale that you have in orthopedics and how quickly we might see that translate into share gains, especially as it relates to some of the underperforming areas like spine which have been struggling below market for a couple of quarters. Just any thoughts on timing? Will this take a couple of years to really see the benefit or can we see tangible share gain process in the near-term you think as a result of your scale and ability to contract?

Thanks, Bob. And again, I would start by saying how pleased I am with the performance of the team so far through such a significant and large-scale integration. We're really excited by again what we've seen so far. As you know, when you do these kind of things, leadership is so important and critical to keeping consistency through this kind of a process. I think we've been able to do that and obviously [Michelle] and his entire team are looking at ways for how do we accelerate growth going forward. Obviously, likely the biggest short-term challenge is spine, because you're bringing two organizations together. We are really pleased with the overall way we're able to work our way through the antitrust issues. We think we've got very complementary portfolios. And we're working our way through the integration with direct sales as well as some of our distributors sales as we speak. And we're are going to do everything that we can to accelerate it, but we also realize that look, this is a multi-year process and our first focus is with the customer. We want to make sure that our customer doesn’t experience any disruption and in fact sees a net benefit to what we’re doing. So, we’re working hard both with our sales forces as well as with our contracting organizations. Our second major area is our R&D prioritization and making sure that we are prioritizing the portfolios, looking for areas where there may be synergies across the different organizations, particularly in places like ENT or maxillofacial, or even in the areas such as biosurgicals and some of the things that we’re doing here. So we think that there is a real -- biologics, there is a real opportunity. And then third, it’s the area of how can we integrate our backend so to also make it very seamless, very efficient, and very effective. And so, again, we see it as really being prioritized in that order as we roll out over the next couple of years.

And what kind of disruption are you assuming on the sort of dis-synergies of sales related to the integration within spine? Is that sort of in the $30 million to $50 million range, Dominic? I think you mentioned that was part of the equation on guidance.

Yeah, I won’t be able to give you an exact number in that regard. But we did consider that in providing the guidance for both this year and the estimates we gave you in advance for next year. So, we do think there’ll be some disruption as we convert and combine those two businesses together. But I won’t be able to give you specifics, Bob, on that.

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

I was just wondering, if you could comment a little bit further on just kind of the orthopedic trends that you saw in the quarter? It sounds like you guys are looking at the market as being improved from 1Q to 2Q. I just want to make sure I understand your comments were at just looking backwards at 1Q data. Then maybe just comment on the price and mix of orthopedics and whether the strength is coming from maybe improved price and mix as well as volumes?

Yes. Let me just take a couple of parts of your question. The first thing that I would say is as we look overall at orthopedic trends, again it's difficult because we are the first company out. But if we look at the trends from Q1 combined with our sales results from Q2, I would say that we are slightly encouraged by what we're seeing and we're obviously going to be watching it very closely. We are not seeing the growth that we saw several years ago in what I'd call pre-recession times. And I'm particularly pleased with the performance of the DePuy Reconstruction Group, now the DePuy Synthes Reconstruction Group, through this period. And I think that's been the result of not only just really good execution through this integration process, but also the rollout of new products in both our hip and knee areas. So, I think that was important. If we look at spine, we see some progress quarter-to-quarter. There is still significant pricing pressure on spine and other market dynamics, but again longer-term we see that as being an opportunity. But if I look specifically at our hip business what we saw overall was total price change of about down 4% mix up about 0.5%. So, a hip price mix change of about minus 3.4% for the quarter. And if we look at knees, if you look at product mix up around 2%, up about 1% on knee price and mix change and hip, so the overall for hip and knee we saw a mixed change of about minus 1%.

Okay. Perfect. And then anything you that you're seeing just across the broader medical device businesses in terms of pricing or do you have any concerns I guess going forward in light of the continued pressure in Europe that things may get more challenging on the price front?

Look we do expect there to be continued pricing pressure. As Dominic mentioned earlier, you see some of that and particularly in Southern Europe with some of our other tenderings in Europe. We're seeing that in some of the U.S. markets, particularly those might be things like diabetes based upon some of the contracting as well as spine. We're seeing more in other areas. It's been pretty consistent with what we've seen in earlier trends.

Okay. Perfect. And then one last on the OTC business. I know, Dominic, you had mentioned that you had updated sales and I guess on the earnings side just for some changes on OTC. Am I correct in just assuming that things relative to kind of last quarter are just taking a little bit longer and it sounds like you're pushing off some of the expenses related to the launch maybe further out and potentially into 2013?

Yeah. Well, just to clarify, so we did update our guidance, now that we -- on sales, that we have a full half-year already in and we have a pretty good idea what it's going to take to comply with the consent decree for the balance of the year. So we took that into consideration in the sales guidance that I gave you. And we still think that the products will still be rolling out in 2012 and through 2013 as we said before. Just to clarify that, we did not change our earnings guidance with respect to OTC at all. Right. We maintained our earnings guidance with respect to the base business despite some changes in sales and increased our earnings guidance as a result of the accretion related to Synthes. So, the impact of OTC is something we're just going to have to manage and we are managing in the business.

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

Alex, you've commented with respect to remediation and I realize it's a focus of that particular unit in consumer. But the question is, you made some statements about learning since the consent decree was actually signed. Could you comment on what one or two of those learnings have been? And then, I often note that there is a strain between the FDA and a company under a consent decree or there can be. Sometimes senior management needs to get directly involved and interface directly with the FDA. Have you found the need to do that at this point or do you think that people within the division are able to actually handle that process. And I have one follow-up, thanks?

Tony, thanks a lot for your question. Let me start with the second half of that first and then I’ll go back to the first part. First of all, we feel very good about our overall relationship with the FDA and it’s one that we take very seriously, that we work on building in an appropriate way with a lot of open dialog and we think it's critically important that the most senior levels of the organization that we demonstrate a commitment and are clearly aligned around our goals and our plans going forward. And so, it absolutely involves people, the most senior level of the organization, including myself. So that’s a real priority for us. And again, we see the FDA as a very important partner not only in this area of our business but really in all areas of our business where ultimately we are attempting to get products to patients or to patients in a timely and well considered manner. I think the other aspect when you talk about learnings as you’re going through it, a couple of thoughts, Tony. First of all, while we agreed to the consent decree about a year ago, the actual submission of the consent decree didn't go until like Q3 of last year. And so, you continue to work with the agency on all the specifics steps as we worked our way through the agreement process and getting aligned, that's one aspect. The second is we are working with an outside party [Quantic], that is working with us, verifying, validating different procedures. So, that's also a learning process as they come onboard ensuring that we're fulfilling all the commitments that we have made along the way. I'd say the third significant learning for us is getting the right balance between our consent decree requirements resources and commitments and then also producing product and getting into the marketplace. Our customers, working with them are clearly interested in getting a consistent and reliable supply. We are very encouraged that when we have got product back on the shelves that we've seen a very solid demand on the part of customers. But that's something as well that we're working, again, very deliberately on and that we will make sure we want to get right having that balance going forward.

Thank you very much for that color. Then a smaller, more modest question. While consumer operationally was up sequentially, modestly, wound care struck me as being down. And while Q1 was actually up year-over-year due to new products, I'm curious what may have occurred in Q2 to drive wound care in a different direction?

Yes. Tony, we have seen some competitive pressure and I know that in one case we decided not to go ahead with the contract on some of our first aid kits, but overall we think we remain fairly competitive.

This will be our last question and then we'll have some closing remarks from Alex.

Your last question comes from the line of David Lewis with Morgan Stanley.

Alex, I wanted to come back to your short-term priorities and your long-term priorities. McNeil obviously was your significant first short-term priority and Global was your second long-term priority. And I guess in most of the comments today there is a great focus on McNeil, but if I sort of go with the intersection of those two comments, it seems like if you take your broader kind of holistic consumer business, emerging markets for consumer seems that it should be a much greater priority for the total business and a much bigger potential gross impactor than McNeil. Can you just sort talk about how you see your emerging market consumer franchise versus your peers and steps you can take to perhaps accelerate growth there?

Sure. Thanks a lot for the question Davis. You're absolutely right. The emerging market growth in our consumer business is a top priority for us. And we've been focused there for a number of years. If you look at, for example, the acquisition that we did with Dabao several years ago, we see a tremendous opportunity. We're seeing very strong performance as of late, particularly in Brazil. China we’ve dealt with a few other issues, but we're very confident in our long-term positioning there and we've also made some changes in our approach in Russia as well. So we do see that as a major growth opportunity. That being said, or over-the-counter business particularly domestically as well as internationally is significant and so we know that that's a major priority for us.

Okay. And just, Dominic, one quick clarification. I know you're very specific on the change in underlying operational guidance on the revenue side and the factors. If I think about the absolute change that implies to the back half of the year, it seems large relative to the size of the divisions like OTC and energy you mentioned. Is there anything else that's a big driver of that relative change other than OTC or energy?

Now I think that it's primarily OTC for the change in guidance and to a lesser extent the impact of energy, and as we mentioned earlier the supply constraints in the endovascular business. But I'd say of that total, it's primarily the OTC change when I compare the current guidance to the previous guidance.

So hey everybody, thank you very much. I hope after the discussions that we’ve had this morning that you have a better understanding of our strategies, priorities and plans to really help more patients and to drive our growth going forward. Please keep in mind that the contributions we make to our shareholders always start from the innovative, ever-increasing contributions our employees make every day to patients and consumers all around the world. I really believe that healthcare is one of the most important and rewarding industries around the globe and we look forward to Johnson & Johnson to helping lead it, shape it for many years to come. Thank you all for joining us today.

Thank you. This concludes today’s Johnson & Johnson second quarter 2012 earnings conference call. You may now disconnect.