Business context and reporting period
Johnson & Johnson’s unaudited Form 10-Q covers the fiscal second quarter and six months ended July 3, 2011. Comparisons are with the quarter and six months ended July 4, 2010; balance-sheet comparisons are with January 2, 2011. The company reports Consumer, Pharmaceutical, and Medical Devices & Diagnostics businesses.
Financial performance and liquidity
| Metric | Fiscal Q2 2011 | Fiscal Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Sales | $16.60bn | $15.33bn | $32.77bn | $30.96bn |
| Gross margin | 68.8% | 69.8% | 69.6% | 70.4% |
| Net earnings | $2.78bn | $3.45bn | $6.25bn | $7.98bn |
| Diluted EPS | $1.00 | $1.23 | $2.25 | $2.85 |
| Net margin | 16.7% | 22.5% | 19.1% | 25.8% |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $6.23bn | $7.53bn |
- Second-quarter sales increased 8.3%; management attributed 2.6 percentage points to operations and 5.7 points to favorable currency. Six-month sales rose 5.8%, comprising 2.2% operational growth and 3.6% currency benefit.
- International sales drove growth: second-quarter international sales rose 15.9%, while U.S. sales were nearly flat at 0.1%. Six-month international sales rose 11.6%; U.S. sales declined 0.2%.
- Second-quarter segment sales were $3.79bn Consumer, $6.23bn Pharmaceutical, and $6.57bn Medical Devices & Diagnostics. Segment operating profit was down 17.9%, 6.5%, and 32.0%, respectively, versus the prior-year quarter.
- At July 3, cash and cash equivalents were $14.97bn and marketable securities were $14.71bn. Total current assets were $52.67bn versus current liabilities of $20.99bn.
- Total debt was $18.73bn ($5.05bn current and $13.68bn long-term), compared with $16.77bn at January 2. Management reported debt of $11.7bn at the end of the year-earlier quarter. Shareholders’ equity was $62.13bn.
- Six-month investing cash outflow was $9.26bn, including $2.05bn for acquisitions and $1.05bn for property and equipment; net purchases of investments were approximately $6.24bn. Financing used $1.46bn, including $3.04bn of dividends and $0.93bn of share repurchases, partly offset by net debt proceeds. Cash declined $4.38bn from year-end.
Material changes versus the prior comparable period
- Net earnings fell 19.5% in the quarter and 21.6% for the six months; diluted EPS declined from $1.23 to $1.00 and from $2.85 to $2.25, respectively. Prior-year six-month results included a $1.5bn net litigation gain, while 2011 included substantial litigation and recall costs and restructuring charges.
- Six-month operating cash flow declined to $6.23bn from $7.53bn, with working-capital movements—including higher inventories and receivables—reducing cash generation.
- Reported growth exceeded operational growth, reflecting favorable foreign exchange. Consumer U.S. sales were weak, partly due to manufacturing constraints and product recalls; pharmaceutical growth was stronger, while Medical Devices & Diagnostics operating profit was pressured by restructuring, litigation, and the prior-year comparison.
- Cost of products sold rose to 31.2% of sales in the quarter from 30.2%; R&D increased to $1.88bn from $1.65bn in the quarter, primarily reflecting higher Pharmaceutical pipeline investment.
Outlook, management commentary, risks and unusual items
- The filing provides no company-wide sales or earnings forecast. Management said operating cash flow, existing credit facilities, and commercial-paper access were expected to provide sufficient resources for operating needs.
- Management estimated 2011 U.S. health-reform impacts of $400–$500m in sales rebates and $150–$175m in selling, marketing and administrative expense. The estimated rebate impact was about $230m for the first six months and $110m for Q2.
- McNeil OTC production remained constrained by facility remediation and FDA-required review processes. Selected products were expected to ship later in 2011, with the remaining key portfolio reintroduced through 2012. The Fort Washington facility was to remain closed pending required remediation and FDA concurrence.
- Loss of U.S. market exclusivity for LEVAQUIN in June 2011 was expected to continue weighing on sales in the second half of 2011. The company also cited generic competition for other products and pricing pressure in medical devices.
- A $676m pre-tax restructuring charge related to exiting the NEVO development program and ending CYPHER stent production and marketing by year-end included $512m of asset write-offs and about $164m of cash-related obligations and expenses.
- In Q2, the company agreed to acquire Synthes for approximately $21.3bn, or about $19.3bn net of acquired cash, subject to closing terms. The proposed consideration was approximately 35% cash and 65% J&J stock. Subsequent to quarter-end, J&J completed the Animal Health divestiture and a Russian OTC brand acquisition, and agreed to divest its U.S. Ortho Dermatologics assets.
- Legal and regulatory exposures include product-liability claims, DePuy ASR hip recall matters, pharmaceutical marketing investigations, and patent disputes. The filing says the company cannot estimate possible losses beyond amounts accrued for certain matters; management did not expect the disclosed matters, net of accruals, to materially affect financial position, but said resolutions could materially affect results or cash flows in a period. Notable unreserved verdicts included a $593m CYPHER stent patent judgment and state RISPERDAL-related awards; appeals or post-trial proceedings were pending. The company had adjusted its accrual for a proposed criminal RISPERDAL resolution, while related civil claims remained uncertain.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the period.
Important facts for investors to verify
- How much of reported sales growth reflects sustainable volume and operations rather than currency, and whether U.S. sales improve.
- Progress, cost, and product-reintroduction timing for McNeil remediation, and the resulting effect on Consumer sales and margins.
- Execution and financing of the proposed Synthes acquisition, alongside the impact of other portfolio changes.
- Updated exposure, accruals, and outcomes for DePuy ASR, product-liability, patent, and government matters, including whether any loss becomes estimable.
- Whether operating cash flow, debt levels, and liquidity remain adequate as acquisition, dividend, and investment needs evolve.