How did the Pfizer Consumer Healthcare acquisition change Johnson & Johnson's financial position?

The $16.6 billion cash purchase, closed December 20, 2006, reduced year-end cash to $4.1 billion and raised total borrowings to $6.6 billion, creating $2.5 billion of net debt versus $13.5 billion of net cash in 2005. The deal added about $6.6 billion of goodwill and $8.9 billion of intangible assets, and the acquired business accounts for 26% of total assets. Its 2006 operating results were not significant, so the full impact will appear in 2007 results.

What are the biggest risks to future revenue and earnings?

The main near-term risks are patent expirations and generic competition. RISPERDAL's primary U.S. patent expires in December 2007 (a pediatric exclusivity extension to June 2008 has been requested), and TOPAMAX's U.S. patent expires in September 2008. DURAGESIC already faces generic competition, with sales down 18.3% in 2006. Litigation outcomes against generic filers and the pending CONMED antitrust trial (damages claimed up to $1.8 billion before trebling) add further uncertainty. The filing itself notes that Item 1A Risk Factors is 'Not applicable.'

How strong is the company's cash generation and shareholder return policy?

Operating cash flow was $14.2 billion in 2006, up $2.4 billion from 2005. Capital expenditures were $2.7 billion, leaving substantial free cash flow to support dividends of $4.3 billion and a $5 billion buyback program that was completed in the fourth quarter of 2006. The company also repurchased an additional 16.6 million shares outside the program during the fourth quarter. The dividend was raised to $0.375 per quarter for 2007.

Did the Guidant transaction affect 2006 earnings?

Yes. The company received a $622 million pre-tax termination fee (about $368 million after tax) associated with the terminated Guidant acquisition, which boosted Medical Devices & Diagnostics segment operating profit by 16.9% and contributed to the 2006 earnings increase. Excluding this one-time gain and IPR&D charges, underlying earnings growth would have been more modest.

Are there any regulatory or legal issues investors should watch?

Yes. On February 12, 2007, the company voluntarily disclosed to the DOJ and SEC that non-U.S. subsidiaries may have made improper payments in connection with medical device sales in two small-market countries, which may fall under the Foreign Corrupt Practices Act. The company is also defending a RISPERDAL-related qui tam action in Texas, DEPUY antitrust class actions, a DOJ investigation into orthopaedic devices, and multiple U.S. Attorney subpoenas on marketing practices. The company states none of these matters is expected to have a material adverse effect on its financial position.

JNJ 10-K Filed Feb 21, 2007

01—Abstract

Summary

Summary of the 10-K filed February 21, 2007. Cited figures are marked; the original filing is the authoritative source.

Johnson & Johnson's 10-K for fiscal 2006 shows a company that grew sales 5.6% to $53.3 billion^a and expanded earnings, but closed the year with a transformational, debt-funded acquisition.

Net earnings rose 9.9% to $11.05 billion^b (diluted EPS $3.73 vs. $3.35), helped by a $622 million Guidant termination fee gain, while worldwide R&D reached $7.1 billion (13.4% of sales). Operating cash flow was a strong $14.2 billion, and the company returned capital through $4.3 billion in dividends (44th consecutive annual increase, $1.455/share) and completion of a $5 billion buyback. The most significant development is the December 20, 2006 purchase of Pfizer's Consumer Healthcare business for $16.6 billion in cash.

This drove total acquisition spending to $18.0 billion, cut year-end cash to $4.1 billion^c from $16.1 billion, and pushed total borrowings to $6.6 billion. Management reports net debt of $2.5 billion versus net cash of $13.5 billion a year earlier. Because the deal closed so late, its results are excluded from 2006 operations and internal control assessment, and the acquired business represents 26% of total assets.

Investors will need to judge whether the Consumer Healthcare brands (LISTERINE, NICORETTE, SUDAFED) can support the growth and margin profile the purchase price implies. The outlook carries clear risks. Several major products face patent expiry or generic pressure: DURAGESIC sales fell 18.3%^d, RISPERDAL's U.S. compound patent expires in December 2007 (with a pediatric extension pending), and TOPAMAX faces litigation and expiry in 2008.

Consumer segment operating margin fell to 14.1% from 17.5% because of IPR&D charges and integration costs. The filing also discloses a February 2007 voluntary disclosure to the DOJ and SEC about possible Foreign Corrupt Practices Act violations, along with extensive product liability, antitrust, and patent litigation.

02—Key points

Key Highlights

Sales rose 5.6% to $53.3 billion, driven by 3.8% volume growth and 1.5% price increases; the Pharmaceutical segment reached $23.3 billion and Medical Devices & Diagnostics $20.3 billion.
Diluted EPS increased 11.3% to $3.73, including a $622 million pre-tax gain from the Guidant acquisition termination fee and $559 million of in-process R&D charges.
The $16.6 billion Pfizer Consumer Healthcare acquisition closed December 20, 2006, with $6.6 billion of goodwill and $8.9 billion of intangibles; results are reported from 2007 onward.
Liquidity shifted sharply: cash fell to $4.1 billion from $16.1 billion, borrowings rose to $6.6 billion, and the company still holds a AAA credit rating with $10.8 billion of unused credit.
Operating cash flow grew to $14.2 billion, and the dividend was raised to $1.455 per share for 2006, continuing a 44-year record of annual increases.
Key patent cliffs loom: RISPERDAL (U.S. expiry December 2007, $4.2 billion in 2006 sales) and TOPAMAX (September 2008), while DURAGESIC sales declined 18.3% after generic entry.
Management voluntarily disclosed possible FCPA violations by non-U.S. subsidiaries in medical device sales (February 2007), and the company faces significant product liability, antitrust, and Average Wholesale Price litigation.

03—Questions

Frequently Asked Questions

How did the Pfizer Consumer Healthcare acquisition change Johnson & Johnson's financial position?
The $16.6 billion cash purchase, closed December 20, 2006, reduced year-end cash to $4.1 billion and raised total borrowings to $6.6 billion, creating $2.5 billion of net debt versus $13.5 billion of net cash in 2005. The deal added about $6.6 billion of goodwill and $8.9 billion of intangible assets, and the acquired business accounts for 26% of total assets. Its 2006 operating results were not significant, so the full impact will appear in 2007 results.
What are the biggest risks to future revenue and earnings?
The main near-term risks are patent expirations and generic competition. RISPERDAL's primary U.S. patent expires in December 2007 (a pediatric exclusivity extension to June 2008 has been requested), and TOPAMAX's U.S. patent expires in September 2008. DURAGESIC already faces generic competition, with sales down 18.3% in 2006. Litigation outcomes against generic filers and the pending CONMED antitrust trial (damages claimed up to $1.8 billion before trebling) add further uncertainty. The filing itself notes that Item 1A Risk Factors is 'Not applicable.'
How strong is the company's cash generation and shareholder return policy?
Operating cash flow was $14.2 billion in 2006, up $2.4 billion from 2005. Capital expenditures were $2.7 billion, leaving substantial free cash flow to support dividends of $4.3 billion and a $5 billion buyback program that was completed in the fourth quarter of 2006. The company also repurchased an additional 16.6 million shares outside the program during the fourth quarter. The dividend was raised to $0.375 per quarter for 2007.
Did the Guidant transaction affect 2006 earnings?
Yes. The company received a $622 million pre-tax termination fee (about $368 million after tax) associated with the terminated Guidant acquisition, which boosted Medical Devices & Diagnostics segment operating profit by 16.9% and contributed to the 2006 earnings increase. Excluding this one-time gain and IPR&D charges, underlying earnings growth would have been more modest.
Are there any regulatory or legal issues investors should watch?
Yes. On February 12, 2007, the company voluntarily disclosed to the DOJ and SEC that non-U.S. subsidiaries may have made improper payments in connection with medical device sales in two small-market countries, which may fall under the Foreign Corrupt Practices Act. The company is also defending a RISPERDAL-related qui tam action in Texas, DEPUY antitrust class actions, a DOJ investigation into orthopaedic devices, and multiple U.S. Attorney subpoenas on marketing practices. The company states none of these matters is expected to have a material adverse effect on its financial position.

04—Continue

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