Johnson & Johnson (JNJ)

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Johnson & Johnson Services, Inc. (JNJ)

Q3 2012 Earnings Call

October 16, 2012 8:30 AM ET

Executives

Louise Mehrotra – VP, IR

Dominic Caruso – VP, Finance and CFO

Joaquin Duato – Worldwide Chairman, Pharmaceuticals Group

Paul Stoffels – Chief Scientific Officer and Worldwide Chairman, Pharmaceuticals Group

Analysts

Matthew Dodds – Citi

Mike Weinstein – JP Morgan

Catherine Arnold – Credit Suisse

Larry Biegelsen – Wells Fargo

Rajeev Jashnani – UBS

Jamie Ruben – Goldman Sachs

Derrick Sung – Sanford Bernstein

Danielle Telsey – Leerink Swann

Glen Novarro – RBC Capital Markets

Matt Miksic – Piper Jaffray

Presentation

Operator

Good morning, and welcome to the Johnson & Johnson Third Quarter 2012 Earnings Conference Call. (Operator Instructions) This call is being recorded. (Operator Instructions) I would now like to turn the conference over to Johnson & Johnson. You may begin.

Louise Mehrotra

Good morning, and welcome. I’m Louise Mehrotra, Vice President of Investor Relations for Johnson & Johnson. This is my pleasure this morning to review our business results for the third quarter of 2012. Joining me on the call today are Dominic Caruso, Vice President Finance and Chief Financial Officer; Joaquin Duato, Worldwide Chairman, Pharmaceuticals Group; and Dr. Paul Stoffels, Chief Scientific Officer and Worldwide Chairman, Pharmaceuticals Group. A few logistics before we get into the details.

This call is being made available to a broader audience via webcast accessible through the Investor Relations’ section of the Johnson & Johnson website. I’ll begin by briefly reviewing highlights of the third quarter for the corporation and highlights for our three business segments. Then Dominic will provide some additional commentary on the third quarter results and discuss guidance for the full year of 2012. Following Dominic’s remarks, Joaquin and Paul will provide a brief update on the pharmaceuticals business. We will then open the call to your questions. We expect the call to last approximately an hour and a half.

Included with the press release that was sent to the investment community earlier this morning is a schedule showing sales for key products and/or businesses to facilitate updating your models. These are also available on the Johnson & Johnson website as is the press release. Please note this webcast includes slides. The slides are available on the website.

Before I get into the results, let me remind you that some of the statements made during this review may be considered forward-looking statements. The 10-K for the fiscal year 2011 identifies certain factors that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made this morning. The 10-K is available through the company or online.

During the review, non-GAAP financial measures may be used to provide information pertinent to ongoing business performance. These non-GAAP financial measures should not be considered replacements for GAAP results. Tables reconciling these measures to the most comparable GAAP measures are available in the press release and on the Investor Relations’ section of the Johnson & Johnson website at investor.jnj.com.

Lastly, today we will be discussing new molecular entities or NMEs and line extensions based on the company’s current knowledge of the status of development. NMEs and line extensions are subject to the challenges and difficulties inherent in product development. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. A number of the compounds and products discussed today are being developed in collaboration with strategic partners or licensed from other companies. These slides list the acknowledgment of those relationships.

Now I would like to review our results for the third quarter of 2012. If you would refer to your copy of the press release, let’s begin with the schedule titled Supplementary Sales Data by Geographic Area. Worldwide sales to customers were $17.1 billion for the third quarter of 2012, up 6.5% as compared to the third quarter of 2011. On an operational basis, sales were up 10.8% and currency had a negative impact of 4.3%.

The acquisition of Synthes was completed in the second quarter this year. In the third quarter, the acquisition net of the impact of the divestiture of the legacy DePuy trauma business contributed 5.8% to the worldwide operational sales growth. The impact to the U.S. and outside the U.S. growth was 7.2 points, and 4.8 points respectively. In the U.S., sales were up 13.4%. In regions outside the U.S., our operational growth was 8.9% while the effect of currency exchange rates negatively impacted our reported results by 7.5 points.

The western hemisphere excluding the U.S. grew by 12.8% operationally while the Asia Pacific Africa region grew 9% on an operational basis. Europe grew 7.1% operationally. The success of new product launches and Synthes sales made strong contributions to the results in all regions.

If you’ll now turn to the consolidated statement of earnings, net earnings attributable to Johnson & Johnson were $3 billion compared to 3.2 billion dollars in the same period of 2011. Earnings per share were $1.05 versus $1.15 a year ago. Please direct your attention to the box section of the schedule where we have provided earnings adjusted to exclude special items. As referenced in the accompanying table on non-GAAP measures, 2012 third quarter net earnings were adjusted to exclude the after tax impact of noncash net charges related to in-process research and development due to the discontinuation of the Phase III clinical development of Bapineuzumab IV, transaction and integration costs related to the acquisition of Synthes, Inc., and a few ASR hip replacement costs.

Third quarter 2011 net earnings were adjusted to exclude the after tax impact of a mark-to-market adjustment to the value of the currency option and deal costs related to the acquisition of Synthes, Inc. Excluding these special items, net earnings for the current quarter were $3.5 billion and diluted earnings per share were $1.25 representing increases of 2.3% and 0.8% respectively as compared to the same period in 2011.

I would now like to make some additional comments relative to the components leading to earnings before we move on to the segment highlights. For the third quarter of 2012, cost of goods sold at 32.8% was up 110 basis points from the same period last year primarily due to an inventory step-up charge related to the Synthes acquisition. Excluding the inventory step-up charge, which has been treated as a special item, cost of goods sold increased 20 basis points versus the same period last year, primarily due to ongoing remediation costs in our consumer business.

Third quarter selling, marketing and administrative expenses at 30.6% of sales were down 210 basis points due to cost containment initiatives across many of our businesses. Our investment in research and development as a percent to sales was 11.3%, 20 basis points higher than the third quarter of 2011 primarily due to the timing of milestone payments in our pharmaceutical business. Interest expense net of interest income of $120 million was up $3 million for just the third quarter of 2011. Other income net of other expense was $90 million in the third quarter of 2012 compared to $308 million in the same period last year.

Excluding special items, other income net of other expense of $175 million was $449 million less than 2011 due to lower gains on divestitures. Excluding special items, the effective tax rate was 22.2% in the third quarter of 2012, in line with 2011.

Turning now to business segment highlights, please refer to the supplementary sales schedule highlighting key products or businesses for the third quarter of 2012. I’ll begin with the consumer segment. Worldwide consumer segment sales for the third quarter of 2012 of $3.6 billion decreased 4.3% compared to the same period last year. On an operational basis, sales increased 1% while the impact of currency was negative 5.3%.

U.S. sales were down 0.4% while international sales grew 1.8% on an operational basis. Baby care products decreased on an operational basis by 1.9% when compared to the third quarter of 2011, primarily due to lower international sales of lotions and creams, partially offset by strong growth of hair care products. Sales in the oral care business increased 3% operationally due to strong sales outside the U.S. from newly launched Listerine products.

For the third quarter of 2012, sales for OTC pharmaceuticals and nutritionals increased 5.9% on an operational basis compared to the same period in 2011 with U.S. sales up 5.7% and sales outside the U.S. up 6% on an operational basis. Sales in the U.S. increased primarily due to the relaunch of selected key products and the impact of the acquisition of full ownership rights to certain digestive health products partially offset by supply constraints on other products.

McNeil PPC is operating under a consent decree covering the manufacturing facilities in Las Piedras, Puerto Rico, and Fort Washington and Lancaster, Pennsylvania. McNeil continues to operate the manufacturing facilities in Las Piedras and Lancaster. As previously discussed, production volumes from these facilities continued to be impacted by additional review and approval processes. We expect this to continue throughout 2012 and most of 2013. Plants operating under the consent decree are producing a simplified portfolio focused on key brands.

Our Skin Care business grew 0.2% on an operational basis in the third quarter of 2012 with the U.S. up 3.7% due to strong performance of Neutrogena. Sales outside the U.S. were down 2.2% due to competitive and marketplace pressures.

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