Johnson & Johnson — Q2 2010 Form 10-Q
Reporting period: Fiscal quarter and six months ended July 4, 2010. Unaudited consolidated results; dollar amounts in millions unless noted.
Business context and performance
Johnson & Johnson operates through Consumer, Pharmaceutical, and Medical Devices & Diagnostics segments. Second-quarter worldwide sales were nearly flat, while six-month sales increased modestly, with international growth offsetting U.S. declines.
Key financial metrics
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Sales | $15,330 (+0.6%) | $15,239 | $30,961 (+2.3%) | $30,265 |
| Gross margin | 69.8% | 70.8% | 70.4% | 71.3% |
| Net earnings | $3,449 (+7.5%) | $3,208 | $7,975 (+18.8%) | $6,715 |
| Diluted EPS | $1.23 | $1.15 | $2.85 | $2.41 |
| Operating cash flow | Not separately provided | Not separately provided | $7,527 | $6,190 |
Q2 operating earnings before taxes were $4,220, down 1.0%; net earnings rose partly because the tax provision fell to $771 from $1,055, following a favorable tax ruling related to a litigation settlement. Six-month pretax earnings included $1,576 of net other income, primarily reflecting a $1.5 billion net litigation gain. Thus, earnings growth was materially affected by unusual litigation and tax items.
Cash and cash equivalents were $12,713 at July 4, down from $15,810 at January 3; marketable securities were $6,188, up from $3,615. Combined cash, cash equivalents, and marketable securities totaled $18.9 billion. Current liabilities were $17,164; total debt was $11,652 ($3,715 current and $7,937 long-term), down from $14,541 at fiscal year-end. Shareholders’ equity was $52,851. The company paid $2,839 in dividends during the first six months; quarterly dividend per share was $0.54, up from $0.49.
Operating cash flow of $7,527 funded investing outflows of $4,575 and financing outflows of $5,887; cash declined by $3,097 after exchange-rate effects. Investing included $2.9 billion net purchases of marketable securities, $871 of net acquisition spending, and $897 of capital expenditures.
Material changes versus comparable periods
- Q2 sales growth was 0.6%, including 0.1% operational growth and a 0.5% favorable currency effect. U.S. sales declined 2.8%; international sales increased 4.1%.
- For the six months, sales grew 2.3%, but operations were flat; currency contributed 2.3%. U.S. sales fell 3.9%, while international sales rose 9.0%.
- Q2 segment sales: Consumer fell 5.4%, Pharmaceutical rose 1.0%, and Medical Devices & Diagnostics rose 4.1%. Six-month segment sales changed by -2.0%, -0.8%, and +8.2%, respectively.
- Gross margin declined in both comparisons, with higher product costs linked to product recalls, TOPAMAX generic competition, product mix, and pricing. Selling, marketing and administrative expense as a share of sales improved, reflecting cost-containment initiatives.
- Six-month Medical Devices & Diagnostics operating profit included a $1.5 billion net litigation gain; the segment’s six-month operating profit increase is not indicative of underlying growth alone.
Outlook, commentary, risks and unusual items
- No full-year sales or earnings guidance is stated in the supplied filing text. Management estimated that the McNeil facility shutdown and related product availability issues would reduce 2010 annual sales by approximately $600 million. Alternative supply for some products was expected before year-end 2010, with broader supply restoration projected through 2011.
- The April 2010 consumer product recalls and Fort Washington manufacturing suspension led to remediation costs, regulatory scrutiny, congressional inquiries, and litigation. McNeil submitted a remediation plan to the FDA on July 15, 2010.
- Health-care reform was estimated to increase 2010 sales rebates by $400–$500 million, including $150 million in the first six months and $90 million in Q2. The filing also describes future branded-drug fees and Medicare Part D discounts beginning in 2011, and a medical-device excise tax beginning in 2013.
- Management said operating cash flows, existing credit facilities, and commercial-paper access should provide sufficient resources for operating needs. It expected to continue regular quarterly dividends.
- Material exposures include product-liability claims; patent and generic-drug challenges; government investigations and alleged marketing, rebate, pricing, and compliance issues; and other commercial disputes. The company said ultimate outcomes cannot be estimated with certainty and are not expected, net of accruals, to materially harm financial condition, though resolution could materially affect results or cash flows in an individual period.
- Notable matters include the $1.7 billion Boston Scientific stent settlement recorded in Q1; the remaining $725 million plus interest was received August 2, 2010. The $1.9 billion HUMIRA-related judgment in favor of Centocor was under appeal and not recorded. The TOPAMAX government settlement totaled $81.5 million plus interest, an amount previously reserved.
Important facts for investors to verify
- Underlying earnings excluding the $1.5 billion litigation gain and other material litigation or tax effects.
- Progress on McNeil manufacturing remediation, product availability, and the estimated $600 million sales impact.
- Sales, margin, and market-share trends by segment, particularly U.S. Consumer and Pharmaceutical performance and generic exposure.
- Cash conversion, working-capital movements, debt levels, and the effect of litigation receipts and payments on reported cash flow.
- Developments and potential financial consequences from product recalls, government investigations, patent cases, and other legal contingencies.
- Actual costs of health-care reform and the timing and extent of anticipated supply restoration.