Johnson & Johnson — Q3 2014 Form 10-Q
Reporting period: Fiscal quarter ended September 28, 2014; financial statements are unaudited. Comparisons are with the quarter ended September 29, 2013, and the corresponding nine-month periods. J&J reports Consumer, Pharmaceutical, and Medical Devices & Diagnostics segments.
Financial performance
- Revenue: Q3 sales were $18.47 billion, up 5.1% year over year (5.8% operational growth, offset by 0.7% currency headwind). Nine-month sales were $56.08 billion, up 5.9% (6.8% operational growth, offset by 0.9% currency headwind).
- Profit and EPS: Q3 net earnings were $4.75 billion versus $2.98 billion; diluted EPS was $1.66 versus $1.04. Nine-month net earnings were $13.80 billion versus $10.31 billion; diluted EPS was $4.81 versus $3.58. Q3 pretax earnings rose 85.7% to $6.81 billion; nine-month pretax earnings rose 40.4% to $17.86 billion.
- Margins and expenses: Gross margin increased to 70.8% from 69.6% in Q3 and to 69.9% from 69.1% year to date. R&D was $2.02 billion in Q3 and $5.86 billion year to date; as a share of sales, it declined to 11.0% and 10.5%, respectively.
- Cash flow: Nine-month operating cash flow was $14.11 billion, versus $13.28 billion. Investing used $9.38 billion and financing used $11.64 billion. Cash and cash equivalents ended the period at $13.82 billion, down from $20.93 billion at December 29, 2013.
- Liquidity and debt: Cash, cash equivalents, and marketable securities totaled approximately $33.0 billion. Current assets were $59.97 billion and current liabilities $22.98 billion. Total current and long-term debt was about $15.27 billion, compared with $18.18 billion at year-end 2013. The company reported access to commercial paper and a new $10 billion, 364-day credit facility expiring September 17, 2015.
- Capital returns: Nine-month dividends were $5.81 billion and share repurchases were $4.38 billion. A new $5 billion repurchase authorization was approved in July; $1.8 billion had been used by quarter-end. The quarterly dividend was $0.70 per share.
Material changes and drivers
- Pharmaceutical sales were the principal growth driver: Q3 sales rose 18.1% to $8.31 billion, led by OLYSIO/SOVRIAD hepatitis C sales, which contributed 10.7 percentage points to segment operational growth. STELARA, ZYTIGA, and XARELTO also grew strongly.
- Consumer sales declined 0.6% in Q3 to $3.59 billion. Women’s Health was down 20.3%, primarily reflecting prior divestitures; OTC sales grew 4.5%.
- Medical Devices & Diagnostics sales declined 5.2% in Q3 to $6.57 billion. The Ortho-Clinical Diagnostics divestiture reduced segment operational growth by 6.2 percentage points; Vision Care also faced competition and pricing pressure.
- Reported earnings benefited materially from unusual items. Q3 included a pretax gain of approximately $1.9 billion on the Ortho-Clinical Diagnostics sale, as well as lower litigation costs than the prior year. Nine-month results also included a $388 million gain on the K-Y brand divestiture. These items make reported profit growth stronger than underlying sales growth.
- The worldwide effective tax rate for the first nine months increased to 22.7% from 18.9%, reflecting, among other factors, tax on the Ortho-Clinical Diagnostics divestiture, the additional Branded Prescription Drug Fee accrual, and changes in geographic earnings mix. Unrecognized tax benefit liabilities were approximately $2.3 billion.
Outlook, commentary, and risks
- The filing provides no specific full-year revenue or earnings guidance. Management said operating cash flow, credit facilities, and commercial paper access are expected to provide sufficient resources for operating needs, and expects to continue regular quarterly dividends.
- Management cited cost reduction, productivity, and responsible pricing as responses to healthcare cost containment and inflation. Currency fluctuations reduced international growth; Southern European government and distributor receivables remained exposed to delayed payment, although balances declined from year-end.
- Competition and loss of exclusivity are significant risks. Management expected a recently approved competing hepatitis C product to significantly affect future OLYSIO/SOVRIAD sales. Certain European REMICADE patents expire in February 2015, and biosimilar entry could reduce sales.
- Legal and regulatory matters include product-liability claims involving DePuy ASR hips, PINNACLE hips, pelvic mesh, and RISPERDAL. The company described a U.S. ASR settlement program valued at approximately $2.5 billion based on an estimated 8,000 participants, increased Q3 accruals for the ASR program, and said future outcomes and possible losses beyond accrued amounts could not be reliably estimated. Resolution of litigation could materially affect results or cash flows in a period.
- On September 30, after quarter-end, J&J announced an agreement to acquire Alios BioPharma for approximately $1.75 billion in cash, subject to regulatory clearance and customary closing conditions.
Important facts for investors to verify
- How much of earnings and EPS growth reflects recurring operations versus the Ortho-Clinical Diagnostics and K-Y divestiture gains and lower litigation expense?
- Whether hepatitis C competition, REMICADE biosimilar entry, and generic competition affect future pharmaceutical sales as described.
- Developments and potential cash costs in major product-liability, patent, and government proceedings, particularly ASR, pelvic mesh, and REMICADE-related matters.
- Completion, funding, and expected contribution of the Alios acquisition, and use of the remaining share-repurchase authorization.
- Cash conversion, working-capital trends, international currency exposure, and collection of Southern European receivables.