Attached files
| file | filename |
|---|---|
| EX-31.2 - CERTIFICATION OF CFO - Mead Johnson Nutrition Co | exhibit312-3q2014.htm |
| EX-32.1 - CERTIFICATION OF CEO - Mead Johnson Nutrition Co | exhibit321-3q2014.htm |
| EX-31.1 - CERTIFICATION OF CEO - Mead Johnson Nutrition Co | exhibit311-3q2014.htm |
| EXCEL - IDEA: XBRL DOCUMENT - Mead Johnson Nutrition Co | Financial_Report.xls |
| EX-32.2 - CERTIFICATION OF CFO - Mead Johnson Nutrition Co | exhibit322-3q2014.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Commission File Number: 001-34251
MEAD JOHNSON NUTRITION COMPANY
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 80-0318351 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
2701 Patriot Blvd.
Glenview, Illinois 60026
(Address of Principal Executive Offices and Zip Code)
Registrant’s Telephone Number, Including Area Code: (847) 832-2420
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No ý
As of October 20, 2014, there were 202,030,074 shares of the registrant’s common stock outstanding.
MEAD JOHNSON NUTRITION COMPANY
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2014
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF EARNINGS
(Dollars in millions, except per share data)
(UNAUDITED)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
NET SALES | $ | 1,090.7 | $ | 1,046.8 | $ | 3,315.1 | $ | 3,140.0 | |||||||
Cost of Products Sold | 437.9 | 362.3 | 1,270.4 | 1,129.3 | |||||||||||
GROSS PROFIT | 652.8 | 684.5 | 2,044.7 | 2,010.7 | |||||||||||
Operating Expenses: | |||||||||||||||
Selling, General and Administrative | 240.2 | 217.3 | 715.4 | 647.8 | |||||||||||
Advertising and Promotion | 158.9 | 163.8 | 489.2 | 475.9 | |||||||||||
Research and Development | 28.7 | 23.8 | 82.5 | 71.1 | |||||||||||
Other (Income)/Expenses – net | (17.6 | ) | 28.9 | (21.1 | ) | 44.9 | |||||||||
EARNINGS BEFORE INTEREST AND INCOME TAXES | 242.6 | 250.7 | 778.7 | 771.0 | |||||||||||
Interest Expense – net | 18.3 | 12.3 | 46.0 | 38.9 | |||||||||||
EARNINGS BEFORE INCOME TAXES | 224.3 | 238.4 | 732.7 | 732.1 | |||||||||||
Provision for Income Taxes | 36.0 | 68.7 | 160.5 | 199.0 | |||||||||||
NET EARNINGS | 188.3 | 169.7 | 572.2 | 533.1 | |||||||||||
Less Net Earnings Attributable to Noncontrolling Interests | 0.7 | (1.6 | ) | 10.8 | 1.8 | ||||||||||
NET EARNINGS ATTRIBUTABLE TO SHAREHOLDERS | $ | 187.6 | $ | 171.3 | $ | 561.4 | $ | 531.3 | |||||||
Earnings per Share – Basic | |||||||||||||||
Net Earnings Attributable to Shareholders | $ | 0.93 | $ | 0.85 | $ | 2.77 | $ | 2.62 | |||||||
Earnings per Share – Diluted | |||||||||||||||
Net Earnings Attributable to Shareholders | $ | 0.92 | $ | 0.84 | $ | 2.77 | $ | 2.61 | |||||||
Weighted Average Shares - Basic | 202.2 | 202.3 | 202.1 | 202.5 | |||||||||||
Weighted Average Shares – Diluted | 202.7 | 202.8 | 202.6 | 203.1 | |||||||||||
Dividends Declared per Share | $ | 0.375 | $ | 0.340 | $ | 1.125 | $ | 1.020 | |||||||
The accompanying notes are an integral part of these financial statements.
1
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in millions)
(UNAUDITED)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
NET EARNINGS | $ | 188.3 | $ | 169.7 | $ | 572.2 | $ | 533.1 | |||||||
OTHER COMPREHENSIVE INCOME/(LOSS) | |||||||||||||||
Foreign Currency Translation Adjustments | |||||||||||||||
Translation Adjustments | (28.6 | ) | (4.9 | ) | (56.5 | ) | (66.8 | ) | |||||||
Tax Benefit | (2.4 | ) | (0.6 | ) | 0.3 | 4.0 | |||||||||
Deferred Gains/(Losses) on Derivatives Qualifying as Hedges | |||||||||||||||
Deferred Gains/(Losses) on Derivatives Qualifying as Hedges for the Period | 6.0 | 1.2 | (64.3 | ) | 5.2 | ||||||||||
Reclassification Adjustment for (Gains)/Losses Included in Net Earnings | 0.5 | (0.5 | ) | (2.8 | ) | 5.7 | |||||||||
Tax Benefit/(Expense) | (1.9 | ) | (0.2 | ) | 24.5 | (3.0 | ) | ||||||||
Pension and Other Post-employment Benefits | |||||||||||||||
Reclassification Adjustment for Losses Included in Net Earnings | — | — | 0.2 | — | |||||||||||
OTHER COMPREHENSIVE LOSS | (26.4 | ) | (5.0 | ) | (98.6 | ) | (54.9 | ) | |||||||
COMPREHENSIVE INCOME | 161.9 | 164.7 | 473.6 | 478.2 | |||||||||||
Less Comprehensive Income/(Loss) Attributable to Noncontrolling Interests | 0.2 | (3.8 | ) | 4.0 | (7.3 | ) | |||||||||
COMPREHENSIVE INCOME ATTRIBUTABLE TO SHAREHOLDERS | $ | 161.7 | $ | 168.5 | $ | 469.6 | $ | 485.5 | |||||||
The accompanying notes are an integral part of these financial statements.
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MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED BALANCE SHEETS
(Dollars and shares in millions, except per share data)
(UNAUDITED)
September 30, 2014 | December 31, 2013 | ||||||
ASSETS | |||||||
CURRENT ASSETS: | |||||||
Cash and Cash Equivalents | $ | 1,195.2 | $ | 1,050.8 | |||
Receivables – net of allowances of $11.5 and $6.5, respectively | 412.1 | 384.4 | |||||
Inventories | 559.1 | 534.8 | |||||
Deferred Income Taxes – net of valuation allowance | 87.1 | 75.3 | |||||
Income Taxes Receivable | 15.2 | 15.9 | |||||
Prepaid Expenses and Other Assets | 68.1 | 56.9 | |||||
Total Current Assets | 2,336.8 | 2,118.1 | |||||
Property, Plant and Equipment – net | 897.4 | 867.5 | |||||
Goodwill | 170.5 | 196.8 | |||||
Other Intangible Assets – net | 77.8 | 97.5 | |||||
Deferred Income Taxes – net of valuation allowance | 58.9 | 37.0 | |||||
Other Assets | 150.4 | 157.2 | |||||
TOTAL | $ | 3,691.8 | $ | 3,474.1 | |||
LIABILITIES AND EQUITY | |||||||
CURRENT LIABILITIES: | |||||||
Short-term Borrowings | $ | 1.2 | $ | 2.0 | |||
Accounts Payable | 519.4 | 566.8 | |||||
Dividends Payable | 76.5 | 69.3 | |||||
Current Portion of Long-Term Debt | — | 505.6 | |||||
Accrued Expenses | 219.4 | 220.0 | |||||
Accrued Rebates and Returns | 343.8 | 314.9 | |||||
Deferred Income – current | 13.9 | 46.6 | |||||
Income Taxes – payable and deferred | 62.9 | 56.1 | |||||
Total Current Liabilities | 1,237.1 | 1,781.3 | |||||
Long-Term Debt | 1,496.8 | 1,009.1 | |||||
Deferred Income Taxes – noncurrent | 13.5 | 15.3 | |||||
Pension and Other Post-employment Liabilities | 174.1 | 161.8 | |||||
Other Liabilities | 185.4 | 156.4 | |||||
Total Liabilities | 3,106.9 | 3,123.9 | |||||
COMMITMENTS AND CONTINGENCIES | |||||||
REDEEMABLE NONCONTROLLING INTEREST | 61.1 | 49.7 | |||||
EQUITY | |||||||
Shareholders’ Equity | |||||||
Common Stock, $0.01 par value: 3,000 authorized, 207.6 and 206.8 issued, respectively | 2.1 | 2.1 | |||||
Additional Paid-in/(Distributed) Capital | (671.7 | ) | (721.5 | ) | |||
Retained Earnings | 1,748.2 | 1,432.3 | |||||
Treasury Stock – at cost | (408.3 | ) | (351.9 | ) | |||
Accumulated Other Comprehensive Loss | (161.0 | ) | (69.2 | ) | |||
Total Shareholders’ Equity | 509.3 | 291.8 | |||||
Noncontrolling Interests | 14.5 | 8.7 | |||||
Total Equity | 523.8 | 300.5 | |||||
TOTAL | $ | 3,691.8 | $ | 3,474.1 | |||
The accompanying notes are an integral part of these financial statements.
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MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF EQUITY AND REDEEMABLE NONCONTROLLING INTEREST
(Dollars in millions)
(UNAUDITED)
Common Stock | Additional Paid-in (Distributed) Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Loss | Non- controlling Interests | Total Equity | Redeemable Non- controlling Interest | ||||||||||||||||||||||||
Balance as of January 1, 2014 | $ | 2.1 | $ | (721.5 | ) | $ | 1,432.3 | $ | (351.9 | ) | $ | (69.2 | ) | $ | 8.7 | $ | 300.5 | $ | 49.7 | ||||||||||||
Stock-based Compensation Awards | 49.8 | (7.9 | ) | 41.9 | |||||||||||||||||||||||||||
Treasury Stock Acquired | (48.5 | ) | (48.5 | ) | |||||||||||||||||||||||||||
Distributions to Noncontrolling Interests | (4.4 | ) | (4.4 | ) | — | ||||||||||||||||||||||||||
Cash Dividends Declared | (227.9 | ) | (227.9 | ) | |||||||||||||||||||||||||||
Net Earnings | 561.4 | 10.2 | 571.6 | 0.6 | |||||||||||||||||||||||||||
Redeemable Noncontrolling Interest Accretion | (17.6 | ) | (17.6 | ) | 17.6 | ||||||||||||||||||||||||||
Other Comprehensive Loss | (91.8 | ) | — | (91.8 | ) | (6.8 | ) | ||||||||||||||||||||||||
Balance as of September 30, 2014 | $ | 2.1 | $ | (671.7 | ) | $ | 1,748.2 | $ | (408.3 | ) | $ | (161.0 | ) | $ | 14.5 | $ | 523.8 | $ | 61.1 | ||||||||||||
Balance as of January 1, 2013 | $ | 2.1 | $ | (772.8 | ) | $ | 1,052.4 | $ | (244.6 | ) | $ | (18.4 | ) | $ | 10.3 | $ | 29.0 | $ | 36.3 | ||||||||||||
Stock-based Compensation Awards | 45.9 | (17.9 | ) | 28.0 | |||||||||||||||||||||||||||
Treasury Stock Acquired | (76.6 | ) | (76.6 | ) | |||||||||||||||||||||||||||
Distributions to Noncontrolling Interests | (3.7 | ) | (3.7 | ) | (1.2 | ) | |||||||||||||||||||||||||
Cash Dividends Declared | (206.9 | ) | (206.9 | ) | |||||||||||||||||||||||||||
Net Earnings | 531.3 | 1.3 | 532.6 | 0.5 | |||||||||||||||||||||||||||
Redeemable Noncontrolling Interest Accretion | (21.6 | ) | (21.6 | ) | 21.6 | ||||||||||||||||||||||||||
Other Comprehensive Income/(Loss) | (45.8 | ) | 2.0 | (43.8 | ) | (11.1 | ) | ||||||||||||||||||||||||
Balance as of September 30, 2013 | $ | 2.1 | $ | (726.9 | ) | $ | 1,355.2 | $ | (339.1 | ) | $ | (64.2 | ) | $ | 9.9 | $ | 237.0 | $ | 46.1 | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in millions)
(UNAUDITED)
Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net Earnings | $ | 572.2 | $ | 533.1 | |||
Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities: | |||||||
Depreciation and Amortization | 67.8 | 62.1 | |||||
Other | 30.2 | 29.9 | |||||
Changes in Assets and Liabilities | (56.4 | ) | (27.0 | ) | |||
Payments for Settlement of Interest Rate Forward Swaps | (45.0 | ) | — | ||||
Pension and Other Post-employment Benefits Contributions | (4.2 | ) | (6.1 | ) | |||
Net Cash Provided by Operating Activities | 564.6 | 592.0 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Payments for Capital Expenditures | (144.0 | ) | (177.3 | ) | |||
Proceeds from Sale of Property, Plant and Equipment | 0.2 | 2.0 | |||||
Proceeds from/(Investment in) Other Companies | 4.0 | (2.7 | ) | ||||
Net Cash Used in Investing Activities | (139.8 | ) | (178.0 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Proceeds from Short-term Borrowings | 3.2 | 6.8 | |||||
Repayments of Short-term Borrowings | (3.5 | ) | (165.0 | ) | |||
Repayments of Notes Payable | (500.0 | ) | (27.6 | ) | |||
Payments of Dividends | (220.7 | ) | (198.9 | ) | |||
Stock-based-compensation-related Proceeds and Excess Tax Benefits | 27.3 | 19.8 | |||||
Purchases of Treasury Stock | (57.6 | ) | (92.5 | ) | |||
Long-term Debt Borrowings, net of original issue discount and expenses paid | 492.3 | — | |||||
Distributions to Noncontrolling Interests | (4.4 | ) | (4.9 | ) | |||
Net Cash Used in Financing Activities | (263.4 | ) | (462.3 | ) | |||
Effects of Changes in Exchange Rates on Cash and Cash Equivalents | (17.0 | ) | (8.6 | ) | |||
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS | 144.4 | (56.9 | ) | ||||
CASH AND CASH EQUIVALENTS: | |||||||
Beginning of Period | 1,050.8 | 1,042.1 | |||||
End of Period | $ | 1,195.2 | $ | 985.2 | |||
The accompanying notes are an integral part of these financial statements.
5
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION
Mead Johnson Nutrition Company (“MJN” or the “Company”) manufactures, distributes and sells infant formulas, children’s nutrition and other nutritional products. MJN has a broad product portfolio, which extends across routine and specialty infant formulas, children’s milks and milk modifiers, dietary supplements for pregnant and breastfeeding mothers, pediatric vitamins, and products for pediatric metabolic disorders. These products are generally sold to wholesalers, retailers and distributors and are promoted to healthcare professionals, and, where permitted by regulation and policy, directly to consumers.
2. ACCOUNTING POLICIES
Basis of Presentation—The Company prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Under those rules, certain footnotes and other financial information that are normally required by GAAP for annual financial statements have been condensed or omitted. The Company is responsible for the financial statements and the related notes included in this Form 10-Q.
The consolidated financial statements include all of the normal and recurring adjustments necessary for the fair presentation of the Company’s financial position as of September 30, 2014 and December 31, 2013, results of operations and cash flows for the nine months ended September 30, 2014 and 2013. Intercompany balances and transactions have been eliminated. Revenues, expenses, assets and liabilities can vary during each quarter of the year. Accordingly, the results and trends in these unaudited consolidated financial statements may not be indicative of full-year operating results or future performance.
The accounting policies used in preparing these consolidated financial statements are the same as those used to prepare the Company’s annual report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”) with the exception of the Company’s pension accounting policy which is discussed below under “Change in Accounting Principles.” These unaudited consolidated financial statements and the related notes should be read in conjunction with the audited year-end financial statements and accompanying notes included in the Company’s Current Report on Form 8-K filed with the SEC on April 24, 2014 which revised and superseded the corresponding portions of the 2013 Form 10-K.
Recently Adopted Accounting Standards—In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-05, Foreign Currency Matters (Topic 830), clarifying the applicable guidance for the release of the cumulative translation adjustment. ASU 2013-05 was effective for the Company in the period beginning January 1, 2014. The adoption of this update did not have a material impact on the consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists. ASU 2013-11 requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. ASU 2013-11 was effective for the Company beginning January 1, 2014 and the adoption of this standard did not have a material impact on the consolidated financial statements.
Recently Issued Accounting Standards—In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The updated standard will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for MJN in the first quarter of 2017. The Company is currently evaluating the effect, if any, that the updated standard will have on its consolidated financial statements and related disclosures.
Change in Accounting Principles—During the first quarter of 2014, the Company changed its accounting principles for the recognition of actuarial gains and losses for all of its defined benefit pension and other post-employment benefit plans and the calculation of expected return on pension plan assets. Historically, the Company recognized actuarial gains and losses as a component of accumulated other comprehensive loss in its Consolidated Balance Sheets and amortized them into the Consolidated Statements of Earnings over the average future service period of the active employees of these plans to the extent such gains and losses were outside of a corridor. Starting in the first quarter of 2014, the Company elected to immediately recognize actuarial gains and losses in its Consolidated Statements of Earnings on the basis that it is preferable to accelerate the
6
recognition of such gains and losses into earnings rather than to delay them over time. Additionally, for purposes of calculating the expected return on pension plan assets, the Company previously used a calculated value for the market-related valuation of pension plan assets. With this change in accounting principle, the Company now uses the actual fair value of pension plan assets. These changes improve transparency in operating results by immediately recognizing the effects of external conditions on plan obligations, investments and assumptions.
Under these changes in accounting principles, actuarial gains and losses from these plans are recognized upon plan remeasurement in the fourth quarter of each year, or more frequently if a remeasurement occurs. The remaining components of net periodic benefit cost, primarily interest on projected benefit obligation and the expected return on pension plan assets, continue to be recorded on a quarterly basis. Actuarial gains and losses are recognized within Corporate and Other and the remaining components of net periodic benefit costs are recognized in the respective reportable segments.
The Company has applied both of these accounting changes, immediate recognition of actuarial gains or losses and use of actual fair value to calculate expected return on pension plan assets, retrospectively to all periods presented. The cumulative effect of these changes on additional-paid-in/(distributed) capital and retained earnings on the Company’s opening balance sheet as of January 1, 2013 was a decrease of $96.2 million and an increase of $72.4 million, respectively, with an offsetting adjustment to accumulated other comprehensive loss. These changes had no impact on cash flows for the interim periods presented. The following tables present the effects of retrospectively applying these accounting changes for the periods presented:
Three Months Ended September 30, 2013 | Nine Months Ended September 30, 2013 | ||||||||||||||||||||||
Previously Reported | Impact of Change | Recast | Previously Reported | Impact of Change | Recast | ||||||||||||||||||
(in millions except per share data) | |||||||||||||||||||||||
Consolidated Statements of Earnings | |||||||||||||||||||||||
Cost of Products Sold | $ | 365.5 | $ | (3.2 | ) | $ | 362.3 | $ | 1,140.8 | $ | (11.5 | ) | $ | 1,129.3 | |||||||||
Selling, General and Administrative | 222.6 | (5.3 | ) | 217.3 | 666.8 | $ | (19.0 | ) | 647.8 | ||||||||||||||
Research and Development | 24.8 | (1.0 | ) | 23.8 | 74.5 | $ | (3.4 | ) | 71.1 | ||||||||||||||
Other (Income)/Expenses – net | 31.4 | (2.5 | ) | 28.9 | 62.6 | $ | (17.7 | ) | 44.9 | ||||||||||||||
EARNINGS BEFORE INTEREST AND INCOME TAXES | 238.7 | 12.0 | 250.7 | 719.4 | $ | 51.6 | 771.0 | ||||||||||||||||
EARNINGS BEFORE INCOME TAXES | 226.4 | 12.0 | 238.4 | 680.5 | $ | 51.6 | 732.1 | ||||||||||||||||
Provision for Income Taxes | 66.4 | 2.3 | 68.7 | 182.4 | $ | 16.6 | 199.0 | ||||||||||||||||
NET EARNINGS | 160.0 | 9.7 | 169.7 | 498.1 | $ | 35.0 | 533.1 | ||||||||||||||||
NET EARNINGS ATTRIBUTABLE TO SHAREHOLDERS | 161.6 | 9.7 | 171.3 | 496.3 | $ | 35.0 | 531.3 | ||||||||||||||||
Earnings per Share – Basic | $ | 0.80 | $ | 0.05 | $ | 0.85 | $ | 2.45 | $ | 0.17 | $ | 2.62 | |||||||||||
Earnings per Share – Diluted | $ | 0.79 | $ | 0.05 | $ | 0.84 | $ | 2.44 | $ | 0.17 | $ | 2.61 | |||||||||||
Consolidated Statements of Comprehensive Income | |||||||||||||||||||||||
Deferred Gains on Pension and Other Post-employment Benefits | $ | — | — | $ | — | $ | 0.8 | (0.8 | ) | $ | — | ||||||||||||
Reclassification Adjustment for Losses Included in Net Earnings | 4.5 | (4.5 | ) | — | 23.9 | (23.9 | ) | — | |||||||||||||||
Tax Benefit/(Expense) | 0.5 | (0.5 | ) | — | (6.6 | ) | 6.6 | — | |||||||||||||||
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December 31, 2013 | ||||||||||||
Previously Reported | Impact of Change | Recast | ||||||||||
(in millions) | ||||||||||||
Consolidated Balance Sheets | ||||||||||||
Additional Paid-in/(Distributed) Capital | $ | (625.3 | ) | $ | (96.2 | ) | $ | (721.5 | ) | |||
Retained Earnings | 1,470.4 | (38.1 | ) | 1,432.3 | ||||||||
Accumulated Other Comprehensive Loss | (203.5 | ) | 134.3 | (69.2 | ) | |||||||
3. EARNINGS PER SHARE
The numerator for basic and diluted earnings per share is net earnings attributable to shareholders reduced by dividends and undistributed earnings attributable to unvested shares. The denominator for basic earnings per share is the weighted-average shares outstanding during the period. The denominator for diluted earnings per share is the weighted-average shares outstanding adjusted for the effect of dilutive stock options and performance share awards.
The following table presents the calculation of basic and diluted earnings per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In millions, except per share data) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Basic earnings per share: | ||||||||||||||||
Weighted-average shares outstanding | 202.2 | 202.3 | 202.1 | 202.5 | ||||||||||||
Net earnings attributable to shareholders | $ | 187.6 | $ | 171.3 | $ | 561.4 | $ | 531.3 | ||||||||
Dividends and undistributed earnings attributable to unvested shares | (0.3 | ) | (0.3 | ) | (1.0 | ) | (1.1 | ) | ||||||||
Net earnings attributable to shareholders used for basic earnings per share calculation | $ | 187.3 | $ | 171.0 | $ | 560.4 | $ | 530.2 | ||||||||
Net earnings attributable to shareholders per share | $ | 0.93 | $ | 0.85 | $ | 2.77 | $ | 2.62 | ||||||||
Diluted earnings per share: | ||||||||||||||||
Weighted-average shares outstanding | 202.2 | 202.3 | 202.1 | 202.5 | ||||||||||||
Incremental shares outstanding assuming the exercise/vesting of dilutive stock options/performance shares | 0.5 | 0.5 | 0.5 | 0.6 | ||||||||||||
Weighted-average shares — diluted | 202.7 | 202.8 | 202.6 | 203.1 | ||||||||||||
Net earnings attributable to shareholders | $ | 187.6 | $ | 171.3 | $ | 561.4 | $ | 531.3 | ||||||||
Dividends and undistributed earnings attributable to unvested shares | (0.3 | ) | (0.3 | ) | (1.0 | ) | (1.1 | ) | ||||||||
Net earnings attributable to shareholders used for diluted earnings per share calculation | $ | 187.3 | $ | 171.0 | $ | 560.4 | $ | 530.2 | ||||||||
Net earnings attributable to shareholders per share | $ | 0.92 | $ | 0.84 | $ | 2.77 | $ | 2.61 | ||||||||
Potential shares outstanding from all stock-based awards were 2.8 million and 2.9 million as of September 30, 2014 and 2013, respectively. Of these shares, 2.3 million and 2.4 million were not included in the diluted earnings per share calculation for the three months ended September 30, 2014 and 2013, respectively, and 2.3 million were not included in the diluted earnings per share calculation for the nine months ended September 30, 2014 and 2013, respectively.
4. INCOME TAXES
For the three months ended September 30, 2014, the effective tax rate (“ETR”) was 16.0% compared with 28.8% for the same period in 2013. This decrease was primarily due to a change in the reserve for uncertain tax positions, the majority of which relates to the running of the statute of limitations in various jurisdictions during the third quarter of 2014, and the third quarter 2013 administrative penalty in China which was non-deductible for tax purposes.
For the nine months ended September 30, 2014, the ETR was 21.9% compared with 27.2% for the same period in 2013. This decrease was primarily due to the running of the statute of limitations as noted above, favorable geographic earnings mix, and the non-deductible third quarter 2013 administrative penalty in China.
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The Company’s gross reserve for uncertain tax positions, including penalties and interest, as of September 30, 2014 and December 31, 2013, was $137.2 million and $117.4 million, respectively. The Company believes that it has adequately provided for all uncertain tax positions. The Company is currently under examination by taxing authorities in various jurisdictions in which it operates, including the United States. It is reasonably possible that new issues may be raised by tax authorities and that these issues may require adjustments to the balance of uncertain tax positions.
Pursuant to the Amended and Restated Tax Matters Agreement dated December 18, 2009, Bristol-Myers Squibb Company (“BMS”), the Company’s former parent, maintains responsibility for all uncertain tax positions which may exist in the pre-initial public offering period or which may exist as a result of the initial public offering transaction. The Company has a receivable from BMS for uncertain tax positions, including penalties and interest, of $9.5 million and $8.9 million as of September 30, 2014 and December 31, 2013 respectively.
5. SEGMENT INFORMATION
MJN operates in four geographic operating segments: Asia, Europe, Latin America and North America. This operating segmentation is how the chief operating decision maker regularly assesses information for decision making purposes, including allocation of resources. Due to similarities between North America and Europe, the Company aggregated these two operating segments into one reportable segment. As a result, the Company has three reportable segments: Asia, Latin America and North America/Europe.
Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment plans; and income or expenses incurred within the operating segments that are not reflective of ongoing operations and affect the comparability of the operating segments’ results.
During the first quarter of 2014, the Company changed its accounting principles for the recognition of actuarial gains and losses for all of its defined benefit pension and other post-employment plans and the calculation of expected return on pension plan assets (See Note 2 for a discussion of the change in accounting principles). The Company has applied these accounting changes retrospectively to all periods presented and to all reportable segments as well as Corporate and Other.
The following table summarizes net sales and earnings before interest and income taxes for each of the reportable segments:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
Net Sales | Earnings Before Interest and Income Taxes | Net Sales | Earnings Before Interest and Income Taxes | |||||||||||||||||||||||||||||
(In millions) | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | ||||||||||||||||||||||||
Asia | $ | 561.5 | $ | 546.7 | $ | 186.2 | $ | 199.6 | $ | 1,729.8 | $ | 1,635.1 | $ | 623.4 | $ | 613.2 | ||||||||||||||||
Latin America | 222.9 | 221.3 | 52.6 | 62.5 | 659.7 | 645.6 | 152.6 | 157.1 | ||||||||||||||||||||||||
North America/Europe | 306.3 | 278.8 | 66.8 | 64.7 | 925.6 | 859.3 | 200.9 | 192.6 | ||||||||||||||||||||||||
Total reportable segments | 1,090.7 | 1,046.8 | 305.6 | 326.8 | 3,315.1 | 3,140.0 | 976.9 | 962.9 | ||||||||||||||||||||||||
Corporate and Other | — | — | (63.0 | ) | (76.1 | ) | — | — | (198.2 | ) | (191.9 | ) | ||||||||||||||||||||
Total | $ | 1,090.7 | $ | 1,046.8 | $ | 242.6 | $ | 250.7 | $ | 3,315.1 | $ | 3,140.0 | $ | 778.7 | $ | 771.0 | ||||||||||||||||
6. EMPLOYEE STOCK BENEFIT PLANS
The following table summarizes stock-based compensation expense related to stock options, performance share awards and restricted stock units.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Stock options | $ | 1.8 | $ | 1.6 | $ | 5.3 | $ | 4.9 | ||||||||
Performance share awards | 2.9 | 3.5 | 9.7 | 12.9 | ||||||||||||
Restricted stock units | 2.8 | 2.2 | 7.8 | 7.9 | ||||||||||||
Total pre-tax stock-based compensation expense | $ | 7.5 | $ | 7.3 | $ | 22.8 | $ | 25.7 | ||||||||
Net tax benefit related to stock-based compensation expense | $ | (2.5 | ) | $ | (2.6 | ) | $ | (7.8 | ) | $ | (8.8 | ) | ||||
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During the nine months ended September 30, 2014, the Company granted the following awards:
(Shares in millions) | Shares Granted | Weighted- Average Grant Date Fair Value | |||||
Stock options | 0.4 | $ | 17.59 | ||||
Performance share awards | 0.2 | $ | 78.67 | ||||
Restricted stock units | 0.2 | $ | 83.13 | ||||
As of September 30, 2014, the Company had the following award expense yet to be recognized:
(Dollars and shares in millions) | Unrecognized Compensation Expense | Expected Weighted-Average Period to be Recognized (years) | ||||
Stock options | $ | 9.5 | 1.9 | |||
Performance share awards | $ | 10.9 | 1.4 | |||
Restricted stock units | $ | 22.5 | 2.5 | |||
7. PENSION AND OTHER POST-EMPLOYMENT BENEFIT PLANS
During the first quarter of 2014, the Company changed its accounting principles for the recognition of actuarial gains and losses for all of its defined benefit pension and other post-employment benefit plans and the calculation of expected return on pension plan assets. Historically, the Company recognized actuarial gains and losses as a component of accumulated other comprehensive loss in its Consolidated Balance Sheets and amortized them into its Consolidated Statements of Earnings over the average future service period of the active employees of these plans to the extent that such gains and losses were outside of a corridor. The Company elected to immediately recognize actuarial gains and losses in its Consolidated Statements of Earnings on the basis that it is preferable to accelerate the recognition of such gains and losses into earnings rather than to delay them over time. Additionally, for purposes of calculating the expected return on pension plan assets, the Company previously used a calculated value for the market-related valuation of pension plan assets. With this change in accounting, the Company now uses the actual fair value of pension plan assets. These changes improve transparency in operating results by immediately recognizing the effects of external conditions on plan obligations, investments and assumptions. Under the changes in accounting principle, actuarial gains and losses from these plans are recognized upon plan remeasurement in the fourth quarter of each year, or more frequently if a remeasurement occurs. The Company has applied these changes retrospectively, adjusting the comparative periods presented (see Note 2 for discussion of the change in accounting principles).
The net periodic benefit cost of the Company’s defined benefit pension and post-employment benefit plans includes:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
Pension Benefits | Other Benefits | Pension Benefits | Other Benefits | |||||||||||||||||||||||||||||
(In millions) | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | ||||||||||||||||||||||||
Service cost – benefits earned during the period | $ | 0.8 | $ | 1.3 | $ | 0.2 | $ | 0.3 | $ | 3.6 | $ | 3.9 | $ | 0.6 | $ | 0.8 | ||||||||||||||||
Interest cost on projected benefit obligations | 3.6 | 3.6 | 0.4 | 0.4 | 11.2 | 10.8 | 1.2 | 1.0 | ||||||||||||||||||||||||
Amortization of transition cost | — | — | — | — | 0.2 | — | — | — | ||||||||||||||||||||||||
Expected return on plan assets | (3.8 | ) | (4.3 | ) | — | — | (11.6 | ) | (12.8 | ) | — | — | ||||||||||||||||||||
Amortization of prior service benefit | — | — | — | (0.1 | ) | — | — | — | (0.1 | ) | ||||||||||||||||||||||
Net periodic benefit cost | $ | 0.6 | $ | 0.6 | $ | 0.6 | $ | 0.6 | $ | 3.4 | $ | 1.9 | $ | 1.8 | $ | 1.7 | ||||||||||||||||
Curtailments | (5.4 | ) | — | — | — | (5.4 | ) | — | — | — | ||||||||||||||||||||||
Net Actuarial (Gains)/Losses | 9.3 | (7.3 | ) | — | — | 16.4 | (27.2 | ) | — | — | ||||||||||||||||||||||
Total net periodic benefit cost | $ | 4.5 | $ | (6.7 | ) | $ | 0.6 | $ | 0.6 | $ | 14.4 | $ | (25.3 | ) | $ | 1.8 | $ | 1.7 | ||||||||||||||
The Company remeasures its U.S. pension plan when year-to-date aggregate lump sum settlements exceed anticipated interest costs for the year and in each subsequent quarter of that fiscal year as well as at year-end. Because aggregate lump sum settlements exceeded anticipated interest costs for 2014 during the second quarter, the Company remeasured its U.S. pension plan in both the second and third quarter of 2014. During the three and nine months ended September 30, 2014, the Company recognized a net actuarial loss of $9.3 million and $16.4 million, respectively.
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In addition, in the second quarter of 2014, MJN changed the yield curve used in the determination of its discount rate for purposes of measuring the obligation related to the Company’s U.S. pension plan. This change results in a better, more refined estimate of the pension obligation. The change in the yield curve resulted in an approximate $8 million gain which was offset by the remeasurement of the U.S. pension plan.
During the three and nine months ended September 30, 2014, the Company recognized a gain of $5.4 million within Other Expenses/(Income) - net related to the curtailment of a defined benefit pension plan outside the U.S.
For the nine months ended September 30, 2014 and 2013, the Company contributed $4.2 million and $6.1 million, respectively, to pension plans, primarily outside the U.S.
8. OTHER (INCOME)/EXPENSES - NET
The components of other (income)/expenses - net were:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Foreign exchange (gains)/losses - net | $ | (8.2 | ) | $ | 2.1 | $ | (6.0 | ) | $ | 6.9 | ||||||
Administrative penalty (China) | — | 26.0 | — | 33.4 | ||||||||||||
Gain on sale of investment | — | — | (4.0 | ) | — | |||||||||||
Pension curtailment gain | (5.4 | ) | — | (5.4 | ) | — | ||||||||||
Other - net | (4.0 | ) | 0.8 | (5.7 | ) | 4.6 | ||||||||||
Other (income)/expenses - net | $ | (17.6 | ) | $ | 28.9 | $ | (21.1 | ) | $ | 44.9 | ||||||
Foreign exchange (gains)/losses - net for the three and nine months ended September 30, 2014 includes gains in the amount of $5.1 million and $13.7 million, respectively, as a result of the Company’s exchange of Bolivares Fuertes for U.S. dollars through a Venezuela government exchange at a rate more favorable than the rate used to remeasure net monetary assets of its Venezuelan subsidiary. In addition, for the nine months ended September 30, 2014, foreign exchange (gains)/losses - net includes a $6.1 million loss related to the Company’s February 2014 adoption of a new exchange rate for purposes of remeasuring the monetary assets and liabilities of its Venezuelan subsidiary. See Note 18 for additional information.
9. REDEEMABLE NONCONTROLLING INTEREST
On March 15, 2012, the Company acquired 80% of the outstanding capital stock of Nutricion para el Conosur S.A. which manufactures, distributes and sells infant formula and children’s nutrition products in Argentina under the SanCor Bebé and Bebé Plus brands (the “Argentine Acquisition”). Under the terms of an agreement related to the Argentine Acquisition, the noncontrolling interest owner has the right to require MJN to purchase (the “Put Right”) its remaining 20% interest or to sell (the “Call Right”) up to an additional 20% of the outstanding capital stock of Nutricion para el Conosur S.A. The Put Right is exercisable from September 15, 2015 to September 15, 2018 and the decision to exercise is not within the control of MJN. The price paid upon exercise will be determined based on established multiples of sales and earnings of the acquired business and is currently estimated to equate to fair value at the earliest exercise date. As a result of the Put Right, the noncontrolling interest is presented as redeemable noncontrolling interest outside of equity on the balance sheet. Accretion to the redemption value of the Put Right is being recognized through equity using an interest method over the period from March 15, 2012 to September 15, 2015.
10. NET EARNINGS ATTRIBUTABLE TO NONCONTROLLING INTERESTS
Net earnings attributable to noncontrolling interests consists of a 20%, 11% and 10% interest held by third parties in operating entities in Argentina, China and Indonesia, respectively.
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11. INVENTORIES
The major categories of inventories were as follows:
(In millions) | September 30, 2014 | December 31, 2013 | ||||||
Finished goods | $ | 290.6 | $ | 312.7 | ||||
Work in process | 100.1 | 82.5 | ||||||
Raw and packaging materials | 168.4 | 139.6 | ||||||
Inventories | $ | 559.1 | $ | 534.8 | ||||
12. PROPERTY, PLANT AND EQUIPMENT
The major categories of property, plant and equipment were as follows:
(In millions) | September 30, 2014 | December 31, 2013 | ||||||
Land | $ | 12.6 | $ | 12.6 | ||||
Buildings | 725.6 | 550.8 | ||||||
Machinery, equipment and fixtures | 736.1 | 650.3 | ||||||
Construction in progress | 69.8 | 260.9 | ||||||
Accumulated depreciation | (646.7 | ) | (607.1 | ) | ||||
Property, plant and equipment — net | $ | 897.4 | $ | 867.5 | ||||
For the nine months ended September 30, 2014, buildings and machinery, equipment and fixtures increased primarily due to the in-service placement of the Company’s new manufacturing and technology center in Singapore.
13. GOODWILL
The Company tests goodwill for impairment in the third quarter of each year and whenever an event occurs or circumstances change that would, more likely than not, reduce the fair value of a reporting unit below its carrying amount. The Company completed its annual impairment test in the third quarter of 2014 and concluded that no impairment existed.
For the nine months ended September 30, 2013, the change in the carrying amount of goodwill by reportable segment was primarily driven by the cumulative impact of a correction in the currency denomination of the goodwill related to two reporting units. The revision had the impact of decreasing the Company’s total value of goodwill and decreasing the total currency translation adjustment included in the accumulated other comprehensive loss section of shareholders’ equity and other comprehensive income.
For the nine months ended September 30, 2014 and 2013, the change in the carrying amount of goodwill by reportable segment was as follows:
(In millions) | Asia | Latin America | North America/ Europe | Total | |||||||||||
Balance as of January 1, 2014 | $ | — | $ | 177.8 | $ | 19.0 | $ | 196.8 | |||||||
Translation adjustments | — | (26.3 | ) | — | (26.3 | ) | |||||||||
Balance as of September 30, 2014 | $ | — | $ | 151.5 | $ | 19.0 | $ | 170.5 | |||||||
Balance as of January 1, 2013 | $ | — | $ | 253.6 | $ | 17.0 | $ | 270.6 | |||||||
Redenomination | — | (42.5 | ) | 2.0 | (40.5 | ) | |||||||||
Translation adjustments | — | (20.8 | ) | — | (20.8 | ) | |||||||||
Balance as of September 30, 2013 | $ | — | $ | 190.3 | $ | 19.0 | $ | 209.3 | |||||||
As of September 30, 2014, the Company had no accumulated impairment loss.
14. OTHER INTANGIBLE ASSETS
The Company tests intangible assets not subject to amortization for impairment in the third quarter of each year and whenever an event occurs or circumstances change that indicate that it is more likely than not that the asset is impaired. The Company completed its annual impairment test in the third quarter of 2014 and concluded that no impairment existed.
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The gross carrying value and accumulated amortization by class of intangible assets as of September 30, 2014 and December 31, 2013 were as follows:
As of September 30, 2014 | As of December 31, 2013 | |||||||||||||||||||||||
(In millions) | Gross Carrying Amount | Accumulated Amortization | Net Book Value | Gross Carrying Amount | Accumulated Amortization | Net Book Value | ||||||||||||||||||
Indefinite-lived intangible assets: | ||||||||||||||||||||||||
Trademark(1) . | $ | 26.4 | $ | — | $ | 26.4 | $ | 34.5 | $ | — | $ | 34.5 | ||||||||||||
Non-compete agreement(1) . | 5.2 | — | 5.2 | 6.8 | — | 6.8 | ||||||||||||||||||
Sub-total | 31.6 | — | 31.6 | 41.3 | — | 41.3 | ||||||||||||||||||
Amortizable intangible assets: | ||||||||||||||||||||||||
Computer software | 128.2 | (83.9 | ) | 44.3 | 132.8 | (79.3 | ) | 53.5 | ||||||||||||||||
Distributor-customer relationship(1) . | 2.5 | (0.6 | ) | 1.9 | 3.3 | (0.6 | ) | 2.7 | ||||||||||||||||
Sub-total | 130.7 | (84.5 | ) | 46.2 | 136.1 | (79.9 | ) | 56.2 | ||||||||||||||||
Total other intangible assets | $ | 162.3 | $ | (84.5 | ) | $ | 77.8 | $ | 177.4 | $ | (79.9 | ) | $ | 97.5 | ||||||||||
(1) Changes in balances result from currency translation and amortization.
15. DEBT
Short-Term Borrowings and Five-Year Revolving Credit Facility Agreement
As of September 30, 2014 and December 31, 2013 the Company’s short-term borrowings were $1.2 million and $2.0 million, respectively, which consisted of borrowings made by the Company’s subsidiary in Argentina. These short-term borrowings had a weighted-average interest rate of 30% as of September 30, 2014. The Company intends to repay these borrowings within 12 months and has the ability to do so.
During the nine months ended September 30, 2014, the Company amended its revolving credit facility agreement to provide for, among other things, an increase in the aggregate amount available for borrowing under the facility, the addition of certain financial institutions as lenders and the extension of the facility’s maturity date. The amended credit facility is unsecured and repayable at maturity in June 2019, subject to annual extensions if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at any one time under the amended facility is $750.0 million, which may be increased from time to time up to $1.0 billion at the Company’s request, subject to obtaining additional commitments and other customary conditions. The credit facility contains financial covenants, whereby the ratio of consolidated total debt to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (“EBITDA”) cannot exceed 3.50 to 1.0, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.0 to 1.0. The Company was in compliance with these covenants as of September 30, 2014. Borrowings from the Company’s credit facility are used for working capital and other general corporate purposes. As of September 30, 2014, the Company had $750.0 million available under this facility.
Borrowings under the credit facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period, or (b) a floating rate based upon JPMorgan Chase Bank’s prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company’s credit rating. The margin can range from 0% to 1.375% over the base rate. In addition, the Company incurs an annual 0.125% facility fee on the entire facility commitment of $750.0 million.
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Long-Term Debt
The components of long-term debt were as follows:
(Dollars in millions) | September 30, 2014 | December 31, 2013 | ||||||
Principal Value: | ||||||||
3.50% Notes due 2014 | $ | — | $ | 500.0 | ||||
4.90% Notes due 2019 | 700.0 | 700.0 | ||||||
5.90% Notes due 2039 | 300.0 | 300.0 | ||||||
4.60% Notes due 2044 | 500.0 | — | ||||||
Sub-total | 1,500.0 | 1,500.0 | ||||||
Adjustments to Principal Value: | ||||||||
Unamortized basis adjustment for settled interest rate swaps | 9.3 | 16.7 | ||||||
Unamortized bond discount | (4.1 | ) | (2.0 | ) | ||||
Fair value interest rate swaps | (8.4 | ) | — | |||||
Less amount due within one year | — | 505.6 | ||||||
Long-term debt | $ | 1,496.8 | $ | 1,009.1 | ||||
In the third quarter of 2014, the Company redeemed all of its $500.0 million of 3.50% Notes due in 2014 (the “2014 Notes”). The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million.
During the nine months ended September 30, 2014, the Company issued and sold $500.0 million of 4.60% senior notes due June 1, 2044 at a public offering price of 99.465% (the “2044 Notes”). Net proceeds from the sale of the 2044 Notes, after deducting underwriters' discounts and offering expenses, were $492.0 million. Interest on the 2044 Notes is payable semi-annually on June 1 and December 1 of each year. Proceeds from the 2044 Notes, together with cash on hand, was used to redeem the 2014 Notes. In addition, the Company settled a series of cash flow interest rate forward swaps into which it originally entered during the fourth quarter of 2013. These swaps mitigated interest rate exposure associated with the Company’s offering of the 2044 Notes. See Note 16 for discussion of the Company’s interest rate forward swaps.
During the nine months ended September 30, 2014, the Company entered into a series of fair value interest rate swaps that effectively convert the Company’s 4.90% Notes due 2019 (the “2019 Notes”) from a fixed rate structure to a floating rate structure. These swaps have resulted in a fair value adjustment of $8.4 million to reduce long-term debt, which is offset by a long-term derivative liability. See Note 16 for a discussion of the fair value swaps.
Using quoted prices in markets that are not active, the Company determined that the fair value of its long-term debt was $1,640.0 million (Level 2) as of September 30, 2014.
The components of interest expense-net were as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
(In millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Interest expense | $ | 20.6 | $ | 14.5 | $ | 53.2 | $ | 45.3 | ||||||||
Interest income | (2.3 | ) | (2.2 | ) | (7.2 | ) | (6.4 | ) | ||||||||
Interest expense-net | $ | 18.3 | $ | 12.3 | $ | 46.0 | $ | 38.9 | ||||||||
Net interest expense increased compared to the prior year period primarily as a result of the incremental and higher interest expense on the 2044 Notes, cost related to the redemption of the 2014 Notes and the nonrecurrence of the prior year period’s capitalization of interest cost associated with the Company’s new spray dryer and technology center in Singapore. These expenses were partially offset by gains related to the fixed to floating rate fair value hedges on the 2019 Notes and the unamortized benefit from settled interest swaps on the 2014 Notes.
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16. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS
The Company is exposed to market risk due to changes in foreign currency exchange rates, commodities pricing and interest rates. To manage that risk, the Company enters into certain derivative financial instruments, when available on a cost-effective basis, to hedge its underlying economic exposure. The Company does not enter into derivatives for speculative purposes. These financial instruments were classified as Level 2 in the fair value hierarchy at September 30, 2014 and December 31, 2013, and there were no transfers between levels in the fair value hierarchy during the periods then ended.
The following table summarizes the fair value of the Company's outstanding derivatives:
(In millions) | Hedge Designation | Balance Sheet Location | September 30, 2014 | December 31, 2013 | |||||||
Foreign exchange contracts | Cash Flow | Other assets | $ | 3.0 | $ | 4.2 | |||||
Interest rate forward swaps | Cash Flow | Other assets | — | 19.9 | |||||||
Commodity contracts | Cash Flow | Other assets | — | — | |||||||
Foreign exchange contracts | Cash Flow | Accrued expenses | (0.2 | ) | (0.5 | ) | |||||
Commodity contracts | Cash Flow | Accrued expenses | (0.4 | ) | — | ||||||
Interest rate swaps | Fair Value | Other Liabilities | (8.4 | ) | — | ||||||
Net asset/(liability) position of derivatives designated as hedging instruments | $ | (6.0 | ) | $ | 23.6 | ||||||
The Company’s derivative financial instruments present certain market and counterparty risks; however, concentration of counterparty risk is mitigated as the Company deals with a variety of major banks worldwide whose long-term debt is rated A- or higher by Standard & Poor’s Rating Service, Fitch Ratings, or Moody’s Investors Service, Inc. In addition, only conventional derivative financial instruments are used. The Company would not be materially impacted if any of the counterparties to the derivative financial instruments outstanding at September 30, 2014 failed to perform according to the terms of its agreement. Based upon the risk profile of the Company's portfolio, MJN does not require collateral or any other form of security to be furnished by the counterparties to its derivative financial instruments.
Cash Flow Hedges
As of September 30, 2014 and December 31, 2013, all of the Company’s cash flow hedges qualify as hedges of forecasted cash flows and the effective portion of changes in fair value are temporarily reported in accumulated other comprehensive income (loss). During the period that the underlying hedged transaction impacts earnings, the effective portion of the changes in the fair value of the cash flow hedges is recognized within earnings. The Company assesses effectiveness at inception and on a quarterly basis. These assessments determine whether derivatives designated as qualifying hedges continue to be highly effective in offsetting changes in the cash flows of hedged items. Any ineffective portion of the change in fair value is included in current period earnings.
The Company will discontinue cash flow hedge accounting when the forecasted transaction is no longer probable of occurring on the originally forecasted date, or 60 days thereafter, or when the hedge is no longer effective. For the three and nine months ended September 30, 2014 and 2013, the Company did not discontinue any cash flow hedges.
Foreign Exchange Contracts
The Company uses foreign exchange contracts to hedge forecasted transactions, primarily foreign currency denominated intercompany purchases anticipated in the next 18 months and designates these derivative instruments as foreign currency cash flow hedges when appropriate. When the underlying intercompany purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold. The impact of ineffectiveness related to the Company’s foreign exchange hedges on earnings was insignificant for the three months ended September 30, 2014 and 2013. The impact of ineffectiveness related to the Company’s foreign exchange hedges on earnings was $0.8 million for each of the nine months ended September 30, 2014 and 2013.
As of September 30, 2014, the notional value of the Company’s outstanding foreign exchange forward contracts designated as hedging instruments was $252.6 million, with a fair value of $2.8 million in net assets. As of December 31, 2013, the notional value of the Company’s outstanding foreign exchange forward contracts designated as hedging instruments was $201.4 million, with a fair value of $3.7 million in net assets. The fair value of all foreign exchange forward contracts is based on quarter-end forward currency rates. The fair value of foreign exchange forward contracts should be viewed in relation to the fair value of the underlying hedged transactions and the overall reduction in exposure to fluctuations in foreign currency exchange rates.
15
The change in accumulated other comprehensive income (loss) and the impact on earnings from foreign exchange contracts that qualified as cash flow hedges were as follows:
(In millions) | 2014 | 2013 | ||||||
Balance—January 1 | $ | 3.2 | $ | (4.1 | ) | |||
Derivatives qualifying as cash flow hedges deferred in other comprehensive income | (0.1 | ) | 5.2 | |||||
Derivatives qualifying as cash flow hedges reclassified to cost of products sold (effective portion) | (3.3 | ) | 5.7 | |||||
Change in deferred taxes | 0.9 | (3.0 | ) | |||||
Balance—September 30 | $ | 0.7 | $ | 3.8 | ||||
At September 30, 2014, the balance of the effective portion of changes in fair value on foreign exchange forward contracts that qualified for cash flow hedge accounting included in accumulated other comprehensive income was $0.7 million, $0.2 million of which is expected to be reclassified into earnings within the next 12 months.
Interest Rate Forward Swaps
During 2013, the Company entered into interest rate forward starting swaps with a combined notional value of $500.0 million. The forward starting rates of the swaps ranged from 3.79% to 3.94% and had an effective date of October 31, 2014. The interest rate forward starting swaps effectively mitigated the interest rate exposure associated with the Company’s offering of the 2044 Notes, the proceeds of which were used to redeem the 2014 Notes. These derivative instruments were designated as cash flow hedges at inception and were highly effective in offsetting fluctuations in the benchmark interest rate. During the nine months ended September 30, 2014, and around the time of the issuance of the 2044 Notes, the Company paid $45.0 million to settle the outstanding forward swaps. This payment was recognized in accumulated other comprehensive income (loss) and will be amortized over the life of the 2044 Notes. There was $0.5 million of ineffectiveness related to the forward swaps through the date of settlement which was recognized as a loss within other (income)/expenses-net. During the three months and nine months ended September 30, 2014, $0.4 million and $0.5 million of amortization of the settlement amount was recognized within interest expense, respectively.
Commodity Hedges
During the fourth quarter of 2013, the Company began utilizing commodity hedges to minimize the variability in cash flows due to fluctuations in market prices of the Company’s non-fat dry milk purchases for North America. The maturities of the commodity contracts are scheduled to match the pricing terms of the Company’s existing bulk purchase agreements. When the underlying non-fat dry milk purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold.
As of September 30, 2014, there were commodity contracts outstanding which committed the Company to approximately$6 million of forecasted non-fat dry milk purchases, representing approximately 24% of the Company’s total forecasted volume, where pricing is not established through supply agreements, over the next 12 months. The effective portion of the hedges, which was recorded at fair value as a component of accumulated other comprehensive income, and the ineffective portion recognized within other (income)/expenses-net were both insignificant as of September 30, 2014 and for the three and nine month periods then ended.
Fair Value Hedges
Interest Rate Swaps
In November 2009, the Company entered into several interest rate swaps to convert $700.0 million of the Company’s then newly-issued fixed rate debt to be paid in 2014 and 2019 to variable rate debt. In November 2010, the Company settled $200.0 million notional amount of fixed-to-floating interest rate swaps in exchange for cash of $15.6 million. In July 2011, the Company settled the remaining $500.0 million notional amount of fixed-to-floating interest rate swaps in exchange for cash of $23.5 million. The related basis adjustments of the underlying hedged items are being recognized as a reduction of interest expense for the remaining life of the debt instruments. Because the 2014 Notes were redeemed during the three months ended September 30, 2014, the Company recognized an additional $1.6 million reduction in interest expense during the period, which represented the unamortized portion of the settled 2009 swaps related to the 2014 Notes.
In May 2014 the Company entered into eight interest rate swaps with multiple counterparties, which have an aggregate notional amount of $700.0 million of outstanding principal. This series of swaps effectively converts the $700.0 million of 2019 Notes
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from fixed to floating rate debt for the remainder of their term. These interest rate swaps were outstanding at September 30, 2014.
The following table summarizes the interest rate swaps outstanding as of September 30, 2014, all of which have a hedge inception date of May 2014 and a maturity date of November 2019:
(In millions) | Notional Amount of Underlying | Fixed Rate Received | Variable Rate Paid (U.S. 3 Month LIBOR +) | Fair Value | ||||||||||
Swaps associated with the 2019 Notes | $ | 700.0 | 4.9 | % | 3.14 | % | $ | (8.4 | ) | |||||
See Note 15 for discussion of the Company’s long-term debt.
Other Financial Instruments
The Company does not hedge the interest rate risk associated with money market funds which totaled $346.6 million and $447.8 million as of September 30, 2014 and December 31, 2013, respectively. Money market funds are classified as Level 2 in the fair value hierarchy and are included in cash and cash equivalents on the balance sheet. The money market funds have quoted market prices that are generally equivalent to par.
17. EQUITY
Changes in common shares and treasury stock were as follows:
(In millions) | Common Shares Issued | Treasury Stock | Cost of Treasury Stock | |||||||
Balance as of January 1, 2014 | 206.8 | 4.8 | $ | 351.9 | ||||||
Stock-based compensation | 0.8 | 0.1 | 7.9 | |||||||
Treasury stock purchases | — | 0.6 | 48.5 | |||||||
Balance as of September 30, 2014 | 207.6 | 5.5 | $ | 408.3 | ||||||
Balance as of January 1, 2013 | 206.0 | 3.5 | $ | 244.6 | ||||||
Stock-based compensation | 0.7 | 0.2 | 17.9 | |||||||
Treasury stock purchases | — | 1.0 | 76.6 | |||||||
Balance as of September 30, 2013 | 206.7 | 4.7 | $ | 339.1 | ||||||
The Company may use either authorized and unissued shares or treasury shares to meet share requirements resulting from the exercise of stock options and vesting of performance share awards and restricted stock units. Treasury stock is recognized at the cost to reacquire the shares. Shares issued from treasury are recognized using the first-in first-out method.
On September 10, 2013, MJN’s board of directors approved a share repurchase authorization of up to $500.0 million of the Company’s common stock. As of September 30, 2014, the Company had $441.9 million remaining available under this authorization.
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Changes in accumulated other comprehensive loss by component were as follows:
(In millions) | Foreign Currency Translation Adjustments | Deferred Gains/(Losses) on Derivatives Qualifying as Hedges | Pension and Other Post-employment Benefits | Total | Noncontrolling Interest | Redeemable Noncontrolling Interest | |||||||||||||||||||||
Balance as of January 1, 2014 | $ | (83.6 | ) | $ | 15.4 | $ | (1.0 | ) | $ | (69.2 | ) | $ | 1.9 | $ | (14.4 | ) | |||||||||||
Deferred Losses | (49.7 | ) | (64.3 | ) | — | (114.0 | ) | — | (1 | ) | (6.8 | ) | (1 | ) | |||||||||||||
Reclassification Adjustment for (Gains)/Losses Included in Net Earnings | — | (2.8 | ) | 0.2 | (2.6 | ) | — | — | |||||||||||||||||||
Tax Benefit | 0.3 | 24.5 | — | 24.8 | — | — | |||||||||||||||||||||
Balance as of September 30, 2014 | $ | (133.0 | ) | $ | (27.2 | ) | $ | (0.8 | ) | $ | (161.0 | ) | $ | 1.9 | $ | (21.2 | ) | ||||||||||
Balance as of January 1, 2013 | $ | (14.6 | ) | $ | (4.1 | ) | $ | 0.3 | $ | (18.4 | ) | $ | (0.2 | ) | $ | — | |||||||||||
Deferred Gains/(Losses) | (58.8 | ) | 5.2 | — | (53.6 | ) | 3.1 | (1 | ) | (11.1 | ) | (1 | ) | ||||||||||||||
Reclassification Adjustment for Losses Included in Net Earnings | — | 5.7 | — | 5.7 | — | — | |||||||||||||||||||||
Tax Benefit/(Expense) | 5.1 | (3.0 | ) | — | 2.1 | (1.1 | ) | — | |||||||||||||||||||
Balance as of September 30, 2013 | $ | (68.3 | ) | $ | 3.8 | $ | 0.3 | $ | (64.2 | ) | $ | 1.8 | $ | (11.1 | ) | ||||||||||||
(1) Represents foreign currency translation adjustments.
Deferred losses on derivatives qualifying as hedges for the nine months ended September 30, 2014 included $64.4 million related to the change in the underlying position of the Company’s interest rate forward swaps intended to mitigate interest rate exposure associated with the 2044 Notes. These interest rate forward swaps were in a gain position with a fair value of $19.4 million at December 31, 2013. From December 31, 2013 through the Company’s settlement in May 2014, the fair value of these interest rate forward swaps declined $64.4 million, resulting in a loss position with a fair value of $45.0 million upon settlement.
Reclassification adjustments out of accumulated other comprehensive loss were as follows:
Three Months Ended September 30, | ||||||||||||||||||||||||
Affected Statement of Earnings Lines | ||||||||||||||||||||||||
(In millions) | Cost of Products Sold | Tax Benefit/(Expense) | Net | |||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | 2014 | 2013 | |||||||||||||||||||
Deferred Gains/(Losses) on Derivatives Qualifying as Hedges: | ||||||||||||||||||||||||
Foreign Exchange Contracts | $ | — | $ | 0.5 | $ | 0.1 | $ | (0.1 | ) | $ | 0.1 | $ | 0.4 | |||||||||||
Interest Rate Forward Swap | (0.5 | ) | — | — | — | (0.5 | ) | — | ||||||||||||||||
Pension and Other Post-employment Benefit Plans: | ||||||||||||||||||||||||
Prior Service Benefits | — | — | — | — | — | — | ||||||||||||||||||
Total Reclassifications | $ | (0.5 | ) | $ | 0.5 | $ | 0.1 | $ | (0.1 | ) | $ | (0.4 | ) | $ | 0.4 | |||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||||
Affected Statement of Earnings Lines | ||||||||||||||||||||||||
(In millions) | Cost of Products Sold | Tax Benefit/(Expense) | Net | |||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | 2014 | 2013 | |||||||||||||||||||
Deferred Gains/(Losses) on Derivatives Qualifying as Hedges: | ||||||||||||||||||||||||
Foreign Exchange Contracts | $ | 3.3 | $ | (5.7 | ) | $ | (0.9 | ) | $ | 1.7 | $ | 2.4 | $ | (4.0 | ) | |||||||||
Interest Rate Forward Swap | (0.5 | ) | — | — | — | (0.5 | ) | — | ||||||||||||||||
Pension and Other Post-employment Benefit Plans: | ||||||||||||||||||||||||
Prior Service Benefits | (0.2 | ) | — | — | — | (0.2 | ) | — | ||||||||||||||||
Total Reclassifications | $ | 2.6 | $ | (5.7 | ) | $ | (0.9 | ) | $ | 1.7 | $ | 1.7 | $ | (4.0 | ) | |||||||||
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18. VENEZUELA CURRENCY MATTERS
During the first quarter of 2014, the Venezuelan government enacted changes affecting the country’s currency exchange and other controls. In late January 2014, the government announced the replacement of the Commission for the Administration of Foreign Exchange (“CADIVI”) with a new foreign currency administration, the National Center for Foreign Commerce (“CENCOEX”). In conjunction with this replacement, CENCOEX assumed control of the sale and purchase of foreign currency in Venezuela, and has maintained the official exchange rate of 6.3 Bolivares Fuertes (“VEF”) to 1.0 U.S. dollar (“USD”) (the “Official Rate”). Entities can continue to seek approval to transact through the CENCOEX mechanism at the Official Rate, which is honored for certain priority transactions.
Additional changes in January expanded the types of transactions that may be subject to the weekly auction mechanism under the Complimentary Currency Administration System (“SICAD I”). MJN concluded that among other items, future inter-company dividend remittances qualify for the purchase of foreign currency at the SICAD I rate under the revised law. As such, MJN adopted the SICAD I rate for purposes of remeasuring the net monetary assets of our Venezuelan subsidiary effective February 28, 2014. The remeasurement impact of this adoption in the first quarter of 2014 was a loss of $6.1 million, which was recognized in MJN’s Statement of Earnings as a component of other (income)/expenses - net. Because the SICAD I auction rate is a floating rate, the potential exists for additional financial impacts if the auction rate changes significantly. As of September 30, 2014, SICAD I had a published rate of 12.0 VEF to 1.0 USD. In February 2014, the Venezuelan government announced plans for the Alternative Foreign Exchange System (“SICAD II”), which is intended to more closely resemble a market-driven exchange. SICAD II became effective on March 24, 2014. As of September 30, 2014, SICAD II had a published rate of 50.0 VEF to 1.0 USD. MJN currently does not plan to attempt to access USD using the SICAD II exchange under the current exchange structure.
During the three and nine months ended September 30, 2014, the Company recognized gains of $5.1 million and $13.7 million, respectively, related to its exchange of VEF for USD at the CENCOEX Official Rate, which is more favorable than the SICAD I rate used to remeasure net monetary assets of MJN’s Venezuelan subsidiary.
It is possible that the Venezuelan government will further refine or alter mechanisms through which companies are able to access USD, which could change the rate at which MJN can access USD and the rate used by the Company to remeasure the net monetary assets of its Venezuelan subsidiary.
For the year ended December 31, 2013 and the nine months ended September 30, 2014, our Venezuelan subsidiary had net sales that represented approximately 2% of total Company net sales. As of September 30, 2014, our subsidiary had approximately $13 million of net monetary assets.
19. CONTINGENCIES
In the ordinary course of business, the Company is subject to lawsuits, investigations, government inquiries and claims, including, but not limited to, product liability claims, advertising disputes and inquiries, consumer fraud suits, other commercial disputes, premises claims and employment and environmental, health, and safety matters.
The Company records accruals for contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although the Company cannot predict with certainty the final resolution of lawsuits, investigations and claims asserted against the Company, MJN does not believe any currently pending legal proceeding to which the Company is a party will have a material effect on the Company’s business or financial condition, although an unfavorable outcome in excess of amounts recognized as of September 30, 2014, with respect to one or more of these proceedings could have a material effect on the Company’s results of operations and cash flows for the periods in which a loss is recognized.
Following an SEC request for documents relating to certain business activities of the Company’s local subsidiary in China, the Company is continuing an internal investigation of such business activities. The Company’s investigation is focused on certain expenditures that were made in connection with the promotion of the Company’s products or may have otherwise been made. Certain of such expenditures were made in violation of Company policies and may have been made in violation of applicable U.S. and/or local laws, including the U.S. Foreign Corrupt Practices Act (the “FCPA”). The investigation is being conducted by outside legal counsel and has been overseen by a committee of independent members of the Company’s board of directors. The status and results of the investigation are being discussed with the SEC and other governmental authorities. At this time, the Company is unable to predict the scope, timing or outcome of this ongoing matter or any regulatory or legal actions that may be commenced related to this matter. If a violation of the FCPA or other laws is determined to have occurred, the Company could become subject to monetary penalties as well as civil and criminal sanctions.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview of Our Business
We are a global leader in pediatric nutrition. We are committed to building trusted nutritional brands and products that help improve the health and development of infants and children around the world and provide them with the best start in life. Our comprehensive product portfolio addresses a broad range of nutritional needs for infants, children and expectant and nursing mothers. We have over 100 years of innovation experience during which we have developed or improved many breakthrough or industry-defining products across each of our product categories. We operate in four geographic operating segments: Asia, Europe, Latin America and North America. Due to similarities between North America and Europe, we aggregated these two operating segments into one reportable segment. As a result, we have three reportable segments: Asia, Latin America and North America/Europe.
Executive Summary
For the three months ended September 30, 2014, sales grew 4% compared to the prior year period, driven primarily by increased prices throughout all segments. Sales volume increased in North America/Europe due to an expanding U.S. children’s nutrition business and higher infant formula market share. In Latin America, sales volume increased due to category growth in Mexico, partially offset by weaker local currency rates throughout the segment. In Asia, sales increased primarily due to higher prices throughout south Asia and Hong Kong, partially offset by a volume decrease in China due to a trade inventory reduction in advance of a fourth quarter product re-launch and an unfavorable comparison to the third quarter of 2013. Earnings per share increased compared to the prior year period. Higher sales, the nonrecurrence of the prior year administrative penalty in China and a lower effective tax rate were offset by lower gross margin (due to higher dairy input costs and unfavorable foreign exchange impacts) and current year actuarial losses compared to prior year actuarial gains related to our defined benefit pension and other post-employment benefit plans.
For the nine months ended September 30, 2014, sales grew 6% compared to the prior year period, driven by volume growth and increased prices throughout all regions, partially offset by weaker local currency rates in Latin America and, to a lesser extent, Asia. Earnings per share increased 6%, primarily driven by higher sales and the nonrecurrence of the prior year administrative penalty in China, partially offset by lower gross margin, current year actuarial losses compared to prior year actuarial gains related to our defined benefit pension and other post-employment benefit plans, and increased demand-creation investments.
Three Months Results of Operations
Below is a summary of comparative results of operations for the three months ended September 30, 2014 and 2013:
% of Net Sales | |||||||||||||||||
(Dollars in millions, except per share data) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Net Sales | $ | 1,090.7 | $ | 1,046.8 | 4 | % | |||||||||||
Earnings before Interest and Income Taxes | 242.6 | 250.7 | (3 | )% | 22 | % | 24 | % | |||||||||
Interest Expense—net | 18.3 | 12.3 | (49 | )% | 2 | % | 1 | % | |||||||||
Earnings before Income Taxes | 224.3 | 238.4 | (6 | )% | 21 | % | 23 | % | |||||||||
Provision for Income Taxes | 36.0 | 68.7 | 48 | % | 4 | % | 7 | % | |||||||||
Effective Tax Rate | 16.0 | % | 28.8 | % | |||||||||||||
Net Earnings | 188.3 | 169.7 | 11 | % | 17 | % | 16 | % | |||||||||
Less: Net Earnings/(Loss) Attributable to Noncontrolling Interests | 0.7 | (1.6 | ) | (144 | )% | n/a | n/a | ||||||||||
Net Earnings Attributable to Shareholders | $ | 187.6 | $ | 171.3 | 10 | % | 17 | % | 16 | % | |||||||
Weighted-Average Common Shares— Diluted | 202.7 | 202.8 | |||||||||||||||
Earnings per Common Share—Diluted | $ | 0.92 | $ | 0.84 | 10 | % | |||||||||||
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The results for the three months ended September 30, 2014 and 2013 include items that affect the comparability of our results. These items include significant expenses/(income) not indicative of underlying operating results (“Specified Items”) and are listed in the table below.
Three Months Ended September 30, | ||||||||
(In millions) | 2014 | 2013 | ||||||
Pension and other post-employment mark-to-market adjustment | $ | 9.3 | $ | (7.3 | ) | |||
Administrative penalty (China) | — | 26.0 | ||||||
Legal, settlements and related costs | (0.5 | ) | 1.1 | |||||
Severance and other costs | — | 0.1 | ||||||
Pension curtailment gain | (5.4 | ) | — | |||||
Specified Items | $ | 3.4 | $ | 19.9 | ||||
Income tax impact on Specified Items | (3.1 | ) | 2.2 | |||||
Specified Items attributable to Noncontrolling Interests | — | 3.7 | ||||||
Specified Items - net | $ | 0.3 | $ | 18.4 | ||||
For the three months ended September 30, 2014, Specified Items included current year actuarial losses related to a defined benefit pension and other post-employment benefit plan and a gain related to the revision of a defined benefit pension plan outside of the United States. For the three months ended September 30, 2013, Specified Items included the administrative penalty in China and actuarial gains related to a defined benefit pension and other post-employment benefit plan.
Net Sales
Our net sales by reportable segments are shown in the table below:
Three Months Ended September 30, | % Change Due to | |||||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | Volume | Price/Mix | Foreign Exchange | ||||||||||||||
Asia | $ | 561.5 | $ | 546.7 | 3 | % | (2 | )% | 5 | % | — | % | ||||||||
Latin America | 222.9 | 221.3 | 1 | % | 4 | % | 10 | % | (13 | )% | ||||||||||
North America/Europe | 306.3 | 278.8 | 10 | % | 8 | % | 2 | % | — | % | ||||||||||
Net Sales | $ | 1,090.7 | $ | 1,046.8 | 4 | % | 2 | % | 5 | % | (3 | )% | ||||||||
Asia sales increased 3% compared to the prior year period and accounted for 52% of our total net sales. This sales growth was primarily driven by price increases in south Asia and Hong Kong attributed to innovation and higher dairy input costs. Sales volume decreased due to a trade inventory reduction in advance of a planned fourth quarter product re-launch in China and an unfavorable comparison related to a third quarter 2013 competitor’s recall in China, partially offset by category growth.
Latin America sales increased 1% compared to the prior year period and accounted for 20% of our total net sales. Sales volume increased primarily due to category growth in Mexico. Price increases, predominately in Venezuela and Argentina, were more than offset by the negative effects of foreign exchange.
For the three months ended September 30, 2014, Venezuela sales represented 2% of our total net sales. At this time, we are unable to predict with certainty how recent and future developments in Venezuela will affect our ongoing sales growth or operations (see Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion regarding exchange rate variability in Venezuela).
North America/Europe sales increased 10% compared to the prior year period and accounted for 28% of our total net sales. Sales volume increases were driven primarily by a favorable comparison to the prior year period in which U.S. retailers reduced inventories, our expanding U.S. children’s nutrition business and higher infant formula market share.
Our net sales by product category are shown in the table below:
Three Months Ended September 30, | |||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | ||||||||
Infant formula | $ | 619.2 | $ | 604.1 | 3 | % | |||||
Children’s nutrition | 451.5 | 421.5 | 7 | % | |||||||
Other | 20.0 | 21.2 | (6 | )% | |||||||
Net Sales | $ | 1,090.7 | $ | 1,046.8 | 4 | % | |||||
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Infant formula sales increased 3% compared to the prior year period and accounted for the large majority of our sales in North America/Europe and approximately half of our sales in each of our Asia and Latin America segments. Children’s nutrition sales increased 7% compared to the prior year period and were driven primarily by Asia.
We recognize revenue net of various sales adjustments to arrive at net sales as reported on the statements of earnings. These adjustments are referred to as gross-to-net sales adjustments. The reconciliation of our gross sales to net sales is as follows:
Three Months Ended September 30, | % of Gross Sales | |||||||||||||
(Dollars in millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||
Gross Sales | $ | 1,423.8 | $ | 1,326.8 | 100 | % | 100 | % | ||||||
Gross-to-Net Sales Adjustments | ||||||||||||||
WIC Rebates | 201.7 | 169.7 | 14 | % | 13 | % | ||||||||
Sales Discounts | 70.1 | 54.9 | 5 | % | 4 | % | ||||||||
Returns | 23.2 | 17.9 | 1 | % | 1 | % | ||||||||
Other (including Cash Discounts, Coupons) | 38.1 | 37.5 | 3 | % | 3 | % | ||||||||
Total Gross-to-Net Sales Adjustments | 333.1 | 280.0 | 23 | % | 21 | % | ||||||||
Total Net Sales | $ | 1,090.7 | $ | 1,046.8 | 77 | % | 79 | % | ||||||
The gross-to-net sales adjustments increased as a percentage of gross sales compared with the prior year period. The increase was mainly driven by the addition of new WIC contracts in 2014 and higher sales discounts in select markets for promotional programs in 2014.
Gross Profit
Three Months Ended September 30, | |||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | ||||||||
Net Sales | $ | 1,090.7 | $ | 1,046.8 | 4 | % | |||||
Cost of Products Sold | 437.9 | 362.3 | 21 | % | |||||||
Gross Profit | $ | 652.8 | $ | 684.5 | (5 | )% | |||||
Gross Margin | 59.9 | % | 65.4 | % | |||||||
The decrease in gross margin resulted from higher dairy input costs, an unfavorable impact from foreign exchange, higher manufacturing conversion costs and costs related to the start of our new manufacturing center in Singapore, partially offset by increased prices and productivity. The Company anticipates that increased dairy and other commodity costs will negatively impact gross margin comparisons to 2013 through the balance of the year. However, the Company also anticipates that dairy and other commodity costs will have less of a negative impact on gross margin in the fourth quarter of 2014.
Operating Expenses
Three Months Ended September 30, | % of Net Sales | ||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Selling, General and Administrative | $ | 240.2 | $ | 217.3 | 11 | % | 22 | % | 21 | % | |||||||
Advertising and Promotion | 158.9 | 163.8 | (3 | )% | 15 | % | 16 | % | |||||||||
Research and Development | 28.7 | 23.8 | 21 | % | 3 | % | 2 | % | |||||||||
Other (Income)/Expenses—net | (17.6 | ) | 28.9 | n/a | (2 | )% | 3 | % | |||||||||
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 11% compared to the prior year period due to current year actuarial losses of $5.2 million compared to prior year actuarial gains of $4.1 million related to our defined benefit pension and other post-employment benefit plans and increased sales force expense.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product evaluation and education provided to health care professionals and consumers, where permitted by regulation. Advertising and promotion spending decreased compared to the prior period due to weaker local currency rates and the timing of investment spending.
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Research and Development Expenses
Our research and development expenses include the continued investment in our innovation capability, product pipeline and quality programs. The increase in research and development expense included current year actuarial losses of $0.9 million compared to prior year actuarial gains of $0.7 million related to our defined benefit pension and other post-employment benefit plans.
Other (Income)/Expenses — net
Three Months Ended September 30, | ||||||||
(In millions) | 2014 | 2013 | ||||||
Foreign exchange (gains)/losses - net | $ | (8.2 | ) | $ | 2.1 | |||
Pension curtailment gain | (5.4 | ) | — | |||||
Administrative penalty (China) | — | 26.0 | ||||||
Other - net | (4.0 | ) | 0.8 | |||||
Other (income)/expenses - net | $ | (17.6 | ) | $ | 28.9 | |||
Earnings before Interest and Income Taxes
Earnings before interest and income taxes (“EBIT”) from our three reportable segments is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment plans; and income or expenses incurred within our operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results.
Three Months Ended September 30, | % of Net Sales | ||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Asia | $ | 186.2 | $ | 199.6 | (7 | )% | 33 | % | 37 | % | |||||||
Latin America | 52.6 | 62.5 | (16 | )% | 24 | % | 28 | % | |||||||||
North America/Europe | 66.8 | 64.7 | 3 | % | 22 | % | 23 | % | |||||||||
Corporate and Other | (63.0 | ) | (76.1 | ) | 17 | % | n/a | n/a | |||||||||
EBIT | $ | 242.6 | $ | 250.7 | (3 | )% | 22 | % | 24 | % | |||||||
EBIT in Asia decreased compared to the prior year period primarily due to a decline in gross margin. Gross margin was reduced by higher dairy input costs, weaker local currencies and the costs related to the start of our new manufacturing center in Singapore, partially offset by higher sales.
EBIT in Latin America decreased compared to the prior year period due primarily to a decline in gross margin (due to weaker local currencies and higher dairy input costs), partially offset by net foreign exchange gains. In our subsidiary in Venezuela, lower gross margins were partially offset by foreign exchange gains generated from cash received at the official Venezuelan government rate compared to the SICAD I rate adopted by the Company in February 2014 (see Item 1. Financial Statements - Note 18. Venezuela Currency Matters and Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion regarding exchange rate variability in Venezuela).
EBIT in North America/Europe increased compared to the prior year period primarily due to higher sales partially offset by a decline in gross margin (due to the timing of an annual plant shut down and higher dairy input costs) and continued demand-creation investments.
Corporate and Other expenses decreased primarily as a result of the nonrecurrence of the prior year administrative penalty in China, partially offset by current year actuarial losses compared to prior year actuarial gains related to our defined benefit pension and other post-employment benefit plans.
Interest Expense—net
Net interest expense increased compared to the prior year period primarily as a result of the incremental and higher interest expense on the $500.0 million of 4.6% senior notes due in 2044 (the “2044 Notes”) issued in May 2014, cost related to the redemption of the $500.0 million of 3.50% Notes due in 2014 (the “2014 Notes”) and the nonrecurrence of the prior year period’s capitalization of interest cost associated with our new spray dryer and technology center in Singapore. These expenses were partially offset by gains related to the fixed to floating rate fair value hedges on our 2019 Notes and the unamortized benefit from settled interest swaps on our 2014 Notes.
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Income Taxes
The effective tax rate (“ETR”) for the three months ended September 30, 2014 and 2013 was 16.0% and 28.8%, respectively. The ETR decrease was primarily due to a change in the reserve for uncertain tax positions, the majority of which relates to the running of the statute of limitations in various jurisdictions during the third quarter of 2014, and the third quarter 2013 administrative penalty in China, which was non-deductible for tax purposes.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of a 20%, 11% and 10% interest held by third parties in the Company’s operating entities in Argentina, China and Indonesia, respectively.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the three months ended September 30, 2014 of $187.6 million increased 10% compared with the three months ended September 30, 2013.
Nine Months Results of Operations
Below is a summary of comparative results of operations for the nine months ended September 30, 2014 and 2013:
% of Net Sales | |||||||||||||||||
(Dollars in millions, except per share data) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Net Sales | $ | 3,315.1 | $ | 3,140.0 | 6 | % | |||||||||||
Earnings before Interest and Income Taxes | 778.7 | 771.0 | 1 | % | 23 | % | 25 | % | |||||||||
Interest Expense—net | 46.0 | 38.9 | (18 | )% | 1 | % | 2 | % | |||||||||
Earnings before Income Taxes | 732.7 | 732.1 | — | % | 22 | % | 23 | % | |||||||||
Provision for Income Taxes | 160.5 | 199.0 | 19 | % | 5 | % | 6 | % | |||||||||
Effective Tax Rate | 21.9 | % | 27.2 | % | |||||||||||||
Net Earnings | 572.2 | 533.1 | 7 | % | 17 | % | 17 | % | |||||||||
Less: Net Earnings/(Loss) Attributable to Noncontrolling Interests | 10.8 | 1.8 | (500 | )% | — | % | — | % | |||||||||
Net Earnings Attributable to Shareholders | $ | 561.4 | $ | 531.3 | 6 | % | 17 | % | 17 | % | |||||||
Weighted-Average Common Shares— Diluted | 202.6 | 203.1 | |||||||||||||||
Earnings per Common Share—Diluted | $ | 2.77 | $ | 2.61 | 6 | % | |||||||||||
The results for the nine months ended September 30, 2014 and 2013 include items that affect the comparability of our results. These items include Specified Items and are listed in the table below.
Nine Months Ended September 30, | ||||||||
(In millions) | 2014 | 2013 | ||||||
Pension and other post-employment mark-to-market adjustment | $ | 16.4 | $ | (27.2 | ) | |||
Administrative penalty (China) | — | 33.4 | ||||||
Legal, settlements and related costs | 9.6 | 1.3 | ||||||
Severance and other costs | 0.3 | 2.1 | ||||||
Pension curtailment gain | (5.4 | ) | — | |||||
Specified Items | $ | 20.9 | $ | 9.6 | ||||
Income tax impact on Specified Items | (9.1 | ) | 10.3 | |||||
Specified Items attributable to Noncontrolling Interests | — | 3.7 | ||||||
Specified Items - net | $ | 11.8 | $ | 16.2 | ||||
Specified Items for the nine months ended September 30, 2014 included actuarial losses related to a defined benefit pension and other post-employment benefit plan and a gain related to the revision of a defined benefit pension plan outside of the United States. Specified Items in the nine months ended September 30, 2013 included the administrative penalty in China and actuarial gains related to a defined benefit pension and other post-employment benefit plan.
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Net Sales
Our net sales by reportable segments are shown in the table below:
Nine Months Ended September 30, | % Change Due to | |||||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | Volume | Price/Mix | Foreign Exchange | ||||||||||||||
Asia | $ | 1,729.8 | $ | 1,635.1 | 6 | % | 4 | % | 4 | % | (2 | )% | ||||||||
Latin America | 659.7 | 645.6 | 2 | % | 6 | % | 10 | % | (14 | )% | ||||||||||
North America/Europe | 925.6 | 859.3 | 8 | % | 5 | % | 3 | % | — | % | ||||||||||
Net Sales | $ | 3,315.1 | $ | 3,140.0 | 6 | % | 5 | % | 5 | % | (4 | )% | ||||||||
Asia sales increased 6% compared to the prior year period and accounted for 52% of our net sales. This sales growth was driven by price increases attributed to innovation and volume increases due to higher category growth and market share gains in certain markets, partially offset by a decline in category in other parts of the segment.
Latin America sales increased 2% compared to the prior year period and accounted for 20% of our net sales. Sales volume increased primarily due to category growth in Mexico. Price increases, predominately in Venezuela and Argentina, were more than offset by the negative effects of foreign exchange
For the nine months ended September 30, 2014, Venezuela sales represented 2% of our total net sales. At this time, we are unable to predict with certainty how recent and future developments in Venezuela will affect our ongoing sales growth or operations (see Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion regarding exchange rate variability in Venezuela).
North America/Europe sales increased 8% compared to the prior year period and accounted for 28% of our net sales. Volume increases were primarily driven by an expanding U.S. children’s nutrition business, the addition of new WIC contracts and share gains. Price increased throughout the segment.
Our net sales by product category are shown in the table below:
Nine Months Ended September 30, | |||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | ||||||||
Infant formula | $ | 1,897.3 | $ | 1,843.2 | 3 | % | |||||
Children’s nutrition | 1,353.5 | 1,230.7 | 10 | % | |||||||
Other | 64.3 | 66.1 | (3 | )% | |||||||
Net Sales | $ | 3,315.1 | $ | 3,140.0 | 6 | % | |||||
Infant formula sales increased 3% compared to the prior year period and account for the large majority of our sales in North America/Europe and approximately half of our sales in each of our Asia and Latin America segments. Children’s nutrition sales increased 10% compared to the prior year period and were driven primarily by Asia.
We recognize revenue net of various sales adjustments to arrive at net sales as reported on the statements of earnings. These adjustments are referred to as gross-to-net sales adjustments. The reconciliation of our gross sales to net sales is as follows:
Nine Months Ended September 30, | % of Gross Sales | |||||||||||||
(Dollars in millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||
Gross Sales | $ | 4,265.7 | $ | 3,993.7 | 100 | % | 100 | % | ||||||
Gross-to-Net Sales Adjustments | ||||||||||||||
WIC Rebates | 588.1 | 526.4 | 14 | % | 13 | % | ||||||||
Sales Discounts | 183.6 | 155.9 | 4 | % | 4 | % | ||||||||
Returns | 62.6 | 59.9 | 1 | % | 1 | % | ||||||||
Other (including Cash Discounts, Coupons) | 116.3 | 111.5 | 3 | % | 3 | % | ||||||||
Total Gross-to-Net Sales Adjustments | 950.6 | 853.7 | 22 | % | 21 | % | ||||||||
Total Net Sales | $ | 3,315.1 | $ | 3,140.0 | 78 | % | 79 | % | ||||||
The total gross-to-net sales adjustments were consistent as a percentage of gross sales compared with the prior year period. The total dollar amount of WIC rebates in the United States increased mainly due to the addition of new WIC contracts in 2014.
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Gross Profit
Nine Months Ended September 30, | |||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | ||||||||
Net Sales | $ | 3,315.1 | $ | 3,140.0 | 6 | % | |||||
Cost of Products Sold | 1,270.4 | 1,129.3 | 12 | % | |||||||
Gross Profit | $ | 2,044.7 | $ | 2,010.7 | 2 | % | |||||
Gross Margin | 61.7 | % | 64.0 | % | |||||||
The decrease in gross margin resulted from higher dairy input costs and an unfavorable impact from foreign exchange partially offset by increased prices and productivity. The Company anticipates that increased dairy and other commodity costs will negatively impact gross margin comparisons to 2013 through the balance of the year. However, the Company also anticipates that dairy and other commodity costs will have less of a negative impact on gross margin in the fourth quarter of 2014.
Operating Expenses
Nine Months Ended September 30, | % of Net Sales | ||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Selling, General and Administrative | $ | 715.4 | $ | 647.8 | 10 | % | 22 | % | 21 | % | |||||||
Advertising and Promotion | 489.2 | 475.9 | 3 | % | 15 | % | 15 | % | |||||||||
Research and Development | 82.5 | 71.1 | 16 | % | 2 | % | 2 | % | |||||||||
Other (Income)/Expenses—net | (21.1 | ) | 44.9 | n/a | (1 | )% | 1 | % | |||||||||
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 10% primarily due to current year actuarial losses of $9.1 million compared to prior year actuarial gains of $15.1 million related to our defined benefit pension and other post-employment benefit plans, higher legal and related costs associated with our ongoing internal investigation, increased sales force expense and inflation. In addition, a receivable allowance related to a pharmacy distributor in Mexico contributed to the increase.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product evaluation and education provided to health care professionals and consumers, where permitted by regulation. The increase in advertising and promotion expenses reflected demand-creation investments in support of our strategic growth initiatives such as the expansion of the U.S. children’s nutrition business.
Research and Development Expenses
Our research and development expenses include the continued investment in our innovation capability, product pipeline and quality programs. Excluding the current year actuarial losses of $1.6 million compared to prior year actuarial gains of $2.8 million related to a defined benefit pension and other post-employment benefit plan, research and development expense increased $7.0 million as higher project expenses were partially offset by a stronger U.S. dollar.
Other (Income)/Expenses — net
Nine Months Ended September 30, | ||||||||
(In millions) | 2014 | 2013 | ||||||
Foreign exchange (gains)/losses - net | $ | (6.0 | ) | $ | 6.9 | |||
Administrative penalty (China) | — | 33.4 | ||||||
Gain on sale of investment | (4.0 | ) | — | |||||
Pension curtailment gain | (5.4 | ) | — | |||||
Other - net | (5.7 | ) | 4.6 | |||||
Other (income)/expenses - net | $ | (21.1 | ) | $ | 44.9 | |||
Earnings before Interest and Income Taxes
EBIT from our three reportable segments is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general
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and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment plans; and income or expenses incurred within our operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results.
Nine Months Ended September 30, | % of Net Sales | ||||||||||||||||
(Dollars in millions) | 2014 | 2013 | % Change | 2014 | 2013 | ||||||||||||
Asia | $ | 623.4 | $ | 613.2 | 2 | % | 36 | % | 38 | % | |||||||
Latin America | 152.6 | 157.1 | (3 | )% | 23 | % | 24 | % | |||||||||
North America/Europe | 200.9 | 192.6 | 4 | % | 22 | % | 22 | % | |||||||||
Corporate and Other | (198.2 | ) | (191.9 | ) | (3 | )% | n/a | n/a | |||||||||
EBIT | $ | 778.7 | $ | 771.0 | 1 | % | 23 | % | 25 | % | |||||||
EBIT in Asia increased 2% primarily due to higher sales compared to the prior year period partially offset by a decline in gross margin (due to higher dairy input costs and the costs related to the start of our new manufacturing center in Singapore) and increased demand-creation investments.
EBIT in Latin America decreased 3% primarily due to lower gross margin (resulting from higher dairy input costs and weaker local currencies), partially offset by foreign exchange gains. In our subsidiary in Venezuela, lower gross margins were partially offset by foreign exchange gains generated from cash received at the official Venezuelan government rate compared to the SICAD I rate adopted by the Company in February 2014 (see Item 1. Financial Statements - Note 18. Venezuela Currency Matters and Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk” for further discussion regarding exchange rate variability in Venezuela).
EBIT in North America/Europe increased 4% primarily due to higher sales, partially offset by a decline in gross margin (due to the timing of an annual plant shut down and higher dairy input costs) and continued demand-creation investments.
Corporate and Other expenses increased compared to the prior year period primarily due to current year actuarial losses compared to prior year actuarial gains related to our defined benefit pension and other post-employment benefit plans.
Interest Expense—net
Net interest expense increased compared to the prior year period primarily as a result of the incremental and higher interest expense on the 2044 Notes, the nonrecurrence of the prior year period’s capitalization of interest cost associated with our new spray dryer and technology center in Singapore and the costs related to the redemption of the 2014 Notes. These expenses were partially offset by gains related to the fixed to floating rate fair value hedges on our 2019 Notes and the unamortized benefit from settled interest swaps on our 2014 Notes.
Income Taxes
The ETR for the nine months ended September 30, 2014 and 2013 was 21.9% and 27.2%, respectively. The ETR decrease was primarily due to a change in the reserve for uncertain tax positions, the majority of which relates to the running of the statute of limitations in various jurisdictions during the third quarter of 2014, favorable geographic earnings mix, and the third quarter 2013 administrative penalty in China, which was non-deductible for tax purposes.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of a 20%, 11% and 10% interest held by third parties in the Company’s operating entities in Argentina, China and Indonesia, respectively.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the nine months ended September 30, 2014 increased 6% to $561.4 million compared with the nine months ended September 30, 2013.
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash on hand, cash from operations and available borrowings under our $750.0 million credit facility. Cash flows from operating activities represent the inflow of cash from our customers net of the outflow of cash for raw material purchases, manufacturing, operating expenses, interest and taxes. Cash flows used in investing activities
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primarily represent acquisitions and capital expenditures for equipment and buildings. Cash flows from financing activities primarily represent proceeds and repayments of short-term and long-term borrowings, dividend payments and share repurchases.
Cash and cash equivalents totaled $1,195.2 million at September 30, 2014, of which $994.0 million was held outside of the United States. Cash and cash equivalents totaled $1,050.8 million as of December 31, 2013, of which $692.5 million was held outside of the United States.
During the three months ended September 30, 2014, no cash was repatriated to the United States, whereas $5.9 million of cash was repatriated to the United States during the three months ended September 30, 2013 from multiple jurisdictions whose earnings and profits are not permanently invested abroad.
As a result of our evaluation of our global cash position, management has asserted that earnings and profits in certain foreign jurisdictions are permanently invested abroad. We will continue to evaluate our global cash position and whether earnings and profits of certain other foreign jurisdictions are permanently invested abroad. As of September 30, 2014, the amount of cash associated with permanently invested foreign earnings was approximately $732 million. Our intent is to invest these earnings in our foreign operations and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. If we decide at a later date to repatriate these earnings to the United States, the Company would be required to provide U.S. taxes on these amounts.
During the nine months ended September 30, 2014, we completed our offering of $500.0 million 2044 Notes. In addition, we redeemed all $500.0 million of our 2014 Notes. The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million.
In September 2013, the Company’s board of directors approved a share repurchase authorization of up to $500.0 million of the Company’s common stock (the “2013 Authorization”). The 2013 Authorization is intended to offset the dilutive effect on earnings per share from stock-based compensation and allow for opportunistic stock purchases to return capital to stockholders. The 2013 Authorization does not have an expiration date. As of September 30, 2014, we had $441.9 million remaining available under the 2013 Authorization.
Cash Flows
We believe that cash on hand and cash from operations will be sufficient to support our working capital needs, pay our operating expenses, satisfy debt obligations, fund capital expenditures and make dividend payments.
Nine Months Ended September 30, | ||||||||
(Dollars in millions) | 2014 | 2013 | ||||||
Cash flow provided by/(used in): | ||||||||
Operating Activities | ||||||||
Net Earnings | $ | 572.2 | $ | 533.1 | ||||
Depreciation and Amortization | 67.8 | 62.1 | ||||||
Other | 30.2 | 29.9 | ||||||
Changes in Assets and Liabilities | (56.4 | ) | (27.0 | ) | ||||
Payments for Settlement of Interest Rate Forward Swaps | (45.0 | ) | — | |||||
Pension and Other Post-employment Benefits Contributions | (4.2 | ) | (6.1 | ) | ||||
Total Operating Activities | 564.6 | 592.0 | ||||||
Investing Activities | (139.8 | ) | (178.0 | ) | ||||
Financing Activities | (263.4 | ) | (462.3 | ) | ||||
Effects of Changes in Exchange Rates on Cash and Cash Equivalents | (17.0 | ) | (8.6 | ) | ||||
Net Increase/(Decrease) in Cash and Cash Equivalents | $ | 144.4 | $ | (56.9 | ) | |||
For the nine months ended September 30, 2014, cash flow from operating activities was $564.6 million and primarily driven by net earnings, partially offset by an increase in working capital, defined as accounts receivable plus inventory less accounts payable (excluding capital related items), and $45.0 million of payments related to the settlement of interest rate forward swaps. For the nine months ended September 30, 2013, cash flow from operating activities was $592.0 million, due primarily to net earnings.
Cash flow used in investing activities was $38.2 million less than the prior year period. The decrease was largely the result of the current year in-service placement of the Company’s new manufacturing and technology center in Singapore.
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Cash flow used in financing activities was $263.4 million for the nine months ended September 30, 2014, and included repayment of $500.0 million for our 2014 Notes, $220.7 million of dividend payments and $57.6 million of treasury stock purchases, partially offset by $492.3 million of net proceeds related to the offering of our 2044 Notes, after deducting underwriters' discounts and offering expenses paid to date and $27.3 million inflow related to stock-based compensation. For the nine months ended September 30, 2013, cash flow used in financing activities was $462.3 million and included $198.9 million of dividend payments, $158.2 million net repayments from our short-term credit facilities, $92.5 million of treasury stock purchases and $27.6 million for the repayment of our note payable related to the Argentine acquisition, partially offset by $19.8 million inflow related to stock-based compensation.
Capital Expenditures
Capital expenditures and the cash outflow for capital expenditures were as follows:
(In millions) | Capital Expenditures | Cash Outflow for Capital Expenditures | ||||||
Nine Months Ended September 30, 2014 | $ | 97.9 | $ | 144.0 | ||||
Nine Months Ended September 30, 2013 | $ | 149.3 | $ | 177.3 | ||||
Capital expenditures included investment primarily in our new spray manufacturing and technology center in Singapore which was placed in in-service during the third quarter of 2014. We expect capital expenditures in 2014 to be approximately $150 million, including our investment in the capital expenditure in Singapore, with continued emphasis on investment in growth and innovation.
Long-Term Debt, Revolving Credit Facility and Short-Term Borrowings
In the nine months ended September 30, 2014, we issued and sold $500.0 million of 2044 Notes. In the fourth quarter of 2013, prior to the offering of our 2044 Notes, we entered into a series of interest rate forward swaps to lock in an interest rate of approximately 5.3%, reflecting then-prevailing rates, in anticipation of the offering. The fair value of these interest rate forward swaps is dependent on the movements in thirty-year interest rates. As a result of a rise in interest rates leading up to December 31, 2013, these interest rate forward swaps were in a gain position with a fair value of $19.4 million as of that date. However, as a result of a subsequent decline in thirty-year interest rates, the fair value of these interest rate swaps declined $64.4 million, resulting in a loss position with a fair value of $45.0 million upon our settlement in May 2014. This $45.0 million is a deferred loss that will be amortized into interest expense over the life of the 2044 Notes resulting in an effective interest rate of 4.90% on the 2044 Notes.
In the nine month period, we also entered into a series of interest rate swaps to convert our 4.90% notes due in 2019 (the “2019 Notes”) from fixed to floating for the remainder of their term in order to diversify our interest rate exposure. These interest rate swaps have an aggregate notional amount of $700 million of outstanding principal. See “Item 1. Financial Statements - Note 16. Derivatives and Other Financial Instruments” for additional information regarding these swaps.
In addition, we amended our revolving credit facility to provide for, among other things, an increase in the aggregate amount available for borrowing from $500.0 million to $750.0 million (which may be increased from time to time up to $1.0 billion at the request of the Company, subject to obtaining additional commitments and other customary conditions), lower fees, an increase in the number of financial institutions as lenders and the extension of the maturity date from June 2016 to June 2019. For additional information regarding this amended facility, see “Item 1. Financial Statements - Note 15. Debt.” As of September 30, 2014, we had $750.0 million available to us under this facility.
Finally, we redeemed all $500.0 million of the 2014 Notes in the nine month period. The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million.
For information regarding Short-Term Borrowings, Long-Term Debt and Interest Rate Swaps, see “Item 1. Financial Statements - Note 15. Debt and Note 16. Derivatives and Other Financial Instruments.”
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q and other written and oral statements we make from time to time contain certain “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
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Securities Exchange Act of 1934. You can identify these forward-looking statements by the fact they use words such as “should,” “expect,” “anticipate,” “estimate,” “target,” “may,” “project,” “guidance,” “intend,” “plan,” “believe” and other words and terms of similar meaning and expression. Such statements are likely to relate to, among other things, a discussion of goals, plans and projections regarding financial position, results of operations, cash flows, market position, product development, product approvals, sales efforts, expenses, capital expenditures, performance or results of current and anticipated products and the outcome of contingencies such as legal proceedings and financial results. You can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Such forward-looking statements are based on current expectations that involve inherent risks, uncertainties and assumptions that may cause actual results to differ materially from expectations as of the date of this filing. These risks include, but are not limited to: (1) the ability to sustain brand strength, particularly the Enfa family of brands; (2) the effect on our reputation of real or perceived quality issues; (3) the effect of regulatory restrictions related to our products; (4) the adverse effect of commodity costs; (5) increased competition from branded, private label, store and economy-branded products; (6) the effect of an economic downturn on consumers’ purchasing behavior and customers’ ability to pay for product; (7) inventory reductions by customers; (8) the adverse effect of changes in foreign currency exchange rates; (9) the effect of changes in economic, political and social conditions in the markets where we operate; (10) changing consumer preferences; (11) the possibility of changes in the Women, Infant and Children (“WIC”) program, or participation in WIC; (12) legislative, regulatory or judicial action that may adversely affect our ability to advertise our products or maintain product margins; and (13) the ability to develop and market new, innovative products. For additional information regarding these and other factors, see our filings with the United States Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”), which filings are available upon request from the SEC or at www.meadjohnson.com. We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Other than as stated below, there have been no material changes in the information reported under (i) Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” contained in our 2013 Form 10-K, (ii) under Item 3 to Part I of our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2014 and (iii) under Item 3 to Part I of our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2014.
Venezuela Risk
During the first quarter of 2014, the Venezuelan government enacted changes affecting the country’s currency exchange and other controls. In late January 2014, the government announced the replacement of the Commission for the Administration of Foreign Exchange (“CADIVI”) with a new foreign currency administration, the National Center for Foreign Commerce (“CENCOEX”). In conjunction with this replacement, CENCOEX assumed control of the sale and purchase of foreign currency in Venezuela, and has maintained the official exchange rate of 6.3 Bolivares Fuertes (“VEF”) to 1.0 U.S. dollar (“USD”) (the “Official Rate”). Entities can continue to seek approval to transact through the CENCOEX mechanism at the Official Rate, which is honored for certain priority transactions.
Additional changes in January expanded the types of transactions that may be subject to the weekly auction mechanism under the Complimentary Currency Administration System (“SICAD I”). MJN concluded that among other items, future inter-company dividend remittances qualify for the purchase of foreign currency at the SICAD I rate under the revised law. As such, MJN adopted the SICAD I rate for purposes of remeasuring the net monetary assets of our Venezuelan subsidiary effective February 28, 2014. The remeasurement impact of this adoption in the first quarter of 2014 was a loss of $6.1 million, which was recognized in MJN’s Statement of Earnings as a component of other (income)/expenses - net. Because the SICAD I auction rate is a floating rate, the potential exists for additional financial impacts if the auction rate changes significantly. As of September 30, 2014, SICAD I had a published rate of 12.0 VEF to 1.0 USD. In February 2014, the Venezuelan government announced plans for the Alternative Foreign Exchange System (“SICAD II”), which is intended to more closely resemble a market-driven exchange. SICAD II became effective on March 24, 2014. As of September 30, 2014, SICAD II had a published rate of 50.0 VEF to 1.0 USD. MJN currently does not plan to attempt to access USD using the SICAD II exchange under the current exchange structure.
During the three and nine months ended September 30, 2014, the Company recognized gains of $5.1 million and $13.7 million, respectively, related to its exchange of VEF for USD at the CENCOEX Official Rate, which is more favorable than the SICAD I rate used to remeasure net monetary assets of MJN’s Venezuelan subsidiary.
It is possible that the Venezuelan government will further refine or alter mechanisms through which companies are able to access USD, which could change the rate at which MJN can access USD and the rate used by the Company to remeasure the net monetary assets of its Venezuelan subsidiary.
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For the year ended December 31, 2013 and the nine months ended September 30, 2014, our Venezuelan subsidiary had net sales that represented approximately 2% of total Company net sales. As of September 30, 2014, our subsidiary had approximately $13 million of net monetary assets.
ITEM 4. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer (our principal executive officer and principal financial officer, respectively), we have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2014. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of September 30, 2014, the Company’s disclosure controls and procedures were effective in ensuring information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. There has been no change in our internal control over financial reporting during the quarter ended September 30, 2014, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Information pertaining to legal proceedings can be found in Part I of this report under “Item 1. Financial Statements - Note 19. Contingencies” and is incorporated by reference herein.
ITEM 1A. RISK FACTORS.
There is no material change in the information reported under “Item 1A. Risk Factors” contained in our 2013 Form 10-K.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
(c) Issuer Purchases of Equity Securities
The following table includes information about the Company’s stock repurchases during the three-month period ending September 30, 2014:
(Dollars in millions, except per share amounts) Period | Total Number of Shares Purchased (1) | Average Price Paid per Share (2) | Total Number of Shares Purchased as Part of Publicly Announced Program | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (3) | |||||||||
July 1, 2014 through July 31, 2014 | - | - | - | $ | 461.4 | ||||||||
August 1, 2014 through August 31, 2014 | 72,000 | $ | 94.73 | 72,000 | $ | 454.5 | |||||||
September 1, 2014 through September 30, 2014 | 132,419 | $ | 96.15 | 132,419 | $ | 441.9 | |||||||
204,419 | $ | 95.65 | 204,419 | $ | 441.9 | ||||||||
(1) | The total number of shares purchased does not include shares surrendered to the Company to pay the exercise price in connection with the exercise of employee stock options or shares surrendered to the Company to satisfy tax withholding obligations in connection with the exercise of employee stock options or the vesting of restricted stock units. |
(2) | Average Price Paid per Share includes commissions. |
(3) | On September 11, 2013, the Company announced that its board of directors approved a share repurchase authorization of up to $500.0 million of the Company’s common stock (the “2013 Authorization”). The 2013 Authorization does not have an expiration date. As of September 30, 2014, the Company had $441.9 million remaining available under the 2013 Authorization. |
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ITEM 6. EXHIBITS.
Exhibit Number | Exhibit Description | |
31.1 | Rule 13a-14(a) and 15d-14(a) Certification of the Chief Executive Officer | |
31.2 | Rule 13a-14(a) and 15d-14(a) Certification of the Chief Financial Officer | |
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MEAD JOHNSON NUTRITION COMPANY | |||
Date: | October 23, 2014 | By: | /s/ Tom De Weerdt |
Tom De Weerdt | |||
Vice President, Corporate Controller | |||
(Authorized Officer and Chief Accounting Officer) | |||
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