EX-13 4 y86310kexv13.htm EX-13 exv13
 
Table of Contents
 
         
MANAGEMENT’S DISCUSSION AND ANALYSIS
 
30
    Organization and Business Segments
 
30
    Results of Operations
 
31
    Analysis of Sales by Business Segments
 
33
    Analysis of Consolidated Earnings Before Provision for Taxes on Income
 
36
    Liquidity and Capital Resources
 
37
    Other Information
 
40
    Cautionary Factors That May Affect Future Results
 
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
41
    Consolidated Balance Sheets
 
42
    Consolidated Statements of Earnings
 
43
    Consolidated Statements of Equity
 
44
    Consolidated Statements of Cash Flows
 
45
    Notes to Consolidated Financial Statements
 
72
    Report of Independent Registered Public Accounting Firm
 
73
    Management’s Report on Internal Control Over Financial Reporting
 
SUPPORTING SCHEDULES
 
74
    Summary of Operations and Statistical Data 2000 — 2010
 
75
    Shareholder Return Performance Graphs
 
 
JOHNSON & JOHNSON 2010 ANNUAL REPORT 29


 

 
Management’s Discussion and Analysis of Results of Operations and Financial Condition
 
Organization and Business Segments
 
Description of the Company and Business Segments
 
Johnson & Johnson and its subsidiaries (the “Company”) have approximately 114,000 employees worldwide engaged in the research and development, manufacture and sale of a broad range of products in the health care field. The Company conducts business in virtually all countries of the world with the primary focus on products related to human health and well-being.
 
The Company is organized into three business segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. The Consumer segment includes a broad range of products used in the baby care, skin care, oral care, wound care and women’s health care fields, as well as nutritional and over-the-counter pharmaceutical products and wellness and prevention platforms. These products are marketed to the general public and sold both to retail outlets and distributors throughout the world. The Pharmaceutical segment includes products in the following areas: anti-infective, antipsychotic, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management and virology. These products are distributed directly to retailers, wholesalers and health care professionals for prescription use. The Medical Devices and Diagnostics segment includes a broad range of products distributed to wholesalers, hospitals and retailers used principally in the professional fields by physicians, nurses, therapists, hospitals, diagnostic laboratories and clinics. These products include Biosense Webster’s electrophysiology products; Cordis’ circulatory disease management products; DePuy’s orthopaedic joint reconstruction, spinal care, neurological and sports medicine products; Ethicon’s surgical care, aesthetics and women’s health products; Ethicon Endo-Surgery’s minimally invasive surgical products and advanced sterilization products; LifeScan’s blood glucose monitoring and insulin delivery products; Ortho-Clinical Diagnostics’ professional diagnostic products and Vistakon’s disposable contact lenses.
 
The Company’s structure is based upon the principle of decentralized management. The Executive Committee of Johnson & Johnson is the principal management group responsible for the operations and allocation of the resources of the Company. This Committee oversees and coordinates the activities of the Consumer, Pharmaceutical and Medical Devices and Diagnostics business segments.
 
In all of its product lines, the Company competes with companies both local and global, located throughout the world. Competition exists in all product lines without regard to the number and size of the competing companies involved. Competition in research, involving the development and the improvement of new and existing products and processes, is particularly significant. The development of new and innovative products is important to the Company’s success in all areas of its business. This also includes protecting the Company’s portfolio of intellectual property. The competitive environment requires substantial investments in continuing research and in maintaining sales forces. In addition, the development and maintenance of customer demand for the Company’s consumer products involves significant expenditures for advertising and promotion.
 
Management’s Objectives
 
The Company manages within a strategic framework aimed at achieving sustainable growth. To accomplish this, the Company’s management operates the business consistent with certain strategic principles that have proven successful over time. To this end, the Company participates in growth areas in human health care and is committed to attaining leadership positions in these growth areas through the development of high quality, innovative products and services. New products introduced within the past five years accounted for approximately 25% of 2010 sales. In 2010, $6.8 billion, or 11.1% of sales, was invested in research and development. This investment reflects management’s commitment to the importance of ongoing development of new and differentiated products and services to sustain long-term growth.
 
With more than 250 operating companies located in 60 countries, the Company views its principle of decentralized management as an asset and fundamental to the success of a broadly based business. It also fosters an entrepreneurial spirit, combining the extensive resources of a large organization with the ability to anticipate and react quickly to local market changes and challenges.
 
The Company is committed to developing global business leaders who can drive growth objectives. Businesses are managed for the long-term in order to sustain leadership positions and achieve growth that provides an enduring source of value to our shareholders.
 
Our Credo unifies the management team and the Company’s dedicated employees in achieving these objectives, and provides a common set of values that serve as a constant reminder of the Company’s responsibilities to its customers, employees, communities and shareholders. The Company believes that these basic principles, along with its overall mission of improving the quality of life for people everywhere, will enable Johnson & Johnson to continue to be among the leaders in the health care industry.
 
Results of Operations
 
Analysis of Consolidated Sales
 
In 2010, worldwide sales decreased 0.5% to $61.6 billion, compared to a decrease of 2.9% in 2009 and an increase of 4.3% in 2008. These sales changes consisted of the following:
 
                         
Sales (decrease)/increase Due to:   2010     2009     2008  
 
Volume
    (0.5 )%     (0.2 )     1.1  
Price
    (0.8 )     (0.1 )     0.8  
Currency
    0.8       (2.6 )     2.4  
                         
Total
    (0.5 )%     (2.9 )     4.3  
                         
 
Sales by U.S. companies were $29.5 billion in 2010, $30.9 billion in 2009 and $32.3 billion in 2008. This represents a decrease of 4.7% in 2010, a decrease of 4.4% in 2009 and a decrease of 0.4% in 2008. Sales by international companies were $32.1 billion in 2010, $31.0 billion in 2009 and $31.4 billion in 2008. This represents an increase of 3.6% in 2010, a decrease of 1.4% in 2009 and an increase of 9.7% in 2008, respectively.
 
 
 
30 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

(PERFORMANCE GRAPH)
 
The five-year compound annual growth rates for worldwide, U.S. and international sales were 4.0%, 0.7% and 7.7%, respectively. The ten-year compound annual growth rates for worldwide, U.S. and international sales were 7.8%, 5.5% and 10.5%, respectively.
 
(PERFORMANCE GRAPH)
 
Sales in Europe experienced a decline of 2.7% including operational growth of 0.5% and a negative impact from currency of 3.2%. Sales in the Western Hemisphere (excluding the U.S.) achieved growth of 7.6% including an operational decline of 0.5% and an increase of 8.1% related to the positive impact of currency. Sales in the Asia-Pacific, Africa region achieved growth of 11.7%, including operational growth of 5.5% and an increase of 6.2% related to the positive impact of currency.
 
In 2010, 2009 and 2008, the Company did not have a customer that represented 10% or more of total consolidated revenues.
 
2009 results benefited from the inclusion of a 53rd week. (See Note 1 to the Consolidated Financial Statements for Annual Closing Date details). The Company estimated that the fiscal year 2009 growth rate was enhanced by approximately 0.5% due to the 53rd week.
 
U.S. Health Care Reform
The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 were signed into law during March 2010. The newly enacted health care reform legislation included an increase in the minimum Medicaid rebate rate from 15.1% to 23.1% and also extended the rebate to drugs provided through Medicaid managed care organizations. The 2010 impact was an increase in sales rebates reducing sales revenue by approximately $400 million. The 2011 full year impact to sales of the legislation is estimated to be $400 — $500 million.
 
Beginning in 2011, companies that sell branded prescription drugs to specified U.S. Government programs will pay an annual non-tax deductible fee based on an allocation of the company’s market share of total branded prescription drug sales from the prior year. The estimate of the impact on the Company in 2011 is $150 — $200 million. Beginning in 2013, the Company will be required to pay a tax deductible 2.3% excise tax imposed on the sale of certain medical devices.
 
(PERFORMANCE GRAPH)
 
Analysis of Sales by Business Segments
 
Consumer Segment
Consumer segment sales in 2010 were $14.6 billion, a decrease of 7.7% from 2009, with 8.9% of this change due to an operational decline partially offset by positive currency impact of 1.2%. U.S. Consumer segment sales were $5.5 billion, a decrease of 19.3%. International sales were $9.1 billion, an increase of 1.2%, with an operational decline of 1.0% offset by positive currency impact of 2.2%.
 
The Over-the-Counter (OTC) Pharmaceuticals and Nutritionals franchise sales were $4.5 billion, a decrease of 19.2% from 2009. Sales were negatively impacted by the voluntary recalls of certain OTC products announced earlier in the year and suspension of production at McNeil Consumer Healthcare’s Fort Washington, Pennsylvania facility. McNeil’s recalls of products manufactured at both Las Piedras and Fort Washington facilities impacted the total year sales by approximately $900 million.
 
Alternate supplies of products are planned to be available in the latter half of 2011. McNeil Consumer Healthcare submitted its Comprehensive Action Plan (CAP) to the U.S. Food and Drug Administration (FDA) on July 15, 2010, which encompasses, among other items, training, resources and capital investments in quality and manufacturing systems across the McNeil organization. The
 
Major Consumer Franchise Sales:
 
                                         
                      % Change  
(Dollars in Millions)   2010     2009     2008     ’10 vs. ’09     ’09 vs. ’08  
 
OTC Pharmaceuticals & Nutritionals
  $ 4,549       5,630       5,894       (19.2 )%     (4.5 )
Skin Care
    3,452       3,467       3,381       (0.4 )     2.5  
Baby Care
    2,209       2,115       2,214       4.4       (4.5 )
Women’s Health
    1,844       1,895       1,911       (2.7 )     (0.8 )
Oral Care
    1,526       1,569       1,624       (2.7 )     (3.4 )
Wound Care/Other
    1,010       1,127       1,030       (10.4 )     9.4  
                                         
Total
  $ 14,590       15,803       16,054       (7.7 )%     (1.6 )
                                         
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 31


 

Company continues to communicate with the FDA on remediation actions and is on schedule with the commitments made in the CAP.
 
The Skin Care franchise sales were $3.5 billion, a decline of 0.4% compared to the prior year due in part to a temporary reduction in shipments of Neutrogena products due to product supply constraints partially offset by growth in the AVEENO®, JOHNSON’s® Adult, LE PETIT MARSEILLAIS® and DABAO® skin care lines. The Baby Care franchise sales grew by 4.4% to $2.2 billion in 2010, primarily due to growth in the Asia Pacific region partially offset by the impact of the economic situation in Venezuela. The Women’s Health franchise sales were $1.8 billion, a decrease of 2.7% primarily due to increased competitive pressures and the impact of the economic situation in Venezuela. The Oral Care franchise sales were $1.5 billion, a decrease of 2.7% primarily due to the divestiture of the EFFERDENT®/Effergrip® brands in the fiscal fourth quarter of 2009 and lower sales of mouth rinses and toothbrushes in the United States. The Wound Care/Other franchise sales were $1.0 billion, a decrease of 10.4% primarily due to private label competition and slower category growth.
 
Consumer segment sales in 2009 were $15.8 billion, a decrease of 1.6% from 2008, with 2.0% of this change due to operational growth and negative currency impact of 3.6%. U.S. Consumer segment sales were $6.8 billion, a decrease of 1.4%. International sales were $9.0 billion, a decrease of 1.7%, with growth of 4.7% achieved by operations and a decrease of 6.4% resulting from the negative impact of currency fluctuations.
 
Pharmaceutical Segment
 
Pharmaceutical segment sales in 2010 were $22.4 billion, a decrease of 0.6% from 2009, with an operational decline of 1.0% and a positive currency impact of 0.4%. U.S. sales were $12.5 billion, a decrease of 4.0%. International sales were $9.9 billion, an increase of 4.2%, which included 3.4% operational growth and a positive currency impact of 0.8%. Pharmaceutical segment sales in 2010 were reduced by approximately $400 million as a result of U.S. health care reform legislation.
 
REMICADE® (infliximab), a biologic approved for the treatment of a number of immune mediated inflammatory diseases, achieved sales of $4.6 billion in 2010, with growth of 7.1% over the prior year. U.S. export sales grew 24.3% versus the prior year primarily driven by market growth. REMICADE® is competing in a market that is experiencing increased competition due to new entrants, including the successful launches of STELARA® (ustekinumab) and SIMPONI® (golimumab) and the expansion of indications for existing competitors.
 
PROCRIT® (Epoetin alfa) and EPREX® (Epoetin alfa) had combined sales of $1.9 billion in 2010, a decline of 13.9% compared to the prior year. Lower sales of PROCRIT® and EPREX® were primarily due to the declining markets for Erythropoiesis Stimulating Agents (ESAs). EPREX® also experienced increased competition.
 
RISPERDAL® CONSTA® (risperidone), a long-acting injectable antipsychotic, achieved sales of $1.5 billion in 2010, representing an increase of 5.3% as compared to the prior year. Solid growth of 16.4% was achieved outside the U.S., with very strong growth in Japan. In the U.S. the successful launch of INVEGA® SUSTENNAtm (paliperidone palmitate) also increased the growth of the long-acting injectable antipsychotic market.
 
LEVAQUIN® (levofloxacin)/FLOXIN® (ofloxacin) sales were $1.4 billion, a decline of 12.5% versus the prior year primarily due to the decline in the market and increased penetration of generics. Market exclusivity in the U.S. expires in June 2011. The expiration of a product’s market exclusivity is likely to result in a significant reduction in sales.
 
CONCERTA® (methylphenidate HCl), a product for the treatment of attention deficit hyperactivity disorder (ADHD), achieved sales of $1.3 billion in 2010, a decrease of 0.5% compared to the prior year. Sales growth in the U.S. was impacted by lower market share and the health care reform legislation enacted in March 2010 resulting from changes to rebates to Medicaid managed care organizations. On November 1, 2010, the Company entered into a U.S. supply and distribution agreement with Watson Laboratories, Inc. to distribute an authorized generic version of CONCERTA® beginning May 1, 2011. This authorized generic launch is likely to result in a significant reduction in CONCERTA®sales.
 
VELCADE® (bortezomib), a product for the treatment for multiple myeloma, for which the Company has commercial rights in Europe and the rest of the world outside the U.S., achieved sales of $1.1 billion in 2010, representing an increase of 15.8% as compared to the prior year.
 
ACIPHEX®/PARIET® (rabeprazole sodium) sales were $1.0 billion, a decline of 8.2% versus the prior year due to increased competition from generics in the category.
 
TOPAMAX® (topiramate), experienced a sales decline of 53.3% compared to the prior year. Market exclusivity for TOPAMAX® expired in March 2009 in the U.S. and in September 2009 in most European countries. Multiple generics have entered the market. Loss of market exclusivity for the TOPAMAX® patent has resulted in the significant reduction of sales in the U.S. and Europe.
 
In 2010, Other Pharmaceutical sales were $9.1 billion, representing a growth of 6.6% over the prior year. Contributors to the increase were sales of STELARA® (ustekinumab), SIMPONI® (golimumab),
 
Major Pharmaceutical Product Revenues*:
 
                                         
                      % Change  
(Dollars in Millions)   2010     2009     2008     ’10 vs. ’09     ’09 vs. ’08  
 
REMICADE® (infliximab)
  $ 4,610       4,304       3,748       7.1 %     14.8  
PROCRIT®/EPREX® (Epoetin alfa)
    1,934       2,245       2,460       (13.9 )     (8.7 )
RISPERDAL® CONSTA® (risperidone)
    1,500       1,425       1,309       5.3       8.9  
LEVAQUIN®/FLOXIN® (levofloxacin/ofloxacin)
    1,357       1,550       1,591       (12.5 )     (2.6 )
CONCERTA® (methylphenidate HCl)
    1,319       1,326       1,247       (0.5 )     6.3  
VELCADE® (bortezomib)
    1,080       933       787       15.8       18.6  
ACIPHEX®/PARIET® (rabeprazole sodium)
    1,006       1,096       1,158       (8.2 )     (5.4 )
TOPAMAX® (topiramate)
    538       1,151       2,731       (53.3 )     (57.9 )
Other Pharmaceuticals
    9,052       8,490       9,536       6.6       (11.0 )
                                         
Total
  $ 22,396       22,520       24,567       (0.6 )%     (8.3 )
                                         
Prior year amounts have been reclassified to conform to current presentation.
 
 
32 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

PREZISTA® (darunavir), INTELENCE® (etravirine), NUCYNTA® (tapentadol) and INVEGA SUSTENNA® (paliperidone palmitate). This growth was partially offset by lower sales of DURAGESIC®/Fentanyl Transdermal (fentanyl transdermal system) and RISPERDAL®/risperidone oral due to continued generic competition.
 
During 2010, several new compounds were filed for regulatory approval. These included abiraterone acetate, an investigational agent for the treatment of metastatic, advanced prostate cancer which was granted priority review in the U.S. and accepted for accelerated assessment in Europe, and telaprevir, developed in collaboration with Vertex Pharmaceuticals Incorporated, for hepatitis C which was filed and accepted for accelerated assessment in Europe. TMC 278 (rilpivirine) for HIV in treatment-naïve patients was filed in both the U.S. and Europe. Rivaroxaban, an anti-coagulant co-developed with Bayer HealthCare, has been filed in the U.S. for the prevention of stroke in patients with atrial fibrulation. The Company also responded to the FDA complete response letter for its review of the rivaroxaban filing for preventing deep vein thrombosis and pulmonary embolism following total knee and hip replacement surgery.
 
Pharmaceutical segment sales in 2009 were $22.5 billion, a decrease of 8.3% from 2008, with an operational decline of 6.1% and the remaining 2.2% due to the negative impact of currency fluctuations. U.S. sales were $13.0 billion, a decrease of 12.1%. International sales were $9.5 billion, a decrease of 2.6%, which included 3.0% operational growth and a decrease of 5.6% resulting from the negative impact of currency fluctuations.
 
Medical Devices and Diagnostics Segment
 
The Medical Devices and Diagnostics segment achieved sales of $24.6 billion in 2010, representing an increase of 4.4% over the prior year, with operational growth of 3.4% and a positive currency impact of 1.0%. U.S. sales were $11.4 billion, an increase of 3.6% over the prior year. International sales were $13.2 billion, an increase of 5.0% over the prior year, with growth of 3.0% from operations and a positive currency impact of 2.0%.
 
The DePuy franchise achieved sales of $5.6 billion in 2010, a 4.0% increase over the prior year. This growth was primarily due to an increase in the knee and Mitek sports medicine product lines, and outside the U.S., growth of the hip product line. Pressure on pricing continued as a result of economic trends, however new product launches and incremental sales of newly acquired products from Micrus Endovascular Corporation have mitigated some of the impact. In August 2010, DePuy Orthopaedics, Inc. (DePuy) announced a worldwide voluntary recall of its ASRtm XL Acetabular System and DePuy ASRtm Hip Resurfacing System used in hip replacement surgery, principally sold between 2003 and 2009.
 
The Ethicon Endo-Surgery franchise achieved sales of $4.8 billion in 2010, a 5.9% increase over the prior year. This was attributable to growth in the endoscopy, Advanced Sterilization, HARMONIC®, SurgRx and ENSEAL® product lines. The growth was partially offset by the divestiture of the Breast Care business in the third quarter of 2010.
 
The Ethicon franchise achieved sales of $4.5 billion in 2010, a 9.2% increase over the prior year. The growth was attributable to sales of newly acquired products from Acclarent, Inc. in addition to growth in the sutures, Mentor, biosurgical, Women’s Health and Urology, and mesh product lines.
 
The Vision Care franchise achieved sales of $2.7 billion in 2010, a 6.9% increase over prior year primarily driven by 1-DAY ACUVUE® TruEyetm, ACUVUE® OASYStm for Astigmatism, and 1-DAY ACUVUE ® MOIST®, partially offset by lower sales of reusable lenses. During 2010, the Company and Novartis AG, CIBAVISION Corporation and CIBA VISION AG agreed to resolve all pending patent litigation on a worldwide basis enabling the Company to reenter the markets in France and the Netherlands.
 
Sales in the Cordis franchise were $2.6 billion, a decline of 4.7% versus the prior year. The decline reflects lower sales of the CYPHER® Sirolimus-eluting Coronary Stent due to increased global competition. The decline was partially offset by strong growth of the Biosense Webster business.
 
Sales in the Diabetes Care franchise were $2.5 billion in 2010, a 1.2% increase over the prior year. This was primarily attributable to growth in the U.S. and Asia Pacific region partially offset by a sales decline in Europe.
 
The Ortho-Clinical Diagnostics franchise achieved sales of $2.1 billion in 2010, a 4.6% increase over the prior year. Growth was primarily attributable to sales of the VITROS® 5600 and 3600 analyzers partially offset by lower sales in donor screening primarily due to more selective screening for Chagas testing in the U.S.
 
The Medical Devices and Diagnostics segment achieved sales of $23.6 billion in 2009, representing an increase of 1.9% over the prior year, with operational growth of 4.2% and a negative currency impact of 2.3%. U.S. sales were $11.0 billion, an increase of 4.5% over the prior year. International sales were $12.6 billion, a decrease of 0.2%, with growth of 4.0% from operations and a decrease of 4.2% resulting from the negative impact of currency fluctuations.
 
Major Medical Devices and Diagnostics Franchise Sales:
 
                                         
                      % Change  
(Dollars in Millions)   2010     2009     2008     ’10 vs. ’09     ’09 vs. ’08  
 
DEPUY®
  $ 5,585       5,372       5,136       4.0 %     4.6  
ETHICON ENDO-SURGERY®
    4,758       4,492       4,286       5.9       4.8  
ETHICON®
    4,503       4,122       3,840       9.2       7.3  
Vision Care
    2,680       2,506       2,500       6.9       0.2  
CORDIS®
    2,552       2,679       2,988       (4.7 )     (10.3 )
Diabetes Care
    2,470       2,440       2,535       1.2       (3.7 )
ORTHO-CLINICAL DIAGNOSTICS®
    2,053       1,963       1,841       4.6       6.6  
                                         
Total
  $ 24,601       23,574       23,126       4.4 %     1.9  
                                         
 
Analysis of Consolidated Earnings Before Provision for Taxes on Income
 
Consolidated earnings before provision for taxes on income increased by $1.1 billion to $16.9 billion in 2010 as compared to the $15.8 billion earned in 2009, an increase of 7.6%. The increase was primarily related to lower selling, marketing and administrative expenses due to cost containment actions resulting from the restructuring plan initiated and implemented in 2009, income from litigation settlements and the gain on the divestiture of the Breast Care business of Ethicon Endo-Surgery, Inc. This was partially offset by costs associated with product liability expense and the impact of the OTC and DePuy ASRtm Hip recalls. Additional offsets were lower
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 33


 

net selling prices in the Pharmaceutical business due to U.S. health care reform and price reductions in certain Medical Devices and Diagnostics businesses. The 2009 decrease of 6.9% as compared to $16.9 billion in 2008 was primarily related to lower sales, the negative impact of product mix, lower interest income due to lower rates of interest earned and restructuring charges of $1.2 billion. This was partially offset by lower selling, marketing and administrative expenses due to cost containment efforts across all the businesses. The 2008 earnings included purchased in-process research and development (IPR&D) charges of $0.2 billion and increased investment spending in selling, marketing and administrative expenses utilized from the proceeds associated with the divestiture of the Professional Wound Care business of Ethicon, Inc. As a percent to sales, consolidated earnings before provision for taxes on income in 2010 was 27.5% versus 25.4% in 2009.
 
The sections that follow highlight the significant components of the changes in consolidated earnings before provision for taxes on income.
 
Cost of Products Sold and Selling, Marketing and Administrative Expenses:  Cost of products sold and selling, marketing and administrative expenses as a percent to sales were as follows:
 
                         
% of Sales   2010   2009   2008
 
Cost of products sold
    30.5 %     29.8       29.1  
Percent point increase over the prior year
    0.7       0.7        
Selling, marketing and administrative expenses
    31.5       32.0       33.7  
Percent point (decrease)/increase over the prior year
    (0.5 )     (1.7 )     0.2  
 
In 2010, cost of products sold as a percent to sales increased compared to the prior year primarily due to costs associated with the impact of the OTC recall and remediation efforts in the Consumer business, lower net selling prices in the Pharmaceutical business due to U.S. health care reform and price reductions in certain Medical Devices and Diagnostics businesses. Additionally, unfavorable product mix attributable to the loss of market exclusivity for TOPAMAX® contributed to the increase. There was a decrease in the percent to sales of selling, marketing and administrative expenses in 2010 compared to the prior year primarily due to cost containment initiatives principally resulting from the restructuring plan implemented in 2009. The decrease was partially offset by lower net selling prices in the Pharmaceutical business due to U.S. health care reform and price reductions in certain Medical Devices and Diagnostics businesses.
 
In 2009, cost of products sold as a percent to sales increased compared to the prior year primarily due to the continued negative impact of product mix and inventory write-offs associated with the restructuring activity. Additionally, 2008 included some non-recurring positive items. There was a decrease in the percent to sales of selling, marketing and administrative expenses in 2009 compared to the prior year primarily due to cost containment efforts across all the businesses and the annualized savings recognized from the 2007 restructuring program. In addition, in 2008 the Company utilized the proceeds associated with the divestiture of the Professional Wound Care business of Ethicon, Inc. to fund increased investment spending.
 
In 2008, cost of products sold as a percent to sales remained flat to the prior year. The change in the mix of businesses, with higher sales growth in the Consumer business and a slight sales decline in the Pharmaceutical business, had a negative impact on the cost of products sold as a percent to sales. In 2008, this was offset by manufacturing efficiencies and non-recurring positive items in 2008 and negative items in 2007. There was an increase in the percent to sales of selling, marketing and administrative expenses in 2008 primarily due to the change in the mix of businesses, whereby a greater proportion of sales were attributable to the Consumer segment, which has higher selling, marketing and administrative spending. Additionally, in 2008 the Company utilized the gain associated with the divestiture of the Professional Wound Care business of Ethicon, Inc. to fund increased investment spending. This was partially offset by ongoing cost containment efforts.
 
Research and Development expense (excluding purchased in-process research and development charges) by segment of business was as follows:
 
                                                 
    2010     2009     2008  
(Dollars in Millions)   Amount     % of Sales*     Amount     % of Sales*     Amount     % of Sales*  
 
Consumer
  $ 609       4.2 %     632       4.0       624       3.9  
Pharmaceutical
    4,432       19.8       4,591       20.4       5,095       20.7  
Medical Devices and Diagnostics
    1,803       7.3       1,763       7.5       1,858       8.0  
                                                 
Total research and development expense
  $ 6,844       11.1 %     6,986       11.3       7,577       11.9  
Percent (decrease)/increase over the prior year
    (2.0 )%             (7.8 )             (1.3 )        
                                                 
As a percent to segment sales
 
Research and Development Expense:  Research and development 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 consumers and patients. The Company remains committed to investing in research and development with the aim of delivering high quality and innovative products.
 
Restructuring:  In 2009, the Company announced global restructuring initiatives that are expected to generate pre-tax, annual cost savings of approximately $1.5 billion when fully implemented in 2011. The associated savings has provided additional resources to invest in new growth platforms; ensure the successful launch of the Company’s many new products and continued growth of the core businesses; and provide flexibility to adjust to the changed and evolving global environment. In the fiscal fourth quarter of 2009, the Company recorded a pre-tax charge of $1.2 billion, of which $113 million was included in cost of products sold.
 
See Note 22 to the Consolidated Financial Statements for additional details related to the restructuring.
 
Purchased In-Process Research and Development:  Beginning in 2009, in accordance with U.S. GAAP for business combinations, purchased in-process research and development (IPR&D) is no longer expensed but capitalized and tested for impairment. The Company capitalized approximately $0.2 billion of IPR&D in 2010, primarily associated with the acquisitions of Acclarent, Inc., RespiVert Ltd. and Micrus Endovascular Corporation. The Company capitalized $1.7 billion of IPR&D in 2009, primarily associated with the acquisitions of Cougar Biotechnology, Inc. and substantially all of the assets and rights of Elan related to its Alzheimer’s Immunotherapy Program.
 
 
34 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

In 2008, the Company recorded a charge for IPR&D of $181 million before and after tax related to the acquisitions of Amic AB, SurgRx, Inc., HealthMedia, Inc. and Omrix Biopharmaceuticals, Inc. HealthMedia, Inc., a privately held company that creates web-based behavior change interventions, accounted for $7 million before tax of the IPR&D charges and was included in the operating profit of the Consumer segment. The IPR&D charges for all of the following acquisitions were included in the operating profit of the Medical Devices and Diagnostics segment. Amic AB, a Swedish developer of in vitro diagnostic technologies for use in point-of-care and near-patient settings (outside the physical facilities of the clinical laboratory), accounted for $40 million before tax of the IPR&D charges. SurgRx, Inc., a privately held developer of the advanced bipolar tissue sealing system used in the ENSEAL® family of devices, accounted for $7 million before tax of the IPR&D charges. Omrix Biopharmaceuticals, Inc., a fully integrated biopharmaceutical company that develops and markets biosurgical and immunotherapy products, accounted for $127 million before tax of the IPR&D charges.
 
Other (Income) Expense, Net:  Other (income) expense, net includes royalty income; gains and losses related to the sale and write-down of certain investments in equity securities held by Johnson & Johnson Development Corporation; gains and losses on the disposal of property, plant and equipment; currency gains and losses; non-controlling interests; and litigation settlements. The favorable change of $0.2 billion in other (income) expense, net, in 2010 as compared to 2009, was primarily due to a net gain from litigation settlements and the gain on the divestiture of businesses partially offset by product liability expense.
 
In 2009, other (income) expense, net included net litigation settlements of $0.4 billion. In 2008, other (income) expense, net included income from net litigation settlements and awards of $0.5 billion and a gain of $0.5 billion from the divestiture of the Professional Wound Care business of Ethicon, Inc.
 
Operating Profit by Segment
 
Operating profits by segment of business were as follows:
 
                                 
                Percent of Segment Sales  
(Dollars in Millions)   2010     2009     2010     2009  
 
Consumer
  $ 2,342       2,475       16.1 %     15.7  
Pharmaceutical
    7,086       6,413       31.6       28.5  
Medical Devices and Diagnostics
    8,272       7,694       33.6       32.6  
                                 
Total(1)
    17,700       16,582       28.7       26.8  
Less: Expenses not allocated to segments(2)
    753       827                  
                                 
Earnings before provision for taxes on income
  $ 16,947       15,755       27.5 %     25.4  
                                 
 
(1)  See Note 18 to the Consolidated Financial Statements for more details.
 
(2)  Amounts not allocated to segments include interest (income) expense, non-controlling interests, and general corporate (income) expense.
 
(PERFORMANCE GRAPH)
 
Consumer Segment:  In 2010, Consumer segment operating profit decreased 5.4% from 2009. The primary reasons for the decrease in the operating profit were lower sales and higher costs associated with the recall of certain OTC products and the suspension of production at McNeil Consumer Healthcare’s Fort Washington, Pennsylvania facility. In 2009, Consumer segment operating profit decreased 7.4% from 2008. The primary reasons for the decrease in operating profit were $369 million of restructuring charges, partially offset by cost containment initiatives in 2009.
 
Pharmaceutical Segment:  In 2010, Pharmaceutical segment operating profit increased 10.5% from 2009. The primary reasons for the increase in operating profit were lower manufacturing costs, the gain on a divestiture, and benefits from cost improvement initiatives related to the restructuring plan implemented in 2009, partially offset by $333 million of expense related to litigation matters, increased product liability expense and the impact of the newly enacted U.S. health care reform legislation. In 2009, Pharmaceutical segment operating profit decreased 15.7% from 2008. The primary reasons for the decrease in operating profit were $496 million of restructuring charges, $92 million of litigation expense and negative product mix due to the loss of market exclusivity for TOPAMAX® and RISPERDAL® oral.
 
Medical Devices and Diagnostics Segment:  In 2010, Medical Devices and Diagnostics segment operating profit increased 7.5% from 2009. The improved operating profit was due to a gain of $1.3 billion from net litigation matters and the gain on the divestiture of the Breast Care business recorded in 2010. This was partially offset by increased product liability expense, $280 million of costs associated with the DePuy ASRtm Hip recall program and price reductions in certain Medical Devices and Diagnostics businesses. In 2009, the operating profit in the Medical Devices and Diagnostics segment increased 6.5% from 2008. The improved operating profit was due to a $478 million gain from net litigation settlements, favorable product mix, manufacturing efficiencies and cost containment initiatives related to selling, marketing and administrative expenses. This was partially offset by $321 million in restructuring charges.
 
Interest (Income) Expense:  Interest income in 2010 increased by $17 million over the prior year due to higher average cash balances. Cash, cash equivalents and marketable securities totaled $27.7 billion at the end of 2010, and averaged $23.6 billion as compared to the $15.6 billion average cash balance in 2009. The increase in the average cash balance was primarily due to cash generated from operating activities and net cash proceeds from litigation matters and divestitures.
 
Interest expense in 2010 was relatively flat as compared to 2009 due to a lower average rate despite a higher debt balance. The total debt balance at the end of 2010 was $16.8 billion as compared to $14.5 billion at the end of 2009. The higher average debt balance of $15.7 billion in 2010 versus $13.5 billion in 2009 was due to increased borrowings. The Company increased borrowings, capitalizing on favorable terms in the capital markets. The proceeds of the notes were used for general corporate purposes.
 
Interest income in 2009 decreased by $271 million as compared to 2008 due to lower rates of interest earned despite higher average cash balances. The cash balance, including marketable securities, was $19.4 billion at the end of 2009, and averaged $15.6 billion as compared to the $12.2 billion average cash balance in 2008. The increase in the average cash balance was primarily due to cash generated from operating activities.
 
Interest expense in 2009 increased by $16 million as compared to 2008 due to a higher debt balance. The net debt balance at the end of 2009 was $14.5 billion as compared to $11.9 billion at the end of 2008. The higher average debt balance of $13.5 billion in 2009
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 35


 

versus $12.9 billion in 2008 was primarily related to funding acquisitions and investments and the purchase of the Company’s Common Stock under the ongoing Common Stock repurchase program announced on July 9, 2007.
 
Interest income in 2008 decreased by $91 million as compared to 2007 due to lower rates of interest earned despite higher average cash balances. The cash balance, including marketable securities, was $12.8 billion at the end of 2008, and averaged $12.2 billion as compared to the $6.6 billion average cash balance in 2007. The increase in the average cash balance was primarily due to cash generated from operating activities.
 
Interest expense in 2008 increased by $139 million as compared to 2007 due to a higher debt balance. In the second half of 2007, the Company converted some of its short-term debt to fixed long-term debt at higher interest rates. The net debt balance at the end of 2008 was $11.9 billion as compared to $9.5 billion at the end of 2007. The higher debt balance in 2008 was primarily due to the purchase of the Company’s Common Stock under the ongoing Common Stock repurchase program announced on July 9, 2007 and to fund acquisitions.
 
Provision for Taxes on Income:  The worldwide effective income tax rate was 21.3% in 2010, 22.1% in 2009 and 23.5% in 2008. The 2010 tax rate decreased as compared to 2009 due to decreases in taxable income in higher tax jurisdictions relative to taxable income in lower tax jurisdictions and certain U.S. tax adjustments. The 2009 tax rate decreased as compared to 2008 due to increases in taxable income in lower tax jurisdictions relative to taxable income in higher tax jurisdictions.
 
Liquidity and Capital Resources
 
Liquidity & Cash Flows
 
Cash and cash equivalents were $19.4 billion at the end of 2010 as compared with $15.8 billion at the end of 2009. The primary sources of cash that contributed to the $3.6 billion increase versus the prior year were $16.4 billion of cash generated from operating activities, $2.4 billion net proceeds from long and short-term debt and $0.5 billion proceeds from the disposal of assets. The major uses of cash were capital spending of $2.4 billion, acquisitions of $1.3 billion, net investment purchases of $4.7 billion, dividends to shareholders of $5.8 billion, and the repurchase of Common Stock, net of proceeds from the exercise of options, of $1.6 billion.
 
Cash flows from operations were $16.4 billion in 2010. The major sources of cash flow were net income of $13.3 billion, adjusted for non-cash charges for depreciation, amortization, stock based compensation and deferred tax provision of $3.9 billion. The remaining changes to operating cash flow were increases in accounts receivable, inventories and other assets.
 
In 2010, the Company continued to have access to liquidity through the commercial paper market. For additional details on borrowings, see Note 7 to the Consolidated Financial Statements.
 
The Company anticipates that operating cash flows, existing credit facilities and access to the commercial paper markets will provide sufficient resources to fund operating needs in 2011.
 
(PERFORMANCE GRAPH)
 
Financing and Market Risk
 
The Company uses financial instruments to manage the impact of foreign exchange rate changes on cash flows. Accordingly, the Company enters into forward foreign exchange contracts to protect the value of certain foreign currency assets and liabilities and to hedge future foreign currency transactions primarily related to 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 the January 2, 2011 market rates would increase the unrealized value of the Company’s forward contracts by $239 million. Conversely, a 10% depreciation of the U.S. Dollar from the January 2, 2011 market rates would decrease the unrealized value of the Company’s forward contracts by $292 million. In either scenario, the gain or loss on the forward contract would be offset by the gain or loss on the underlying transaction, and therefore, would have no impact on future anticipated earnings and cash flows.
 
The Company hedges the exposure to fluctuations in currency exchange rates, and the effect on certain assets and liabilities in foreign currency, by entering into currency swap contracts. A 1% change in the spread between U.S. and foreign interest rates on the Company’s interest rate sensitive financial instruments would either increase or decrease the unrealized value of the Company’s swap contracts by approximately $212 million. In either scenario, at maturity, the gain or loss on the swap contract would be offset by the gain or loss on the underlying transaction, and therefore, would have no impact on future anticipated cash flows.
 
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 there is no significant concentration of exposure with any one counterparty. Management believes the risk of loss is remote.
 
The Company has access to substantial sources of funds at numerous banks worldwide. In September 2010, the Company secured a new 364-day Credit Facility. Total credit available to the Company approximates $10 billion, which expires September 22, 2011. Interest charged on borrowings under the credit line agreement is based on either bids provided by banks, the prime rate or London Interbank Offered Rates (LIBOR), plus applicable margins. Commitment fees under the agreement are not material.
 
Total borrowings at the end of 2010 and 2009 were $16.8 billion and $14.5 billion, respectively. The increase in borrowings between 2010 and 2009 was a result of financing for general corporate purposes and the continuation of the Company’s Common Stock repurchase program announced in 2007. In 2010, net cash (cash and current marketable securities, net of debt) was $10.9 billion compared to net cash of $4.9 billion in 2009. Total debt represented 22.9% of total capital (shareholders’ equity and total debt) in 2010 and 22.3% of total capital in 2009. Shareholders’ equity
 
 
36 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

per share at the end of 2010 was $20.66 compared with $18.37 at year-end 2009, an increase of 12.5%.
 
A summary of borrowings can be found in Note 7 to the Consolidated Financial Statements.
 
Contractual Obligations and Commitments
 
The Company’s contractual obligations are primarily for leases, debt and unfunded retirement plans, with no other significant obligations. To satisfy these obligations, the Company will use cash from operations. The following table summarizes the Company’s contractual obligations and their aggregate maturities as of January 2, 2011 (see Notes 7, 10 and 16 to the Consolidated Financial Statements for further details):
 
                                         
    Long-Term
    Interest on
    Unfunded
             
    Debt
    Debt
    Retirement
    Operating
       
(Dollars in Millions)   Obligations     Obligations     Plans     Leases     Total  
 
2011
  $ 13       528       54       182       777  
2012
    644       507       55       159       1,365  
2013
    509       457       59       130       1,155  
2014
    9       444       62       106       621  
2015
          444       69       89       602  
After 2015
    7,994       5,180       428       74       13,676  
                                         
Total
  $ 9,169       7,560       727       740       18,196  
                                         
 
For tax matters, see Note 8 to the Consolidated Financial Statements.
 
Share Repurchase and Dividends
 
On July 9, 2007, the Company announced that its Board of Directors approved a stock repurchase program authorizing the Company to buy back up to $10.0 billion of the Company’s Common Stock. As of January 2, 2011, the current stock repurchase program has been completed. The Company repurchased an aggregate of 158.3 million shares of Johnson & Johnson Common Stock at a cost of $10.0 billion. The Company funded the share repurchase program through a combination of available cash and debt. In addition, the Company has an annual program to repurchase shares for use in employee stock and incentive plans.
 
The Company increased its dividend in 2010 for the 48th consecutive year. Cash dividends paid were $2.110 per share in 2010, compared with dividends of $1.930 per share in 2009 and $1.795 per share in 2008. The dividends were distributed as follows:
 
                         
    2010     2009     2008  
 
First quarter
  $ 0.490       0.460       0.415  
Second quarter
    0.540       0.490       0.460  
Third quarter
    0.540       0.490       0.460  
Fourth quarter
    0.540       0.490       0.460  
                         
Total
  $ 2.110       1.930       1.795  
                         
 
On January 3, 2011, the Board of Directors declared a regular quarterly cash dividend of $0.540 per share, payable on March 15, 2011, to shareholders of record as of March 1, 2011. The Company expects to continue the practice of paying regular cash dividends.
 
Other Information
 
Critical Accounting Policies and Estimates
 
Management’s discussion and analysis of results of operations and financial condition are based on the Company’s consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the U.S. (GAAP). The preparation of these financial statements requires that management make estimates and assumptions that affect the amounts reported for revenues, expenses, assets, liabilities and other related disclosures. Actual results may or may not differ from these estimates. The Company believes that the understanding of certain key accounting policies and estimates are essential in achieving more insight into the Company’s operating results and financial condition. These key accounting policies include revenue recognition, income taxes, legal and self-insurance contingencies, valuation of long-lived assets, assumptions used to determine the amounts recorded for pensions and other employee benefit plans and accounting for stock options.
 
Revenue Recognition:  The Company recognizes revenue from product sales when goods are shipped or delivered, and title and risk of loss pass to the customer. Provisions for certain rebates, sales incentives, trade promotions, coupons, product returns and discounts to customers are accounted for as reductions in sales in the same period the related sales are recorded.
 
Product discounts granted are based on the terms of arrangements with direct, indirect and other market participants, as well as market conditions, including prices charged by competitors. Rebates, the largest being the Medicaid rebate provision, are estimated based on contractual terms, historical experience, trend analysis and projected market conditions in the various markets served. The Company evaluates market conditions for products or groups of products primarily through the analysis of wholesaler and other third-party sell-through and market research data, as well as internally generated information.
 
Sales returns are generally estimated and recorded based on historical sales and returns information. Products that exhibit unusual sales or return patterns due to dating, competition or other marketing matters are specifically investigated and analyzed as part of the accounting for sales return accruals.
 
Sales returns allowances represent a reserve for products that may be returned due to expiration, destruction in the field, or in specific areas, product recall. The returns reserve is based on historical return trends by product and by market as a percent to gross sales. In accordance with the Company’s accounting policies, the Company generally issues credit to customers for returned goods. The Company’s sales return reserves are accounted for in accordance with the U.S. GAAP guidance for revenue recognition when right of return exists. Sales return reserves are recorded at full sales value. Sales returns in the Consumer and Pharmaceutical segments are almost exclusively not resalable. Sales returns for certain franchises in the Medical Devices and Diagnostics segment are typically resalable but are not material. The Company rarely exchanges products from inventory for returned products. The sales returns reserve for the total Company has ranged between 1.0% and 1.2% of annual net trade sales during the prior three fiscal reporting years 2008 — 2010.
 
Promotional programs, such as product listing allowances and cooperative advertising arrangements, are recorded in the year incurred. Continuing promotional programs include coupons and volume-based sales incentive programs. The redemption cost of consumer coupons is based on historical redemption experience by product and value. Volume-based incentive programs are based on estimated sales volumes for the incentive period and are recorded as products are sold. The Company also earns service revenue for co-promotion of certain products. For all years presented, service revenues were less than 2% of total revenues and are included in sales to customers. These arrangements are evaluated to determine the appropriate amounts to be deferred.
 
In addition, the Company enters into collaboration arrangements, which contain multiple revenue generating activities. The revenue for these arrangements is recognized as each activity is performed or delivered, based on the relative fair value. Upfront fees received as part of these arrangements are deferred and recognized as revenue earned over the obligation period. See Note 1 to
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 37


 

the Consolidated Financial Statements for additional disclosures on collaborations.
 
Reasonably likely changes to assumptions used to calculate the accruals for rebates, returns and promotions are not anticipated to have a material effect on the financial statements. The Company currently discloses the impact of changes to assumptions in the quarterly or annual filing in which there is a material financial statement impact.
 
Below are tables that show the progression of accrued rebates, returns, promotions, reserve for doubtful accounts and reserve for cash discounts by segment of business for the fiscal years ended January 2, 2011 and January 3, 2010.
 
Consumer Segment
 
                                 
    Balance at
                Balance at
 
    Beginning of
                End of
 
(Dollars in Millions)   Period     Accruals     Payments/Other     Period  
 
2010
                               
Accrued rebates(1)
  $ 121       361       (351 )     131  
Accrued returns
    127       156       (138 )     145  
Accrued promotions
    272       2,418       (2,396 )     294  
                                 
Subtotal
  $ 520       2,935       (2,885 )     570  
                                 
Reserve for doubtful accounts
    107       6       (56 )     57  
Reserve for cash discounts
    21       249       (249 )     21  
                                 
Total
  $ 648       3,190       (3,190 )     648  
                                 
                                 
2009
                               
Accrued rebates(1)
  $ 131       380       (390 )     121  
Accrued returns
    115       134       (122 )     127  
Accrued promotions
    202       1,996       (1,926 )     272  
                                 
Subtotal
  $ 448       2,510       (2,438 )     520  
                                 
Reserve for doubtful accounts
    110       23       (26 )     107  
Reserve for cash discounts
    22       285       (286 )     21  
                                 
Total
  $ 580       2,818       (2,750 )     648  
                                 
 
(1)  Includes reserve for customer rebates of $50 million at January 2, 2011 and $46 million at January 3, 2010, recorded as a contra asset.
 
Pharmaceutical Segment
 
                                 
    Balance at
                Balance at
 
    Beginning of
                End of
 
(Dollars in Millions)   Period     Accruals     Payments/Other     Period  
 
2010
                               
Accrued rebates(1)(2)
  $ 1,064       4,768       (4,312 )     1,520  
Accrued returns
    342       27       (75 )     294  
Accrued promotions
    84       135       (136 )     83  
                                 
Subtotal
  $ 1,490       4,930       (4,523 )     1,897  
                                 
Reserve for doubtful accounts
    83       91       (29 )     145  
Reserve for cash discounts
    48       379       (373 )     54  
                                 
Total
  $ 1,621       5,400       (4,925 )     2,096  
                                 
                                 
2009
                               
Accrued rebates(1)
  $ 1,261       3,975       (4,172 )     1,064  
Accrued returns
    490       147       (295 )     342  
Accrued promotions
    107       330       (353 )     84  
                                 
Subtotal
  $ 1,858       4,452       (4,820 )     1,490  
                                 
Reserve for doubtful accounts
    48       37       (2 )     83  
Reserve for cash discounts
    23       462       (437 )     48  
                                 
Total
  $ 1,929       4,951       (5,259 )     1,621  
                                 
 
(1)  Includes reserve for customer rebates of $320 million at January 2, 2011 and $372 million at January 3, 2010, recorded as a contra asset.
 
(2)  Includes additional sales rebates to Medicaid managed care organizations as a result of health care reform legislation.
 
Medical Devices and Diagnostics Segment
 
                                 
    Balance at
                Balance at
 
    Beginning of
                End of
 
(Dollars in Millions)   Period     Accruals     Payments/Other     Period  
 
2010
                               
Accrued rebates(1)
  $ 454       2,363       (2,322 )     495  
Accrued returns
    220       334       (353 )     201  
Accrued promotions
    73       111       (134 )     50  
                                 
Subtotal
  $ 747       2,808       (2,809 )     746  
                                 
Reserve for doubtful accounts
    143       33       (38 )     138  
Reserve for cash discounts
    32       484       (481 )     35  
                                 
Total
  $ 922       3,325       (3,328 )     919  
                                 
                                 
2009
                               
Accrued rebates(1)
  $ 416       2,229       (2,191 )     454  
Accrued returns
    189       74       (43 )     220  
Accrued promotions
    47       120       (94 )     73  
                                 
Subtotal
  $ 652       2,423       (2,328 )     747  
                                 
Reserve for doubtful accounts
    109       50       (16 )     143  
Reserve for cash discounts
    34       416       (418 )     32  
                                 
Total
  $ 795       2,889       (2,762 )     922  
                                 
 
(1)  Includes reserve for customer rebates of $331 million at January 2, 2011 and $311 million at January 3, 2010, recorded as a contra asset.
 
Income Taxes:  Income taxes are recorded based on amounts refundable or payable for the current year and include the results of any difference between U.S. GAAP accounting and tax reporting, recorded as deferred tax assets or liabilities. The Company estimates deferred tax assets and liabilities based on current tax regulations and rates. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities in the future. Management believes that changes in these estimates would not have a material effect on the Company’s results of operations, cash flows or financial position.
 
In 2007, in accordance with U.S. GAAP, the Company adopted the standard related to accounting for uncertainty in income taxes. The Codification prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Codification also provides guidance on derecognition, classification and other matters. See Note 8 to the Consolidated Financial Statements for further information regarding income taxes.
 
At January 2, 2011 and January 3, 2010, the cumulative amounts of undistributed international earnings were approximately $37.0 billion and $32.2 billion, respectively. The Company intends to continue to reinvest its undistributed international earnings to expand its international operations; therefore, no U.S. tax expense has been recorded with respect to the undistributed portion not intended for repatriation.
 
Legal and Self Insurance Contingencies:  The Company records accruals for various contingencies including legal proceedings and product liability cases as these arise in the normal course of business. The accruals are based on management’s judgment as to the probability of losses and, where applicable, actuarially determined estimates. Additionally, the Company records insurance receivable amounts from third-party insurers when recovery is probable. As appropriate, reserves against these receivables are recorded for estimated amounts that may not be collected from third-party insurers.
 
The Company follows the provisions of U.S. GAAP when recording litigation related contingencies. A liability is recorded when a loss is probable and can be reasonably estimated. The best estimate of a loss within a range is accrued; however, if no estimate in the range is better than any other, the minimum amount is accrued.
 
 
38 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

Long-Lived and Intangible Assets:  The Company assesses changes in economic conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Company’s property, plant and equipment, goodwill and intangible assets. As these assumptions and estimates may change over time, it may or may not be necessary for the Company to record impairment charges.
 
Employee Benefit Plans:  The Company sponsors various retirement and pension plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. These plans are based on assumptions for the discount rate, expected return on plan assets, expected salary increases and health care cost trend rates. See Note 10 to the Consolidated Financial Statements for further details on these rates and the effect a rate change would have on the Company’s results of operations.
 
Stock Based Compensation:  The Company recognizes compensation expense associated with the issuance of equity instruments to employees for their services. The fair value of each award is estimated on the date of grant using the Black-Scholes option valuation model and is expensed in the financial statements over the vesting period. The input assumptions used in determining fair value are the expected life, expected volatility, risk-free rate and the dividend yield. See Note 17 to the Consolidated Financial Statements for additional information.
 
New Accounting Pronouncements
 
Refer to Note 1 to the Consolidated Financial Statements for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of January 2, 2011.
 
Economic and Market Factors
 
The Company is aware that its products are used in an environment where, for more than a decade, policymakers, consumers and businesses have expressed concerns about the rising cost of health care. In response to these concerns, the Company has a long-standing policy of pricing products responsibly. For the period 2000 — 2010, in the United States, the weighted average compound annual growth rate of the Company’s net price increases for health care products (prescription and over-the-counter drugs, hospital and professional products) was below the U.S. Consumer Price Index (CPI).
 
Inflation rates continue to have an effect on worldwide economies and, consequently, on the way companies operate. The Company accounted for operations in Venezuela as highly inflationary in 2010, as the prior three-year cumulative inflation rate has surpassed 100%. In the face of increasing costs, the Company strives to maintain its profit margins through cost reduction programs, productivity improvements and periodic price increases.
 
The Company is exposed to fluctuations in currency exchange rates. A 1% change in the value of the U.S. Dollar as compared to all foreign currencies in which the Company had sales, income or expense in 2010 would have increased or decreased the translation of foreign sales by approximately $300 million and income by $65 million.
 
The Company faces various worldwide health care changes that may continue to result in pricing pressures that include health care cost containment and government legislation relating to sales, promotions and reimbursement.
 
Changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage, as a result of the current global economic downturn, may continue to impact the Company’s businesses.
 
The Company also operates in an environment which has become increasingly hostile to intellectual property rights. Generic drug firms have filed Abbreviated New Drug Applications (ANDAs) seeking to market generic forms of most of the Company’s key pharmaceutical products, prior to expiration of the applicable patents covering those products. In the event the Company is not successful in defending the patent claims challenged in ANDA filings, the generic firms will then introduce generic versions of the product at issue, resulting in the potential for substantial market share and revenue losses for that product. For further information see the discussion on “Litigation Against Filers of Abbreviated New Drug Applications” in Note 21 to the Consolidated Financial Statements.
 
Legal Proceedings
 
The Company is involved in numerous product liability cases in the United States, many of which concern alleged adverse reactions to drugs and medical devices. The damages claimed are substantial, and while the Company is confident of the adequacy of the warnings and instructions for use that accompany such products, it is not feasible to predict the ultimate outcome of litigation. However, the Company believes that in most cases product liability will be substantially covered by existing amounts accrued in the Company’s balance sheet under its self-insurance program.
 
The Company is also involved in a number of patent, trademark and other lawsuits, as well as investigations, incidental to its business. The ultimate legal and financial liability of the Company in respect to all claims, lawsuits and proceedings referred to above cannot be reasonably estimated. However, in the Company’s opinion, based on its examination of these matters, its experience to date, and discussions with counsel, the ultimate outcome of legal proceedings, net of liabilities already accrued in the Company’s balance sheet, is not expected to be material to the Company’s financial position, although the resolution in any reporting period of one or more of these matters could have a material impact on the Company’s results of operations and cash flows for that period.
 
See Note 21 to the Consolidated Financial Statements for further information regarding legal proceedings.
Common Stock Market Prices
 
The Company’s Common Stock is listed on the New York Stock Exchange under the symbol JNJ. The composite market price ranges for Johnson & Johnson Common Stock during 2010 and 2009 were:
 
                                 
    2010     2009  
    High     Low     High     Low  
 
First quarter
  $ 65.95       61.89       61.00       46.25  
Second quarter
    66.20       57.55       56.65       50.12  
Third quarter
    62.70       56.86       62.47       55.71  
Fourth quarter
    64.92       61.25       65.41       58.78  
Year-end close
  $61.85   64.41
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 39


 

 
Cautionary Factors That May Affect Future Results
 
This Annual Report contains forward-looking statements. Forward-looking statements do not relate strictly to historical or current facts and anticipate results based on management’s plans that are subject to uncertainty. Forward-looking statements may be identified by the use of words such as “plans,” “expects,” “will,” “anticipates,” “estimates” and other words of similar meaning in conjunction with, among other things, discussions of future operations, financial performance, the Company’s strategy for growth, product development, regulatory approval, market position and expenditures.
 
Forward-looking statements are based on current expectations of future events. The Company cannot guarantee that any forward-looking statement will be accurate, although the Company believes that it has been reasonable in its expectations and assumptions. Investors should realize that if underlying assumptions prove inaccurate or that unknown risks or uncertainties materialize, actual results could vary materially from the Company’s expectations and projections. Investors are therefore cautioned not to place undue reliance on any forward-looking statements. The Company does not undertake to update any forward-looking statements as a result of new information or future events or developments.
 
Risks and uncertainties include, but are not limited to, general industry conditions and competition; economic factors, such as interest rate and currency exchange rate fluctuations; technological advances, new products and patents attained by competitors; challenges inherent in new product development, including obtaining regulatory approvals; challenges to patents; significant litigation adverse to the Company; impact of business combinations; financial distress and bankruptcies experienced by significant customers and suppliers; changes to governmental laws and regulations and U.S. and foreign health care reforms; trends toward healthcare cost containment; increased scrutiny of the healthcare industry by government agencies; changes in behavior and spending patterns of purchasers of healthcare products and services; manufacturing difficulties or delays; product efficacy or safety concerns resulting in product recalls or regulatory action.
 
The Company’s report on Form 10-K for the year ended January 2, 2011 includes, in Exhibit 99, a discussion of additional factors that could cause actual results to differ from expectations. The Company notes these factors as permitted by the Private Securities Litigation Reform Act of 1995.
 
 
40 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
JOHNSON & JOHNSON AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
At January 2, 2011 and January 3, 2010
(Dollars in Millions Except Share and Per Share Data) (Note 1)
 
                 
    2010     2009  
 
Assets
               
Current assets
               
Cash and cash equivalents (Notes 1 and 2)
  $ 19,355       15,810  
Marketable securities (Notes 1 and 2)
    8,303       3,615  
Accounts receivable trade, less allowances for doubtful accounts $340 (2009, $333)
    9,774       9,646  
Inventories (Notes 1 and 3)
    5,378       5,180  
Deferred taxes on income (Note 8)
    2,224       2,793  
Prepaid expenses and other receivables
    2,273       2,497  
                 
Total current assets
    47,307       39,541  
                 
Property, plant and equipment, net (Notes 1 and 4)
    14,553       14,759  
Intangible assets, net (Notes 1 and 5)
    16,716       16,323  
Goodwill (Notes 1 and 5)
    15,294       14,862  
Deferred taxes on income (Note 8)
    5,096       5,507  
Other assets
    3,942       3,690  
                 
Total assets
  $ 102,908       94,682  
                 
Liabilities and Shareholders’ Equity
               
Current liabilities
               
Loans and notes payable (Note 7)
  $ 7,617       6,318  
Accounts payable
    5,623       5,541  
Accrued liabilities
    4,100       4,625  
Accrued rebates, returns and promotions
    2,512       2,028  
Accrued compensation and employee related obligations
    2,642       2,777  
Accrued taxes on income
    578       442  
                 
Total current liabilities
    23,072       21,731  
                 
Long-term debt (Note 7)
    9,156       8,223  
Deferred taxes on income (Note 8)
    1,447       1,424  
Employee related obligations (Notes 9 and 10)
    6,087       6,769  
Other liabilities
    6,567       5,947  
                 
Total liabilities
    46,329       44,094  
                 
Shareholders’ equity
               
Preferred stock — without par value (authorized and unissued 2,000,000 shares)
           
Common stock — par value $1.00 per share (Note 12) (authorized 4,320,000,000 shares; issued 3,119,843,000 shares)
    3,120       3,120  
Accumulated other comprehensive income (Note 13)
    (3,531 )     (3,058 )
Retained earnings
    77,773       70,306  
                 
      77,362       70,368  
Less: common stock held in treasury, at cost (Note 12) (381,746,000 shares and 365,522,000 shares)
    20,783       19,780  
                 
Total shareholders’ equity
    56,579       50,588  
                 
Total liabilities and shareholders’ equity
  $ 102,908       94,682  
                 
 
See Notes to Consolidated Financial Statements
 
 
CONSOLIDATED FINANCIAL STATEMENTS 41


 

JOHNSON & JOHNSON AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF EARNINGS
(Dollars in Millions Except Per Share Figures) (Note 1)
 
                         
    2010     2009     2008  
 
Sales to customers
  $ 61,587       61,897       63,747  
                         
Cost of products sold
    18,792       18,447       18,511  
                         
Gross profit
    42,795       43,450       45,236  
Selling, marketing and administrative expenses
    19,424       19,801       21,490  
Research and development expense
    6,844       6,986       7,577  
Purchased in-process research and development (Note 20)
                181  
Interest income
    (107 )     (90 )     (361 )
Interest expense, net of portion capitalized (Note 4)
    455       451       435  
Other (income) expense, net
    (768 )     (526 )     (1,015 )
Restructuring (Note 22)
          1,073        
                         
Earnings before provision for taxes on income
    16,947       15,755       16,929  
Provision for taxes on income (Note 8)
    3,613       3,489       3,980  
                         
Net earnings
  $ 13,334       12,266       12,949  
                         
Basic net earnings per share (Notes 1 and 15)
  $ 4.85       4.45       4.62  
Diluted net earnings per share (Notes 1 and 15)
  $ 4.78       4.40       4.57  
Cash dividends per share
  $ 2.110       1.930       1.795  
Basic average shares outstanding (Notes 1 and 15)
    2,751.4       2,759.5       2,802.5  
Diluted average shares outstanding (Notes 1 and 15)
    2,788.8       2,789.1       2,835.6  
                         
 
See Notes to Consolidated Financial Statements
 
 
42 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

JOHNSON & JOHNSON AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF EQUITY
(Dollars in Millions) (Note 1)
 
                                                 
                      Accumulated
             
                      Other
          Treasury
 
          Comprehensive
    Retained
    Comprehensive
    Common Stock
    Stock
 
    Total     Income     Earnings     Income     Issued Amount     Amount  
 
Balance, December 30, 2007
  $ 43,319               55,280       (693 )     3,120       (14,388 )
                                                 
Net earnings
    12,949       12,949       12,949                          
Cash dividends paid
    (5,024 )             (5,024 )                        
Employee compensation and stock option plans
    2,180               175                       2,005  
Conversion of subordinated debentures
                  (1 )                     1  
Repurchase of common stock
    (6,651 )                                     (6,651 )
Other comprehensive income, net of tax:
                                               
Currency translation adjustment
    (2,499 )     (2,499 )             (2,499 )                
Unrealized losses on securities
    (59 )     (59 )             (59 )                
Employee benefit plans
    (1,870 )     (1,870 )             (1,870 )                
Gains on derivatives & hedges
    166       166               166                  
Reclassification adjustment
            (27 )                                
                                                 
Total comprehensive income
            8,660                                  
                                                 
                                                 
                                                 
Balance, December 28, 2008
  $ 42,511               63,379       (4,955 )     3,120       (19,033 )
                                                 
Net earnings
    12,266       12,266       12,266                          
Cash dividends paid
    (5,327 )             (5,327 )                        
Employee compensation and stock option plans
    1,402               25                       1,377  
Conversion of subordinated debentures
    2               (4 )                     6  
Repurchase of common stock
    (2,130 )                                     (2,130 )
Other
    (33 )             (33 )                        
Other comprehensive income, net of tax:
                                               
Currency translation adjustment
    1,363       1,363               1,363                  
Unrealized losses on securities
    (55 )     (55 )             (55 )                
Employee benefit plans
    565       565               565                  
Gains on derivatives & hedges
    24       24               24                  
                                                 
Total comprehensive income
            14,163                                  
                                                 
                                                 
                                                 
Balance, January 3, 2010
  $ 50,588               70,306       (3,058 )     3,120       (19,780 )
                                                 
Net earnings
    13,334       13,334       13,334                          
Cash dividends paid
    (5,804 )             (5,804 )                        
Employee compensation and stock option plans
    1,730               (62 )                     1,792  
Conversion of subordinated debentures
    1               (1 )                     2  
Repurchase of common stock
    (2,797 )                                     (2,797 )
Other comprehensive income, net of tax:
                                               
Currency translation adjustment
    (461 )     (461 )             (461 )                
Unrealized gains on securities
    54       54               54                  
Employee benefit plans
    (21 )     (21 )             (21 )                
Losses on derivatives & hedges
    (45 )     (45 )             (45 )                
                                                 
Total comprehensive income
            12,861                                  
                                                 
                                                 
                                                 
Balance, January 2, 2011
  $ 56,579               77,773       (3,531 )     3,120       (20,783 )
                                                 
 
See Notes to Consolidated Financial Statements
 
 
CONSOLIDATED FINANCIAL STATEMENTS 43


 

JOHNSON & JOHNSON AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions) (Note 1)
 
                         
    2010     2009     2008  
 
Cash flows from operating activities
                       
Net earnings
  $ 13,334       12,266       12,949  
Adjustments to reconcile net earnings to cash flows from operating activities:
                       
Depreciation and amortization of property and intangibles
    2,939       2,774       2,832  
Stock based compensation
    614       628       627  
Purchased in-process research and development
                181  
Deferred tax provision
    356       (436 )     22  
Accounts receivable allowances
    12       58       86  
Changes in assets and liabilities, net of effects from acquisitions:
                       
(Increase)/decrease in accounts receivable
    (207 )     453       (736 )
(Increase)/decrease in inventories
    (196 )     95       (101 )
Increase/(decrease) in accounts payable and accrued liabilities
    20       (507 )     (272 )
(Increase)/decrease in other current and non-current assets
    (574 )     1,209       (1,600 )
Increase in other current and non-current liabilities
    87       31       984  
                         
Net cash flows from operating activities
    16,385       16,571       14,972  
                         
Cash flows from investing activities
                       
Additions to property, plant and equipment
    (2,384 )     (2,365 )     (3,066 )
Proceeds from the disposal of assets
    524       154       785  
Acquisitions, net of cash acquired (Note 20)
    (1,269 )     (2,470 )     (1,214 )
Purchases of investments
    (15,788 )     (10,040 )     (3,668 )
Sales of investments
    11,101       7,232       3,059  
Other (primarily intangibles)
    (38 )     (109 )     (83 )
                         
Net cash used by investing activities
    (7,854 )     (7,598 )     (4,187 )
                         
Cash flows from financing activities
                       
Dividends to shareholders
    (5,804 )     (5,327 )     (5,024 )
Repurchase of common stock
    (2,797 )     (2,130 )     (6,651 )
Proceeds from short-term debt
    7,874       9,484       8,430  
Retirement of short-term debt
    (6,565 )     (6,791 )     (7,319 )
Proceeds from long-term debt
    1,118       9       1,638  
Retirement of long-term debt
    (32 )     (219 )     (24 )
Proceeds from the exercise of stock options/excess tax benefits
    1,226       882       1,486  
                         
Net cash used by financing activities
    (4,980 )     (4,092 )     (7,464 )
                         
Effect of exchange rate changes on cash and cash equivalents
    (6 )     161       (323 )
                         
Increase in cash and cash equivalents
    3,545       5,042       2,998  
Cash and cash equivalents, beginning of year (Note 1)
    15,810       10,768       7,770  
                         
Cash and cash equivalents, end of year (Note 1)
  $ 19,355       15,810       10,768  
                         
Supplemental cash flow data
                       
Cash paid during the year for:
                       
Interest
  $ 491       533       525  
Income taxes
    2,442       2,363       4,068  
Supplemental schedule of noncash investing and financing activities
                       
Treasury stock issued for employee compensation and stock option plans, net of cash proceeds
  $ 673       541       593  
Conversion of debt
    1       2        
Acquisitions
                       
Fair value of assets acquired
  $ 1,321       3,345       1,328  
Fair value of liabilities assumed and non-controlling interests
    (52 )     (875 )     (114 )
                         
Net cash paid for acquisitions
  $ 1,269       2,470       1,214  
                         
 
See Notes to Consolidated Financial Statements
 
 
44 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

JOHNSON & JOHNSON AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   Summary of Significant Accounting Policies
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of Johnson & Johnson and subsidiaries (the “Company”). Intercompany accounts and transactions are eliminated.
 
Description of the Company And Business Segments
 
The Company has approximately 114,000 employees worldwide engaged in the research and development, manufacture and sale of a broad range of products in the health care field. The Company conducts business in virtually all countries of the world and its primary focus is on products related to human health and well-being.
 
The Company is organized into three business segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. The Consumer segment manufactures and markets a broad range of products used in the baby care, skin care, oral care, wound care and women’s health care fields, as well as nutritional and over-the-counter pharmaceutical products and wellness and prevention platforms. These products are marketed to the general public and sold both to retail outlets and distributors throughout the world. The Pharmaceutical segment includes products in the following areas: anti-infective, antipsychotic, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management and virology. These products are distributed directly to retailers, wholesalers and health care professionals for prescription use. The Medical Devices and Diagnostics segment includes a broad range of products distributed to wholesalers, hospitals and retailers used principally in the professional fields by physicians, nurses, therapists, hospitals, diagnostic laboratories and clinics. These products include Biosense Webster’s electrophysiology products; Cordis’ circulatory disease management products; DePuy’s orthopaedic joint reconstruction, spinal care, neurological and sports medicine products; Ethicon’s surgical care, aesthetics and women’s health products; Ethicon Endo-Surgery’s minimally invasive surgical products and advanced sterilization products; LifeScan’s blood glucose monitoring and insulin delivery products; Ortho-Clinical Diagnostics’ professional diagnostic products and Vistakon’s disposable contact lenses.
 
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
 
During the fiscal first quarter of 2010 the Company adopted the Financial Accounting Standards Board (FASB) guidance and amendments related to the criteria for separating consideration in multiple-deliverable revenue arrangements. The guidance (a) provides principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated; (b) requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price; and (c) eliminates the use of the residual method and requires an entity to allocate the revenue using the relative selling price method. The adoption did not have a material impact on the Company’s results of operations, cash flows or financial position; however it expanded the disclosures for multiple-deliverable revenue arrangements.
 
During the fiscal first quarter of 2010, the Company adopted the FASB standard related to variable interest entities. The adoption of this standard did not have an impact on the Company’s results of operations, cash flows or financial position.
 
During the fiscal first quarter of 2010, the Company adopted the new accounting guidance on fair value measurements and disclosures. This guidance requires the Company to disclose the amount of significant transfers between Level 1 and Level 2 inputs and the reasons for these transfers as well as the reasons for any transfers in or out of Level 3 of the fair value hierarchy. In addition, the guidance clarifies certain existing disclosure requirements. The adoption of this standard did not have a material impact on the Company’s results of operations, cash flows or financial position.
 
Recently Issued Accounting Standards,
Not Adopted as of January 2, 2011
 
During the fiscal second quarter of 2010 the FASB issued an accounting standard update related to revenue recognition under the milestone method. The objective of the accounting standard update is to provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. This guidance was effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The adoption of this standard is not expected to have a material impact on the Company’s results of operations, cash flows or financial position.
 
Cash Equivalents
 
The Company considers securities with maturities of three months or less, when purchased, to be cash equivalents.
 
Investments
 
Short-term marketable securities are carried at cost, which approximates fair value. Investments classified as available-for-sale are carried at estimated fair value with unrealized gains and losses recorded as a component of accumulated other comprehensive income. Long-term debt securities that the Company has the ability and intent to hold until maturity are carried at amortized cost. Management determines the appropriate classification of its investment in debt and equity securities at the time of purchase and re-evaluates such determination at each balance sheet date. The Company periodically reviews its investments in equity securities for impairment and adjusts these investments to their fair value when a decline in market value is deemed to be other than temporary. If losses on these securities are considered to be other than temporary, the loss is recognized in earnings.
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 45


 

 
Property, Plant and Equipment and Depreciation
Property, plant and equipment are stated at cost. The Company utilizes the straight-line method of depreciation over the estimated useful lives of the assets:
 
         
Building and building equipment
    20 — 40 years  
Land and leasehold improvements
    10 — 20 years  
Machinery and equipment
    2 — 13 years  
 
The Company capitalizes certain computer software and development costs, included in machinery and equipment, when incurred in connection with developing or obtaining computer software for internal use. Capitalized software costs are amortized over the estimated useful lives of the software, which generally range from 3 to 8 years.
 
The Company reviews long-lived assets to assess recoverability using undiscounted cash flows. When certain events or changes in operating or economic conditions occur, an impairment assessment may be performed on the recoverability of the carrying value of these assets. If the asset is determined to be impaired, the loss is measured based on the difference between the asset’s fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows.
 
Revenue Recognition
 
The Company recognizes revenue from product sales when the goods are shipped or delivered and title and risk of loss pass to the customer. Provisions for certain rebates, sales incentives, trade promotions, coupons, product returns and discounts to customers are accounted for as reductions in sales in the same period the related sales are recorded.
 
Product discounts granted are based on the terms of arrangements with direct, indirect and other market participants, as well as market conditions, including prices charged by competitors. Rebates, the largest being the Medicaid rebate provision, are estimated based on contractual terms, historical experience, trend analysis and projected market conditions in the various markets served. The Company evaluates market conditions for products or groups of products primarily through the analysis of wholesaler and other third-party sell-through and market research data, as well as internally generated information.
 
Sales returns are generally estimated and recorded based on historical sales and returns information. Products that exhibit unusual sales or return patterns due to dating, competition or other marketing matters are specifically investigated and analyzed as part of the accounting for sales return accruals. Sales returns allowances represent a reserve for products that may be returned due to expiration, destruction in the field, or in specific areas, product recall. The returns reserve is based on historical return trends by product and by market as a percent to gross sales. In accordance with the Company’s accounting policies, the Company generally issues credit to customers for returned goods. The Company’s sales return reserves are accounted for in accordance with U.S. GAAP guidance for revenue recognition when right of return exists. Sales return reserves are recorded at full sales value. Sales returns in the Consumer and Pharmaceutical segments are almost exclusively not resalable. Sales returns for certain franchises in the Medical Devices and Diagnostics segment are typically resalable but are not material. The Company rarely exchanges products from inventory for returned products. The sales returns reserve for the total Company has ranged between 1.0% and 1.2% of annual sales to customers during the prior three fiscal reporting years 2008 — 2010.
 
Promotional programs, such as product listing allowances and cooperative advertising arrangements, are recorded in the year incurred. Continuing promotional programs include coupons and volume-based sales incentive programs. The redemption cost of consumer coupons is based on historical redemption experience by product and value. Volume-based incentive programs are based on the estimated sales volumes for the incentive period and are recorded as products are sold. The Company also earns service revenue for co-promotion of certain products and includes it in sales to customers. These arrangements are evaluated to determine the appropriate amounts to be deferred.
 
Shipping and Handling
 
Shipping and handling costs incurred were $945 million, $964 million and $1,017 million in 2010, 2009 and 2008, respectively, and are included in selling, marketing and administrative expense. The amount of revenue received for shipping and handling is less than 0.5% of sales to customers for all periods presented.
 
Inventories
 
Inventories are stated at the lower of cost or market determined by the first-in, first-out method.
 
Intangible Assets and Goodwill
 
The authoritative literature on U.S. GAAP requires that goodwill and intangible assets with indefinite lives be assessed annually for impairment. The Company completed the annual impairment test for 2010 in the fiscal fourth quarter and no impairment was determined. Future impairment tests will be performed annually in the fiscal fourth quarter, or sooner if a triggering event occurs.
 
Intangible assets that have finite useful lives continue to be amortized over their useful lives, and are reviewed for impairment when warranted by economic conditions. See Note 5 for further details on Intangible Assets and Goodwill.
 
Financial Instruments
 
As required by U.S. GAAP, all derivative instruments are recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction, and if so, the type of hedge transaction.
 
 
46 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
The Company documents all relationships between hedged items and derivatives. The overall risk management strategy includes reasons for undertaking hedge transactions and entering into derivatives. The objectives of this strategy are: (1) minimize foreign currency exposure’s impact on the Company’s financial performance; (2) protect the Company’s cash flow from adverse movements in foreign exchange rates; (3) ensure the appropriateness of financial instruments; and (4) manage the enterprise risk associated with financial institutions. See Note 6 for additional information on Financial Instruments.
 
Product Liability
 
Accruals for product liability claims are recorded, on an undiscounted basis, when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. The accruals are adjusted periodically as additional information becomes available. As a result of cost and availability factors, effective November 1, 2005, the Company ceased purchasing third-party product liability insurance. Based on the availability of prior coverage, receivables for insurance recoveries related to product liability claims are recorded on an undiscounted basis, when it is probable that a recovery will be realized.
 
Research and Development
 
Research and development expenses are expensed as incurred. Upfront and milestone payments made to third-parties in connection with research and development collaborations are expensed as incurred up to the point of regulatory approval. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life of the related product. Amounts capitalized for such payments are included in other intangibles, net of accumulated amortization.
 
The Company enters into collaborative arrangements, typically with other pharmaceutical or biotechnology companies, to develop and commercialize drug candidates or intellectual property. These arrangements typically involve two (or more) parties who are active participants in the collaboration and are exposed to significant risks and rewards dependent on the commercial success of the activities. These collaborations usually involve various activities by one or more parties, including research and development, marketing and selling and distribution. Often, these collaborations require upfront, milestone and royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development. Amounts due from collaborative partners related to development activities are generally reflected as a reduction of research and development expense because the performance of contract development services is not central to the Company’s operations. In general, the income statement presentation for these collaborations is as follows:
 
     
Nature/Type of Collaboration   Statement of Earnings Presentation
 
Third-party sale of product
 
Sales to customers
Royalties/milestones paid to collaborative partner (post-regulatory approval)*
 
Cost of goods sold
Royalties received from collaborative partner
 
Other income (expense), net
Upfront payments & milestones paid to collaborative partner (pre-regulatory approval)
 
Research and development expense
Research and development payments to collaborative partner
 
Research and development expense
Research and development payments received from collaborative partner
 
Reduction of Research and development expense
 
 
Milestones are capitalized as intangible assets and amortized to cost of goods sold over the useful life.
 
Advertising
 
Costs associated with advertising are expensed in the year incurred and are included in the selling, marketing and administrative expenses. Advertising expenses worldwide, which are comprised of television, radio, print media and Internet advertising, were $2.5 billion, $2.4 billion and $2.9 billion in 2010, 2009 and 2008, respectively.
 
Income Taxes
 
The Company intends to continue to reinvest its undistributed international earnings to expand its international operations; therefore, no U.S. tax expense has been recorded with respect to the undistributed portion not intended for repatriation. At January 2, 2011 and January 3, 2010, the cumulative amount of undistributed international earnings was approximately $37.0 billion and $32.2 billion, respectively.
 
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.
 
Net Earnings Per Share
 
Basic earnings per share is computed by dividing net earnings available to common shareholders 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 were exercised or converted into common stock using the treasury stock method.
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 47


 

 
Use of Estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported. Estimates are used when accounting for sales discounts, rebates, allowances and incentives, product liabilities, income taxes, depreciation, amortization, employee benefits, contingencies and intangible asset and liability valuations. For instance, in determining annual pension and post-employment benefit costs, the Company estimates the rate of return on plan assets, and the cost of future health care benefits. Actual results may or may not differ from those estimates.
 
The Company follows the provisions of U.S. GAAP when recording litigation related contingencies. A liability is recorded when a loss is probable and can be reasonably estimated. The best estimate of a loss within a range is accrued; however, if no estimate in the range is better than any other, the minimum amount is accrued.
 
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 the fiscal year consists of 53 weeks, as was the case in 2009 and will be the case again in 2014.
 
Reclassification
 
Certain prior period amounts have been reclassified to conform to current year presentation.
 
2.   Cash, Cash Equivalents and Current Marketable Securities
 
At the end of 2010 and 2009, the amortized cost of cash, cash equivalents and current marketable securities were comprised of:
                 
    Amortized Cost  
(Dollars in Millions)   2010     2009  
 
Cash
  $ 2,293       2,517  
Government securities and obligations
    22,349       13,370  
Corporate debt securities
    225       426  
Money market funds
    2,135       1,890  
Time deposits
    656       1,222  
                 
Total cash, cash equivalents and current marketable securities
  $ 27,658       19,425  
                 
 
The estimated fair value was the same as the amortized cost as of January 2, 2011. The estimated fair value was $19,426 million as of January 3, 2010 reflecting a $1 million unrealized gain in Government securities and obligations.
 
As of January 2, 2011, current marketable securities consisted of $8,153 million and $150 million of government securities and obligations and corporate debt securities, respectively.
 
As of January 3, 2010, current marketable securities consisted of $3,434 million and $181 million of government securities and obligations and corporate debt securities, respectively.
 
Fair value of government securities and obligations and corporate debt securities were estimated using quoted broker prices in active markets.
 
The Company invests its excess cash in both deposits with major banks throughout the world and other high-quality money market instruments. The Company has a policy of making investments only with commercial institutions that have at least an A (or equivalent) credit rating.
 
3.   Inventories
 
At the end of 2010 and 2009, inventories were comprised of:
 
                 
(Dollars in Millions)   2010     2009  
 
Raw materials and supplies
  $ 1,073       1,144  
Goods in process
    1,460       1,395  
Finished goods
    2,845       2,641  
                 
Total inventories
  $ 5,378       5,180  
                 
 
4.   Property, Plant and Equipment
 
At the end of 2010 and 2009, property, plant and equipment at cost and accumulated depreciation were:
 
                 
(Dollars in Millions)   2010     2009  
 
Land and land improvements
  $ 738       714  
Buildings and building equipment
    9,079       8,863  
Machinery and equipment
    18,032       17,153  
Construction in progress
    2,577       2,521  
                 
Total property, plant and equipment, gross
  $ 30,426       29,251  
Less accumulated depreciation
    15,873       14,492  
                 
Total property, plant and equipment, net
  $ 14,553       14,759  
                 
 
The Company capitalizes interest expense as part of the cost of construction of facilities and equipment. Interest expense capitalized in 2010, 2009 and 2008 was $73 million, $101 million and $147 million, respectively.
 
Depreciation expense, including the amortization of capitalized interest in 2010, 2009 and 2008, was $2.2 billion, $2.1 billion and $2.0 billion, respectively.
 
Upon retirement or other disposal of property, plant and equipment, the costs and related amounts of accumulated depreciation or amortization are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds are recorded in earnings.
 
 
48 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
5.   Intangible Assets and Goodwill
 
At the end of 2010 and 2009, the gross and net amounts of intangible assets were:
 
                 
(Dollars in Millions)   2010     2009  
 
Intangible assets with definite lives:
               
Patents and trademarks — gross
  $ 6,660       5,697  
Less accumulated amortization
    2,629       2,177  
                 
Patents and trademarks — net
  $ 4,031       3,520  
                 
Other intangibles — gross
  $ 7,674       7,808  
Less accumulated amortization
    2,880       2,680  
                 
Other intangibles — net
  $ 4,794       5,128  
                 
Total intangible assets with definite lives — gross
  $ 14,334       13,505  
Less accumulated amortization
    5,509       4,857  
                 
Total intangible assets with definite lives — net
  $ 8,825       8,648  
                 
Intangible assets with indefinite lives:
               
Trademarks
  $ 5,954       5,938  
Purchased in-process research and development*
    1,937       1,737  
                 
Total intangible assets with indefinite lives
  $ 7,891       7,675  
                 
Total intangible assets — net
  $ 16,716       16,323  
                 
 
 
Purchased in-process research and development will be accounted for as an indefinite-lived intangible asset until the underlying project is completed or abandoned.
 
Goodwill as of January 2, 2011 and January 3, 2010, as allocated by segment of business is as follows:
 
                                 
                Med Dev
       
(Dollars in Millions)   Consumer     Pharm     and Diag     Total  
 
Goodwill at December 28, 2008
  $ 7,474       963       5,282       13,719  
                                 
Acquisitions
          271       401       672  
Currency translation/other*
    600       10       (139 )     471  
                                 
Goodwill at January 3, 2010
  $ 8,074       1,244       5,544       14,862  
                                 
Acquisitions
                397       397  
Currency translation/other
    70       (19 )     (16 )     35  
                                 
Goodwill at January 2, 2011
  $ 8,144       1,225       5,925       15,294  
                                 
 
 
Includes reclassification between segments.
 
The weighted average amortization periods for patents and trademarks and other intangible assets are 17 years and 28 years, respectively. The amortization expense of amortizable assets was $748 million, $675 million and $788 million before tax, for the fiscal years ended January 2, 2011, January 3, 2010 and December 28, 2008, respectively. Certain patents and intangible assets were written down to fair value during fiscal years 2010, 2009 and 2008, with the resulting charge included in amortization expense. These write downs did not have a material impact on the Company’s results of operations, cash flows or financial position.
 
The estimated amortization expense for the five succeeding years approximates $730 million before tax, per year. Substantially all of the amortization expense is included in cost of products sold.
 
6.   Fair Value Measurements
 
The Company uses forward exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of future intercompany product and third-party purchases of raw materials denominated in foreign currency. The Company also uses cross currency interest rate swaps to manage currency risk primarily related to borrowings. Both types of derivatives are designated as cash flow hedges. The Company also uses forward exchange contracts to manage its exposure to the variability of cash flows for repatriation of foreign dividends. These contracts are designated as net investment hedges. Additionally, the Company uses forward exchange contracts to offset its exposure to certain foreign currency assets and liabilities. These forward exchange contracts are not designated as hedges and therefore, changes in the fair values of these derivatives are recognized in earnings, thereby offsetting the current earnings effect of the related foreign currency assets and liabilities. The Company does not enter into derivative financial instruments for trading or speculative purposes, or contain credit risk related contingent features or requirements to post collateral. On an ongoing basis, the Company monitors counterparty credit ratings. The Company considers credit non-performance risk to be low, because the Company enters into agreements with commercial institutions that have at least an A (or equivalent) credit rating. As of January 2, 2011, the Company had notional amounts outstanding for forward foreign exchange contracts and cross currency interest rate swaps of $21 billion and $3 billion, respectively.
 
All derivative instruments are to be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction, and if so, the type of hedge transaction.
 
The designation as a cash flow hedge is made at the entrance date into the derivative contract. At inception, all derivatives are expected to be highly effective. Changes in the fair value of a derivative that is designated as a cash flow hedge and is highly effective are recorded in accumulated other comprehensive income until the underlying transaction affects earnings, and are then reclassified to earnings in the same account as the hedged transaction. Gains/losses on net investment hedges are accounted for through the currency translation account and are insignificant. On an ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes in the cash flows of hedged items. If and when a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is included in current period earnings in other (income) and expense, net, and was not material for the fiscal years ended January 2, 2011 and January 3, 2010. Refer to Note 13 for disclosures of movements in Accumulated Other Comprehensive Income.
 
As of January 2, 2011, the balance of deferred net gains on derivatives included in accumulated other comprehensive income was $100 million after-tax. For additional information, see Note 13. The Company expects that substantially all of the amount related to foreign exchange contracts will be reclassified into earnings over the next 12 months as a result of transactions that are expected to occur over that period. The maximum length of time over which the Company is hedging transaction exposure is 18 months, excluding interest rate swaps. The amount ultimately realized in earnings will differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity of the derivative.
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 49


 

 
The following table is a summary of the activity related to designated derivatives for the fiscal years ended January 2, 2011 and January 3, 2010:
 
                                                 
                Gain/(Loss)
    Gain/(Loss)
 
    Gain/(Loss)
    Reclassified from
    Recognized in
 
    Recognized in
    Accumulated OCI
    Other
 
Cash Flow Hedges
  Accumulated OCI(1)     into Income(1)     Income/expense(2)  
(Dollars in Millions)   2010     2009     2010     2009     2010     2009  
 
Foreign exchange contracts
  $ (66 )     (63 )     (52 )(A)     (47 )(A)     (2 )     1  
Foreign exchange contracts
    (296 )     (173 )     (300 )(B)     70 (B)     (38 )     (1 )
Foreign exchange contracts
    51       5       57 (C)     13 (C)     5        
Cross currency interest rate swaps
    (40 )     241       6 (D)     (16 )(D)            
Foreign exchange contracts
    18       28       1 (E)     (6 )(E)     3       (12 )
                                                 
Total
  $ (333 )     38       (288 )     14       (32 )     (12 )
                                                 
 
All amounts shown in the table above are net of tax.
 
 
(1)   Effective portion
 
(2)   Ineffective portion
 
(A)  Included in Sales to customer
 
(B)  Included in Cost of products sold
 
(C)  Included in Research and development expense
 
(D)  Included in Interest (income)/Interest expense, net
 
(E)  Included in Other (income)/expense, net
 
For the fiscal years ended January 2, 2011 and January 3, 2010, a loss of $31 million and a gain of $21 million, respectively, was recognized in Other (income)/expense, net, relating to foreign exchange contracts not designated as hedging instruments.
 
Fair value is the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The authoritative literature establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels within the hierarchy are described below with Level 1 having the highest priority and Level 3 having the lowest.
 
The fair value of a derivative financial instrument (i.e. forward exchange contract, currency swap) is the aggregation by currency of all future cash flows discounted to its present value at the prevailing market interest rates and subsequently converted to the U.S. dollar at the current spot foreign exchange rate. The Company does not believe that fair values of these derivative instruments materially differ from the amounts that could be realized upon settlement or maturity, or that the changes in fair value will have a material effect on the Company’s results of operations, cash flows or financial position. The Company also holds equity investments that are classified as Level 1 as they are traded in an active exchange market.
 
The following three levels of inputs are used to measure fair value:
 
Level 1 — Quoted prices in active markets for identical assets and liabilities.
 
Level 2 — Significant other observable inputs.
 
Level 3 — Significant unobservable inputs.
 
 
50 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
The Company’s significant financial assets and liabilities measured at fair value as of January 2, 2011 and January 3, 2010 were as follows:
 
                                         
                      2010     2009  
(Dollars in Millions)   Level 1     Level 2     Level 3     Total     Total(1)  
 
Derivatives designated as hedging instruments:
                                       
Assets:
                                       
Foreign exchange contracts   $       321             321       436  
Cross currency interest rate swaps(2)             17               17       126  
                                         
Total
          338             338       562  
                                         
Liabilities:
                                       
Foreign exchange contracts           586             586       608  
Cross currency interest rate swaps(3)             502               502       571  
                                         
Total
          1,088             1,088       1,179  
                                         
Derivatives not designated as hedging instruments:
                                       
Assets:
                                       
Foreign exchange contracts           19             19       33  
Liabilities:
                                       
Foreign exchange contracts           39             39       40  
Other investments
  $ 1,165                   1,165       1,134  
                                         
 
(1)  2009 assets and liabilities are all classified as Level 2 with the exception of other investments of $1,134 million which are classified as Level 1.
 
(2)  Includes $14 million and $119 million of non-current assets for the fiscal years ending January 2, 2011 and January 3, 2010, respectively.
 
(3)  Includes $502 million and $517 million of non-current liabilities for the fiscal years ending January 2, 2011 and January 3, 2010, respectively.
 
See Notes 2 and 7 for financial assets and liabilities held at carrying amount on the Consolidated Balance Sheet.
 
7.   Borrowings
 
The components of long-term debt are as follows:
 
                                 
          Effective
          Effective
 
(Dollars in Millions)   2010     Rate %     2009     Rate %  
 
5.15% Debentures due 2012
  $ 599       5.18 %     599       5.18  
3.80% Debentures due 2013
    500       3.82       500       3.82  
5.55% Debentures due 2017
    1,000       5.55       1,000       5.55  
5.15% Debentures due 2018
    898       5.15       898       5.15  
4.75% Notes due 2019 (1B Euro 1.3268)(2)/(1B Euro 1.4382)(3)
    1,319 (2)     5.35       1,429 (3)     5.35  
3% Zero Coupon Convertible Subordinated Debentures due 2020
    194       3.00       188       3.00  
2.95% Debentures due 2020
    541       3.15              
6.73% Debentures due 2023
    250       6.73       250       6.73  
5.50% Notes due 2024 (500MM GBP 1.5403)(2)/ (500MM GBP 1.6189)(3)
    764 (2)     5.71       803 (3)     5.71  
6.95% Notes due 2029
    294       7.14       294       7.14  
4.95% Debenture due 2033
    500       4.95       500       4.95  
5.95% Notes due 2037
    995       5.99       995       5.99  
5.86% Debentures due 2038
    700       5.86       700       5.86  
4.50% Debentures due 2040
    539       4.63              
Other (Includes Industrial Revenue Bonds)
    76               101          
                                 
      9,169(4 )     5.25 (1)     8,257 (4)     5.42(1 )
Less current portion
    13               34          
                                 
    $ 9,156               8,223          
                                 
 
(1)  Weighted average effective rate.
 
(2)  Translation rate at January 2, 2011.
 
(3)  Translation rate at January 3, 2010.
 
(4)  The excess of the fair value over the carrying value of debt was $1.0 billion in 2010 and $0.8 billion in 2009.
 
Fair value of the non-current debt was estimated using market prices, which were corroborated by quoted broker prices in active markets.
 
The Company has access to substantial sources of funds at numerous banks worldwide. In September 2010, the Company secured a new 364-day Credit Facility. Total credit available to the Company approximates $10 billion, which expires September 22, 2011. Interest charged on borrowings under the credit line agreements is based on either bids provided by banks, the prime rate or London Interbank Offered Rates (LIBOR), plus applicable margins. Commitment fees under the agreements are not material.
 
Throughout 2010 the Company continued to have access to liquidity through the commercial paper market. Short-term borrowings and the current portion of long-term debt amounted to approximately $7.6 billion at the end of 2010, of which $7.4 billion was borrowed under the Commercial Paper Program. The remainder represents principally local borrowing by international subsidiaries.
 
The Company has a shelf registration with the Securities and Exchange Commission that enables the Company to issue on a timely basis debt securities and warrants to purchase debt securities.
 
Aggregate maturities of long-term obligations commencing in 2010 are:
 
(Dollars in Millions)
                                             
                              After
 
2011     2012     2013     2014     2015     2015  
 
$ 13       644       509       9             7,994  
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 51


 

 
8.   Income Taxes
 
The provision for taxes on income consists of:
 
                         
(Dollars in Millions)   2010     2009     2008  
 
Currently payable:
                       
U.S. taxes   $ 2,063       2,410       2,334  
International taxes     1,194       1,515       1,624  
                         
Total currently payable
    3,257       3,925       3,958  
                         
Deferred:
                       
U.S. taxes     (4 )     187       126  
International taxes     360       (623 )     (104 )
                         
Total deferred
    356       (436 )     22  
                         
Provision for taxes on income
  $ 3,613       3,489       3,980  
                         
 
A comparison of income tax expense at the U.S. statutory rate of 35% in 2010, 2009 and 2008, to the Company’s effective tax rate is as follows:
 
                         
(Dollars in Millions)   2010     2009     2008  
 
U.S. 
  $ 6,392       7,141       6,579  
International
    10,555       8,614       10,350  
                         
Earnings before taxes on income:
  $ 16,947       15,755       16,929  
                         
Tax rates:
                       
U.S. statutory rate
    35.0 %     35.0       35.0  
Ireland and Puerto Rico operations
    (5.1 )     (5.1 )     (6.8 )
Research and orphan drug tax credits
    (0.6 )     (0.6 )     (0.6 )
U.S. state and local
    1.0       1.8       1.6  
International subsidiaries excluding Ireland
    (7.5 )     (6.7 )     (5.6 )
U.S. manufacturing deduction
    (0.5 )     (0.4 )     (0.4 )
In-process research and development (IPR&D)
                0.4  
U.S. Tax international income
    (0.6 )     (1.6 )     (0.5 )
All other
    (0.4 )     (0.3 )     0.4  
                         
Effective tax rate
    21.3 %     22.1       23.5  
                         
 
The Company has subsidiaries manufacturing in Ireland under an incentive tax rate. In addition, the Company has subsidiaries operating in Puerto Rico under various tax incentive grants. The decrease in the 2010 tax rate was primarily due to decreases in taxable income in higher tax jurisdictions relative to taxable income in lower tax jurisdictions and certain U.S. tax adjustments. The decrease in the 2009 tax rate was primarily due to increases in taxable income in lower tax jurisdictions relative to taxable income in higher tax jurisdictions.
 
Temporary differences and carry forwards for 2010 and 2009 are as follows:
 
                                 
    2010
    2009
 
    Deferred Tax     Deferred Tax  
(Dollars in Millions)   Asset     Liability     Asset     Liability  
 
Employee related obligations
  $ 2,211               2,153          
Stock based compensation
    1,225               1,291          
Depreciation
            (769 )             (661 )
Non-deductible intangibles
            (2,725 )             (2,377 )
International R&D capitalized for tax
    1,857               1,989          
Reserves & liabilities
    948               1,014          
Income reported for tax purposes
    691               648          
Net operating loss carryforward international
    738               615          
Miscellaneous international
    1,326       (106 )     1,474       (110 )
Miscellaneous U.S. 
    470               799          
                                 
Total deferred income taxes
  $ 9,466       (3,600 )     9,983       (3,148 )
                                 
 
The difference between the net deferred tax on income per the balance sheet and the net deferred tax above is included in taxes on income on the balance sheet. The 2009 deferred tax Miscellaneous U.S. includes current year tax receivables. The Company has a wholly-owned international subsidiary that has cumulative net losses. The Company believes that it is more likely than not that this subsidiary will realize future taxable income sufficient to utilize these deferred tax assets.
 
The following table summarizes the activity related to unrecognized tax benefits:
 
                         
(Dollars in Millions)   2010     2009     2008  
 
Beginning of year
  $ 2,403       1,978       1,653  
Increases related to current year tax positions
    465       555       545  
Increases related to prior period tax positions
    68       203       87  
Decreases related to prior period tax positions
    (431 )     (163 )     (142 )
Settlements
    (186 )     (87 )     (137 )
Lapse of statute of limitations
    (12 )     (83 )     (28 )
                         
End of year
  $ 2,307       2,403       1,978  
                         
 
The Company had $2.3 billion, $2.4 billion and $2.0 billion of unrecognized tax benefits as of January 2, 2011, January 3, 2010 and December 28, 2008, respectively. All of the unrecognized tax benefits of $2.3 billion at January 2, 2011, if recognized, would affect the Company’s annual effective tax rate. The Company conducts business and files tax returns in numerous countries and currently has tax audits in progress with a number of tax authorities. The U.S. Internal Revenue Service (IRS) has completed its audit for the tax years through 2005; however, there are a limited number of issues remaining open for prior tax years going back to 1999. In other major jurisdictions where the Company conducts business, the years remain open generally back to the year 2003. The Company does not expect that the total amount of unrecognized tax benefits will significantly change over the next twelve months. The Company is not able to provide a reasonably reliable estimate of the timing of any other future tax payments relating to uncertain tax positions.
 
 
52 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
The Company classifies liabilities for unrecognized tax benefits and related interest and penalties as long-term liabilities. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. The Company recognized after tax interest of $34 million income, $36 million expense and $69 million expense in 2010, 2009 and 2008, respectively. The total amount of accrued interest was $264 million and $309 million in 2010 and 2009, respectively.
 
9.   Employee Related Obligations
 
At the end of 2010 and 2009, employee related obligations recorded on the Consolidated Balance Sheet were:
 
                 
(Dollars in Millions)   2010     2009  
 
Pension benefits
  $ 2,175       2,792  
Postretirement benefits
    2,359       2,245  
Postemployment benefits
    1,379       1,504  
Deferred compensation
    820       790  
                 
Total employee obligations
    6,733       7,331  
Less current benefits payable
    646       562  
                 
Employee related obligations — non-current
  $ 6,087       6,769  
                 
 
Prepaid employee related obligations of $615 million and $266 million for 2010 and 2009, respectively, are included in other assets on the consolidated balance sheet.
 
10.   Pensions and Other Benefit 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 U.S. retired employees and their dependents.
 
Many 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. International subsidiaries have plans under which funds are deposited with trustees, annuities are purchased under group contracts, or reserves are provided.
 
The Company does not fund retiree health care benefits in advance and has the right to modify these plans in the future.
 
The Company uses the date of its consolidated financial statements (January 2, 2011 and January 3, 2010, respectively) as the measurement date for all U.S. and international retirement and other benefit plans.
 
In accordance with U.S. GAAP, the Company has adopted the recent standards related to employers’ accounting for defined benefit pension and other postretirement plans.
 
Net periodic benefit costs for the Company’s defined benefit retirement plans and other benefit plans for 2010, 2009 and 2008 include the following components:
 
                                                         
    Retirement Plans     Other Benefit Plans        
(Dollars in Millions)   2010     2009     2008     2010     2009     2008        
 
Service cost
  $ 550       511       545     $ 134       137       142          
Interest cost
    791       746       701       202       174       166          
Expected return on plan assets
    (1,005 )     (934 )     (876 )     (1 )     (1 )     (2 )        
Amortization of prior service cost
    10       13       10       (4 )     (5 )     (4 )        
Amortization of net transition asset
    1       1       2                            
Recognized actuarial losses
    236       155       62       48       55       64          
Curtailments and settlements
    1       (11 )     7             (1 )              
                                                         
Net periodic benefit cost
  $ 584       481       451     $ 379       359       366          
                                                         
 
The net periodic benefit cost attributable to U.S. retirement plans was $294 million, $286 million and $220 million in 2010, 2009 and 2008, respectively.
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 53


 

 
Amounts expected to be recognized in net periodic benefit cost in the coming year for the Company’s defined benefit retirement plans and other postretirement plans:
 
         
(Dollars in Millions)      
 
Amortization of net transition obligation
  $ 1  
Amortization of net actuarial losses
    402  
Amortization of prior service cost
    5  
         
 
Unrecognized gains and losses for the U.S. pension plans are amortized over the average remaining future service for each plan. For plans with no active employees, they are amortized over the average life expectancy. The amortization of gains and losses for the other U.S. benefit plans is determined by using a 10% corridor of the greater of the market value of assets or the projected benefit obligation. Total unamortized gains and losses in excess of the corridor are amortized over the average remaining future service.
 
Prior service costs/benefits for the U.S. pension plans are amortized over the remaining future service of plan participants at the time of the plan amendment. Prior service cost/benefit for the other U.S. benefit plans is amortized over the average remaining service to full eligibility age of plan participants at the time of the plan amendment.
 
The weighted-average assumptions in the following table represent the rates used to develop the actuarial present value of projected benefit obligation for the year listed and also the net periodic benefit cost for the following year.
 
                                                 
    Retirement Plans     Other Benefit Plans  
(Dollars in Millions)   2010     2009     2008     2010     2009     2008  
 
U.S. Benefit Plans
                                               
Discount rate
    5.98 %     6.50       6.50       5.98 %     6.50       6.50  
Expected long-term rate of return on plan assets
    9.00       9.00       9.00       9.00       9.00       9.00  
Rate of increase in compensation levels
    4.25       4.50       4.50       4.25       4.50       4.50  
International Benefit Plans
                                               
Discount rate
    5.26 %     5.75       6.00       6.32 %     6.75       7.25  
Expected long-term rate of return on plan assets
    8.00       8.00       8.00                    
Rate of increase in compensation levels
    4.00       4.00       4.00       4.75       4.75       4.50  
                                                 
 
The Company’s discount rates are determined by considering current yield curves representing high quality, long-term fixed income instruments. The resulting discount rates are consistent with the duration of plan liabilities.
 
The expected long-term rate of return on plan assets assumption is determined using a building block approach, considering historical averages and real returns of each asset class. In certain countries, where historical returns are not meaningful, consideration is given to local market expectations of long-term returns.
 
The following table displays the assumed health care cost trend rates, for all individuals:
 
                 
Health Care Plans   2010     2009  
 
Health care cost trend rate assumed for next year
    7.50 %     8.00  
Rate to which the cost trend rate is assumed to decline (ultimate trend)
    5.00 %     5.00  
Year the rate reaches the ultimate trend rate
    2018       2017  
                 
 
A one-percentage-point change in assumed health care cost trend rates would have the following effect:
 
                 
    One-Percentage-
    One-Percentage-
 
(Dollars in Millions)   Point Increase     Point Decrease  
 
Health Care Plans
               
Total interest and service cost
  $ 36     $ (28 )
Postretirement benefit obligation
    377       (302 )
                 
 
 
54 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

 
The following table sets forth information related to the benefit obligation and the fair value of plan assets at year-end 2010 and 2009 for the Company’s defined benefit retirement plans and other postretirement plans:
 
                                 
    Retirement Plans     Other Benefit Plans  
(Dollars in Millions)   2010     2009     2010     2009  
 
Change in Benefit Obligation
                               
Projected benefit obligation — beginning of year
  $ 13,449       11,923     $ 3,590       2,765  
Service cost
    550       511       134       137  
Interest cost
    791       746       202       174  
Plan participant contributions
    42       50              
Amendments
          3              
Actuarial losses
    815       412       115       51  
Divestitures & acquisitions
          15             13  
Curtailments & settlements & restructuring
    (10 )     (3 )           748  
Benefits paid from plan
    (627 )     (570 )     (476 )     (313 )
Effect of exchange rates
    (17 )     362       7       15  
                                 
Projected benefit obligation — end of year*
  $ 14,993       13,449     $ 3,572       3,590  
                                 
Change in Plan Assets
                               
Plan assets at fair value — beginning of year
  $ 10,923       7,677     $ 16       17  
Actual return on plan assets
    1,466       2,048       2       4  
Company contributions
    1,611       1,354       472       308  
Plan participant contributions
    42       50              
Settlements
    (7 )                  
Benefits paid from plan assets
    (627 )     (570 )     (476 )     (313 )
Effect of exchange rates
    25       364              
                                 
Plan assets at fair value — end of year
  $ 13,433       10,923     $ 14       16  
                                 
Funded status at — end of year*
  $ (1,560 )     (2,526 )   $ (3,558 )     (3,574 )
                                 
Amounts Recognized in the Company’s Balance Sheet consist of the following:
                               
Non-current assets
  $ 615       266     $        
Current liabilities
    (54 )     (53 )     (576 )     (484 )
Non-current liabilities
    (2,121 )     (2,739 )     (2,982 )     (3,090 )
                                 
Total recognized in the consolidated balance sheet — end of year
  $ (1,560 )     (2,526 )   $ (3,558 )     (3,574 )
                                 
Amounts Recognized in Accumulated Other Comprehensive Income consist of the following:
                               
Net actuarial loss
  $ 3,539       3,415     $ 1,017       924  
Prior service cost (credit)
    39       47       (21 )     (23 )
Unrecognized net transition obligation
    4       5              
                                 
Total before tax effects
  $ 3,582       3,467     $ 996       901  
                                 
Accumulated Benefit Obligations — end of year*
  $ 13,134       11,687                  
                                 
Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income
                               
Net periodic benefit cost
  $ 584       481     $ 379       359  
                                 
Net actuarial loss (gain)
    354       (704 )     134       48  
Amortization of net actuarial loss
    (242 )     (134 )     (46 )     (131 )
Prior service cost
          3              
Amortization of prior service (cost) credit
    (10 )     (13 )     4       5  
Effect of exchange rates
    13       57       3       2  
                                 
Total recognized in other comprehensive income, before tax
  $ 115       (791 )   $ 95       (76 )
                                 
Total recognized in net periodic benefit cost and other comprehensive income
  $ 699       (310 )   $ 474       283  
                                 
 
 
The Company does not fund certain plans, as funding is not required. $1.3 billion and $1.2 billion of the 2010 and 2009 projected benefit obligation and $1.3 billion and $1.2 billion of the underfunded status for each of the fiscal years 2010 and 2009, respectively, relates to the unfunded pension plans. $1.1 billion and $1.0 billion of the accumulated benefit obligation for the fiscal years 2010 and 2009, respectively, relate to these unfunded pension plans.
 
Plans with accumulated benefit obligations in excess of plan assets consist of the following:
 
                 
    Retirement Plans  
(Dollars in Millions)   2010     2009  
 
Accumulated benefit obligation
  $ (2,361 )     (4,065 )
Projected benefit obligation
    (2,771 )     (4,663 )
Plan assets at fair value
    817       2,564  
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 55


 

The following table displays the projected future benefit payments from the Company’s retirement and other benefit plans:
 
                                                 
(Dollars in Millions)   2011     2012     2013     2014     2015     2016-2020  
 
Projected future benefit payments
                                               
Retirement plans
  $ 596       598       614       642       682       4,153  
                                                 
Other benefit plans — gross
  $ 263       212       200       202       203       1,075  
Medicare rebates
    (10 )     (12 )                        
                                                 
Other benefit plans — net
  $ 253       200       200       202       203       1,075  
                                                 
 
The 2011 other benefit plan future projected benefit payments exclude $345 million of severance payments associated with the 2009 worldwide restructuring program.
 
In 2010, the Company contributed $1,236 million and $375 million to its U.S. and international pension plans, respectively.
 
The Company plans to continue to fund its U.S. defined benefit plans to comply with the Pension Protection Act of 2006.
 
International plans are funded in accordance with local regulations. Additional discretionary contributions are made when deemed appropriate to meet the long-term obligations of the plans. For certain plans, funding is not a common practice, as funding provides no economic benefit. Consequently the Company has several pension plans that are not funded.
 
The following table displays the projected future minimum contributions to the Company’s U.S. and international unfunded retirement plans. These amounts do not include any discretionary contributions that the Company may elect to make in the future.
 
                                                 
(Dollars in Millions)   2011     2012     2013     2014     2015     2016-2020  
 
Projected future contributions
                                               
Unfunded U.S. retirement plans
  $ 36       38       40       43       46       300  
                                                 
Unfunded international retirement plans
  $ 18       17       19       19       23       128  
                                                 
 
Each pension plan is overseen by a local committee or board that is responsible for the overall administration and investment of the pension plans. In determining investment policies, strategies and goals, each committee or board considers factors including, local pension rules and regulations; local tax regulations; availability of investment vehicles (separate accounts, commingled accounts, insurance funds, etc.); funded status of the plans; ratio of actives to retirees; duration of liabilities; and other relevant factors including, diversification, liquidity of local markets and liquidity of base currency. A majority of the Company’s pension funds are open to new entrants and are expected to be on-going plans. Permitted investments are primarily liquid and/or listed, with little reliance on illiquid and non-traditional investments such as hedge funds. An asset allocation of 75% equities and 25% fixed income is generally pursued unless local regulations and illiquidity require otherwise.
 
The Company’s retirement plan asset allocation at the end of 2010 and 2009 and target allocations for 2011 are as follows:
 
                         
    Percent of
    Target
 
    Plan Assets     Allocation
 
    2010     2009     2011  
 
U.S. Retirement Plans
                       
Equity securities
    79 %     76 %     75 %
Debt securities
    21       24       25  
                         
Total plan assets
    100 %     100 %     100 %
                         
International Retirement Plans
                       
                         
Equity securities
    65 %     65 %     65 %
Debt securities
    35       34       35  
Real estate and other
          1        
                         
Total plan assets
    100 %     100 %     100 %
                         
 
The Company’s other benefit plans are unfunded except for U.S. life insurance contract assets of $14 million and $16 million at January 2, 2011 and January 3, 2010, respectively.
 
The fair value of Johnson & Johnson Common Stock directly held in plan assets was $453 million (3.4% of total plan assets) at January 2, 2011 and $469 million (4.3% of total plan assets) at January 3, 2010.
 
Determination of Fair Value
 
The Plan has an established and well-documented process for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, fair value is based upon models that primarily use, as inputs, market-based or independently sourced market parameters, including yield curves, interest rates, volatilities, equity or debt prices, foreign exchange rates and credit curves.
 
While the Plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
 
Valuation Hierarchy
 
The authoritative literature establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels within the hierarchy are described in the table below with Level 1 having the highest priority and Level 3 having the lowest.
 
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
 
 
56 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

Following is a description of the valuation methodologies used for the investments measured at fair value.
 
  •  Short-term investments — Cash and quoted short-term instruments are valued at the closing price or the amount held on deposit by the custodian bank. Other investments are through investment vehicles valued using the Net Asset Value (NAV) provided by the administrator of the fund. The NAV is based on the value of the underlying assets owned by the fund, minus its liabilities, and then divided by the number of shares outstanding. The NAV is a quoted price in a market that is not active and classified as Level 2.
 
  •  Government and agency securities — A limited number of these investments are valued at the closing price reported on the major market on which the individual securities are traded. Where quoted prices are available in an active market, the investments are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available for the specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. When quoted market prices for a security are not available in an active market, they are classified as Level 2.
 
  •  Debt instruments — A limited number of these investments are valued at the closing price reported on the major market on which the individual securities are traded. Where quoted prices are available in an active market, the investments are classified as Level 1. If quoted market prices are not available for the specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows and are classified as Level 2. Level 3 debt instruments are priced based on unobservable inputs.
 
  •  Equity securities — Common stocks are valued at the closing price reported on the major market on which the individual securities are traded. Substantially all common stock is classified within Level 1 of the valuation hierarchy.
 
  •  Commingled funds — The investments are public investment vehicles valued using the NAV provided by the fund administrator. The NAV is based on the value of the underlying assets owned by the fund, minus its liabilities, and then divided by the number of shares outstanding. Assets in the Level 2 category have a quoted market price in a market that is not active.
 
  •  Insurance contracts — The instruments are issued by insurance companies. The fair value is based on negotiated value and the underlying investments held in separate account portfolios as well as considering the credit worthiness of the issuer. The underlying investments are government, asset-backed and fixed income securities. In general, insurance contracts are classified as Level 3 as there are no quoted prices nor other observable inputs for pricing.
 
  •  Other assets — Other assets are represented primarily by limited partnerships and real estate investments, as well as commercial loans and commercial mortgages that are not classified as corporate debt. Other assets that are exchange listed and actively traded are classified as Level 1, while inactively traded assets are classified as Level 2. Most limited partnerships represent investments in private equity and similar funds that are valued by the general partners. These, as well as any other assets valued using unobservable inputs, are classified as Level 3.
 
The following table sets forth the trust investments measured at fair value as of January 2, 2011 and January 3, 2010:
 
                                                                 
    Quoted Prices
    Significant
    Significant
             
    in Active
    Other
    Unobserv-
             
    Markets for
    Observable
    able
             
    Identical Assets
    Inputs
    Inputs
             
    (Level 1)     (Level 2)     (Level 3)     Total Assets  
(Dollars in Millions)   2010     2009     2010     2009     2010     2009     2010     2009  
 
Short-term investment funds
  $ 80       91       371       358                   451       449  
Government and agency securities
    69             1,484       1,165                   1,553       1,165  
Debt instruments
    5       3       1,149       1,145       13       5       1,167       1,153  
Equity securities
    6,744       5,068       14       58       24       15       6,782       5,141  
Commingled funds
    1             3,173       2,673       35       26       3,209       2,699  
Insurance contracts
                            29       32       29       32  
Other assets
    10       31       150       171       82       82       242       284  
                                                                 
Trust investments at fair value
  $ 6,909       5,193       6,341       5,570       183       160       13,433       10,923  
                                                                 
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 57


 

Level 3 Gains and Losses
 
The table below sets forth a summary of changes in the fair value of the Plan’s Level 3 assets for the years ended January 2, 2011 and January 3, 2010:
 
                                                 
    Debt
    Equity
    Commingled
    Insurance
    Other
    Total
 
(Dollars in Millions)   Instruments     Securities     Funds     Contracts     Assets     Level 3  
 
Balance December 28, 2008
  $ 7       15       15       29       85       151  
Realized gains (losses)
                      3             3  
Unrealized gains (losses)
    2       (2 )     (2 )           (3 )     (5 )
Purchases, sales, issuances and settlements, net
    (4 )     2       13                   11  
                                                 
Balance January 3, 2010
    5       15       26       32       82       160  
Realized gains (losses)
    (1 )                 (3 )     1       (3 )
Unrealized gains (losses)
    1       4       4             (3 )     6  
Purchases, sales, issuances and settlements, net
    8       5       5             2       20  
                                                 
Balance January 2, 2011
  $ 13       24       35       29       82       183  
                                                 
 
11.   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. Total Company matching contributions to the plans were $157 million, $163 million and $166 million in 2010, 2009 and 2008, respectively.
 
12.   Capital and Treasury Stock
 
Changes in treasury stock were:
 
                 
(Amounts in Millions Except Treasury Stock
  Treasury Stock  
Number of Shares in Thousands)   Shares     Amount  
 
Balance at December 30, 2007
    279,620     $ 14,388  
Employee compensation and stock option plans
    (29,906 )     (2,005 )
Conversion of subordinated debentures
    (19 )     (1 )
Repurchase of common stock
    100,970       6,651  
                 
Balance at December 28, 2008
    350,665       19,033  
Employee compensation and stock option plans
    (22,161 )     (1,377 )
Conversion of subordinated debentures
    (96 )     (6 )
Repurchase of common stock
    37,114       2,130  
                 
Balance at January 3, 2010
    365,522       19,780  
Employee compensation and stock option plans
    (28,827 )     (1,792 )
Conversion of subordinated debentures
    (39 )     (2 )
Repurchase of common stock
    45,090       2,797  
                 
Balance at January 2, 2011
    381,746     $ 20,783  
                 
 
Aggregate shares of Common Stock issued were approximately 3,119,843,000 shares at the end of 2010, 2009 and 2008.
 
Cash dividends paid were $2.110 per share in 2010, compared with dividends of $1.930 per share in 2009, and $1.795 per share in 2008.
 
13.   Accumulated Other Comprehensive Income
 
Components of other comprehensive income/(loss) consist of the following:
 
                                         
                            Total
 
                      Gains/
    Accumulated
 
    Foreign
    Gains/
          (Losses) on
    Other
 
    Currency
    (Losses) on
    Employee
    Derivatives
    Comprehensive
 
(Dollars in Millions)   Translation     Securities     Benefit Plans     & Hedges     Income/(Loss)  
 
December 30, 2007
  $ 628       84       (1,360 )     (45 )     (693 )
2008 changes
                                       
Unrealized gain (loss)           (32 )           94          
Net amount reclassed to net earnings           (27 )           72          
                                         
Net 2008 changes
    (2,499 )     (59 )     (1,870 )     166       (4,262 )
                                         
December 28, 2008
  $ (1,871 )     25       (3,230 )     121       (4,955 )
2009 changes
                                       
Unrealized gain (loss)           (52 )           38          
Net amount reclassed to net earnings           (3 )           (14 )        
                                         
Net 2009 changes
    1,363       (55 )     565       24       1,897  
                                         
January 3, 2010
  $ (508 )     (30 )     (2,665 )     145       (3,058 )
2010 changes
                                       
Unrealized gain (loss)           99             (333 )        
Net amount reclassed to net earnings           (45 )           288          
Net 2010 changes
    (461 )     54       (21 )     (45 )     (473 )
                                         
January 2, 2011
  $ (969 )     24       (2,686 )     100       (3,531 )
                                         
 
The tax effect on the unrealized gains/(losses) on the equity securities was expense of $13 million in 2010, income of $14 million in 2009 and expense of $14 million in 2008. The tax effect related to employee benefit plans was $11 million, $302 million and $1,090 million in 2010, 2009 and 2008, respectively. The tax effect on the gains/(losses) on derivatives and hedges was expense of $54 million, $78 million and $70 million in 2010, 2009 and 2008, respectively. See Note 6 for additional information relating to derivatives and hedging.
 
The currency translation adjustments are not adjusted for income taxes as they relate to permanent investments in international subsidiaries.
 
 
58 JOHNSON & JOHNSON 2010 ANNUAL REPORT


 

14.   International Currency Translation
 
For translation of its subsidiaries operating in non-U.S. Dollar 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, or where a substantial portion of its cash flows are not in the local currency.
 
In consolidating international subsidiaries, balance sheet currency effects are recorded as a component of accumulated other comprehensive income. 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. The translation of balance sheet accounts for highly inflationary economies are reflected in the operating results.
 
An analysis of the changes during 2010, 2009 and 2008 for foreign currency translation adjustments is included in Note 13.
 
Net currency transaction gains and losses included in other (income) expense were losses of $130 million, $210 million and $31 million in 2010, 2009 and 2008, respectively.
 
15.   Earnings Per Share
 
The following is a reconciliation of basic net earnings per share to diluted net earnings per share for the fiscal years ended January 2, 2011, January 3, 2010 and December 28, 2008:
 
                         
(In millions Except Per Share Data)   2010     2009     2008  
 
Basic net earnings per share
  $ 4.85       4.45       4.62  
Average shares outstanding — basic
    2,751.4       2,759.5       2,802.5  
Potential shares exercisable under stock option plans
    156.1       118.0       179.0  
Less: shares repurchased under treasury stock method
    (122.3 )     (92.0 )     (149.6 )
Convertible debt shares
    3.6       3.6       3.7  
                         
Adjusted average shares outstanding — diluted
    2,788.8       2,789.1       2,835.6  
Diluted net earnings per share
  $ 4.78       4.40       4.57  
                         
 
The diluted net earnings per share calculation includes the dilutive effect of convertible debt that is offset by the related reduction in interest expense of $4 million after-tax for years 2010, 2009 and 2008.
 
Diluted net earnings per share excludes 66 million, 121 million and 59 million shares underlying stock options for 2010, 2009 and 2008, respectively, as the exercise price of these options was greater than their average market value, which would result in an anti-dilutive effect on diluted earnings per share.
 
16.   Rental Expense and Lease Commitments
 
Rentals of space, vehicles, manufacturing equipment and office and data processing equipment under operating leases were approximately $299 million, $322 million and $309 million in 2010, 2009 and 2008, respectively.
 
The approximate minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year at January 2, 2011 are:
 
(Dollars in Millions)
 
                                                 
                            After
       
2011   2012     2013     2014     2015     2015     Total  
 
$182
    159       130       106       89       74       740  
 
Commitments under capital leases are not significant.
 
17.   Common Stock, Stock Option Plans and Stock Compensation Agreements
 
At January 2, 2011, the Company had 7 stock-based compensation plans. The shares outstanding are for contracts under the Company’s 2000 Stock Option Plan, the 2005 Long-Term Incentive Plan, the 1997 Non-Employee Director’s Plan and the ALZA Corporation, Inverness Medical Technology, Inc., and Scios Inc. Stock Option Plans. During 2010, no options or restricted shares were granted under any of these plans except under the 2005 Long-Term Incentive Plan.
 
The compensation cost that has been charged against income for these plans was $614 million, $628 million and $627 million for 2010, 2009 and 2008, respectively. The total income tax benefit recognized in the income statement for share-based compensation costs was $205 million, $210 million and $210 million for 2010, 2009 and 2008, respectively. The total unrecognized compensation cost was $613 million as of January 2, 2011, $612 million as of January 3, 2010 and $632 million as of December 28, 2008. The weighted average period for this cost to be recognized was 1.05 years, 1.16 years and 1.06 years for 2010, 2009, and 2008, respectively. Share-based compensation costs capitalized as part of inventory were insignificant in all periods.
 
Stock Options
 
Stock options expire 10 years from the date of grant and vest over service periods that range from six months to four years. All options are granted at the average of the high and low prices of the Company’s Common Stock on the New York Stock Exchange on the date of grant. Under the 2005 Long-Term Incentive Plan, the Company may issue up to 260 million shares of common stock. Shares available for future grants under the 2005 Long-Term Incentive Plan were 121.3 million at the end of 2010.
 
The Company settles employee stock option exercises with treasury shares. Treasury shares are replenished throughout the year for the number of shares used to settle employee stock option exercises.
 
The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility represents a blended rate of 4-year daily historical average volatility rate, and a 5-week average implied volatility rate based on at-the-money traded Johnson & Johnson options with a life of 2 years. Historical data is used to determine the expected life of the option. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant.
 
The average fair value of options granted was $8.03, $8.35 and $7.66, in 2010, 2009, and 2008, respectively. The fair value was estimated based on the weighted average assumptions of:
 
                         
    2010     2009     2008  
 
Risk-free rate
    2.78 %     2.71 %     2.97 %
Expected volatility
    17.4 %     19.5 %     15.0 %
Expected life
    6.0yrs       6.0yrs       6.0yrs  
Dividend yield
    3.30 %     3.30 %     2.90 %
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 59


 

A summary of option activity under the Plan as of January 2, 2011, January 3, 2010 and December 28, 2008 and changes during the years ending on those dates is presented below:
 
                         
                Aggregate
 
                Intrinsic
 
          Weighted
    Value
 
    Outstanding
    Average
    (Dollars in
 
(Shares in Thousands)   Shares     Exercise Price     Millions)  
 
Shares at December 30, 2007
    228,629     $ 56.83     $ 2,411  
                         
Options granted
    22,428       61.80          
Options exercised
    (30,033 )     50.27          
Options canceled/forfeited
    (5,525 )     61.90          
                         
Shares at December 28, 2008
    215,499       58.14     $ 597  
                         
Options granted
    21,576       58.32          
Options exercised
    (18,225 )     50.97          
Options canceled/forfeited
    (6,131 )     61.85          
                         
Shares at January 3, 2010
    212,719       58.66     $ 1,310  
                         
Options granted
    13,996       62.62          
Options exercised
    (25,020 )     51.84          
Options canceled/forfeited
    (8,005 )     62.36          
                         
Shares at January 2, 2011
    193,690     $ 59.68     $ 648  
                         
 
The total intrinsic value of options exercised was $278 million, $184 million and $506 million in 2010, 2009 and 2008, respectively.
 
The following table summarizes stock options outstanding and exercisable at January 2, 2011:
 
                                         
(Shares in Thousands)   Outstanding     Exercisable  
    </