JOHNSON & JOHNSON quarterly report, Q2 FY2018

Johnson & Johnson — Q2 2018 Form 10-Q

Reporting period: Fiscal second quarter and six months ended July 1, 2018. Unaudited results; amounts below are U.S. dollars.

Business context and results

Johnson & Johnson operates through Consumer, Pharmaceutical and Medical Devices segments. Second-quarter worldwide sales rose 10.6% to $20.83 billion, reflecting 8.7% operational growth and a 1.9% favorable currency effect. For the first six months, sales increased 11.6% to $40.84 billion, including 8.6% operational growth and 3.0% favorable currency impact. Acquisitions and divestitures contributed positively to operational growth in both periods.

Despite sales growth, pretax margin declined: 23.9% versus 25.2% in Q2 and 25.6% versus 28.2% for the six-month period. Cost of products sold rose to 33.3% of sales in Q2 from 31.0%, and to 33.2% from 30.8% year to date, primarily due to higher amortization, particularly from Actelion. R&D spending increased as a share of sales; selling, marketing and administrative costs declined as a share.

Segment performance and material changes

• Pharmaceutical: Q2 sales grew 19.9% to $10.35bn; six-month sales rose 19.7% to $20.20bn. Oncology growth was strong, led by DARZALEX, IMBRUVICA and ZYTIGA; STELARA also grew rapidly. REMICADE sales fell 13.7% in Q2 amid biosimilar competition and increased discounts. INVOKANA/INVOKAMET declined 27.1% in Q2.
• Medical Devices: Q2 sales increased 3.7% to $6.97bn; six-month sales rose 5.5% to $13.74bn. Vision and Interventional Solutions grew, while Diabetes Care and Orthopaedics weakened. Segment pretax margin fell to 11.4% in Q2 from 14.7%, partly due to higher litigation expense.
• Consumer: Q2 sales rose 0.7% to $3.50bn; six-month sales rose 2.9% to $6.90bn. Baby Care and Wound Care/Other declined; Beauty and OTC grew. Consumer pretax results benefited from a $0.3bn NIZORAL divestiture gain.

Cash, debt and liquidity

At July 1, cash and cash equivalents were $17.57bn and current marketable securities were $0.57bn. Cash declined $0.26bn from year-end 2017. Six-month operating cash flow of $9.69bn funded $1.53bn of capital expenditures, $4.67bn of dividends, $1.59bn of share repurchases and other uses. Investing activities used $1.13bn net, including $0.87bn of asset-sale proceeds; financing activities used $8.64bn, including $2.43bn net repayment of short-term debt.

Current liabilities were $27.49bn and current assets $45.44bn. Current and long-term debt totaled approximately $32.08bn, versus $34.58bn a year earlier; long-term debt was $29.41bn. Management stated that operating cash flow, borrowing capacity, commercial paper markets and external funding should provide sufficient resources for operating needs. A $10bn 364-day credit facility was due to expire September 13, 2018. The July 2018 quarterly dividend was declared at $0.90 per share.

Outlook, risks and unusual items

• The filing provides no numerical full-year sales or EPS guidance.
• Medical Devices restructuring, announced in 2016, is expected to generate $0.8bn–$1.0bn in annual pretax savings, mostly by the end of 2018; estimated total charges are about $2.4bn. Separately announced global supply-chain actions are expected to yield $0.6bn–$0.8bn in annual pretax savings substantially by 2022, with $1.9bn–$2.3bn of charges over four to five years. About 70% of those estimated costs are expected to be cash outlays.
• The Company suspended ongoing Phase 2B trials of AL-8176 pending analysis of new information. Its $1.7bn in-process R&D carrying value will be reassessed; delay or abandonment could result in impairment.
• The $13.0bn provisional Tax Cuts and Jobs Act charge recorded in 2017 remained subject to further adjustments. The Company reported approximately $3.2bn of unrecognized tax-benefit liabilities; the IRS audit of 2010–2012 tax years was expected to conclude in 2019.
• Product liability, government investigations and patent disputes remain significant uncertainties. The filing reports about 10,600 pending U.S. talc-related plaintiffs and a recent $4.7bn jury verdict, which the Company intends to appeal; it had accrued defense costs only for talc litigation. The Company said it could not estimate potential losses beyond amounts accrued for a number of matters. Opioid-related litigation and investigations were also ongoing.
• Generic and biosimilar competition threatens products including REMICADE and potentially ZYTIGA; an unfavorable ZYTIGA patent outcome could permit generic entry and materially reduce sales. Other identified risks include pricing pressure, foreign-exchange movements, supply-chain disruption and evolving regulation.
• LifeScan was classified as held for sale following a binding offer of approximately $2.1bn, with closing expected by year-end 2018. A binding offer to sell Advanced Sterilization Products for approximately $2.7bn was expected to close in early 2019. After the quarter, the Company announced an agreement to acquire Zarbee’s.

Key facts for investors to verify

• How much of reported sales growth reflects ongoing operations versus currency, acquisitions and divestitures, especially Actelion.
• Whether higher Actelion-related amortization and litigation costs continue to pressure margins and segment profitability.
• Progress and cash costs of the Medical Devices and global supply-chain restructuring plans against stated savings targets.
• Developments in talc, opioid and other litigation, including appeals, accrual adequacy and potential cash exposure; possible losses beyond recorded accruals are not clearly quantified in the filing.
• Outcomes of the AL-8176 review, tax-law measurement-period adjustments and the IRS audit, plus the expected proceeds and timing of announced divestitures.