EXHIBIT 13
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Overview
Record 1998 sales of $23.66 billion, an increase over 1997 of 4.5%, marked the
sixty-sixth consecutive year of positive sales growth. The Company achieved this
increase despite the impact of the stronger dollar that depressed sales by 2.5%.
During the fourth quarter of 1998, the Company completed the acquisition of
DePuy, Inc. and approved a reconfiguration plan for its manufacturing facilities
worldwide. As a result, net earnings included special charges of $610 million
for the cost of purchased In-Process Research and Development (IPR&D) primarily
related to the DePuy acquisition as well as restructuring costs related to the
reconfiguration plan. The objective of the reconfiguration plan was to enhance
worldwide operating efficiencies. For detailed discussion of this plan, see Note
15 and 17. Reported net earnings decreased by 7.4% to $3.06 billion. Prior to
the effect of the special charges, net earnings increased 11.1% over 1997 and
the net income margin for 1998 was a record high of 15.5%.
The Company's investment in research and development continues to drive
sales of innovative products. In 1998, $2.3 billion or 9.6% of sales was
invested in research and development. This level of investment, the highest in
the Company's history, reflects the Company's continued commitment to achieving
significant advances in health care through the discovery and development of
innovative, knowledge-based, cost effective products that prolong and enhance
the quality of life.
In 1998, the Company continued to improve operating margins. The gross
profit margin, excluding special charges, improved from 68.4% to 68.6% while
selling, marketing and administrative expenses as a percent to sales dropped
from 38.5% to 37.7%.
Cash from operations in 1998 was $4.89 billion and served as the primary
source of funding to finance capital investments of $1.5 billion, dividend
distribution of $1.3 billion and the purchase of treasury stock of $.9 billion,
with the remaining cash used to partially fund the DePuy acquisition. Cash
dividends paid to shareowners in 1998 increased by 14.1% over 1997 and
represented the thirty-sixth consecutive year of dividend increases.
Total equity market capitalization was $112.7 billion, an increase of
29.1% over 1997, while the percentage return on average shareowners' equity,
excluding the impact of special charges, was 27.6% in 1998.
The worldwide health care market continues to be transformed as customers
have become more knowledgeable and demand even greater value. Simultaneously,
the marketplace has become increasingly more competitive. The Company believes
that it is well positioned to meet these challenges by providing innovative
products as demonstrated by the Company's commitment to research and
development. In addition, dedicated employees along with strong Credo values and
decentralized management structure enable the Company to provide its customers
with value creating, innovative products and services.
Sales and Earnings
In 1998, worldwide sales increased 4.5% to $23.66 billion compared to increases
of 4.7% in 1997 and 14.7% in 1996. Excluding the impact of foreign currencies,
worldwide sales increased 7.0% in 1998, 8.7% in 1997 and 16.5% in 1996.
Sales to Customers
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Worldwide net earnings for 1998 including the impact of the Restructuring
and IPR&D charges were $3.06 billion, reflecting a 7.4% decrease from 1997.
Worldwide net earnings per share for 1998 equaled $2.23 per share, a decrease of
7.5% from the $2.41 net earnings per share in 1997.
Worldwide net earnings for 1998 excluding the impact of the Restructuring
and IPR&D charges were $3.67 billion, reflecting an 11.1% increase over 1997.
Excluding the impact of these charges, worldwide net earnings per share for 1998
equaled $2.67 per share, an increase of 10.8% over the $2.41 net earnings per
share in 1997. The income margin for 1998, excluding the impact of these charges
was a record 15.5%, up from 14.6% in 1997.
Worldwide net earnings for 1997 were $3.30 billion, or net earnings per
share of $2.41, representing an increase over 1996 of 13.7%. In 1996, worldwide
net earnings were $2.89 billion, or net earnings per share of $2.12 on a
split-adjusted basis, representing an increase over 1995 of 16.5%.
Average diluted shares of common stock outstanding in 1998 and 1997 were
1.37 billion compared with 1.36 billion in 1996.
Net Earnings
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Sales by domestic companies were $12.56 billion in 1998, $11.76 billion in 1997
and $10.9 billion in 1996. This represents an increase of 6.8% in 1998, 7.9% in
1997 and 18.6% in 1996. The strong performance of products introduced in the
past few years and the continued expansion of base businesses resulted in the
sales increase in 1998.
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Sales by international companies were $11.1 billion in 1998, $10.87
billion in 1997 and $10.72 billion in 1996. This represents an increase of 2.1%
in 1998, 1.4% in 1997 and 11.1% in 1996. Excluding the impact of the foreign
currency fluctuations over the past three years, international company sales
increased 7.3% in 1998, 9.5% in 1997 and 14.6% in 1996.
All geographic areas throughout the world posted solid operational gains
during 1998. Excluding the effect of exchange rate fluctuations of the U.S.
dollar on foreign currencies, sales increased 10.3% in Europe, 5.7% in the
Western Hemisphere (excluding the U.S.) and 8.8% in the Asia-Pacific, Africa
regions.
The Company achieved an annual compound growth rate of 10.2% for worldwide
sales for the ten-year period since 1988 with domestic sales growing at a rate
of 10.6% and international sales growing at a rate of 9.6%. For the same
ten-year period, excluding the impact of special charges in 1998, worldwide net
earnings achieved an annual growth rate of 14.2%, while earnings per share grew
at a rate of 14.3%. For the last five years, the annual compound growth rate for
sales was 10.8%. Excluding the special charges, the annual compound growth rate
for net earnings was 15.5% and the annual compound growth rate for earnings per
share was 14.4%.
Common Stock Market Prices
The Company's common stock is listed on the New York Stock Exchange under the
symbol JNJ. The approximate number of shareowners of record at year-end 1998 was
165,900. The composite market price ranges for Johnson & Johnson common stock
during 1998 and 1997 were:
Cash Dividends Paid
The Company increased its dividends in 1998 for the thirty-sixth consecutive
year. Cash dividends paid were $.97 per share in 1998 compared with dividends of
$.85 per share in 1997 and $.735 per share in 1996. The dividends were
distributed as follows:
On December 3, 1998, the Board of Directors declared a regular cash dividend of
$.25 per share, paid on March 9, 1999 to shareowners of record on February 11,
1999.
The Company expects to continue the practice of paying regular cash
dividends.
Costs and Expenses
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, excluding the write-off of IPR&D primarily in connection
with the acquisition of DePuy, were as follows:
Research expense as a percent of sales for the Pharmaceutical segment was
15.8% for 1998, 16.7% for 1997 and 15.2% in 1996, while averaging 6.1%, 5.7% and
5.6% in the other two segments.
Research Expense
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Advertising expenses, which are comprised of television, radio and print
media, were $1.19 billion in 1998 and $1.26 billion in both 1997 and 1996.
Additionally, significant expenditures were incurred for promotional activities
such as couponing and performance allowances.
The Company believes that its operations comply in all material respects
with applicable environmental laws and regulations. The Company or its
subsidiaries are parties to a number of proceedings brought under the
Comprehensive Environmental Response, Compensation and Liability Act, commonly
known as Superfund, and comparable state laws, in which primary relief sought is
the cost of past and future remediation. While it is not feasible to predict or
determine the outcome of these proceedings, in the opinion of the Company, such
proceedings would not have a material adverse effect on the results of
operations, cash flows or financial position of the Company.
Worldwide sales do not reflect any significant degree of seasonality;
however, spending has been heavier in the fourth quarter of each year than in
other quarters. This reflects increased spending decisions, principally for
advertising and research grants.
The worldwide effective income tax rate was 28.3% in 1998, 27.8% in 1997
and 28.4% in 1996. The increase in the 1998 worldwide effective tax rate was
primarily due to the Company's charge for IPR&D in the fourth quarter of 1998,
which is not tax deductible. Refer to Note 6 of the Notes to Consolidated
Financial Statements for additional information.
A summary of operations and related statistical data for the years
1988-1998 can be found on page 46.
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Distribution of Sales Revenues
The distribution of sales revenues for 1998, 1997 and 1996 were:
Liquidity and Capital Resources
Cash generated from operations and selected borrowings provide the major sources
of funds for the growth of the business, including working capital, additions to
property, plant and equipment and acquisitions. Cash and current marketable
securities totaled $2.58 billion at the end of 1998 as compared with $2.90
billion at the end of 1997.
Total unused credit available to the Company approximates $3.2 billion,
including $1.2 billion of credit commitments with various worldwide banks, $800
million of which expires on October 1, 1999 and $400 million on October 6, 2003.
In 1998 the Company issued $60 million of 5.12% notes due 2003, the
proceeds of which were used for general corporate purposes. The Company issued
no medium term notes during 1998. At January 3, 1999, the Company had $2.29
billion remaining on its shelf registration of $2.59 billion. A summary of
borrowings can be found on page 36.
Total borrowings at the end of 1998 and 1997 were $4.02 billion and $1.84
billion, respectively. The increase in borrowings was attributable to financing
the acquisition of DePuy. In 1998 net debt (debt net of cash and current
marketable securities) was 9.6% of net capital (shareowners' equity and net
debt). In 1997 net cash (cash and current marketable securities net of debt) was
$1.06 billion. Total debt represented 22.8% of total capital (shareowners'
equity and total debt) in 1998 and 13.0% of total capital in 1997. Shareowners'
equity per share at the end of 1998 was $10.11 compared with $9.19 at year-end
1997, an increase of 10.0%.
Financial Instruments
The Company uses financial instruments to manage the impact of interest rate and
foreign exchange rate changes on earnings and cash flows. Accordingly, the
Company enters into forward foreign exchange contracts to protect the value of
existing foreign currency assets and liabilities and to hedge future foreign
currency product costs. Gains or losses on these contracts are offset by the
gains or losses on the underlying transactions. A 10% appreciation of the U.S.
Dollar from January 3, 1999 market rates would increase the unrealized value of
the Company's forward contracts by $225 million. Conversely, a 10% depreciation
of the U.S. Dollar from January 3, 1999 market rates would decrease the
unrealized value of the Company's forward contracts by $259 million. In either
scenario, the gain or loss on the forward contract is offset by the gain or loss
on the underlying transaction and therefore has no impact on future earnings and
cash flows.
The Company enters into interest rate and currency swap contracts to
manage the Company's exposure to interest rate changes and hedge foreign
currency denominated debt. The impact of a 1% change in interest rates on the
Company's interest rate sensitive financial instruments is immaterial.
The Company does not enter into financial instruments for trading or
speculative purposes. Further, the Company has a policy of only entering into
contracts with parties that have at least an "A" (or equivalent) credit rating.
The counterparties to these contracts are major financial institutions and the
Company does not have significant exposure to any one counterparty. Management
believes the risk of loss is remote and in any event would be immaterial.
Changing Prices and Inflation
Johnson & Johnson is aware that its products are used in a setting where, for
more than a decade, policymakers, consumers, and businesses have expressed
concern about the rising cost of health care. In response to these concerns,
Johnson & Johnson has a long-standing policy of pricing products responsibly.
For the period 1980-1998, 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) for the period.
Inflation rates, even though moderate in many parts of the world during
1998, 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.
YEAR 2000
The YEAR 2000 problem may occur when computer systems use the two digits "00"to
represent the year 2000. As a result, these systems may not process dates after
1999, causing system errors or failures. The Company has had a program in place
since the fourth quarter of 1996 to address YEAR 2000 issues in our critical
business areas relating to information management systems (IM), non-IM systems
with embedded technology, products, suppliers and customers. A report on this
program's process has been provided to the Board of Directors.
The Company has completed its review of critical IM systems and is in the
process of correcting issues as necessary. These corrective actions will be
substantially complete by the second quarter of 1999. Additionally, the Company
is reviewing all other automated systems including non-IM systems with embedded
technology and adjusting these systems as needed. This phase is also expected to
be completed by the end of the second quarter of 1999.
26
The Company has made substantial progress in its assessment and testing
plan for all its products. The Company has substantially completed this plan at
year-end 1998 with full completion expected by the third quarter of 1999.
The Company's ability to implement its YEAR 2000 program and the related
non-implementation costs cannot be accurately determined at this time. Although
a failure to completely correct one system may adversely affect other systems,
the Company does not believe that these effects are likely. A material adverse
effect on the financial condition and results of operations of the business may
occur if a significant number of such failures should take place, requiring
manual backup methods and related costs.
The Company has been reviewing and has requested assurances on the status
of YEAR 2000 readiness of its critical suppliers. Many of these suppliers
however, have either declined to provide or have limited their assurances on the
status of their YEAR 2000 readiness. The Company has established a plan for
continued monitoring of critical suppliers during 1999.
Although the Company has contacted major customers to assess the status of
their YEAR 2000 issues, their YEAR 2000 readiness is unclear. If a significant
number of suppliers and customers experience disruptions as a result of YEAR
2000 issues, this could have a material adverse effect on the financial position
and results of operations of the Company.
The Company is formulating contingency plans to deal with the impact of
YEAR 2000 problems on critical suppliers and major customers. For critical
suppliers, these plans may include identifying the availability of alternate
utilities and raw material supply sources as well as increasing levels of
inventory. To mitigate the effects of lack of YEAR 2000 readiness of major
customers, the Company has few alternatives other than manual methods.
Regardless of the contingency plans developed, there can be no assurance that
these plans will address all YEAR 2000 problems or that implementation of these
plans will be successful.
The total cost of addressing the Company's YEAR 2000 readiness issues is
not expected to be material to the Company's financial condition or results of
operations. Since the initiation of the YEAR 2000 readiness program in 1996, the
Company estimates that it has expensed approximately $125 million in internal
and external costs on a pre-tax basis. The Company currently estimates that the
total costs for addressing YEAR 2000 readiness will approximate $200 million on
a pre-tax basis. These costs are being expensed as incurred and are funded
through operating cash flows. No projects material to the financial condition or
results of operations of the Company have been deferred or delayed as a result
of the Company's YEAR 2000 program.
New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). This standard is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999.
FAS 133 requires that all derivative instruments be recorded on the
balance sheet at their respective fair values. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on the designation of the hedge transaction. For fair-value
hedge transactions in which the Company is hedging changes in an asset's,
liability's or firm commitment's fair value, changes in the fair value of the
derivative instrument will generally be offset by changes in the hedged item's
fair value. For cash flow hedge transactions in which the Company is hedging the
variability of cash flows related to a variable rate asset, liability or
forecasted transaction, changes in the fair value of the derivative instrument
will be reported in other comprehensive income. The gains and losses on the
derivative instrument that are reported in other comprehensive income will be
recognized in earnings in the periods in which earnings are impacted by the
variability of the cash flows of the hedged item.
The Company will adopt FAS 133 in the first quarter of 2000 and does not
expect it to have a material effect on the Company's results of operations, cash
flows or financial position.
Segments of Business
Financial information for the Company's three worldwide business segments is
summarized below. Refer to page 45 for additional information on segments of
business.
Sales by Segment of Business
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Operating Profit by Segment of Business(2)
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Operating Profit
(1) 1998 results excluding Restructuring and In-Process Research and Development
charges. Excluding these charges, operating profit as a percent of sales by
segment was: Consumer 10.1%, Pharmaceutical 36.0%, and Professional 16.4%.
(2) Prior year restated to conform to 1998 presentation according to SFAS No.
131.
Consumer
The Consumer segment's principal products are personal care and hygienic
products, including oral and baby care products, first aid products,
nonprescription drugs, sanitary protection products and adult skin and hair care
products. Major brands include ACT Fluoride Rinse; BAND-AID Brand Adhesive
Bandages; CAREFREE Panty Shields; CLEAN & CLEAR skin care products; IMODIUM A-D,
an antidiarrheal; JOHNSON'S Baby line of products; JOHNSON'S pH5.5 skin and hair
care products; MONISTAT, a remedy for vaginal yeast infections; adult and
children's MOTRIN analgesic products; MYLANTA gastrointestinal products and
PEPCID AC Acid Controller from the Johnson & JohnsonoMerck Consumer
Pharmaceuticals Co.; NEUTROGENA skin and hair care products; NICOTROL smoking
cessation products; o.b. Tampons; PENATEN and NATUSAN baby care products; PIZ
BUIN and SUNDOWN sun care products; REACH toothbrushes; RoC skin care products;
SHOWER TO SHOWER personal care products; STAYFREE and SURE & NATURAL sanitary
protection products; and the broad family of TYLENOL acetaminophen products.
These products are marketed principally to the general public and distributed
both to wholesalers and directly to independent and chain retail outlets.
Consumer segment sales in 1998 were $6.53 billion, an increase of .4% over
1997. Domestic sales increased by 2.6% while international sales declined by
1.7%. International sales gains in local currency of 5.2% were offset by a
negative currency impact of 6.9%. Consumer sales were led by continued strength
in the skin care franchise that includes the NEUTROGENA, RoC and CLEAN & CLEAR
product lines, as well as strong performances from the adult and children's
MOTRIN line of analgesic products. During the fourth quarter, the Company
announced the signing of a definitive agreement to acquire the dermatological
skin care business of S.C. Johnson & Son, Inc., including the AVEENO brand
specialty soaps, bath, anti-itch and moisturizing cream and lotion products.
The 1998 special pre-tax charge for the Consumer segment was $244 million.
See Note 15 for detailed discussion on the Restructuring charges.
Consumer segment sales in 1997 were $6.50 billion, an increase of 2.1%
over 1996. Sales by domestic companies accounted for 49.9% of the total segment,
while international companies accounted for 50.1%. During 1997, the Company
announced a licensing agreement with Raisio Group of Finland for the North
American marketing rights (as well as a letter of intent for the worldwide
marketing rights) to a dietary ingredient, stanol ester, which is patented for
use in reducing cholesterol. The Company also established an alliance with
Takeda Chemical Industries in Japan for the sale and distribution of OTC
products beginning with several forms of TYLENOL brand acetaminophen products.
Consumer segment sales in 1996 were $6.36 billion, an increase of 9.1%
over 1995. Sales by domestic companies accounted for 49.7% of the total segment,
while international companies accounted for 50.3%. The sales growth was led by
the strong performance of TYLENOL brand products, despite heavy competition.
Pharmaceutical
The Pharmaceutical segment represents over 50% of operating profit for all
segments.
The Pharmaceutical segment's principal worldwide franchises are in the
allergy, anti-infective, antifungal, antianemia, central nervous system,
contraceptive, dermatology, gastrointestinal, and pain management fields. These
products are distributed both directly and through wholesalers for use by health
care professionals and the general public.
Prescription drugs include DURAGESIC (fentanyl transdermal system sold
abroad as DUROGESIC), a transdermal patch for chronic pain; EPREX (Epoetin alfa
sold in the U.S. as PROCRIT), a biotechnology derived version of the human
hormone erythropoietin that stimulates red blood cell production; ERGAMISOL
(levamisole hydrochloride), a colon cancer drug; FLOXIN (ofloxacin) and LEVAQUIN
(levofloxacin), both anti-infectives; IMODIUM (loperamide HCl), an
antidiarrheal; LEUSTATIN (cladribine), for hairy cell leukemia; MOTILIUM
(domperidone), a gastrointestinal mobilizer; NIZORAL (ketoconazole), SPORANOX
(itraconazole) and TERAZOL (terconazole), antifungals; ORTHOCLONE OKT-3
(muromonab-CD3), for reversing the rejection of kidney, heart and liver
transplants; ORTHO-NOVUM (norethindrone/mestranol) group of oral contraceptives;
PREPULSID (cisapride sold in the U.S. as PROPULSID), a gastrointestinal
prokinetic; RETIN-A (tretinoin), a dermatological
28
cream for acne; RISPERDAL (risperidone), an antipsychotic drug; and ULTRAM
(tramadol hydrochloride), a centrally acting prescription analgesic for moderate
to moderately severe pain.
Johnson & Johnson markets more than 90 prescription drugs around the
world, with 45% of the sales generated outside the United States. Twenty-eight
drugs sold by the Company had 1998 sales in excess of $50 million, with 17 of
them in excess of $100 million.
Pharmaceutical segment sales in 1998 were $8.56 billion, an increase of
11.3% over 1997 including 21.4% growth in domestic sales. International sales
increased .9% as sales gains in local currency of 5.7% were offset by a negative
currency impact of 4.8%. Worldwide growth reflects the strong performance of
RISPERDAL, PROCRIT, DURAGESIC, LEVAQUIN, and the oral contraceptive line of
products. At year-end 1998, the Company received approval from the FDA for
LEVAQUIN for the indication of uncomplicated urinary tract infection.
The 1998 special pre-tax charge for the Pharmaceutical segment was $65
million. See Note 15 for detailed discussion on the Restructuring charges.
Pharmaceutical segment sales in 1997 were $7.70 billion, an increase of
7.1% over 1996. This growth reflected the strong performance of RISPERDAL,
PROCRIT, PROPULSID, ULTRAM, DURAGESIC, and LEVAQUIN, a new anti-infective
launched in 1997. At year-end 1997, the Company received approval from the FDA
for REGRANEX (becaplermin), the first biologic treatment proven to increase the
incidence of healing in diabetic foot ulcers.
Pharmaceutical segment sales in 1996 were $7.19 billion, an increase of
14.6% over 1995. Domestic sales advanced 24.4% while international sales
advanced 7.2%. The worldwide growth was a result of the outstanding performances
of PROCRIT, RISPERDAL, SPORANOX, PROPULSID, ULTRAM, and DURAGESIC.
Significant research activities continued in the Pharmaceutical segment,
increasing to $1.4 billion in 1998, or $68 million over 1997. This represents
15.8% of 1998 Pharmaceutical sales and a compound annual growth rate of
approximately 14.6% for the five-year period since 1993.
Pharmaceutical research is led by two worldwide organizations, Janssen
Research Foundation, headquartered in Belgium and the R.W. Johnson
Pharmaceutical Research Institute, headquartered in the United States.
Additional research is conducted through collaboration with the James Black
Foundation in London, England.
Professional
The Professional segment includes suture and mechanical wound closure products,
minimally invasive surgical instruments, diagnostic products, cardiology
products, disposable contact lenses, surgical instruments, orthopaedic joint
replacements, products for wound management and infection prevention and other
medical equipment and devices. These products are used principally in the
professional fields by physicians, nurses, therapists, hospitals, diagnostic
laboratories and clinics. Distribution to these markets is done both directly
and through surgical supply and other dealers.
Worldwide sales of $8.57 billion in the Professional segment represented
an increase of 1.6% over 1997. Domestic sales decreased 2.4% while international
sales gains in local currency of 10.7% were partially offset by the strength of
the U.S. dollar.
Strong sales growth from Ethicon Endo-Surgery's laparoscopy and mechanical
closure products, Ethicon's Mitek suture anchors and Gynecare's women's health
products and the acquisition of the DePuy orthopaedic products business were
offset by a decline in sales of Cordis' coronary stents.
During the fourth quarter, the Company completed the acquisition of DePuy,
one of the world's leading orthopaedic products companies with products in
reconstructive, spinal, trauma and sports medicine for $3.7 billion. The Company
also completed the acquisition of FemRx, a leader in the development of
proprietary surgical systems that enable surgeons to perform less invasive
alternatives to hysterectomy.
At year-end 1998, two new Cordis products were approved for marketing by
the FDA. The S.M.A.R.T. stent, a self-expanding, crush-recoverable nitinol stent
was approved for use in treating biliary obstructions. Its nitinol alloy design
allows for precise placement and flexibility in reaching lesions, even through
very tortuous vessels. In addition, the NINJA balloon was approved in the U.S.
for use in angioplasty procedures.
The 1998 special pre-tax charge for the Professional segment for
restructuring was $304 million. Additionally, the write-off of IPR&D related to
acquisitions was $164 million. See Note 15 and 17 for detailed discussion on
Restructuring charges and Acquisitions.
Worldwide sales of $8.44 billion in 1997 in the Professional segment
represented an increase of 4.5 % over 1996. Sales growth continued to be fueled
by the excellent performance of Ethicon Endo-Surgery's minimally invasive
surgical instruments, Johnson & Johnson's orthopaedics business, Vistakon's
disposable contact lenses and LifeScan's blood glucose monitoring systems. The
Asia-Pacific and Central Europe regions contributed significantly to the overall
increase in the Professional segment. There were also several business
combinations in the Professional segment during 1997. These included Biopsys
Medical, Inc., a maker of products for the diagnosis and management of breast
cancer; Biosense, Inc., a leader in medical sensor technology for use in
diagnostic and therapeutic interventional procedures; Gynecare, Inc., a maker of
minimally invasive medical devices for the treatment of uterine disorders; and
Innotech, Inc., a manufacturer of equipment for high quality prescription
eyeglass lenses.
In 1996, Professional segment sales increased 19.8% over 1995, to $8.07
billion. The sales growth included the full year impact of the merger with
Cordis Corporation in early 1996. Strong growth in the Asia-Pacific region also
contributed to the increase in the Professional segment, as did excellent
performances by LifeScan's blood glucose monitors, Vistakon's disposable contact
lenses, Ethicon Endo-Surgery's minimally invasive surgical instruments and
Johnson & Johnson Professional's orthopaedic business. Acquisitions and
divestitures during 1998 and 1997 are described in more detail on page 42.
29
Geographic Areas
The Company further categorizes its sales by major geographic area as presented
for the years 1998 and 1997.
Sales
International sales were once again negatively impacted by the translation of
local currency operating results into U.S. dollars. Average exchange rates to
the dollar have declined each year since 1995.
See page 45 for additional information on geographic areas.
Sales by Geographic Area of Business
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Description of Business
The Company, which employees 93,100 employees worldwide, is engaged in the
manufacture and sale of a broad range of products in the health care field. It
conducts business in virtually all countries of the world. The Company's primary
interest, both historically and currently, has been in products related to
health and well-being.
The Company is organized on the principle of decentralized management. The
Executive Committee of Johnson & Johnson is the principal management group
responsible for the operations and allocations of resources of the Company. In
addition, several Executive Committee members serve as Chairmen of Group
Operating Committees, which are comprised of managers who represent key
operations within the group, as well as management expertise in other
specialized functions. The composition of these Committees can change over time
in response to business needs. These Committees oversee and coordinate the
activities of domestic and international companies related to each of the
Consumer, Pharmaceutical and Professional businesses. Operating management is
headed by a Chairman, President, General Manager or Managing Director who
reports directly, or through a line executive to a Group Operating Committee.
In line with this policy of decentralization, each international
subsidiary is, with some exceptions, managed by citizens of the country where it
is located. The Company's international business is conducted by subsidiaries
manufacturing in 36 countries outside the United States and selling in over 175
countries throughout the world.
In all its product lines, the Company competes with companies both large
and small, located in the U.S. and abroad. Competition is strong in all lines
without regard to the number and size of the competing companies involved.
Competition in research, involving the development and improvement of new and
existing products and processes, is particularly significant and results from
time to time in product and process obsolescence. The development of new and
improved products is important to the Company's success in all areas of its
business. This competitive environment requires substantial investments in
continuing research and in multiple sales forces. In addition, the winning and
retention of customer acceptance of the Company's consumer products involves
heavy expenditures for advertising, promotion, and selling.
Cautionary Factors that May Affect Future Results
This Annual Report may contain forward-looking statements that anticipate
results based on management's plans that are subject to uncertainty. The use of
the words "expects," "plans, " "anticipates" and other similar words in
conjunction with discussions of future operations or financial performance
identifies these statements.
Forward-looking statements are based on current expectations of future
events. The Company cannot ensure 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 our projections. The Company assumes
no obligation to update any forward-looking statements as a result of future
events or developments.
In Item 1 of the Company's Annual Report on Form 10-K for the year ended
January 3, 1999 that will be filed in April 1999, the Company discusses in more
detail various factors that could cause actual results to differ from
expectations. Prior to the filing of Form 10-K, investors should reference the
Company's quarterly report on Form 10-Q for the quarter ended September 27,
1998. The Company notes these factors as permitted by the Private Securities
Litigation Reform Act of 1995. Investors are cautioned not to place undue
reliance on such statements that speak only as of the date made. Investors also
should understand that it is not possible to predict or identify all such
factors and should not consider this list to be a complete statement of all
potential risks and uncertainties.
30
Consolidated Balance Sheet Johnson & Johnson and Subsidiaries
See Notes to Consolidated Financial Statements
31
Consolidated Statement of Earnings Johnson & Johnson and Subsidiaries
See Notes to Consolidated Financial Statements
32
Consolidated Statement of Equity Johnson & Johnson and Subsidiaries
See Notes to Consolidated Financial Statements
33
Consolidated Statement of Cash Flows Johnson & Johnson and Subsidiaries
See Notes to Consolidated Financial Statements
34
Notes to Consolidated Financial Statements Johnson & Johnson and Subsidiaries
--------------------------------------------------------------------------------
1 Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Johnson & Johnson
and subsidiaries. Intercompany accounts and transactions are eliminated.
Cash Equivalents
The Company considers securities with maturities of three months or less, when
purchased, to be cash equivalents.
Revenue Recognition
The Company recognizes revenue from product sales when the goods are shipped and
title passes to the customer.
Inventories
Inventories are stated at the lower of cost or market determined by the
first-in, first-out method.
Depreciation of Property
The Company utilizes the straight-line method of depreciation for financial
statement purposes for all additions to property, plant and equipment.
Intangible Assets
The excess of the cost over the fair value of net assets of purchased businesses
is recorded as goodwill and is amortized on a straight-line basis over periods
of 40 years or less. The cost of other acquired intangibles is amortized on a
straight-line basis over their estimated useful lives. The Company continually
evaluates the carrying value of goodwill and other intangible assets. Any
impairments would be recognized when the expected future operating cash flows
derived from such intangible assets is less than their carrying value.
Financial Instruments
Gains and losses on foreign currency hedges of existing assets or liabilities,
or hedges of firm commitments, are deferred and recognized in income as part of
the related transaction.
Unrealized gains and losses on currency swaps which hedge third party debt
are classified in the balance sheet as other assets or liabilities. Interest
expense under these agreements, and the respective debt instruments that they
hedge, are recorded at the net effective interest rate of the hedged
transaction.
In the event of early termination of a currency swap contract that hedges
third party debt, the gain or loss on the swap contract is amortized over the
remaining life of the related transaction. If the underlying transaction
associated with a swap, or other derivative contract, is accounted for as a
hedge and is terminated early, the related derivative contract is terminated
simultaneously and any gains or losses would be included in income immediately.
Advertising
Costs associated with advertising are expensed in the year in- curred.
Advertising expenses worldwide, which are comprised of television, radio and
print media, were $1.19 billion in 1998 and $1.26 billion in 1997 and 1996
respectively.
Income Taxes
The Company intends to continue to reinvest its undistributed international
earnings to expand its international operations; therefore, no tax has been
provided to cover the repatriation of such undistributed earnings. At January 3,
1999 and December 28, 1997 the cumulative amount of undistributed international
earnings was approximately $7.0 billion and $5.9 billion, respectively.
Net Earnings Per Share
Basic earnings per share is computed by dividing net income available to common
shareowners by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.
Risks and Uncertainties
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported. Actual results are not
expected to differ materially from those estimates.
Annual Closing Date
The Company follows the concept of a fiscal year which ends on the Sunday
nearest to the end of the month of December. Normally each fiscal year consists
of 52 weeks, but every five or six years, as in 1998, the fiscal year consists
of 53 weeks.
Reclassification
Certain prior year amounts have been reclassified to conform with current year
presentation.
--------------------------------------------------------------------------------
2 Inventories
At the end of 1998 and 1997, inventories were comprised of:
35
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3 Property, Plant and Equipment
At the end of 1998 and 1997, property, plant and equipment at cost and
accumulated depreciation consisted of:
The Company capitalizes interest expense as part of the cost of
construction of facilities and equipment. Interest expense capitalized in 1998,
1997 and 1996 was $71, $40 and $55 million, respectively.
Upon retirement or other disposal of fixed assets, the cost and related
amount of accumulated depreciation or amortization are eliminated from the asset
and reserve accounts, respectively. The difference, if any, between the net
asset value and the proceeds is adjusted to income. For additional discussion on
property, plant and equipment, see Note 15.
--------------------------------------------------------------------------------
4 Borrowings
The Components of long-term debt are as follows:
(1) The principal amounts of these debt issues include the effect of foreign
currency movements. Such debt was converted to fixed or floating rate U.S.
dollar liabilities via interest rate and currency swaps. Unrealized currency
gains (losses) on currency swaps are not included in the basis of the related
debt transactions and are classified in the balance sheet as other assets
(liabilities).
(2) Weighted average effective rate.
(3) Represents 5% Deutsche Mark notes due 2001 issued by a Japanese subsidiary
and converted to a 1.98% fixed rate yen note via an interest rate and currency
swap.
(4) Represents 5.12% U.S. Dollar notes due 2003 issued by a Japanese subsidiary
and converted to a 0.82% fixed rate yen note via an interest rate and currency
swap
.
The Company has access to substantial sources of funds at numerous banks
worldwide. Total unused credit available to the Company approximates $3.2
billion, including $1.2 billion of credit commitments with various worldwide
banks, $800 million of which expire on October 1, 1999 and $400 million on
October 6, 2003. Interest charged on borrowings under the credit line agreements
is based on either bids provided by the banks, the prime rate or London
Interbank Offered Rates (LIBOR), plus applicable margins. Commitment fees under
the agreements are not material.
The Company's shelf registration filed with the Securities and Exchange
Commission enables the Company to issue up to $2.59 billion of unsecured debt
securities, and warrants to purchase debt securities, under its medium term note
(MTN) program. No MTN's were issued during 1998. At January 3, 1999, the Company
had $2.29 billion remaining on its shelf registration. In 1998 the Company
issued $60 million of 5.12% notes due 2003, the proceeds of which were used for
general corporate purposes.
Short-term borrowings and current portion of long-term debt amounted to
$2.7 billion at the end of 1998. These borrowings are composed of $2.2 billion
U.S. commercial paper, at an average rate of 5.0% and $0.5 billion of local
borrowings, principally by international subsidiaries.
Aggregate maturities of long-term obligations for each of the next five
years commencing in 1999 are:
5 Intangible Assets
At the end of 1998 and 1997, the gross and net amounts of intangible assets
were:
The weighted average amortization periods for goodwill, patents and trademarks
and other intangibles are 32 years, 21 years and 18 years, respectively.
36
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6 Income Taxes
The provision for taxes on income consists of:
Deferred income taxes are recognized for tax consequences of "temporary
differences" by applying enacted statutory tax rates, applicable to future
years, to differences between the financial reporting and the tax basis of
existing assets and liabilities.
Temporary differences and carryforwards for 1998 are as follows:
A comparison of income tax expense at the federal statutory rate of 35% in
1998, 1997 and 1996, to the Company's effective tax rate is as follows:
The increase in the 1998 worldwide effective tax rate was primarily due to the
Company's fourth quarter purchased IPR&D charge. During 1998, the Company had
subsidiaries operating in Puerto Rico under a tax incentive grant expiring
December 31, 2007. In addition, the Company has subsidiaries manufacturing in
Ireland under an incentive tax rate effective through the year 2010.
--------------------------------------------------------------------------------
7 International Currency Translation
For translation of its international currencies, the Company has determined that
the local currencies of its international subsidiaries are the functional
currencies except those in highly inflationary economies, which are defined as
those which have had compound cumulative rates of inflation of 100% or more
during the past three years.
In consolidating international subsidiaries, balance sheet currency
effects are recorded as a separate component of shareowners' equity. This equity
account includes the results of translating all balance sheet assets and
liabilities at current exchange rates, except for those located in highly
inflationary economies, principally Latin America, which are reflected in
operating results.
An analysis of the changes during 1998 and 1997 for cumulative currency
translation adjustments is included in Note 8.
Net currency transaction and translation gains and losses included in
other expense were after-tax losses of $15 million in 1998, after-tax losses of
$27 million in 1997, and after-tax gains of $2 million in 1996.
--------------------------------------------------------------------------------
8 Accumulated Other Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income" that the
Company adopted in the first quarter of 1998. SFAS 130 requires presentation of
comprehensive income and its components in the financial statements. Components
of other comprehensive income/(loss) consist of the following:
The change in unrealized gains/(losses) on marketable securities during 1998
includes reclassification adjustments of $38 million of losses realized from the
write-down of marketable securities and the associated tax benefit was $13
million. The tax effect on the components of other comprehensive income are
benefits of $17 million and $21 million in 1998 and 1997, respectively and
expense of $16 million in 1996 related to unrealized gains (losses) on
securities.
The currency translation adjustments are not adjusted for income taxes as
they relate to indefinite investments in non-U.S. subsidiaries.
37
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9 Rental Expense and Lease Commitments
Rentals of space, vehicles, manufacturing equipment and office and data
processing equipment under operating leases amounted to approximately $239
million in 1998, $235 million in 1997 and $237 million in 1996.
The approximate minimum rental payments required under operating leases that
have initial or remaining noncancellable lease terms in excess of one year at
January 3, 1999 are:
Commitments under capital leases are not significant.
--------------------------------------------------------------------------------
10 Common Stock, Stock Option Plans and Stock
Compensation Agreements
At January 3, 1999 the Company had eight stock-based compensation plans. Under
the 1995 Employee Stock Option Plan, the Company may grant options to its
employees for up to 56 million shares of common stock. The shares outstanding
are for contracts under the Company's 1986, 1991 and 1995 Employee Stock Option
Plans, the 1997 Non-Employee Directors' Plan and the Mitek, Cordis, Biosense and
Gynecare Stock Option plans.
Stock options expire ten years from the date they are granted and vest
over service periods that range from one to six years. Shares available for
future grants amounted to 15.0 million, 22.7 million and 32.9 million in 1998,
1997 and 1996, respectively.
A summary of the status of the Company's stock option plans as of January
3, 1999, December 28, 1997 and December 29, 1996 and changes during the years
ending on those dates, is presented below:
* Adjusted to reflect the 1996 two-for-one stock split.
The Company applies the provisions of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," that calls for companies to
measure employee stock compensation expense based on the fair value method of
accounting. However, as allowed by the Statement, the Company elected continued
use of Accounting Principle Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees, " with pro forma disclosure of net income and earnings per
share determined as if the fair value method had been applied in measuring
compensation cost. Had the fair value method been applied, net income would have
been reduced by $66 million or $.05 per share in 1998 and $30 million or $.02
per share in 1997. In 1996, net income would have been reduced by $16 million or
$.01 earnings per share. These calculations only take into account the options
issued since January 1, 1995. The average fair value of options granted was
$19.62 in 1998, $17.50 in 1997 and $13.37 in 1996. The fair value was estimated
using the Black-Scholes option pricing model based on the weighted average
assumptions of:
The following table summarizes stock options outstanding and exercisable
at January 3, 1999:
(a) Average contractual life remaining in years
--------------------------------------------------------------------------------
11 Employee Related Obligations
At the end of 1998 and 1997, employee related obligations were:
--------------------------------------------------------------------------------
12 Segments of Business and Geographic Areas
In 1998 the Company adopted Financial Accounting Standards No. 131, "Segments of
Business;" see page 45.
38
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13 Retirement and Pension Plans
The Company sponsors various retirement and pension plans, including defined
benefit, defined contribution and termination indemnity plans, which cover most
employees worldwide. The Company also provides postretirement benefits,
primarily health care to all domestic retired employees and their dependents.
Most international employees are covered by government-sponsored programs and
the cost to the Company is not significant.
Retirement plan benefits are primarily based on the employee's
compensation during the last three to five years before retirement and the
number of years of service. The Company's objective in funding its domestic
plans is to accumulate funds sufficient to provide for all accrued benefits.
International subsidiaries have plans under which funds are deposited with
trustees, annuities are purchased under group contracts, or reserves are
provided.
In certain countries other than the United States, the funding of pension
plans is not a common practice as funding provides no economic benefit.
Consequently, the Company has several pension plans which are not funded.
The Company does not fund retiree health care benefits in advance and has
the right to modify these plans in the future.
Effective December 29, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 132,"Employers' Disclosures about Pensions and
Postretirement Benefits," which standardizes the disclosure requirements for
pensions and other postretirement benefits. The Statement addresses disclosure
only. It does not address liability measurement or expense recognition. There
was no effect on financial position or net income as a result of adopting SFAS
No. 132.
Net periodic benefit costs for the Company's defined benefit retirement
plans and other benefit plans for 1998, 1997 and 1996 include the following
components:
The net periodic cost attributable to domestic retirement plans included above
was $40 million in 1998, $50 million in 1997 and $84 million in 1996.
The following tables provide the weighted-average assumptions used to
develop net periodic benefit cost and the actuarial present value of projected
benefit obligations:
Health care cost trends are projected at annual rates grading from 10% for
employees under age 65 and 7% for employees over age 65 down to 5% for both
groups by the year 2008 and beyond. The effect of a 1% change in these assumed
cost trends on the accumulated postretirement benefit obligation at the end of
1998 would be a $99 million increase or an $88 million decrease and the effect
on the service and interest cost components of the net periodic postretirement
benefit cost for 1998 would be a $12 million increase or a $10 million decrease.
39
The following tables set forth the change in benefit obligations and
change in plan assets at year-end 1998 and 1997 for the Company's defined
benefit retirement plans and other postretirement plans:
Amounts recognized in the Company's balance sheet consist of the following:
Plans with accumulated benefit obligations in excess of plan assets consist of
the following:
40
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14 Savings Plan
The Company has voluntary 401(k) savings plans designed to enhance the existing
retirement programs covering eligible employees. The Company matches a
percentage of each employee's contributions consistent with the provisions of
the plan for which he/she is eligible.
In the U.S. salaried plan, one-third of the Company match is paid in
Company stock under an employee stock ownership plan (ESOP). In 1990, to
establish the ESOP, the Company loaned $100 million to the ESOP Trust to
purchase shares of the Company stock on the open market. In exchange, the
Company received a note, the balance of which is recorded as a reduction of
shareowners' equity.
Total Company contributions to the plans were $63 million in 1998, $58
million in 1997, and $50 million in 1996.
--------------------------------------------------------------------------------
15 Restructuring and In-Process Research and Development Charges
In the fourth quarter of 1998, the Company approved a plan to reconfigure its
global network of manufacturing and operating facilities with the objective of
enhancing operating efficiencies. It is expected that the plan will be completed
over the next eighteen months. Among the initiatives supporting this plan were
the closure of inefficient manufacturing facilities, exiting certain businesses
which were not providing an acceptable return and related employee separations.
The closure of these facilities represented approximately 10% of the Company's
manufacturing capacity.
The estimated cost of this plan is $613 million which has been reflected
in cost of sales ($60 million) and restructuring charge ($553 million). The
charge consisted of employee separation costs of $161 million, asset impairments
of $322 million, impairments of intangibles of $52 million, and other exit costs
of $78 million. Employee separations will occur primarily in manufacturing and
operations facilities affected by the plan. The decision to exit certain
facilities and businesses decreased cash flows triggering the asset impairment.
The amount of impairment of such assets was calculated using discounted cash
flows or appraisals.
Special charges recorded during 1998 were as follows:
The headcount reduction for the year ended January 3, 1999 was
approximately 225 employees.
In connection with the businesses acquired in 1998, the Company recognized
charges for in-process research and development (IPR&D) in the amount of $164
million related primarily to DePuy. The value of the IPR&D projects was
calculated with the assistance of third party appraisers and was based on the
estimated percentage completion of the various research and development projects
being pursued using cash flow projections discounted for the risk inherent in
such projects. The majority of the value of the IPR&D is associated with DePuy
projects that focus on spinal and hip implants. For additional discussion on
acquisitions, see Note 17.
The special charges impacted the business segments as follows: the special
pre-tax charge for the Consumer segment was $244 million. This charge reflects
$85 million for severance costs associated with the termination of approximately
2,550 employees; $133 million for the write-down of impaired assets and $26
million for other exit costs. The Pharmaceutical business segment recorded $65
million of the special charge representing $18 million for severance costs
associated with the termination of approximately 250 employees and $47 million
for the write-down of impaired assets. Acquisitions within the Professional
business segment resulted in a $164 million write-off of purchased IPR&D.
Additionally, the Professional business segment recorded other special charges
of $304 million. This charge included $58 million for severance costs associated
with the termination of approximately 2,300 employees; $194 million for the
write-down of impaired assets and $52 million for other exit costs.
--------------------------------------------------------------------------------
16 Financial Instruments
Derivative Financial Instrument Risk
The Company uses derivative financial instruments to manage the impact of
interest rate and foreign exchange rate changes on earnings and cash flows. The
Company does not enter into financial instruments for trading or speculative
purposes.
The Company has a policy of only entering into contracts with parties that
have at least an "A" (or equivalent) credit rating. The counterparties to these
contracts are major financial institutions and the Company does not have
significant exposure to any one counterparty. Management believes the risk of
loss is remote and in any event would be immaterial.
Interest Rate and Foreign Exchange Risk Management
The Company uses interest rate and currency swaps to manage interest rate and
currency risk primarily related to borrowings. Interest rate and currency swap
agreements that hedge third party debt mature with these borrowings and are
described in Note 4.
The Company enters into forward foreign exchange contracts maturing within
five years to protect the value of existing foreign currency assets and
liabilities and to hedge future foreign currency product costs. The Company has
forward exchange contracts outstanding at year-end in various currencies,
principally in U.S. Dollars, Belgian Francs and Swiss Francs. In addition, the
Company has currency swaps outstanding, principally in U.S. Dollars, Belgian
Francs and French Francs. Unrealized gains and losses, based on dealer quoted
market prices, are presented in the following table:
41
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents and current and non-current
marketable securities approximates fair value of these instruments. In addition
the carrying amount of long-term investments, long-term debt, interest rate and
currency swaps (used to hedge third party debt) approximates fair value of these
instruments for 1998 and 1997.
The fair value of current and non-current marketable securities, long-term
debt and interest rate and currency swap agreements was estimated based on
quotes obtained from brokers for those or similar instruments. The fair value of
long-term investments was estimated based on quoted market prices at year-end.
Concentration of Credit Risk
The Company invests its excess cash in both deposits with major banks throughout
the world and other high quality short-term liquid money market instruments
(commercial paper, government and government agency notes and bills, etc.). The
Company has a policy of making investments only with commercial institutions
that have at least an "A" (or equivalent) credit rating. These investments
generally mature within six months and the Company has not incurred any related
losses.
The Company sells a broad range of products in the health care field in
most countries of the world. Concentrations of credit risk with respect to trade
receivables are limited due to the large number of customers comprising the
Company's customer base. Ongoing credit evaluations of customers' financial
condition are performed and, generally, no collateral is required. The Company
maintains reserves for potential credit losses and such losses, in the
aggregate, have not exceeded management's expectations.
--------------------------------------------------------------------------------
17 Mergers, Acquisitions and Divestitures
Certain businesses were acquired for $3.8 billion during 1998 and the purchase
method of accounting was employed. The most significant 1998 acquisition was
DePuy, Inc., a leading orthopaedics company. DePuy's product lines include
reconstructive products (implants for hips, knees and extremities), spinal
implants, trauma repair and sports-related injury products.
The excess of purchase price over the estimated fair value amounted to
$3.3 billion. This amount has been allocated to identifiable intangibles and
goodwill. Approximately $164 million has been identified as the value of IPR&D
associated with the acquisitions. The majority of the value is associated with
DePuy projects that focus on spinal and hip implants, which were near regulatory
approval as of the acquisition date. The remaining effort and cost to complete
these projects is not expected to be material. The Company is in the process of
finalizing a plan to reconfigure and integrate DePuy's operations, which will be
completed within one year of acquisition. This effort is expected to result in
employee terminations, facility closures and other related costs, which will be
recorded as adjustments to the opening balance sheet and are not expected to be
material. Pro forma information is not provided since the impact of the
acquisitions does not have a material effect on the Company's results of
operations, cash flows or financial position.
During 1997, certain businesses were merged with Johnson & Johnson at a
value, net of cash, of $737 million. The mergers have been accounted for as
poolings of interests; prior period financial statements have not been restated
since the effect of these mergers would not materially effect previously issued
financial statements. The 1997 mergers included Biopsys Medical, Inc., Biosense,
Inc. and Gynecare, Inc. Biopsys Medical, Inc. is an innovator and marketer of
the MAMMOTOME Breast Biopsy System. Biosense, Inc. is a leader in developing
medical sensor technology and is developing several applications that will
facilitate a variety of diagnostic and therapeutic interventional and
cardiovascular procedures. Gynecare, Inc. is the developer and marketer of
innovative, minimally invasive medical devices utilized in the treatment of
uterine disorders.
Certain businesses were acquired for $180 million during 1997 and the
purchase method of accounting was employed. The most significant 1997
acquisition was Innotech, Inc., a developer and marketer of eyeglass lens
products.
The excess of purchase price over the estimated fair value of 1997
acquisitions amounted to $157 million. This amount has been allocated to
identifiable intangibles and goodwill. Pro forma information is not provided for
in 1997 as the impact of the acquisition does not have a material effect on the
Company's results of operations, cash flows or financial position.
Divestitures in 1998 and 1997 did not have a material effect on the
Company's results of operations, cash flows or financial position.
--------------------------------------------------------------------------------
18 Pending 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 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
reserves established under its self-insurance program and by commercially
available excess liability insurance.
The Company, along with numerous other pharmaceutical manufacturers and
distributors, is a defendant in a large number of individual and class actions
brought by retail pharmacies in state and federal courts under the antitrust
laws. These cases assert price discrimination and price-fixing violations
resulting from an alleged industry-wide agreement to deny retail pharmacists
price discounts on sales of brand name prescription drugs. The Company believes
the claims against the Company in these actions are without merit and is
defending them vigorously.
The Company, together with another contact lens manufacturer, a trade
association and various individual defendants, is a defendant in several
consumer class actions and an action brought by multiple State Attorneys General
on behalf of consumers alleging violations of federal and state antitrust laws.
These cases assert that enforcement of the Company's long-standing policy of
selling contact lenses only to licensed eye care professionals is a result of an
unlawful conspiracy to eliminate alternative distribution channels from the
disposable contact lens market. The Company believes that these actions are
without merit and is defending them vigorously.
The Company is involved in a number of patent, trademark and other
lawsuits incidental to its business. Among those is a patent infringement action
in which U.S. Surgical Corporation seeks substantial damages and an injunction
based on what it alleges are infringing trocar surgical instrument sales by the
Company's Ethicon Endo-Surgery unit. The Company disputes infringement as well
as the validity and enforceability of the asserted patents and is vigorously
contesting the claims.
42
However, it is not possible to predict with certainty the outcome of litigation,
and while the Company does not believe an adverse result would have a material
effect on the Company's consolidated financial position, it could be material to
the results of operations for a fiscal year.
The Company's Ortho Biotech subsidiary is party to an arbitration
proceeding filed against it by Amgen, Ortho's licensor of U.S. non-dialysis
rights to EPO, in which Amgen seeks to terminate Ortho's U.S. license rights
based on alleged deliberate EPO sales by Ortho during the early 1990's into
Amgen's reserved dialysis market. The Company believes no basis exists for
terminating Ortho's U.S. license rights and is vigorously contesting Amgen's
claims. However, Ortho's U.S. license rights to EPO are material to the Company;
thus, an unfavorable outcome could have a material adverse effect on the
Company's consolidated financial position, liquidity or results of operations.
In December 1998, Ortho Biotech was found in a separate arbitration not to
have rights in what Amgen describes as its second-generation EPO product, known
as Novel Erythropoiesis Stimulating Protein, or NESP. The effect of the ruling
is to allow Amgen's NESP product, if approved, to compete with Ortho's EPO
product in the U.S. non-dialysis market and in all markets overseas, except
China and Japan, which are reserved to Kirin-Amgen. Currently, Ortho is Amgen's
exclusive licensee for EPO in U.S. non-dialysis markets and in all ex-U.S.
markets except China and Japan. Because NESP is still in clinical trials, it is
not possible to predict the impact on Ortho's marketing of EPO.
The Company believes that the above proceedings, except as noted above,
would not have a material adverse effect on its results of operations, cash
flows or financial position.
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19 Earnings Per Share
The following is a reconciliation of basic net earnings per share to diluted net
earnings per share for the years ended January 3, 1999, December 28, 1997 and
December 29, 1996:
(1) 1998 results excluding Restructuring and In-Process Research & Development
charges are: Basic EPS at $2.73 and diluted EPS at $2.67 (unaudited).
--------------------------------------------------------------------------------
20 Capital and Treasury Stock Changes in treasury stock were:
Shares of common stock authorized and issued were 1,534,824,000 shares at the
end of 1998, 1997, 1996 and 1995.
--------------------------------------------------------------------------------
21 Selected Quarterly Financial Data (Unaudited)
Selected unaudited quarterly financial data for the years 1998 and 1997 is
summarized below:
(1) 1998 results excluding Restructuring and In-Process Research & Development
charges: Earnings before taxes $924; Net earnings $693; Basic EPS $.52 and
Diluted EPS $.50.
43
Report of Management
The management of Johnson & Johnson is responsible for the integrity and
objectivity of the accompanying financial statements and related information.
The statements have been prepared in conformity with generally accepted
accounting principles, and include amounts that are based on our best judgments
with due consideration given to materiality.
Management maintains a system of internal accounting controls monitored by
a corporate staff of professionally trained internal auditors who travel
worldwide. This system is designed to provide reasonable assurance, at
reasonable cost, that assets are safeguarded and that transactions and events
are recorded properly. While the Company is organized on the principle of
decentralized management, appropriate control measures are also evidenced by
well-defined organizational responsibilities, management selection, development
and evaluation processes, communicative techniques, financial planning and
reporting systems and formalized procedures.
It has always been the policy and practice of the Company to conduct its
affairs ethically and in a socially responsible manner. This responsibility is
characterized and reflected in the Company's Credo and Policy on Business
Conduct that are distributed throughout the Company. Management maintains a
systematic program to ensure compliance with these policies.
PricewaterhouseCoopers LLP, independent auditors, is engaged to audit our
financial statements. Pricewaterhouse-Coopers LLP maintains an understanding of
our internal controls and conducts such tests and other auditing procedures
considered necessary in the circumstances to express their opinion in the report
that follows.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with the independent auditors, management and
internal auditors to review their work and confirm that they are properly
discharging their responsibilities. In addition, the independent auditors, the
General Counsel and the Vice President, Internal Audit are free to meet with the
Audit Committee without the presence of management to discuss the results of
their work and observations on the adequacy of internal financial controls, the
quality of financial reporting and other relevant matters.
/s/ Ralph S. Larsen /s/ Robert J. Darretta
Ralph S. Larsen Robert J. Darretta
Chairman, Board of Directors Vice President, Finance
and Chief Executive Officer and Chief Financial Officer
Independent Auditor's Report
To the Shareowners and Board of Directors of Johnson & Johnson:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, consolidated statements of equity, and
consolidated statements of cash flows present fairly, in all material respects,
the financial position of Johnson & Johnson and its subsidiaries at January 3,
1999 and December 28, 1997, and the results of their operations and their cash
flows for each of the three years in the period ended January 3, 1999, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCooper LLP
New York, New York
January 25, 1999
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Segments of Business(1) Johnson & Johnson and Subsidiaries
Geographic Areas (2)
(1) See Management's Discussion and Analysis, pages 27 to 30, for a
description of the segments in which the Company does business.
(2) Export sales and intersegment sales are not significant. No single
customer or country represents 10% or more of total sales.
(3) Prior years restated to conform to 1998 presentation according to SFAS No.
131.
(4) Amounts not allocated to segments include interest income/expense,
minority interests and general corporate income and expense.
(5) 1998 results excluding Restructuring and In-Process Research and
Development charges: Consumer $658, Pharmaceutical $3,081 and Professional
$1,409.
See Note 15 for details of Restructuring and IPR&D charges by segment.
Geographic Areas(2)
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Summary of Operations and
Statistical Data 1988-1998 Johnson & Johnson and Subsidiaries
* Adjusted to reflect the 1996 two-for-one stock split.
(1) Excluding the cumulative effect of accounting changes of $595 million.-1992
earnings percent of sales to customers before accounting changes is 11.8%. -1992
earnings percent return on average shareowners' equity before accounting changes
is 28.5%. -1993 basic net earnings per share percent increase over prior year
before accounting change is 11.4%; 1992 is 12.3%.
(2) Excluding Latin America non-recurring charges of $125 million. -1990 net
earnings percent of sales to customers before non-recurring charges is
11.3%.-1990 percent return on average shareowners' equity before non-recurring
charges is 27.6%. -1991 basic net earnings per share percent increase over prior
year before non-recurring charges is 15.3%; 1990 is 17.3%.
(3) Excluding Restructuring and In-Process Research and Development charges of
$610 million. -1998 earnings percent of sales to customers before special
charges is 15.5%. -1998 basic net earnings per share before special charges of
$2.73. -1998 diluted net earnings per share before special charges is $2.67.
-1998 percent return on average shareowners' equity before special charges is
27.6%. -1998 basic net earnings per share increase over prior year before
special charges is 10.5%. -1998 diluted net earnings per share increase over
prior year before special charges is 10.8%. - 1998 cost of products sold
includes $60 million of inventory write-offs for restructuring.
(4) Includes Latin America non-recurring charge of $36 million for the
liquidation of Argentine debt and $104 million writedown in other expenses for
permanent impairment of certain assets and operations in Latin America.
(5) Net of interest and other income.
(6) Also included in cost of materials and services category.
(7) Includes taxes on income, payroll, property and other business taxes.
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