EX-13 10 y74152exv13.htm EX-13: PAGES OF COMPANY'S ANNUAL REPORT TO SHAREHOLDERS EX-13
Exhibit 13
 
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS
         
  34    
Organization and Business Segments
  34    
Results of Operations
  35    
Analysis of Sales by Business Segments
  37    
Analysis of Consolidated Earnings Before Provision for Taxes on Income
  40    
Liquidity and Capital Resources
  41    
Other Information
  43    
Cautionary Factors That May Affect Future Results
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
         
  44    
Consolidated Balance Sheets
  45    
Consolidated Statements of Earnings
  46    
Consolidated Statements of Equity
  47    
Consolidated Statements of Cash Flows
  48    
Notes to Consolidated Financial Statements
  69    
Report of Independent Registered Public Accounting Firm
  69    
Management’s Report on Internal Control over
       
Financial Reporting
  70    
Summary of Operations and Statistical Data 1998-2008
  71    
Shareholder Return Performance Graphs


         
JOHNSON & JOHNSON 2008 ANNUAL REPORT
    33


 

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 118,700 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. These products are marketed to the general public and sold both to distributors and directly to independent and chain retail outlets throughout the world. The Pharmaceutical segment includes products in the following therapeutic areas: anti-infective, antipsychotic, cardiovascular, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management, urology 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 used principally in the professional fields by physicians, nurses, therapists, hospitals, diagnostic laboratories and clinics. These products include Cordis’ circulatory disease management products; DePuy’s orthopaedic joint reconstruction, spinal care and sports medicine products; Ethicon’s surgical care and women’s health products; Ethicon Endo-Surgery’s minimally invasive surgical 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 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
A primary objective of the Company is to achieve superior levels of capital efficient profitable 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 innovative products and services. New products introduced within the past five years accounted for approximately 30% of 2008 sales. In 2008, $7.6 billion, or 11.9% of sales, was invested in research and development, consistent with 2007. 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 57 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 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.
     Unifying the management team and the Company’s dedicated employees in achieving these objectives is Our Credo. Our Credo provides a common set of values and serves 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 2008, worldwide sales increased 4.3% to $63.7 billion, compared to increases of 14.6% in 2007 and 5.6% in 2006. These sales increases consisted of the following:
                               
Sales increase due to:
      2008       2007       2006
Volume
      1.1%         10.1         3.8  
Price
      0.8         1.4         1.5  
Currency
      2.4         3.1         0.3  
                   
Total
      4.3%         14.6         5.6  
                   
Sales by U.S. companies were $32.3 billion in 2008, $32.4 billion in 2007 and $29.8 billion in 2006. This represents a decrease of 0.4% in 2008 and increases of 9.0% and 4.9% in 2007 and 2006, respectively. Sales by international companies were $31.4 billion in 2008, $28.7 billion in 2007 and $23.5 billion in 2006. This represents an increase of 9.7% in 2008, 21.7% in 2007 and 6.4% in 2006.


   
34
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

(Sales10year)
     The five-year compound annual growth rates for worldwide, U.S. and international sales were 8.8%, 5.0% and 13.6%, respectively. The ten-year compound annual growth rates for worldwide, U.S. and international sales were 10.3%, 9.6% and 11.2%, respectively.
(Sales-region)
     All international geographic regions experienced sales growth during 2008, consisting of 7.3% in Europe, 10.5% in the Western Hemisphere (excluding the U.S.) and 13.9% in the Asia-Pacific, Africa regions. These sales increases include the impact of currency fluctuations between the U.S. dollar and foreign currencies, which had positive impacts of 5.5% in Europe, 2.8% in the Western Hemisphere (excluding the U.S.) and 5.5% in the Asia-Pacific, Africa region.
     In 2008, 2007 and 2006, the Company did not have a customer that represented 10% or more of total consolidated revenues.
(Sales-segment)
Analysis of Sales by Business Segments
CONSUMER SEGMENT
Consumer segment sales in 2008 were $16.0 billion, an increase of 10.8% over 2007 with 8.3% of this change due to operational growth and the remaining 2.5% due to positive currency fluctuations. U.S. Consumer segment sales were $6.9 billion, an increase of 8.3%. International sales were $9.1 billion, an increase of 12.8%, with 8.3% as a result of operations and 4.5% due to currency fluctuations over 2007.
     The Over-the-Counter (OTC) Pharmaceuticals and Nutritionals franchise sales were $5.9 billion, an increase of 14.6% from 2007. The primary contributor to the growth was the successful launch of over-the-counter ZYRTEC® allergy product line in the U.S. In 2008, the Company announced a voluntary labeling change on children’s cough and cold medicines regarding usage for children under the age of 4 years, to encourage the safe, effective use of these products. These actions did not have a significant impact on sales for the OTC Pharmaceuticals and Nutritionals franchise.
     The Skin Care franchise sales grew by 10.8% to $3.4 billion in 2008. The sales growth was primarily due to the AVEENO®, CLEAN & CLEAR®, NEUTROGENA® and JOHNSON’S® Adult product lines, as well as new products related to the acquisition of Beijing Dabao Cosmetics Co. Ltd. The Baby Care franchise sales grew by 11.7% to $2.2 billion in 2008. This growth was primarily in international markets across all product lines. The Women’s Health franchise sales grew by 5.8% to $1.9 billion in 2008 primarily due to the successful launch of new products. The Oral Care franchise sales grew by 9.1% to $1.6 billion in 2008. Sales growth was driven by the performance of the LISTERINE® mouthwash product line.
     Consumer segment sales in 2007 were $14.5 billion, an increase of 48.3% over 2006 with 44.2% of this change due to operational growth and the remaining 4.1% due to positive currency fluctuations. U.S. Consumer segment sales were $6.4 billion, an increase of 40.1%. International sales were $8.1 billion, an increase of 55.5%, with 47.8% as a result of operations and 7.7% due to currency fluctuations over 2006. The acquisition of Pfizer Inc.’s Consumer Healthcare business, net of the related divestitures, increased both total sales growth and operational growth for the total Consumer segment by 40.3% in 2007.


 
Major Consumer Franchise Sales:
                                                   
 
                                    % Change  
(Dollars in Millions)
    2008       2007       2006         '08 vs. '07     '07 vs. '06  
 
OTC Pharmaceuticals & Nutritionals
    $ 5,894         5,142         2,742         14.6 %       87.5  
Skin Care
      3,381         3,051         2,633         10.8         15.9  
Baby Care
      2,214         1,982         1,740         11.7         13.9  
Women’s Health
      1,911         1,806         1,666         5.8         8.4  
Oral Care
      1,624         1,488         406         9.1         266.5  
Wound Care/Other
      1,030         1,024         587         0.6         74.4  
                               
Total
    $ 16,054         14,493         9,774            10.8 %       48.3  
                               
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
35


 

PHARMACEUTICAL SEGMENT
Pharmaceutical segment sales in 2008 were $24.6 billion, a decrease of 1.2% over 2007, with an operational decline of 3.1% and 1.9% increase due to the positive impact of currency fluctuations. U.S. Pharmaceutical segment sales were $14.9 billion, a decrease of 4.9%. International Pharmaceutical segment sales were $9.7 billion, an increase of 5.1%, which included 0.1% of operational growth and 5.0% related to the positive impact of currency fluctuations.
     REMICADE® (infliximab), a biologic approved for the treatment of Crohn’s disease, ankylosing spondylitis, psoriasis, psoriatic arthritis, ulcerative colitis and use in the treatment of rheumatoid arthritis, achieved sales of $3.7 billion in 2008, with growth of 12.7% over prior year. Growth was driven by increased demand due to the introduction of new clinical data and overall market growth. REMICADE® is competing in a market which is experiencing increased competition due to new entrants and the expansion of indications for existing competitors.
     TOPAMAX® (topiramate), which has been approved for adjunctive and monotherapy use in epilepsy, as well as for the prophylactic treatment of migraines, achieved sales of $2.7 billion in 2008, an increase of 11.3% over prior year. The growth was primarily due to increases in the migraine category partially offset by generic competition in certain markets outside the U.S. The patent for TOPAMAX® (topiramate) in the U.S. expired in September 2008. In July 2008, the U.S. Food and Drug Administration (FDA) granted pediatric exclusivity for TOPAMAX®, which extends market exclusivity in the U.S. until March 2009. In 2008, U.S. sales of TOPAMAX® were $2.3 billion. The expiration of the product patent or loss of market exclusivity is likely to result in a significant reduction in sales.
     PROCRIT® (Epoetin alfa) and EPREX® (Epoetin alfa) had combined sales of $2.5 billion in 2008, a decline of 14.7% compared to prior year. The decline was primarily due to the declining markets for Erythropoiesis Stimulating Agents (ESAs) in the U.S. The FDA issued an order requiring a labeling supplement making specific revisions to the label for ESAs, including PROCRIT®. The label for PROCRIT® was updated July 30, 2008, based on review of emerging safety data for the use of ESAs in patients with cancer. Outside the U.S., new competition and the emerging safety data issues have contributed to the lower sales results for EPREX®. Discussions with European regulators regarding changes to the label for ESAs, including EPREX®, are nearing finalization.
     RISPERDAL® (risperidone), a medication that treats the symptoms of schizophrenia, bipolar mania and irritability associated with autistic behavior in indicated patients, experienced a sales decline of 37.8% to $2.1 billion in 2008. Market exclusivity for RISPERDAL® oral in the U.S. expired on June 29, 2008. Loss of market exclusivity for the RISPERDAL®
oral patent has resulted in a significant reduction in sales in the U.S. In 2008, U.S. sales of RISPERDAL® oral were $1.3 billion. In the first half of the 2008 fiscal year U.S. sales of RISPERDAL® oral were $1.1 billion and $0.2 billion in the second half.
     RISPERDAL® CONSTA® (risperidone), a long-acting injectable for the treatment of schizophrenia, achieved sales of $1.3 billion in 2008, representing an increase of 16.0% as compared to the prior year. The growth was due to a positive shift from once per day therapies to longer-acting RISPERDAL® CONSTA®.
     CONCERTA® (methylphenidate HCl), a product for the treatment of attention deficit hyperactivity disorder (ADHD), achieved sales of $1.2 billion in 2008, representing an increase of 21.3% over 2007. Sales results were favorably impacted by approximately $115 million related to a change in the estimate of accrued sales reserves. An additional contributor to the sales growth was market growth. Although the original CONCERTA® patent expired in 2004, the FDA has not approved any generic version that is substitutable for CONCERTA®. Two parties have filed Abbreviated New Drug Applications (ANDAs) for generic versions of CONCERTA®, which are pending and may be approved at any time.
     LEVAQUIN® (levofloxacin)/FLOXIN® (ofloxacin) and ACIPHEX®/PARIET® (rabeprazole sodium) experienced sales declines of 3.3% and 14.7%, respectively, versus the prior year due to competition in the category. DURAGESIC®/Fentanyl Transdermal (fentanyl transdermal system) sales declined 11.0% versus the prior year due to generic competition.
     In 2008, Other Pharmaceutical sales were $7.2 billion, representing a growth of 10.9% over prior year. Contributors to the increase were sales of VELCADE® (bortezomib), a product for the treatment of multiple myeloma, PREZISTA® (darunavir), for the treatment of HIV/AIDS patients and INVEGA® (paliperidone), a once-daily atypical antipsychotic.
     During 2008, the Company received regulatory approval in the U.S., Canada and European Union for INTELENCETM (etravirine) for HIV combination therapy. STELARATM (ustekinumab) was approved in Canada and the European Union for the treatment of moderate to severe plaque psoriasis and is currently under review with the FDA. In addition, NUCYNTATM (tapentadol) immediate-release tablets for the relief of moderate to severe acute pain in adults 18 years of age or older was approved in the U.S.
     The Company also received approvals expanding the indications for several key products, including CONCERTA®, to treat ADHD in adults ages 18 to 65 in the U.S., VELCADE®, in combination with melphalan and prednisone for the treatment of patients with previously untreated multiple myeloma in the European Union


 
Major Pharmaceutical Product Revenues*:
                                                   
 
                                      % Change  
(Dollars in Millions)
    2008       2007       2006         '08 vs. '07     '07 vs. '06  
 
REMICADE® (infliximab)
    $ 3,748         3,327         3,013         12.7 %       10.4  
TOPAMAX® (topiramate)
      2,731         2,453         2,027         11.3         21.0  
PROCRIT®/EPREX® (Epoetin alfa)
      2,460         2,885         3,180         (14.7 )       (9.3 )
RISPERDAL® (risperidone)
      2,126         3,420         3,334         (37.8 )       2.6  
LEVAQUIN®/FLOXIN® (levofloxacin/ofloxacin)
      1,591         1,646         1,530         (3.3 )       7.6  
RISPERDAL® CONSTA® (risperidone)
      1,309         1,128         849         16.0         32.9  
CONCERTA® (methylphenidate HCl)
      1,247         1,028         930         21.3         10.5  
ACIPHEX®/PARIET® (rabeprazole sodium)
      1,158         1,357         1,239         (14.7 )       9.5  
DURAGESIC®/Fentanyl Transdermal (fentanyl transdermal system)
      1,036         1,164         1,295         (11.0 )       (10.1 )
Other
      7,161         6,458         5,870         10.9         10.0  
                               
Total
    $ 24,567         24,866         23,267               (1.2 )%       6.9  
                               
* Prior year amounts have been reclassified to conform to current presentation.


   
36
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

and PREZISTA®, for once-daily dosing as part of HIV combination therapy in treatment-naïve adults and traditional approval as a twice-daily dose for use in treatment-experienced adult patients in the U.S. Outside the U.S., the European Commission granted full approval of PREZISTA® in combination with ritonavir and other anti-retroviral medicinal products for the treatment of HIV-1 infection, and extended the indication to include all treatment-experienced adult patients.
     The Company submitted applications for regulatory approval of four additional compounds in 2008. Golimumab, a monthly subcutaneous treatment for adults with active forms of rheumatoid arthritis, psoriatic arthritis and ankylosing spondylitis, was filed in the U.S. and European Union. In the U.S., filings were submitted for rivaroxaban, an oral, once-daily anticoagulant for the prevention of deep vein thrombosis (DVT) and pulmonary embolism (PE) in patients undergoing hip or knee replacement surgery, carisbamate, for the adjunctive treatment of partial-onset seizures in patients 16 years of age and older, and trabectedin, known as YONDELIS® outside the U.S., administered in combination with DOXIL® (doxorubicin HCl liposome injection) for the treatment of women with relapsed ovarian cancer.
     Pharmaceutical segment sales in 2007 were $24.9 billion, an increase of 6.9% over 2006, with 4.3% of this change due to operational growth and the remaining 2.6% increase related to the positive impact of currency fluctuations. U.S. Pharmaceutical segment sales were $15.6 billion, an increase of 3.4%. International Pharmaceutical segment sales were $9.3 billion, an increase of 13.3%, which included 5.9% of operational growth and 7.4% related to the positive impact of currency fluctuations.
MEDICAL DEVICES AND DIAGNOSTICS SEGMENT
The Medical Devices and Diagnostics segment achieved sales of $23.1 billion in 2008, representing an increase of 6.4% over the prior year, with operational growth of 3.5% and 2.9% due to a positive impact from currency fluctuations. U.S. sales were $10.5 billion, an increase of 1.0%. International sales were $12.6 billion, an increase of 11.3%, with 5.8% from operations and a positive currency impact of 5.5%.
     The DePuy franchise achieved sales of $5.0 billion in 2008, an 8.8% increase over prior year. This growth was primarily due to DePuy’s orthopaedic joint reconstruction products, including the hip and knee product lines. Additionally, new product launches in the Mitek sports medicine product line contributed to the growth.
     The Ethicon Endo-Surgery franchise achieved sales of $4.3 billion in 2008, an 11.8% increase over prior year. This growth was mainly driven by the HARMONIC® technology business due to the success of newly launched products and the underlying strength of
the technology. Additional contributors to the growth were the REALIZE® Gastric Band in the U.S. and endoscopy products outside the U.S.
     The Ethicon franchise achieved sales of $3.8 billion in 2008, a 6.6% increase over prior year. This was a result of growth in the hemostasis, meshes and biosurgical product lines.
     Sales in the Cordis franchise were $3.1 billion, a decline of 8.5% over 2007. The decline reflects lower sales of the CYPHER® Sirolimus-eluting Coronary Stent due to increased global competition. The decline was partially offset by the performance of the Biosense Webster and neurovascular businesses.
     The Diabetes Care franchise achieved sales of $2.5 billion in 2008, a 6.8% increase over prior year. This growth was driven by sales in the Animas business due to new product launches and sales growth in the ULTRA® product lines outside the U.S.
     The Vision Care franchise achieved sales of $2.5 billion in 2008, a 13.2% increase over prior year. Sales of ACUVUE® OASYS™, 1-DAY ACUVUE® MOIST™, and ACUVUE® OASYS™ for ASTIGMATISM were the major contributors to this growth.
     The Ortho-Clinical Diagnostics franchise achieved sales of $1.8 billion in 2008, an 8.0% increase over prior year resulting from growth in both immunohematology and immunodiagnostics products.
     The Medical Devices and Diagnostics segment achieved sales of $21.7 billion in 2007, representing an increase over prior year of 7.2%, with operational growth of 3.9% and 3.3% due to a positive impact from currency fluctuations. U.S. sales were $10.4 billion, an increase of 3.2%. International sales were $11.3 billion, an increase of 11.1%, with 4.6% from operations and a positive currency impact of 6.5%.
Analysis of Consolidated Earnings Before Provision for Taxes on Income
Consolidated earnings before provision for taxes on income increased by $3.6 billion to $16.9 billion in 2008 as compared to the $13.3 billion earned in 2007. Contributing to the $3.6 billion increase in 2008 were lower in-process research and development charges of $0.6 billion, higher income from divestitures of $0.5 billion and higher litigation gains of $0.5 billion versus restructuring charges of $0.7 billion and the write-down of the NATRECOR® intangible asset of $0.7 billion recorded in 2007. The decrease in 2007 of 8.9% over the $14.6 billion in 2006 was primarily due to restructuring charges and the write-down of the NATRECOR® intangible asset in 2007. As a percent to sales, consolidated earnings before provision for taxes on income in 2008 was 26.5% versus 21.7% in 2007. The sections that follow highlight the significant components of the changes in consolidated earnings before provision for taxes on income.


 
Major Medical Devices and Diagnostics Franchise Sales*:
                                                   
 
                                      % Change  
(Dollars in Millions)
    2008       2007       2006         '08 vs. '07     '07 vs. '06  
DEPUY®
    $ 4,989         4,587         4,105         8.8 %       11.7  
ETHICON ENDO-SURGERY®
      4,286         3,834         3,376         11.8         13.6  
ETHICON®
      3,840         3,603         3,223         6.6         11.8  
CORDIS®
      3,135         3,425         4,088         (8.5 )       (16.2 )
Diabetes Care
      2,535         2,373         2,074         6.8         14.4  
Vision Care
      2,500         2,209         1,879         13.2         17.6  
ORTHO-CLINICAL DIAGNOSTICS®
      1,841         1,705         1,538         8.0         10.9  
                               
Total
    $ 23,126         21,736         20,283               6.4 %       7.2  
                               
* Prior year amounts have been reclassified to conform to current presentation.
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
37


 

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
      2008     2007       2006  
                   
Cost of products sold
      29.1 %       29.1         28.2  
Percent point increase over the prior year
              0.9         0.5  
Selling, marketing and administrative expenses
      33.7         33.5         32.7  
Percent point increase/(decrease) over the prior year
      0.2         0.8         (1.4 )
                   
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 continues to have 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.
     In 2007, there was an increase in the percent to sales of cost of products sold primarily due to the impact of newly acquired consumer brands. There was an increase in the percent to sales of selling, marketing and administrative expenses in 2007 primarily due to the impact of newly acquired consumer brands partially offset by cost containment efforts.
     In 2006, there was an increase in the percent to sales of cost of products sold. This was due to unfavorable product mix and higher manufacturing costs in the Pharmaceutical and Consumer segments. There was a decrease in the percent to sales of selling, marketing and administrative expenses in 2006. This was a result of leveraging selling expenses and a reduction in advertising and promotional spending.


 
   Research and Development expense (excluding in-process research and development charges) by segment of business was as follows:
                                                       
 
      2008     2007       2006  
(Dollars in Millions)
    Amount       % of Sales     Amount     % of Sales       Amount     % of Sales  
                   
Consumer
    $ 624       3.9 %       564       3.9         395       4.0  
Pharmaceutical
      5,095             20.7         5,265       21.2         4,964       21.3  
Medical Devices and Diagnostics
      1,858       8.0         1,851       8.5         1,766       8.7  
                                               
Total research and development expense
    $ 7,577       11.9         7,680       12.6         7,125       13.4  
Percent (decrease)/increase over the prior year
      (1.3 )%               7.8                 10.3          
                   

Research and Development: 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.
     In 2008, the reduction in the Pharmaceutical research and development spending was primarily due to increased efficiencies in Pharmaceutical research and development activities.
Restructuring: The Company has achieved approximately $1.6 billion in annual cost savings as outlined in the restructuring program announced in 2007. See Note 22 to the Consolidated Financial Statements for additional details related to the restructuring.
In-Process Research and Development: In 2008, the Company recorded a charge for in-process research and development (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.
     In 2007, the Company recorded a charge for IPR&D of $807 million before and after tax related to the acquisition of Conor Medsystems, Inc. The IPR&D charge was included in the operating profit of the Medical Devices and Diagnostics segment.
     In 2006, the Company recorded IPR&D charges of $559 million before tax related to the acquisitions of the Consumer Healthcare business of Pfizer Inc., Vascular Control Systems, Inc., Ensure Medical, Inc., ColBar LifeScience Ltd., Hand Innovations LLC and Future Medical Systems S.A. The charge related to the Consumer Healthcare business acquired from Pfizer Inc. accounted for $320 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. Vascular Control Systems, Inc., a privately held company focused on developing medical devices to treat fibroids and to control bleeding in obstetric and gynecologic applications, accounted for $87 million before tax of the IPR&D charges. Ensure Medical, Inc., a privately held company that develops devices for post-catheterization closure of the femoral artery, accounted for $66 million before tax of the IPR&D charges. ColBar LifeScience Ltd., a privately held company specializing in reconstructive medicine and tissue engineering, accounted for $49 million before tax of the IPR&D charges. Hand Innovations LLC, a privately held manufacturer of fracture fixation products for the upper extremities, accounted for $22 million before tax of the IPR&D charges. Future Medical Systems S.A., a privately held company that


   
38
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

primarily develops, manufactures and markets arthroscopic fluid management systems, accounted for $15 million before tax of the IPR&D charges.
Other (Income) Expense, Net: Other (income) expense, net includes 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, minority interests, litigation settlements and liabilities and royalty income. The favorable change of $1.5 billion in other (income) expense, net from 2008 to 2007 was primarily due to an increase in income from net litigation settlements and awards of $0.5 billion, a gain of $0.5 billion from the divestiture of the Professional Wound Care business of Ethicon, Inc. in 2008 and the NATRECOR® intangible asset write-down of $0.7 billion in 2007.
     In 2007, other (income) expense, net included a charge of $678 million before tax related to the NATRECOR® intangible asset write-down. A gain of $622 million associated with the Guidant acquisition agreement termination fee, less associated expenses, was included in 2006. In addition, 2006 also included expenses associated with the recording of additional product liability reserves and the integration costs associated with the acquisition of the Consumer Healthcare business of Pfizer Inc.
OPERATING PROFIT BY SEGMENT
Operating profits by segment of business were as follows:
                                         
 
                          Percent of  
                          Segment Sales  
(Dollars in Millions)
    2008       2007         2008     2007  
                         
Consumer
    $ 2,674         2,277         16.7 %       15.7  
Pharmaceutical
      7,605         6,540         31.0         26.3  
Med Devices and Diagnostics
      7,223         4,846         31.2         22.3  
                         
Total (1)
      17,502         13,663         27.4         22.4  
Less: Expenses not allocated to segments (2)
      573         380                      
                         
Earnings before provision for taxes on income
    $ 16,929         13,283         26.5 %       21.7  
                         
(1) See Note 11 to the Consolidated Financial Statements for more details.
 
(2) Amounts not allocated to segments include interest (income) expense, minority interest, and general corporate (income) expense.
(BAR CHART)
Consumer Segment: In 2008, Consumer segment operating profit increased 17.4% from 2007. As a percent to sales, 2008 operating profit increased to 16.7%. Cost synergies, lower integration costs in 2008 related to the acquisition of the Consumer Healthcare business of Pfizer Inc., and other cost containment initiatives contributed to the increased operating profit. In 2007, Consumer segment operating profit increased 65.7% from 2006 due to the acquisition costs associated with the Consumer Healthcare business of Pfizer Inc. in 2006. As a percent to sales, 2007 operating profit increased to 15.7%. IPR&D expenses of $320 million as well as expenses associated with
the Consumer Healthcare business of Pfizer Inc. integration were recorded during 2006.
Pharmaceutical Segment: In 2008, Pharmaceutical segment operating profit increased 16.3% from 2007. As a percent to sales, 2008 operating profit increased to 31.0%. The primary driver of the improved operating profit was due to the restructuring charges of $429 million and $678 million for the NATRECOR® intangible asset write-down recorded in 2007. In 2007, Pharmaceutical segment operating profit decreased 5.1% from 2006. As a percent to sales, 2007 operating profit decreased to 26.3% resulting from $429 million of restructuring charges and $678 million for the NATRECOR® intangible asset write-down in 2007.
Medical Devices and Diagnostics Segment: In 2008, the operating profit in the Medical Devices and Diagnostics segment increased 49.1% from 2007. As a percent to sales, 2008 operating profit increased to 31.2%. The improved operating profit was the result of the $429 million gain from net litigation settlements, favorable product mix, manufacturing efficiencies and lower IPR&D charges of $174 million in 2008 versus $807 million in 2007. Additionally, $301 million of restructuring charges were recorded in 2007. In 2007, the operating profit in the Medical Devices and Diagnostics segment decreased 20.9% from 2006. As a percent to sales, 2007 operating profit decreased to 22.3%, resulting from $807 million of IPR&D charges and $301 million of restructuring charges in 2007, while 2006 included the gain associated with the Guidant acquisition agreement termination fee, less associated expenses, of $622 million.
Interest (Income) Expense: Interest income in 2008 decreased by $91 million 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 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.
     Interest income in 2007 decreased by $377 million due to lower average cash balances. The decline in the average cash balance was primarily due to the acquisition of the Consumer Healthcare business of Pfizer Inc. on December 20, 2006.
     Interest expense in 2007 increased by $233 million as compared to prior year due to a higher average debt balance. The net debt balance at the end of 2007 was $9.5 billion as compared to $6.6 billion at the end of 2006. The higher debt balance in 2007 was due to the debt associated with the acquisition of the Consumer Healthcare business of Pfizer Inc. and the Common Stock repurchase program announced in 2007.
     Interest income in 2006 increased by $342 million due primarily to higher rates of interest, as well as a higher average cash balance, despite the $5.0 billion Common Stock repurchase program and an increase in acquisition activity as compared to prior year.
     Interest expense in 2006 increased slightly as compared to 2005 due to a higher average debt balance, from $2.6 billion in 2005 to $3.1 billion in 2006. This was partially offset by a decrease in interest rates.


   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
39


 

Provision for Taxes on Income: The worldwide effective income tax rate was 23.5% in 2008, 20.4% in 2007 and 24.2% in 2006. The 2008 tax rate increased as compared to 2007 due to increases in taxable income in higher tax jurisdictions relative to taxable income in lower jurisdictions. In addition, the 2007 tax rate benefited from a one-time gain of $267 million related to a business restructuring of certain international subsidiaries, as well as increases in taxable income in lower tax jurisdictions relative to taxable income in higher tax jurisdictions and lower international tax rates in certain countries as compared to the prior year.
Liquidity and Capital Resources
LIQUIDITY & CASH FLOWS
Cash and cash equivalents were $10.8 billion at the end of 2008 as compared with $7.8 billion at the end of 2007. The primary sources of cash that contributed to the $3.0 billion increase versus prior year were $15.0 billion of cash generated from operating activities and $2.7 billion net proceeds from long and short-term debt. The major uses of cash were capital spending of $3.1 billion, acquisitions of $1.2 billion, dividends to shareholders of $5.0 billion and the repurchase of common stock, net of proceeds from the exercise of options, of $5.2 billion.
     Cash flow from operations of $15.0 billion is the result of $12.9 billion of net earnings and $3.5 billion of non-cash charges related to depreciation and amortization, stock based compensation, and $0.2 billion of IPR&D offset by increased working capital of $0.8 billion and a net use related to changes in assets and liabilities net of effects from acquisitions of $0.8 billion.
     In 2008, the Company continued to have access to liquidity through the commercial paper market. For additional details on borrowings, see Note 6 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 2009.
(BAR CHART)
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 products 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 December 28, 2008 market rates would increase the unrealized value of the Company’s forward contracts by $226 million. Conversely, a 10% depreciation of the U.S. Dollar from the December 28, 2008 market rates would decrease the unrealized value of the Company’s forward contracts by $276 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 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 $97 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 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 2008, the Company secured a new 364-day and 5-year Credit Facility. Total credit available to the Company approximates $7.7 billion, of which $6.3 billion expires September 24, 2009, and $1.4 billion expires September 25, 2013. 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 agreement are not material.
     Total borrowings at the end of 2008 and 2007 were $11.9 billion and $9.5 billion, respectively. The increase in borrowings between 2008 and 2007 was a result of financing general corporate purposes and the continuation of the Common Stock repurchase program announced in 2007. In 2008, net cash (cash and current marketable securities, net of debt) was $1.0 billion compared to net debt of $0.2 billion in 2007. Total debt represented 21.8% of total capital (shareholders’ equity and total debt) in 2008 and 18.0% of total capital in 2007. Shareholders’ equity per share at the end of 2008 was $15.35 compared with $15.25 at year-end 2007, an increase of 0.7%.
     Johnson & Johnson continues to be one of a few industrial companies with a Triple A credit rating and to have access to credit at commercially favorable terms. A summary of borrowings can be found in Note 6 to the Consolidated Financial Statements.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has contractual obligations, primarily lease, 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 December 28, 2008 (see Notes 4, 6 and 13 to the Consolidated Financial Statements for further details):
                                 
 
                    Unfunded        
    Operating     Debt     Retirement        
(Dollars in Millions)
  Leases     Obligations (1)   Plans     Total  
 
2009
  $ 171       221       56            448  
2010
    145       22       58       225  
2011
    123       18       62       203  
2012
    107       620       66       793  
2013
    89       507       70       666  
After 2013
    93       6,953       436       7,482  
     
Total
  $ 728       8,341       748       9,817  
 
(1) Amounts do not include interest expense.
For tax matters, see Note 8 to the Consolidated Financial Statements.


   
40
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

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. The repurchase program has no time limit and may be suspended for periods or discontinued at any time. Any shares acquired will be available for general corporate purposes. The Company funds the share repurchase program through a combination of available cash and debt. As of December 28, 2008, the Company repurchased an aggregate of 124.9 million shares of Johnson & Johnson common stock under the current repurchase program at a cost of $8.1 billion. 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 2008 for the 46th consecutive year. Cash dividends paid were $1.795 per share in 2008, compared with dividends of $1.620 per share in 2007 and $1.455 per share in 2006. The dividends were distributed as follows:
                               
 
      2008       2007       2006  
                   
First quarter
    $ 0.415         0.375         0.330  
Second quarter
      0.460         0.415         0.375  
Third quarter
      0.460         0.415         0.375  
Fourth quarter
      0.460         0.415         0.375  
                   
Total
    $ 1.795         1.620         1.455  
 
On January 5, 2009, the Board of Directors declared a regular cash dividend of $0.460 per share, payable on March 10, 2009, to shareholders of record as of February 24, 2009. 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. 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.
     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 and includes it in sales to customers. Promotional 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.
     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 which 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 December 28, 2008 and December 30, 2007.
CONSUMER SEGMENT
                                 
 
    Balance at                     Balance at  
    Beginning             Payments/     End  
(Dollars in Millions)
  of Period     Accruals     Other     of Period  
 
2008
                               
Accrued rebates(1)
  $ 217       300       (386 )     131  
Accrued returns
    113       135       (133 )     115  
Accrued promotions
    297       2,369       (2,464 )     202  
     
Subtotal
  $ 627       2,804       (2,983 )     448  
     
Reserve for doubtful accounts
    71       41       (2 )     110  
Reserve for cash discounts
    23       272       (273 )     22  
     
Total
  $ 721       3,117       (3,258 )     580  
     
2007
                               
Accrued rebates(1)
  $ 164       492       (439 )     217  
Accrued returns
    92       257       (236 )     113  
Accrued promotions
    211       2,249       (2,163 )     297  
     
Subtotal
  $ 467       2,998       (2,838 )     627  
     
Reserve for doubtful accounts
    42       17       12       71  
Reserve for cash discounts
    15       278       (270 )     23  
     
Total
  $ 524       3,293       (3,096 )     721  
 
(1) Includes reserve for customer rebates of $73 million at December 28, 2008 and $76 million at December 30, 2007, recorded as a contra asset.


   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
41


 

PHARMACEUTICAL SEGMENT
                               
 
  Balance at                     Balance at  
  Beginning             Payments/     End  
(Dollars in Millions)
of Period     Accruals     Other     of Period  
 
2008
                             
Accrued rebates(1)
  $1,249       3,331       (3,319 )     1,261  
Accrued returns
  345       168       (23 )     490  
Accrued promotions
  263       414       (570 )     107  
     
Subtotal
  $1,857       3,913       (3,912 )     1,858  
     
Reserve for doubtful accounts
  26       24       (2 )     48  
Reserve for cash discounts
  24       376       (377 )     23  
     
Total
  $1,907       4,313 (2)     (4,291 )     1,929  
     
2007
                             
Accrued rebates(1)
  $1,233       3,175       (3,159 )     1,249  
Accrued returns
  324       36       (15 )     345  
Accrued promotions
  205       523       (465 )     263  
     
Subtotal
  $1,762       3,734       (3,639 )     1,857  
     
Reserve for doubtful accounts
  30             (4 )     26  
Reserve for cash discounts
  29       531       (536 )     24  
     
Total
  $1,821       4,265       (4,179 )     1,907  
 
(1) Includes reserve for customer rebates of $344 million at December 28, 2008 and $321 million at December 30, 2007, recorded as a contra asset.
 
(2) Includes $115 million adjustment related to previously estimated accrued sales reserves.
MEDICAL DEVICES AND DIAGNOSTICS SEGMENT
                               
 
  Balance at                     Balance at  
  Beginning             Payments/     End  
(Dollars in Millions)
of Period     Accruals     Other     of Period  
 
2008
                             
Accrued rebates(1)
  $336       1,947       (1,867 )     416  
Accrued returns
  190       99       (100 )     189  
Accrued promotions
  18       208       (179 )     47  
     
Subtotal
  $544       2,254       (2,146 )     652  
     
Reserve for doubtful accounts
  96       36       (23 )     109  
Reserve for cash discounts
  24       257       (247 )     34  
     
Total
  $664       2,547 (2)     (2,416 )     795  
     
2007
                             
Accrued rebates(1)
  $294       1,576       (1,534 )     336  
Accrued returns
  183       102       (95 )     190  
Accrued promotions
  41       136       (159 )     18  
     
Subtotal
  $518       1,814       (1,788 )     544  
     
Reserve for doubtful accounts
  88       25       (17 )     96  
Reserve for cash discounts
  18       213       (207 )     24  
     
Total
  $624       2,052       (2,012 )     664  
 
(1) Includes reserve for customer rebates of $304 million at December 28, 2008 and $313 million at December 30, 2007, recorded as a contra asset.
 
(2) Includes $56 million adjustment related to previously estimated sales rebate reserve.
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.
Income Taxes: Income taxes are recorded based on amounts refundable or payable for the current year and include the results of any difference between 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, the Company adopted FASB Interpretation 48 (FIN48), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. This interpretation 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 interpretation also provides guidance on derecognition, classification and other matters. See Note 8 to the Consolidated Financial Statements for further information regarding income taxes.
     At December 28, 2008 and December 30, 2007, the cumulative amounts of undistributed international earnings were approximately $27.7 billion and $23.7 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.
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 13 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 Options: During the fiscal first quarter of 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), Share Based Payment. The Company has applied the modified retrospective transition method to implement SFAS No. 123(R). Previously reported financial statements have been restated in accordance with the provisions of SFAS No. 123(R). See Note 10 for further information regarding stock options.
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 December 28, 2008.


   
42
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

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 1998-2008, 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. 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 2008 would have increased or decreased the translation of foreign sales by $300 million and income by $50 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 will 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 18 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 which accompany such products, it is not feasible to predict the ultimate outcome of litigation. However, the Company believes that if any liability results from such cases, it will be substantially covered by existing amounts accrued in the Company’s balance sheet under its self-insurance program and by third-party product liability insurance.
     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 estimated with any certainty. 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 have a material adverse effect on the Company’s financial condition, although the resolution in any
reporting period of one or more of these matters could have a significant impact on the Company’s results of operations and cash flows for that period.
     See Note 18 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 2008 and 2007 were:
                                     
 
      2008       2007  
      High     Low       High     Low  
             
First quarter
    $ 68.85       61.17         68.22       59.87  
Second quarter
      68.32       63.40         65.45       59.95  
Third quarter
      72.76       63.10         65.75       59.72  
Fourth quarter
      69.86       52.06         68.75       63.55  
Year-end close
      $58.56         67.38    
             
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 general industry conditions and competition; economic conditions, 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; U.S. and foreign health care reforms and governmental laws and regulations; trends toward health care cost containment; increased scrutiny of the health care industry by government agencies; product efficacy or safety concerns resulting in product recalls or regulatory action.
     The Company’s report on Form 10-K for the year ended December 28, 2008 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.


   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
43


 

                     
Consolidated Balance Sheets
    Johnson & Johnson and Subsidiaries  
         
                 
At December 28, 2008 and December 30, 2007 (Dollars in Millions Except Share and Per Share Data) (Note 1)
    2008       2007  
             
 
                   
Assets
                   
             
Current assets
                   
Cash and cash equivalents (Notes 1 and 14)
    $ 10,768         7,770  
Marketable securities (Notes 1 and 14)
      2,041         1,545  
Accounts receivable trade, less allowances for doubtful accounts $268 (2007, $193)
      9,719         9,444  
Inventories (Notes 1 and 2)
      5,052         5,110  
Deferred taxes on income (Note 8)
      3,430         2,609  
Prepaid expenses and other receivables
      3,367         3,467  
             
 
                   
Total current assets
      34,377         29,945  
             
Marketable securities, non-current (Notes 1 and 14)
      4         2  
Property, plant and equipment, net (Notes 1 and 3)
      14,365         14,185  
Intangible assets, net (Notes 1 and 7)
      13,976         14,640  
Goodwill, net (Notes 1 and 7)
      13,719         14,123  
Deferred taxes on income (Note 8)
      5,841         4,889  
Other assets (Note 5)
      2,630         3,170  
             
 
                   
Total assets
    $ 84,912         80,954  
             
 
                   
Liabilities and Shareholders’ Equity
                   
             
Current liabilities
                   
Loans and notes payable (Note 6)
    $ 3,732         2,463  
Accounts payable
      7,503         6,909  
Accrued liabilities
      5,531         6,412  
Accrued rebates, returns and promotions
      2,237         2,318  
Accrued salaries, wages and commissions
      1,432         1,512  
Accrued taxes on income
      417         223  
             
 
                   
Total current liabilities
      20,852         19,837  
             
 
                   
Long-term debt (Note 6)
      8,120         7,074  
Deferred taxes on income (Note 8)
      1,432         1,493  
Employee related obligations (Notes 5 and 13)
      7,791         5,402  
Other liabilities
      4,206         3,829  
             
 
                   
Total liabilities
      42,401         37,635  
             
 
                   
Shareholders’ equity
                   
Preferred stock — without par value
(authorized and unissued 2,000,000 shares)
               
Common stock — par value $1.00 per share (Note 20)
(authorized 4,320,000,000 shares; issued 3,119,843,000 shares)
      3,120         3,120  
Accumulated other comprehensive income (Note 12)
      (4,955 )       (693 )
Retained earnings
      63,379         55,280  
             
 
      61,544         57,707  
 
                   
Less: common stock held in treasury, at cost (Note 20)
(350,665,000 shares and 279,620,000 shares)
      19,033         14,388  
             
 
                   
Total shareholders’ equity
      42,511         43,319  
             
 
                   
Total liabilities and shareholders’ equity
    $ 84,912         80,954  
             
See Notes to Consolidated Financial Statements
   
44
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

                               
Consolidated Statements of Earnings
    Johnson & Johnson and Subsidiaries  
         
                         
                         
(Dollars in Millions Except Per Share Figures) (Note 1)
    2008       2007       2006  
                   
 
                             
Sales to customers
    $ 63,747         61,095         53,324  
                   
 
                             
Cost of products sold
      18,511         17,751         15,057  
                   
 
                             
Gross profit
      45,236         43,344         38,267  
 
                             
Selling, marketing and administrative expenses
      21,490         20,451         17,433  
Research expense
      7,577         7,680         7,125  
Purchased in-process research and development (Note 17)
      181         807         559  
Restructuring (Note 22)
              745          
Interest income
      (361 )       (452 )       (829 )
Interest expense, net of portion capitalized (Note 3)
      435         296         63  
Other (income) expense, net
      (1,015 )       534         (671 )
                   
 
      28,307         30,061         23,680  
                   
Earnings before provision for taxes on income
      16,929         13,283         14,587  
Provision for taxes on income (Note 8)
      3,980         2,707         3,534  
                   
 
                             
Net earnings
    $ 12,949         10,576         11,053  
                   
 
                             
Basic net earnings per share (Notes 1 and 19)
    $ 4.62         3.67         3.76  
                   
 
                             
Diluted net earnings per share (Notes 1 and 19)
    $ 4.57         3.63         3.73  
                   
See Notes to Consolidated Financial Statements
   
CONSOLIDATED FINANCIAL STATEMENTS
45


 

                                                 
Consolidated Statements of Equity
                    Johnson & Johnson and Subsidiaries  
                                             
                            Accumulated                
                            Other             Treasury  
            Comprehensive     Retained     Comprehensive     Common Stock     Stock  
(Dollars in Millions) (Note 1)
  Total     Income     Earnings     Income     Issued Amount     Amount  
 
 
                                               
Balance, January 1, 2006
    $38,710               42,310       (755 )     3,120       (5,965 )
 
Net earnings
    11,053       11,053       11,053                          
Cash dividends paid
    (4,267 )             (4,267 )                        
Employee compensation and stock option plans
    1,858               181                       1,677  
Conversion of subordinated debentures
    26               (10 )                     36  
Repurchase of common stock
    (6,722 )                                     (6,722 )
Other
    23               23                          
Other comprehensive income, net of tax:
                                               
Currency translation adjustment
    362       362               362                  
Unrealized losses on securities
    (9 )     (9 )             (9 )                
Employee benefit plans
    (1,710 )     (34 )             (1,710 )                
Losses on derivatives & hedges
    (6 )     (6 )             (6 )                
Reclassification adjustment
            (9 )                                
 
                                             
Total comprehensive income
            11,357                                  
 
                                             
 
                                               
                   
Balance, December 31, 2006
    $39,318               49,290       (2,118 )     3,120       (10,974 )
 
Net earnings
    10,576       10,576       10,576                          
Cash dividends paid
    (4,670 )             (4,670 )                        
Employee compensation and stock option plans
    2,311               131                       2,180  
Conversion of subordinated debentures
    9               (4 )                     13  
Repurchase of common stock
    (5,607 )                                     (5,607 )
Adoption of FIN 48
    (19 )             (19 )                        
Other
    (24 )             (24 )                        
Other comprehensive income, net of tax:
                                               
Currency translation adjustment
    786       786               786                  
Unrealized gains on securities
    23       23               23                  
Employee benefit plans
    670       670               670                  
Losses on derivatives & hedges
    (54 )     (54 )             (54 )                
Reclassification adjustment
            (5 )                                
 
                                             
Total comprehensive income
            11,996                                  
 
                                             
 
                                               
                   
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 )
 
See Notes to Consolidated Financial Statements
   
46
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

                               
Consolidated Statements of Cash Flows
      Johnson & Johnson and Subsidiaries  
                         
                         
(Dollars in Millions) (Note 1)
    2008       2007       2006  
                   
 
                             
Cash flows from operating activities
                             
                   
Net earnings
    $ 12,949         10,576         11,053  
Adjustments to reconcile net earnings to cash flows from operating activities:
                             
Depreciation and amortization of property and intangibles
      2,832         2,777         2,177  
Stock based compensation
      627         698         659  
Purchased in-process research and development
      181         807         559  
Intangible asset write-down (NATRECOR®)
              678          
Decrease/(increase) in deferred tax provision
      22         (1,762 )       (1,168 )
Accounts receivable allowances
      86         22         (14 )
Changes in assets and liabilities, net of effects from acquisitions:
                             
Increase in accounts receivable
      (736 )       (416 )       (699 )
(Increase)/decrease in inventories
      (101 )       14         (210 )
(Decrease)/increase in accounts payable and accrued liabilities
      (272 )       2,642         1,750  
Increase in other current and non-current assets
      (1,600 )       (1,578 )       (269 )
Increase in other current and non-current liabilities
      984         564         410  
             
Net cash flows from operating activities
      14,972         15,022         14,248  
                   
 
                             
Cash flows from investing activities
                             
                   
Additions to property, plant and equipment
      (3,066 )       (2,942 )       (2,666 )
Proceeds from the disposal of assets
      785         457         511  
Acquisitions, net of cash acquired (Note 17)
      (1,214 )       (1,388 )       (18,023 )
Purchases of investments
      (3,668 )       (9,659 )       (467 )
Sales of investments
      3,059         7,988         426  
Other (primarily intangibles)
      (83 )       (368 )       (72 )
                   
 
                             
Net cash used by investing activities
      (4,187 )       (5,912 )       (20,291 )
                   
 
                             
Cash flows from financing activities
                             
                   
Dividends to shareholders
      (5,024 )       (4,670 )       (4,267 )
Repurchase of common stock
      (6,651 )       (5,607 )       (6,722 )
Proceeds from short-term debt
      8,430         19,626         6,385  
Retirement of short-term debt
      (7,319 )       (21,691 )       (2,633 )
Proceeds from long-term debt
      1,638         5,100         6  
Retirement of long-term debt
      (24 )       (18 )       (13 )
Proceeds from the exercise of stock options/excess tax benefits
      1,486         1,562         1,135  
                   
 
                             
Net cash used by financing activities
      (7,464 )       (5,698 )       (6,109 )
                   
 
                             
Effect of exchange rate changes on cash and cash equivalents
      (323 )       275         180  
                   
Increase/(decrease) in cash and cash equivalents
      2,998         3,687         (11,972 )
Cash and cash equivalents, beginning of year (Note 1)
      7,770         4,083         16,055  
                   
 
                             
Cash and cash equivalents, end of year (Note 1)
    $ 10,768         7,770         4,083  
                   
 
                             
Supplemental cash flow data
                             
                   
Cash paid during the year for:
                             
Interest
    $ 525         314         143  
Income taxes
      4,068         4,099         4,250  
 
                             
Supplemental schedule of noncash investing and financing activities
                             
                   
Treasury stock issued for employee compensation and
stock option plans, net of cash proceeds
    $ 593         738         622  
Conversion of debt
              9         26  
 
                             
Acquisitions
                             
                   
Fair value of assets acquired
    $ 1,328         1,620         19,306  
Fair value of liabilities assumed
      (114 )       (232 )       (1,283 )
                   
 
                             
Net cash paid for acquisitions
    $ 1,214         1,388         18,023  
                   
See Notes to Consolidated Financial Statements
   
CONSOLIDATED FINANCIAL STATEMENTS
47


 

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”). Inter-company accounts and transactions are eliminated.
DESCRIPTION OF THE COMPANY AND BUSINESS SEGMENTS
The Company has approximately 118,700 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. These products are marketed to the general public and sold both to distributors and directly to independent and chain retail outlets throughout the world. The Pharmaceutical segment includes products in the following therapeutic areas: anti-infective, antipsychotic, cardiovascular, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management, urology 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 used principally in the professional fields by physicians, nurses, therapists, hospitals, diagnostic laboratories and clinics. These products include Cordis’ circulatory disease management products; DePuy’s orthopaedic joint reconstruction, spinal care and sports medicine products; Ethicon’s surgical care and women’s health products; Ethicon Endo-Surgery’s minimally invasive surgical 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
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement was effective in the fiscal first quarter of 2008 except for non-financial assets and liabilities recognized or disclosed at fair value on a recurring basis, for which the effective date is for fiscal years beginning after November 15, 2008. The Company adopted SFAS No. 157 in the fiscal first quarter of 2008, the impact of which is discussed in Note 23.
     In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities, which permits an entity to measure certain financial assets and financial liabilities at fair value. SFAS No. 159 was effective for fiscal year 2008 and the Company adopted it in the fiscal first quarter of 2008. The adoption of SFAS No. 159 did not have a material effect on the Company’s results of operations, cash flows or financial position.
     EITF Issue 07-03: Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities. This issue is effective for financial statements issued for fiscal years beginning after December 15, 2007 and was adopted by the Company in the fiscal first quarter of 2008. This issue requires nonrefundable advance payments for research and development to be capitalized and recognized as an expense as related goods are delivered or services are performed. The adoption of EITF 07-03 did not have a significant impact on the Company’s results of operations, cash flows or financial position.
RECENTLY ISSUED ACCOUNTING STANDARDS,
NOT ADOPTED AS OF DECEMBER 28, 2008
In December 2007, FASB issued SFAS No. 141(R), Business Combinations, and No. 160, Noncontrolling Interests in Consolidated Financial Statements. These statements aim to improve, simplify and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. These statements are effective for fiscal years beginning after December 15, 2008. SFAS No. 141(R) will have a significant impact on the manner in which the Company accounts for future acquisitions beginning in the fiscal year 2009. Significant changes include the capitalization of in-process research and development (IPR&D), expensing of acquisition related restructuring actions and transaction related costs and the recognition of contingent purchase price consideration at fair value at the acquisition date. In addition, changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will be recognized in earnings rather than as an adjustment to the cost of acquisition. This accounting treatment for taxes is applicable to acquisitions that occurred both prior and subsequent to the adoption of SFAS No. 141(R). The Company believes that the adoption of SFAS No. 141(R) and SFAS No. 160 will not have a material effect on its results of operations, cash flows or financial position.
     In March 2008, the FASB issued SFAS Statement No. 161, Disclosures About Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, to enhance the disclosure regarding the Company’s derivative and hedging activities, to improve the transparency of financial reporting. This statement is effective for fiscal years beginning after November 15, 2008. The adoption of SFAS No. 161 will have no impact on the Company’s results of operations, cash flows or financial position.
     EITF Issue 07-01: Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property. This issue is effective for financial statements issued for fiscal years beginning after December 15, 2008. This issue addresses the income statement classification of payments made between parties in a collaborative arrangement. The adoption of EITF 07-01 is not expected to have a significant impact on the Company’s results of operations, cash flows or financial position.
     EITF Issue 08-07: Accounting for Defensive Intangible Assets. This issue applies to acquired intangible assets in situations in which an entity does not intend to actively use the asset, but intends to hold the asset to prevent others from obtaining access to the asset, except for intangible assets that are used in research and development activities. This issue is effective for fiscal years beginning after December 15, 2008. The adoption of EITF 08-07 is not expected to have a significant impact on the Company’s results of operations, cash flows or financial position.


   
48
JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

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, which also approximates fair value. 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.
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 5 years.
     The Company reviews long-lived assets to assess recoverability using undiscounted cash flows. When necessary, charges for impairments of long-lived assets are recorded for the amount by which the present value of future cash flows is less than the carrying value of these assets.
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.
     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. Promotional 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.
SHIPPING AND HANDLING
Shipping and handling costs incurred were $1,017 million, $934 million and $693 million in 2008, 2007 and 2006, 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
SFAS No. 142 requires that goodwill and non-amortizable intangible assets be assessed annually for impairment. The Company completed the annual impairment test for 2008 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 7 for further details on Intangible Assets.
FINANCIAL INSTRUMENTS
The Company follows the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. SFAS No. 133 requires that all derivative instruments 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 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 currency swaps to manage currency risk primarily related to borrowings. Both of these types of derivatives are designated as cash flow hedges. Additionally, the Company uses forward exchange contracts to offset its exposure to certain foreign currency denominated assets and liabilities. These forward exchange contracts are not designated as hedges and therefore, changes in the fair values of these derivatives are recognized currently in earnings, thereby offsetting the current earnings effect of the related foreign currency assets and liabilities.


     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   49

 


 

     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. The fair value of a derivative instrument (i.e., forward foreign exchange contract, currency swap) is the aggregation, by currency, of all future cash flows discounted to its present value at prevailing market interest rates and subsequently converted to the U.S. Dollar at the current spot foreign exchange rate.
     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, and was insignificant in 2008, 2007 and 2006.
     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.
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.
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 $2.9 billion in 2008, $2.7 billion in 2007 and $1.9 billion in 2006.
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 December 28, 2008 and December 30, 2007, the cumulative amount of undistributed international earnings were approximately $27.7 billion and $23.7 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.
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.
ANNUAL CLOSING DATE
The Company follows the concept of a fiscal year, which ends on the Sunday nearest to the end of the month of December. Normally each fiscal year consists of 52 weeks, but every five or six years, as will be the case in 2009, the fiscal year consists of 53 weeks.
RECLASSIFICATION
Certain prior period amounts have been reclassified to conform to current year presentation.
2. Inventories
At the end of 2008 and 2007, inventories were comprised of:
                     
 
(Dollars in Millions)
    2008       2007  
             
Raw materials and supplies
    $ 839         905  
Goods in process
      1,372         1,384  
Finished goods
      2,841         2,821  
             
 
    $ 5,052         5,110  
             


     
50
  JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

3. Property, Plant and Equipment
At the end of 2008 and 2007, property, plant and equipment at cost and accumulated depreciation were:
                     
 
(Dollars in Millions)
    2008       2007  
             
Land and land improvements
    $ 886         756  
Buildings and building equipment
      7,720         7,913  
Machinery and equipment
      15,234         14,554  
Construction in progress
      3,552         3,243  
             
 
      27,392         26,466  
Less accumulated depreciation
      13,027         12,281  
             
 
    $ 14,365         14,185  
             
The Company capitalizes interest expense as part of the cost of construction of facilities and equipment. Interest expense capitalized in 2008, 2007 and 2006 was $147 million, $130 million and $118 million, respectively.
     Depreciation expense, including the amortization of capitalized interest in 2008, 2007 and 2006, was $2.0 billion, $1.9 billion and $1.6 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.
4. Rental Expense and Lease Commitments
Rentals of space, vehicles, manufacturing equipment and office and data processing equipment under operating leases were approximately $309 million in 2008, $302 million in 2007 and $285 million in 2006.
     The approximate minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year at December 28, 2008 are:
                                                 
 
(Dollars in Millions)
    After        
2009   2010     2011     2012     2013     2013     Total  
 
$171
    145       123       107       89       93       728  
Commitments under capital leases are not significant.
5. Employee Related Obligations
At the end of 2008 and 2007, employee related obligations were:
                     
 
(Dollars in Millions)
    2008       2007  
             
Pension benefits
    $ 4,382         2,014  
Postretirement benefits
      2,217         2,134  
Postemployment benefits
      870         1,119  
Deferred compensation
      772         740  
             
Total employee obligations
      8,241         6,007  
Less current benefits payable
      450         605  
             
Employee related obligations — long-term
    $ 7,791         5,402  
             
Prepaid employee related obligations of $136 million and $481 million for 2008 and 2007, respectively, are included in other assets on the consolidated balance sheet.
6. Borrowings
The components of long-term debt are as follows:
                                     
 
              Effective               Effective  
(Dollars in Millions)
    2008     Rate %       2007     Rate %  
             
3% Zero Coupon
Convertible Subordinated
Debentures due 2020
    $ 183       3.00 %       178       3.00  
4.95% Debentures due 2033
      500       4.95         500       4.95  
3.80% Debentures due 2013
      500       3.82         500       3.82  
6.95% Notes due 2029
      294       7.14         294       7.14  
6.73% Debentures due 2023
      250       6.73         250       6.73  
6.625% Notes due 2009
      199       6.80         199       6.80  
5.55% Debentures due 2017
      1,000       5.55         1,000       5.55  
5.95% Notes due 2037
      995       5.99         995       5.99  
5.50% Notes due 2024
(500 GBP1.4759)(2)/(500 GBP1.9944)(3)
      731 (2)     5.71         989 (3)     5.71  
4.75% Notes due 2019
(1B Euro 1.4000)(2)/
(1B Euro 1.4573)(3)
      1,390 (2)     5.35         1,447 (3)     5.35  
5.15% Debentures due 2012
      599       5.18         599       5.18  
5.86% Debentures due 2038
      700       5.86                    
5.15% Debentures due 2018
      898       5.15                    
Other (Includes Industrial Revenue Bonds)
      102               132        
             
 
      8,341 (4)     5.46 (1)       7,083 (4)     5.47 (1)
Less current portion
      221                 9        
             
 
    $ 8,120                 7,074          
             
(1) Weighted average effective rate.
(2) Translation rate at December 28, 2008.
(3) Translation rate at December 30, 2007.
(4) The excess of the fair value over the carrying value of debt was $1.4 billion in 2008 and $0.3 billion in 2007.
The Company has access to substantial sources of funds at numerous banks worldwide. In September 2008, the Company secured a new 364-day and 5-year Credit Facility. Total credit available to the Company approximates $7.7 billion of which $6.3 billion expires September 24, 2009, and $1.4 billion expires September 25, 2013. 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.
     The Company filed a shelf registration with the Securities and Exchange Commission that became effective March 11, 2008 which enables the Company to issue an unlimited aggregate principal amount in debt securities and warrants to purchase debt securities. The Company issued bonds in June 2008 for a total of $1.6 billion for general corporate purposes.
     On July 28, 2000, ALZA Corporation, a subsidiary of the Company, completed a private offering of the 3% Zero Coupon Convertible Subordinated Debentures, which were issued at a price of $551.26 per $1,000 principal amount at maturity. Under the terms of the 3% Debentures, holders are entitled to convert their debentures into approximately 15.0 million shares of Johnson & Johnson stock at a price of $40.102 per share. Approximately 11.4 million shares have been issued as of December 28, 2008, due to voluntary conversions by note holders. At the option of the holder, the 3% Debentures may be repurchased by the Company on July 28, 2013, at a purchase price equal to the issue price plus accreted original issue discount to such purchase date. The Company, at its option, may also redeem any or all of the 3% Debentures after July 28, 2003 at the issue price plus accreted original issue discount.


     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   51

 


 

     Throughout 2008 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 $3.7 billion at the end of 2008, of which $3.1 billion was raised under the Commercial Paper Program. The remainder represents principally local borrowing by international subsidiaries.
     Aggregate maturities of long-term obligations commencing in 2008 are:
                                         
 
(Dollars in Millions)
    After  
2009
  2010     2011     2012     2013     2013  
 
$221
    22       18       620       507       6,953  
7. Intangible Assets and Goodwill
At the end of 2008 and 2007, the gross and net amounts of intangible assets and goodwill were:
                     
 
(Dollars in Millions)
    2008       2007  
             
Trademarks (non-amortizable) — gross
    $ 5,879         6,457  
Less accumulated amortization
      145         144  
             
Trademarks (non-amortizable) — net
    $ 5,734         6,313  
             
Patents and trademarks — gross
    $ 5,119         4,597  
Less accumulated amortization
      1,820         1,615  
             
Patents and trademarks — net
    $ 3,299         2,982  
             
Other intangibles — gross
    $ 7,376         7,399  
Less accumulated amortization
      2,433         2,054  
             
Other intangibles — net
    $ 4,943         5,345  
             
Subtotal intangible assets — gross
    $ 18,374         18,453  
Less accumulated amortization
      4,398         3,813  
             
Subtotal intangible assets — net
    $ 13,976         14,640  
             
Goodwill — gross
    $ 14,441         14,866  
Less accumulated amortization
      722         743  
             
Goodwill — net
    $ 13,719         14,123  
             
Total intangible assets and goodwill — gross
    $ 32,815         33,319  
Less accumulated amortization
      5,120         4,556  
             
Total intangible assets and goodwill — net
    $ 27,695         28,763  
             
Goodwill as of December 28, 2008 and December 30, 2007, as allocated by segment of business is as follows:
                                 
 
                    Med Dev        
(Dollars in Millions)
  Consumer     Pharm     and Diag     Total  
 
Goodwill at December 31, 2006
  $ 7,866       902       4,572       13,340  
     
Acquisitions
    3             449       452  
Translation/other
    256       62       13       331  
     
Goodwill at December 30, 2007
  $ 8,125       964       5,034       14,123  
     
Acquisitions
    191             286       477  
Translation/other
    (842 )     (1 )     (38 )     (881 )
     
Goodwill at December 28, 2008
  $ 7,474       963       5,282       13,719  
 
The weighted average amortization periods for patents and trademarks and other intangible assets are 16 years and 28 years, respectively. The amortization expense of amortizable assets for the fiscal years ended December 28, 2008, December 30, 2007 and December 31, 2006 was $788 million, $844 million and $594 million before tax, respectively. Certain patents and intangible assets were written down to fair value during fiscal years 2008, 2007 and 2006, with the resulting charge included in amortization expense.
The estimated amortization expense for the five succeeding years approximates $814 million before tax, per year. Substantially all of the amortization expense is included in cost of products sold.
8. Income Taxes
The provision for taxes on income consists of:
                               
 
(Dollars in Millions)
    2008       2007       2006  
                   
Currently payable:
                             
U.S. taxes
    $ 2,334         2,990         3,625  
International taxes
      1,624         1,479         1,077  
                   
 
      3,958         4,469         4,702  
                   
Deferred:
                             
U.S. taxes
      126         (722 )       (726 )
International taxes
      (104 )       (1,040 )       (442 )
                   
 
      22         (1,762 )       (1,168 )
                   
 
    $ 3,980         2,707         3,534  
                   
A comparison of income tax expense at the U.S. statutory rate of 35% in 2008, 2007 and 2006, to the Company’s effective tax rate is as follows:
                               
 
(Dollars in Millions)
    2008       2007       2006  
                   
U.S.
    $ 6,579         5,237         8,110  
International
      10,350         8,046         6,477  
                   
Earnings before taxes on income:
    $ 16,929         13,283         14,587  
                   
Tax rates:
                             
U.S. statutory rate
      35.0 %       35.0         35.0  
Puerto Rico and Ireland operations
      (6.8 )       (8.8 )       (7.5 )
Research and orphan drug tax credits
      (0.6 )       (0.8 )       (0.7 )
U.S. state and local
      1.6         2.1         1.6  
International subsidiaries excluding Ireland
      (5.6 )       (7.3 )       (3.5 )
U.S. manufacturing deduction
      (0.4 )       (0.3 )       (0.2 )
In process research and development (IPR&D)
      0.4         2.1         0.6  
U.S. Tax international income
      (0.5 )       (1.9 )       (0.7 )
All other
      0.4         0.3         (0.4 )
                   
Effective tax rate
      23.5 %       20.4         24.2  
                   
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 increase in the 2008 tax rate was mainly attributed to increases in taxable income in higher tax jurisdictions relative to taxable income in lower jurisdictions. The decrease in the 2007 tax rate was mainly attributed to a business restructuring of certain international subsidiaries, resulting in a one-time benefit of $267 million, which reduced the effective tax rate by 2%.


     
52
  JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

     Temporary differences and carry forwards for 2008 and 2007 are as follows:
                                     
 
      2008       2007  
      Deferred Tax       Deferred Tax  
(Dollars in Millions)
    Asset     Liability       Asset     Liability  
             
Employee related obligations
    $ 2,615                 1,727          
Stock based compensation
      1,296                 1,173          
Depreciation
              (523 )               (463 )
Non-deductible intangibles
              (1,791 )               (1,554 )
International R&D capitalized for tax
      1,914                 1,773          
Reserves & liabilities
      688                 1,155          
Income reported for tax purposes
      629                 487          
Miscellaneous international
      1,357       (251 )       1,177       (127 )
Capitalized intangibles
      74                 89          
Miscellaneous U.S.
      1,754                 542          
             
Total deferred income taxes
    $ 10,327       (2,565 )       8,123       (2,144 )
             
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 2008 deferred tax Miscellaneous U.S. includes current year tax receivables.
     The Company adopted FIN No. 48, Accounting for Uncertainty in Income Taxes effective January 1, 2007. The Company had $1.7 billion of gross unrecognized tax benefits, as of December 30, 2007. 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. During the fiscal year ended December 28, 2008, the Company recognized $106 million of interest expense with an after-tax impact of $69 million. For the year ended December 30, 2007, the Company recognized $58 million of interest expense and $42 million of interest income with an after-tax impact of $10 million expense. The total amount of accrued interest was $227 million and $187 million in 2008 and 2007, respectively.
     The following table summarizes the activity related to unrecognized tax benefits:
                     
 
(Dollars in Millions)
    2008       2007  
             
Beginning of year
    $ 1,653         1,262  
Increases related to current year tax positions
      545         487  
Increases related to prior period tax positions
      87         77  
Decreases related to prior period tax positions
      (142 )       (117 )
Settlements
      (137 )       (14 )
Lapse of statute of limitations
      (28 )       (42 )
             
End of year
    $ 1,978         1,653  
             
All of the unrecognized tax benefits of approximately $2.0 billion at December 28, 2008, 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 2002. In other major jurisdictions where the Company conducts business, the years remain open generally back to the year 2002 with some jurisdictions remaining open as far back as 1995. The Company does not expect that the total amount of unrecognized tax benefits will significantly change over the next twelve months. The Company does not expect a significant payment within the next twelve months, and is not able to provide a reasonably reliable estimate of the timing of any future tax payments relating to uncertain tax positions.
9. 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 2008, 2007 and 2006 for foreign currency translation adjustments is included in Note 12.
     Net currency transaction and translation gains and losses included in other (income) expense were losses of $31 million, $23 million and $18 million in 2008, 2007 and 2006, respectively.
10. Common Stock, Stock Option Plans and
Stock Compensation Agreements
STOCK OPTIONS
At December 28, 2008, the Company had 14 stock-based compensation plans. The shares outstanding are for contracts under the Company’s 1995 and 2000 Stock Option Plans, the 2005 Long-Term Incentive Plan, the 1997 Non-Employee Director’s Plan and the Centocor, Innovasive Devices, ALZA, Inverness, and Scios Stock Option Plans. During 2008, no options or restricted shares were granted under any of these plans except under the 2005 Long-Term Incentive Plan.
     The compensation cost recorded under SFAS No. 123(R) that has been charged against income for these plans was $627 million for 2008, $698 million for 2007 and $659 million for 2006. The total income tax benefit recognized in the income statement for share-based compensation costs was $210 million for 2008, $238 million for 2007 and $228 million for 2006. Share-based compensation costs capitalized as part of inventory were insignificant in all periods.
     Stock options expire 10 years from the date of grant and vest over service periods that range from six months to five 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 167.6 million at the end of 2008.


     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   53

 


 

     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 $7.66, $11.67 and $12.22 in 2008, 2007 and 2006, respectively. The fair value was estimated based on the weighted average assumptions of:
                               
 
      2008       2007       2006  
                   
Risk-free rate
      2.97 %       4.78 %       4.60 %
Expected volatility
      15.0 %       14.7 %       19.6 %
Expected life
    6.0 yrs       6.0 yrs       6.0 yrs
Dividend yield
      2.90 %       2.50 %       2.50 %
                   
A summary of option activity under the Plan as of December 28, 2008, December 30, 2007 and December 31, 2006 and changes during the years ending on those dates is presented below:
                         
 
                    Aggregate  
            Weighted     Intrinsic  
    Outstanding     Average     Value  
  (Shares in Thousands)        Shares        Exercise Price     (Dollars in Millions)  
 
Shares at January 1, 2006
    248,542       $53.05       $2,031  
 
                       
Options granted
    28,962       58.38          
Options exercised
    (26,152 )     42.80          
Options canceled/forfeited
    (8,425 )     59.33          
     
Shares at December 31, 2006
    242,927       54.57       $2,788  
                         
Options granted
    26,789       65.61          
Options exercised
    (33,224 )     45.92          
Options canceled/forfeited
    (7,863 )     63.00          
     
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  
 
The total intrinsic value of options exercised was $506 million, $625 million and $542 million in 2008, 2007 and 2006, respectively. The total unrecognized compensation cost was $632 million as of December 28, 2008, $652 million as of December 30, 2007 and $649 million as of December 31, 2006. The weighted average period for this cost to be recognized was 1.06 years, 1.01 years and 0.99 years for 2008, 2007 and 2006, respectively.
     The following table summarizes stock options outstanding and exercisable at December 28, 2008:
                                         
 
 (Shares in Thousands)     Outstanding     Exercisable  
                    Average             Average  
 Exercise           Average     Exercise             Exercise  
 Price Range   Options     Life (1)   Price     Options     Price  
 
$  3.62-$29.07
    325       1.5     $ 18.00       325     $ 18.00  
$31.27-$40.08
    349       0.9       35.22       349       35.22  
$40.98-$50.08
    11,263       1.1       49.61       11,263       49.61  
$50.50-$52.11
    19,600       1.8       50.70       19,600       50.70  
$52.20-$53.77
    23,759       4.1       52.22       23,759       52.22  
$53.93-$54.89
    27,992       5.0       53.93       27,992       53.93  
$55.01-$58.25
    27,803       3.1       57.30       27,775       57.30  
$58.34-$66.08
    69,136       8.0       61.90       815       62.76  
$66.18-$68.37
    35,272       6.1       66.20       33,084       66.19  
     
 
    215,499       5.3     $ 58.14       144,962     $ 56.25  
 
(1) Average contractual life remaining in years.
Stock options exercisable at December 30, 2007 and December 31, 2006 were 137,310 at an average price of $52.33 and an average life of 5.6 years and 131,077 at an average price of $50.23 and an average life of 5.9 years, respectively.
RESTRICTED SHARE UNITS
The Company grants restricted share units with a vesting period of three years. The Company settles employee stock issuance with treasury shares. Treasury shares are replenished throughout the year for the number of shares used for employee stock issuances.
     A summary of share activity under the Plan as of December 28, 2008:
         
 
    Outstanding  
   (Shares in Thousands)   Shares  
 
 Shares at January 1, 2006
    111  
 Shares granted
    7,320  
 Shares issued
    (33 )
 Shares canceled/forfeited
    (513 )
 
     
 Shares at December 31, 2006
    6,885  
 Shares granted
    8,029  
 Shares issued
    (33 )
 Shares canceled/forfeited
    (1,220 )
 
     
 Shares at December 30, 2007
    13,661  
 Shares granted
    10,105  
 Shares issued
    (40 )
 Shares canceled/forfeited
    (1,468 )
 
     
 Shares at December 28, 2008
    22,258  
 
The average fair value of the restricted share units granted was $56.70, $60.86 and $54.17 in 2008, 2007 and 2006, respectively, using the fair market value at the date of grant. The fair value of restricted share units was discounted for dividends, which are not paid on the restricted share units during the vesting period. The fair value of restricted share units settled was $2.5 million, $1.8 million and $1.7 million in 2008, 2007 and 2006, respectively.


     
54
  JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

11. Segments of Business(1) and Geographic Areas
                               
 
      Sales to Customers(2)  
(Dollars in Millions)
    2008       2007       2006  
                   
Consumer —
                             
United States
    $ 6,937         6,408         4,573  
International
      9,117         8,085         5,201  
                   
Total
      16,054         14,493         9,774  
                   
Pharmaceutical —
                             
United States
      14,831         15,603         15,092  
International
      9,736         9,263         8,175  
                   
Total
      24,567         24,866         23,267  
                   
Medical Devices and Diagnostics —
                             
United States
      10,541         10,433         10,110  
International
      12,585         11,303         10,173  
                   
Total
      23,126         21,736         20,283  
                   
Worldwide total
    $ 63,747         61,095         53,324  
                   
                                                             
 
      Operating Profit       Identifiable Assets  
(Dollars in Millions)
    2008 (5)     2007 (6)     2006 (7)     2008       2007       2006  
                                     
Consumer
    $ 2,674         2,277         1,374       $ 23,765         26,550         25,380  
Pharmaceutical
      7,605         6,540         6,894         19,544         19,780         18,799  
Medical Devices and Diagnostics
      7,223         4,846         6,126         20,779         19,978         18,601  
                                     
Total
      17,502         13,663         14,394         64,088         66,308         62,780  
Less: (Income) Expense not allocated to segments(3)
      573         380         (193 )                              
General corporate(4)
                                    20,824         14,646         7,776  
                                     
Worldwide total
    $ 16,929         13,283         14,587       $ 84,912         80,954         70,556  
                                     
                                                             
 
      Additions to Property,       Depreciation and  
      Plant & Equipment       Amortization  
(Dollars in Millions)
    2008       2007       2006       2008       2007       2006  
                                     
Consumer
    $ 499         504         344       $ 489         472         255  
Pharmaceutical
      920         1,137         1,246         986         1,033         929  
Medical Devices and Diagnostics
      1,251         919         823         1,146         1,080         861  
                                     
Segments total
      2,670         2,560         2,413         2,621         2,585         2,045  
General corporate
      396         382         253         211         192         132  
                                     
Worldwide total
    $ 3,066         2,942         2,666       $ 2,832         2,777         2,177  
                                     
                                                             
 
      Sales to Customers(2)       Long-Lived Assets(8)  
(Dollars in Millions)
    2008       2007       2006       2008       2007       2006  
                                     
United States
    $ 32,309         32,444         29,775       $ 21,674         21,685         22,432  
Europe
      16,782         15,644         12,786         14,375         15,578         14,443  
Western Hemisphere excluding U.S.
      5,173         4,681         3,542         3,328         3,722         3,108  
Asia-Pacific, Africa
      9,483         8,326         7,221         1,898         1,261         1,206  
                                     
Segments total
      63,747         61,095         53,324         41,275         42,246         41,189  
General corporate
                                    785         702         543  
Other non long-lived assets
                                    42,852         38,006         28,824  
                                     
Worldwide total
    $ 63,747         61,095         53,324       $ 84,912         80,954         70,556  
                                     
(1) See Note 1 for a description of the segments in which the Company operates.
 
(2) Export sales are not significant. In 2008, 2007 and 2006, the Company did not have a customer that represented 10% of total revenues.
 
(3) Amounts not allocated to segments include interest (income) expense, minority interest and general corporate (income) expense.
 
(4) General corporate includes cash and marketable securities.
 
(5) Includes $7 million and $174 million of In-Process Research and Development (IPR&D) for the Consumer and Medical Devices and Diagnostics segments, respectively. Includes $379 million of fourth quarter net litigation gain, comprised of a $50 million expense in the Consumer segment and a gain of $429 million in the Medical Devices and Diagnostics segment. The Medical Devices and Diagnostics segment also includes $536 million gain on the divestiture of the Professional Wound Care business of Ethicon, Inc.
 
(6) Includes $745 million of restructuring expense, comprised of $15 million, $429 million, and $301 million for the Consumer, Pharmaceutical, and Medical Devices and Diagnostics segments, respectively. The Medical Devices and Diagnostics segment includes $807 million of IPR&D. The Pharmaceutical segment also includes $678 million for the write-down of the NATRECOR® intangible asset.
 
(7) Includes $320 million and $239 million of IPR&D for the Consumer and Medical Devices and Diagnostics segments, respectively. The Medical Devices and Diagnostics segment also includes the Guidant acquisition agreement termination fee, less associated expenses, of $622 million.
 
(8) Long-lived assets include property, plant and equipment, net for 2008, 2007 and 2006 of $14,365, $14,185 and $13,044, respectively, and intangible assets and goodwill, net for 2008, 2007 and 2006 of $27,695, $28,763 and $28,688, respectively.
     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   55

 


 

12. Accumulated Other Comprehensive Income
Components of other comprehensive income/(loss) consist of the following:
                                         
 
                                    Total  
            Unrealized             Gains/     Accumulated  
  Foreign     Gains/             (Losses) on     Other  
  Currency     (Losses) on     Employee     Derivatives     Comprehensive  
(Dollars in Millions)
Translation     Securities     Benefit Plans     & Hedges     Income/(Loss )
 
January 1, 2006
  $ (520 )     70       (320 )     15       (755 )
2006 changes
                                       
Net change due to hedging transactions
                      17          
Net amount reclassed to net earnings
                      (23 )        
                               
Net 2006 changes
    362       (9 )     (1,710 )     (6 )     (1,363 )
     
December 31, 2006
  $ (158 )     61       (2,030 )     9       (2,118 )
2007 changes
                                       
Net change due to hedging transactions
                      (78 )        
Net amount reclassed to net earnings
                      24          
                               
Net 2007 changes
    786       23       670       (54 )     1,425  
     
December 30, 2007
  $ 628       84       (1,360 )     (45 )     (693 )
2008 changes
                                       
Net change due to hedging transactions
                      94          
Net amount reclassed to net earnings
                      72          
                               
Net 2008 changes
    (2,499 )     (59 )     (1,870 )     166       (4,262 )
     
December 28, 2008
  $ (1,871 )     25       (3,230 )     121       (4,955 )
 
Total comprehensive income for 2008 includes reclassification adjustment gains of $41 million realized from the sale of equity securities and the associated tax expense of $14 million.
     Total comprehensive income for 2007 includes reclassification adjustment gains of $7 million realized from the sale of equity securities and the associated tax expense of $2 million.
     Total other comprehensive income for 2006 includes reclassification adjustment gains of $13 million realized from the sale of equity securities and the associated tax expense of $4 million.
     The tax effect on the unrealized gains/(losses) on the equity securities was an expense of $14 million, $46 million and $33 million in 2008, 2007 and 2006, respectively. The tax effect related to employee benefit plans was $1,090 million, $349 million and $891 million in 2008, 2007 and 2006, respectively. The tax effect on the gains/(losses) on derivatives and hedges are losses of $70 million in 2008, gains of $24 million in 2007, and losses of $4 million in 2006. See Note 15 for additional information relating to derivatives and hedging.
     The currency translation adjustments are not currently adjusted for income taxes as they relate to permanent investments in international subsidiaries.
13. 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 (December 28, 2008 and December 30, 2007, respectively) as the measurement date for all U.S. and international retirement and other benefit plans.
     In September 2006, Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans was issued and amends further the disclosure requirements for pensions and other postretirement benefits. This Statement was an amendment of FASB Statements No. 87, 88, 106 and 132(R). The incremental effect of applying FASB No. 158 was a $1.7 billion reduction in Shareholder Equity, net of deferred taxes.


     
56
  JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

     Net periodic benefit costs for the Company’s defined benefit retirement plans and other benefit plans for 2008, 2007 and 2006 include the following components:
                                                             
 
      Retirement Plans       Other Benefit Plans  
(Dollars in Millions)
    2008       2007       2006       2008       2007       2006  
                                     
Service cost
    $ 545         597         552       $ 142         140         122  
Interest cost
      701         656         570         166         149         136  
Expected return on plan assets
      (876 )       (809 )       (701 )       (2 )       (2 )       (3 )
Amortization of prior service cost
      10         10         10         (4 )       (7 )       (7 )
Amortization of net transition asset
      2         1         (1 )                        
Recognized actuarial losses
      62         186         251         64         66         74  
Curtailments and settlements
      7         5         4                          
                                     
Net periodic benefit cost
    $ 451         646         685       $ 366         346         322  
                                     
The net periodic benefit cost attributable to U.S. retirement plans was $220 million, $379 million and $423 million in 2008, 2007 and 2006, respectively.
     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
    236  
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)
    2008       2007       2006       2008       2007       2006  
                                     
U.S. Benefit Plans
                                                           
                                     
Discount rate
      6.50 %       6.50         6.00         6.50 %       6.50         6.00  
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
      4.50         4.50         4.50         4.50         4.50         4.50  
International Benefit Plans
                                                           
                                     
Discount rate
      6.00 %       5.50         5.00         7.25 %       6.50         6.00  
Expected long-term rate of return on plan assets
      8.00         8.25         8.00                          
Rate of increase in compensation levels
      4.00         4.00         3.75         4.50         4.50         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
    2008       2007  
             
Health care cost trend rate assumed for next year
      9.00 %       9.00  
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
      2015         2014  
             
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
    $  34       $  (28 )
Postretirement benefit obligation
    320       (258 )
 


     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   57

 


 

The following table sets forth information related to the benefit obligation and the fair value of plan assets at year-end 2008 and 2007 for the Company’s defined benefit retirement plans and other postretirement plans:
                                         
 
      Retirement Plans       Other Benefit Plans  
(Dollars in Millions)
    2008       2007       2008       2007  
                         
Change in Benefit Obligation
                                       
                         
Projected benefit obligation — beginning of year
    $ 12,002         11,660       $ 2,721         2,668  
Service cost
      545         597         142         140  
Interest cost
      701         656         166         149  
Plan participant contributions
      60         62                  
Amendments
      10         14         1          
Actuarial (gains) losses
      (318 )       (876 )       (124 )       (1 )
Divestitures & acquisitions
              79         (2 )       8  
Curtailments & settlements
      (2 )       (46 )                
Benefits paid from plan
      (535 )       (481 )       (122 )       (255 )
Effect of exchange rates
      (540 )       337         (17 )       12  
                         
Projected benefit obligation — end of year*
    $ 11,923         12,002       $ 2,765         2,721  
                         
Change in Plan Assets
                         
Plan assets at fair value — beginning of year
    $ 10,469         9,538       $ 29         30  
Actual return (loss) on plan assets
      (2,787 )       743         (7 )       4  
Company contributions
      978         317         117         250  
Plan participant contributions
      60         62                  
Settlements
      (1 )       (38 )                
Divestitures & acquisitions
              55                  
Benefits paid from plan assets
      (535 )       (481 )       (122 )       (255 )
Effect of exchange rates
      (507 )       273                  
                         
Plan assets at fair value — end of year
    $ 7,677         10,469       $ 17         29  
                         
Funded status at — end of year*
    $ (4,246 )       (1,533 )     $ (2,748 )       (2,692 )
                         
Amounts Recognized in the Company’s Balance Sheet consist of the following:
                         
Non-current assets
    $ 136         481                  
Current liabilities
      (45 )       (43 )       (212 )       (262 )
Non-current liabilities
      (4,337 )       (1,971 )       (2,536 )       (2,430 )
                         
Total recognized in the consolidated balance sheet — end of year
    $ (4,246 )       (1,533 )     $ (2,748 )       (2,692 )
                         
Amounts Recognized in Accumulated Other Comprehensive Income consist of the following:
                         
Net actuarial (gain) loss
    $ (2,064 )       1,027       $ (472 )       1,013  
Prior service cost (credit)
      5         51         31         (36 )
Unrecognized net transition asset
      6         7                  
                         
Total before tax effects
    $ (2,053 )       1,085       $ (441 )       977  
                         
Accumulated Benefit Obligations end of year*
    $ 10,357         10,282                      
                         
Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income
                         
Net periodic benefit cost
    $ 451         646       $ 366         346  
                         
Net actuarial loss (gain)
      3,344         (555 )       60         11  
Amortization of net actuarial loss
      (68 )       (435 )       (65 )       (13 )
Prior service cost
      (11 )       (9 )       1         (34 )
Amortization of prior service cost
      10         14         6         6  
Effect of exchange rates
      (102 )       23         (1 )       3  
                         
Total recognized in other comprehensive income, before tax
    $ 3,173         (962 )     $ 1         (27 )
                         
Total recognized in net periodic benefit cost and other comprehensive income
    $ 3,624         (316 )     $ 367         319  
                         

* The Company does not fund certain plans, as funding is not required. $1.2 billion of the projected benefit obligation, $1.2 billion of the underfunded status, and $0.9 billion of the accumulated benefit obligation for the fiscal years 2008 and 2007 relates to these unfunded pension plans.
          


Plans with accumulated benefit obligations in excess of plan assets consist of the following:
                       
   
          Retirement Plans  
 
(Dollars in Millions)
    2008       2007  
               
 
Accumulated benefit obligation
    $ (9,885 )       (4,914 )
 
Projected benefit obligation
      (11,379 )       (5,233 )
 
Plan assets at fair value
      7,021         3,735  
               
     
58
  JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

Strategic asset allocations are determined by country, based on the nature of the liabilities and considering the demographic composition of the plan participants (average age, years of service and active versus retiree status). The Company’s plans are considered
non-mature plans and the long-term strategic asset allocations are consistent with these types of plans. Emphasis is placed on diversifying equities on a broad basis combined with currency matching of the fixed income assets.


     The following table displays the projected future benefit payments from the Company’s retirement and other benefit plans:
                                                 
 
 (Dollars in Millions)   2009   2010   2011   2012   2013   2014-2018  
 
 Projected future benefit payments
                                               
 
 Retirement plans
  $ 489       485       523       543       571       3,480  
     
 Other benefit plans — gross
  $ 229       185       189       191       193       1,049  
 Medicare rebates
    (9 )     (10 )     (11 )     (12 )     (13 )     (85 )
     
 Other benefit plans — net
  $ 220     $ 175     $ 178     $ 179     $ 180     $ 964  
 

In 2008, the Company contributed $399 million and $579 million to its U.S. and international pension plans, respectively. In addition, the Company funded $450 million to its U.S. plans in the first two months of 2009.
     In 2006, Congress passed the Pension Protection Act of 2006. The Act amended the Employee Retirement Income Security Act (ERISA) for plan years beginning after 2007 and established new minimum funding standards for U.S. employer defined benefit plans. The Company plans to continue to fund its U.S. defined benefit plans to comply with the Act.
     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)   2009     2010     2011     2012     2013     2014-2018 
 
 Projected future contributions
                                               
 
 Unfunded U.S. retirement plans
  $ 31       33       36       39       42       283 
     
 Unfunded International retirement plans
  $ 25       25       26       27       28       153 
 
     The Company’s retirement plan asset allocation at the end of 2008 and 2007 and target allocations for 2009 are as follows:
                             
 
      Percent of   Target  
      Plan Assets   Allocation  
      2008       2007     2009  
             
 U.S. Retirement Plans
                           
             
 Equity securities
      70 %       79 %     75 %
 Debt securities
      30         21       25  
             
 Total plan assets
      100 %       100 %     100 %
             
 International Retirement Plans
                           
             
 Equity securities
      61 %       67 %     67 %
 Debt securities
      38         32       33  
 Real estate and other
      1         1          
             
 Total plan assets
      100 %       100 %     100 %
             

The Company’s other benefit plans are unfunded except for U.S. life insurance contract assets of $17 million and $29 million at December 28, 2008 and December 30, 2007, respectively.
     The fair value of Johnson & Johnson common stock directly held in plan assets was $416 million (5.4% of total plan assets) at December 28, 2008 and $462 million (4.4% of total plan assets) at December 30, 2007.


     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  59     

 


 

14. Cash, Cash Equivalents and Marketable Securities
                                                     
 
      December 28, 2008       December 30, 2007  
      Amortized     Unrealized     Estimated       Amortized     Unrealized     Estimated  
(Dollars in Millions)
    Cost     Gains/(Losses)     Fair Value       Cost     Gains/(Losses)     Fair Value  
             
Current Investments
                                                   
             
Cash
    $ 3,276             3,276         2,978             2,978  
Government securities and obligations
      7,486       4       7,490         2,722       1       2,723  
Corporate debt securities
      627       1       628         1,805       3       1,808  
Money market funds
      813             813         407             407  
Time deposits
      607             607         1,403             1,403  
             
Total cash, cash equivalents and current marketable securities
    $ 12,809       5       12,814         9,315       4       9,319  
             
Non-Current Investments
                                                   
             
Marketable securities
    $ 4             4         2             2  
             

As of December 28, 2008, current marketable securities consist of $1,663 million, $342 million and $36 million of government securities and obligations, corporate debt securities and time deposits, respectively.
     As of December 30, 2007, current marketable securities consist of $251 million and $1,294 million of government securities and obligations and corporate debt, respectively.
CONCENTRATION OF CREDIT RISK
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.
15. Financial Instruments
All derivative instruments are recorded on the balance sheet at fair value. See Note 23 for additional details.
     As of December 28, 2008, the balance of deferred net gains on derivatives included in accumulated other comprehensive income was $121 million after-tax. For additional information, see Note 12. The Company expects that substantially all of this amount 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. 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. Derivative gains/(losses), initially reported as a component of other comprehensive income, are reclassified to earnings in the period when the forecasted transactions affect earnings.
     For the fiscal years ended December 28, 2008, December 30, 2007 and December 31, 2006, the net impact of hedge ineffectiveness, transactions not qualifying for hedge accounting and discontinuance of hedges, to the Company’s financial statements, was insignificant.
     Refer to Note 12 for disclosures of movements in Accumulated Other Comprehensive Income.
16. 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 $166 million in 2008, $169 million in 2007 and $158 million in 2006.
17. Mergers, Acquisitions and Divestitures
Certain businesses were acquired for $1,214 million in cash and $114 million of liabilities assumed during 2008. These acquisitions were accounted for by the purchase method and, accordingly, results of operations have been included in the financial statements from their respective dates of acquisition.
     The 2008 acquisitions included: Amic AB, a privately held Swedish developer of in vitro diagnostic technologies for use in point-of-care and near-patient settings; Beijing Dabao Cosmetics Co., Ltd., a company that sells personal care brands in China; SurgRx, Inc., a privately held developer of the advanced bipolar tissue sealing system used in the ENSEAL® family of devices; HealthMedia, Inc., a privately held company that creates web-based behavior change interventions; LGE Performance Systems, Inc., a privately held company known as Human Performance Institute™, which develops science-based training programs to improve employee engagement and productivity and Omrix Biopharmaceuticals, Inc., a fully integrated biopharmaceutical company that develops and markets biosurgical and immunotherapy products.
     The excess of purchase price over the estimated fair value of tangible assets acquired amounted to $891 million and has been assigned to identifiable intangible assets, with any residual recorded to goodwill. Approximately $181 million has been identified as the value of IPR&D associated with the acquisitions of Omrix Biopharmaceuticals, Inc., Amic AB, SurgRx, Inc. and HealthMedia, Inc.
     The IPR&D charge related to the acquisition of Omrix Biopharmaceuticals, Inc. was $127 million and is associated with stand-alone and combination biosurgical technologies used to achieve hemostasis. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. Probability of success factors ranging from 60 – 90% were used to reflect inherent clinical and regulatory risk. The discount rate applied was 14%. As of the end of the 2008 fiscal year, 97.8% of the outstanding shares of Common Stock of Omrix Biopharmaceuticals, Inc. had been tendered by stockholders. Excluding shares that were tendered subject to guaranteed delivery procedures, 90.2% of the outstanding shares of Common Stock had been tendered. On December 30, 2008 the Company completed the acquisition of Omrix Biopharmaceuticals, Inc.
     The IPR&D charge related to the acquisition of Amic AB was $40 million and is associated with point-of-care device and 4CAST Chip technologies. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. The discount rate applied was 20%.


   
60
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

     The IPR&D charge related to the acquisition of SurgRx, Inc. was $7 million and is associated with vessel cutting and sealing surgical devices. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. Probability of success factors ranging from 90 – 95% were used to reflect inherent clinical and regulatory risk. The discount rate applied was 18%.
     The IPR&D charge related to the acquisition of HealthMedia, Inc. was $7 million and is associated primarily with process enhancements to software technology. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. A probability of success factor of 90% was used to reflect inherent risk. The discount rate applied was 14%.
     Certain businesses were acquired for $1,388 million in cash and $232 million of liabilities assumed during 2007. These acquisitions were accounted for by the purchase method and, accordingly, results of operations have been included in the financial statements from their respective dates of acquisition.
     The 2007 acquisitions included: Conor Medsystems, Inc., a cardiovascular device company, with new drug delivery technology; Robert Reid, Inc., a Japanese orthopedic product distributor; and Maya’s Mom, Inc., a social media company.
     The excess of purchase price over the estimated fair value of tangible assets acquired amounted to $636 million and has been assigned to identifiable intangible assets, with any residual recorded to goodwill. Approximately $807 million has been identified as the value of IPR&D associated with the acquisition of Conor Medsystems, Inc.
     The IPR&D charge related to the acquisition of Conor Medsystems, Inc. was $807 million and is associated with research related to the discovery and application of the stent technology. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. The discount rate applied was 19%.
     Certain businesses were acquired for $18.0 billion in cash and $1.3 billion of liabilities assumed during 2006. These acquisitions were accounted for by the purchase method and, accordingly, results of operations have been included in the financial statements from their respective dates of acquisition except as noted below.
     On December 20, 2006, the Company completed the acquisition of the Consumer Healthcare business of Pfizer Inc. for a purchase price of $16.6 billion in cash. The operating results of the Consumer Healthcare business of Pfizer Inc. were reported in the Company’s financial statements beginning in 2007, as 2006 results subsequent to the acquisition date were not significant.
     In order to obtain regulatory approval of the transaction, the Company agreed to divest certain overlapping businesses. The Company completed the divestiture of the ZANTAC® product on December 20, 2006 and the divestitures of KAOPECTATE®, UNISOM®, CORTIZONE®, BALMEX® and ACT® products on January 2, 2007.
     The following table provides pro forma results of operations for the fiscal year ended December 31, 2006, as if the Consumer Healthcare business of Pfizer Inc. had been acquired as of the beginning of the period presented. The pro forma results include the effect of divestitures and certain purchase accounting adjustments such as the estimated changes in depreciation and amortization expense on the acquired tangible and intangible assets. However, pro forma results do not include any anticipated cost savings or other effects of the planned integration of the Consumer Healthcare business of Pfizer Inc. Accordingly, such amounts are not necessarily indicative of the results if the acquisition had occurred on the dates indicated or which may occur in the future.
         
 
(Unaudited)
  Pro forma results  
    Year ended  
    December 31,  
(Shares in Millions Except Per Share Data)
  2006  
 
Net sales
  $ 57,115  
Net earnings
  $ 10,770  
Diluted net earnings per share
  $ 3.64  
 
The IPR&D charge related to the acquisition of the Consumer Healthcare business of Pfizer Inc. was $320 million on a pre-tax basis and $217 million on an after-tax basis and is primarily associated with rights obtained to the switch of ZYRTEC® from U.S. prescription to over-the-counter status. The switch was approved by the FDA effective November 2007. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. A probability of success factor of 95% was used to reflect inherent regulatory risk as of the acquisition date and the discount rate applied was 11%.
     The Company completed the analysis of integration plans, pursuant to which the Company is incurring costs primarily related to the elimination of certain duplicate selling, general and administrative functions between the two companies in areas such as global business services, corporate staff and go-to-market support, as well as excess manufacturing capacity.
     In addition to the acquisition of the Consumer Healthcare business of Pfizer Inc., 2006 acquisitions included: Animas Corporation, a leading maker of insulin infusion pumps and related products; Hand Innovations LLC, a privately held manufacturer of fracture fixation products for the upper extremities; Future Medical Systems S.A., a privately held company that primarily develops, manufactures and markets arthroscopic fluid management systems; Vascular Control Systems, Inc., a privately held company focused on developing medical devices to treat fibroids and to control bleeding in obstetric and gynecologic applications; Groupe Vendôme S.A., a privately held French marketer of adult and baby skin care products; ColBar LifeScience Ltd., a privately held company specializing in reconstructive medicine and tissue engineering and Ensure Medical, Inc., a privately held company that develops devices for post-catheterization closure of the femoral artery.
     Excluding the acquisition of the Consumer Healthcare business of Pfizer Inc., the excess of purchase price over the estimated fair value of tangible assets acquired in 2006 amounted to $1,209 million and has been assigned to identifiable intangible assets, with any residual recorded to goodwill. Approximately $239 million has been identified as the value of IPR&D primarily associated with the acquisitions of Hand Innovations LLC, Future Medical Systems S.A., Vascular Control Systems, Inc., ColBar LifeScience Ltd. and Ensure Medical, Inc.
     The IPR&D charge related to the acquisition of Hand Innovations LLC was $22 million and is associated with fracture repair technologies. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. Probability of success factors ranging from 38 – 95% were used to reflect inherent clinical and regulatory risk and the discount rate applied was 17%.
     The IPR&D charge related to the acquisition of Future Medical Systems S.A. was $15 million and is associated with the NEXTRA and DUO PUMP product technologies. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. A probability of success factor of 90% for both technologies was used to reflect inherent clinical and regulatory risk and the discount rate applied was 22%.
     The IPR&D charge related to the acquisition of Vascular Control Systems, Inc. was $87 million and is associated with the FLOSTAT system technology. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects.


   
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61

 


 

A probability of success factor of 75% was used to reflect inherent clinical and regulatory risk and the discount rate applied was 21%.
     The IPR&D charge related to the acquisition of ColBar LifeScience Ltd. was $49 million and is associated with the EVOLENCE® family of products, which are biodegradable dermal fillers. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. Probability of success factors ranging from 70 – 80% were used to reflect inherent clinical and regulatory risk and the discount rate applied was 21%.
     The IPR&D charge related to the acquisition of Ensure Medical, Inc. was $66 million and is associated with the femoral artery closure device. The value of the IPR&D was calculated using cash flow projections discounted for the risk inherent in such projects. A probability of success factor of 75% was used to reflect inherent clinical and regulatory risk and the discount rate applied was 22%.
     With the exception of the Consumer Healthcare business of Pfizer Inc., supplemental pro forma information for 2008, 2007 and 2006 per SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, is not provided, as the impact of the aforementioned acquisitions did not have a material effect on the Company’s results of operations, cash flows or financial position.
     With the exception of the divestiture of the Professional Wound Care business of Ethicon, Inc., which resulted in a gain of $536 million before tax, and is recorded in other (income) expense, net, in 2008, divestitures in 2008, 2007 and 2006 did not have a material effect on the Company’s results of operations, cash flows or financial position.
18. Legal Proceedings
PRODUCT LIABILITY
The Company’s subsidiaries are 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 if any product liability results from such cases, it will be substantially covered by existing amounts accrued in the Company’s balance sheet and, where available, by third-party product liability insurance.
     Multiple products of Johnson & Johnson subsidiaries are subject to numerous product liability claims and lawsuits, including ORTHO EVRA®, RISPERDAL®, DURAGESIC®, CYPHER® Stent and the CHARITÉ™ Artificial Disc. There are approximately 900 claimants who have pending lawsuits or claims regarding injuries allegedly due to ORTHO EVRA®, 507 with respect to RISPERDAL®, 267 with respect to CHARITÉ™, 85 with respect to CYPHER® and 65 with respect to DURAGESIC®. These claimants seek substantial compensatory and, where available, punitive damages.
     With respect to RISPERDAL®, the Attorneys General of eight states and the Office of General Counsel of the Commonwealth of Pennsylvania have filed actions seeking reimbursement of Medicaid or other public funds for RISPERDAL® prescriptions written for off-label use, compensation for treating their citizens for alleged adverse reactions to RISPERDAL®, civil fines or penalties, punitive damages, or other relief. The Attorney General of Texas has joined a qui tam action in that state seeking similar relief. Certain of these actions also seek injunctive relief relating to the promotion of RISPERDAL®. The Attorneys General of more than 40 other states have indicated a potential interest in pursuing similar litigation against the Company’s Janssen subsidiary (now Ortho-McNeil-Janssen Pharmaceuticals Inc.) (OMJPI), and have obtained a tolling agreement staying the running of the statute of limitations while they inquire into the issues. In addition, there are six cases filed by union health plans seeking damages for
alleged overpayments for RISPERDAL®, several of which seek certification as class actions. In the case brought by the Attorney General of West Virginia, based on claims for alleged consumer fraud as to DURAGESIC® as well as RISPERDAL®, Janssen was found liable on motion, and damages are likely to be assessed at less than $20 million. Janssen intends to seek to appeal.
     Numerous claims and lawsuits in the United States relating to the drug PROPULSID®, withdrawn from general sale by the Company’s Janssen subsidiary in 2000, have been resolved or are currently enrolled in settlement programs with an aggregate cap below $100 million. Litigation concerning PROPULSID® is pending in Canada, where a class action of persons alleging adverse reactions to the drug has been certified.
AFFIRMATIVE STENT PATENT LITIGATION
In patent infringement actions tried in Delaware Federal District Court in late 2000, Cordis Corporation (Cordis), a subsidiary of Johnson & Johnson, obtained verdicts of infringement and patent validity, and damage awards against Boston Scientific Corporation (Boston Scientific) and Medtronic AVE, Inc. (Medtronic) based on a number of Cordis vascular stent patents. In December 2000, the jury in the damage action against Boston Scientific returned a verdict of $324 million and the jury in the Medtronic action returned a verdict of $271 million. The Court of Appeals for the Federal Circuit has upheld liability in these cases, and on September 30, 2008, the district court entered judgments, including interest, in the amounts of $702 million and $521 million against Boston Scientific and Medtronic, respectively. Medtronic paid $472 million in October 2008, representing the judgment, net of amounts exchanged in settlement of a number of other litigations between the companies. The net settlement of $472 million was recorded as a credit to other (income) expense, net in the 2008 consolidated statement of earnings. The $702 million judgment against Boston Scientific is not reflected in the 2008 financial statements as Boston Scientific has appealed the judgments, and no amounts have been received.
     Cordis also has two arbitrations against Medtronic seeking royalties for the sale of stent products introduced by Medtronic subsequent to December 2000 pursuant to a 1997 cross-license agreement between Cordis and Medtronic. The hearing on the first of these arbitrations will take place in March 2009.
     In January 2003, Cordis filed a patent infringement action against Boston Scientific in Delaware Federal District Court accusing its Express2™, Taxus® and Liberte® stents of infringing the Palmaz patent that expired in November 2005. The Liberte® stent was also accused of infringing Cordis’ Gray patent that expires in 2016. In June 2005, a jury found that the Express2™, Taxus® and Liberte® stents infringed the Palmaz patent and that the Liberte® stent also infringed the Gray patent. Boston Scientific has appealed to the U.S. Court of Appeals for the Federal Circuit.
     Cordis has filed several lawsuits in New Jersey Federal District Court against Guidant Corporation (Guidant), Abbott Laboratories, Inc. (Abbott), Boston Scientific and Medtronic alleging that the Xience V™ (Abbott), Promus™ (Boston Scientific) and Endeavor® (Medtronic) drug eluting stents infringe several patents owned by or licensed to Cordis. In October 2008, Cordis filed suit against Boston Scientific in Delaware Federal Court accusing the Taxus Liberte® stent of infringing the Gray patent.
PATENT LITIGATION AGAINST VARIOUS JOHNSON & JOHNSON SUBSIDIARIES
The products of various Johnson & Johnson subsidiaries are the subject of various patent lawsuits, the outcomes of which could potentially adversely affect the ability of those subsidiaries to


   
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sell those products, or require the payment of past damages and future royalties.
     In July 2005, a jury in Federal District Court in Delaware found that the Cordis CYPHER® Stent infringed Boston Scientific’s Ding ‘536 patent and that the Cordis CYPHER® and BX VELOCITY® Stents also infringed Boston Scientific’s Jang ‘021 patent. The jury also found both of those patents valid. Boston Scientific seeks substantial damages and an injunction in those actions. Cordis appealed. On January 15, 2009, the Court of Appeals for the Federal Circuit held the Ding patent invalid. It is expected that Boston Scientific will move for reconsideration. The appeal of the Jang patent case is still pending and if the judgment is upheld it will be remanded for a trial on the issues of damages and injunctive relief.
     In Germany, Boston Scientific has several actions based on its Ding patents pending against the Cordis CYPHER® Stent. Cordis was successful in these actions at the trial level, but Boston Scientific has appealed. Boston Scientific has brought actions in Belgium, the Netherlands, Germany, France and Italy under its Kastenhofer patent, which purports to cover two-layer catheters such as those used to deliver the CYPHER® Stent, to enjoin the manufacture and sale of allegedly infringing catheters in those countries, and to recover damages. A decision by the lower court in the Netherlands in Boston Scientific’s favor was reversed on appeal in April 2007. Boston Scientific has filed an
appeal to the Dutch Supreme Court. In October 2007, Boston Scientific prevailed in the nullity action challenging the validity of the Kastenhofer patent filed by Cordis in Germany. Cordis has appealed. No substantive hearings have been scheduled in the French or Italian actions.
     Trial in Boston Scientific’s U.S. case based on the Kastenhofer patent in Federal District Court in California concluded in October 2007 with a jury finding that the patent was invalid. The jury also found for Cordis on its counterclaim that sale by Boston Scientific of its balloon catheters and stent delivery systems infringe Cordis’ Fontirroche patent. The Court has denied Boston Scientific’s post trial motions and is considering the appropriate remedy for future infringement.
     In May 2008, Centocor, Inc. (now COBI) filed a lawsuit against Genentech, Inc. (Genentech) in U.S. District Court for the Central District of California seeking to invalidate the Cabilly II patent. Prior to filing suit, Centocor had a sublicense under this patent from Celltech (who was licensed by Genentech) for REMICADE® and had been paying royalties to Celltech. Centocor has terminated that sublicense and stopped paying royalties. Genentech has filed a counterclaim alleging that REMICADE® infringes its Cabilly II patents and that the manufacture of REMICADE®, ustekinumab, golimumab and ReoPro infringe various of its patents relating to the purification of antibodies made through recombinant DNA techniques.


     The following chart summarizes various patent lawsuits concerning products of Johnson & Johnson subsidiaries that have yet to proceed to trial:
                         
 
J&J Product
  Company   Patents   Plaintiff/
Patent Holder
  Court   Trial Date   Date Filed
 
Two-layer Catheters
  Cordis   Kastenhofer   Boston Scientific Corp.   Multiple European   *   09/07
 
Contact Lenses
  Vision Care   Nicolson   CIBA Vision   M.D. FL   03/09   09/03
 
CYPHER® Stent
  Cordis   Wall   Wall   E.D. TX   04/11   11/07
 
CYPHER® Stent
  Cordis   Bonutti   MarcTec   S.D. IL   05/09   11/07
 
CYPHER® Stent
  Cordis   Saffran   Saffran   E.D. TX   01/11   10/07
 
Stent/Catheter Delivery Systems
  Cordis/Ethicon   Schock   Cardio Access LLC   E.D. TX   *   06/08
 
LISTERINE® Tooth Whitening
Strips
  McNeil-PPC   Sagel   Procter & Gamble   W.D. WI   *   05/08
 
Blood Glucose Meters and Strips
  Lifescan   Wilsey   Roche Diagnostics   D. DE   *   11/07
 
REMICADE®, ustekinumab,
golimumab, ReoPro
  Centocor   Cabilly II   Genentech   C.D. CA   *   05/08
 
* Trial date to be scheduled.

LITIGATION AGAINST FILERS OF ABBREVIATED NEW DRUG APPLICATIONS (ANDAs)
The following chart indicates lawsuits pending against generic firms that filed Abbreviated New Drug Applications (ANDAs) seeking to market generic forms of products sold by various subsidiaries of the Company prior to expiration of the applicable patents covering those products. These ANDAs typically include allegations of
non-infringement, invalidity and unenforceability of these patents. In the event the subsidiary of the Company involved is not successful in these actions, or the statutory 30-month stay expires before a ruling from the district court is obtained, the firms involved will have the ability, upon FDA approval, to introduce generic versions of the product at issue resulting in very substantial market share and revenue losses for the product of the Company’s subsidiary.


   
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63


 

     As noted in the following chart, 30-month stays expired during 2006, 2007 and 2008, and will expire in 2009, 2010 and 2011 with respect to ANDA challenges regarding various products:
                         
 
Brand Name
  Patent/NDA   Generic       Trial   Date   30-Month
Product
  Holder   Challenger   Court   Date   Filed   Stay Expiration
 
CONCERTA®
  McNeil-PPC   Andrx   D. DE   12/07   09/05   None
18, 27, 36 and 54 mg controlled release tablet
  ALZA                    
 
LEVAQUIN® 250, 500, 750 mg
tablet
  Ortho-McNeil   Lupin   D. NJ   *   10/06   03/09
 
ORTHO TRI-CYCLEN® LO
  Ortho-McNeil   Barr   D. NJ   *   10/03   02/06
0.18 mg/0.025 mg, 0.215 mg/
0.025 mg and 0.25 mg/
0.025 mg
      Watson   D. NJ   *   10/08   03/11
 
RAZADYNE®
  Janssen   Teva   D. DE   05/07   07/05   08/08
 
      Mylan   D. DE   05/07   07/05   08/08
 
      Dr. Reddy’s   D. DE   05/07   07/05   08/08
 
      Purepac   D. DE   05/07   07/05   08/08
 
      Barr   D. DE   05/07   07/05   08/08
 
      AlphaPharm   D. DE   05/07   07/05   08/08
 
RAZADYNE® ER
  Janssen   Barr   D. NJ   *   06/06   None
 
      Sandoz   D. NJ   *   05/07   None
 
      KV Pharma   D. NJ   *   12/07   05/10
 
ULTRAM® ER 100, 200, 300 mg
tablet
  Ortho-McNeil   Par   D. DE   01/09   05/07   09/09
 
ULTRAM® ER 100 mg tablet
  Ortho-McNeil-
Janssen
  Impax   D. DE   *   08/08   01/11
 
* Trial date to be scheduled.

In the action against Barr Pharmaceuticals, Inc. (Barr) regarding ORTHO TRI-CYCLEN® LO, on January 22, 2008, the Company’s subsidiary Ortho Women’s Health & Urology, a Division of Ortho-McNeil-Janssen Pharmaceuticals, Inc., and Barr agreed to a non-binding term sheet to settle the litigation, which settlement discussions are still underway. The trial court postponed the January 22, 2008 trial without setting a new trial date.
     On October 16, 2008, the Company’s subsidiary Ortho-McNeil-Janssen Pharmaceuticals, Inc. (OMJPI) filed suit in Federal District Court in New Jersey against Watson Laboratories, Inc. (Watson) in response to Watson’s ANDA regarding ORTHO TRI-CYCLEN® LO.
     In the action against Barr and AlphaPharm with respect to their ANDA challenges to the RAZADYNE® patent that Janssen licenses from Synaptech, Inc. (Synaptech), a four-day non-jury trial was held in the Federal District Court in Delaware in May 2007. On August 27, 2008, the court held that the patent was invalid because it was not enabled. Janssen and Synaptech have appealed the decision. Since the court’s decision, three generic companies have received final approvals for their products and have launched “at risk” pending appeal. Additional generic approvals and launches could occur at any time.
     In the action by McNEIL-PPC, Inc. against Andrx Corporation (Andrx) with respect to its ANDA challenge to the CONCERTA® patents, a five-day non-jury trial was held in the Federal District Court in Delaware in December 2007. The Court has yet to issue its ruling in that action.
     In the RAZADYNE® ER cases, a lawsuit was filed against Barr on the RAZADYNE® use patent that Janssen licenses from Synaptech in June 2006 and on the RAZADYNE® ER formulation patent in March 2007. Lawsuits (each for different dosages) were filed against KV Pharmaceutical Company (KV) on the RAZADYNE® ER formulation patent in December 2007 and June 2008. Suit was filed against Sandoz on the RAZADYNE® use patent that Janssen licenses from Synaptech in May 2007 and on the RAZADYNE® ER formulation patent in June 2008. In September 2008, the above-discussed Delaware decision invalidating the RAZADYNE® use patent resulted in entry of judgment for Barr on that patent, and the case against Sandoz on that patent has been
stayed pending appeal of the Delaware decision. Litigation against Barr, KV and Sandoz as to the RAZADYNE® ER formulation patent is proceeding. Barr has received FDA approval of its product and has launched “at risk.”
     In the action against Lupin Pharmaceuticals, Inc. (Lupin) regarding its ANDA concerning LEVAQUIN®, Lupin contends that the United States Patent and Trademark Office improperly granted a patent term extension to the patent that Ortho-McNeil (now Ortho-McNeil-Janssen Pharmaceuticals, Inc.) (OMJPI) licenses from Daiichi Pharmaceuticals, Inc. (Daiichi). Lupin alleges that the active ingredient in LEVAQUIN® was the subject of prior marketing, and therefore was not eligible for the patent term extension. Lupin concedes validity and that its product would violate the patent if marketed prior to the expiration of the original patent term.
     In the ULTRAM® ER actions, Ortho-McNeil (now OMJPI), filed lawsuits (each for different dosages) against Par Pharmaceuticals, Inc. and Par Pharmaceuticals Companies, Inc. (Par) in May, June and October 2007 on two Tramadol ER formulation patents owned by Purdue Pharma Products L.P. (Purdue) and Napp Pharmaceutical Group Ltd. (Napp). OMJPI also filed lawsuits (each for different dosages) against Impax Laboratories, Inc. (Impax) on a Tramadol ER formulation patent owned by Purdue and Napp in August and November 2008. Purdue, Napp and Biovail Laboratories International SRL (Biovail)(the NDA holder) joined as co-plaintiffs in the lawsuits against Par and Impax.
AVERAGE WHOLESALE PRICE (AWP) LITIGATION
Johnson & Johnson and several of its pharmaceutical subsidiaries, along with numerous other pharmaceutical companies, are defendants in a series of lawsuits in state and federal courts involving allegations that the pricing and marketing of certain pharmaceutical products amounted to fraudulent and otherwise actionable conduct because, among other things, the companies allegedly reported an inflated Average Wholesale Price (AWP) for the drugs at issue. Many of these cases, both federal actions and state actions removed to federal court, have been consolidated for pre-trial purposes in a Multi-District Litigation (MDL) in Federal District Court in Boston, Massachusetts. The plaintiffs in these cases include classes of private persons or entities that paid for any portion of the


   
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purchase of the drugs at issue based on AWP, and state government entities that made Medicaid payments for the drugs at issue based on AWP.
     The MDL Court identified classes of Massachusetts-only private insurers providing “Medi-gap” insurance coverage and private payers for physician-administered drugs where payments were based on AWP (“Class 2” and “Class 3”), and a national class of individuals who made co-payments for physician-administered drugs covered by Medicare (“Class 1”). A trial of the two Massachusetts-only class actions concluded before the MDL Court in December 2006. In June 2007, the MDL Court issued post-trial rulings, dismissing the Johnson & Johnson defendants from the case regarding all claims of Classes 2 and 3, and subsequently of Class 1 as well. The ruling is the subject of a pending appeal. AWP cases brought by various Attorneys General have proceeded to trial against other manufacturers. Cases including Johnson & Johnson subsidiaries are expected to be set for trial in 2009 and thereafter.
OTHER
In July 2003, Centocor (now COBI), a Johnson & Johnson subsidiary, received a request that it voluntarily provide documents and information to the criminal division of the U.S. Attorney’s Office, District of New Jersey, in connection with its investigation into various Centocor marketing practices. Subsequent requests for documents have been received from the U.S. Attorney’s Office. Both the Company and Centocor have responded to these requests for documents and information.
     In December 2003, Ortho-McNeil (now OMJPI) received a subpoena from the U.S. Attorney’s Office in Boston, Massachusetts seeking documents relating to the marketing, including alleged off-label marketing, of the drug TOPAMAX® (topiramate). Additional subpoenas for documents have been received, and current and former employees have testified before a grand jury. Discussions are underway in an effort to resolve this matter, but whether agreement can be reached and on what terms is uncertain.
     In January 2004, Janssen (now OMJPI) received a subpoena from the Office of the Inspector General of the U.S. Office of Personnel Management seeking documents concerning sales and marketing of, any and all payments to physicians in connection with sales and marketing of, and clinical trials for, RISPERDAL® (risperidone) from 1997 to 2002. Documents subsequent to 2002 have also been requested. An additional subpoena seeking information about marketing of and adverse reactions to RISPERDAL® was received from the U.S. Attorney’s Office for the Eastern District of Pennsylvania in November 2005. Subpoenas seeking testimony from various witnesses before a grand jury have also been received. Janssen is cooperating in responding to these subpoenas.
     In September 2004, Ortho Biotech Inc. (now COBI), received a subpoena from the U.S. Office of Inspector General’s Denver, Colorado field office seeking documents directed to the sales and marketing of PROCRIT® (Epoetin alfa) from 1997 to the present, as well as to dealings with U.S. Oncology Inc., a healthcare services network for oncologists. Ortho Biotech (now COBI) has responded to the subpoena.
     In September 2004, plaintiffs in an employment discrimination litigation initiated against the Company in 2001 in Federal District Court in New Jersey moved to certify a class of all African American and Hispanic salaried employees of the Company and its affiliates in the U.S., who were employed at any time from November 1997 to the present. Plaintiffs seek monetary damages for the period 1997 through the present (including punitive damages) and equitable relief. The Court denied plaintiffs’ class certification motion in December 2006 and their motion for reconsideration in April 2007. Plaintiffs sought to appeal these decisions and, in April 2008, the
Court of Appeals ruled that plaintiffs’ appeal of the denial of class certification was untimely. Plaintiffs are now engaged in further discovery of individual plaintiffs’ claims.
     In March 2005, DePuy Orthopaedics, Inc. (DePuy), a Johnson & Johnson subsidiary, received a subpoena from the U.S. Attorney’s Office, District of New Jersey, seeking records concerning contractual relationships between DePuy and surgeons or surgeons-in-training involved in hip and knee replacement and reconstructive surgery. This investigation was resolved by DePuy and the four other leading suppliers of hip and knee implants in late September 2007 by agreements with the U.S. Attorney’s Office for the District of New Jersey. The settlements include an 18-month Deferred Prosecution Agreement (DPA), acceptance by each company of a monitor to assure compliance with the DPA and, with respect to four of the five companies, payment of settlement monies and entry into five year Corporate Integrity Agreements. DePuy paid $85 million as its settlement. In November 2007, the Attorney General of the Commonwealth of Massachusetts issued a civil investigative demand to DePuy seeking information regarding financial relationships between a number of Massachusetts-based orthopedic surgeons and providers and DePuy, which relationships had been publicly disclosed by DePuy pursuant to the DPA. In February 2008, DePuy received a written request for information from the U.S. Senate Special Committee on Aging, as a follow-up to earlier inquiries, concerning a number of aspects of the DPA.
     In July 2005, Scios Inc. (Scios), a Johnson & Johnson subsidiary, received a subpoena from the U.S. Attorney’s Office, District of Massachusetts, seeking documents related to the sales and marketing of NATRECOR®. Scios is responding to the subpoena. In early August 2005, Scios was advised that the investigation would be handled by the U.S. Attorney’s Office for the Northern District of California in San Francisco. Additional requests for documents have been received and responded to and former and current Scios employees have testified before a grand jury in San Francisco.
     In September 2005, Johnson & Johnson received a subpoena from the U.S. Attorney’s Office, District of Massachusetts, seeking documents related to sales and marketing of eight drugs to Omni-care, Inc., a manager of pharmaceutical benefits for long-term care facilities. The Johnson & Johnson subsidiaries involved responded to the subpoena. Several employees of the Company’s pharmaceutical subsidiaries have been subpoenaed to testify before a grand jury in connection with this investigation.
     In November 2005, Amgen filed suit against Hoffmann-LaRoche, Inc. (Roche) in the U.S. District Court for the District of Massachusetts seeking a declaration that the Roche product CERA, which Roche has indicated it would seek to introduce into the United States, infringes a number of Amgen patents concerning EPO. Amgen licenses EPO for sale in the United States to Ortho Biotech (now COBI) for non-dialysis indications. Trial in this action concluded in October 2007 with a verdict in Amgen’s favor, finding the patents valid and infringed. The judge issued a preliminary injunction blocking the CERA launch, but said he was considering modifying that injunction to grant Roche a compulsory license that would allow it to launch in the U.S. if it paid a 22.5 percent royalty. In a subsequent decision, the district judge indicated he would not grant Roche a compulsory license.
     In February 2006, Johnson & Johnson received a subpoena from the U.S. Securities & Exchange Commission (SEC) requesting documents relating to the participation by several Johnson & Johnson subsidiaries in the United Nations Iraq Oil for Food Program. The subsidiaries are cooperating with the SEC and U.S. Department of Justice (DOJ) in producing responsive documents.


   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
65


 

     In September 2006, Janssen (now OMJPI) received a subpoena from the Attorney General of the State of California seeking documents regarding sales and marketing and side-effects of RISPERDAL®, as well as interactions with State officials regarding the State’s formulary for Medicaid-reimbursed drugs. Janssen (now OMJPI) has responded to the subpoena.
     In February 2007, Johnson & Johnson voluntarily disclosed to the DOJ and the SEC that subsidiaries outside the United States are believed to have made improper payments in connection with the sale of medical devices in two small-market countries, which payments may fall within the jurisdiction of the Foreign Corrupt Practices Act (FCPA). In the course of continuing dialogues with the agencies, other issues potentially rising to the level of FCPA violations in additional markets have been brought to the attention of the agencies by the Company. The Company has provided and will continue to provide additional information to DOJ and SEC, and will cooperate with the agencies’ reviews of these matters. Law enforcement agencies of a number of other countries are also pursuing investigations of matters voluntarily disclosed by the Company to DOJ and SEC. Discussions are underway in an effort to resolve these matters, and the Iraq Oil for Food matter referenced above, but whether agreement can be reached and on what terms is uncertain.
     In March 2007, the Company received separate subpoenas from the U.S. Attorney’s Office in Philadelphia, the U.S. Attorney’s Office in Boston and the U.S. Attorney’s Office in San Francisco. The subpoenas relate to investigations by these three offices referenced above concerning, respectively, sales and marketing of RISPERDAL® by Janssen (now OMJPI), TOPAMAX® by Ortho-McNeil (now OMJPI) and NATRECOR® by Scios. The subpoenas request information regarding the Company’s corporate supervision and oversight of these three subsidiaries, including their sales and marketing of these drugs. The Company responded to these requests. In addition, the U.S. Attorney’s office in Boston has issued subpoenas for grand jury testimony to several employees of Johnson & Johnson.
     In May 2007, the New York State Attorney General issued a subpoena seeking information relating to the marketing and safety of PROCRIT®. The Company is responding to these requests.
     In April 2007, the Company received two subpoenas from the Office of the Attorney General of the State of Delaware. The subpoenas seek documents and information relating to nominal pricing agreements. For purposes of the subpoenas, nominal pricing agreements are defined as agreements under which the Company agreed to provide a pharmaceutical product for less than ten percent of the Average Manufacturer Price for the product. The Company responded to these requests.
     In January 2008, the European Commission (“EC”) began an industry-wide antitrust inquiry concerning competitive conditions within the pharmaceutical sector. Because this is a sector inquiry, it is not based on any specific allegation that the Company has violated EC competition law. The inquiry began with unannounced raids of a substantial number of pharmaceutical companies throughout Europe, including Johnson & Johnson affiliates. In March 2008, the EC issued detailed questionnaires to approximately 100 companies, including Johnson & Johnson affiliates. In November 2008, the EC issued a preliminary report summarizing its findings. The final report is expected in June or July of 2009.
     In March 2008, the Company received a letter request from the Attorney General of the State of Michigan. The request seeks documents and information relating to nominal price transactions. The Company is responding to the request and will cooperate with the inquiry.
     In June 2008, Johnson & Johnson received a subpoena from the United States Attorneys Office for the District of Massachusetts relating to the marketing of biliary stents by the Company’s Cordis subsidiary. Cordis is cooperating in responding to the subpoena.
     In September 2008, Multilan AG, an indirect subsidiary of Schering-Plough Corporation, commenced arbitration against Janssen Pharmaceutica NV for an alleged wrongful termination of an agreement relating to payments in connection with termination of certain marketing rights. Multilan seeks declaratory relief, specific performance and damages. Multilan alleges that damages exceed 700 million. The parties are in the process of selecting an arbitral tribunal.
     In recent years the Company has received numerous requests from a variety of United States Congressional Committees to produce information relevant to ongoing congressional inquiries. It is the Company’s policy to cooperate with these inquiries by producing the requested information.
     With respect to all the above matters, the Company and its subsidiaries are vigorously contesting the allegations asserted against them and otherwise pursuing defenses to maximize the prospect of success. The Company and its subsidiaries involved in these matters continually evaluate their strategies in managing these matters and, where appropriate, pursue settlements and other resolutions where those are in the best interest of the Company.
     The Company is also involved in a number of other patent, trademark and other lawsuits 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 estimated with any certainty. 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 accrued in the Company’s balance sheet, is not expected to have a material adverse effect on the Company’s financial condition, although the resolution in any reporting period of one or more of these matters could have a significant impact on the Company’s results of operations and cash flows for that period.


   
66
JOHNSON & JOHNSON 2008 ANNUAL REPORT


 

19. 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 December 28, 2008, December 30, 2007 and December 31, 2006:
                               
 
   (Shares in Millions Except Per Share Data)     2008       2007       2006  
                   
Basic net earnings per share
    $ 4.62         3.67         3.76  
Average shares outstanding — basic
      2,802.5         2,882.9         2,936.4  
Potential shares exercisable under stock option plans
      179.0         178.6         207.0  
Less: shares repurchased under treasury stock method
      (149.6 )       (154.5 )       (186.3 )
Convertible debt shares
      3.7         3.7         3.9  
                   
Adjusted average shares outstanding — diluted
      2,835.6         2,910.7         2,961.0  
Diluted net earnings per share
    $ 4.57         3.63         3.73  
                   
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 2008, 2007 and 2006.
     Diluted net earnings per share excludes 59 million, 64 million and 43 million shares underlying stock options for 2008, 2007 and 2006, 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.
20. 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 January 1, 2006
    145,364     $ 5,965  
Employee compensation and stock option plans
    (26,526 )     (1,677 )
Conversion of subordinated debentures
    (540 )     (36 )
Repurchase of common stock
    108,314       6,722  
     
Balance at December 31, 2006
    226,612       10,974  
Employee compensation and stock option plans
    (33,296 )     (2,180 )
Conversion of subordinated debentures
    (194 )     (13 )
Repurchase of common stock
    86,498       5,607  
     
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  
 
Aggregate shares of Common Stock issued were approximately 3,120 million shares at the end of 2008, 2007 and 2006.
     Cash dividends paid were $1.795 per share in 2008, compared with dividends of $1.620 per share in 2007 and $1.455 per share in 2006.


21. Selected Quarterly Financial Data (unaudited)
Selected unaudited quarterly financial data for the years 2008 and 2007 are summarized below:
                                                                     
 
      2008       2007  
      First     Second     Third     Fourth       First     Second     Third     Fourth  
    (Dollars in Millions Except Per Share Data)     Quarter     Quarter (1)   Quarter     Quarter (2)     Quarter (3)   Quarter     Quarter (4)   Quarter (5)
             
Segment sales to customers
                                                                   
Consumer
    $ 4,064       4,036       4,099       3,855         3,496       3,564       3,623       3,810  
Pharmaceutical
      6,429       6,340       6,113       5,685         6,221       6,149       6,099       6,397  
Med Devices & Diagnostics
      5,701       6,074       5,709       5,642         5,320       5,418       5,248       5,750  
             
Total sales
    $ 16,194       16,450       15,921       15,182         15,037       15,131       14,970       15,957  
             
Gross profit
      11,580       11,699       11,147       10,810         10,652       10,773       10,696       11,223  
Earnings before provision for taxes on income
      4,747       4,375       4,290       3,517         3,652       4,031       3,268       2,332  
Net earnings
      3,598       3,327       3,310       2,714         2,573       3,081       2,548       2,374  
             
Basic net earnings per share
    $ 1.27       1.18       1.19       0.98         0.89       1.06       0.88       0.83  
             
Diluted net earnings per share
    $ 1.26       1.17       1.17       0.97         0.88       1.05       0.88       0.82  
             
   (1) The second quarter of 2008 includes an after-tax charge of $40 million for IPR&D.
 
   (2) The fourth quarter of 2008 includes an after-tax charge of $141 million for IPR&D, $229 million after-tax of income from net litigation and $331 million after-tax gain on the divestiture of the Professional Wound Care business of Ethicon, Inc. The gain from the divestiture of the Professional Wound Care business of Ethicon, Inc. was reinvested in the business.
 
   (3) The first quarter of 2007 includes an after-tax charge of $807 million for IPR&D.
 
   (4) The third quarter of 2007 includes an after-tax charge of $528 million for restructuring.
 
   (5) The fourth quarter of 2007 includes an after-tax charge of $441 million for the NATRECOR® intangible asset write-down and a one-time tax gain of $267 million for restructuring. The lower tax rate is due to increases in taxable income in lower tax jurisdictions relative to taxable income in higher tax jurisdictions.
   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
          67

 


 

22. Restructuring
In the third quarter of 2007, the Company announced restructuring initiatives in an effort to improve its overall cost structure. This action was taken to offset the anticipated negative impacts associated with generic competition in the Pharmaceutical segment and challenges in the drug-eluting stent market. The Company’s Pharmaceuticals segment has reduced its cost base by consolidating certain operations, while continuing to invest in recently launched products and its late-stage pipeline of new products. The Cordis franchise has moved to a more integrated business model to address the market changes underway with drug-eluting stents and to better serve the broad spectrum of its patients’ cardiovascular needs, while reducing its cost base. This program allowed the Company to accelerate steps to standardize and streamline certain aspects of its enterprise-wide functions such as human resources, finance and information technology to support growth across the business, while also leveraging its scale more effectively in areas such as procurement to benefit its operating companies. Additionally, as part of this program the Company plans to eliminate approximately 4,400 positions of which approximately 3,500 have been eliminated since the restructuring initiative was announced in 2007.
     During the fiscal third quarter of 2007, the Company recorded $745 million in related pre-tax charges, of which, approximately $500 million of the pre-tax restructuring charges are expected to require cash payments. The $745 million of restructuring charges consists of severance costs of $450 million, asset write-offs of $272 million and $23 million related to leasehold obligations. The $272 million of asset write-offs relate to property, plant and equipment of $166 million, intangible assets of $48 million and other assets of $58 million.
     The following table summarizes the severance charges and the associated spending:
         
 
(Dollars in Millions)
  Severance  
 
2007 severance charge
  $ 450  
Cash outlays
    (46 )
 
     
Reserve balance, December 30, 2007
    404  
Cash outlays
    (226 )
 
     
Reserve balance, December 28, 2008*
  $ 178  
 
* Remaining reserve balance for severance is expected to be paid in accordance with the Company’s plans and local laws.
For additional information on the restructuring as it relates to the segments, see Note 11.
23. Fair Value Measurements
During the fiscal first quarter of 2008, the Company adopted SFAS No. 157, Fair Value Measurements except for non-financial assets and liabilities recognized or disclosed at fair value on a non-recurring basis, for which the effective date is fiscal years beginning after November 15, 2008. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.
     During the fiscal first quarter of 2008, the Company adopted SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits the Company to measure certain financial assets and financial liabilities at fair value. The Company assessed the fair value option made available upon adopting SFAS No. 159, and has elected not to apply the fair value option to any financial instruments that were not already recognized at fair value.
     SFAS No. 157 defines fair value as 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 statement 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.
     The following table provides a summary of the significant assets and liabilities that are measured at fair value as of December 28, 2008.
                                 
 
          Quoted          
          prices in          
          active   Significant      
          markets for   other   Significant  
          identical   observable   unobservable  
            assets     inputs     inputs  
(Dollars in Millions)
December 28, 2008     Level 1     Level 2     Level 3  
 
Assets:
                               
Derivative instruments
  $ 1,432           $ 1,432        
Liabilities:
                               
Derivative instruments
  $ 2,378           $ 2,378        
 
The Company uses forward exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes on future intercompany and third-party purchases of raw materials denominated in foreign currency. The Company also uses currency swaps to manage currency risk primarily related to borrowings. The fair value of derivative instruments is the aggregation, by currency, of all future cash flows discounted to present value at prevailing market interest rates, and subsequently converted to the United States 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 did not have any other significant financial assets or liabilities, which would require revised valuations under SFAS No. 157 that are recognized at fair value.
24. Subsequent Events
On January 23, 2009, the Company completed the acquisition of Mentor Corporation for a net purchase price of $1.1 billion. Mentor Corporation is a leading supplier of medical products for the global aesthetic market.


   
68
JOHNSON & JOHNSON 2008 ANNUAL REPORT

 


 

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of Johnson & Johnson:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, statements of equity, and statements of cash flows present fairly, in all material respects, the financial position of Johnson & Johnson and its subsidiaries (“the Company”) at December 28, 2008 and December 30, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying, “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over
financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
     A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
-s- PricewaterhouseCooper LLP
New York, New York
February 17, 2009


 
Management’s Report on Internal Control Over Financial Reporting

Under Section 404 of the Sarbanes-Oxley Act of 2002, management is required to assess the effectiveness of the Company’s internal control over financial reporting as of the end of each fiscal year and report, based on that assessment, whether the Company’s internal control over financial reporting is effective.
     Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance as to the reliability of the Company’s financial reporting and the preparation of external financial statements in accordance with generally accepted accounting principles.
     Internal controls over financial reporting, no matter how well designed, have inherent limitations. Therefore, internal control over financial reporting determined to be effective can provide only reasonable assurance with respect to financial statement preparation and may not prevent or detect all misstatements. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
     The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 28, 2008. In making this assessment, the Company
used the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control-Integrated Framework.” These criteria are in the areas of control environment, risk assessment, control activities, information and communication, and monitoring. The Company’s assessment included extensive documenting, evaluating and testing the design and operating effectiveness of its internal controls over financial reporting.
     Based on the Company’s processes and assessment, as described above, management has concluded that, as of December 28, 2008, the Company’s internal control over financial reporting was effective.
     The effectiveness of the Company’s internal control over financial reporting as of December 28, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which appears herein.
     
-s- William C. Weldon
  -s- Dominic J. Caruso
William C. Weldon
  Dominic J. Caruso
Chairman, Board of Directors, and Chief Executive Officer
  Vice President, Finance, and Chief Financial Officer


   
JOHNSON & JOHNSON 2008 ANNUAL REPORT
69


 

                                                                                                               
 Summary of Operations and Statistical Data 1998-2008
(Dollars in Millions Except Per Share Figures)
    2008       2007       2006       2005       2004       2003       2002       2001       2000       1999       1998  
 
Sales to customer — U.S.
    $ 32,309         32,444         29,775         28,377         27,770         25,274         22,455         19,825         17,316         15,532         12,901  
Sales to customer — International
      31,438         28,651         23,549         22,137         19,578         16,588         13,843         12,492         11,856         11,825         10,910  
                                                                   
Total sales
      63,747         61,095         53,324         50,514         47,348         41,862         36,298         32,317         29,172         27,357         23,811  
                                                                   
Cost of products sold
      18,511         17,751         15,057         14,010         13,474         12,231         10,498         9,622         8,987         8,559         7,711  
Selling, marketing and administrative expenses
      21,490         20,451         17,433         17,211         16,174         14,463         12,520         11,510         10,675         10,182         8,595  
Research expense
      7,577         7,680         7,125         6,462         5,344         4,834         4,094         3,704         3,186         2,821         2,538  
Purchased in-process research and development
      181         807         559         362         18         918         189         105         66                 298  
Interest income
      (361 )       (452 )       (829 )       (487