Johnson & Johnson — Q3 2012 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the fiscal quarter ended September 30, 2012, and the nine months ended on that date. Johnson & Johnson reports Consumer, Pharmaceutical, and Medical Devices & Diagnostics segments. Synthes, acquired in June 2012, is included from June 14 onward.
Financial performance and position
| Metric | Q3 2012 | Comparable period | Nine months 2012 | Comparable period |
|---|---|---|---|---|
| Sales | $17.052bn | $16.005bn; +6.5% | $49.666bn | $48.775bn; +1.8% |
| Gross margin | 67.2% | 68.3% | 68.5% | 69.2% |
| Earnings attributable to J&J | $2.968bn | $3.202bn | $8.286bn | $9.454bn |
| Diluted EPS | $1.05 | $1.15 | $2.96 | $3.40 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $12.020bn | $10.847bn |
Q3 net earnings were $2.629bn; the $339m net loss attributable to noncontrolling interests increased earnings attributable to J&J to $2.968bn. Nine-month net earnings were $7.947bn before the same $339m noncontrolling-interest adjustment. Attributable net margin was 17.4% in Q3 and 16.7% for nine months, versus 20.0% and 19.4%, respectively, in the comparable periods.
At September 30, cash and cash equivalents were $15.486bn and marketable securities were $4.285bn, totaling $19.771bn. Total debt was approximately $16.9bn ($5.423bn current and $11.428bn long-term); shareholders’ equity was $63.761bn. Current assets were $44.791bn and current liabilities $23.935bn. The company reported $12.020bn of nine-month operating cash flow, $2.007bn net cash used in investing, and $19.091bn net cash used in financing. Financing included $12.919bn of share repurchases, primarily related to the Synthes acquisition, and $4.924bn of dividends.
Material changes and drivers
- Reported sales growth was substantially acquisition-led: Synthes, net of the related trauma-business divestiture, contributed 5.8 percentage points to Q3 growth and 2.2 points to nine-month growth. Nine-month operational sales growth was 5.0%, offset by a 3.2% negative currency impact.
- Q3 segment sales were Consumer $3.581bn, down 4.3%; Pharmaceutical $6.402bn, up 7.0%; and Medical Devices & Diagnostics $7.069bn, up 12.5%. Synthes drove most of the medical-device growth. Nine-month sales rose 3.0% in Pharmaceuticals and 3.9% in Medical Devices & Diagnostics, while Consumer sales declined 3.7%.
- Profitability fell despite higher sales. Nine-month earnings before tax declined 11.4% to $10.675bn. The filing cites $2.0bn of intangible-asset and in-process R&D write-downs, Synthes-related costs, and lower prior-year gains; cost containment partly offset these effects. Q3 earnings before tax fell 12.6% to $3.595bn.
- Nine-month other expense included substantial impairment charges, principally related to the Crucell vaccine business. A $679m Q3 in-process R&D charge followed discontinuation of Phase III development of bapineuzumab IV; $339m was attributable to noncontrolling interests. The nine-month effective tax rate rose to 25.6% from 21.5%.
Outlook, risks, and unusual items
- The filing gives no numerical sales or earnings guidance. Management said operating cash flows, credit facilities, and commercial paper access were expected to provide sufficient resources for operating needs. A new $10bn 364-day credit facility runs through September 19, 2013.
- Management expected McNeil manufacturing constraints and additional review processes under the FDA consent decree to continue through 2012 and most of 2013; Fort Washington remained shut. The company also cited ongoing remediation costs and supply constraints affecting products including DOXIL/CAELYX.
- The 2013 medical-device excise tax was estimated at $200–$300m. The company expected a regular quarterly dividend; a $0.61-per-share dividend was declared in October 2012.
- Key disclosed exposures include product-liability litigation involving DePuy hip devices, pelvic mesh, and other products; pharmaceutical marketing and government investigations; and patent and generic-entry disputes. The filing says ultimate litigation outcomes were not expected to materially harm financial position, but individual-period results and cash flows could be materially affected. Possible losses beyond accrued amounts were not estimable for certain matters.
- The company disclosed a nonmaterial cash-flow classification error in its Q2 2012 filing involving Synthes shares: investing cash use had been overstated by $13.3bn, financing cash use understated by $12.8bn, and operating cash flow overstated by $0.5bn. The nine-month statement correctly presents the shares as supplemental non-cash information; the Q2 revision was to be reflected in the 2013 Q2 filing.
- The IRS could challenge the tax treatment of Synthes-related accelerated share repurchase and internal transactions; the company said potential tax, if challenged, could be up to the total Synthes share purchase price plus interest.
Important facts for investors to verify
- How much future growth and margin performance depends on Synthes, and how the final purchase-price allocation and integration costs develop.
- Whether impairment charges, litigation accruals, and the higher effective tax rate persist or change materially.
- Progress on McNeil facility remediation and product availability, and restoration of DOXIL/CAELYX supply.
- Developments in major product-liability, government, patent, and generic-entry matters, including whether outcomes exceed recorded accruals.
- Cash, debt, and liquidity after acquisition-related financing and share repurchases, and the timing and final settlement of the Synthes-related accelerated share repurchase agreements.