Good morning. Welcome to Johnson & Johnson's Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference call over to Johnson & Johnson. You may begin.

Hello. This is Chris DelOrefice, Vice President of Investor Relations for Johnson & Johnson. Welcome to our company's review of business results for the fourth quarter and full year of 2018. Joining me on today's call are Alex Gorsky, Chairman of the Board of Directors and Chief Executive Officer; and Joe Wolk, Executive Vice President, Chief Financial Officer. Thank you for your interest in Johnson & Johnson. We are very pleased with our 2018 fourth quarter and full year results. Once again, our performance illustrates a track record of consistent growth, exceeding financial expectations and making progress on our long-term strategies. Sales for the business accelerated versus 2017 on both an operational and adjusted basis. Consistent with the guidance we provided at the beginning of the year, this acceleration was driven by the continued strength of our Pharmaceutical segment, delivering on our objective of restoring consumer growth to above-market levels and improving performance in Medical Devices. 2018 also marked another year of disciplined portfolio management, including the completion of key divestitures while also advancing our portfolio with strategic acquisitions and collaborative agreements that we believe will fortify long-term performance. As we enter 2019, we are confident in the strength of our business. We believe our Pharmaceutical business will deliver growth while absorbing significant impacts from biosimilar and generic competition. We expect Consumer to maintain above-market growth, and we anticipate our Medical Devices segment will continue to improve. We plan to deliver innovation that will have an enduring impact on patients, caregivers and consumers while also delivering solid financial performance. A few logistics before we get into the details. This review is being made available via webcast, accessible through the Investor Relations section of the Johnson & Johnson website at investor.jnj.com, where you can also find additional materials, including today's presentation…

Thank you, Chris, and thanks to all of you for joining us today. We're pleased to be highlighting the strong results we delivered in 2018. Given the focused execution of our performance-driven strategy, I'm proud to share that we exceeded the financial performance metrics we set at the beginning of last year. And we also delivered on the commitments and responsibilities to our patients, employees and communities as defined in our credo. Now as you've heard me mention throughout 2018, we have been celebrating the 75th anniversary of our credo. Introduced in 1943 by General Robert Wood Johnson, our credo has been the blueprint for shaping the caring role that Johnson & Johnson plays in society. Although our credo is etched in stone, it is a living document that on a few select occasions, we have evolved to keep pace with the world in which we live. To that end, in anticipation of the 75th anniversary, we introduced some enhancements to our credo responsibilities that were inspired by feedback from more than 2,000 of our diverse Johnson & Johnson employees, representing all regions, sectors and functions. These enhancements explicitly put the patient first and at the center of our focus, reflect the needs of a changing world in a new generation of employees, underscore our commitment to diversity and inclusion and solidify our commitment to improving the health of humanity. Our credo remains as relevant today as when it was first introduced 75 years ago, and I'm excited and confident that, together, we will propel Johnson & Johnson forward to shape the next 75 years and beyond of health care. With that long-term mindset, we remain focused on leveraging our broad-based capabilities to continue to drive the next generation of growth across our entire portfolio, both in markets where we…

Thank you, Alex. Good morning, everyone. As Alex and Chris mentioned, we are pleased with our performance in 2018, which exhibited the strength of our portfolio and disciplined management of our business. In fact, our adjusted operational sales growth of 5.5% was the highest since 2014, and our adjusted EPS growth was the highest in over 10 years. We ended the year exceeding the consensus estimates from the latest analyst models for both revenue and earnings per share. Our results were also at the higher end or exceeded the ranges that we provided in October for the full year guidance. Since Chris already provided a detailed overview of sales for the quarter and Alex has provided an overall business update, I'll provide commentary on the P&L, cash and guidance for 2019. I will start by sharing highlights regarding the full year 2018 statement of earnings. Please direct your attention to the boxed section at the bottom of the schedule. You will see we have provided our earnings adjusted to exclude intangible amortization expense and special items. Our adjusted operational EPS growth in our latest guidance for 2018 was in the range of 9.3% to 10%. As reported this morning, our adjusted EPS of $8.18 reflects reported growth of 12.1% and operational growth of 10.4%, again, at the upper end of our estimate range for reported EPS and exceeding our operational guidance from October, driven by our strong sales results and margin improvement. Regarding adjusted pretax operating margins, our latest guidance come into at least 150 basis point improvement versus 2017. For the full year, we exceeded those projections, achieving a 210 basis point improvement while we continue to invest in our business. This improvement is attributable to sales growth and leveraging our scale for productivity, coupled with improved cost of…

Thank you, Joe. Before we move to the Q&A portion of the webcast, please remember to mark your calendars for our Pharmaceutical Business Review, which is scheduled for Wednesday, May 15. We will now move on to the Q&A portion of the webcast. Rob, can you please provide instructions for those on the line wishing to ask a question?

[Operator Instructions]. Your first question comes from Chris Schott with JPMorgan.

I guess, my first one was just on -- a little bit more on your assumption for net U.S. price -- pharma pricing in 2019. I think you mentioned a 6% to 8% erosion in 2018. Just talk a little bit about how we should think about dynamics as we think about this year. And then my second question was specifically on XARELTO and just a little bit more about the 4Q performance. It's a little bit more what's happening with net price for the product. And as we think about 2019 for that product, how are we thinking about kind of balancing, I guess, competitive dynamics in the core indications, the step-up in the donut hole against the recent label expansion? I'm just trying to get hands around some of the pushes and pulls on that product specifically.

Great. Chris, thanks for the question. With respect to net U.S. pharma pricing, what Alex referred to was obviously the experience we had in 2018, which was greater than 6%. As we see it right now, we'll provide some more details in our Transparency Report, which should be out in about 4 to 6 weeks. In terms of going forward, we do expect it to be elevated levels. What I would say is, it's a great testament to the -- just the strength of the innovative portfolio that we have in the Pharmaceutical segment. We grew about 8% for the year, and that is in the face of net price decreases of greater than 6%. We don't predict, obviously, for competitive reasons what they may look like going forward, but we do plan for continued price decreases on a net basis into the future. With respect to XARELTO, yes, I think what you saw in the quarter was some of those pricing dynamics. There was some catch-up with respect to donut hole provisions. To a modest level, some inventory adjustments in terms of the pipeline out there. We are growing our volume. We are gaining prescription share. So we feel good about the brand. And as we move into 2019, we would expect the CAD/PAD indications to be a differentiating factor moving forward to expand not only market share for the brand, but also the market itself as it's going to reach a broader base of patients.

Your next question comes from Danielle Antalffy with Leerink Partners.

I'm just hoping you could give a little bit more color on the Medical Device business and what you're seeing from a utilization perspective more broadly. Did you see a seasonal uptick in Q4? And generally, in 2018? And what you're expecting for 2019 for that business, considering all the moving parts as it relates to the economy? Is it slowing? Is it -- where are we today with that? And also emerging, if you could comment on emerging markets.

Sure, Danielle. Alex here. Thank you for your question. First of all, look, we were overall pleased with the continued improved performance that we saw, particularly across our Hospital Medical Devices group. If you look at the Q4 performance for them, it was about 3.6%, which was one of their strongest quarters. And what we saw was really strong growth being driven by Interventional Solutions at over 14%. Our launch with CERENOVUS is almost a 20% growth. We saw really good performance in biosurgicals, up 9%; energy, up about 5%; and wound closure was up over 7%. We did see as well some modest improvement across the Orthopaedics group, particularly in trauma. That was up almost 2.5%, hips around 2% and, as mentioned earlier, also in our spine business. So regarding volumes themselves, we see -- of course, we don't have line of sight yet to all the Q4 data, but it would be our expectation that we would see continued slight improved trends coming out of Q3 overall. And we continue to see very strong performance in emerging markets and in BRIC. For the year, we had about 10% growth across all of our BRIC markets. And by the way, that was consistent across each one of our sectors. China and particularly -- remained particularly strong. In our Medical Device group, we were very pleased both in Hospital Medical Devices but also in our Vision Care business as well.

Thanks, Alex. And Danielle, just to build on the procedures. In 3Q, we did see procedure increases, admission surgical procedures increasing about 1.5%. Lab procedures were about 1%, and we see that being relatively consistent. We don't see any major seasonal dynamics in any one particular area. So thank you for your question.

Your next question is from Larry Biegelsen with Wells Fargo.

Joe, one on the guidance and one product-related question. So Joe, the 2019 adjusted operational growth of 2% to 3% was a little below what we expected based on your public comments in Q4. So I want to understand the component. It sounds like you expect Consumer to accelerate or at least stay consistent with 2018 in 2019, and you expect Med Tech to accelerate versus 2018. So the implication is that Pharma is going to be about 2% at the midpoint in 2019, which is slightly below the market growth of, I think, 3% to 4% you said you could achieve in 2019 during your public comments in Q4. So is my math directionally accurate? And did something change since Q4? And then I'll just throw the product question in here. There were some changes to the leadership at Verb. Can you talk about the progress you're making with the surgical robot and Orthotaxy and remind us when you expect to launch? Is it -- I believe you said 2020 for both in the past.

Sure, Larry, and thanks for the question. So no, I don't think anything has fundamentally changed. Although we don't provide guidance by segment, qualitatively, I can say you're directionally correct. We do expect that the -- we have turned the corner in our Consumer business. If you look at the first half growth of about 1.5%, the second half growth of about 5%, we feel really good about the innovative products we have in premium Skin Care. The relaunch of our Baby franchise, as Chris noted in his prepared remarks, is off to a great start. In Medical Devices, we are expecting to see what we've seen throughout 2018, and that's improved quarterly upticks with respect to growth, getting us on that path to what we articulated at Analyst Day in May of being at or above the market in 2020. With Pharmaceuticals, again, I just really think it speaks to the tremendous strength and health of this business. If you think about a $3 billion to $3.5 billion headwind with respect to generic and biosimilar competition and we're still talking about growth, most companies would be talking about contraction, and the dialogue would be when you're going to get back to growth. It really speaks to the health of the business. And whether it's 2% or 3%, Larry, I think once this anniversary, we feel very confident about 2019. But it really portends very strongly for the future outlook of our company longer term. If you take those out, the base portfolio of Pharmaceuticals is still growing up to 2 to 3x the market, which it has done historically. And I can also say, it is a testament to the strength of the broad-based nature of Johnson & Johnson. This is not a statement we could have made a decade ago. So I feel good that we're talking about growth despite a $3 billion to $3.5 billion headwind. I'll turn it over to Alex to talk a little bit about our surgical platform.

Hey, Larry. Thanks for the question. Before I talk about Verb though, I'd just like to complement some of the comments that Joe made because we remain extremely excited about our business prospects as we head into 2019. And to put a bit of an exclamation point on Joe's comments, if you look at the underlying strength of our Pharma business, growing in excess of like almost 6%, 7% if we pull ZYTIGA out of it, the number of additional indications that we're going to have across our oncology and immunology platforms, the new product launches with both esketamine as well as erdafitinib that we're expecting this year, again, we think that sets us up not only for very strong performance in the face of significant headwinds in 2019, but also even more accelerated growth in 2020 and beyond. So we remain very confident and optimistic in those opportunities. And I think consistent with what you've seen happen with us in past years, you'll see that play out as we go through the year. And we'll continue to provide updates as we deliver. Regarding Verb, look, we were just out there, and I had an opportunity to visit but -- myself, Ashley as well as Paul Stoffels, other members of the leadership team. And I think based upon our latest update, we feel frankly even more confident in the progress that we're seeing in this platform. That includes, yes, the robotics, what I'd call the front end, but also the great work that's taking place on the back end, on the system part of it that really represents the transition in robotics into digital surgery. And the progress that, that team has made, I think, over the last 12 months has been very strong. We believe we continue to be…

Your next question comes from David Lewis with Morgan Stanley.

Just one for Joe and then a follow-up for Alex. Joe, I just want to focus on margins for 2019. By our math, it looks like at the midpoint around 50, 60 basis points of margin expansion. Obviously, you're down from the significant expansion from 2018. But obviously, you have these Pharmaceutical headwinds that you've talked about. Can you help us sort of parse out the margin impact either from currency or from the Pharmaceutical headwinds in 2019? Or any color you could give us on sort of the underlying margin performance in '19 as it compares to 2018?

Yes. So David, I think that's an astute observation on your part that it isn't the margin expansion that we had in 2018. But again, given that our Pharmaceutical segment enjoys the best margins across all of our businesses and that growth is going to be moderated somewhat in 2019, I think it's a reasonable expectation. We want to continue like we always have to invest for the long term. So 2019 and delivering on these results are very important, but we also want to make sure we're well positioned for 2 to 5 years out as well. And so we're going to take that opportunity to do that. In terms of segment performance, you already have a Pharmaceutical sector that's best in class in terms of their overall margins. Medical Device is still at the top of the peer set as well. We want to continue to invest there to make sure we do accelerate and deliver on those plans to grow at or above market in 2020. And then in Consumer, I would say that's probably our biggest opportunity for margin improvement. We lag the peer set by a little bit there from the midpoint perspective. So we are looking at additional measures. In addition to just being an $80 billion company with the infrastructure, we'll look at some of the complementary services, such as finance, human resources, information technology, to make sure we're being not just effective there, but efficient as well.

Okay. Very helpful. Now just 2 strategic questions for you. The first is your business on talc has been very clear. I just wonder if you'd help us understand this, do you expect any impact derivative to talc on the consumer franchise? And will it impact your strategic activity from an M&A perspective? And then somewhat related to that, I noticed that the Medical Device business moved down on your priority list last year versus this year, just help us understand the underlying driver of that.

Okay, David. Thanks a lot. Just one comment before I answer those questions. I want to pick up on Joe's former comment. I think what's really important about the way that we're managing the business, particularly in 2019, is to both ensure that we're continuing to invest in areas, frankly, that we think are important to our growth going forward while simultaneously managing our P&L in our business, we believe, in a very appropriate way. And so when it comes to additional deal opportunities, for example, the argenx deal with our Pharmaceutical group, we think that's a great investment. I think if you look at the track record of that group and the way that they've been able to perform, especially on those deals where we identify compounds like the CD 70 very early and then create multibillion-dollar platforms, reaching many, many patients with significant unmet need, we think that's a good investment for the future and the same thing in our Medical Device group. Our Medical Device group has, as Joe mentioned, been at the top of their peer group. But when it comes to investments in things like digital, in certain cases, David, as you well know, frankly, we need to improve our performance in other areas. So we have invested additional funds in areas as it relates to just straight-out execution in the field, both in the United States as well as abroad, in places like China. So we will continue to do that to make sure that we deliver in '19. But as important, maybe even more, that we deliver in '20, '21, '22 and beyond. Now as it relates to the other issue regarding the impact on talc, what I would say is it does not have an impact on our long-run strategic look at…

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Actually, I have two of them. One of the things you repeatedly have talked about is improving your Orthopaedic franchise. You just rambled off spine, sports, shoulders and other pockets of the business. We have AAOS coming up. Could you please give us an idea of how you're approaching improving some of those? And how we would expect or what we should expect at AAOS?

Sure, Joanne. Thank you very much for the question. Look, there's a number of reasons why we believe we're going to see improving performance across this platform. Number one, it starts with our knee platform and the continued launch of ATTUNE Revision as well as cementless. We have several additional platforms that we're rolling out that we think will reinforce the profile not only here in North America, but as Chris mentioned earlier, we're seeing very good uptake with ATTUNE on a worldwide basis. And we also have some additional instrument sets that are being launched. And as you know, the cementless section of that market is growing faster. And so we remain confident that those launches are going to help reinforce that platform. In spine, we continue to focus on areas such as severe deformity, degeneration as well as the others. We have a number of new launches that we have coming out including the interbody cage. Biomaterials is an area that's of interest to us as well. In hips, we've continued to see strong performance. We have a few additional launches that we'll be announcing, and you'll be seeing more, particularly as it relates to the Anterior Approach. And as I mentioned, look, we still have some work to do in sports, shoulders and those areas. But we're also confident that, overall, with the 20 to 25 launchers that we'll have taking place in the course of 2018, many of those in the space were, frankly, that were done in the back end of 2018 as we head into '19 will enable us to continue that momentum.

Joanne, if I might add, too, that if you look a little bit longer term out, we also are looking forward to the addition of robotic digital capabilities there with our Orthotaxy platform in Orthopaedics.

And then I wanted to spend a moment on the health program with the Apple Watches. I mean, can you think about or talk about how you plan on rolling them out, not just across AF but across other applications. Ultimately, I'm trying to get my head around, are people who wear the watch are going to walk in and say, "Hey, I have x, y and z"? Are physicians going to be handing this out? How do you see this moving into a commercialization stage and over what time frame?

Hey, Joanne. Thank you very much. Look, we're very excited about the partnership that we have with Apple in this area. And we think it does represent what we've been talking about for a while is that next step in introducing digital adaptation almost consumer level and how does that augment what we currently have across our Pharmaceutical, Medical Device as well as our Consumer area. I think it's safe to say that it's still early days, but here's an opportunity to better detect patients who either have the potential for AFib or are experiencing AFib and then, of course, longer term, how they respond to various treatments as well as other support programs that are helping to ensure compliance as well as broader wellness programs as well. So we think this, again, is going to be a great first step for us. We really appreciate the commitment and the time, the resources and the prioritization that Apple has placed on this and the way our teams have worked together. But look, we think that this is likely the first of many steps that you'll see not only in our Pharma space, but again, our Device as well as Consumer space in the years to come.

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

Joe, I was wondering if you can give us a little bit more color on the sales and EPS cadence for 2019. So for example, you're talking about reported sales for the full year in the range of down 1.5 to down 0.5. Should we be thinking in the first half down 2 or 3 and then positive growth as we enter the fourth quarter? And then EPS at the midpoint of your range is plus 5%. Should we be thinking flattish growth, EPS growth in the first half and then high single in the fourth quarter? And then just lastly, tying into all of this, a lot of our companies are telling us that the FX hit in the first quarter will be around 5% and maybe even 2% or 3% in the second quarter. Is that consistent with how you're viewing the FX impact in the first half of the year?

Yes. So Glenn, thanks for the question. We don't provide quarterly guidance. But what I would say is from an FX perspective, if you think about it, in the first 2 quarters of last year, I would think the average -- let's use the euro spot rate, it was about $1.20 to $1.22. Today, we're standing at something a little bit less than $1.14. So you would expect to see a more pronounced effect in terms of the reported results in the first half of the year. In terms of EPS, I wouldn't think it would be as stark as flat to high single digits, flat in the first half, high single digits in the second half, as you mentioned. I think it'd be a little bit more calibrated, again, a little bit softer in the first half but then a little bit strong in the second half as that spot rate, assuming today's rate holds, is pretty consistent.

The next question is from the line of Vamil Divan with Crédit Suisse.

So one, if you can maybe just provide a little more detail on that other income and expense line. I believe you mentioned is they provide $2 billion to $3 billion of income for the year. That's a little bit more than what we were estimating. So just a little more color on what you're already incorporating in there at the start of the year. And then again, maybe a little bit of sense of the quarterly breakdown would be very helpful given it's a fairly large number. And then on the Pharma side, just one question. You mentioned esketamine or erdafitinib that are both in front of the FDA. I know they both had breakthrough designation. I'm just wondering if you've seen any impact given the government shutdown on your interactions with the FDA over the past month. Or is there any sense that these reviews may take a little bit longer than you're previously estimating?

Great. Thanks, Vamil. Thanks for the question. So with respect to other income, it's $2 billion, $2.3 billion is what we've guided at this point in time. That is the accounting which we capture royalty income, gains from equity investments we hold through Johnson & Johnson Development Corp. as well as any gains we might have related to divestitures. I would expect that, that would be more of a first half dynamic with respect to some of the divestitures that we have planned. The most notable one would be our sterilization products business, which should happen late first quarter, early second quarter. Again, that's just one component of the overall number. I will remind folks, too, that we have seen these levels in 2015 and 2017. And in the subsequent years, we're very cognizant of managing that. So we take the opportunity when we have other income that's at elevated levels to invest again in the long term, making sure that we're well positioned across all of our segments to influence health care in a positive way, which should result in a better return for shareholders. With respect to the government shutdown, I would say, yes, esketamine and erdafitinib have breakthrough designation, certainly, with esketamine being a little bit more near term. The PDUFA date has not changed as of yet, so it's March 4. What we did receive information on recently was a delay of an ad board meeting. So we don't think that, that will impact the PDUFA date, but we are monitoring the situation closely. Obviously, the FDA, through their designation of breakthrough status for the drug, realizes the importance that this has for patients who suffer from treatment-resistant depression, who really haven't had a new mechanism of action in better than a couple of decades now. So we hope that, that level of energy on both sides will carry through. We certainly hope both sides come together to reopen the government and end the partial shutdown, but we're monitoring it very closely.

The next question is from Geoff Meacham with Barclays.

I just had a few quick ones. Joe, on the Pharma segment, J&J has previously used a number of novel contracting approaches, and this includes REMICADE and ZYTIGA. Are there opportunities for the broader portfolio in 2019? And specifically, how are you thinking about the payer approach this year to ERLEADA with generic ZYTIGA now in the market? And I have one follow-up for Alex.

Yes. Thanks for the question, Geoff. I would say we're looking for contracts that make sense. As you know, we've got a very -- I would say best-in-class strategic customer group within our Pharmaceutical unit. We want to make sure that payers understand the value that our medications bring based on outcomes. So we'll continue to change our contracting with the landscape and want to influence how a payment occurs. Again, we do have some outcomes-based pilots out there that -- or across a number of therapeutic areas. We think that's a way that could potentially be a long-term solution. We certainly understand the conversation around pharmaceutical pricing. But again, I'll reiterate what I said earlier with respect to just our strong Pharmaceutical performance. We've got products that make a difference in patients' lives. It is better for the health care system overall, less costly to utilize those therapeutics. And our 8% growth this year was delivered even though we were able to decrease net price 6%.

Okay. Just as a follow-up to that, Joe or Alex, you guys have been very transparent on drug pricing. How viable do you think the Part D OUS reference pricing proposal really is? And do you feel like your assumptions on pricing across the portfolio per se later-stage products is conservative enough?

Geoff, thanks for the question. Look, we're obviously engaged with the administration and a lot of different groups right now in the issue of pharmaceutical pricing. We understand that it's important and it's critical for all of us to do things in a responsible way in this area. We do think that there are some changes around Part D and especially Part D as it relates to out-of-pocket costs that can and should be addressed to alleviate some of the current pressure in the system. Regarding the reference pricing, we do have some concerns with reference pricing overall. At the same time, what I would say is, we regularly track the pricing of our products on a global level, and we can tell you when you take a look at net pricing overall, we think that we're actually quite competitive. But again, we are concerned about unintended consequences around access and innovation as it relates to some of the proposals, but I think it's still early days. And look, we'll continue to work with the government and others to ultimately get the right outcome that ensures that we're going to continue to get a number of great breakthrough therapies at responsible prices and in a transparent and open way.

Thank you, Geoff, and thanks, everyone, for the questions asked and for your continued interest in our company. Apologies for those that we couldn't get due to time, but don't hesitate to reach out to the IR team as needed. I'll now turn the call back to Alex for some closing remarks.

I just want to thank all of you again for your continued support and confidence in Johnson & Johnson. We're pleased with the performance that we were able to generate over the course of 2018, and we believe that we delivered on all of our priority commitments. But we're even more excited about 2019 for all the reasons that we just outlined and enumerated. So on behalf of the entire leadership team, thank you very much. And I look forward to engaging with all of you in the coming weeks and months.

Thank you. This concludes today's Johnson & Johnson's Fourth Quarter 2018 Earnings Conference Call. You may now disconnect.