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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period
ended September 26, 2004
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the for the transition
period from to
Commission file number 1-3215
JOHNSON & JOHNSON
(Exact name of registrant as specified in its charter)
NEW JERSEY 22-1024240
(State or other jurisdiction of (I.R.S.Employer
Incorporation or organization) Identification No.)
One Johnson & Johnson Plaza
New Brunswick, New Jersey 08933
(Address of principal executive offices)
Registrant's telephone number, including area code
(732) 524-0400
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No
Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). Yes (X) No
Indicate the number of shares outstanding of each of
the issuer's classes of common stock, as of the latest
practicable date.
On October 24, 2004, 2,967,726,203 shares of Common
Stock, $1.00 par value, were outstanding.
1
JOHNSON & JOHNSON AND SUBSIDIARIES
TABLE OF CONTENTS
Part I - Financial Information Page No.
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets -
September 26, 2004 and December 28, 2003 3
Consolidated Statements of Earnings for the Fiscal
Third Quarters Ended September 26, 2004 and
September 28, 2003 6
Consolidated Statements of Earnings for the Fiscal
Nine Months Ended September 26, 2004 and
September 28, 2003 7
Consolidated Statements of Cash Flows for the Fiscal
Nine Months Ended September 26, 2004 and
September 28, 2003 8
Notes to Consolidated Financial Statements 10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results
of Operations 31
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 42
Item 4. Controls and Procedures 42
Part II - Other Information
Item 1. Legal Proceedings 42
Item 5. Exhibits and Reports on Form 8-K 42
Signatures 44
2
Part I - FINANCIAL INFORMATION
Item 1 - Financial Statements
JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; Dollars in Millions)
ASSETS
September 26, December 28,
2004 2003
Current Assets:
Cash and cash equivalents $ 7,348 5,377
Marketable securities 5,746 4,146
Accounts receivable, trade, less
allowances for doubtful accounts
$204(2003, $192) 6,939 6,574
Inventories (Note 4) 3,669 3,588
Deferred taxes on income 1,662 1,526
Prepaid expenses and other
receivables 1,452 1,784
Total current assets 26,816 22,995
Marketable securities, non-current 62 84
Property, plant and equipment,
at cost 17,632 17,052
Less accumulated
depreciation 8,037 7,206
Property, plant and equipment, net 9,595 9,846
Intangible assets (Note 5) 14,764 14,168
Less accumulated amortization 3,036 2,629
Intangible assets, net 11,728 11,539
Deferred taxes on income 955 692
Other assets 2,933 3,107
Total assets $52,089 48,263
See Notes to Consolidated Financial Statements
3
JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; Dollars in Millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
September 26, December 28,
2004 2003
Current Liabilities:
Loans and notes payable $ 454 1,139
Accounts payable 3,646 4,966
Accrued liabilities 2,951 2,639
Accrued rebates, returns
and promotions 2,855 2,308
Accrued salaries, wages and
commissions 995 1,452
Accrued Taxes on income 1,428 944
Total current liabilities 12,329 13,448
Long-term debt 2,961 2,955
Deferred tax liability 791 780
Employee related obligations 2,438 2,262
Other liabilities 2,057 1,949
Shareholders' equity:
Preferred stock - without par
value (authorized and unissued
2,000,000 shares) - -
Common stock - par value $1.00
per share (authorized
4,320,000,000 shares; issued
3,119,842,000 shares) 3,120 3,120
Note receivable from employee
stock ownership plan (11) (18)
Accumulated other comprehensive
income (Note 8) (491) (590)
Retained earnings 35,022 30,503
4
Less common stock held in treasury,
at cost (151,421,000 & 151,869,000
shares) 6,127 6,146
Total shareholders' equity 31,513 26,869
Total liabilities and shareholders'
equity $52,089 48,263
See Notes to Consolidated Financial Statements
5
JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited; dollars & shares in millions
except per share figures)
Fiscal Third Quarter Ended
Sept. 26, Percent Sept. 28, Percent
2004 to Sales 2003 to Sales
Sales to customers
(Note 6) $11,553 100.0 10,455 100.0
Cost of products sold 3,187 27.6 2,980 28.5
Gross Profit 8,366 72.4 7,475 71.5
Selling, marketing and
administrative expenses 3,854 33.3 3,428 32.8
Research expense 1,198 10.4 1,177 11.3
Purchased in-process
research and
development 18 .2 - -
Interest income (49) (.4) (63) (.6)
Interest expense, net of
portion capitalized 30 .2 75 .7
Other (income)expense, net 41 .4 (91) (.9)
Earnings before provision
for taxes on income 3,274 28.3 2,949 28.2
Provision for taxes on
income (Note 3) 933 8.0 877 8.4
NET EARNINGS $2,341 20.3 2,072 19.8
NET EARNINGS PER SHARE
(Note 7)
Basic $ .79 .70
Diluted $ .78 .69
CASH DIVIDENDS PER SHARE $ .285 .24
AVG. SHARES OUTSTANDING
Basic 2,968.1 2,968.0
Diluted 3,009.0 3,008.3
See Notes to Consolidated Financial Statements
6
JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited; dollars & shares in millions
except per share figures)
Fiscal Nine Months Ended
Sept. 26, Percent Sept. 28, Percent
2004 to Sales 2003 to Sales
Sales to customers
(Note 6) $34,596 100.0 30,608 100.0
Cost of products sold 9,716 28.1 8,668 28.3
Gross Profit 24,880 71.9 21,940 71.7
Selling, marketing and
administrative expenses 11,205 32.4 10,077 32.9
Research expense 3,476 10.0 3,195 10.4
Purchased in-process
research and
development 18 .1 918 3.0
Interest income (123) (.4) (145) (.5)
Interest expense, net of
portion capitalized 127 .4 164 .6
Other (income)expense, net (36) (.1) (203) (.6)
Earnings before provision
for taxes on income 10,213 29.5 7,934 25.9
Provision for taxes on
income (Note 3) 2,921 8.4 2,582 8.4
NET EARNINGS $7,292 21.1 5,352 17.5
NET EARNINGS PER SHARE
(Note 7)
Basic $ 2.46 1.80
Diluted $ 2.43 1.78
CASH DIVIDENDS PER SHARE $ .81 .685
AVG. SHARES OUTSTANDING
Basic 2,968.1 2,968.0
Diluted 3,004.4 3,012.0
See Notes to Consolidated Financial Statements
7
JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; Dollars in Millions)
Fiscal Nine Months Ended
Sept. 26, Sept. 28,
2004 2003
CASH FLOWS FROM OPERATIONS
Net earnings $ 7,292 5,352
Adj. to reconcile net earnings to cash flows:
Depreciation and amortization of
property and intangibles 1,506 1,347
Purchased in-process research and
development 18 918
Increase in deferred taxes (424) (508)
Accounts receivable provisions 68 (31)
Changes in assets and liabilities, net
of effects from acquisition of businesses:
Increase in accounts receivable (452) (679)
Increase in inventories (91) (231)
(Decrease) increase in accounts
payable and accrued liabilities (787) 628
Decrease (increase) in other
current and non-current assets 545 (505)
Increase in other current
and non-current liabilities 995 752
NET CASH FLOWS FROM OPERATING
ACTIVITIES 8,670 7,043
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant
and equipment (1,142) (1,472)
Proceeds from the disposal of assets 235 334
Acquisition of businesses, net of cash
acquired (330) (2,781)
Purchases of investments (9,121) (5,064)
Sales of investments 7,508 4,673
Other (91) (104)
NET CASH USED BY INVESTING
ACTIVITIES (2,941) (4,414)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends to shareholders (2,404) (2,033)
Repurchase of common stock (985) (941)
Proceeds from short-term debt 313 1,633
Retirement of short-term debt (1,114) (1,621)
Proceeds from long-term debt 16 1,013
Retirement of long-term debt (1) (108)
Proceeds from the exercise of
stock options 434 240
NET CASH USED BY FINANCING
ACTIVITIES (3,741) (1,817)
8
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS (17) 144
INCREASE IN CASH AND CASH
EQUIVALENTS 1,971 956
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD 5,377 2,894
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 7,348 3,850
ACQUISITION OF BUSINESSES
Fair value of assets acquired 369 3,096
Fair value of liabilities assumed (39) (315)
Net cash paid for acquisitions $ 330 2,781
See Notes to Consolidated Financial Statements
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - The accompanying unaudited interim
financial
statements and related notes should be read in conjunction
with
the Consolidated Financial Statements of Johnson &
Johnson and
Subsidiaries (the "Company") and related notes as
contained in
the Annual Report on Form 10-K for the fiscal year
ended
December 28, 2003. The unaudited interim financial
statements
include all adjustments (consisting only of normal
recurring
adjustments) and accruals necessary in the judgment of
management
for a fair presentation of such statements.
NOTE 2 - FINANCIAL INSTRUMENTS
The Company follows the provisions of SFAS 133 requiring that
all derivative instruments be recorded on the balance sheet
at fair value.
As of September 26, 2004, the balance of deferred net
losses on derivatives included in accumulated other
comprehensive income was $76 million after-tax. For
additional information, see Note 8. The Company expects that
substantially all of this amount will be reclassified into
earnings over the next 12 months as a result of transactions
that are expected to occur over that period. The amount
ultimately realized in earnings will differ as foreign
exchange rates change. Realized gains and losses are
ultimately determined by actual exchange rates at maturity of
the derivative. Transactions with third parties will cause
the amount in accumulated other comprehensive income to
affect net earnings. The maximum length of time over which
the Company is hedging is 18 months.
For the first fiscal nine months ended September 26, 2004,
the net impact of the hedges' ineffectiveness to the
Company's financial statements was insignificant. For the
first fiscal nine months ended September 26, 2004, the
Company has recorded a net loss of $1 million after tax in
the "other (income) expense, net" category of the
consolidated statement of earnings, representing the impact
of discontinuance of cash flow hedges because it is probable
that the originally forecasted transactions will not occur by
the end of the originally specified time period.
NOTE 3 - INCOME TAXES
The worldwide effective income tax rates for the first
fiscal nine months of 2004 and 2003 were 28.6% and
32.5% respectively. The decrease in the effective tax rate
for the first fiscal nine months of 2004 compared with the
same period a year ago was due to acquisition-related In-
process Research and Development (IPR&D) charges in 2003 that
were non-deductible for tax purposes. The 2003 tax rate
excluding the effect of IPR&D was 29.2%. The decrease was
also due to the increase in taxable income in lower tax
jurisdictions relative to taxable income in higher tax
jurisdictions.
10
NOTE 4 - INVENTORIES
(Dollars in Millions)
Sept. 26, 2004 December 28, 2003
Raw materials and supplies $ 1,087 966
Goods in process 1,048 981
Finished goods 1,534 1,641
$ 3,669 3,588
NOTE 5 - INTANGIBLE ASSETS
Intangible assets that have definite useful lives are
amortized over their useful lives. Goodwill and non-
amortizable intangible assets are assessed annually for
impairment. The impairment assessment was completed in the
fiscal fourth quarter of 2003 and no impairment was
determined. In the absence of a triggering event during the
year, future impairment tests will be performed in the
fiscal fourth quarter, annually.
(Dollars in Millions)
Sept. 26, 2004 December 28, 2003
Goodwill $ 6,297 6,085
Less accumulated amortization 719 695
Goodwill - net 5,578 5,390
Trademarks (non-amortizable) 1,130 1,098
Less accumulated amortization 136 136
Trademarks (non-amortizable)- net 994 962
Patents and trademarks 3,997 3,798
Less accumulated amortization 1,027 818
Patents and trademarks - net 2,970 2,980
Other amortizable intangibles 3,340 3,187
Less accumulated amortization 1,154 980
Other intangibles - net 2,186 2,207
Total intangible assets 14,764 14,168
Less accumulated amortization 3,036 2,629
Total intangibles - net $11,728 11,539
11
Goodwill as of September 26, 2004 as allocated by segment of
business is as follows:
(Dollars in Millions)
Med. Dev
Consumer Pharm & Diag Total
Goodwill, net of
accumulated amortization
at December 28, 2003 $882 781 3,727 5,390
Acquisitions 176 21 6 203
Translation & other 5 (3) (17) (15)
Goodwill as of
September 26, 2004 $1,063 799 3,716 5,578
The weighted average amortization periods for patents and
trademarks and other intangible assets were 16 years and 18
years, respectively. The amortization expense of amortizable
intangible assets for the first fiscal nine months ended
September 26, 2004 was $382 million before tax and the
estimated amortization expense for each of the five
succeeding years approximates $500 million before tax.
NOTE 6 - SEGMENTS OF BUSINESS AND GEOGRAPHIC AREAS
(Dollars in Millions)
SALES BY SEGMENT OF BUSINESS
Fiscal Third Quarter
Percent
2004 2003 Change
Consumer
U.S. $ 1,023 984 4.0
International 1,001 857 16.8
2,024 1,841 9.9%
Pharmaceutical
U.S. $ 3,694 3,285 12.5
International 1,791 1,550 15.5
5,485 4,835 13.4%
Med Devices and Diagnostics
U.S. $ 2,073 2,145 (3.4)
International 1,971 1,634 20.6
4,044 3,779 7.0%
U.S. $ 6,790 6,414 5.9
International 4,763 4,041 17.9
Worldwide $ 11,553 10,455 10.5%
12
Fiscal Nine Months
Percent
2004 2003 Change
Consumer
U.S. $ 3,090 2,915 6.0
International 2,981 2,536 17.5
6,071 5,451 11.4%
Pharmaceutical
U.S. $ 10,980 9,825 11.8
International 5,308 4,559 16.4
16,288 14,384 13.2%
Med Devices and Diagnostics
U.S. $ 6,306 5,797 8.8
International 5,931 4,976 19.2
12,237 10,773 13.6%
U.S. $ 20,376 18,537 9.9
International 14,220 12,071 17.8
Worldwide $ 34,596 30,608 13.0%
OPERATING PROFIT BY SEGMENT OF BUSINESS
Fiscal Third Quarter
Percent
2004 2003 Change
Consumer $ 358 364 (1.6)
Pharmaceutical 1,922 1,751 9.8
Med. Dev. & Diag.(1) 1,052 931 13.0
Segments total 3,332 3,046 9.4
Expenses not allocated
to segments (58) (97)
Worldwide total $ 3,274 2,949 11.0%
Fiscal Nine Months
Percent
2004 2003 Change
Consumer $ 1,187 1,148 3.4
Pharmaceutical(2) 6,117 4,702 30.1
Med. Dev. & Diag.(3) 3,179 2,332 36.3
Segments total 10,483 8,182 28.1
Expenses not allocated
to segments (270) (248)
Worldwide total $ 10,213 7,934 28.7%
13
(1)Includes $18 million of In-process Research and
Development (IPR&D) charges related to an acquisition
in the fiscal third quarter of 2004.
(2)Includes $737 million of IPR&D charges related to
acquisitions for the first fiscal nine months of 2003.
(3)Includes $18 million and $181 million of IPR&D charges
related to acquisitions for the first fiscal nine months
of 2004 and 2003, respectively.
SALES BY GEOGRAPHIC AREA
Fiscal Third Quarter
Percent
2004 2003 Change
U.S. $ 6,790 6,414 5.9
Europe 2,638 2,241 17.7
Western Hemisphere,
excluding U.S. 639 576 10.9
Asia-Pacific, Africa 1,486 1,224 21.4
Total $ 11,553 10,455 10.5%
Fiscal Nine Months
Percent
2004 2003 Change
U.S. $ 20,376 18,537 9.9
Europe 8,124 6,909 17.6
Western Hemisphere,
excluding U.S. 1,858 1,603 15.9
Asia-Pacific, Africa 4,238 3,559 19.1
Total $ 34,596 30,608 13.0%
14
NOTE 7 - EARNINGS PER SHARE
The following is a reconciliation of basic net earnings per
share to diluted net earnings per share for the fiscal third
quarters ended September 26, 2004 and September 28, 2003.
(Shares in Millions)
Fiscal Third Quarter Ended
Sept. 26, Sept. 28,
2004 2003
Basic net earnings per share $ .79 .70
Average shares outstanding - basic 2,968.1 2,968.0
Potential shares exercisable under
stock option plans 194.9 95.8
Less: shares which could be repurchased
under treasury stock method (168.6) (70.4)
Convertible debt shares 14.6 14.9
Adjusted average shares
outstanding - diluted 3,009.0 3,008.3
Diluted earnings per share $ .78 .69
The diluted earnings per share calculation included the
dilutive effect of convertible debt that was offset by the
related decrease in interest expense of $3 million each
for the fiscal third quarters ended September 26, 2004 and
September 28, 2003, respectively.
The diluted earnings per share excluded 43 million and 125
million shares related to options for the fiscal third
quarters ended September 26, 2004 and September 28, 2003,
respectively, as the exercise price per share of these
options was greater than the average market value, which
would have resulted in an anti-dilutive effect on diluted
earnings per share.
The following is a reconciliation of basic net earnings per
share
to diluted net earnings per share for the fiscal nine
months ended September 26, 2004 and September 28, 2003.
(Shares in Millions)
Fiscal Nine Months Ended
Sept. 26, Sept. 28,
2004 2003
Basic net earnings per share $ 2.46 1.80
Average shares outstanding - basic 2,968.1 2,968.0
Potential shares exercisable under
stock option plans 193.4 172.9
Less: shares which could be repurchased
under treasury stock method (171.7) (143.8)
Convertible debt shares 14.6 14.9
Adjusted average shares
outstanding - diluted 3,004.4 3,012.0
Diluted earnings per share $ 2.43 1.78
The diluted earnings per share calculation included the
dilutive effect of convertible debt that was offset by the
related
15
decrease in interest expense of $11 million each for
the first fiscal nine months ended September 26, 2004 and
September 28, 2003, respectively.
The diluted earnings per share excluded 44 million and 48
million shares related to options for the first fiscal nine
months ended September 26, 2004 and September 28, 2003,
respectively, as the exercise price per share of these
options was greater than the average market value, which
would have resulted in an anti-dilutive effect on diluted
earnings per share.
NOTE 8 - ACCUMULATED OTHER COMPREHENSIVE INCOME
The total comprehensive income for the first fiscal nine
months ended September 26, 2004 was $7.4 billion, compared
with $5.5 billion for the same period a year ago.
Total comprehensive income included net earnings, net
unrealized currency gains and losses on translation, net
unrealized gains and losses on available for sale securities
and net gains and losses on derivative instruments
qualifying and designated as cash flow hedges. The
following table sets forth the components of
accumulated other comprehensive income.
Total
Unrld Gains/ Accum
For. Gains/ Pens (Losses) Other
Cur. (Losses) Liab on Deriv Comp
Trans. on Sec Adj. & Hedg Inc/
(Loss)
December 28, 2003 $ (373) 27 (64) (180) (590)
2004 nine months changes:
Net change associated
with current period
hedging transactions - - - 211
Net amount reclassed to
net earnings - - - (107)*
Net nine months
changes (46) 41 - 104 99
September 26, 2004 $ (419) 68 (64) (76) (491)
Note: All amounts, other than foreign currency translation,
are net of tax. Foreign currency translation adjustments
are not currently adjusted for income taxes, as they relate to
permanent investments in non-US subsidiaries.
*Primarily offset in net earnings by changes in value of the
underlying transactions.
NOTE 9 - MERGERS, ACQUISITIONS AND DIVESTITURES
There were no acquisitions in the fiscal first quarter of
2004. DePuy's Castings business was divested in the fiscal
first quarter of 2004 and did not have a material effect on
the Company's results of operations, cash flows or financial
position.
On March 30, 2004, Johnson & Johnson acquired Merck's 50%
interest in the Johnson & Johnson-Merck Consumer
Pharmaceuticals Co. European non-prescription pharmaceutical
joint venture for a
16
net purchase price of $230 million. This resulted in Johnson
&
Johnson acquiring all the infrastructure and brand assets
currently managed by the European JV including brands
contributed by Merck (DOLORMIN (r), PEPCID (r), FRENADOL (r)
and DACRYYO(r)) and those acquired by both companies (through
the acquisition of Woelm Pharma and Laboratoires Martin).
On May 18, 2004, Johnson & Johnson completed the
acquisition of Egea Biosciences, Inc. through the exercise of
the option to acquire the remaining outstanding stock not
owned by Johnson & Johnson. Egea Biosciences has developed a
proprietary technology platform called Gene Writer, that
allows for the rapid and highly accurate synthesis of DNA
sequences, gene assembly, and construction of large synthetic
gene libraries.
On June 18, 2004, Johnson & Johnson acquired the stock of
Artemis Medical, Inc. Artemis was a privately held company
founded in 1999. Its products include ultrasound and x-ray
visible biopsy site breast markers as well as hybrid markers.
On June 28, 2004, Johnson & Johnson acquired the U.S.
commercial rights to certain patents and know-how in the
field of sedation and analgesia from Scott Lab, Inc. The
Company incurred a charge for IPR&D of approximately $18
million before tax and $12 million after tax.
The total net cash paid for acquisitions in the first
fiscal nine months of 2004 was $330 million.
On January 29, 2003, Johnson & Johnson acquired certain
assets of Orquest, Inc., a privately held biotechnology
company focused on developing biologically based implants for
orthopaedic and spine surgery. Orquest's principal product,
HEALOS Bone Graft Substitute, is designed to reduce the time
and pain associated with standard bone graft harvesting and
represents a therapeutic advance for patients requiring bone
graft material for spine fusion. The Company incurred a
charge for IPR&D of approximately $11 million before tax and
$8 million after tax.
On February 10, 2003, Johnson & Johnson acquired OraPharma,
Inc., a specialty pharmaceutical company focused on the
development and commercialization of unique therapeutics.
Orapharma's initial product, ARESTIN, is the first locally
administered, time-released antibiotic encapsulated in
microspheres that control the germs that can cause periodontal
disease. The transaction was valued at approximately $85
million, net of cash.
On March 28, 2003, Johnson & Johnson acquired 3-Dimensional
Pharmaceuticals, Inc., a company with a technology platform
focused on the discovery and development of potential new
drugs in early stage development for the treatment of
cardiovascular disorders, oncology and inflammation. The
transaction was valued at approximately $88 million, net of
cash. The Company incurred a before and after tax charge for
IPR&D of approximately $7 million.
On April 17, 2003, Johnson & Johnson acquired the
CORTAID(r) brand business, the #3 brand in the anti-itch
treatment segment of the first aid category. The transaction
was valued at approximately $37 million.
17
On April 29, 2003, Johnson & Johnson acquired Scios Inc.,
a biopharmaceutical company with a marketed product for
cardiovascular disease and research projects focused on auto-
immune diseases. Scios was acquired to strengthen the
Company's business in key therapeutic areas and technology
platforms. Scios' product NATRECOR(r) is a novel agent
approved for congestive heart failure and has several
significant advantages over existing therapies. The
transaction was valued at approximately $2.4 billion, net of
cash, and the Company incurred a charge for IPR&D of $730
million before and after tax. The purchase price was
allocated to the tangible and identifiable intangible assets
acquired and liabilities assumed based on their estimated
fair values at the acquisition date. The excess of the
purchase price over the fair values of assets and liabilities
acquired was approximately $440 million and was allocated to
goodwill. Goodwill associated with this deal will not be
deductible for tax purposes.
On May 9, 2003, Johnson & Johnson acquired Inscope, an
intraluminal multiple clip applier technology. This
transaction was valued at $26 million.
On June 3, 2003, Johnson & Johnson acquired Link Spine
Group, Inc., a privately owned corporation that has provided
the Company with exclusive worldwide rights to the SB CHARITE
(tm) Artificial Disc for the treatment of spine disorders.
Under the terms of the agreement, the Company paid a $325
million upfront payment with further contingent payments due
upon achievement of regulatory and other milestones, and the
Company incurred a charge for IPR&D of $170 million before
and after tax. The purchase price was allocated to the
tangible and identifiable intangible assets acquired and
liabilities assumed based on their estimated fair values at
the acquisition date. The excess of the purchase price over
the fair values of assets and liabilities acquired was
approximately $84 million and was allocated to goodwill.
Goodwill associated with this deal will not be deductible for
tax purposes.
The supplemental pro forma information for the current
interim period and the preceeding year per SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets" are not provided as the impact of these
aforementioned acquisitions did not have a material effect on
the Company's results of operations, cash flows or financial
position.
NOTE 10 - PRO FORMA STOCK BASED COMPENSATION
At September 26, 2004, the Company had 21 stock-based
employee compensation plans. The Company accounted for those
plans under the recognition and measurement principles of
Accounting Principle Board Opinion No. 25 "Accounting for
Stock Issued to Employees" and its related Interpretations.
Compensation costs were not recorded in net income for stock
options, as all options granted under those plans had an
exercise price equal to the market value of the underlying
common stock on the date of grant.
As required by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure-an amendment of
FASB Statement No. 123," the following table shows the
estimated effect on net income and earnings per share if the
Company had applied the fair value recognition provision of
SFAS No. 123, "Accounting for Stock-Based Compensation,"
to stock-based employee compensation.
18
(Dollars in Millions
Except Per Share Data) Fiscal Third Quarter Ended
Sept. 26, 2004 Sept. 28, 2003
Net income,
as reported $ 2,341 2,072
Less:
Compensation
expense(1) 88 87
Pro forma $ 2,253 1,985
Earnings per share:
Basic - as reported $.79 $.70
- pro forma .76 .67
Diluted - as reported $.78 $.69
- pro forma .75 .66
(1) Determined under fair value based method for all awards,
net of tax.
(Dollars in Millions
Except Per Share Data) Fiscal Nine Months Ended
Sept. 26, 2004 Sept. 28, 2003
Net income,
as reported $ 7,292 5,352
Less:
Compensation
expense(1) 254 262
Pro forma $ 7,038 5,090
Earnings per share:
Basic - as reported $2.46 $1.80
- pro forma 2.37 1.71
Diluted - as reported $2.43 $1.78
- pro forma 2.36 1.70
(1) Determined under fair value based method for all awards,
net of tax.
19
NOTE 11 - PENSIONS AND OTHER POSTRETIREMENT BENEFITS
Components of Net Periodic Benefit Costs
Net periodic benefit costs for the Company's defined benefit
retirement plans and other benefit plans for the fiscal third
quarter of 2004 and 2003 include the following components:
(Dollars in Millions)
Retirement Plans Other Benefit
Plans
Fiscal Third Quarter ended
Sept. 26, Sept. 28, Sept. 26, Sept. 28,
2004 2003 2004 2003
Service cost $ 107 81 13 7
Interest cost 114 97 26 18
Expected return on
plan assets (129) (123) (1) -
Amortization of prior
service cost 4 5 (1) -
Amortization of net
transition asset (1) (1) - -
Recognized actuarial
losses (gains) 52 16 10 -
Curtailments and
settlements - - - -
Net periodic benefit
cost $ 147 75 47 25
Net periodic benefit costs for the Company's defined benefit
retirement plans and other benefit plans for the first fiscal
nine months of 2004 and 2003 include the following
components:
(Dollars in Millions)
Retirement Plans Other Benefit Plans
Fiscal Nine Months ended
Sept. 26, Sept. 28, Sept. 26, Sept. 28,
2004 2003 2004 2003
Service cost $ 319 244 37 21
Interest cost 339 293 77 53
Expected return on
plan assets (387) (371) (2) (2)
Amortization of prior
service cost 11 14 (2) (2)
Amortization of net
transition asset (2) (3) - -
Recognized actuarial
losses (gains) 155 49 32 2
Curtailments and
settlements - 1 - -
Net periodic benefit
cost $ 435 227 142 72
Company Contributions
As of September 26, 2004, the Company has contributed $155
million to its U.S. retirement plans during 2004. The
Company has no statutory requirements to further fund U.S.
retirement plans in 2004 but continually evaluates the need
for future funding.
20
NOTE 12 - LEGAL PROCEEDINGS
The Company is involved in numerous product liability
cases in the United States, many of which concern adverse
reactions to drugs and medical devices. The damages claimed
are substantial, and while the Company is confident of the
adequacy of the warnings and instructions for use which
accompany such products, it is not feasible to predict the
ultimate outcome of litigation. However, the Company believes
that if any liability results from such cases, it will be
substantially covered by existing amounts accrued in the
Company's balance sheet under its self-insurance program and
by third party product liability insurance.
One group of cases against the Company concerns the
Janssen Pharmaceutica Inc. product PROPULSID, which was
withdrawn from general sale and restricted to limited use in
2000. In the wake of publicity about those events, numerous
lawsuits have been filed against Janssen, which is a wholly
owned subsidiary of the Company, and the Company regarding
PROPULSID, in state and federal courts across the country.
There are approximately 429 such cases currently pending,
including the claims of approximately 5,900 plaintiffs. In
the active cases, 415 individuals are alleged to have died
from the use of PROPULSID. These actions seek substantial
compensatory and punitive damages and accuse Janssen and the
Company of inadequately testing for and warning about the
drug's side effects, of promoting it for off-label use and of
over promotion. In addition, Janssen and the Company have
entered into agreements (tolling agreements) with various
plaintiffs' counsel halting the running of the statutes of
limitations with respect to the potential claims of a
significant number of individuals while those attorneys
evaluate whether or not to sue Janssen and the Company on
their behalf.
In September 2001, the first ten plaintiffs in the
Rankin case, which comprises the claims of 155 PROPULSID
plaintiffs, went to trial in state court in Claiborne County,
Mississippi. The jury returned compensatory damage verdicts
for each plaintiff in the amount of $10 million, for a total
of $100 million. The trial judge thereafter dismissed the
claims of punitive damages. On March 4, 2002, the trial judge
reduced these verdicts to a total of $48 million, and denied
the motions of Janssen and the Company for a new trial. On
May 13, 2004, the Supreme Court of Mississippi reversed the
verdicts against Janssen and the Company, and remanded the
case to the trial court. The Supreme Court found the joint
trial of multiple plaintiffs' cases against Janssen was
prejudicial and directed the trial court to return the cases
of the individual plaintiffs for separate trials to their
home counties. A motion for rehearing was denied on August 5,
2004.
In April 2002, a state court judge in New Jersey denied
plaintiffs' motion to certify a national class of PROPULSID
users for purposes of medical monitoring and refund of the
costs of purchasing PROPULSID. An effort to appeal that
ruling has been denied. In June 2002, the federal judge
presiding over the
21
PROPULSID Multi-District Litigation in New Orleans, Louisiana
similarly denied plaintiffs' motion there to certify a
national class of PROPULSID users. Plaintiffs in the Multi-
District Litigation have said they are preserving their right
to appeal that ruling, and other complaints filed against
Janssen and the Company include class action allegations,
which could be the basis for future attempts to have classes
certified.
On February 5, 2004, Janssen announced that it had
reached an agreement in principle with the Plaintiffs
Steering Committee (PSC), of the PROPULSID Federal Multi-
District Litigation (MDL), to resolve federal lawsuits
related to PROPULSID. There are approximately 4,000
individuals included in the Federal MDL of whom approximately
300 are alleged to have died from use of the drug. The
agreement becomes effective once 85 percent of the death
claims, and 75 percent of the remainder, agree to the terms
of the settlement. In addition, 12,000 individuals who have
not filed lawsuits, but whose claims are the subject of
tolling agreements suspending the running of the statutes of
limitations against those claims, must also agree to
participate in the settlement before it will become
effective. Those agreeing to participate in the settlement
will submit medical records to an independent panel of
physicians who will determine whether the claimed injuries
were caused by PROPULSID and otherwise meet the standards for
compensation. If those standards are met, a court-appointed
special master will determine compensatory damages. If the
agreement becomes effective, Janssen will pay as compensation
a minimum of $69.5 million and a maximum of $90 million,
depending upon the number of plaintiffs who enroll in the
program. Janssen will also establish an administrative fund
not to exceed $15 million, and will pay legal fees to the PSC
up to $22.5 million, subject to court approval.
With respect to all the various PROPULSID actions
against them, Janssen and the Company dispute the claims in
those lawsuits and are vigorously defending against them
except where, in their judgment, settlement is appropriate.
Janssen and the Company believe they have adequate self-
insurance accruals and third party product liability
insurance with respect to these cases. In communications to
the Company, the excess insurance carriers have raised
certain defenses to their liability under the policies and to
date have declined to reimburse Janssen and the Company for
PROPULSID-related costs despite demand for payment. However,
in the opinion of the Company, those defenses are pro forma
and lack substance and the carriers will honor their
obligations under the policies either voluntarily or after
litigation. In March 2004, the Company commenced arbitration
against Allianz Underwriters Insurance Company, which issued
the first layer of applicable excess insurance coverage, to
obtain reimbursement of PROPULSID-related costs.
The Company's Ethicon, Inc. subsidiary has over the
last several years had a number of claims and lawsuits filed
against it relating to VICRYL sutures. The actions allege
that the sterility of VICRYL sutures was compromised by
inadequacies in Ethicon's
22
systems and controls, causing patients who were exposed to
these sutures to incur infections which would not otherwise
have occurred. Ethicon on several occasions recalled batches
of VICRYL sutures in light of questions raised about
sterility but does not believe any contamination of suture
products in fact occurred. In November 2003, a trial judge in
West Virginia certified for class treatment all West Virginia
residents who had VICRYL sutures implanted during Class I or
II surgeries from May 1, 1994 to December 31, 1997. The
certification is subject to later challenge following the
conclusion of discovery. A previous trial date has been
adjourned and not reset. Ethicon has been and intends to
continue vigorously defending against the claims.
In September 2004, plaintiffs in an employment
discrimination litigation initiated against the Company in
2001 moved to certify a class of all African American and
Hispanic salaried employees of the Company and its affiliates
in the United States, who were employed at any time from
November 1997 to the present. Plaintiffs seek monetary
damages for the period 1997 through the present (including
punitive damages) and equitable relief. The Company is
expected to file its response to plaintiffs' class
certification motion in the first quarter of 2005. A
decision by the district court is not expected before late
2005. The Company disputes the allegations in the lawsuit and
is vigorously defending against them.
Affirmative Stent Patent Litigation
In patent infringement actions tried in Delaware
Federal Court in late 2000, Cordis Corporation, a subsidiary
of Johnson & Johnson, obtained verdicts of infringement and
patent validity, and damage awards, against Boston Scientific
Corporation and Medtronic AVE, Inc., based on a number of
Cordis vascular stent patents. On December 15, 2000, the jury
in the damage action against Boston Scientific returned a
verdict of $324 million and on December 21, 2000, the jury in
the Medtronic AVE action returned a verdict of $271 million.
These sums represent lost profit and reasonable royalty
damages to compensate Cordis for infringement but do not
include pre or post judgment interest. In February 2001 a
hearing was held on the claims of Boston Scientific and
Medtronic AVE that the patents at issue were unenforceable
owing to alleged inequitable conduct before the patent
office.
In March and May 2002, the district judge issued post
trial rulings that confirmed the validity and enforceability
of the main Cordis stent patent claims but found certain
other Cordis patents unenforceable. Further, the district
judge granted Boston Scientific a new trial on liability and
damages and vacated the verdict against Medtronic AVE on
legal grounds. On August 12, 2003, the Court of Appeals for
the Federal Circuit found the trial judge erred in vacating
the verdict against Medtronic AVE and remanded the case to
the trial judge for further proceedings. Cordis filed motions
before the trial court on October 14, 2003 to reinstate the
verdicts against both Medtronic AVE and Boston
23
Scientific and to award interest and enter injunctions
against the stent products at issue in those two cases (the
GFX and MicroStent stents of Medtronic AVE and the NIR stent
of Boston Scientific) and colorable variations thereof.
Medtronic AVE and Boston Scientific are resisting
reinstatement of these verdicts and will likely attempt to
appeal to the Court of Appeals for the Federal Circuit once
judgments are entered.
In January 2003, Cordis filed an additional patent
infringement action against Boston Scientific in Delaware
Federal Court accusing its Express2 and TAXUS stents of
infringing one of the Cordis patents involved in the earlier
actions against Boston Scientific and Medtronic AVE. In
February 2003, Cordis moved in that action for a preliminary
injunction seeking to bar the introduction of the TAXUS stent
based on that patent. On November 21, 2003, the district
judge denied that request for a preliminary injunction and
that decision was affirmed by the Court of Appeals for the
Federal Circuit in May 2004. Cordis also has pending in
Delaware Federal Court another action against Medtronic AVE
accusing Medtronic AVE of infringement by sale of stent
products introduced by Medtronic AVE subsequent to its GFX
and MicroStent products, the subject of the earlier action
referenced above.
In early June 2003, an arbitration panel in Chicago, in
a preliminary ruling, found in favor of Cordis in its
arbitration against ACS/Guidant involving infringement by
ACS/Guidant of a Cordis stent patent. On August 19, 2003, the
panel confirmed that ruling, rejecting the challenge of
ACS/Guidant. Under the terms of an earlier agreement between
Cordis and ACS/Guidant, the arbitration panel's ruling
obligated ACS/Guidant to make a payment of $425 million to
Cordis which was made in the fiscal fourth quarter of 2003.
As a result of resolving this matter, in the fiscal fourth
quarter, $230 million was recorded in other income and
expense (approximately $142 million after tax) relating to
past periods. The balance of the award, $195 million
(approximately $120 million after tax), will be recognized in
income in future periods over the estimated remaining life of
the intellectual property. No additional royalties for
ACS/Guidant's continued use of the technology and no
injunction are involved.
Patent Litigation Against Various Johnson & Johnson Operating
Companies
The products of various Johnson & Johnson operating
companies are the subject of various patent lawsuits, which
could potentially affect the ability of those operating
companies to sell those products, or require the payment of
past damages and future royalties. The following chart
summarizes various patent lawsuits concerning important
products of Johnson & Johnson operating companies:
24
Product Patents Plaintiff/ Court Trial Date
J&J Patent Date Filed
Oper Holder
Company
Stents Cordis Jang Boston D.Del. 6/13/05 3/03
Scientific
Corporation
Drug Cordis Ding Boston D.Del. 6/13/05 4/03
Eluting Scientific
Corporation
Stents
Drug Cordis Kunz Boston D.Del. 10/17/05 12/03
Eluting Grainger Scientific
Corporation
Stents
Stents Cordis Rockey Arlaine and S.D.Fla. TBD 7/02
Gena Rockey
Inc.
Stents Cordis Boneau Medtronic D.Del. TBD 4/02
Inc.
Two- Cordis Kastenho- Boston N.D.Cal. TBD 2/02
layer fer Scientific
Cathet- Forman Corporation
ers
Remi- Centocor Cerami Rockefeller E.D.Tex. TBD 4/04
cade University
and
Chiron
Corporation
Two- Cordis Kastenho- Boston Belgium TBD 12/03
layer fer Scientific
Cathet- (Schneider)
ers
Stents Cordis Israel Medinol Multiple 1st 5/2003
trial -
E.U. Netherl 5/2004
juris- ands
dictions Jan
2005
With respect to all of these matters, the Johnson &
Johnson operating company involved is vigorously defending
against the claims of infringement and disputing where
appropriate the validity and enforceability of the patent
claims asserted against it.
Litigation Against Filers of Abbreviated New Drug
Applications (ANDAs)
The following chart indicates lawsuits pending against
generic firms that filed Abbreviated New Drug Applications
seeking to market generic forms of products sold by various
subsidiaries of the Company prior to expiration of the
applicable patents covering those products. These ANDAs
typically include allegations of non-infringement,
invalidity and unenforceability
25
of these patents. In the event the subsidiary of the Company
involved is not successful in these actions, the firms
involved will then introduce generic versions of the product
at issue resulting in very substantial market share and
revenue losses for the product of the Company's subsidiary.
Brand Name Patent/NDA Generic Court Trial Date
Product Holder Challenger Date Filed
Aciphex Eisai Teva SDNY TBD 11/20/03
20 mg delay (for Dr. SDNY TBD 11/17/03
release Janssen) Reddy's
tablet
Mylan SDNY TBD 01/28/04
Ditropan XL Ortho Mylan DWV 2/8/05 5/2/03
McNeil,
5, 10, 15 mg ALZA Impax NDCal TBD 9/4/03
controlled
release
tablet
Duragesic Janssen, Mylan D Vt 8/25/03 1/25/02
ALZA
25, 50, 75,
100
micrograms/hr
patch
Levaquin Daiichi, Mylan DWV 5/24/04 2/22/02
Tablets
JJPRD,
250, 500, 750 Ortho McNeil Teva DNJ TBD 6/11/06
mg tablets
Levaquin Daiichi, Bedford/ DNJ TBD 3/24/03
Injectable
Single use JJPRD, Ortho Ben
vials and 5 Venue
ml/mg
premix McNeil Sicor DNJ TBD 12/15/03
(Teva)
Levaquin Daiichi, American DNJ TBD 12/19/03
Injectable
Single use JJPRD, Ortho Pharmac-
vials McNeil eutical
Partners
Quixin Daiichi, Hi-Tech DNJ TBD 12/18/03
Opthalmic
Solution
(Levo-
floxacin) Ortho McNeil Pharmacal
Opthalmic
solution
Ortho Tri- Ortho McNeil Barr DNJ TBD 10/01/03
cyclen LO
0.18 mg/0.025
mg, 0.215
mg/0.025 mg
and 0.25
mg/0.025 mg
Risperdal Janssen Mylan DNJ TBD 12/29/03
Tablets
..25, 0.5, 1, Dr. DNJ TBD 12/29/03
2, 3, 4 mg Reddy's
tablets
Sporanox Janssen Eon Labs EDNY 5/17/04 4/15/01
100 mg
capsule
Topamax Ortho McNeil Mylan DNJ TBD 04/12/04
25, 100, 200
mg tablet
Ultracet Ortho McNeil Kali DNJ TBD 11/25/02
(Par)
37.5 tram/325 Teva DNJ TBD 02/25/04
apap tablet
Caraco ED TBD 09/22/04
Mich
26
In the Duragesic matter referenced above, the district
court in March 2004 found ALZA's patent valid, enforceable
and infringed by Mylan's generic. Mylan is appealing that
ruling. In June 2004, FDA ruled that Mylan's ANDA would be
subject to ALZA's period of pediatric exclusivity ending in
January 2005. In late June, Mylan filed actions against FDA
seeking to require the agency to grant it approval to market
on July 24, 2004, the day after the Duragesic patent expired.
On August 17, 2004, the district court ruled against Mylan
and in favor of FDA's recognition of pediatric exclusivity
for Duragesic. Mylan has appealed that ruling to the Court of
Appeals for the District of Columbia Circuit.
In the action against Mylan involving Levaquin, post-
trial papers following the second phase of the trial were
submitted to the district court in July 2004 and a decision
is expected in the fourth quarter of 2004.
In the action against Eon Labs involving Sporanox, the
district court ruled on July 28, 2004 that Janssen's patent
was valid but not infringed by Eon's generic. Janssen has
appealed this ruling to the Court of Appeals for the Federal
Circuit.
In the action against Kali involving Ultracet, Kali has
moved for summary judgment on the issues of infringement and
invalidity. The briefing on that motion was completed in
October 2004 and a decision is expected in the fourth quarter
of 2004. With respect to claims other than that at issue in
the litigation against Kali, Ortho-McNeil has filed a reissue
application in the U.S. Patent and Trademark Office seeking
to narrow the scope of the claims.
In the action against Mylan involving Ditropan XL,
Mylan moved for summary judgment on July 14, 2004 on the
issues of non-infringement and invalidity. A decision is
expected in the fourth quarter of 2004.
In the action against Mylan relating to Topamax,
Mylan on October 8, 2004 filed a motion for summary judgment
of non-infringement of Ortho-McNeil's patent. A decision is
expected after January 1, 2005.
With respect to all of the above matters, the Johnson &
Johnson operating company involved is vigorously defending
the validity and enforceability and asserting the
infringement of its own or its licensor's patents.
Average Wholesale Price (AWP) Litigation
Johnson & Johnson and its pharmaceutical operating
companies, along with numerous other pharmaceutical
companies, are defendants in a series of lawsuits in state
and federal courts involving allegations that the pricing and
marketing of certain pharmaceutical products amounted to
fraudulent and otherwise actionable conduct because, among
other things, the companies
27
allegedly reported an inflated Average Wholesale Price for
the drugs at issue. Most of these cases, both federal actions
and state actions removed to federal court, have been
consolidated for pre- trial purposes in a Multi-District
Litigation (MDL) in federal court in Boston, Massachusetts.
The plaintiffs in these cases include classes of private
persons or entities that paid for
any portion of the purchase of the drugs at issue based on
AWP, and state government entities that made Medicaid
payments for the drugs at issue based on AWP.
Ethicon Endo-Surgery, Inc., a Johnson & Johnson
operating company which markets endoscopic surgical
instruments, and the Company, are named defendants in a North
Carolina state court class action lawsuit alleging AWP
inflation and improper marketing activities against TAP
Pharmaceuticals. Ethicon Endo- Surgery, Inc. is a defendant
based on claims that several of its former sales
representatives are alleged to have been involved in
arbitrage of a TAP drug. The allegation is that these sales
representatives persuaded certain physicians in states where
the drug's price was low to purchase from TAP excess
quantities of the drug and then resell it in states where its
price was higher. Ethicon Endo- Surgery, Inc. and the Company
deny any liability for the claims made against them in this
case and are vigorously defending against it. On April 24,
2003, the trial judge certified a national class of
purchasers of the TAP product at issue. On July 6, 2004, that
class was decertified by the North Carolina Court of Appeals
and the matter remanded to the trial court for additional
consideration.
Other
The New York State Attorney General's office and the
Federal Trade Commission issued subpoenas in January and
February 2003 seeking documents relating to the marketing of
sutures and endoscopic instruments by the Company's Ethicon,
Inc. and Ethicon Endo-Surgery, Inc. subsidiaries. The
Connecticut Attorney General's office also issued a subpoena
for the same documents. These subpoenas focus on the bundling
of sutures and endoscopic instruments in contracts offered to
Group Purchasing Organizations and individual hospitals in
which discounts are predicated on the hospital achieving
specified market share targets for both categories of
products. The operating companies involved have responded to
the subpoenas.
On June 26, 2003, the Company received a request for
records and information from the U.S. House of
Representatives' Committee on Energy and Commerce in
connection with its investigation into pharmaceutical
reimbursements and rebates under Medicaid. The Committee's
request focuses on the drug REMICADE (infliximab), marketed
by the Company's Centocor, Inc. subsidiary. On July 2, 2003,
Centocor received a request that it voluntarily provide
documents and information to the criminal division of the
U.S. Attorney's Office, District of New Jersey, in connection
with its investigation into various Centocor marketing
practices. Both
28
the Company and Centocor have responded to these requests for
documents and information.
On August 1, 2003, the Securities and Exchange
Commission (SEC) advised the Company of its informal
investigation under the Foreign Corrupt Practices Act of
allegations of payments to Polish
governmental officials by U.S. pharmaceutical companies. On
November 21, 2003, the SEC advised the Company that the
investigation had become formal and issued a subpoena for the
information previously requested in an informal fashion, plus
other background documents. The Company and its operating
units in Poland are responding to these requests.
On December 8, 2003, the Company's Ortho-McNeil
Pharmaceutical unit received a subpoena from the United
States Attorney's office in Boston, Massachusetts seeking
documents relating to the marketing, including alleged off-
label marketing, of the drug TOPAMAX (topiramate).
Ortho-McNeil is cooperating in responding to the subpoena.
In October 2004, the U.S. Attorney's Office in Boston asked
attorneys for Ortho-McNeil Pharmaceutical to cooperate in
facilitating the subpoenaed testimony of several present
and former Ortho-McNeil witnesses before a grand jury in
Boston. That requested cooperation is being provided.
On January 20, 2004, the Company's Janssen unit
received a subpoena from the Office of the Inspector General
of the United States Office of Personnel Management seeking
documents concerning sales and marketing of, any and all
payments to physicians in connection with sales and marketing
of, and clinical trials for, RISPERDAL from 1997 to 2002.
Janssen is cooperating in responding to the subpoena.
In April 2004, the Company's pharmaceutical units were
requested to submit information to the Senate Finance
Committee on their use of the "nominal pricing exception" in
calculating Best Price under the Medicaid Rebate Program.
This request was sent to manufacturers for the top twenty
drugs reimbursed under the Medicaid Program. The Company's
pharmaceutical units have responded to the request.
On July 27, 2004, the Company received a letter request
from the New York State Attorney General's Office for
documents pertaining to marketing, off-label sales and
clinical trials for Topamax, Risperdal, Procrit, Reminyl,
Remicade and Aciphex. The Company is responding to the
request.
On August 9, 2004, Johnson & Johnson Health Care
Systems, Inc., a Johnson & Johnson operating company,
received a subpoena from the Dallas, Texas U. S. Attorney's
Office seeking documents relating to the relationships
between the group purchasing organization Novation and HCS
and other J&J operating companies. The Company's operating
entities involved are responding to the subpoena.
On September 30, 2004, Ortho Biotech Inc. received a
29
subpoena from the U.S. Office of Inspector General's Denver,
Colorado field office seeking documents directed to sales and
marketing of Procrit from 1997 to the present. Ortho Biotech
is responding to the subpoena.
After a remand from the Federal Circuit Court of
Appeals in January 2003, a partial retrial was commenced in
October and concluded in November 2003 in Boston,
Massachusetts in the action Amgen v. Transkaryotic Therapies,
Inc. (TKT) and Aventis Pharmaceutical, Inc. The matter is a
patent infringement action brought by Amgen against TKT, the
developer of a gene-activated EPO product, and Aventis, which
holds marketing rights to the TKT product, asserting that
TKT's product infringes various Amgen patent claims. TKT and
Aventis dispute infringement and are
seeking to invalidate the Amgen patents asserted against
them. On October 15, 2004, the district court issued rulings
that upheld its initial findings in 2001, that Amgen's patent
claims were valid and infringed. Further proceedings and an
appeal will follow. The Amgen patents at issue in the case
are exclusively licensed to Ortho Biotech Inc., a Johnson &
Johnson operating company, in the U.S. for non-dialysis
indications. Ortho Biotech Inc. is not a party to the action.
On October 21, 2004, in a companion action brought by TKT and
Aventis against Amgen and Ortho Biotech's U.K. affiliate in
the United Kingdom, the House of Lords, the highest court in
the U.K., invalidated the pertinent claims of Amgen's U.K.
patent on EPO which expires in December 2004. The ruling
clears the way for the commercial launch of TKT's gene-
activated EPO product in the U.K., but has no effect outside
the U.K. Elsewhere in Western Europe, Amgen's counterpart
to the U.K. patent at issue in the proceeding also expires in
December 2004, except in France, where it expires in November
2007.
The Company is also involved in a number of other
patent, trademark and other lawsuits incidental to its
business. The ultimate legal and financial liability of the
Company in respect to all claims, lawsuits and proceedings
referred to above cannot be estimated with any certainty.
However, in the opinion of management, based on its
examination of these matters, its experience to date and
discussions with counsel, the ultimate outcome of legal
proceedings, net of liabilities already accrued in the
Company's consolidated balance sheet, is not expected to have
a material adverse effect on the Company's consolidated
financial position, although the resolution in any reporting
period of one or more of these matters could have a
significant impact on the Company's results of operations and
cash flows for that period.
NOTE 13 - SUBSEQUENT EVENTS
On October 7, 2004 Johnson & Johnson Consumer France S.A.S.
acquired Biapharm SAS, a privately held French producer and
marketer of skin care products centered around the leading
brand BIAFINE(r) which is used as a radiotherapy burn-healing
product.
The American Jobs Creation Act of 2004 was signed into law
on October 22, 2004. The Company is currently evaluating the
impact
30
of this law.
On October 26, 2004, the FDA approved the CHARITE(tm)
Artificial Disc, a device that treats severe low back pain by
replacing a damaged or worn out spinal disc with an
artificial one. This is the first FDA approval of such a
device for spinal discs.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Analysis of Consolidated Sales
For the first fiscal nine months of 2004, worldwide sales
were $34.6 billion, an increase of 13.0% over 2003 first
fiscal nine month sales of $30.6 billion. The impact of
foreign currencies
accounted for 3.6% of the total reported fiscal nine month
increase.
Sales in the U.S. were $20.4 billion in the first fiscal
nine months of 2004, which represented an increase of 9.9%
over the same period last year. Sales in international
markets were $14.2 billion, which represented an increase of
17.8%, of which 9.0% was due to currency fluctuations.
All geographic areas throughout the world achieved sales
increases during the first fiscal nine months of 2004 as
sales increased 17.6% in Europe, 15.9% in the Western
Hemisphere (excluding the U.S.) and 19.1% in the Asia-
Pacific, Africa region. These sales gains include the
positive impact of currency fluctuations between the U.S.
dollar and foreign currencies in Europe of 11.0%, in the
Western Hemisphere (excluding the U.S.) of 4.1% and in the
Asia-Pacific, Africa region of 7.5%.
For the fiscal third quarter of 2004, worldwide sales
were $11.6 billion, an increase of 10.5% over 2003 fiscal
third quarter
sales of $10.5 billion. The impact of foreign currencies
accounted for 2.8% of the total reported fiscal third
quarter 2004 increase.
Sales by U.S. companies were $6.8 billion in the
fiscal third quarter of 2004, which represented an increase
of 5.9%. Sales by international companies were $4.8
billion, which
represented an increase of 17.9%, of which 7.1% was
due to currency fluctuations.
All geographic areas throughout the world posted sales
increases during the fiscal third quarter of 2004 as
sales increased 17.7% in Europe, 10.9% in the Western
Hemisphere (excluding the U.S.) and 21.4% in the Asia-
Pacific, Africa region. These sales gains include the
positive impact of currency fluctuations between
the U.S. dollar and foreign currencies in Europe of 9.5%, in
the Western Hemisphere (excluding the U.S.) of 1.5% and in
the Asia-Pacific, Africa region of 5.5%.
Analysis of Sales by Business Segments
Consumer
Consumer segment sales in the first fiscal nine months of
2004 were $6.1 billion, an increase of 11.4% over the same
period a year ago with 7.9% of operational growth and a
positive currency
31
impact of 3.5%. U.S. Consumer segment sales increased by 6.0%
while international sales gains of 17.5% included a positive
currency impact of 7.5%.
Major Consumer Franchise Sales - First Fiscal Nine Months
Total Operations Currency
2004 2003 %Change %Change %Change
OTC &
Nutritionals $1,662 $1,433 16.0% 14.5% 1.5%
Skin Care 1,580 1,334 18.5 13.5 5.0
Women's
Health 1,087 1,015 7.1 2.8 4.3
Baby &
Kids Care 1,064 971 9.6 4.9 4.7
Other 678 698 (2.9) (4.8) 1.9
Total $6,071 $5,451 11.4% 7.9% 3.5%
Consumer segment sales in the fiscal third quarter of 2004
were $2.0 billion, an increase of 9.9% over the same period
a year ago with 7.4% of operational growth and a positive
currency impact of 2.5%. U.S. Consumer segment sales
increased by 4.0% while international sales gains of 16.8%
included a positive currency impact of 5.4%.
Major Consumer Franchise Sales - Fiscal Third Quarter
Total Operations Currency
2004 2003 %Change %Change %Change
OTC &
Nutritionals $ 566 $ 498 13.7% 12.7% 1.0%
Skin Care 509 421 20.9 17.1 3.8
Women's
Health 371 358 3.6 .5 3.1
Baby &
Kids Care 361 337 7.4 3.8 3.6
Other 217 227 (4.4) (5.3) .9
Total $2,024 $1,841 9.9% 7.4% 2.5%
Consumer segment sales growth in the fiscal third quarter
was attributable to strong sales performance in the major
franchises
in this segment including McNeil Over-The-Counter and
Nutritional products, Skin Care, and Baby & Kids Care in the
U.S. The growth in McNeil Over-The-Counter and Nutritional
products was driven by the acquisition of the remaining 50%
stake in the Johnson & Johnson-Merck Consumer Pharmaceuticals
Co. non-prescription pharmaceuticals joint venture, and the
continued growth of SPLENDA(r) Tabletop brand no calorie
sweetener, partially offset by the sale of the
SPLENDA(r)ingredients business on April 2, 2004. The Skin
Care franchise sales growth was broad based, with strong
performance by the NEUTROGENA(r), AVEENO(r), RoC(r) and CLEAN
& CLEAR(r) brands. NEUTROGENA(r) achieved strong growth in
the U.S. with the new line of Advanced Solutions
(tm)products, and RoC(r) had strong international
growth with the Retinol Gold brand. The Baby & Kids Care
franchise growth in the U.S. was led by
JOHNSON'S(r)SOFTWASH(tm), Milk Lotion and Milk Bath products.
Pharmaceutical
Pharmaceutical segment sales in the first fiscal nine
months of 2004 were $16.3 billion, an increase of 13.2% over
the same period
32
a year ago with 10.4% of this change due to operational
increases
and the remaining 2.8% increase related to the positive
impact of currency. The U.S. Pharmaceutical sales increase
was 11.8% and the growth in international Pharmaceutical
sales was 16.4% which included 9.0% related to the positive
impact of currency.
Major Pharmaceutical Product Sales - First Fiscal Nine Months
Total Operations Currency
2004 2003 %Change %Change %Change
PROCRIT(r)/
EPREX(r) $2,739 $3,017 (9.2%) (11.8%) 2.6%
RISPERDAL(r) 2,203 1,855 18.8 14.4 4.4
REMICADE(r) 1,548 1,273 21.6 21.6 0.0
DURAGESIC(r) 1,548 1,200 29.0 24.5 4.5
TOPAMAX(r) 1,029 747 37.7 35.4 2.3
Hormonal
Contraceptives 975 847 15.1 14.0 1.1
LEVAQUIN(r)/
FLOXIN(r) 921 824 11.9 12.0 (0.1)
Other 5,325 4,621 15.2 11.6 3.6
Total $16,288 $14,384 13.2% 10.4% 2.8%
Pharmaceutical segment sales in the fiscal third quarter
of 2004 were $5.5 billion, an increase of 13.4% over the same
period a year ago with 11.1% of this change due to
operational increases and the remaining 2.3% increase related
to the positive impact of currency. The U.S. Pharmaceutical
sales increase was 12.5% and the growth in international
Pharmaceutical sales was 15.5% which included 7.2% related to
the positive impact of currency.
Major Pharmaceutical Product Sales - Fiscal Third Quarter
Total Operations Currency
2004 2003 %Change %Change %Change
PROCRIT(r)/
EPREX(r) $ 887 $1,005 (11.7%) (13.7%) 2.0%
RISPERDAL(r) 746 599 24.6 20.8 3.8
REMICADE(r) 545 443 22.9 22.9 0.0
DURAGESIC(r) 536 424 26.7 22.8 3.9
TOPAMAX(r) 365 253 44.6 42.7 1.9
Hormonal
Contraceptives 304 292 4.2 3.2 1.0
LEVAQUIN(r)/
FLOXIN(r) 270 253 7.0 7.2 (0.2)
Other 1,832 1,566 17.0 14.0 3.0
Total $5,485 $4,835 13.4% 11.1% 2.3%
Pharmaceutical segment sales growth was adversely affected
by the sales decline of PROCRIT(r) (Epoetin alfa) and
EPREX(r) (Epoetin alfa) due to increased competition.
Combined, PROCRIT (r)(sold in the U.S.) and EPREX(r)(sold
internationally) sales declined 11.7% in the fiscal third
quarter of 2004 versus the
same period a year ago. Sales of PROCRIT(r) in the fiscal
third
quarter were down 12.7% versus the same period last year. On
a unit basis, PROCRIT(r) declined slightly when compared with
the fiscal third quarter 2003.
33
RISPERDAL(r) (risperidone), a medication that treats the
symptoms of schizophrenia, fueled by RISPERDAL(r) CONSTA(tm)
grew by 24.6% in the fiscal third quarter 2004. REMICADE(r)
(infliximab), a novel monoclonal antibody therapy indicated
to treat Crohn's disease and used in the treatment of
rheumatoid arthritis, continued to maintain its leadership
position in the
growing Anti-TNF-a (tumor necrosis factor alpha) market. In
September the FDA approved REMICADE(r) for expanded use as a
first line therapy in patients with moderate to severe
rheumatoid arthritis. Sales of DURAGESIC(r) (fentanyl
transdermal systems) grew by 26.7% in the fiscal third
quarter 2004. In August, the U.S. District Court for the
District of Columbia affirmed the pediatric exclusivity for
DURAGESIC (r) granted to Janssen by the FDA. The pediatric
exclusivity will expire on January 23, 2005. TOPAMAX(r)
(topiramate), an antiepileptic and recently approved for use
in the prevention of migraines, had strong growth over the
same period a year ago.
Growth was also achieved in DITROPAN XL(r) (oxybutynin
chloride), a treatment for overactive bladder, REMINYL(r)
(galantamine (HBr)), a treatment for patients with mild to
moderate Alzheimer's disease, NATRECOR(r) (nesiritide), a
treatment for acute congestive heart failure, and
ULTRACET(r)(37.5
mg tramadol hydrochloride/325 mg acetaminophen tablets), used
in the management of acute pain. CONCERTA(r)(methylphenidate
HCl), a treatment for attention deficit hyperactivity disorder,
sales continued to grow despite the current absence of patent
exclusivity in the U.S. At present, the FDA has not approved
any generic that is substitutable for CONCERTA(r).
Medical Devices and Diagnostics
Medical Devices and Diagnostics segment sales in the first
fiscal nine months of 2004 were $12.2 billion, an increase of
13.6% over
the same period a year ago with 9.1% of this change due to
operational increases and the remaining 4.5% increase related
to the positive impact of currency. The U.S. Medical Devices
and Diagnostics sales increase was 8.8% and the growth in
international Medical Devices and Diagnostics sales was 19.2%
which included 9.8% related to the positive impact of
currency.
Major Medical Devices and Diagnostics Franchise Sales - First
Fiscal Nine Months
Total Operations Currency
2004 2003 %Change %Change %Change
DePuy $2,468 $2,206 11.9% 7.9% 4.0%
Cordis 2,298 1,811 26.9 23.1 3.8
Ethicon 2,085 1,942 7.3 1.7 5.6
Ethicon Endo-
Surgery 2,047 1,894 8.1 3.7 4.4
LifeScan 1,240 1,040 19.2 15.0 4.2
Vision Care 1,123 959 17.2 11.6 5.6
Ortho-Clinical
Diagnostics 928 868 7.0 2.5 4.5
Other 48 53 (9.4) (8.1) (1.3)
Total $12,237 $10,773 13.6% 9.1% 4.5%
34
Medical Devices and Diagnostics segment sales in the fiscal
third quarter of 2004 were $4.0 billion, an increase of 7.0%
over the same period a year ago with 3.6% of this change due
to operational increases and the remaining 3.4% increase
related to the positive
impact of currency. The U.S. Medical Devices and Diagnostics
sales decrease was 3.4% and the growth in international
Medical Devices and Diagnostics sales was 20.6% which
included 7.8% related to the positive impact of currency.
Major Medical Devices and Diagnostics Franchise Sales -
Fiscal Third Quarter
Total Operations Currency
2004 2003 %Change %Change %Change
DePuy $ 790 $ 718 10.0% 6.9% 3.1%
Cordis 756 791 (4.4) (7.0) 2.6
Ethicon 687 640 7.3 3.0 4.3
Ethicon Endo-
Surgery 672 622 8.0 4.7 3.3
LifeScan 420 362 16.1 12.6 3.5
Vision Care 392 343 14.6 10.2 4.4
Ortho-Clinical
Diagnostics 309 287 7.9 4.4 3.5
Other 18 16 12.5 3.8 8.7
Total $4,044 $3,779 7.0% 3.6% 3.4%
DePuy franchise growth in the fiscal third quarter was
primarily due to DePuy's orthopaedic joint reconstruction
products including the knee and hip product lines. Solid
growth was also reported in the area of spine. The positive
growth was partially offset by the sale of the Castings
business in the first quarter of 2004 and weakness in the
neuro and trauma lines.
Cordis sales declined by 4.4% in the fiscal third quarter
2004. This was the result of a 37% decrease in U.S. sales of
the CYPHER(r) Sirolimus-eluting Stent when compared to the
fiscal third quarter 2003. The third quarter of this year is
the second full quarter with a competitive product in the
U.S. marketplace. Internationally, Cordis sales grew by
51.3% in the fiscal third quarter. This included 41.8% of
operational growth and a favorable currency impact of 9.5%.
The launch of CYPHER(r)in Japan during the fiscal third
quarter 2004 contributed to the strong international sales
growth.
On April 2, 2004 and July 22, 2004, Cordis Cardiology
Division of Cordis Corporation, a Johnson & Johnson Company,
received warning letters from the FDA regarding observations
concerning Good Manufacturing Practice regulations. These
observations followed post-approval site inspections completed
in 2003, including sites involved in the production of the
CYPHER(r) stent. In response to the warning letters, Cordis
as met periodically with the FDA representatives at the Center
and the Districts advising them of the progress in addressing
the Quality System issues.
Ethicon franchise growth was related to strong sales of
VICRYL
35
(r)(polyglactin 910) PLUS antibacterial coated sutures, as
well as new products such as the Multipass needle introduced
in April 2004. Ethicon Endo-Surgery franchise experienced
growth in
Endocutter sales that include products used in performing
bariatric procedures, an important focus for the franchise.
Strong sales in the Advanced Sterilization product line were
also a key contributor to results in the quarter.
LifeScan franchise growth was due to increased sales of
the OneTouch(r) Ultra(r) brand primarily in international
markets.
Vision Care franchise growth was led by continued success in
the Japanese market as well as strong growth in the U.S.
market led by the introduction of Acuvue(r) Advance(tm) with
HydraClear(tm), a silicone hydrogel material launched
nationwide in the U.S. in January 2004.
Cost of Goods Sold and Selling, General and Administrative
Expenses
Consolidated costs of goods sold for the first fiscal nine
months of 2004 decreased to 28.1% from 28.3% of sales over
the same period a year ago. The cost of goods sold for the
fiscal third quarter of 2004 was 27.6% of sales. The cost of
goods sold as a percentage of sales in the fiscal third
quarter of 2003 was 28.5%. The favorable change in the third
fiscal quarter of 2004 was primarily in the Medical Devices
and Diagnostics segment, related to positive mix, divestiture
of low gross margin businesses, and the absence of certain
CYPHER(r)stent related costs incurred in 2003. There were
also cost containment activities across all segments.
Consolidated selling, general and administrative expenses
as a percent to sales for the first fiscal nine months of
2004 were 32.4% versus 32.9% for the same period a year ago,
which represented an improvement of .5% as a percent of
sales. This improvement was primarily due to the Company's
focus on managing expenses. Consolidated selling, general and
administrative expenses as a percent to sales increased from
32.8% in the fiscal third quarter of 2003 to 33.3% in the
fiscal third quarter of 2004. This increase was primarily
attributable to decisions to increase investment spending
behind certain OTC and Consumer brands and certain products
and regions in the Pharmaceutical segment.
Research & Development
Research activities represent a significant part of the
Company's business. These expenditures relate to the
development of new products, improvement of existing
products, technical support of products and compliance with
governmental regulations for the protection of the consumer.
Worldwide costs of research activities, for the first fiscal
nine months of 2004 were $3.5 billion, an increase of 8.8%
over the same period a year ago. Research and development
spending in the fiscal third quarter of 2004 was $1.2 billion,
an increase of 1.8% over the fiscal third quarter of 2003.
36
In-Process Research & Development
In the fiscal third quarter of 2004, the Company recorded In-
process Research & Development (IPR&D) charges of $18 million
before tax and $12 million after tax as a result of the
acquisition of U.S. commercial rights to certain patents and
know-how in the field of sedation and analgesia from Scott
Lab, Inc.
In the fiscal second quarter of 2003, the Company recorded
In-process Research & Development charges of $900 million
before and after tax related to acquisitions. These
acquisitions included Scios Inc. and the Link Spine Group,
Inc. Scios Inc. is a biopharmaceutical company with a
marketed product for
cardiovascular disease and research projects focused on auto-
immune diseases. Link Spine Group, Inc. was acquired to
provide the Company with exclusive worldwide rights to the SB
Charite Artificial Disc for the treatment of spine disorders.
In the fiscal first quarter of 2003, the Company
recorded IPR&D charges of $15 million after tax ($18
million before tax) related to acquisitions. These
acquisitions included certain assets of Orquest, Inc., a
privately-held biotechnology company focused on developing
biologically-based implants for orthopaedics spine
surgery, and 3-Dimensional Pharmaceuticals, Inc., a
company with a technology platform focused on the
discovery and development of potential new drugs in early
stage development for the treatment of cardiovascular
diseases, oncology and inflammation.
Other (Income) Expense, Net
Other (income) expense included gains and losses related to
the
sale and write-down of certain equity securities of the
Johnson &
Johnson Development Corporation, losses on the disposal of
assets, currency gains & losses, minority interests,
litigation
settlement expense as well as royalty income. The
unfavorable change in other (income) expense in the first
fiscal nine months of 2004 as compared to the same period a
year ago was due primarily to the gain associated with the
Vascular Access divestiture in the fiscal second quarter of
2003. The unfavorable change in other (income) expense in
the fiscal third quarter of 2004 as compared to the same
period a year ago was due primarily to the positive impact in
2003 of the recovery of a loan that had been written off in a
prior year, as well as the establishment of an insurance
receivable reserve and an increase in asset write-offs in the
fiscal third quarter of 2004.
OPERATING PROFIT BY SEGMENT
Consumer Segment
Operating profit for the Consumer segment as a percent to
sales in the first fiscal nine months of 2004 was 19.6%
versus 21.1% over the same period a year ago. This decrease
was primarily due to ongoing costs associated with a plant
closure and the decision to increase investment spending
behind certain OTC and Consumer brands. Operating profit as
a percent to sales in the fiscal third quarter of 2004 was
17.7% versus 19.8% over the same period a year ago. This
decrease was due to the decision to increase investment
spending behind certain OTC and Consumer brands.
37
Pharmaceutical Segment
Operating profit for the Pharmaceutical segment as a percent
to sales in the first fiscal nine months of 2004 was 37.6%
versus 32.7% over the same period a year ago. Excluding
IPR&D charges,
operating profit as a percent to sales in the first fiscal
nine months of 2003 was 37.8%. Operating profit as a percent
to sales in the fiscal third quarter of 2004 was 35.0% versus
36.2% over the same period a year ago. The decrease in 2004
was due to the decision to increase investment spending for
certain products and in certain regions.
Medical Devices and Diagnostics Segment
Operating profit for the Medical Devices and Diagnostics
segment as a percent to sales in the first fiscal nine months
of 2004 was 26.0% versus 21.6% over the same period a year
ago. Excluding IPR&D charges,
operating profit as a percent to sales was 26.1% in the first
fiscal nine months of 2004, and 23.3% in the first fiscal
nine months of 2003. Operating profit as a percent to sales
in the fiscal third quarter of 2004 was 26.0% versus 24.6% in
the fiscal third quarter of 2003. Excluding IPR&D charges,
operating profit as a percent to sales in the fiscal third
quarter of 2004 was 26.5%. The increase in 2004 was due to
favorable sales mix, the impact of divestitures of low gross
margin businesses, the absence of certain CYPHER(r) stent
related costs incurred in 2003, and cost containment
activities.
Interest (Income) Expense
Interest income decreased in both the first fiscal nine
months and
fiscal third quarter of 2004 as compared to the same periods
a year ago. The decrease was due to a decline in the average
rate on investments partially offset by a higher average cash
balance. The cash balance including marketable securities at
the end of the fiscal third quarter of 2004 was $13.2
billion, which was
$4.2 billion higher than the same period a year ago.
Interest expense decreased in both the first fiscal nine
months and fiscal third quarter of 2004 as compared to the
same periods a year ago. The decrease is due to the
redemption of commercial paper during 2004.
Provision For Taxes on Income
The worldwide effective income tax rates for the first fiscal
nine months of 2004 and 2003 were 28.6% and 32.5%. The
decrease in the effective tax rate for the first fiscal nine
months of 2004 compared with the same period a year ago was
principally due to 2003 acquisition related IPR&D charges
that are non-deductible for tax purposes. The 2003 tax rate
excluding the effect of IPR&D was 29.2%.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Cash generated from operations provided the major sources of
funds for the growth of the business, including working
capital, capital expenditures, acquisitions, share
repurchases, dividends and debt repayments. In the first
fiscal nine months of 2004, cash flow
38
from operations was $8.7 billion, an increase of $1.6 billion
over
the same period a year ago. The major factor contributing to
the
increase in cash generated from operations was from a net
income increase of $1.0 billion, net of the non-cash impact
of IPR&D charges. Net cash used by investing activities
decreased by $1.5
billion versus the same period a year ago due to a decrease
in acquisition activity offset by an increase in the purchase
of investments. Net cash used by financing activities
increased by $1.9 billion primarily due to a decrease in
proceeds from short and long term debt.
On October 1, 2004 the Company announced that it had
exercised its option to redeem all of its $300,000,000
aggregate principal amount of 8.72% debentures due 2024 that
remained outstanding on the redemption date, November 1,
2004.
Dividends
On July 20, 2004, the Board of Directors declared a regular
cash dividend of $0.285 per share, payable on September 7,
2004 to shareholders of record as of August 17, 2004.
On October 22, 2004, the Board of Directors declared a
regular cash dividend of $0.285 per share, payable on
December 7, 2004 to shareholders of record as of November 16,
2004. The Company expects to continue the practice of paying
regular cash dividends.
OTHER INFORMATION
New Accounting Standards
In January 2003, the FASB issued FIN 46, "Consolidation of
Variable Interest Entities - an interpretation of ARB No.
51", and in December 2003, issued a revised FIN 46(R),
"Consolidation of Variable Interest Entities - an
interpretation of ARB No. 51", both of which address
consolidation of variable interest entities. FIN 46 expanded
the criteria for consideration in determining whether a
variable interest entity should be consolidated by a business
entity, and requires existing unconsolidated variable
interest entities (which include, but are not limited to,
Special Purpose Entities, or SPEs) to be consolidated by
their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. This
interpretation was immediately applicable to variable
interest entities created after January 31,
2003. The adoption of this portion of FIN 46 did not have a
material effect on the Company's results of operations, cash
flows or financial position. FIN 46 is applicable in 2004 to
variable interest entities in which an enterprise holds a
variable interest that was acquired before February 1, 2003.
The adoption of this portion of FIN 46 did not have a
material effect on the results of operations, cash flows and
financial position of the Company.
In December 2003, the FASB issued FASB Staff Position (FSP)
FAS No. 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003", which is effective for interim or
annual financial statements of fiscal years ending after
December 7, 2003. The Company elected to defer adoption of
FSP FAS No. 106-1 until
39
authoritative guidance was issued, as allowed by the
Standard. This guidance was issued by the FASB in May 2004
via FSP FAS No. 106-2. The Company adopted FSP FAS No. 106-1
and 106-2 in the fiscal third quarter of 2004, as allowed by
the Standards. This adoption did not have a material effect
on the Company's results of operations, cash flows or
financial position.
In July 2004 the FASB ratified the EITF consensus on Issue 02-
14, "Whether an Investor should Apply the Equity Method of
Accounting to Investments Other Than Common Stock". The
Company will adopt EITF Issue 02-14 in the fourth quarter of
2004, as prescribed by the Standard. This adoption is not
expected to have a material effect on the Company's results
of operations, cash flows and financial position.
The Company adopted EITF Issue 03-6 "Participating Securities
and the Two-Class Method under FASB Statement No. 128" in the
fiscal third quarter of 2004. This adoption did not have an
effect on the Company's results of operations, cash flows and
financial position.
Economic and Market Factors
Johnson & Johnson is aware that its products are used in an
environment where, for more than a decade, policymakers,
consumers and businesses have expressed concern about the
rising cost of
health care. Johnson & Johnson has a long-standing policy of
pricing products responsibly. For the period 1993 - 2003, in
the
United States, the weighted average compound annual growth
rate of
Johnson & Johnson price increases for health care products
(prescription and over-the-counter drugs, hospital and
professional products) was below the U.S. Consumer Price
Index (CPI).
Inflation rates, even though moderate in many parts of the
world during 2004, continue to have an effect on worldwide
economies and, consequently, on the way companies operate. In
the face of increasing costs, the Company strives to maintain
its profit margins through cost reduction programs,
productivity improvements and periodic price increases.
The Company faces various worldwide health care changes that
may result in pricing pressures that include health care cost
containment and government legislation relating to sales,
promotions and reimbursement. On December 8, 2003, the
Medicare Prescription Drug Improvement and Modernization Act
of 2003 was enacted that introduces a prescription drug
benefit under Medicare as well as a subsidy to sponsors of
retiree health care benefit plans. The Company elected to
defer the recognition of the Act until such time when the
authoritative guidance was issued. This guidance was issued
by the FASB in May 2004. The Company adopted the recognition
of the Act in the fiscal third quarter of 2004.
40
The Company also operates in an environment which is becoming
increasingly hostile to intellectual property rights. Generic
drug firms have filed Abbreviated New Drug Applications
seeking to market generic forms of most of the Company's key
pharmaceutical products, prior to expiration of the
applicable patents covering those products. In the event the
Company is not successful in defending a lawsuit resulting
from an Abbreviated New Drug
Application filing, the generic competition typically results
in creating a loss of market exclusivity and may result in a
significant reduction in sales. For further information see
the discussion on "Litigation Against Filers of Abbreviated
New Drug Applications" in Note 12.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This Form 10-Q contains forward-looking statements. Forward-
looking statements do not relate strictly to historical or
current facts and anticipate results based on management's
plans that are subject to uncertainty. Forward-looking
statements may be identified by the use of words like
"plans," "expects," "will,"
"anticipates," "estimates" and other words of similar meaning
in conjunction with, among other things, discussions of
future operations, financial performance, the Company's
strategy for growth, product development, regulatory
approval, market position and expenditures.
Forward-looking statements are based on current expectations
of future events. The Company cannot guarantee that any
forward- looking statement will be accurate, although the
Company believes
that it has been reasonable in its expectations and
assumptions. Investors should realize that if underlying
assumptions prove inaccurate or that unknown risks or
uncertainties materialize, actual results could vary
materially from the Company's expectations and projections.
Investors are therefore cautioned not to place undue reliance
on any forward-looking statements. The Company assumes no
obligation to update any forward-looking statements as a
result of new information or future events or developments.
Risks and uncertainties include general industry conditions
and competition; economic conditions, such as interest rate
and currency exchange rate fluctuations; technological
advances, new products and patents attained by competitors;
challenges inherent in new product development, including
obtaining regulatory approvals; challenges to patents; U.S.
and foreign health care reforms and governmental laws and
regulations; trends toward health care cost containment;
increased scrutiny of the health care industry by government
agencies; product efficacy or safety concerns resulting in
product recalls or regulatory action.
The Company's report on Form 10-K for the year ended December
28, 2003 contains, as an Exhibit, a discussion of additional
factors that could cause actual results to differ from
expectations. The Company notes these factors as permitted by
the Private Securities
Litigation Reform Act of 1995.
41
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
There has been no material change in the Company's assessment
of its sensitivity to market risk since its presentation set
forth in Item 7A, "Quantitative and Qualitative Disclosures
About Market Risk," in its Annual Report on Form 10-K for the
fiscal year ended December 28, 2003.
Item 4 - CONTROLS AND PROCEDURES-EVALUATION OF DISCLOSURE
CONTROLS AND PROCEDURES
Disclosure controls and procedures. As of the end of the
period covered by this report, the Company evaluated the
effectiveness of the design and operation of its disclosure
controls and procedures. The Company's disclosure controls
and procedures are designed to ensure that the Company
records, processes, summarizes and reports in a timely manner
the information the Company must
disclose in its reports filed under the Securities
Exchange Act. William C. Weldon, Chairman and Chief
Executive Officer, and Robert J. Darretta, Vice Chairman and
Chief Financial Officer, reviewed and participated in this
evaluation. Based on this
evaluation, Messrs. Weldon and Darretta concluded that, as of
the date of their evaluation, the Company's disclosure
controls and procedures were effective.
Internal control. Since the date of the evaluation
described above, there have not been any significant
changes in the Company's internal control over financial
reporting that have materially affected, or are reasonably
likely to materially affect, the Company's internal control.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
The information called for by this item is
incorporated herein by reference to Note 12
included in Part I, Notes to Consolidated
Financial Statements.
Item 5. Exhibits and Reports on Form 8-K
(a) Exhibit
Exhibit 99.3 Certifications Under Rule 13a-14(a) of
the Securities Exchange Act Pursuant to Section 302
of the Sarbanes-Oxley Act.
Exhibit 99.15 Certifications Pursuant to Section 906
of the Sarbanes-Oxley Act.
42
(b) Reports on Form 8-K
A Report on Form 8-K was furnished on July 15, 2004,
which included the press release for the period ended
June 27, 2004. Also included in this filing are the
unaudited comparative supplementary sales data and
condensed consolidated statement of earnings for this
fiscal second quarter and six month period ended June
27, 2004.
A Report on Form 8-K was filed on October 4, 2004, which
included a press release dated October 1, 2004
announcing
the redemption of 8.72% debentures due November 2024.
A Report on Form 8-K was filed on October 6, 2004, which
included a press release dated October 1, 2004
announcing that Ortho Biotech Products, L.P., a Johnson
& Johnson company, received a subpoena from the
Inspector General, Department of Health and Human
Services, requesting documents related to the sales and
marketing of PROCRIT(r) (Epoetin Alfa)
A report on Form 8-K was furnished on October 13, 2004,
which included the press release for the period ended
September 26, 2004. Also included in this filing are the
unaudited comparative supplementary sales data and
condensed consolidated statement of earnings for the
fiscal third quarter and nine month period ended
September 26, 2004.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
JOHNSON & JOHNSON
(Registrant)
Date: November 3, 2004 By /s/ R. J. DARRETTA
R. J. DARRETTA
Vice Chairman
(Chief Financial Officer)
Date: November 3, 2004 By /s/ S. J. COSGROVE
S. J. COSGROVE
Controller
(Chief Accounting Officer)
44