10-Q 1 a3q10q10-02x16.htm 10-Q 3Q 2016 Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
 
 
þ
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended October 2, 2016
or
 
 
 
o
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from            to
Commission file number 1-3215
jnjlogoa03a01a01a01a01a05.jpg
(Exact name of registrant as specified in its charter)
NEW JERSEY
(State or other jurisdiction of
incorporation or organization)
 
22-1024240
(I.R.S. Employer
Identification No.)

One Johnson & Johnson Plaza
New Brunswick, New Jersey 08933
(Address of principal executive offices)
Registrant’s telephone number, including area code (732) 524-0400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
On October 28, 2016, 2,720,531,728 shares of Common Stock, $1.00 par value, were outstanding.



JOHNSON & JOHNSON AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
Page
 
 
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 EX-31.1
 EX-32.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT



2


Part I — FINANCIAL INFORMATION

Item 1 — FINANCIAL STATEMENTS

JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; Dollars in Millions Except Share and Per Share Data)

 
 
October 2, 2016
 
January 3, 2016
ASSETS
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
18,205

 
13,732

Marketable securities
 
22,228

 
24,644

Accounts receivable, trade, less allowances for doubtful accounts $267 (2015, $268)
 
11,798

 
10,734

Inventories (Note 2)
 
8,488

 
8,053

Prepaid expenses and other
 
2,600

 
3,047

Total current assets
 
63,319

 
60,210

Property, plant and equipment at cost
 
38,373

 
36,648

Less: accumulated depreciation
 
(22,278
)
 
(20,743
)
Property, plant and equipment, net
 
16,095

 
15,905

Intangible assets, net (Note 3)
 
27,642

 
25,764

Goodwill (Note 3)
 
23,171

 
21,629

Deferred taxes on income
 
5,897

 
5,490

Other assets
 
4,245

 
4,413

Total assets
 
$
140,369

 
133,411

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
 
 
 
 
Loans and notes payable
 
$
3,443

 
7,004

Accounts payable
 
5,971

 
6,668

Accrued liabilities
 
5,283

 
5,411

Accrued rebates, returns and promotions
 
5,181

 
5,440

Accrued compensation and employee related obligations
 
2,554

 
2,474

Accrued taxes on income
 
798

 
750

Total current liabilities
 
23,230

 
27,747

Long-term debt (Note 4)
 
23,546

 
12,857

Deferred taxes on income
 
3,193

 
2,562

Employee related obligations
 
8,217

 
8,854

Other liabilities
 
9,414

 
10,241

Total liabilities
 
67,600

 
62,261

Shareholders’ equity:
 
 
 
 
Common stock — par value $1.00 per share (authorized 4,320,000,000 shares; issued 3,119,843,000 shares)
 
$
3,120

 
3,120

Accumulated other comprehensive income (loss) (Note 7)
 
(12,715
)
 
(13,165
)
Retained earnings
 
108,860

 
103,879

Less: common stock held in treasury, at cost (397,259,000 and 364,681,000 shares)
 
26,496

 
22,684

Total shareholders’ equity
 
72,769

 
71,150

Total liabilities and shareholders' equity
 
$
140,369

 
133,411

See Notes to Consolidated Financial Statements

3


JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited; Dollars & Shares in Millions Except Per Share Amounts)
 
 
Fiscal Third Quarters Ended
 
 
October 2,
2016
 
Percent
to Sales
 
September 27,
2015
 
Percent
to Sales
Sales to customers (Note 9)
 
$
17,820

 
100.0
 %
 
$
17,102

 
100.0
 %
Cost of products sold
 
5,486

 
30.8

 
5,224

 
30.5

Gross profit
 
12,334

 
69.2

 
11,878

 
69.5

Selling, marketing and administrative expenses
 
4,772

 
26.8

 
5,081

 
29.7

Research and development expense
 
2,178

 
12.2

 
2,154

 
12.6

In-process research and development
 

 

 
10

 
0.1

Interest income
 
(97
)
 
(0.5
)
 
(32
)
 
(0.2
)
Interest expense, net of portion capitalized
 
192

 
1.0

 
123

 
0.7

Other (income) expense, net
 
(54
)
 
(0.2
)
 
420

 
2.5

Restructuring (Note 12)
 
62

 
0.3

 

 

Earnings before provision for taxes on income
 
5,281

 
29.6

 
4,122

 
24.1

Provision for taxes on income (Note 5)
 
1,009

 
5.6

 
764

 
4.5

NET EARNINGS
 
$
4,272

 
24.0
 %
 
$
3,358

 
19.6
 %
 
 
 
 
 
 
 
 
 
NET EARNINGS PER SHARE (Note 8)
 
 
 
 
 
 
 
 
Basic
 
$
1.56

 
 
 
$
1.21

 
 
Diluted
 
$
1.53

 
 
 
$
1.20

 
 
CASH DIVIDENDS PER SHARE
 
$
0.80

 
 
 
$
0.75

 
 
AVG. SHARES OUTSTANDING
 
 
 
 
 
 
 
 
Basic
 
2,731.6

 
 
 
2,768.4

 
 
Diluted
 
2,785.4

 
 
 
2,807.2

 
 
See Notes to Consolidated Financial Statements


4



JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited; Dollars & Shares in Millions Except Per Share Amounts)
 
 
 
 
 
 
 
 
 
 
 
Fiscal Nine Months Ended
 
 
October 2,
2016
 
Percent
to Sales
 
September 27,
2015
 
Percent
to Sales
Sales to customers (Note 9)
 
$
53,784

 
100.0
 %
 
$
52,263

 
100.0
 %
Cost of products sold
 
16,151

 
30.0

 
15,863

 
30.4

Gross profit
 
37,633

 
70.0

 
36,400

 
69.6

Selling, marketing and administrative expenses
 
14,636

 
27.2

 
15,312

 
29.3

Research and development expense
 
6,455

 
12.0

 
6,182

 
11.8

In-process research and development
 
29

 
0.1

 
10

 
0.0

Interest income
 
(268
)
 
(0.5
)
 
(75
)
 
(0.1
)
Interest expense, net of portion capitalized
 
542

 
1.0

 
392

 
0.7

Other (income) expense, net
 
464

 
0.9

 
(859
)
 
(1.6
)
Restructuring expense (Note 12)
 
296

 
0.5

 

 

Earnings before provision for taxes on income
 
15,479

 
28.8

 
15,438

 
29.5

Provision for taxes on income (Note 5)
 
2,753

 
5.1

 
3,244

 
6.2

NET EARNINGS
 
$
12,726

 
23.7
 %
 
$
12,194

 
23.3
 %
 
 
 
 
 
 
 
 
 
NET EARNINGS PER SHARE (Note 8)
 
 
 
 
 
 
 
 
Basic
 
$
4.64

 
 
 
$
4.39

 
 
Diluted
 
$
4.55

 
 
 
$
4.33

 
 
CASH DIVIDENDS PER SHARE
 
$
2.35

 
 
 
$
2.20

 
 
AVG. SHARES OUTSTANDING
 
 
 
 
 
 
 
 
Basic
 
2,744.9

 
 
 
2,774.8

 
 
Diluted
 
2,796.6

 
 
 
2,817.1

 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements


5


JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited; Dollars in Millions)

 
Fiscal Third Quarters Ended
 
Fiscal Nine Months Ended
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
 
 
 
 
 
 
 
Net earnings
$
4,272

 
3,358

 
12,726

 
12,194

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Foreign currency translation
(94
)
 
(1,069
)
 
490

 
(2,729
)
 
 
 
 
 
 
 
 
Securities:
 
 
 
 
 
 
 
  Unrealized holding gain (loss) arising during period
29

 
(44
)
 
129

 
267

  Reclassifications to earnings
(42
)
 
(46
)
 
(136
)
 
(127
)
  Net change
(13
)
 
(90
)
 
(7
)
 
140

 
 
 
 
 
 
 
 
Employee benefit plans:
 
 
 
 
 
 
 
  Prior service cost amortization during period
(5
)
 
(5
)
 
(15
)
 
(16
)
  Gain (loss) amortization during period
103

 
159

 
310

 
477

  Net change
98

 
154

 
295

 
461

 
 
 
 
 
 
 
 
Derivatives & hedges:
 
 
 
 
 
 
 
  Unrealized gain (loss) arising during period
4

 
160

 
(437
)
 
26

  Reclassifications to earnings
(3
)
 
38

 
109

 
(37
)
  Net change
1

 
198

 
(328
)
 
(11
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
(8
)
 
(807
)
 
450

 
(2,139
)
 
 
 
 
 
 
 
 
Comprehensive income
$
4,264

 
2,551

 
13,176

 
10,055

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements

The tax effects in other comprehensive income for the fiscal third quarters were as follows for 2016 and 2015, respectively: Securities: $7 million and $48 million; Employee Benefit Plans: $51 million and $75 million; Derivatives & Hedges: less than $1 million and $107 million.
 
The tax effects in other comprehensive income for the fiscal nine months were as follows for 2016 and 2015, respectively: Securities: $4 million and $76 million; Employee Benefit Plans: $155 million and $226 million; Derivatives & Hedges: $177 million and $6 million.
 
 

6


JOHNSON & JOHNSON AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; Dollars in Millions)
 
 
Fiscal Nine Months Ended
 
 
October 2,
2016
 
September 27,
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net earnings
 
$
12,726

 
12,194

Adjustments to reconcile net earnings to cash flows from operating activities:
 
 
 
 
Depreciation and amortization of property and intangibles
 
2,699

 
2,713

Stock based compensation
 
704

 
677

Asset write-downs
 
187

 
367

Net gain on sale of assets/businesses
 
(276
)
 
(1,274
)
Deferred tax provision
 
215

 
233

Accounts receivable allowances
 
(10
)
 
2

Changes in assets and liabilities, net of effects from acquisitions and divestitures:
 
 
 
 
Increase in accounts receivable
 
(736
)
 
(910
)
Increase in inventories
 
(408
)
 
(719
)
Decrease in accounts payable and accrued liabilities
 
(1,220
)
 
(1,271
)
(Increase)/Decrease in other current and non-current assets
 
(379
)
 
986

(Decrease)/Increase in other current and non-current liabilities
 
(1,388
)
 
1,486

 
 
 
 
 
NET CASH FLOWS FROM OPERATING ACTIVITIES
 
12,114

 
14,484

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
Additions to property, plant and equipment
 
(2,133
)
 
(2,097
)
Proceeds from the disposal of assets/businesses, net
 
873

 
1,620

Acquisitions, net of cash acquired
 
(4,050
)
 
(233
)
Purchases of investments
 
(27,677
)
 
(28,766
)
Sales of investments
 
30,437

 
23,167

Other
 
(37
)
 
(35
)
 
 
 
 
 
NET CASH USED BY INVESTING ACTIVITIES
 
(2,587
)
 
(6,344
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Dividends to shareholders
 
(6,451
)
 
(6,101
)
Repurchase of common stock
 
(6,954
)
 
(3,394
)
Proceeds from short-term debt
 
149

 
2,107

Retirement of short-term debt
 
(3,926
)
 
(930
)
Proceeds from long-term debt, net of issuance costs
 
11,951

 
3

Retirement of long-term debt
 
(953
)
 
(27
)
Proceeds from the exercise of stock options/employee withholding tax on stock awards, net
 
1,112

 
550

Other
 
(15
)
 
(50
)
 
 
 
 
 
NET CASH USED BY FINANCING ACTIVITIES
 
(5,087
)
 
(7,842
)
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
33

 
(1,182
)
Increase/(Decrease) in cash and cash equivalents
 
4,473

 
(884
)
Cash and Cash equivalents, beginning of period
 
13,732

 
14,523

CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
18,205

 
13,639

 
 
 
 
 
Acquisitions
 
 
 
 
Fair value of assets acquired
 
$
4,094

 
477

Fair value of liabilities assumed and noncontrolling interests
 
(44
)
 
(244
)
Net cash paid for acquisitions
 
4,050

 
233

See Notes to Consolidated Financial Statements

7


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — The accompanying unaudited interim consolidated financial statements and related notes should be read in conjunction with the audited Consolidated Financial Statements of Johnson & Johnson and its subsidiaries (the Company) and related notes as contained in the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2016. The unaudited interim financial statements include all adjustments (consisting only of normal recurring adjustments) and accruals necessary in the judgment of management for a fair statement of the results for the periods presented.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements

During the fiscal first quarter of 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2016-09 Compensation - Stock Compensation: Improvements to Employee Share Based Payment Accounting. The amendments in the update are effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. During the fiscal second quarter of 2016, the Company elected to early adopt this standard. The update requires the following changes to presentation of the financial statements:
All excess tax benefits and deficiencies to be recognized as a reduction or an increase to the provision for taxes on income. Previously, the Company recorded these benefits directly to Retained Earnings. The tax benefit for the Company was $47 million and $335 million for the fiscal third quarter and fiscal nine months ended for 2016, respectively. The standard does not permit retroactive presentation of this benefit to prior fiscal years on the Consolidated Statement of Earnings.
The tax benefit or deficiency is required to be classified and presented as a cash flow to/from operating activities. It was previously required to be presented as a cash flow to/from financing activities on the Consolidated Statement of Cash Flows. As permitted in the standard, the Company has elected to adopt this reclassification on a prospective basis and therefore prior fiscal years for the Consolidated Statement of Cash Flows have not been recast for this provision.
Clarifies that all cash payments made to taxing authorities on employees’ share-based compensation should be classified as a cash outflow from financing activities. This reclassification is required to be recast retrospectively. As a result, for the fiscal nine months of 2016, $264 million was classified as a cash outflow from financing activities and for the fiscal nine months of 2015, $287 million of cash outflow was reclassified from an operating activity to a financing activity (Proceeds from the exercise of stock options/employee withholding tax on stock awards, net).
In the diluted net earnings per share calculation, when applying the treasury stock method for shares that could be repurchased, the assumed proceeds no longer include the amount of excess tax benefit. This did not have a material impact on the Company's diluted net earnings per share calculation.

During the fiscal third quarter of 2015, the FASB issued Accounting Standards Update 2015-16 Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This update is effective for the Company for all annual and interim periods beginning after December 15, 2015. The amendments in this update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. This update did not have a material impact on the Company’s consolidated financial statements.

During the fiscal second quarter of 2015, the FASB issued Accounting Standards Update 2015-03: Simplifying the Presentation of Debt Issuance Costs. This update requires capitalized debt issuance costs to be presented as a reduction to the carrying value of debt instead of being classified as a deferred charge, as currently required. This update is effective for the Company for all annual and interim periods beginning after December 15, 2015 and is required to be applied retroactively for all periods presented. This update did not have a material impact on the presentation of the Company’s financial position.

During the fiscal second quarter of 2014, the FASB issued amended guidance Accounting Standards Update No. 2014-10: Development Stage Entities: Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entity Guidance in Topic 810, Consolidation.  The change in the current guidance will require the Company to determine if it should consolidate one of these entities based on the change in the consolidation analysis.  This update to the consolidation analysis became effective for all annual periods and interim reporting periods beginning after December 15, 2015.  The adoption of this standard did not have a material impact on the presentation of the Company's consolidated financial statements.


8



Recently Issued Accounting Standards
Not Adopted as of October 2, 2016

In October 2016, the FASB issued Accounting Standards Update 2016-16 Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This update removes the current exception in US GAAP prohibiting entities from recognizing current and deferred income tax expenses or benefits related to transfer of assets, other than inventory, within the consolidated entity. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The amendments in this update are effective for public entities for annual reporting periods beginning after December 15, 2017. Early adoption is permitted and should be in the first interim period if an entity issues interim financial statements. The Company is currently assessing the impact of the future adoption of this standard on its consolidated financial statements.

During the fiscal third quarter of 2016, the FASB issued Accounting Standards Update 2016-15 Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update addresses whether to present certain specific cash flow items as operating, investing or financing activities. The amendments in this update are effective for public entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact of the future adoption of this standard on its consolidated Statements of Cash Flows.

During the fiscal first quarter of 2016, the FASB issued Accounting Standards Update 2016-07 Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. The amendments in the update eliminate the requirement that when an investment qualifies for the use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step by step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the application of the equity method. Earlier adoption is permitted for any entity in any interim or annual period. The adoption of this standard is not expected to have a material impact on the presentation of the Company's consolidated financial statements.

During the fiscal first quarter of 2016, the FASB issued Accounting Standards Update 2016-02 Leases (Topic 842). This update requires the recognition of lease assets and lease liabilities on the balance sheet for all lease obligations and disclosing key information about leasing arrangements. This update requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous generally accepted accounting principles. This update will be effective for the Company for all annual and interim periods beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. The Company is currently assessing the impact of the future adoption of this standard on its financial statements.
 
During the fiscal first quarter of 2016, the FASB issued Accounting Standards Update 2016-01 Financial Instruments: Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update supersede the guidance to classify equity securities with readily determinable fair values into different categories (that is, trading or available-for-sale) and require equity securities to be measured at fair value with changes in the fair value recognized through net income. The standard amends financial reporting by providing relevant information about an entity’s equity investments and reducing the number of items that are recognized in other comprehensive income. This update will be effective for the Company for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Company is unable to estimate the impact of the future adoption of this standard on its financial statements as it will depend on the equity investments as of the adoption date.

During the fiscal second quarter of 2015, the FASB issued Accounting Standards Update 2015-11: Simplifying the Measurement of Inventory. This update requires inventory to be measured at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This update will be effective for the Company for all annual and interim periods beginning after December 15, 2016. The amendments in this update should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. This update will not have a material impact on the presentation of the Company’s financial position.

9



During the fiscal second quarter of 2014, the FASB issued Accounting Standards Update 2014-09: Revenue from Contracts with Customers. This standard replaces substantially all current revenue recognition accounting guidance. During the fiscal third quarter of 2015, the FASB approved a one year deferral to the effective date to be adopted by all public companies for all annual periods and interim reporting periods beginning after December 15, 2017. During the fiscal first quarter of 2016, the FASB issued additional guidance and clarification relating to Identifying Performance Obligations, Licensing, and Principal versus Agent Considerations. During the second quarter of 2016, the FASB issued additional guidance and clarification relating to assessing collectability, presentation of sales taxes, noncash consideration, and contract modifications & completed contracts at transition. Early adoption of this standard is permitted but not before the original effective date for all annual periods and interim reporting periods beginning after December 15, 2016. The Company is currently assessing the impact of the future adoption of this standard on its financial statements.

During the fiscal third quarter of 2014, the FASB issued Accounting Standards Update No. 2014-15: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This standard requires management to evaluate, for each annual and interim reporting period, whether there are conditions and events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued or are available to be issued. If substantial doubt is raised, additional disclosures around management’s plan to alleviate these doubts are required. This update will become effective for all annual periods and interim reporting periods ending after December 15, 2016.  This standard is not expected to have any impact on current disclosures in the financial statements.


NOTE 2 — INVENTORIES

(Dollars in Millions)
 
October 2, 2016
 
January 3, 2016
Raw materials and supplies
 
$
974

 
936

Goods in process
 
1,859

 
2,241

Finished goods
 
5,655

 
4,876

Total inventories
 
$
8,488

 
8,053



NOTE 3 — INTANGIBLE ASSETS AND GOODWILL

Intangible assets that have finite useful lives are amortized over their estimated useful lives. The latest annual impairment assessment of goodwill and indefinite lived intangible assets was completed in the fiscal fourth quarter of 2015. Future impairment tests for goodwill and indefinite lived intangible assets will be performed annually in the fiscal fourth quarter, or sooner, if warranted.
(Dollars in Millions)
 
October 2, 2016
 
January 3, 2016
Intangible assets with definite lives:
 
 
 
 
Patents and trademarks — gross
 
$
10,815

 
8,299

Less accumulated amortization
 
5,017

 
4,745

Patents and trademarks — net
 
5,798

 
3,554

Customer relationships and other intangibles — gross
 
17,830

 
17,583

Less accumulated amortization
 
6,411

 
5,816

Customer relationships and other intangibles — net
 
11,419

 
11,767

Intangible assets with indefinite lives:
 
 
 
 
Trademarks
 
7,042

 
7,023

Purchased in-process research and development
 
3,383

 
3,420

Total intangible assets with indefinite lives
 
10,425

 
10,443

Total intangible assets — net
 
$
27,642

 
25,764



10


Goodwill as of October 2, 2016 was allocated by segment of business as follows:
(Dollars in Millions)
 
Consumer
 
Pharm
 
Med Devices
 
Total
Goodwill, net at January 3, 2016
 
$
7,240

 
2,889

 
11,500

 
21,629

Goodwill, related to acquisitions
 
1,332

 

 
180

 
1,512

Goodwill, related to divestitures
 
(24
)
 
(10
)
 

 
(34
)
Currency translation/Other
 
27

 
15

 
22

 
64

Goodwill, net at October 2, 2016
 
$
8,575

 
2,894

 
11,702

 
23,171


The weighted average amortization periods for patents and trademarks and customer relationships and other intangible assets are 19 years and 24 years, respectively. The amortization expense of amortizable intangible assets included in cost of products sold was $895 million and $912 million for the fiscal nine months ended October 2, 2016 and September 27, 2015, respectively. The estimated amortization expense for the five succeeding years approximates $1.3 billion, before tax, per year. Intangible asset write-downs are included in Other (income) expense, net.

The primary driver of the increase to intangible assets and goodwill is the Vogue International LLC acquisition in the fiscal third quarter of 2016, which resulted in the recording of $2.3 billion to intangible assets and $1.1 billion to goodwill. The intangible assets and goodwill amounts related to the Vogue acquisition are based on the preliminary purchase price allocation. See Note 10 to the Consolidated Financial Statements for additional details on the Vogue acquisition.



NOTE 4 — FAIR VALUE MEASUREMENTS

The Company uses forward foreign exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of future intercompany products and third-party purchases of materials denominated in a foreign currency. The Company uses cross currency interest rate swaps to manage currency risk primarily related to borrowings.
The Company also uses equity collar contracts to manage exposure to market risk associated with certain equity investments.
All three types of derivatives are designated as cash flow hedges.

Additionally, the Company uses interest rate swaps as an instrument to manage interest rate risk related to fixed rate borrowings. These derivatives are designated as fair value hedges. The Company uses forward foreign exchange contracts designated as net investment hedges. Additionally, the Company uses forward foreign exchange contracts to offset its exposure to certain foreign currency assets and liabilities. These forward foreign 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 that contain credit risk related contingent features or requirements to post collateral (excluding equity collar contracts) by either the Company or the counter-party. For equity collar contracts, the Company pledged the underlying hedged marketable equity securities to the counter-party as collateral. On an ongoing basis, the Company monitors counter-party credit ratings. The Company considers credit non-performance risk to be low, because the Company primarily enters into agreements with commercial institutions that have at least an investment grade credit rating. Refer to the table on significant financial assets and liabilities measured at fair value contained in this footnote for receivables and payables with these commercial institutions. As of October 2, 2016, the Company had notional amounts outstanding for forward foreign exchange contracts, cross currency interest rate swaps, interest rate swaps and equity collar contracts of $35.0 billion, $2.3 billion, $2.2 billion, and $0.4 billion respectively.

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.

The designation as a cash flow hedge is made at the entrance date of 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 and losses associated with interest rate swaps and changes in fair value of hedged debt attributable to changes in interest rates are recorded to interest expense in the period in which they occur. Gains and losses on net investment hedges are accounted for through the currency translation account. On an

11


ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes 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) expense, net for forward foreign exchange contracts, cross currency interest rate swaps, net investment hedges and equity collar contracts. For interest rate swaps designated as fair value hedges, hedge ineffectiveness, if any, is included in current period earnings within interest expense. For the current reporting period, hedge ineffectiveness associated with interest rate swaps was not material.

During the fiscal second quarter of 2016, the Company designated its Euro denominated notes issued in May 2016 with due dates ranging from 2022 to 2035 as a net investment hedge of the Company's investments in certain of its international subsidiaries that use the Euro as their functional currency in order to reduce the volatility caused by changes in exchange rates.
During the fiscal third quarter of 2016, the change in the carrying value due to remeasurement of these Euro notes resulted in a $76 million pretax gain reflected in foreign currency translation adjustment, within the Consolidated Statements of Comprehensive Income.

As of October 2, 2016, the balance of deferred net losses on derivatives included in accumulated other comprehensive income was $364 million after-tax. For additional information, see the Consolidated Statements of Comprehensive Income and Note 7. The Company expects that substantially all of the amounts related to forward 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 contracts, net investment hedges and equity collar contracts. The amount ultimately realized in earnings may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity of the derivative.

The following table is a summary of the activity related to derivatives designated as cash flow hedges for the fiscal third quarters in 2016 and 2015:
 
 
 
 
 
 
 
 
 
 
 
Gain/(Loss)
Recognized In
Accumulated
OCI(1)
 
Gain/(Loss) Reclassified From
Accumulated OCI
Into Income(1)
 
Gain/(Loss)
Recognized In
Other
Income/Expense(2)
(Dollars in Millions)
 
Fiscal Third Quarters Ended
Cash Flow Hedges By Income Statement Caption
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Sales to customers(3)
 
$
(12
)
 
3

 
(8
)
 
(24
)
 
(1
)
 
(3
)
Cost of products sold(3)
 
(4
)
 
222

 
13

 
(34
)
 
(4
)
 
1

Research and development expense(3)
 
(5
)
 
(10
)
 
(2
)
 
7

 
1

 

Interest (income)/Interest expense, net(4)
 
29

 
(13
)
 
12

 
1

 

 

Other (income) expense, net(3) (5)
 
(4
)
 
(42
)
 
(12
)
 
12

 

 
(1
)
Total
 
$
4

 
160

 
3

 
(38
)
 
(4
)
 
(3
)

The following table is a summary of the activity related to derivatives designated as cash flow hedges for the fiscal nine months in 2016 and 2015:
 
 
 
 
 
 
 
 
 
 
 
Gain/(Loss)
Recognized In
Accumulated
OCI(1)
 
Gain/(Loss) Reclassified From
Accumulated OCI
Into Income(1)
 
Gain/(Loss)
Recognized In
Other
Income/Expense(2)
(Dollars in Millions)
 
Fiscal Nine Months Ended
Cash Flow Hedges By Income Statement Caption
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Sales to customers(3)
 
$
(39
)
 
(52
)
 
(29
)
 
(95
)
 
(1
)
 
(5
)
Cost of products sold(3)
 
(226
)
 
106

 
5

 
82

 
(10
)
 
15

Research and development expense(3)
 
(100
)
 
(13
)
 
(98
)
 
(2
)
 

 

Interest (income)/Interest expense, net(4)
 
38

 
(42
)
 
27

 
(2
)
 

 

Other (income) expense, net(3) (5)
 
(110
)
 
27

 
(14
)
 
54

 
(3
)
 

Total
 
$
(437
)
 
26

 
(109
)
 
37

 
(14
)
 
10

 
 
 
 
 
 
 
 
 
 
 
 
 
All amounts shown in the table above are net of tax.

12


(1) Effective portion
(2) Ineffective portion
(3) Forward foreign exchange contracts
(4) Cross currency interest rate swaps
(5) Includes equity collar contracts

For the fiscal third quarters ended October 2, 2016 and September 27, 2015, a gain of $35 million and a loss of $8 million, respectively, was recognized in Other (income) expense, net, relating to forward foreign exchange contracts not designated as hedging instruments.

For the fiscal nine months ended October 2, 2016 and September 27, 2015, a loss of $6 million and a gain of $32 million, respectively, was recognized in Other (income) expense, net, relating to forward 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 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 foreign exchange contracts, interest rate contracts) 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 which are classified as Level 1 and debt securities which are classified as Level 2. The Company did not have any other significant financial assets or liabilities which would require revised valuations under this standard that are recognized at fair value.

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.



The Company’s significant financial assets and liabilities measured at fair value as of October 2, 2016 and January 3, 2016 were as follows:

13


 
 
October 2, 2016
 
 
 
January 3, 2016
(Dollars in Millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Total(1)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(7)
 
$

 
222

 

 
222

 
452

Interest rate contracts (2)(4)(7)
 

 
50

 

 
50

 
28

Total
 

 
272

 

 
272

 
480

Liabilities:
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(8)
 

 
542

 

 
542

 
358

Interest rate contracts (3)(4)(8)
 

 
309

 

 
309

 
241

Equity collar contracts (8)(9)
 

 
95

 

 
95

 

Total
 

 
946

 

 
946

 
599

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(7)
 

 
14

 

 
14

 
33

Liabilities:
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(8)
 

 
33

 

 
33

 
41

Available For Sale Other Investments:
 
 
 
 
 
 
 
 
 
 
Equity investments(5)
 
1,332

 

 

 
1,332

 
1,494

Debt securities(6)
 
$

 
12,237

 

 
12,237

 
8,316


(1)
2015 assets and liabilities are all classified as Level 2 with the exception of equity investments of $1,494 million, which are classified as Level 1.
(2)
Includes $35 million and $20 million of non-current other assets for October 2, 2016 and January 3, 2016, respectively.
(3)
Includes $309 million and $239 million of non-current other liabilities for October 2, 2016 and January 3, 2016, respectively.
(4)
Includes cross currency interest rate swaps and interest rate swaps.
(5)
Classified as non-current other assets with the exception of $345 million of current other assets for October 2, 2016. The carrying amount of the equity investments were $544 million and $528 million as of October 2, 2016 and January 3, 2016, respectively. The unrealized gains were $802 million and $979 million as of October 2, 2016 and January 3, 2016, respectively. The unrealized losses were $14 million and $13 million as of October 2, 2016 and January 3, 2016, respectively.
(6)
Classified as current marketable securities.
(7)
Classified as other current assets.
(8)
Classified as accounts payable.
(9)
Includes $16 million of non-current other liabilities for October 2, 2016.



14




The Company's cash, cash equivalents and current marketable securities as of October 2, 2016 comprised:
 
October 2, 2016
(Dollars in Millions)
Carrying Amount
 
Unrecognized Gain
 
Unrecognized Loss
 
Estimated Fair Value
 
Cash & Cash Equivalents
 
Current Marketable Securities
Cash
$
1,971

 

 

 
1,971

 
1,971

 
 
U.S. Gov't Securities(1)
10,498

 
1

 

 
10,499

 
6,997

 
3,501

Other Sovereign Securities(1)
3,385

 

 

 
3,385

 
952

 
2,433

U.S. Reverse repurchase agreements(1)
5,883

 

 

 
5,883

 
4,882

 
1,001

Other Reverse repurchase agreements(1)
96

 

 

 
96

 
96

 
 
Corporate debt securities(1)
3,501

 
1

 

 
3,502

 
790

 
2,711

Money market funds
1,448

 

 

 
1,448

 
1,448

 
 
Time deposits(1)
1,069

 

 

 
1,069

 
1,069

 
 
     Subtotal
27,851

 
2

 

 
27,853

 
18,205

 
9,646

 
 
 
Unrealized Gain
 
Unrealized Loss
 
 
 
 
 
 
Gov't securities
10,235

 
120

 
(1
)
 
10,354

 

 
10,354

Other Sovereign Securities
91

 

 

 
91

 

 
91

Corporate debt securities
1,782

 
11

 
(1
)
 
1,792

 

 
1,792

Equity investments
50

 
314

 
(19
)
 
345

 

 
345

     Subtotal Available for Sale(2)
$
12,158

 
445

 
(21
)
 
12,582

 

 
12,582

Total cash, cash equivalents and current marketable securities


 


 


 


 
18,205

 
22,228


(1) Held to maturity investments are reported at amortized cost and gains or losses are reported in earnings.
(2) Available for sale securities are reported at fair value with unrealized gains and losses reported net of taxes in other comprehensive income.

Fair value of government securities and obligations and corporate debt securities was estimated using quoted broker prices and significant other observable inputs.

The Company classifies all highly liquid investments with stated maturities of three months or less from date of purchase as cash equivalents and all highly liquid investments with stated maturities of greater than three months from the date of purchase as current marketable securities. Available for sale securities with stated maturities of greater than one year from the date of purchase are available for current operations and are classified as current marketable securities.

The estimated fair value was the same as the amortized cost as of January 3, 2016.
The contractual maturities of the available for sale securities at October 2, 2016 are as follows:
(Dollars in Millions)
 
Cost Basis
 
Fair Value
Due within one year
 
$
475

 
475

Due after one year through five years
 
11,445

 
11,575

Due after five years through ten years
 
188

 
187

Total debt securities
 
$
12,108

 
12,237







15


Financial Instruments not measured at Fair Value:
The following financial liabilities are held at carrying amount on the consolidated balance sheet as of October 2, 2016:
(Dollars in Millions)
 
Carrying Amount
 
Estimated Fair Value
 
 
 
 
 
Financial Liabilities
 
 
 
 
 
 
 
 
 
Current Debt
 
$
3,443

 
3,443

 
 
 
 
 
Non-Current Debt
 
 
 
 
1.125% Notes due 2017
 
703

 
705

5.15% Debentures due 2018
 
899

 
958

1.65% Notes due 2018
 
608

 
616

4.75% Notes due 2019 (1B Euro 1.1198)
 
1,115

 
1,287

1.875% Notes due 2019
 
511

 
524

0.89% Notes due 2019
 
299

 
300

1.125% Notes due 2019
 
699

 
700

3% Zero Coupon Convertible Subordinated Debentures due in 2020
 
94

 
152

2.95% Debentures due 2020
 
545

 
578

3.55% Notes due 2021
 
447

 
491

2.45% Notes due 2021
 
349

 
367

1.65% Notes due 2021
 
997

 
1,013

0.250% Notes due 2022 (1B Euro 1.1198)
 
1,116

 
1,132

6.73% Debentures due 2023
 
249

 
335

3.375% Notes due 2023
 
807

 
875

2.05% Notes due 2023
 
497

 
507

0.650% Notes due 2024 (750MM Euro 1.1198)
 
834

 
863

5.50% Notes due 2024 (500 MM GBP 1.3000)
 
643

 
868

2.45% Notes due 2026
 
1,989

 
2,059

1.150% Notes due 2028 (750MM Euro 1.1198)
 
830

 
886

6.95% Notes due 2029
 
296

 
440

4.95% Debentures due 2033
 
497

 
635

4.375% Notes due 2033
 
857

 
1,026

1.650% Notes due 2035 (1.5B Euro 1.1198)
 
1,660

 
1,884

3.55% Notes due 2036
 
987

 
1,098

5.95% Notes due 2037
 
991

 
1,457

5.85% Debentures due 2038
 
695

 
1,016

4.50% Debentures due 2040
 
537

 
674

4.85% Notes due 2041
 
296

 
390

4.50% Notes due 2043
 
495

 
624

3.70% Notes due 2046
 
1,970

 
2,213

Other
 
34

 
34

Total Non-Current Debt
 
$
23,546

 
26,707


The weighted average effective interest rate on non-current debt is 3.14%.

The excess of the estimated fair value over the carrying value of debt was $1.7 billion at January 3, 2016.

Fair value of the non-current debt was estimated using market prices, which were corroborated by quoted broker prices and significant other observable inputs.

16




NOTE 5 — INCOME TAXES

The worldwide effective income tax rates for the fiscal nine months of 2016 and 2015 were 17.8% and 21.0%, respectively. In the fiscal nine months of 2016, the Company had higher income in lower tax jurisdictions relative to higher tax jurisdictions as compared to 2015, which decreased the effective tax rate by approximately 0.8%.  As described in Note 1, the Company has adopted a new accounting standard for the reporting of tax benefits on share-based compensation. The adoption of this new standard reduced the tax rate for the first nine months of fiscal 2016 by approximately 2.0% versus 2015. The remainder of the change in the effective tax rate from prior year was primarily related to the U.S. Research & Development tax credit and the Controlled Foreign Corporation look-through provisions, which were not enacted into law until the fiscal fourth quarter of 2015, and the settlement of several uncertain tax positions in international jurisdictions.

As of October 2, 2016, the Company had approximately $3.1 billion of liabilities from unrecognized tax benefits. The Company believes it is possible that audits may be completed by tax authorities in some jurisdictions over the next twelve months. The Company is not able to provide a reasonably reliable estimate of the timing of any future tax payments relating to uncertain tax positions.

NOTE 6 — PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Components of Net Periodic Benefit Cost

Net periodic benefit cost for the Company’s defined benefit retirement plans and other benefit plans for the fiscal third quarters of 2016 and 2015 include the following components:
 
 
Fiscal Third Quarters Ended
 
 
Retirement Plans
 
Other Benefit Plans
(Dollars in Millions)
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Service cost
 
$
224

 
247

 
56

 
64

Interest cost
 
232

 
246

 
39

 
46

Expected return on plan assets
 
(490
)
 
(451
)
 
(1
)
 
(2
)
Amortization of prior service cost/(credit)
 
2

 

 
(9
)
 
(8
)
Recognized actuarial losses
 
123

 
186

 
33

 
50

Curtailments and settlements
 
6

 

 

 

Net periodic benefit cost
 
$
97

 
228

 
118

 
150


Net periodic benefit cost for the Company’s defined benefit retirement plans and other benefit plans for the fiscal nine months of 2016 and 2015 include the following components:
 
 
 
 
 
 
 
 
 
 
 
Fiscal Nine Months Ended
 
 
Retirement Plans
 
Other Benefit Plans
(Dollars in Millions)
 
October 2, 2016
 
September 27, 2015
 
October 2, 2016
 
September 27, 2015
Service cost
 
$
676

 
744

 
166

 
193

Interest cost
 
698

 
743

 
118

 
139

Expected return on plan assets
 
(1,475
)
 
(1,361
)
 
(4
)
 
(5
)
Amortization of prior service cost/(credit)
 
2

 
1

 
(25
)
 
(25
)
Recognized actuarial losses
 
371

 
560

 
101

 
150

Curtailments and settlements
 
11

 
4

 

 

Net periodic benefit cost
 
$
283

 
691

 
356

 
452

 
 
 
 
 
 
 
 
 

17


Company Contributions

For the fiscal nine months ended October 2, 2016, the Company contributed $372 million and $21 million to its U.S. and international retirement 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.

NOTE 7 — ACCUMULATED OTHER COMPREHENSIVE INCOME

Components of other comprehensive income (loss) consist of the following:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign
 
Gain/(Loss)
 
Employee
 
Gain/(Loss)
 
Total Accumulated
 
 
Currency
 
On
 
Benefit
 
On Derivatives
 
Other Comprehensive
(Dollars in Millions)
 
Translation
 
Securities
 
Plans
 
& Hedges
 
Income (Loss)
January 3, 2016
 
$
(8,435
)
 
604

 
(5,298
)
 
(36
)
 
(13,165
)
Net change
 
490

 
(7
)
 
295

 
(328
)
 
450

October 2, 2016
 
$
(7,945
)
 
597

 
(5,003
)
 
(364
)
 
(12,715
)

Amounts in accumulated other comprehensive income are presented net of the related tax impact. Foreign currency translation is not adjusted for income taxes where it relates to permanent investments in international subsidiaries. For additional details on comprehensive income see the Consolidated Statements of Comprehensive Income.

Details on reclassifications out of Accumulated Other Comprehensive Income:
Gain/(Loss) On Securities - reclassifications released to Other (income) expense, net.
Employee Benefit Plans - reclassifications are included in net periodic benefit cost. See Note 6 for additional details.
Gain/(Loss) On Derivatives & Hedges - reclassifications to earnings are recorded in the same account as the underlying transaction. See Note 4 for additional details.

NOTE 8 — EARNINGS PER SHARE

The following is a reconciliation of basic net earnings per share to diluted net earnings per share for the fiscal third quarters ended October 2, 2016 and September 27, 2015:
 
 
Fiscal Third Quarters Ended
(Shares in Millions)
 
October 2, 2016
 
September 27, 2015
Basic net earnings per share
 
$
1.56

 
1.21

Average shares outstanding — basic
 
2,731.6

 
2,768.4

Potential shares exercisable under stock option plans
 
140.8

 
129.4

Less: shares which could be repurchased under treasury stock method
 
(88.4
)
 
(92.8
)
Convertible debt shares
 
1.4

 
2.2

Average shares outstanding — diluted
 
2,785.4

 
2,807.2

Diluted net earnings per share
 
$
1.53

 
1.20


The diluted net earnings per share calculation for both the fiscal third quarters ended October 2, 2016 and September 27, 2015 included the dilutive effect of convertible debt that was offset by the related reduction in interest expense.

The diluted net earnings per share calculation for the fiscal third quarter ended October 2, 2016 included all shares related to stock options, as there were no options or other instruments which were anti-dilutive. The diluted net earnings per share calculation for the fiscal third quarter ended September 27, 2015 excluded 20 million shares related to stock options, 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.




18






The following is a reconciliation of basic net earnings per share to diluted net earnings per share for the fiscal nine months ended October 2, 2016 and September 27, 2015:
 
 
 
 
 
 
 
Fiscal Nine Months Ended
(Shares in Millions)
 
October 2, 2016
 
September 27, 2015
Basic net earnings per share
 
$
4.64

 
4.39

Average shares outstanding — basic
 
2,744.9

 
2,774.8

Potential shares exercisable under stock option plans
 
144.0

 
129.1

Less: shares which could be repurchased under treasury stock method
 
(93.7
)
 
(89.0
)
Convertible debt shares
 
1.4

 
2.2

Average shares outstanding — diluted
 
2,796.6

 
2,817.1

Diluted net earnings per share
 
$
4.55

 
4.33

 
 
 
 
 

The diluted net earnings per share calculation for both the fiscal nine months ended October 2, 2016 and September 27, 2015 included the dilutive effect of convertible debt that was offset by the related reduction in interest expense.

The diluted net earnings per share calculation for the fiscal nine months ended October 2, 2016 included all shares related to stock options, as there were no options or other instruments which were anti-dilutive. The diluted net earnings per share calculation for the fiscal nine months ended September 27, 2015 excluded 20 million shares related to stock options, 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.

NOTE 9 — SEGMENTS OF BUSINESS AND GEOGRAPHIC AREAS

SALES BY SEGMENT OF BUSINESS
 
 
Fiscal Third Quarters Ended
(Dollars in Millions)
 
October 2,
2016
 
September 27,
2015
 
Percent
Change
 
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
United States
 
$
1,291

 
1,277

 
1.1
 %
International
 
1,970

 
2,037

 
(3.3
)
Total
 
3,261

 
3,314

 
(1.6
)
Pharmaceutical
 
 
 
 
 
 
United States
 
5,042

 
4,509

 
11.8

International
 
3,358

 
3,185

 
5.4

Total
 
8,400

 
7,694

 
9.2

Medical Devices
 
 
 
 
 
 
United States
 
3,048

 
3,005

 
1.4

International
 
3,111

 
3,089

 
0.7

Total
 
6,159

 
6,094

 
1.1

Worldwide
 
 
 
 
 
 
United States
 
9,381

 
8,791

 
6.7

International
 
8,439

 
8,311

 
1.5

Total
 
$
17,820

 
17,102

 
4.2
 %

19


 
 
 
 
 
 
 
 
 
Fiscal Nine Months Ended
(Dollars in Millions)
 
October 2,
2016
 
September 27,
2015
 
Percent
Change
 
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
United States
 
$
4,033

 
3,991

 
1.1
 %
International
 
5,842

 
6,196

 
(5.7
)
Total
 
9,875

 
10,187

 
(3.1
)
Pharmaceutical
 
 
 
 
 
 
United States
 
15,123

 
13,423

 
12.7

International
 
10,109

 
9,943

 
1.7

Total
 
25,232

 
23,366

 
8.0

Medical Devices
 
 
 
 
 
 
United States
 
9,118

 
8,980

 
1.5

International
 
9,559

 
9,730

 
(1.8
)
Total
 
18,677

 
18,710

 
(0.2
)
Worldwide
 
 
 
 
 
 
United States
 
28,274

 
26,394

 
7.1

International
 
25,510

 
25,869

 
(1.4
)
Total
 
$
53,784

 
52,263

 
2.9
 %
INCOME BEFORE TAX BY SEGMENT
 
 
Fiscal Third Quarters Ended
(Dollars in Millions)
 
October 2,
2016
 
September 27,
2015
 
Percent
Change
Consumer(1)
 
$
679

 
811

 
(16.3
)%
Pharmaceutical(2)
 
3,309

 
2,732

 
21.1

Medical Devices(3)
 
1,526

 
835

 
82.8

Segments operating profit
 
5,514

 
4,378

 
25.9

Less: Expense not allocated to segments (4)
 
233

 
256

 
 
Worldwide income before tax
 
$
5,281

 
4,122

 
28.1
 %
 
 
 
 
 
 
 
 
 
Fiscal Nine Months Ended
(Dollars in Millions)
 
October 2, 2016
 
September 27, 2015
 
Percent
Change
Consumer(1)
 
$
1,816

 
1,772

 
2.5
 %
Pharmaceutical(2)
 
10,340

 
9,816

 
5.3

Medical Devices(3)
 
4,041

 
4,640

 
(12.9
)
Segments operating profit
 
16,197

 
16,228

 
(0.2
)
Less: Expense not allocated to segments (4)
 
718

 
790

 
 
Worldwide income before taxes
 
$
15,479

 
15,438

 
0.3
 %
(1) Includes a gain of $229 million from the divestiture of the SPLENDA® brand recorded in the fiscal third quarter and fiscal nine months of 2015.
(2) Includes litigation expense of $136 million recorded in the fiscal nine months of 2015. Includes a gain of $981 million recorded in the fiscal nine months of 2015 from the divestiture of the U.S. license rights to NUCYNTA® (tapentadol), NUCYNTA® ER (tapentadol extended-release tablets), and NUCYNTA® (tapentadol) oral solution. Includes a positive adjustment of $513 million and $462 million to previous reserve estimates in the fiscal nine months of 2016 and 2015, respectively.
(3) Includes a restructuring related charge of $109 million and $387 million in the fiscal third quarter and fiscal nine months of 2016, respectively. Includes litigation expense of $55 million and $731 million recorded in the fiscal third quarter and fiscal

20


nine months of 2016, respectively. Includes litigation expense of $409 million in the fiscal third quarter of 2015. Includes a $346 million intangible asset write-down related to Acclarent recorded in the fiscal third quarter and fiscal nine months of 2015. The fiscal nine months of 2015 included $148 million for costs associated with the DePuy ASRTM Hip program.
(4) Amounts not allocated to segments include interest income/expense and general corporate income/expense.
SALES BY GEOGRAPHIC AREA
 
 
Fiscal Third Quarters Ended
(Dollars in Millions)
 
October 2, 2016
 
September 27, 2015
 
Percent
Change
United States
 
$
9,381

 
8,791

 
6.7
 %
Europe
 
3,832

 
3,802

 
0.8

Western Hemisphere, excluding U.S.
 
1,396

 
1,463

 
(4.6
)
Asia-Pacific, Africa
 
3,211

 
3,046

 
5.4

Total
 
$
17,820

 
17,102

 
4.2
 %
 
 
 
 
 
 
 
 
 
Fiscal Nine Months Ended
(Dollars in Millions)
 
October 2, 2016
 
September 27, 2015
 
Percent
Change
United States
 
$
28,274

 
26,394

 
7.1
 %
Europe
 
11,769

 
11,993

 
(1.9
)
Western Hemisphere, excluding U.S.
 
4,269

 
4,603

 
(7.3
)
Asia-Pacific, Africa
 
9,472

 
9,273

 
2.1

Total
 
$
53,784

 
52,263

 
2.9
 %

NOTE 10— BUSINESS COMBINATIONS AND DIVESTITURES
During the fiscal third quarter of 2016, the Company completed the acquisition of Vogue International LLC, a privately-held company focused on the marketing, development and distribution of salon-influenced and nature inspired hair care and other personal products for $3.3 billion in cash. The net purchase price of $3.3 billion was primarily recorded as amortizable intangible assets for $2.3 billion and goodwill for $1.1 billion. The weighted average life for the $2.3 billion of total amortizable intangibles is approximately 22 years. The trademark asset values were determined to have definite lives ranging from 10 to 22 years, with the majority being 22 years. The customer relationship asset values were determined to have definite lives of 15 years. The goodwill is primarily attributable to synergies expected to arise from the business acquisition and is expected to be deductible for tax purposes. The intangible assets and goodwill amounts are based on the preliminary purchase price allocation. The assets acquired were recorded in the Consumer segment.

During the fiscal third quarter of 2016, the company announced a definitive agreement to acquire Abbott Medical Optics (AMO), a wholly-owned subsidiary of Abbott Laboratories, for $4.325 billion in cash. The acquisition will include ophthalmic products related to: cataract surgery, laser refractive surgery and consumer eye health. The transaction is expected to close in the first quarter of 2017. The closing is subject to antitrust clearance and other customary closing conditions.
During the fiscal second quarter of 2016, the Company completed the acquisitions of NeuWave Medical, Inc., a privately-held medical device company that manufactures and markets minimally invasive soft tissue microwave ablation systems and NeoStrata Company, Inc., a global leader in dermocosmetics. Additionally, during the fiscal second quarter of 2016, the Company completed the divestiture of its controlled substance raw material and active pharmaceutical ingredient (API) business. The proceeds from the divestiture were $650 million.

During the fiscal third quarter of 2015, the Company completed the divestiture of its SPLENDA® brand. The pre-tax gain on the divestiture was $229 million and was recognized in Other (income) expense, net.

During the fiscal second quarter of 2015, the Company completed the divestiture of its U.S. license rights to NUCYNTA® (tapentadol), NUCYNTA ® ER (tapentadol extended-release tablets), and NUCYNTA® (tapentadol) oral solution for approximately $1.05 billion. The pre-tax gain on the divestiture was $981 million and was recognized in Other (income) expense, net. During the fiscal first quarter of 2015, the Company acquired XO1 Limited, a privately-held biopharmaceutical company developing an anti-thrombin antibody.

21



NOTE 11 — LEGAL PROCEEDINGS

Johnson & Johnson and certain of its subsidiaries are involved in various lawsuits and claims regarding product liability, intellectual property, commercial and other matters; governmental investigations; and other legal proceedings that arise from time to time in the ordinary course of their business.

The Company records accruals for loss contingencies associated with these legal matters when it is probable that a liability will be incurred and the amount of the loss can be reasonably estimated. As of October 2, 2016, the Company has determined that the liabilities associated with certain litigation matters are probable and can be reasonably estimated. The Company has accrued for these matters and will continue to monitor each related legal issue and adjust accruals as might be warranted based on new information and further developments in accordance with ASC 450-20-25. For these and other litigation and regulatory matters discussed below for which a loss is probable or reasonably possible, the Company is unable to estimate the possible loss or range of loss beyond the amounts already accrued. Amounts accrued for legal contingencies often result from a complex series of judgments about future events and uncertainties that rely heavily on estimates and assumptions. The ability to make such estimates and judgments can be affected by various factors, including whether damages sought in the proceedings are unsubstantiated or indeterminate; scientific and legal discovery has not commenced or is not complete; proceedings are in early stages; matters present legal uncertainties; there are significant facts in dispute; or there are numerous parties involved.

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 accrued in the Company's balance sheet, is not expected to have a material adverse effect on the Company's financial position. However, the resolution of, or increase in accruals for, one or more of these matters in any reporting period may have a material adverse effect on the Company's results of operations and cash flows for that period.

PRODUCT LIABILITY

Johnson & Johnson and certain of its subsidiaries are involved in numerous product liability claims and lawsuits involving multiple products. Claimants in these cases seek substantial compensatory and, where available, punitive damages. While the Company believes it has substantial defenses, it is not feasible to predict the ultimate outcome of litigation. The Company has established accruals for product liability claims and lawsuits in compliance with ASC 450-20 based on currently available information, which in some cases may be limited. The Company accrues an estimate of the legal defense costs needed to defend each matter when those costs are probable and can be reasonably estimated. For certain of these matters, the Company has accrued additional amounts such as estimated costs associated with settlements, damages and other losses. Product liability accruals can represent projected product liability for thousands of claims around the world, each in different litigation environments and with different fact patterns. Changes to the accruals may be required in the future as additional information becomes available.

The most significant of these cases include the DePuy ASR™ XL Acetabular System and DePuy ASR™ Hip Resurfacing System, the PINNACLE® Acetabular Cup System, pelvic meshes, RISPERDAL®, XARELTO® and JOHNSON'S® Baby Powder. As of October 2, 2016, in the U.S. there were approximately 2,900 plaintiffs with direct claims in pending lawsuits regarding injuries allegedly due to the DePuy ASR™ XL Acetabular System and DePuy ASR™ Hip Resurfacing System, 9,300 with respect to the PINNACLE® Acetabular Cup System, 53,400 with respect to pelvic meshes, 15,400 with respect to RISPERDAL®, 15,600 with respect to XARELTO® and 2,400 with respect to JOHNSON'S® Baby Powder.

In August 2010, DePuy Orthopaedics, Inc. (DePuy) announced a worldwide voluntary recall of its ASR™ XL Acetabular System and DePuy ASR Hip Resurfacing System used in hip replacement surgery. Claims for personal injury have been made against DePuy and Johnson & Johnson. The number of pending lawsuits is expected to fluctuate as certain lawsuits are settled or dismissed and additional lawsuits are filed. Cases filed in federal courts in the United States have been organized as a multi-district litigation in the United States District Court for the Northern District of Ohio. Litigation has also been filed in countries outside of the United States, primarily in the United Kingdom, Canada, Australia, Ireland, Germany and Italy. In November 2013, DePuy reached an agreement with a Court-appointed committee of lawyers representing ASR Hip System plaintiffs to establish a program to settle claims with eligible ASR Hip patients in the United States who had surgery to replace their ASR Hips, known as revision surgery, as of August 31, 2013. This settlement covered approximately 8,000 patients. In February 2015, DePuy reached an additional agreement, which effectively extends the existing settlement program to ASR Hip patients who had revision surgeries after August 31, 2013 and prior to February 1, 2015. This second agreement is estimated to cover approximately 1,800 additional patients. The estimated cost of these agreements is covered by existing accruals. This settlement program is expected to bring to a close significant ASR Hip litigation activity in the United States. However, many lawsuits in the United States will remain, and the settlement program does not address litigation outside of the United States. In Australia,

22


a settlement has been reached with representatives of a class action lawsuit pending in the Federal Court of New South Wales that resolves the claims of the majority of ASR Hip patients in that country. The Company continues to receive information with respect to potential costs associated with this recall on a worldwide basis. The Company has established accruals for the costs associated with the DePuy ASR™ Hip program and related product liability litigation. Changes to these accruals may be required in the future as additional information becomes available.

Claims for personal injury have also been made against DePuy and Johnson & Johnson relating to DePuy's PINNACLE® Acetabular Cup System used in hip replacement surgery. The number of pending product liability lawsuits continues to increase, and the Company continues to receive information with respect to potential costs and the anticipated number of cases. Cases filed in federal courts in the United States have been organized as a multi-district litigation in the United States District Court for the Northern District of Texas. Litigation has also been filed in countries outside of the United States, primarily in the United Kingdom. The Company has established an accrual for defense costs in connection with product liability litigation associated with DePuy's PINNACLE® Acetabular Cup System. Changes to this accrual may be required in the future as additional information becomes available.

Claims for personal injury have been made against Ethicon, Inc. (Ethicon) and Johnson & Johnson arising out of Ethicon's pelvic mesh devices used to treat stress urinary incontinence and pelvic o