Mead Johnson Nutrition Co
Item 1. BUSINESS.
In this Annual Report on Form 10-K, we refer to Mead Johnson Nutrition Company and its subsidiaries as "the Company," "MJN," "Mead Johnson," "we" or "us."
Our Company
Mead Johnson Nutrition Company is a global leader in pediatric nutrition with $3.7 billion in net sales for the year ended December 31, 2011. We are committed to being the world's leading nutrition company for infants and children and to helping nourish the world's children for the best start in life. Our Enfa family of brands, including Enfamil infant formula, is the world's leading brand franchise in pediatric nutrition, based on retail sales. 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. Our singular focus on pediatric nutrition and our implementation of a business model that integrates nutritional science with health care and consumer marketing expertise differentiate us from many of our competitors.
We market our portfolio of more than 70 products to mothers, health care professionals and retailers in more than 50 countries in Asia, North America, Latin America and Europe. Our two reportable segments are Asia/Latin America and North America/Europe, which comprised 66% and 34%, respectively, of our net sales for the year ended December 31, 2011. See "Item 8. Financial Statements-Note 7. Segment Information." For the year ended December 31, 2011, 72% of our net sales were generated in countries outside of the United States.
We believe parents and health care professionals associate the Mead Johnson name and the Enfa family of brands with quality, science-based pediatric nutrition products. We believe the strength of our brands allows us to create and maintain consumer loyalty across our product portfolio and stages of pediatric development.
The two principal product categories in which we operate are infant formula and children's nutrition, which represented 59% and 38% of our net sales for the year ended December 31, 2011, respectively.
Our History
Mead Johnson was founded in 1905 and introduced Dextri-Maltose, our first infant feeding product, in 1911. Over the next several decades, we built upon our leadership in science-based nutrition, introducing many innovative infant feeding products while expanding into vitamins, pharmaceutical products and adult and children's nutrition. Some of our products, developed in cooperation with clinicians and leading nutrition researchers, established a partnership between Mead Johnson and the scientific community that continues to this day.
During the course of our history, we have expanded our operations into geographies outside of the United States, including Asia, Latin America and Europe and now focus solely on pediatric nutrition. Throughout our history, our deeply-held commitment to support breastfeeding and our commitment to improve the health and development of infants and children around the world have been hallmarks of our organization.
Our Brands
The Mead Johnson name has been associated with science-based nutritional products for over 100 years. In addition to the Mead Johnson name, our products are marketed around the world under brands that we have developed through our global sales and marketing efforts.
Enfa Family of Brands
The Enfa family of brands includes several of the world's leading infant formula and children's nutrition brands. We have positioned the Enfa family of brands as providing unique, clinically supported health and developmental benefits. The Enfa family of brands features infant formula products that include docosahexaenoic acid (DHA) and arachidonic (ARA) to support brain, visual and nervous and immune system development. Our Enfa family of brands accounted for 80% of our net sales for the year ended December 31, 2011, and is the world's leading brand franchise in pediatric nutrition, based on retail sales.
Building upon the strength of our brand equity, we have extended the Enfa family of brands into the fast-growing children's nutrition category. We believe we have enhanced consumer retention by creating links between age groups and leveraging brand loyalty.
Additionally, the use of the Enfa prefix in our prenatal nutrition products (such as EnfaMama A+) reinforces the scientific basis, quality and innovation that these products hold in common with our core pediatric nutrition line.
We consistently promote the brand through our global sales and marketing operations. Our studies show mothers and health care professionals often associate the Enfa family of brands with science, superior nutrition, quality and good value. Mothers often describe the Enfa family of brands as science-based, sophisticated, trustworthy, reliable and comforting. Additionally, health care professionals frequently comment on our professional and innovative approach to nutrition science.
Complementary Brands
In addition to the Enfa family of brands, we market several other powerful brands on a local, regional or global basis. These brands complement the Enfa family of brands portfolio and are designed to meet the specific nutritional needs of infants under the supervision of health care professionals (such as Nutramigen) or the nutritional needs of broad consumer populations (such as ChocoMilk and Cal-C-Tose).
Stages of Development
Generally, there are six stages of pediatric development and we produce different products for each of these stages. The general stages of pediatric development are illustrated below:
In the United States, our business is primarily focused on the infant formula category (Stages 1 and 2) and certain children's nutrition products (Stage 3). Outside of the United States, however, we market both infant formula products (Stages 1 and 2) and an extended range of children's nutrition products designed for the changing nutritional needs of growing toddlers and children (Stages 3, 4
and 5). This allows us to take advantage of brand loyalty developed in Stages 1 and 2 to retain consumers as they grow older.
Our Products
Our pediatric nutrition products are grouped by category of feeding: (1) infant formula products, (2) children's nutrition products and (3) other products. Infant formula, children's nutrition and other product sales comprised approximately 59%, 38% and 3% of our net sales for the year ended December 31, 2011, respectively.
Infant Formula
General
Our infant formula products include formulas for routine feeding, solutions formulas for mild intolerance and specialty formula products, including formulas for severe intolerance, formulas for premature and low birth weight infants and medical nutrition products. The table below illustrates our key infant formula brands and products:
ROUTINE INFANT FORMULA
SOLUTIONS INFANT FORMULA FOR
COMMON FEEDING PROBLEMS
SPECIALTY INFANT FORMULAS
Stage 1
Many available in stages 1 and 2
Many available in stages 1 and 2
•
Enfamil Premium
•
Enfamil Gentlease: for gas/fussiness
•
Nutramigen LIPIL: for mild to
•
Enfamil Premium Newborn*
•
Enfamil ProSobee: soy formula
moderate cow's milk or soy allergies
•
Enfamil A+
•
Enfamil LactoFree: for lactose
•
Nutramigen AA: for severe cow's
•
Enfalac A+
intolerance
milk protein or multiple food
Stage 2
•
Enfamil AR: for anti-regurgitation
allergies
•
Enfapro A+
•
Enfamil HA: for infants at risk of
•
Pregestimil: for fat malabsorption
•
Enfapro Premium
cow's milk protein allergy
•
Enfamil Premature: for premature
•
Enfamil Comfort: for gas/fussiness
infants
•
Enfacare: for premature infants
*0 to 3 months
Routine Infant Formula
We design routine infant formula as a breast milk substitute for healthy, full-term infants without special nutritional needs both for use as the infant's sole source of nutrition and as a supplement to breastfeeding. We endeavor to develop routine infant formula closer to breast milk. We also provide products within our routine formula line for healthy full-term infants who experience common feeding problems with symptoms such as mild spit-up, fussiness or gas.
Each product is referred to as a "formula", as it is formulated for the specific nutritional needs of an infant of a given age. Generally, our routine infant formula has the following four main components: (1) protein from cow's milk that is processed to have a profile similar to human milk, (2) a blend of vegetable fats (including DHA/ARA) to replace bovine milk fat in order to better resemble the composition of human milk, (3) a carbohydrate, generally lactose from cow's milk and (4) a vitamin and mineral "micronutrient" pre-mix that is blended into the product to meet the specific needs of the infant at a given age. Patterned after breast milk, which changes composition to meet the infant's changing nutritional needs, we produce two stages of infant formula. Stage 1 formula is consumed by newborn infants up to six months of age (up to three months of age in the case of Enfamil Premium Newborn), and Stage 2 formula is generally consumed by infants aged from six to twelve months. Our most prominent product form around the world is milk-based powder, but we also produce several infant formulas in ready-to-use and concentrated liquid form for sale primarily in the United States and Canada.
We market the same product under different names in different regions, based on regional marketing strategies and regional brand recognition. For example, our premium Stage 1 infant formulas containing DHA and ARA are sold under the brands Enfamil Premium and Enfamil Premium Newborn in the United States. Outside the United States, Enfamil Premium is sold under the brands Enfamil A+ and Enfalac A+. In parts of Asia, Latin America and Europe, we use the name Enfapro for our Stage 2 products.
Routine infant formula products comprised 68%, 69%, and 67% of our infant formula net sales for the years ended December 31, 2011, 2010, and 2009, respectively.
Solutions Infant Formulas
We design several solutions infant formulas to address common feeding tolerance problems in normal infants, including spit-up, fussiness, gas and lactose intolerance. We market our solutions infant formulas for mild intolerance such as Gentlease and Prosobee under the Enfa family of brands name.
Solutions infant formula products comprised 18%, 16%, and 18% of our infant formula net sales for the years ended December 31, 2011, 2010, and 2009, respectively.
Specialty Infant Formulas
Our specialty infant formulas include: (1) formulas for severe intolerance, (2) formulas for premature and low birth weight infants and (3) medical nutrition products. Specialty infant formula products comprised 14%, 15%, and 15% of our infant formula net sales for the years ended December 31, 2011, 2010, and 2009, respectively.
Formulas for Severe Intolerance
We design formulas for severe intolerance to be used on the specific recommendation and under the supervision of a doctor. We specially formulate these products for use by infants displaying symptoms of certain conditions or diagnosed with special medical needs.
Nutramigen infant formula was the first infant formula to include protein hydrolysate in the United States. This ingredient is easier for infants with severe intolerance to digest because its protein is extensively hydrolyzed (or broken down into peptides, a process that would otherwise be performed in the infant's stomach). We designed Nutramigen infant formula for use by infants with severe cow's milk protein allergies. Nutramigen with LGG infant formula is a variant of Nutramigen we market in Europe and the United States. LGG is a probiotic ingredient that has been associated with reduced incidence of infant atopic dermatitis, a non-contagious skin disease characterized by chronic inflammation of the skin, resulting from an allergy to cow's milk. Nutramigen AA infant formula is an amino acid formula we formulated with fully broken-down proteins that can be consumed without the need for digestion of the protein. We designed this product for infants who experience a severe allergy to cow's milk or multiple other food allergies. Pregestimil infant formula is a variation of the Nutramigen formulation designed mainly for fat malabsorption. It contains medium chain triglycerides oil instead of fat.
Formulas for Premature and Low Birth Weight Infants
We also design products for premature and low birth weight infants to meet these infants' unique needs under the supervision of a doctor, most often in the hospital. Typically, such infants need extra assistance obtaining the requisite nutrition. They require a higher density of nutrients and calories because they cannot take in enough volume of breast milk or routine infant formula. We designed Enfamil Human Milk Fortifier product as a supplement to a mother's breast milk that improves nutritional density. EnfaCare infant formula, another of our products, is a hypercaloric formula
available at retail for premature babies when they are able to go home. In addition, Enfamil Premature is an infant formula used primarily in the hospital.
Medical Nutrition
We also produce medical foods, or foods for special medical purposes, for nutritional management of individuals with rare, inborn errors of metabolism such as maple syrup urine disease (Mead Johnson BCAD) and phenylketonuria (Mead Johnson Phenyl-Free). Category 1 products are intended for infants and young children from zero to three years of age and Category 2 products are suitable for children and adults. We produce approximately 20 formulas targeted at specific disorders for use under the direct and continuous supervision of a physician. We market these medical nutrition products under the Mead Johnson brand name.
Children's Nutrition Products
Children's nutrition products are designed to provide children with enhanced nutrition. Our children's nutrition business is present primarily in Asia and Latin America. We separate our children's nutrition products into two categories: (1) Enfa branded children's nutrition products and (2) other children's nutrition products. The table below illustrates our key children's nutrition products:
ENFA BRANDED CHILDREN'S
NUTRITION PRODUCTS
OTHER CHILDREN'S NUTRITION PRODUCTS
Stage 3
Many available in stages 3, 4 and 5
•
Enfagrow A+
•
Sustagen KID: nutritious powdered milk for picky eaters
•
Enfagrow Premium
•
Lactum: nutritious powdered milk for picky eaters
Stage 4
•
Alacta: nutritious powdered milk
•
Enfakid A+
•
ChocoMilk: nutritious milk modifier
Stage 5
•
Cal-C-Tose: nutritious milk modifier
•
EnfaSchool A+
Enfa Branded Children's Nutrition Products
We market children's nutrition products under the Enfa family of brands. We design these products to meet the changing nutrition needs of children at different stages of development. We offer products at Stages 3, 4 and 5 that are designed for children's nutritional needs at one to three years of age, three to five years of age and beyond five years of age, respectively. These products are not breast milk substitutes and are not designed for use as the sole source of nutrition but instead are designed to be a part of a child's appropriate diet. Our use of the Enfa prefix allows for a consistent equity across Stages 3, 4 and 5, with products such as Enfagrow offered at Stage 3 and Enfakid offered at Stage 4 and EnfaSchool at Stage 5. Enfa branded children's nutrition products comprised 71%, 68%, and 65% of our children's nutrition products sales for the years ended December 31, 2011, 2010, and 2009, respectively.
Other Products
We also produce a range of other products, including pre-natal and post-natal nutritional supplements for expectant and nursing mothers, including Expecta LIPIL and EnfaMama A+. Our products for expectant or nursing mothers provide the developing fetus or breastfed infant with vitamin supplements and/or an increased supply of DHA for brain, visual and nervous system development. These products also supplement the mother's diet by providing either DHA or ARA with increased proteins, as well as 24 vitamins and minerals. Our pediatric vitamin products, such as Enfamil Poly-Vi-Sol, provide a range of benefits for infants, including multivitamins and iron supplements. These
other products comprised 3%, 2%, and 4% of our net sales for the years ended December 31, 2011, 2010, and 2009, respectively.
The Special Supplemental Nutrition Program for Women, Infants and Children (WIC)
The WIC program is a U.S. Department of Agriculture (USDA) program created to provide nutritious foods, nutrition education and referrals to health care professionals and other social services to those considered to be at nutritional risk, including low-income pregnant, postpartum and breastfeeding women and infants and children up to age five. It is estimated that approximately 52% of all infants born in the United States during the 12-month period ended December 31, 2011, benefited from the WIC program. The USDA program is administered individually by each state.
Participation in the WIC program is an important part of our U.S. business based on the volume of infant formula sold under the program. Our financial results reflect net WIC sales, after taking into account the rebates we paid to the state WIC agencies, which represented approximately 10% of our U.S. net sales and 3% of our global net sales in the year ended December 31, 2011. In late 2009, changes went into effect that resulted in less infant formula per participant being provided under the WIC program. As a result of these program changes, infant formula is made available based on the amount of an infant's consumption; previously, fixed amounts of product were made available regardless of an infant's age. These program changes have reduced the amount of free product available by an average of 10%.
Most state WIC programs provide vouchers that participants use at authorized food stores to obtain the products covered by the program, including infant formula. State WIC agencies enter into contracts with manufacturers, pursuant to which the state agency provides mothers with vouchers for a single manufacturer's brand of infant formula and, in return, the manufacturer gives the state agency a rebate for each can of infant formula purchased by WIC participants. Retailers purchase infant formula directly from the manufacturer, paying the manufacturer's published wholesale price. Mothers redeem the vouchers received from the WIC agency for infant formula at authorized retailers. The retailer is then reimbursed the full retail price by the WIC agency for redeemed vouchers. On a monthly basis, each state WIC agency invoices the contracted manufacturer for an amount equal to the number of cans of infant formula redeemed by the agency and paid to retailers during the month multiplied by the agreed rebate per can.
The bid solicitation process is determined by each state's procurement laws, but the process is relatively standardized across the WIC program. Some states form groups and hold their bid processes jointly while other states solicit bids individually. Some states split bids between separate contracts for milk- and soy-based formulas. During the bid process, each manufacturer submits a sealed bid. The manufacturer with the lowest net price, calculated as the manufacturer's published wholesale price less the manufacturer's rebate bid, is awarded the contract. No other factors are considered. WIC contracts are generally three years in duration with some contracts providing for extensions. Specific contract provisions can vary significantly from state to state.
Manufacturers that choose to compete for WIC contracts must have a widely distributed infant formula brand in order to meet the requirements of the contract bidding process. As of December 31, 2011, we hold the contracts that supply approximately 42% of WIC births.
As of December 31, 2011, we hold the exclusive WIC contract for the following states and territories:
(1)As of October 2011, as reported by the United States Department of Agriculture Food and Nutrition Service (the USDA FNS).
(2)Contract contains extension provisions.
Sales and Marketing
We conduct regional marketing in North America, Europe, Asia and Latin America within a global strategic framework focused on both parents and health care professionals in compliance with our policy with respect to the International Code of Marketing of Breast-milk Substitutes (the Code). See "-Regulatory-Global Policy and Guidance-WHO." We maintain a health care professional sales force and retail sales organization throughout the world. Our marketing activities vary from region to region depending on our market position, consumer trends and the regulatory environment. Our marketing teams seek to anticipate market and consumer trends, and attempt to capture deep consumer insight to determine strategy for brand positioning and communication, product innovation and demand-generation programs. The marketing teams work with external agencies to create strong marketing campaigns for health care professionals, retail sales organizations and consumers, as permitted under the Code and individual countries' laws and regulations.
Health Care Professionals
Our health care professional sales force educates health care professionals about the benefits of our infant formula products in each of the countries where we market our infant formula products. Primary marketing efforts for infant formula products are directed toward securing the recommendation of the Enfa family of brands by physicians or other health care professionals. We focus our product detailing efforts on neonatal intensive care units, physicians and other health care professionals, hospital group purchasing organizations and other integrated buying organizations. We believe we have an industry-leading health care professional sales force.
Our health care professional sales force receives continuous training about our products and on customer service skills. We support health care professionals by organizing continuing medical education programs, symposia and other educational interfaces.
Retail Sales Organization
Our retail sales force markets our products to each of the retail channels where our products are purchased by consumers, including mass merchandisers, club stores, grocery stores, drug stores and, to a limited extent, convenience stores. The size, role and purpose of our retail sales organization varies significantly from country to country depending on our market position, the consolidation of the retail trade, consumer trends and the regulatory environment. In North America, Latin America and Asia, we focus on all retail channels, while in Europe we focus primarily on pharmacies. We have entered into logistics partnerships with distributors and wholesalers in most of our markets.
Consumers
As their children grow older, parents play an increasing role in brand selection. We participate in a variety of marketing activities intended for parents of older children, including print and television advertising, direct mail, online/internet and promotional programs. Our marketing is evidence-based and emphasizes our superior nutritional science.
In the United States, our Enfamil Family Beginnings program provides new or prospective parents with many resources to help them with their newborns, including free samples, nutritional and developmental information for mother and child and widely accepted instantly redeemable coupons. The program also includes a direct mail component used to better inform mothers on nutritional and developmental topics, as well as frequent e-mail updates that provide pertinent information to program participants. The marketing materials at each of these stages are designed to develop interest in our products with respect to mothers' current and future needs in order to drive purchase and create brand loyalty. The program's educational materials are designed to help all mothers with their newborns while the program's promotional aspects are focused primarily on our core consumer targets, mainly non-WIC parents.
Global Supply Chain
We manage sourcing, manufacturing and distribution through our fully integrated global supply chain. We operate in-house production facilities at eight different locations around the world and additionally use third-party manufacturers for a portion of our requirements.
Locations
Our in-house manufacturing and finishing facilities are located in the United States, Mexico, the Netherlands, China, the Philippines and Thailand. See "Item 2. Properties" for a description of our global manufacturing facilities. In addition, we lease a packaging facility in Brazil where we also employ the workforce.
As the production process advances, regional or sub-regional teams support the global team, overseeing manufacturing activities such as the finishing of our products. Our four regional quality departments perform regional and manufacturing site quality control and assurance. These departments focus on regulatory requirements, food safety, pest control, continuous quality improvement, third-party compliance and ingredient supplier manufacturing operations.
Suppliers
We generally enter into long-term supply agreements. We source approximately 80% of our materials from approximately 30 suppliers. Through these suppliers, we obtain key raw materials and primary packaging materials.
We procure key raw materials and primary packaging materials on a global basis. Certain raw materials, while managed and contracted on a global basis, are subject to regional and local variations in price under the terms of the supply agreement. For example, milk prices vary at the local level around the world partly due to government pricing regulation. Dairy products, consisting primarily of milk powders, non-fat dry milk, lactose and whey protein concentrates, accounted for approximately 41% of our global expenditures for materials in the year ended December 31, 2011.
Distribution
We manage our distribution networks locally with regional oversight. We generally enter into distribution agreements with third-party logistics providers and distributors and maintain a small staff at the local or regional level to track performance and implement initiatives.
Customers
Our products are sold principally to wholesale and retail customers, both nationally and internationally. Sales to two of our customers, Wal-Mart Stores, Inc. (including sales to Sam's Club) and DKSH International Ltd. (including sales to its regional affiliates), accounted for approximately 12%, 12% and 12% and approximately 14%, 12% and 11% of our gross sales for the years ended December 31, 2011, 2010, and 2009, respectively.
Competition
We compete in two primary categories, infant formula and children's nutrition. The competitive landscape in each category is similar around the world, as the majority of the large global players are active in these categories. Our main global competitors for sales of infant formula and children's nutrition products are Abbott Laboratories, Danone, Nestlé S.A. and Pfizer Inc.
Other companies, including manufacturers of private label, store and economy brand products, manufacture and sell one or more products that are similar to those marketed by us. We believe sources of competitive advantage include product quality and clinical claims for efficacy, brand identity, image and associated value, broad distribution capabilities and consumer satisfaction. Significant expenditures for advertising, promotion and marketing (where permitted by regulation and policy) are generally required to achieve acceptance of products among consumers and health care professionals.
Research and Development (R&D)
Continuing to invest in R&D capabilities is an important part of our business. Our research and development organization consists of professionals of which many have extensive industry experience and advanced educational backgrounds. Our main R&D facilities are located in Mexico, Thailand, the Netherlands and Evansville, Indiana, the headquarters of our global R&D operations. In 2011, we completed construction of new Pediatric Nutrition Institutes (PNI) in Mexico City, Mexico, and Guangzhou, China, to complement our existing PNI in Evansville, Indiana.
With respect to infant formula, we organize our research and development on a global scale because these science-based products address nutritional needs that are broadly common around the world. With respect to children's nutritional products, we organize our research and development on a more regional basis to incorporate geographic-specific consumer behaviors and preferences.
We have a global formulation management system that supports our innovative portfolio management and product development process. This system provides significant benefits throughout the product development and manufacturing process.
We also have strong external development relationships that complement our internal research and development capabilities. We manage our research and development activities in collaboration with leading scientists and institutes around the world and we have an active portfolio of projects involving commercial technology suppliers. We believe this approach allows us to be at the forefront of scientific and technological developments relevant for pediatric nutrition. Research and development expense was $92.5 million, $78.5 million, and $71.9 million in the years ended December 31, 2011, 2010, and 2009, respectively.
Intellectual Property
Patents
We own or license approximately 43 active U.S. patents and 193 active non-U.S. patents and have 73 pending U.S. patent applications and 708 pending non-U.S. patent applications as of December 31, 2011.
Trademarks
We file and maintain our trademarks in those countries in which we have, or desire to have, a business presence. We hold an extensive portfolio of trademarks across our key geographies. We maintain more than 6,000 trademark registrations and applications in more than 140 countries worldwide.
Regulatory
We are subject to the laws and regulations in each country in which we market our products. We have proven processes, systems and resources in place to manage the current regulatory requirements and to participate proactively in the shaping of future regional, country and global policy, guidance and regulations.
United States Food and Drug Administration (U.S. FDA)
The main regulatory body in the United States is the U.S. FDA. The U.S. FDA's Center for Food Safety and Applied Nutrition is responsible for the regulation of infant formula and other foods. The Office of Nutrition, Labeling, and Dietary Supplements (ONLDS) has program responsibility for, among other matters, infant formula while the Office of Food Additive Safety (OFAS) has program responsibility for food ingredients and packaging. ONLDS evaluates whether the infant formula manufacturer has met the requirements under the Federal Food, Drug and Cosmetic Act (FFDCA) and consults with OFAS regarding the safety of ingredients in infant formula and of packaging materials for infant formula.
All manufacturers of pediatric nutrition products must begin with safe food ingredients, which are either generally recognized as safe or approved as food additives. The specific requirements for infant formula are governed by the Infant Formula Act of 1980, as amended (Formula Act). The purpose of the Formula Act is to ensure the safety and nutrition of infant formulas, including minimum, and in some cases, maximum levels of specified nutrients.
Once an infant formula product is formulated, the manufacturer must provide regulatory agencies assurance of the nutritional quality of that particular formulation before marketing the infant formula. The U.S. FDA has established requirements for certain labeling, nutrient content, manufacturer quality control procedures (to assure the nutrient content of infant formulas), as well as company records and
reports. A manufacturer must notify the U.S. FDA 90 days before the first processing of any infant formula that differs fundamentally in processing or in composition from any previous formulation produced by the manufacturer. The U.S. FDA currently is finalizing incremental good manufacturing practices, quality control procedures, quality factors, notification requirements, and reports and records, for the production of infant formulas.
In addition, as part of its responsibility to implement the provisions of the Formula Act, the U.S. FDA continuously monitors infant formula products. The Formula Act requires infant formula manufacturers to test product composition during production and shelf-life, to keep records on production, testing and distribution of each batch of infant formula and to use good manufacturing practices and quality control procedures. In addition, the Formula Act requires infant formula manufacturers to maintain records of all complaints, some of which are reviewed to evaluate the possible existence of a hazard to health. The U.S. FDA conducts yearly inspections of all facilities that manufacture infant formula.
Outside of the United States
Country-specific regulations and laws have provisions that include requirements for certain labeling, nutrient content and manufacturers quality control procedures (to assure the nutrient content of infant formulas), as well as company records and reports. With the exception of the European Union, most other countries' regulatory agencies have not promulgated specific requirements for the testing of new and reformulated infant formulas. Other countries will generally refer to the U.S. FDA, European Food Safety Authority or the World Health Organization (WHO) in establishing standards for infant formulas.
Global Policy and Guidance
WHO
The WHO is the directing and coordinating authority for health within the United Nations system. It is responsible for providing leadership on global health matters, shaping the health research agenda, setting norms and standards, articulating policy recommendations, providing technical support to countries and monitoring and assessing health trends.
In 1981, many Member States of the WHO's World Health Assembly voted to adopt the International Code of Marketing of Breast-milk Substitutes (the Code). The Code aims to protect and promote breastfeeding and to ensure the proper use of breast-milk substitutes, when they are necessary, on the basis of adequate information and through appropriate marketing and distribution. Countries have taken variable action to enact legislation based on the recommendations of the Code. In 1983, we believe we were the first U.S. infant formula manufacturer to develop internal marketing guidelines for developing countries based on the Code. While the Code is not international law, it is our policy to comply with all applicable laws and regulations and take guidance from the Code in developing countries.
Codex
The Codex Alimentarius (Codex) is the publication of internationally recognized standards, codes of practice, guidelines and other recommendations relating to infant formula and food production. These texts are developed and maintained by the Codex Commission, a body that was established in 1963 by the United Nations Food and Agriculture Organization and the WHO. In 2007, new comprehensive and more restrictive infant formula standards were published by the Codex Commission. It is usual practice for countries in Latin America, Africa and Asia to incorporate Codex standards directly into national law. We are in material compliance with all national laws and with Codex standards where national regulatory requirements have not yet been enacted.
Environmental, Health and Safety
Our facilities and operations are subject to various environmental, health and safety laws and regulations in each of the jurisdictions in which we operate. Among other things, these requirements regulate the emission or discharge of materials into the environment, the use, management, treatment, storage and disposal of solid and hazardous substances and wastes, the control of combustible dust, the reduction of noise emissions and fire and explosion risks, the cleanup of contamination and the prevention of workplace exposures and injuries. Pollution controls and various permits and programs are required for many of our operations. Each of our global manufacturing facilities undergoes periodic internal audits relating to environmental, health and safety requirements and we incur operating and capital costs to improve our facilities or maintain compliance with applicable requirements on an ongoing basis. If we violate or become subject to liabilities under environmental, health and safety laws and regulations, including requirements under the permits and programs required for our operations, we could incur, among other things, substantial costs (including civil or criminal fines or penalties or clean-up costs), third-party claims for property damage or personal injury, or requirements to install additional pollution control or safety equipment.
From time to time, we may be responsible under various state, Federal and foreign laws, including the U.S. Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), for certain costs of investigating and/or remediating substances at our current or former sites and/or at waste disposal or reprocessing facilities operated by third parties. Liability under CERCLA and analogous state or foreign laws may be imposed without regard to knowledge, fault or ownership at the time of the disposal or release. Most of our facilities have a history of production operations in the food and drug industry, and some substances used in such production require proper controls in their storage and disposal. We have been named as a "potentially responsible party", or are involved in investigation and remediation, at two third-party disposal sites. As of December 31, 2011, management believes that the investigation and/or remediation costs related to our sites or third-party disposal sites that were probable and reasonably estimable, as well as any related accruals, are not material to us.
We are not aware of any pending environmental, health or safety-related litigation or significant environmental, health or safety-related financial obligations or liabilities arising from current or former operations or properties that are likely to have a material adverse impact on our business, financial position or results of operations. Liabilities or obligations, which could require us to make significant expenditures, could arise in the future, however, as the result of, among other things, changes in, or new interpretations of, existing laws, regulations or enforcement policies, claims relating to on- or off-site contamination, or the imposition of unanticipated investigation or cleanup obligations. See "Item 3. Legal Proceedings."
Insurance
Our business involves an inherent risk of product liability and any claims of this type could have an adverse impact on us. We will take what we believe are appropriate precautions to provide adequate coverage for possible product liability claims. Though our insurance coverage and cash flows have been adequate to provide for liability claims in the past, product liability claims could exceed our insurance coverage limits and cash flows, and insurance may not be available on commercially reasonable terms or at all. We evaluate our insurance requirements on an ongoing basis to ensure we maintain adequate levels of coverage.
Employees
As of December 31, 2011, we employed approximately 6,600 people worldwide. Our manufacturing workforces in Zeeland, Michigan; Evansville, Indiana; Guangzhou, China; and Chonburi, Thailand are not unionized. The manufacturing workforces in Delicias, Mexico, and São Paulo, Brazil, are unionized and covered by collective bargaining agreements that are negotiated annually. The manufacturing workforce and non-supervised sales force in Makati, Philippines, are unionized and covered by a three-year collective bargaining agreement, which was renewed in December 2010. In addition, European Works Councils represent the manufacturing workforce in Nijmegen, the Netherlands, and the commercial organizations in France and Spain.
Available Information
Our internet web site address is www.meadjohnson.com. On our website, we make available, free of charge, our annual, quarterly and current reports, including amendments to such reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the U.S. Securities and Exchange Commission (SEC). Stockholders and other interested parties may request email notification of the posting of these documents through the section of our website captioned "Investors."
The information on our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings we make with the SEC.
Item 1A. RISK FACTORS
In addition to the other information in this Annual Report on Form 10-K, any of the factors described below could significantly and negatively affect our business, prospects, financial condition or operating results, which could cause the trading price of our securities to decline.
Risks Relating to Our Business
Our success depends on sustaining the strength of our brands, particularly our Enfa family of brands.
The Enfa family of brands accounts for a significant portion of our net sales. The willingness of consumers to purchase our products depends upon our ability to offer attractive brand value propositions. This in turn depends in part on consumers attributing a higher value to our products than to alternatives. If the difference in the value attributed to our products as compared to those of our competitors narrows, or if there is a perception of such a narrowing, consumers may choose not to buy our products. If we fail to promote and maintain the brand equity of our products across each of our markets, then consumer perception of our products' nutritional quality may be diminished and our business could be materially adversely affected. Our ability to maintain or improve our value propositions will impact whether these circumstances will result in decreased market share and profitability.
We may experience liabilities or negative effects on our reputation as a result of real or perceived quality issues, including product recalls, injuries or other claims.
Whether real or perceived, contamination, spoilage or other adulteration, product mislabeling or product tampering could result in our recall of products. From time to time we have experienced recalls of our products. While such recalls have not been material to our business on a global level in the past, we cannot assure you that such material product recalls will not occur in the future. We may also be subject to liability if our products or operations violate or are alleged to violate applicable laws or regulations or in the event our products cause, or are alleged to cause, injury, illness or death.
Powder milk products are not sterile. Because the possibility of environmental contamination exists, we conduct numerous quality checks during production to confirm that our products are free of contaminants when they leave our facilities. Furthermore, a substantial portion of our products must be prepared and maintained according to label instruction to retain their flavor and nutritional value and avoid contamination or deterioration. Depending on the specific type of product, a risk of contamination or deterioration may exist at each stage of the production cycle, including the purchase and delivery of raw food materials, the processing and packaging of food products and upon use and handling by health care professionals, hospital personnel and consumers. In the event that certain of our products are found, or are alleged, to have suffered contamination or deterioration, whether or not such products were under our control, our brand reputation and business could be materially adversely affected.
Whether real or perceived, reports or allegations of inadequate product quality control with respect to other manufacturers of pediatric nutrition products also could adversely impact sales of our products. Such reports or allegations could contribute to a perceived safety risk for certain pediatric nutrition products and adversely impact sales or otherwise disrupt our business. Moreover, the risk of reputational harm may be magnified and/or distorted through the rapid dissemination of information over the Internet, including through news articles, blogs, chat rooms and social media sites. For example, recent unfounded media reports of alleged cronobacter contamination of one of our products in the United States resulted in several retailers temporarily removing such product from their store shelves. Such actions, whether or not justified, could have a material adverse effect on our reputation, brand image and results of operations. Moreover, federal, state and local governments and municipalities could propose or pass legislation banning the use of such products. Events such as these may create a perception of contamination risk among consumers with respect to all products in our industry.
In addition, we advertise our products and could be the target of claims relating to false or deceptive advertising under foreign laws and U.S. federal and state laws, including the consumer protection statutes of some states. A significant product liability or other legal claim or judgment against us or a widespread product recall may negatively impact our profitability. Even if a product liability or consumer fraud claim is unsuccessful or is not merited or fully pursued, the negative publicity surrounding such assertions regarding our products or processes could materially adversely affect our reputation and brand image and therefore our business.
We are subject to numerous governmental regulations, and it can be costly to comply with these regulations. Changes in governmental regulations could harm our business.
As a producer of pediatric nutrition products, our activities are subject to extensive regulation by governmental authorities and international organizations, including rules and regulations with respect to the environment, employee health and safety, hygiene, quality control, advertising and tax laws. It can be costly to comply with these regulations and to develop compliant product processes. Our activities may also be subject to barriers or sanctions imposed by countries or international organizations limiting international trade and increasingly dictating the specific content of our products and limiting information and advertising about the benefits of products that we market. In addition, public policy changes or decisions that restrict the marketing, promotion and availability of our products, continued access to health care professionals, the ability to include genetically modified organisms in our products, as well as the manufacture and labeling of our products, could materially adversely affect our business. For example, regulations in the Philippines require governmental review of all advertisements for products intended for children under the age of two. In addition, certain advocates, along with governmental agencies and non-governmental organizations, have lobbied against the marketing and sale of some pediatric nutrition products. These efforts could result in increased governmental restrictions on our activities in the future. Our activities could be materially adversely affected by any significant changes in such policies or their enforcement. Our ability to anticipate and comply with
changing global standards requires significant investment in monitoring the global external environment and we may be unable to comply with changes in policies restricting our ability to continue to operate our business or manufacture, market or sell our products.
Commodity price increases will increase our operating costs and may reduce our profitability.
Commodity prices impact our business directly through the cost of raw materials used to make our products (such as skim milk powder, whole milk powder, lactose and whey protein concentrate), the cost of inputs used to manufacture and ship our products (such as crude oil and energy) and the amount we pay to produce or purchase packaging for our products (such as cans, pouches, cardboard and plastic). Commodities such as these are susceptible to price volatility caused by conditions outside of our control, including fluctuations in commodities markets, currency fluctuations, availability of supply, weather, consumer demand and changes in governmental agricultural programs. Dairy costs are the largest component of our cost of goods sold. Increases in the price of dairy and other raw materials would negatively impact our gross margins if we were unable to offset such increases through increases in our selling price, changes in product mix or cost reduction/productivity enhancement efforts. The prices of these materials may continue to rise due to a general increase in commodities prices, especially for agricultural products. This would in turn affect the unit costs of products sold for our pediatric nutrition products. Although we monitor our exposure to commodity prices as an integral part of our overall risk management program, continued volatility in the prices of commodities we purchase could increase the costs of our products and we may experience lower profitability and be unable to maintain historical levels of productivity. Furthermore, increases in our selling prices imposed to offset increases in commodity prices could result in lower sales volume, if consumers shift their purchases to lower-priced products.
Our business is particularly vulnerable to commodity price increases in Asia, the fastest growing region in the pediatric nutrition industry. Commodity price increases could reduce our profits and limit our ability to pursue our growth strategy in that region. We employ various purchasing and pricing contract techniques in an effort to minimize commodity price volatility. Generally, these techniques include incorporating clauses setting forth unit pricing that is based on an average commodity price over a corresponding period of time. If we fail to manage our commodity price exposure adequately, our business may be materially adversely affected.
Our profitability may suffer as a result of competition in our markets.
The pediatric nutrition industry is intensely competitive. Our primary competitors, including Abbott Laboratories, Danone, Nestlé S.A. and Pfizer Inc., have substantial financial, marketing and other resources. We compete against large global companies, as well as regional and local companies, in each of the regions in which we operate. In most product categories, we compete not only with other widely advertised branded products, but also with private label, store and economy brand products that are generally sold at lower prices. Competition in our product categories is based on the following factors:
•brand recognition and loyalty;
•product quality;
•effectiveness of marketing, promotional activity and the ability to identify and satisfy consumer preferences;
•product innovation;
•price; and
•distribution and availability of products.
From time to time, in order to protect our existing market share or capture increased market share, we may need to improve our brand recognition and product value proposition, and increase our spending on marketing, advertising and new product innovation. The success of marketing, advertising and new product innovation is subject to risks, including uncertainties about trade and consumer acceptance. We may also need to reduce prices for some of our products in order to respond to competitive and customer pressures and to maintain our market share. Competitive and customer pressures, as well as price controls, may restrict our ability to increase prices, including in response to commodity and other cost increases. Our business will suffer if profit margins decrease, either as a result of a reduction in prices or an increase in costs with an inability to increase prices proportionally.
Economic downturns could cause consumers to shift their purchases from our higher-priced premium products to lower-priced products, which could materially adversely affect our business.
The willingness of consumers to purchase premium brand pediatric nutrition products depends in part on local economic conditions. In periods of economic uncertainty, consumers may shift their purchases from our higher-priced premium products to lower-priced products or delay having children.
Volatility in the financial markets could adversely affect our liquidity, cash flow and financial flexibility, as well as the demand for our products.
Volatility in the financial markets could adversely affect economic activity and credit markets in the United States and other regions of the world in which we do business. This could have an adverse impact on our customers, distributors, suppliers, counterparties to certain financial instruments, financial service providers and other service providers.
Our operations face significant foreign currency exchange rate exposure that could materially negatively impact our operating results.
We hold assets, incur liabilities, earn revenue and pay expenses in a variety of currencies other than the U.S. dollar, primarily the Chinese renminbi, the Hong Kong dollar, the euro, the Malaysian ringitt, the Mexican peso, the Philippine peso, the Canadian dollar and the Thai bhat. Because our financial statements are presented in U.S. dollars, we must translate our assets, liabilities, sales and expenses into U.S. dollars at the then-applicable exchange rates. Consequently, changes in the value of the U.S. dollar versus these other currencies may negatively affect the value of these items in our financial statements, even if their value has not changed in their original currency. While we attempt to mitigate some of this risk with hedging and other activities, our business will nevertheless remain subject to substantial foreign exchange risk from foreign currency translation exposures that we will not be able to manage through effective hedging or the use of other financial instruments.
The global nature of our business subjects us to additional business risks that could cause our sales and profitability to decline.
We operate our business and market our products internationally in more than 50 countries. For the years ended December 31, 2011, 2010, and 2009, 72%, 68%, and 65%, respectively, of our net sales were generated in countries outside of the United States. The risks associated with our operations outside of the United States include:
•multiple regulatory requirements that are subject to change and that could restrict our ability to manufacture, market or sell our products;
•inflation, recession, fluctuations in foreign currency exchange and interest rates and discriminatory fiscal policies;
•adverse tax consequences from the repatriation of cash;
•trade protection measures, including increased duties and taxes, and import or export licensing requirements;
•price controls;
•government health promotional programs intended to discourage the use of our products;
•differing local product preferences and product requirements;
•difficulty in establishing, staffing and managing operations;
•differing labor regulations;
•potentially negative consequences from changes in or interpretations of tax laws;
•political and economic instability;
•enforcement of remedies in various jurisdictions;
•changes in foreign medical reimbursement policies and programs; and
•diminished protection of intellectual property in some countries.
These and other risks could have a material adverse effect on our business.
Our global operations are subject to political and economic risks of developing countries, and special risks associated with doing business in corrupt environments.
We operate our business and market our products internationally in more than 50 countries, and we are focusing on increasing our sales and operations in regions, including Asia, Latin America, India and Russia, which are less developed, have less stability in legal systems and financial markets, and are potentially more corrupt business environments than the United States, and therefore present greater political, economic and operational risks. We have in place policies, procedures and certain ongoing training of employees with regard to business ethics and many key legal requirements, such as applicable anti-corruption laws, including the U.S. Foreign Corrupt Practices Act (FCPA), which make it illegal for us to give anything of value to foreign officials in order to obtain or retain any business or other advantages; however, there can be no assurance that our employees will adhere to our code of business ethics or any other of our policies, applicable anti-corruption laws, including the FCPA, or other legal requirements. If we fail to enforce our policies and procedures properly or maintain adequate record-keeping and internal accounting practices to accurately record our transactions, we may be subject to regulatory sanctions. If we believe or have reason to believe that our employees have or may have violated applicable anti-corruption laws, including the FCPA, or other laws or regulations, we investigate or have outside counsel investigate the relevant facts and circumstances, and if violations are found or suspected could face civil and criminal penalties, and significant costs for investigations, litigation, fees, settlements and judgments, which in turn could have a material adverse effect on our business. In addition, some of our competitors may not be subject to the FCPA or other anti-corruption laws.
Our China operations subject us to risks that could negatively affect our business.
A significant and growing portion of our revenue and profit is derived from sales in China. Consequently, our overall financial results are increasingly dependent on this market, and our business is increasingly exposed to risks there. These risks include changes in economic conditions (including wage and commodity inflation, consumer spending and unemployment levels), tax rates and laws and consumer preferences, as well as changes in the regulatory environment and increased competition. In addition, the translation into U.S. dollars of our results of operations in China and the value of our Chinese assets are affected by fluctuations in currency exchange rates, which may adversely affect reported earnings. There can be no assurance as to the future effect of any such changes on our results of operations, financial condition or cash flows.
Furthermore, any significant or prolonged deterioration in U.S.-China relations could adversely affect our China business. Certain risks and uncertainties of doing business in China are solely within the control of the Chinese government, and Chinese law regulates the scope of our foreign investments and business conducted within China. There are also uncertainties regarding the interpretation and application of laws and regulations and the enforceability of intellectual property and contract rights in China. If we were unable to enforce our intellectual property or contract rights in China, our business could be materially adversely impacted.
Sales of our products are subject to changing consumer preferences, and our success depends upon our ability to predict, identify and interpret changes in consumer preferences and develop and offer new products rapidly enough to meet those changes.
Our success depends on our ability to predict, identify and interpret the tastes, dietary habits and nutritional needs of consumers and to offer products that appeal to those preferences. If we do not succeed in offering products that consumers want to buy, our sales and market share will decrease, resulting in reduced profitability. If we are unable to predict accurately which shifts in consumer preferences will be long lasting, or to introduce new and improved products to satisfy those preferences, our sales will decline. In addition, given the variety of cultures and backgrounds of consumers in our global consumer base, we must offer a sufficient array of products to satisfy the broad spectrum of consumer preferences. As such, we must be successful in developing innovative products across our product categories.
The consolidation of our retail customers and their reduction of inventory levels may put pressures on our profitability.
Our retail customers, such as mass merchandisers, club stores, grocery stores, drug stores and convenience stores, have consolidated in recent years and consolidation is expected to continue throughout the United States, Europe and other major markets. This consolidation has produced large, sophisticated customers with increased buying power, which are more capable of operating with reduced inventories, resisting price increases and demanding lower pricing, increased promotional programs and specifically tailored products. In addition to reducing their inventory levels, these customers may use shelf space currently used for our products for their private label or store brand products. Meeting demands from these customers may adversely affect our margins and, if we fail to effectively respond to these demands, our sales could decline, each of which could materially adversely affect our profitability.
We rely on third parties to provide us with materials and services in connection with the manufacturing and distribution of our products.
Unaffiliated third-party suppliers provide us with materials necessary for commercial production of our products, including certain key raw materials and primary packaging materials (such as cans). In particular, Martek Biosciences Corporation (Martek) provides us with most of the supply of DHA and ARA that we use in our products. We may be unable to manufacture our products in a timely manner, or at all, if any of our third-party suppliers, including Martek, should cease or interrupt production or otherwise fail to supply us or if the supply agreements are suspended, terminated or otherwise expire without renewal. If these suppliers are not able to supply us with the quantities of materials we need or if these suppliers are not able to provide services in the required time period, this could have a material adverse effect on our business. We also utilize third parties in several countries throughout the world to distribute our products. If any of our third-party distributors fail to distribute our products in a timely manner, or at all, or if our distribution agreements are suspended, terminated or otherwise expire without renewal, our profitability could be materially adversely affected.
The manufacture of many of our products is a highly exacting and complex process, and if we or one of our suppliers should encounter problems manufacturing products, our business could suffer.
The manufacture of many of our products is a highly exacting and complex process, in part due to strict regulatory requirements. Problems may arise during the manufacturing process for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, maintenance of our manufacturing environment, natural disasters, various contagious diseases and process safety issues. If problems arise during the production of a batch of product, that batch of product may have to be discarded. This could, among other things, lead to increased costs, lost sales, damage to customer relations, time and expenses being spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the affected product is released to the market, recall and product liability costs as well as reputational damage may also be incurred. To the extent that we or one of our suppliers experience significant manufacturing problems, this could have a material adverse effect on our business.
We may experience difficulties and delays inherent in the manufacturing and selling of our products.
We may experience difficulties and delays inherent in the manufacturing and selling of our products, such as: (1) seizure or recalls of products and raw materials or forced closings of manufacturing plants; (2) the failure to obtain, the imposition of limitations on the use of, or loss of, patent, trademark or other intellectual property rights; (3) our failure, or the failure of any of our vendors or suppliers, to comply with current good manufacturing practices and other applicable regulations and quality assurance guidelines that could lead to temporary manufacturing shutdowns, product shortages and delays in product manufacturing; (4) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for our products; (5) other manufacturing or distribution problems, including changes in manufacturing production sites and limits to manufacturing capability due to regulatory requirements, changes in types of products produced or physical limitations that could impact continuous supply; (6) availability of raw materials; and (7) restrictions associated with the transportation of raw materials or goods in and out of foreign countries.
If we fail to increase our production and manufacturing capacity, we will be unable to continue to grow and our ability to produce new products, expand within our existing markets and enter into new markets will be limited.
Global growth and demand for our products has increased the utilization of our production and manufacturing facilities, including manufacturing capacity provided by third-party manufacturers and packaging capacity with respect to our products. If we are unable to successfully expand our production and manufacturing capacity, we will be unable to continue our growth and expand within our existing markets or enter into additional geographic markets or new product categories. In addition, failure to successfully expand our production and manufacturing capacity will limit our ability to introduce and distribute new products, including our existing pipeline of innovations and product improvements, or otherwise take advantage of opportunities in new and existing markets. Further, increasing our production and manufacturing facilities requires significant investment and time to build. Delays in increasing capacity could also limit our ability to continue our growth and materially adversely affect our business.
Disruption of our global supply chain could materially adversely affect our business.
Our ability to manufacture, distribute and sell products is critical to our success. Damage or disruption to raw material supplies or our manufacturing or distribution capabilities due to weather, natural disaster, fire, terrorism, strikes, various contagious diseases or other reasons could impair our ability to manufacture or sell our products. Failure to take adequate steps to mitigate the likelihood or
potential impact of such events, or to effectively manage such events if they occur, particularly when a product is sourced from a single location, could materially adversely affect our business.
Changes in WIC, or our participation in it, could materially adversely affect our business.
Participation in WIC involves a competitive bidding process and is an important part of our U.S. business based on the volume of infant formula sold under the program. As of December 31, 2011, we hold the contracts that supply approximately 42% of WIC births. As a result, our business strategy includes bidding for new WIC contracts and maintaining current WIC relationships. Our failure to win bids for new contracts pursuant to the WIC program or our inability to maintain current WIC relationships could have a material adverse effect on our business. In addition, any changes to how the WIC program is administered and any changes to the eligibility requirements and/or overall participation in the WIC program could also have a material adverse effect on our business.
Our business could be harmed by a failure of our information technology, administrative or outsourcing systems.
We rely on our information technology, administrative and outsourcing systems to effectively manage our business data, communications, supply chain, order entry and fulfillment and other business processes. Difficulties or failure to implement our information technology initiatives by us or our service providers or the failure of our information technology, administrative or outsourcing systems to perform as we anticipate could disrupt our business and result in transaction errors, processing inefficiencies and the loss of sales and customers, causing our business to suffer. In addition, our information technology, administrative and outsourcing systems may be vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, systems failures, security breaches and viruses. Any such damage or interruption could have a material adverse effect on our business and prevent us from paying our suppliers or employees, invoicing and receiving payments from our customers or performing other information technology, administrative or outsourcing services on a timely basis.
Increased IT security threats and more sophisticated and targeted computer crime could pose a risk to our systems, networks, products, solutions and services.
Increased global IT security threats and more sophisticated and targeted computer crime pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. While we attempt to mitigate these risks by employing a number of measures, our systems, networks, products, solutions and services remain potentially vulnerable to advanced persistent threats. Depending on their nature and scope, such threats could potentially lead to the compromising of confidential information, improper use of our systems and networks, manipulation and destruction of data, defective products, production downtimes and operational disruptions, which in turn could materially adversely affect our reputation, competitiveness and results of operations.
We may face difficulties as we expand our operations into countries in which we have no prior operating experience or as we expand our operations into new product categories.
We intend to continue to expand our global footprint in order to enter into new markets. This may involve expanding into countries other than those in which we currently operate. It may involve expanding into less developed countries, which may have less political, social or economic stability and less developed infrastructure and legal systems. We also intend to expand our product portfolio by adding new product categories. As we expand our business into new countries or product categories we may encounter regulatory, personnel, technological and other difficulties that increase our expenses or delay our ability to start up our operations or become profitable in such countries or product categories. This may affect our relationships with customers, suppliers and regulators and could have a material adverse effect on our business.
Resources devoted to research and development may not yield new products that achieve commercial success.
Our ability to develop new pediatric nutrition products depends on, among other factors, our ability to understand the composition and variation of breast milk. Analyzing breast milk requires significant investment in research and development and testing of new ingredients and new production processes. We devote significant resources to investment in research and development in order gain a deep understanding of the composite ingredients of breast milk, as well as the optimal nutritional requirements of infants and children. The research and development process is expensive, prolonged and entails considerable uncertainty. Development of a new product, from discovery through testing and registration to initial product launch, typically takes between five and seven years, but may require an even longer timeline. Each of these periods varies considerably from product to product and country to country. Because of the complexities and uncertainties associated with research and development, products that we are currently developing may not complete the development process or obtain the regulatory approvals required for us to market such products successfully. In addition, new regulations or changes to existing regulations may have a negative effect on innovations in our pipeline, especially late-stage pipeline products. The development of new products may take longer and cost more to develop and may be less successful than we currently anticipate as a result of:
•products that may appear promising in development but fail to reach market within the expected or optimal time frame, or fail to ever reach market, for any number of reasons, including efficacy and the difficulty or excessive cost to manufacture;
•failure to enter into or successfully implement optimal alliances where appropriate for the discovery and commercialization of products, or otherwise to maintain a consistent scope and variety of promising late-stage pipeline products; or
•failure of one or more of our products to achieve or maintain commercial viability.
We cannot assure you that any of our products currently in our development pipeline will be commercially successful.
We could incur substantial costs to comply with environmental, health and safety laws and regulations and to address violations of or liabilities under these requirements.
Our facilities and operations are subject to various environmental, health and safety laws and regulations in each of the jurisdictions in which we operate. Among other things, these requirements regulate the emission or discharge of materials into the environment, the use, management, treatment, storage and disposal of solid and hazardous substances and wastes, the control of combustible dust, the reduction of noise emissions and fire and explosion risks, the cleanup of contamination and the prevention of workplace exposures and injuries. Pollution controls and various permits and programs are required for many of our operations. We could incur or be subject to, among other things, substantial costs (including civil or criminal fines or penalties or clean-up costs), third party damage claims, requirements to install additional pollution control or safety control equipment and/or permit revocations in the event of violations by us of environmental, health, and safety requirements applicable to our facilities and operations or our failure to obtain, develop or comply with required environmental permits or programs.
In addition, most of our facilities have a history of production operations in the food and drug industry, and some substances used in such production require proper controls in their storage and disposal. We have been named as a "potentially responsible party," or are involved in investigation and remediation, at two third party disposal sites. We can be held responsible, in some cases without regard to knowledge, fault, or ownership at the time of the release, for the costs of investigating or remediating contamination of any real property we or our predecessors ever owned, operated, or used as a waste disposal site. In addition, we can be required to compensate public authorities or private
owners for damages to natural resources or other real property, or to restore those properties, in the event of off-site migration of contamination. Changes in, or new interpretations of, existing laws, regulations or enforcement policies, could also cause us to incur additional or unexpected costs to achieve or maintain compliance. The assertion of claims relating to on- or off-site contamination, the discovery of previously unknown environmental liabilities or the imposition of unanticipated investigation or cleanup obligations, could result in potentially significant expenditures to address contamination or resolve claims or liabilities. Such costs and expenditures could have a material adverse effect on our business, financial condition or results of operations.
We may not be able to adequately protect our intellectual property rights.
Given the importance of brand recognition to our business, we have invested considerable effort in seeking trademark protection for our brands, including the Enfa family of brands. However, we cannot be certain that the steps we have taken will be sufficient to protect our intellectual property rights in our brands adequately or that third parties will not infringe upon or misappropriate any such rights. We also cannot be certain that the steps we have taken to protect our brands will be sufficient to discourage or eliminate counterfeiting of our products. Our trademark registrations and applications can potentially be challenged and cancelled or narrowed. Moreover, some of the countries in which we operate offer less protection for these rights, and may subject these rights to higher risks, than is the case in Europe or North America. In addition, it is costly to litigate in order to protect any of our intellectual property rights. If we are unable to prevent third parties from infringing or misappropriating these rights in our core products or brands, including our Enfa family of brands, our future financial condition and our ability to develop our business could be materially adversely affected.
Other companies have from time to time taken, and may in the future take, actions that we believe violate our intellectual property rights and we may decide to enforce (and in some cases are currently enforcing) those rights against such actions. Uncertainties inherent in such litigation make the outcome and associated costs difficult to predict. If unsuccessful, the legal actions could result in the invalidation of some of our intellectual property rights, which could materially adversely affect our business.
We rely on a combination of security measures, confidentiality policies, contractual arrangements and trade secret laws to protect our proprietary formulae and other valuable trade secrets. We also rely on patent, copyright and trademark laws to further protect our intellectual property rights. We cannot, however, be certain that the steps we take will prevent the development and marketing of similar, competing products and services by third parties. Our existing patents and any future patents that we obtain may not be sufficiently broad to protect us against third parties with similar products or to provide us with a competitive advantage. Moreover, our patents can potentially be challenged and narrowed or invalidated. Trade secrets are difficult to protect, and despite our efforts may become known to competitors or independently discovered. The confidentiality agreements we rely on with our employees, customers, contractors and others may be breached, and we may not have adequate remedies for such breach. Failure to adequately protect our valuable intellectual property from being infringed or misappropriated could materially adversely affect our business.
We may be required to defend ourselves against intellectual property claims from third parties, which could harm our business.
Regardless of merit, there are third-party patents that may cover our products. Third parties may obtain patents in the future and claim that use of our technologies infringes upon these patents. If a third party asserts that our products or services are infringing upon its intellectual property, these claims could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages and/or prevent us from selling our products. Even if we were to prevail against such claims, any litigation regarding intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our
business operations. Furthermore, as a result of an intellectual property challenge, we may find it necessary to enter into royalty licenses or other costly agreements, and we may not be able to obtain such agreements at all or on terms acceptable to us.
Our sales and marketing practices may be challenged by consumers and competitors, which could harm our business.
We participate in a variety of marketing activities, including print and television advertising, direct mail, online/internet and promotional programs. We work with external agencies to create strong marketing campaigns for health care professionals, retail sales organizations and consumers. Although our marketing is evidence-based and emphasizes our superior nutritional science, consumers and competitors may challenge, and have challenged, certain of our practices by claiming, among other things, false and misleading advertising with respect to advertising for certain of our products. Such challenges could result in our having to pay monetary damages or limit our ability to maintain current sales and marketing practices.
Although we cannot predict with certainty the ultimate resolution of such potential lawsuits, investigations and claims asserted against us, we do not believe any currently pending legal proceeding to which we are a party would have a material adverse effect on our business or financial condition, although an unfavorable outcome in excess of amounts recognized as of December 31, 2011, with respect to one or more of these proceedings could have a material adverse effect on our results of operations for the periods in which a loss would be recognized.
Increases in costs of current and post-retirement benefits may reduce our profitability.
Our profitability may be affected by increases in costs of current and post-retirement medical and other employee benefits, particularly within the United States. These costs can vary substantially as a result of changes in health care costs, volatility in investment returns on pension plan assets and changes in discount rates used to calculate related liabilities. These factors may put upward pressure on the cost of providing medical and other benefits. We can provide no assurance that we will succeed in limiting future cost increases, and upward pressure would reduce our profitability.
Labor disputes may cause work stoppages, strikes and disruptions.
Our manufacturing workforces in Zeeland, Michigan; Evansville, Indiana; Guangzhou, China; and Chonburi, Thailand are not unionized. The manufacturing workforces in Delicias, Mexico, and São Paulo, Brazil, are unionized and covered by collective bargaining agreements that are negotiated annually. The manufacturing workforce and non-supervised sales force in Makati, Philippines, are unionized and covered by a three-year collective bargaining agreement, which was renewed in December 2010. In addition, European Works Councils represent the manufacturing workforce in Nijmegen, the Netherlands, and the commercial organizations in France and Spain. As a result, any labor disputes, including work stoppages, strikes and disruptions, could have a material adverse impact on our business.
Our success depends on attracting and retaining qualified people in a competitive environment.
Our business strategy and future success depends, in part, on our ability to attract, hire and retain, in a competitive environment, highly-skilled and diverse leaders, managers and professionals who are critical to our business functions and growth strategy. The market for highly-skilled employees is competitive in the labor markets in which we operate. Our business could be materially adversely affected if we are unable to retain key employees or recruit qualified personnel in a timely fashion, or if we are required to incur unexpected increases in compensation costs to retain key employees or meet our hiring goals. If we are not able to attract and retain the personnel that we require, or we are not
able to do so on a cost-effective basis, it could be more difficult for us to sell and develop our products and services and execute our business strategy.
We derive a significant percentage of our sales from two customers. The loss of either of these customers could materially adversely affect our financial performance.
Our products are sold principally to the wholesale and retail trade, both nationally and internationally, and sales to two customers, Wal-Mart Stores, Inc. and DKSH International Ltd., accounted for approximately 12% and 14%, respectively, of our gross sales for the year ended December 31, 2011. If either of these customers ceases doing business with us or if we encounter any difficulties in our relationship with either of them, our business could be materially adversely affected.
An adverse change in favorable demographic and economic trends as well as a change in scientific opinion regarding our products in any of our largest markets could materially adversely affect our business and reduce our profitability.
Our growth plan relies on favorable demographic and economic trends in various markets, including: (1) rising incomes in emerging markets, (2) increasing number of working mothers and (3) increasing consumer global awareness of the importance of pediatric nutrition on wellness and health outcomes. If these demographic trends change in an adverse way, our business could be materially adversely affected. In addition, an adverse change in scientific opinion regarding our products, such as the health benefits of DHA and ARA, or a continued decline in birth rates could materially adversely affect our business.
We have substantial debt, which could materially adversely affect our business and our ability to meet our obligations.
We had total indebtedness of $1,531.9 million as of December 31, 2011. See "Item 8. Financial Statements-Note 15. Short-Term Borrowings and Long-Term Debt" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Financial Position, Liquidity and Capital Resources-Short-Term Borrowings and Long-Term Debt."
This amount of debt could have important consequences to us and our investors, including:
•requiring a substantial portion of our cash flow from operations to make payments on this debt;
•requiring us to repay the full amount of our debt upon a change of control triggering event;
•making it more difficult to satisfy other obligations;
•increasing the risk of future credit rating downgrades of our debt, which could increase future debt costs;
•increasing our vulnerability to general adverse economic and industry conditions;
•reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow our business;
•limiting our flexibility in planning for, or reacting to, changes in our business and industry;
•placing us at a competitive disadvantage to our competitors that may not be as leveraged as we are;
•limiting our ability to borrow additional funds as needed or take advantage of business opportunities as they arise; and
•limiting our ability to pay cash dividends or repurchase common stock.
To the extent we become more leveraged, the risks described above could increase. In addition, our actual cash requirements in the future may be greater than expected. Our cash flow from operations may not be sufficient to repay at maturity all of the outstanding debt as it becomes due, and we may not be able to borrow money, sell assets or otherwise raise funds on acceptable terms, or at all, to refinance our debt.
In order to achieve a desired proportion of variable versus fixed rate debt, we have in the past entered into and exited interest rate swap agreements. Developing an effective strategy for dealing with risks from movements in interest rates is complex, and no strategy can completely insulate us from risks associated with such fluctuations. In addition, we are exposed to counter-party credit risk for nonperformance and, in the event of nonperformance, to market risk for changes in interest rates. Finally, our interest rate risk management activities could expose us to substantial losses if interest rates move materially differently from our expectations. As a result, our economic hedging activities may not effectively manage our interest rate sensitivity or have the desired beneficial impact on our financial condition or results of operations. Further discussion of our hedging of interest rate risk is included in "Item 7A. Quantitative and Qualitative Disclosures About Market Risk."
We could evaluate acquisitions, joint ventures and other strategic initiatives, any of which could distract our management or otherwise have a negative effect on our sales, costs and stock price.
Our future success may depend on opportunities to buy or obtain rights to other businesses or technologies that could complement, enhance or expand our current business or products or that might otherwise offer us growth opportunities. We could evaluate potential mergers, acquisitions, joint ventures, strategic initiatives, alliances, vertical integration opportunities and divestitures. If we attempt to engage in these transactions, we expose ourselves to various inherent risks, including:
•accurately assessing the value, future growth potential, strengths, weaknesses, contingent and other liabilities and potential profitability of acquisition candidates;
•the potential loss of key personnel of an acquired or combined business;
•our ability to achieve projected economic and operating synergies;
•difficulties successfully integrating, operating, maintaining and managing newly-acquired operations or employees;
•difficulties maintaining uniform standards, controls, procedures and policies;
•unanticipated changes in business and economic conditions affecting an acquired business;
•the potential discovery of latent unethical business practices;
•the possibility we could incur impairment charges if an acquired business performs below expectations; and
•the diversion of our management's attention from our existing business to integrate the operations and personnel of the acquired or combined business or implement the strategic initiative.
If any of the foregoing risks materializes, our results of operations and the results of the proposed transactions would likely differ from ours, and market expectations, and our stock price could, accordingly, decline. In addition, we may not be able to complete desirable transactions for various reasons.
We depend on cash flows generated by our subsidiaries, and a failure to receive distributions from our subsidiaries may result in our inability to meet our financial obligations, or to pay dividends.
We are a holding company with no material assets other than the equity interests of our subsidiaries and certain intellectual property. Our subsidiaries conduct substantially all of our operations and own substantially all of our assets and intellectual property. Consequently, our cash flow and our ability to meet our obligations and pay dividends to our stockholders depends upon the cash flow of our subsidiaries and the payment of funds by our subsidiaries to us in the form of dividends, tax sharing payments or otherwise. There are a number of other factors that could affect our ability to pay dividends, including the following:
•lack of availability of cash to pay dividends due to changes in our operating cash flow, capital expenditure requirements, working capital requirements and other cash needs;
•unexpected or increased operating or other expenses or changes in the timing thereof;
•restrictions under Delaware law or other applicable law on the amount of dividends that we may pay;
•a decision by our board of directors to modify or revoke its policy to pay dividends; and
•the other risks described in this "Risk Factors" section.
Each of our subsidiaries is a distinct legal entity and its ability to make any payments will depend on its earnings, the terms of its indebtedness and legal restrictions. Under certain circumstances, legal restrictions may limit or delay our ability to obtain cash from our subsidiaries and our subsidiaries may not be able to, or be permitted to, make distributions to us in the future. In the event that we do not receive distributions from our subsidiaries, we may be unable to meet our financial obligations.
Risks Related to Our Relationship with Our Former Parent
If our split-off from BMS fails to qualify for non-recognition of gain and loss, we may in certain circumstances be required to indemnify BMS for any resulting taxes and related expenses, and we believe that the payment if required could have a material adverse effect on our financial condition and results of operations.
In connection with our split-off from BMS on December 23, 2009, BMS and its counsel have relied on certain assumptions and representations as to factual matters from us, as well as certain covenants by us regarding the future conduct of our business and other matters, the incorrectness or violation of which could affect the qualification for non-recognition of gain and loss of our split-off from BMS. As a result, BMS and we agreed to certain tax-related indemnities set forth in the Amended and Restated Tax Matters Agreement referred to herein. We agreed, generally, to indemnify BMS for taxes and certain related expenses resulting from the failure of our split-off from BMS to qualify for non-recognition of gain and loss to the extent attributable to (i) the failure of any of our representations to be true or the breach by us of any of our covenants, (ii) the application of Section 355(e) or Section 355(f) of the Internal Revenue Code to any acquisition of our stock or assets or any of our affiliates or (iii) certain other acts or omissions by us or our affiliates. To the extent we become obligated to make an indemnification payment under the Amended and Restated Tax Matters Agreement, we believe that the payment could have a material adverse effect on our financial condition and results of operations. In addition, we agreed that, for 30 months following the qualification for non-recognition of gain and loss of our split-off from BMS, if we propose to enter into or permit certain transactions or series of related transactions as a result of which one or more persons would directly or indirectly acquire 10% or more of our total value or total voting power, we would undertake in good faith to provide written notice to BMS, including an explanation as to why such transactions do not cause our split-off from BMS to fail to qualify for non-recognition of gain and loss.
Risks Related to Our Common Stock
Our failure to successfully execute our growth strategy could adversely affect our business and results of operations and cause our stock price to decline.
Our continued success in part depends on our ability to successfully execute our growth strategy. We intend to grow our business profitably through several strategic initiatives, including geographic and category expansion and productivity savings. There can be no assurance that we will be successful in achieving our strategic plan. If we fail to fully implement any material part of our strategic initiatives, or if we achieve these initiatives and they fail to yield the expected benefits, there could be an adverse affect on our business and results of operations. Any such adverse affect on our business and results of operations could result in a decline in the price of our common stock.
Anti-takeover provisions in our charter documents could discourage, delay or prevent a change of control of our company and may result in an entrenchment of management and diminish the value of our common stock.
Several provisions of our certificate of incorporation and by-laws could make it difficult for our stockholders to change the composition of our board of directors, preventing them from changing the composition of management. In addition, the same provisions may discourage, delay or prevent a merger or acquisition that our stockholders may consider favorable.
These provisions include:
•authorizing our board of directors to issue "blank check" preferred shares without stockholder approval;
•prohibiting cumulative voting in the election of directors;
•prohibiting shareholder action by written consent;
•limiting the persons who may call special meetings of stockholders; and
•establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder.
These anti-takeover provisions could substantially impede the ability of our common stockholders to benefit from a change of control and, as a result, could materially adversely affect the market price of our common stock and our stockholders' ability to realize any potential change-in-control premium.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
Our corporate headquarters are located in Glenview, Illinois, where we lease office space. We maintain our global supply chain and R&D headquarters in Evansville, Indiana, where we own office, operations and laboratory buildings comprising approximately 700,000 square feet. We also own the seven manufacturing facilities identified in the table below. For additional information related to our seven manufacturing facilities around the world, see "Item 1. Business-Global Supply Chain." We lease the vast majority of our office facilities worldwide.
The following table illustrates our owned global manufacturing locations, the approximate square footage of the facilities and the reportable segment served by such locations:
(1)Powder manufacturing facility.
(2)Liquid manufacturing facility.
Item 3. LEGAL PROCEEDINGS
In the ordinary course of business, we are 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.
Our facilities and operations are subject to various environmental, health and safety laws and regulations in each of the jurisdictions in which we operate. Among other things, these requirements regulate the emission or discharge of materials into the environment, the use, management, treatment, storage and disposal of solid and hazardous substances and wastes, the control of combustible dust, the reduction of noise emissions and fire and explosion risks, the cleanup of contamination and the prevention of workplace exposures and injuries. Pollution controls and various permits and programs are required for many of our operations. Each of our global manufacturing facilities undergoes periodic internal audits relating to environmental, health, and safety requirements and we incur operating and capital costs to improve our facilities or maintain compliance with applicable requirements on an ongoing basis.
From time to time, we may be responsible under various state, federal and foreign laws, including CERCLA, for certain costs of investigating and/or remediating substances at our current or former sites, and/or at waste disposal or reprocessing facilities operated by third parties. Liability under CERCLA and analogous state or foreign laws may be imposed without regard to knowledge, fault, or ownership at the time of the disposal or release. Most of our facilities have a history of production operations in the food and drug industry, and some substances used in such production require proper controls in their storage and disposal. We have been named as a "potentially responsible party", or are involved in investigation and remediation, at two third-party disposal sites. As of December 31, 2011, management believes that those future site costs which were probable and reasonably estimable, as well as any related accruals, are not material.
We are not aware of any pending environmental, health or safety-related litigation or significant environmental, health or safety-related financial obligations or liabilities arising from current or former operations or properties that are likely to have a material impact on our business, financial position or results of operations. Liabilities or obligations, which could require us to make significant expenditures, could arise in the future, however, as the result of, among other things, changes in, or new interpretations of, existing laws, regulations or enforcement policies, claims relating to on- or off-site contamination, or the imposition of unanticipated investigation or cleanup obligations.
On November 14, 2011, the Company's subsidiary Mead Johnson & Company, LLC ("MJC") obtained final court approval of a nationwide class settlement with plaintiffs in eight putative consumer class actions that had been consolidated and transferred to the U.S. District Court for the Southern District of Florida. The suits all involved allegations of false and misleading advertising with respect to certain Enfamil LIPIL infant formula advertising, and the settlement will resolve all claims in all of the pending suits. In its final order approving the class action settlement (the "Final Order"), the court found the settlement to be fair, reasonable and adequate. The settlement allows consumers who purchased Enfamil LIPIL infant formula between October 13, 2005, and March 31, 2010, to receive infant formula or cash. The amount each consumer can receive depends on how long the consumer purchased the formula; consumers who received their formula through the Women, Infants and Children ("WIC") program are not eligible to participate. The period within which class members could file claims expired on November 25, 2011. As of the close of the claims period, the total amount claimed by class members was less than $8.0 million. As a result and consistent with the Company's previously-reported obligations under the settlement agreement, MJC received court approval on January 9, 2012, to distribute the difference between $8.0 million and the total amount claimed in the form of infant formula to Feeding America, the nation's largest domestic hunger-relief charity. MJC also agreed not to oppose, and the court approved in its Final Order, attorneys' fees and expenses to plaintiffs' counsel of $3.5 million and $140,000, respectively. As previously reported, MJC agreed to pay costs of notice and settlement administration. Two class members have separately appealed the court's Final Order to the U.S. Court of Appeals for the Eleventh Circuit. Briefing in the appeal has not yet started. Until the appeal has been resolved, distribution of benefits to class members will be delayed. MJC expects distribution of benefits would begin shortly after a successful resolution of the appeal.
We record accruals for such contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although we cannot predict with certainty the final resolution of these or other lawsuits, investigations and claims asserted against it, we do not believe any currently pending legal proceeding to which we are a party will have a material effect on our business or financial condition, although an unfavorable outcome in excess of amounts recognized as of December 31, 2011, with respect to one or more of these proceedings could have a material effect on our results of operations for the periods in which a loss is recognized.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Prices and Dividend Information
Mead Johnson Nutrition Company common stock is traded on the New York Stock Exchange (NYSE) under the symbol "MJN". The following table describes the per share range of high and low sales prices, as reported by the NYSE, for shares of our common stock and dividends declared per share of our common stock for the quarterly periods indicated.
Holders of Common Stock
The number of record holders of common stock at December 31, 2011, was 1,570. The number of record holders is based upon the actual number of holders registered on our books at such date and does not include holders of shares held in "street name" or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies.
Issuer Purchases of Equity Securities
None.
Performance Graph
Comparison of 34-month Cumulative Total Return
The following graph compares the cumulative total return on our common stock for the periods indicated with the performance of the Standard & Poor's 500 Stock Index (S&P 500) and the Mead Johnson performance peer group index. The graph assumes $100 invested on February 11, 2009, the date shares of our common stock commenced trading, or January 31, 2009, in index, and the reinvestment of all dividends for each of the reported time periods.
Comparison of 34 Month Cumulative Total Return
Among Mead Johnson Nutrition Company, the S&P 500 Index
and a Peer Group
The Mead Johnson performance peer group consists of the following corporations considered our market competitors in the food and beverage and consumer products industries on the basis of industry leadership and global focus: Campbell's Soup Company, Colgate Palmolive Company, General Mills, Inc., H.J. Heinz Company, The Hershey Company, The J.M. Smucker Company, Kellogg Company, McCormick & Company, Incorporated and Sara Lee Corp.
Item 6. SELECTED FINANCIAL DATA.
*On February 17, 2009, we completed the offering of 34.5 million shares of common stock in an initial public offering.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This management's discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. See "Item 1A. Risk Factors" for a discussion of the uncertainties, risks and assumptions associated with those statements. The following discussion should be read in conjunction with our audited financial statements and the notes to our audited financial statements. Our results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those in "Risk Factors."
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 segments: Asia, Europe, Latin America and North America. Due to similarities in gross margin and other economic attributes, products offered, production process, customer base and regulatory environment, these operating segments have been aggregated into two reportable segments: Asia/Latin America and North America/Europe.
Executive Summary
Sales increased by 17% for the year ended December 31, 2011. The sales growth was led by our Asia/Latin America segment which grew by 26% and now accounts for 66% of sales. China/Hong Kong continues to lead growth in Asia while Latin America's percentage growth was in the mid-teens, underpinned by exceptional growth in Brazil and Peru. Sales increased by 3% in our North America/Europe segment. In the U.S., higher pricing and market share gains from both a competitor's recall and prior and current year product launches were offset in part by declining birth rates and lower consumption.
Earnings per share grew 12% in the year ended December 31, 2011. Sales growth of 17% was partially offset by higher demand-generation investments, commodity cost increases, higher performance incentives and higher IT and other separation costs.
Results of Operations
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Below is a summary of comparative results of operations for the years ended December 31, 2011 and 2010:
The results for the years ended December 31, 2011 and 2010 included several items that affect the comparability of our results. These items include significant expenses not indicative of on-going results (Specified Items) and are listed in the table below.
Net Sales
Our net sales by reportable segments are shown in the table below:
Our Asia/Latin America segment continues to have significant sales growth and represented 66% of sales for the year ended December 31, 2011, compared with 61% for the year ended December 31, 2010. Our success in Asia/Latin America comes from share gains and market growth driven by our investments in advertising and promotion, sales force, and product innovation. Our
strongest performance in Asia continues to be in China/Hong Kong, primarily reflecting increased market share, market growth, pricing and geographic expansion into additional cities. Latin America's percentage growth was in the mid-teens, underpinned by exceptional growth in Brazil and Peru.
The North America/Europe segment was led by our U.S. business with higher pricing and market share gains partially offset by declining birth rates and lower consumption. Market share gains reflected the effects of a competitor's 2010 recall and our current and prior year product launches. Volume is expected to decrease in 2012 due to declining birth rates and consumption, the non-recurrence of the favorable effects experienced in the first half of 2011 from the competitor's recall, and the consequences of unfounded media reports of alleged product contamination at the end of 2011.
Our net sales by product category are shown in the table below:
Our sales in North America/Europe are comprised of approximately 90% Infant Formula. Infant Formula sales growth reflected the weighting of the growth rates in Asia/Latin America and North America/Europe. Growth in Children's Nutrition reflected the performance in Asia/Latin America.
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:
Gross-to-net sales adjustments declined as a percentage of gross sales as U.S. WIC rebates declined as a percentage of global gross sales due to higher growth in the Asia/Latin America segment.
Gross Profit
The decline in gross margin compared with a year ago is primarily due to higher commodity costs, particularly dairy inputs, partially offset by productivity and higher product pricing.
Expenses
Selling, General and Administrative Expenses (SG&A)
The increase in SG&A reflected increases in sales force expense, performance-based compensation, distribution expenses, IT separation costs, and the duplication of costs as we transitioned to a new outsourced service provider for IT, accounting and indirect procurement. The performance-based compensation increase reflected the phase-in of equity awards following our 2009 initial public offering (IPO) and our outstanding financial performance as measured against incentive plan targets and stock performance. Because equity awards are generally expensed over a period of three years, 2011 is the first year in which we had three overlapping grants of these awards.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product trial and education provided to both health care professionals and consumers, where permissible by regulation. The increase in advertising and promotion expenses reflected investments in demand-generation activities in support of our strategic growth initiatives.
Research and Development Expenses
The increase in research and development expenses reflected our continued investment in our innovation capability and product pipeline.
Other Expense/(Income)-net (OIE)
For the year ended December 31, 2011, OIE included severance and other specified items, pension settlement costs for frozen defined benefit plans, and foreign currency and other gains and losses. In 2011 and 2010, pension settlements were $9.7 million and $10.6 million, respectively. In 2010, $8.5 million of foreign currency losses were recognized in Venezuela due to both the devaluation of the bolivar and the application of highly inflationary accounting.
Earnings before Interest and Income Taxes
EBIT from our two reportable segments, Asia/Latin America and North America/Europe, is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated general and administrative expenses and global business support activities, including research and development, marketing and supply chain costs.
The increase in EBIT for Asia/Latin America was primarily related to sales growth, partially offset by higher expenses, such as advertising and promotion, sales force growth, the allocation of new outsourced service and system expenses, and performance-based compensation.
EBIT for North America/Europe decreased due to higher expenses, primarily the allocation of new outsourced service and system expenses, performance-based compensation and distribution expense, partially offset by an increase in sales.
The new outsourced service and system expenses recorded in the operating segments include new information technology, accounting and procurement services. These new operations replaced similar services provided by the Company's former parent under transitional services agreements; the replaced services have been consistently reflected in Corporate and Other.
Corporate and Other expenses increased due to higher IT separation costs.
Interest Expense-net
Interest expense for the year ended December 31, 2011 primarily represented interest incurred on $1.5 billion of notes. The increase in interest expense reflected the termination of our fixed-to-floating interest rate swaps. The weighted-average interest rate on our long-term debt, including the impact of the swaps, was 4.0% and 3.6% for the years ended December 31, 2011 and 2010, respectively.
Income Taxes
The ETR remained relatively unchanged at 28.1% and 27.8% for the years ended December 31, 2011 and 2010, respectively.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consisted of an 11% interest in our China legal entity and a 10% interest in our Indonesia legal entity held by third parties.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the year ended December 31, 2011 increased 12% to $508.5 million compared with the year ended December 31, 2010.
Results of Operations
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Below is a summary of comparative results of operations for the years ended December 31, 2010 and 2009:
The results for the years ended December 31, 2010 and 2009 included several items that affect the comparability of our results. These items include significant expenses not indicative of on-going results (Specified Items) and are listed in the table below.
Net Sales
Our net sales by reportable segments are shown in the table below:
Our Asia/Latin America segment continued to have significant sales growth and represented 61% of sales for the year ended December 31, 2010, compared with 58% for the year ended December 31, 2009. Our success in Asia/Latin America came from market growth and share gains
driven by our investments in advertising and promotion, sales force, and product innovation. The most notable sales gains were achieved in China, Hong Kong, Mexico and Brazil. Our strongest performance continued to be in China, primarily reflecting market growth, increased market share and geographic expansion. The segment was adversely affected by sales declines in Venezuela primarily due to the devaluation of the bolivar.
For the year ended December 31, 2010, sales in the North America/Europe segment grew slightly compared with the prior year. The U.S. business improvements from market share gains, due to successful new product launches and a competitor's product recall, and lower WIC rebates were offset by the contraction in the U.S. market from lower births. The European business grew due to a 2009 reduction in customer inventory in the European business in preparation for the move from Bristol-Myers Squibb Co. (BMS) as our primary distributor.
Our net sales by product category are shown in the table below:
Infant formula sales increased 8%, including a favorable foreign exchange impact of 1%, reflecting results in the North America/Europe segment, which are predominantly infant formula markets, and growth in the Asia/Latin America segment. Children's nutrition sales increased 22%, including a favorable foreign exchange impact of 4%, reflecting the strength of the Asia/Latin America segment where over 90% of our children nutrition sales are generated. The decline in other products is primarily driven by the expiration of a 2009 marketing services agreement under which we sold pharmaceutical products in two Asia markets on behalf of BMS.
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:
Gross-to-net sales adjustments declined as a percentage of gross sales due to a decline in WIC rebates. The decline in WIC rebates was due to a reduction in the amount of infant formula provided under the program and a reduction in WIC participants due to lower birth rates.
Gross Profit
Gross margin declined compared to a year ago due to increased commodity and manufacturing costs, partially offset by productivity gains and higher product pricing.
Expenses
Selling, General and Administrative Expenses (SG&A)
The increase in SG&A expenses reflected sales force growth, primarily in China and Brazil, the temporary duplication of costs as we transition to a new shared service provider for IT, accounting and indirect procurement (Shared Service Overlap) and new stand-alone corporate costs.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product trial and education provided to both health care professionals and consumers, where permissible by regulation. The increase in advertising and promotion expenses reflected continued investment in demand-generation activities in support of our strategic growth initiatives.
Research and Development Expenses
The increase in research and development expenses reflected our continued investment in our innovation capability and product pipeline.
Other Expense/(Income)-net (OIE)
For the year ended December 31, 2010, OIE included $10.6 million in pension settlement costs for defined benefit plans, an $8.5 million foreign currency loss from the initial balance sheet remeasurement of our Venezuela subsidiary upon the devaluation of the bolivar and the application of highly inflationary accounting, and severance costs. For the year ended December 31, 2009, OIE included litigation costs, severance costs, and currency losses on assets held in non-functional currencies, partially offset by a gain on sale of a non-strategic intangible asset and a favorable patent settlement.
Earnings before Interest and Income Taxes
EBIT from our two reportable segments, Asia/Latin America and North America/Europe, is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated general and administrative expenses and global business support activities, including research and development, marketing and supply chain costs.
The increase in EBIT for Asia/Latin America was due to sales growth partially offset by increased expenses, primarily higher advertising and promotion costs, along with sales force growth, and a lower gross margin, primarily due to higher commodity and manufacturing costs, partially offset by productivity gains.
The decrease in EBIT for North America/Europe was primarily due to a lower gross margin reflecting higher commodity and manufacturing costs, partly offset by productivity gains.
Corporate and Other expenses increased due to increased IT and other separation costs, the Shared Service Overlap, new stand-alone corporate costs and the absence of a gain in 2009 on the sale of a non-strategic intangible asset, partly offset by the elimination of IPO-related costs.
Interest Expense-net
Interest expense for the year ended December 31, 2010 primarily represented interest incurred on $1.5 billion of notes. Interest expense declined by $44.0 million due to lower interest rates resulting from our November 2009 debt refinancing, combined with the benefit from fixed-to-floating interest rate swaps on a portion of that debt, and a reduction in debt. For the year ended December 31, 2009, interest expense primarily represented interest incurred on $1.7 billion of notes. The average interest rate on our long-term debt, including the impact of the swaps, was 3.6% and 5.3% for the years ended December 31, 2010 and 2009, respectively.
Income Taxes
The ETR for the years ended December 31, 2010 and 2009, was 27.8% and 30.1%, respectively. The difference in the rates was primarily attributable to the benefits of a tax ruling in the Netherlands, management's assertion that certain foreign earnings and profits are permanently invested abroad, and a favorable change in our geographic earnings mix.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consisted of an 11% interest in our China legal entity and a 10% interest in our Indonesia legal entity held by third parties.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the year ended December 31, 2010 increased 13% to $452.7 million compared with the year ended December 31, 2009.
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash on hand, cash from operations and available borrowings under our $500.0 million revolving credit facility. Cash flows from operating activities represent the inflow of cash from our customers and the outflow of cash for raw material purchases, manufacturing, and operating expenses, interest and taxes. Cash flows used in investing activities primarily represent capital expenditures for equipment, buildings and computer software. Cash flows used in financing activities primarily represent proceeds and repayments of short-term borrowings, dividend payments and share repurchases.
Cash and cash equivalents totaled $840.3 million at December 31, 2011 of which $734.0 million was held outside of the United States. Approximately $360 million of cash and cash equivalents were held by foreign subsidiaries whose undistributed earnings are considered permanently reinvested. Our intent is to reinvest these funds 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 funds to the United States, the Company would be required to provide U.S. taxes on these amounts.
The declaration and payment of dividends is at the discretion of our board of directors and depends on many factors, including our financial condition, earnings, legal requirements, restrictions under the terms of our debt agreements and other relevant factors. Cash dividends paid for the years ended December 31, 2011, 2010 and 2009 were $205.7 million, $179.6 million and $102.3 million, respectively.
Our board of directors previously authorized the repurchase of up to $300 million of the Company's stock. The repurchase program is primarily intended to offset the dilutive effect on earnings from stock-based compensation over the next three years. During the year ended December 31, 2011, we purchased 1.3 million shares under the program for $81.6 million. As of December 31, 2011, we have $218.3 million available under the authorization.
Cash Flows
We believe that cash on hand, cash from operations, and the available credit facility will be sufficient to support our working capital needs, pay our operating expenses, satisfy debt obligations, fund capital expenditures and make dividend payments.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Cash flow provided from operating activities increased by $118.6 million in 2011 compared with 2010. Higher earnings, along with lower cash paid for income taxes, lower cash contributions to our frozen U.S. defined benefit pension plan and higher accounts payable were partially offset by increased inventories and receivables. The 2011 increase in inventories included an advance purchase of approximately $80 million for select dairy inputs along with a corresponding increase in accounts payable.
Cash flow used in investing activities decreased $62.0 million in 2011 compared to 2010. 2010 included expenditures for new packaging lines and higher spending for investments in our global IT platform.
Cash flow used in financing activities was $275.2 million for the year ended December 31, 2011, primarily from dividend payments of $205.7 million and treasury stock repurchases of $87.7 million. The termination of interest rate swaps provided $23.5 million to cash flow from financing activities. Cash flow used in financing activities was $306.4 million for the year ended December 31, 2010, and reflected dividend payments of $179.6 million and the net repayment of $120.0 million of our short-term Credit Facility borrowing.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Cash flow from operating activities fell by $62.4 million in 2010 compared with 2009. Higher earnings, along with increased non-cash depreciation and amortization expense, were more than offset by a smaller reduction in working capital and other short-term assets and liabilities, along with increased cash contributions to our frozen U.S. defined benefit pension plan.
Cash flow used in investing activities increased $93.3 million primarily due to higher capital spending from investments in our global IT platform and new packaging lines. Cash flows used in investing activities in 2010 included a $5.5 million investment in International Pediatric Nutrition Company, our joint venture with Almarai Company in Saudi Arabia serving countries in the Gulf Cooperation Council.
Cash flow used in financing activities was $306.4 million for the year ended December 31, 2010, primarily from $179.6 million of dividend payments and the net repayment of $120.0 million of borrowing under our short-term Credit Facility. Cash flow provided by financing activities was $49.1 million for the year ended December 31, 2009, and reflected $1,495.3 million from the private placement of notes and $782.3 million net cash proceeds from the IPO, partially offset by $2,348.1 million repayment of BMS debt and other items.
Capital Expenditures
Capital expenditures and the cash outflow for capital expenditures were as follows:
Capital expenditures included investments in our global IT platform, new packaging lines, and research and development capabilities.
In December 2011, we announced a planned capital expenditure for a new, greenfield spray dryer and technology center in Singapore that will cost approximately $300 million over a three-year period. We expect capital expenditures in 2012 to be approximately $220 million, including approximately
$100 million for the first year of the planned capital expenditure in Singapore, and continued emphasis on investment in growth and innovation. The Company expects to fund capital expenditures from its operations.
Short-Term Borrowings
In June 2011, the Company entered into a five-year revolving credit facility agreement (2011 Credit Facility). The 2011 Credit Facility replaces the Company's three-year revolving credit facility agreement dated February 17, 2009 (2009 Credit Facility). Borrowings from the 2011 Credit Facility are to be used for working capital and other general corporate purposes. The 2011 Credit Facility is unsecured and repayable on maturity in June 2016, and 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 2011 Credit Facility is $500.0 million, which may be increased from time to time up to $750.0 million at the Company's request and with the consent of the lenders, subject to satisfaction of customary conditions.
The Credit Facility contains customary covenants, including covenants applicable to limiting liens, substantial asset sales and mergers. Most of these restrictions are subject to certain minimum thresholds and exceptions. 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 3.25 to 1.0, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.0 to 1.0. We were in compliance with all debt covenants as of December 31, 2011.
Borrowings under the 2011 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 0.075% to 1.45% over the base rate. In addition, the Company incurs an annual 0.2% facility fee on the entire facility commitment of $500.0 million.
If our corporate credit rating falls below (i) Baa3 by Moody's Investors Service, Inc. (Moody's) and (ii) BBB- by Standard & Poor's Ratings Service (S&P), then Mead Johnson & Company shall automatically be deemed to guarantee the obligations under the Credit Facility. The Moody's credit rating for MJN is currently Baa1. S&P's credit rating for MJN is currently BBB.
There were no short-term borrowings as of December 31, 2011.
Long-Term Debt
The components of our long-term debt are detailed in the table below:
The notes may be prepaid at any time, in whole or in part, at a redemption price equal to the greater of par value or an amount calculated based upon the sum of the present values of the remaining scheduled payments. Upon a change of control, we may be required to repurchase the notes
in an amount equal to 101% of the then outstanding principal amount plus accrued and unpaid interest.
In November 2009, the Company entered into interest rate swaps with a notional amount of $700.0 million. In November 2010, the Company terminated a notional amount of $200.0 million in interest rate swaps on our 2019 Notes for cash of $15.6 million. In July 2011, we terminated the remaining notional amount of $500.0 million in interest rate swaps on our 2014 Notes for cash of $23.5 million. The related basis adjustments of the underlying hedged items are being recognized as a reduction of interest expense over the remaining life of the underlying debt.
For additional information on our long-term debt and interest rate swaps, see "Item 8. Financial Statements and Supplementary Data."
Contractual Obligations
As of December 31, 2011, our contractual obligations and other commitments were as follows:
Our operating lease obligations are generally related to real estate leases for offices, manufacturing-related leases, and vehicle leases. Capital lease obligations relate to assets used for interplant transportation of materials and finished goods. Purchase obligations are for unconditional commitments related to a master service agreement with IBM for information technology, accounting and indirect procurement services; for the purchase of materials used in manufacturing; and for promotional services. The future interest payments on long-term debt are based on coupon payments.
Off-Balance Sheet Arrangements
Pursuant to an Amended and Restated Tax Matters Agreement with BMS, we agreed to indemnify BMS for (i) any tax payable with respect to any separate tax return that we are required to file or cause to be filed, (ii) any tax incurred as a result of any gain that may be recognized by a member of the BMS affiliated group with respect to a transfer of certain foreign affiliates by us in preparation for the IPO, and (iii) any tax arising from the failure or breach of any representation or covenant made by us which failure or breach results in the intended tax consequences of the split-off transaction not being achieved.
We do not use off-balance sheet derivative financial instruments to hedge or partially hedge interest rate exposure nor do we maintain any other off-balance sheet arrangements for the purpose of credit enhancement, hedging transactions or other financial or investment purposes.
Significant Accounting Estimates
In presenting our financial statements in accordance with accounting principles generally accepted in the United States (GAAP), we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures.
Some of the estimates and assumptions that we are required to make relate to matters that are inherently uncertain as they pertain to future events. We base these estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under the circumstances. On an on-going basis, we reconsider and evaluate our estimates and assumptions. Actual results may differ significantly from these estimates. Future results may differ from our estimates under different assumptions or conditions.
We believe that the significant accounting estimates listed below involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our financial statements.
For information on our accounting policies, see "Item 8. Financial Statements and Supplementary Data."
Revenue Recognition
We recognize revenue when substantially all the risks and rewards of ownership have transferred to the customer. Revenue is recognized on the date of receipt by the purchaser. Revenues are reduced at the time of recognition to reflect expected returns that are estimated based on historical experience and business trends. Additionally, provisions are made at the time of revenue recognition for discounts, WIC rebates and estimated sales allowances based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. We offer sales incentives to customers and consumers through various programs consisting primarily of customer pricing allowances, merchandising funds and consumer coupons. Provisions are made at the time of revenue recognition for these items based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue.
WIC Rebates-We participate on a competitive bidding basis in nutrition programs sponsored by states, tribal governments, the Commonwealth of Puerto Rico, and U.S. territories for WIC. Under these programs, we reimburse these entities for the difference between our wholesaler list price and the contract price on eligible products. We account for WIC contract rebates by establishing an accrual in an amount equal to our estimate of WIC rebate claims attributable to a sale. We determine our estimate of the WIC rebate accrual primarily based on historical experience regarding WIC rebates and current contract prices under the WIC programs. We consider levels of inventory in the distribution channel, new WIC contracts, terminated WIC contracts, changes in existing WIC contracts and WIC participation, and adjust the accrual periodically throughout the year to reflect actual expense. WIC rebate accruals were $210.1 million and $195.3 million at December 31, 2011 and 2010, respectively, and are included in accrued rebates and returns on our balance sheet. Rebates under the WIC program reduced revenues by $700.7 million, $680.8 million, and $735.7 million in the years ended December 31, 2011, 2010 and 2009, respectively.
Sales Returns-We account for sales returns by establishing an accrual in an amount equal to our estimate of sales recorded for which the related products are expected to be returned. We determine our estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also consider other factors that could impact sales returns such as discontinuations and new product introductions. Sales return accruals were $43.0 million and $43.5 million at December 31, 2011 and 2010, respectively, and are included in accrued rebates and returns on our balance sheet. Returns reduced sales by $81.8 million, $84.3 million, and $72.0 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Income Taxes
The effective tax rate reflects statutory tax rates in the various jurisdictions in which we operate, including tax rulings, management's assertion that certain foreign earnings and profits are permanently
invested abroad and management's estimate of appropriate reserves against uncertain tax positions. Significant judgment is required in determining the effective tax rate and in evaluating the uncertainty in tax positions.
The income tax provision prepared in the post split-off period reflects a separate return methodology based on the legal structure where we are a separate taxpayer in the respective jurisdictions. The income tax provision prepared in the period following the IPO but preceding the split-off reflects a separate return methodology based on the actual legal entity structure as if we were a separate taxpayer in the respective jurisdictions with certain accommodations pursuant to a tax matters agreement as noted below. This is in contrast to the pre-IPO period in which the income tax provision was prepared on a separate return stand-alone methodology reflecting a hypothetical legal entity structure in which we were included in the tax grouping of other BMS entities within the respective entity's tax jurisdiction.
The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of our assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable earnings in effect for the years in which those tax attributes are expected to be recovered or paid, and are adjusted for changes in tax rates and tax laws when changes are enacted. The ultimate liability incurred by us may differ from the provision estimates based on a number of factors, including interpretations of tax laws and the resolution of examinations by the taxing authorities.
Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The assessment of whether or not a valuation allowance is required often requires significant judgment including the long-range forecast of future taxable earnings and the evaluation of tax planning initiatives. Adjustments to the deferred tax valuation allowances are made to earnings in the period when such assessments are made.
Changes in uncertain tax positions and changes in valuation allowances could be material to our results of operations for any period, but are not expected to be material to our financial position.
Pension and Other Post Retirement Benefits
Our pension plans and post retirement benefit plans are accounted for using actuarial valuations. Management, in consultation with our actuaries, is required to make significant subjective judgments about a number of actuarial assumptions, including discount rates, long-term returns on plan assets, retirement, health care cost trend rates and mortality rates. Depending on the assumptions and estimates used, the pension and post retirement benefit expense could vary within a range of outcomes and have a material effect on reported earnings, projected benefit obligations and future cash funding. Our key assumptions used in calculating the cost of pension benefits are the discount rate and expected long term returns on plan assets. Actual results in any given year may differ from those estimated because of economic and other factors.
The discount rate assumptions used to value the pension and post retirement benefit obligations reflect the yield to maturity of high quality corporate bonds that coincides with the cash flows of the plans' estimated payouts. In developing the expected rate of return on pension plan assets, we estimate returns for individual asset classes with input from external advisors. We also consider long-term historical returns on the asset classes, the investment mix of plan assets, investment manager performance and projected future returns of the asset classes.
Our principal pension plan is the Mead Johnson & Company Retirement Plan in the United States (U.S. Pension Plan), which is a frozen plan and represents approximately 80% of the Company's total pension assets and obligations. The assumptions used to determine net periodic benefit costs for the year are established at the beginning of the plan year and the assumptions used to determine benefit obligation are established as of the balance sheet date. The key assumptions for the U.S. Pension Plan were as follows:
The obligation for the U.S. Pension Plan grew by $74.8 million during 2011, primarily due to the change in the discount rate and the timing of expected payment assumptions. The change in the discount rate assumption reflected both the assumption used for the timing of expected payments and lower corporate bond rates.
The following table shows the impact on pension expense of hypothetical changes in the rates assumed for the U.S. pension plan:
See "Item 8. Financial Statements and Supplementary Data" for additional information on our pension and post retirement benefits.
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K 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 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 in connection with any discussion of future operating or financial performance. 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 and involve inherent risks, uncertainties, and assumptions including factors that could delay, divert or change any of them, and could cause actual outcomes to differ materially from current expectations. These statements are likely to relate to, among other things, our goals, plans and projections regarding its financial position, results of operations, cash flows, market position, product development, product approvals, sales efforts, expenses, performance or results of current and anticipated products and the outcome of contingencies such as legal proceedings and financial results, which are based on current expectations that involve inherent risks and uncertainties, including internal or external factors that could delay, divert or change any of them in the next several years. We have included important factors in the cautionary statements included in "Item 1A. Risk Factors," that we believe could cause actual results to differ materially from any forward-looking statement.
Although we believe we have been prudent in our plans and assumptions, we can give no assurance that any goal or plan set forth in forward-looking statements can be achieved and we caution readers not to place undue reliance on such statements, which speak only as of the date made. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of new information, future events or otherwise.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to certain market risks which exist as part of our on-going business operations. In addition to our costs for materials, compensation, media, distribution and other purchased services being subject to inflationary pressures, we are exposed to changes in currency exchange rates, price volatility for certain commodities and changes in interest rates. To reduce our exposure to these risks, we use a variety of contract techniques and financial instruments as described below. As a policy, we do not engage in speculative or leveraged transactions, nor do we hold or issue financial instruments for trading purposes.
Foreign Exchange Risk
We are exposed to market risk due to changes in currency exchange rates. Our primary net foreign currency exposures are the Chinese renminbi, the Hong Kong dollar, the euro, the Malaysian ringitt, the Mexican peso, the Philippine peso, and the Canadian dollar. In addition to these primary exposures, as a global business, we are exposed to foreign currency translation risk in all countries in which we do business whose local reporting currency is not the U.S. dollar.
We use foreign currency contracts to hedge anticipated transactions on certain foreign currencies and designate these derivative instruments as foreign currency cash flow hedges when appropriate. If the derivative is designated as a cash flow hedge, the change in the fair value of the derivative is initially recorded in accumulated other comprehensive income(loss) and then recognized in our statement of earnings when the corresponding hedged item impacts our earnings. The foreign currency derivatives resulted in losses of $2.9 million, $7.8 million, and $5.0 million in the years ended December 31, 2011, 2010 and 2009, respectively. The impact of hedge ineffectiveness on earnings was not significant.
We enter into hedging and other foreign exchange management arrangements to reduce the risk of foreign currency exchange rate fluctuations on earnings to the extent that cost-effective derivative financial instruments or other non-derivative financial instrument approaches are available. The intent of gains and losses on hedging transactions is to offset the respective gains and losses on the underlying exposures being hedged. While we attempt to mitigate some of this risk with hedging and other activities, our business will nevertheless remain subject to substantial foreign exchange risk from foreign currency translation exposures that we will not be able to manage through effective hedging or the use of other financial instruments.
The Company uses foreign exchange forward contracts to hedge exposures and the total notional amount of these contracts was $134.3 million at December 31, 2011, representing a fair value asset of $5.1 million.
The following table summarizes the foreign exchange forward contracts outstanding and the related weighted-average contract exchange rates as of December 31, 2011:
All of these derivatives were hedges of anticipated transactions and mature within 12 months. Assuming an unfavorable 10% change in year-end exchange rates, the fair value would have changed by $14.3 million and would have switched to a payable position. The unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.
Commodity Risk
We purchase certain products in the normal course of business, including dairy, agricultural oils, and packaging materials, the costs of which are affected by global commodity changes. Therefore, we are exposed to price volatility related to market conditions outside of our control.
We employ various purchasing and pricing contract techniques in an effort to reduce volatility. Generally, these techniques include unit pricing that is based on an average of commodity prices over a contractually defined period of time, timing of purchases, and setting fixed prices with suppliers. We do not generally make use of financial instruments to hedge commodity prices, partially because of these contract pricing techniques. As of December 31, 2011, we had no outstanding commodity derivative instruments.
Interest Rate Risk
We are exposed to changes in interest rates primarily as a result of our borrowing and investing activities used to maintain liquidity and fund business operations. Primary exposures include movements in U.S Treasury rates, LIBOR, and commercial paper rates. The nature and amount of our short-term and long-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. Our debt obligations totaled $1.5 billion. For information on our debt obligations, see
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audited Consolidated Financial Statements of Mead Johnson Nutrition Company:
Consolidated Statements of Earnings for the Years Ended December 31, 2011, 2010 and
Consolidated Balance Sheets as of December 31, 2011 and 2010
Consolidated Statements of Comprehensive Income and Equity (Deficit) for the Years Ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and 2009
Notes to Financial Statements
Schedule II-Valuation and Qualifying Accounts
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Mead Johnson Nutrition Company
Glenview, Illinois
We have audited the accompanying consolidated balance sheets of Mead Johnson Nutrition Company and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of earnings, comprehensive income and equity (deficit), and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Mead Johnson Nutrition Company and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2012 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 17, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Mead Johnson Nutrition Company
Glenview, Illinois
We have audited the internal control over financial reporting of Mead Johnson Nutrition Company and subsidiaries (the "Company") as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2011 of the Company and our report dated February 17, 2012 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 17, 2012
AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF MEAD JOHNSON
NUTRITION COMPANY
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
(Dollars and shares in millions, except per share data)
The accompanying notes are an integral part of these financial statements.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2011 AND 2010
(Dollars and shares in millions, except per share data)
The accompanying notes are an integral part of these financial statements.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2011, 2010, AND 2009
(Dollars in millions)
The accompanying notes are an integral part of these consolidated financial statements.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
(Dollars in millions)
The accompanying notes are an integral part of these financial statements.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
1. ORGANIZATION
Mead Johnson Nutrition Company manufactures, distributes and sells infant formulas, children's nutrition and other nutritional products. Mead Johnson Nutrition Company has a broad product portfolio, which extends across routine and specialty infant formulas, children's milks and milk modifiers, pediatric vitamins, dietary supplements for pregnant and breastfeeding mothers, and products for metabolic disorders. These products are generally sold to wholesalers and retailers and are promoted to healthcare professionals, and, where permitted by regulation and policy, directly to consumers.
2. INITIAL PUBLIC OFFERING AND SEPARATION ACTIVITIES
On February 17, 2009, Mead Johnson Nutrition Company completed the initial public offering (IPO) of 34.5 million shares common stock at a price of $24.00 per share. Prior to and immediately following the IPO, 170.0 million shares of common stock were owned by Bristol-Myers Squibb Company (BMS). The net proceeds from the IPO, after deducting a total of $45.7 million of underwriting discounts, commissions and offering expenses, totaled $782.3 million. All of the net proceeds of the IPO were used to settle pre-existing obligations to the Company's former parent, BMS.
On November 15, 2009, BMS announced an exchange offer whereby BMS shareholders could exchange a portion of BMS common stock for Mead Johnson Nutrition Company stock. The exchange offer was completed on December 23, 2009, resulting in the separation of Mead Johnson Nutrition Company and the disposal of BMS's entire ownership and voting interest.
Expensed transaction costs for the IPO recorded within selling, general, and administrative expense for the year ended December 31, 2009 were $31.0 million.
3. ACCOUNTING POLICIES
Basis of Presentation-The financial statements present the results of operations, financial position, and cash flows of Mead Johnson Nutrition Company and its majority-owned and controlled subsidiaries (MJN or the Company). Intercompany balances and transactions have been eliminated. The Company prepared the accompanying consolidated financial statements in accordance with generally accepted accounting principles in the United States (GAAP).
Use of Estimates-The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used in revenue recognition, including sales rebate and return accruals, goodwill, income tax assets and liabilities, income tax expense, and legal liabilities, as well as the accounting for stock-based compensation and retirement and post retirement benefits, including the actuarial assumptions. Actual results may or may not differ from estimated results.
Fair Value Measurements-The fair value of financial assets and liabilities are classified in the fair value hierarchy as follows: Level 1-unadjusted quoted prices in active markets for identical assets or liabilities, Level 2-observable prices that are based on inputs not quoted on active markets, and
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
3. ACCOUNTING POLICIES (Continued)
Level 3-unobservable inputs that reflect estimates about the assumptions market participants would use in pricing the asset or liability.
Revenue Recognition-MJN recognizes revenue when substantially all the risks and rewards of ownership have transferred to the customer. Revenue is recognized on the date of receipt by the purchaser. Revenues are reduced at the time of recognition to reflect expected returns that are estimated based on historical experience and business trends. Additionally, provisions are made at the time of revenue recognition for discounts, Women, Infants and Children (WIC) rebates and estimated sales allowances based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. The Company offers sales incentives to customers and consumers through various programs consisting primarily of customer pricing allowances, merchandising funds and consumer coupons. Provisions are made at the time of revenue recognition for these items based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue.
WIC rebate accruals were $210.1 million and $195.3 million at December 31, 2011 and 2010, respectively, and are included in accrued rebates and returns on the Company's balance sheet. MJN participates on a competitive bidding basis in nutrition programs sponsored by states, tribal governments, the Commonwealth of Puerto Rico, and U.S. territories for WIC. Under these programs, MJN reimburses these entities for the difference between wholesaler list price and the contract price on eligible products. The Company accounts for WIC rebates by establishing an accrual in an amount equal to the Company's estimate of WIC rebate claims attributable to a sale. MJN determines its estimate of the WIC rebate accrual primarily based on historical experience regarding WIC rebates and current contract prices under the WIC programs. The Company considers levels of inventory in the distribution channel, new WIC contracts, terminated WIC contracts, changes in existing WIC contracts and WIC participation, and adjusts the accrual periodically throughout the year to reflect actual expense. Rebates under the WIC program reduced revenues by $700.7 million, $680.8 million, and $735.7 million in the years ended December 31, 2011, 2010, and 2009, respectively.
Sales return accruals were $43.0 million and $43.5 million at December 31, 2011 and 2010, respectively, and are included in accrued rebates and returns on the Company's balance sheet. The Company accounts for sales returns by establishing an accrual in an amount equal to its estimate of sales recorded for which the related products are expected to be returned. The Company determines its estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also considers other factors that could impact sales returns such as discontinuations and new product introductions. Returns reduced sales by $81.8 million, $84.3 million, and $72.0 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Income Taxes-The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of the Company's assets and liabilities. Deferred tax assets and liabilities are
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
3. ACCOUNTING POLICIES (Continued)
measured using the currently enacted tax rates that apply to taxable earnings in effect for the years in which those tax attributes are expected to be recovered or paid, and are adjusted for changes in tax rates and tax laws when changes are enacted.
Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The assessment of whether or not a valuation allowance is required often requires significant judgment. Adjustments to the deferred tax valuation allowances are made to earnings in the period when such assessments are made.
Uncertain tax positions that relate to deferred tax assets are recorded against deferred tax assets; otherwise, uncertain tax positions are recorded as either a current or noncurrent liability.
The income tax provision prepared in the post separation period reflects a separate return methodology based on the legal entity structure where the Company is a separate taxpayer in the respective jurisdictions. The income tax provision prepared in the period following the IPO but preceding the separation reflects a separate return methodology based on the legal entity structure as if the Company were a separate taxpayer in the respective jurisdictions with certain accommodations pursuant to a tax matters agreement with BMS. This is in contrast to the pre-IPO period in which the income tax provision was prepared on a separate return stand-alone methodology reflecting a hypothetical legal entity structure in which the Company was included in the tax grouping of other BMS entities within the respective entity's tax jurisdiction. In the pre-IPO period, with the exception of MJN-dedicated entities, the Company did not maintain taxes payable to or from BMS as the Company was deemed to settle the annual current tax balances immediately with the tax paying legal entities in the respective jurisdictions. These settlements were reflected as changes in equity (deficit).
Cash and Cash Equivalents-Cash and cash equivalents consist of bank deposits, time deposits and money market funds. The Company maintains cash and cash equivalent balances in U.S. dollars and foreign currencies, which are subject to currency rate risk. Cash equivalents are primarily highly liquid investments with original maturities of three months or less at the time of purchase and are recorded at cost, which approximates fair value. Money market funds, which totaled $449.2 million and $246.8 million at December 31, 2011 and 2010, respectively, are classified as Level 2 in the fair value hierarchy.
Inventory Valuation-Inventories are stated at average cost, not in excess of market.
Capital Assets and Depreciation-Expenditures for additions and improvements are capitalized at cost. Depreciation is generally computed on a straight-line method based on the estimated useful lives of the related assets. The estimated useful lives of the major classes of depreciable assets are up to 50 years for buildings and 3 to 40 years for machinery, equipment, and fixtures. Maintenance and repair costs are expensed as incurred.
Capitalized Software-Certain costs to obtain internal-use software for significant systems projects are capitalized and amortized on a straight-line basis over the estimated useful life of the software, which ranges from 3 to 7 years. Costs to obtain software for projects that are not significant are expensed as incurred.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
3. ACCOUNTING POLICIES (Continued)
Impairment of Long-Lived Assets-The Company periodically evaluates whether current facts or circumstances indicate that the carrying value of its depreciable assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists. If an asset is determined to be impaired, the loss is measured based on the difference between the asset's fair value and its carrying value. An estimate of the asset's fair value is based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows. The Company reports an asset to be disposed of at the lower of its cost less accumulated depreciation or its estimated net realizable value.
Goodwill-Goodwill is tested for impairment using a two-step process on an annual basis or when current facts or circumstances indicate that a potential impairment may exist. The first step is to identify a potential impairment, and the second step measures the amount of the impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit's goodwill exceeds its estimated fair value. The Company completed its annual goodwill impairment assessment during the first quarter and monitored for any potential impairment in the remaining quarters. No impairment of goodwill was required in 2011, 2010 or 2009.
Contingencies-In the ordinary course of business, the Company is subject to loss contingencies, such as 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 such loss contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. The Company does not recognize gain contingencies until realized. Legal costs are expensed as incurred.
Derivatives-Derivatives are used by the Company principally in the management of its foreign currency and interest rate exposures. The Company records all derivatives on the balance sheet at fair value. The Company does not hold or issue derivatives for speculative purposes.
The Company designates and assigns derivatives as hedges of forecasted transactions, specific assets or specific liabilities. When hedged assets or liabilities are sold or extinguished or the forecasted transactions being hedged are no longer expected to occur, the Company immediately recognizes the gain or loss on the designated hedging financial instruments in the consolidated statements of earnings.
If derivatives are designated as a cash flow hedge, the effective portion of changes in the fair value is temporarily reported in accumulated other comprehensive income (loss) and is recognized in earnings when the hedged item affects earnings, in cost of products sold, or is deemed ineffective, in other expenses/income-net; cash flows are classified consistent with the underlying hedged item. The Company assesses hedge 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
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
3. ACCOUNTING POLICIES (Continued)
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.
If derivatives are designated as a fair value hedge, both the changes in the fair value of the derivatives and of the hedged item attributable to the hedged risk are recognized in the consolidated statements of earnings; cash flows are classified consistent with the underlying hedged item.
Pension and Other Post Retirement Benefits-The funded status of the Company's defined pension and post retirement benefit plans is measured as the difference between the fair value of plan assets and the benefit obligation. For the defined benefit plans, the benefit obligation is the projected benefit obligation; for any other defined benefit post retirement plans, the benefit obligation is the accumulated post retirement benefit obligation. The net over- or under-funded status is recognized as an asset or a liability on the balance sheet. Any unrecognized actuarial gain or loss, or service cost or benefit is reported as a component of accumulated other comprehensive income (loss).
Shipping and Handling Costs-The Company typically does not charge customers for shipping and handling costs. Shipping and handling costs, including warehousing expenses, were $104.3 million, $75.8 million, and $68.5 million in the years ended December 31, 2011, 2010, and 2009, respectively, and are included in selling, general and administrative expenses.
Advertising Costs-Advertising costs are expensed as incurred and were $180.6 million, $155.3 million, and $136.9 million in the years ended December 31, 2011, 2010, and 2009, respectively.
Research and Development-Research and development costs are expensed as incurred.
Foreign Currency Translation-The statements of earnings of the Company's foreign subsidiaries whose functional currencies are other than the U.S. dollar are translated into U.S. dollars using average exchange rates for the period. The net assets of the Company's foreign subsidiaries whose functional currencies are other than the U.S. dollar are translated into U.S. dollars using exchange rates as of the balance sheet date. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation adjustment account, which is included in accumulated other comprehensive income (loss).
Recently Issued Accounting Standards-In 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820), clarifying the existing measurement and disclosure requirements and expanding the disclosure requirements for certain fair value measurements. ASU 2011-04 is effective for the Company in the period beginning January 1, 2012. The adoption of this ASU will not affect the Company's financial statements. The Company will provide enhanced disclosures as required upon the effective date.
In 2011, the FASB issued ASU No. 2011-05 and ASU No. 2011-12, Comprehensive Income (Topic 220), requiring entities to present net income and other comprehensive income in either a single continuous statement or in two consecutive statements of net income and other comprehensive income. The ASUs are effective for the Company in the period beginning January 1, 2012. The Company will provide the required financial reporting presentation upon the effective date.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
3. ACCOUNTING POLICIES (Continued)
In 2011, FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350), allowing entities the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step impairment test. If, as a result of the qualitative assessment, it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. ASU 2011-08 is effective for the Company in the period beginning January 1, 2012. The adoption of this ASU will not have a material effect on the Company's financial statements.
4. 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 number of 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:
Potential shares outstanding were 2.9 million, 2.3 million and 1.7 million as of December 31, 2011, 2010 and 2009, respectively, of which 2.2 million, 1.9 million and 1.6 million were not included in the diluted earnings per share calculation for the years ended December 31, 2011, 2010 and 2009, respectively.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
5. OTHER EXPENSES/(INCOME)-NET
The components of other expenses/(income)-net were:
6. INCOME TAXES
A new legal entity structure was created to facilitate the IPO. As such, adjustments have been made to the income tax accounts and equity (deficit) during the year ended December 31, 2009, to reflect the impact of this restructuring.
In the pre-IPO period, with the exception of MJN-dedicated entities, the Company did not maintain taxes payable to or from BMS as the Company was deemed to settle the annual current tax balances immediately with the tax paying legal entities in the respective jurisdictions. These settlements were reflected as changes in equity (deficit).
On February 10, 2009, the Company entered into a tax matters agreement with BMS. This agreement governs the tax relationship between the Company and BMS for the tax periods through the December 23, 2009 separation of the Company from BMS. Under this agreement, responsibility is allocated between BMS and MJN for the payment of taxes resulting from filing (i) tax returns on a combined, consolidated or unitary basis and (ii) single entity tax returns for entities that have both MJN and non-MJN operations. Accordingly, BMS prepared returns for MJN for all periods during which MJN was included in a combined, consolidated or unitary group with BMS for federal, state, local or foreign tax purposes, as if MJN itself was filed as a combined, consolidated or unitary group. BMS also prepared returns for the Company for all periods during which a single-entity tax return was filed for an entity that has both MJN and non-MJN operations. MJN made payments to BMS and BMS made payments to MJN with respect to such returns, as if such returns were actually required to be filed under the laws of the applicable taxing jurisdiction and BMS was the relevant taxing authority of such jurisdiction.
On December 18, 2009, the Company and BMS entered into an Amended and Restated Tax Matters Agreement in anticipation of the separation from BMS. With respect to the period before the separation, the Amended and Restated Tax Matters Agreement allocates the responsibility of BMS and MJN for the payment of taxes in the same manner as discussed above with respect to the tax matters agreement. Pursuant to the Amended and Restated Tax Matters Agreement, the Company consented to join BMS in electing to allocate items ratably between the portion of the taxable year in which the Company was included in the BMS consolidated tax group, and the short period beginning after the
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
6. INCOME TAXES (Continued)
separation and ending on December 31, 2009, when the Company is a separate taxpayer. Additionally under the Amended and Restated Tax Matters Agreement, BMS agreed to indemnify the Company for (i) any tax attributable to a MJN legal entity for any taxable period ending on or before December 31, 2008, (ii) any tax arising solely as a result of the IPO and the restructuring preceding the IPO, and (iii) any transaction tax associated with the separation transaction. The Company agreed to indemnify BMS for (i) any tax payable with respect to any separate return that the Company is required to file or cause to be filed, (ii) any tax incurred as a result of any gain which may be recognized by a member of the BMS affiliated group with respect to a transfer of certain foreign affiliates by the Company in preparation for the IPO, and (iii) any tax arising from the failure or breach of any representation or covenant made by the Company which failure or breach results in the intended tax consequences of the separation transaction not being achieved.
The components of earnings before income taxes were:
The above amounts are categorized based on the location of the taxing authorities.
The provision (benefit) for income taxes attributable to operations consisted of:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
6. INCOME TAXES (Continued)
Effective Tax Rate-MJN's provision for income taxes in the years ended December 31, 2011, 2010 and 2009 was different from the amount computed by applying the statutory U.S. federal income tax rate to earnings before income taxes as a result of the following:
The Company negotiated a tax ruling effective from January 1, 2010, under which certain profits in the Netherlands are exempt from taxation through the year ending December 31, 2019; this agreement succeeds a prior agreement which expired on December 31, 2009.
Deferred Taxes and Valuation Allowance-The components of current and noncurrent deferred income tax assets (liabilities) were:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
6. INCOME TAXES (Continued)
As of December 31, 2011, the Company had gross foreign net operating loss (NOL) carryforwards of $47.0 million. These NOL carryforwards will begin to expire in 2012. The valuation allowance recorded for these NOL carryforwards increased by $3.7 million during the year ended December 31, 2011. The valuation allowance relates to foreign NOL carryforwards incurred in the post-IPO period.
Current and noncurrent deferred income tax assets totaled $129.4 million and $68.7 million as of December 31, 2011 and 2010, respectively. The change in the balance between periods is primarily driven by current year pension losses, increases in accrued expenses and an increase in the intercompany profit reserve.
Income taxes paid were $174.3 million, $217.7 million, and $167.1 million in the years ended December 31, 2011, 2010, and 2009, respectively. The income taxes were paid to federal, state and foreign taxing authorities and pursuant to the terms of the tax matters agreement, as well as taxes deemed paid to BMS prior to the date of the IPO.
As of December 31, 2011, U.S. taxes have not been provided on approximately $411 million of foreign earnings as these undistributed earnings have been or are expected to be permanently invested offshore. If, in the future, these earnings are repatriated to the U.S., or if such earnings are determined to be remitted in the foreseeable future, additional tax provisions would be required. If these earnings are repatriated to the United States in such a manner that the entire amount of foreign earnings would be subject to U.S. tax, and assuming there would be no U.S. tax relief for foreign taxes already paid, then such earnings would be taxed at the U.S. statutory tax rate in effect at the time of the repatriation, resulting in a U.S. tax liability of approximately $144 million estimated at the current U.S. tax rate of 35%. However, the Company has no plans to repatriate these foreign earnings.
The Company's tax returns are routinely audited by federal, state and foreign tax authorities and these tax audits are at various stages of completion at any given time. The Internal Revenue Service has completed examinations of the Company's U.S. income tax filings through December 31, 2007. At December 31, 2011, tax years remaining open to examination outside the U.S. include 2003 and forward.
A reconciliation of the Company's changes in gross uncertain tax positions is as follows:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
6. INCOME TAXES (Continued)
Uncertain tax positions have been recorded as part of other liabilities with no reversal expected in the next twelve months. The amounts of uncertain tax positions that, if recognized, would impact the effective tax rate were $10.9 million, $3.0 million, and $2.4 million as of December 31, 2011, 2010 and 2009, respectively.
Interest and penalties related to uncertain tax positions were $8.2 million, $6.2 million, and $4.1 million for the years ended December 31, 2011, 2010 and 2009, respectively, and are included as a component of other liabilities. The Company classifies interest and penalties related to uncertain tax positions as a component of provision for income taxes. The amount of interest and penalties included as a component of provision for income taxes was $0.6 million and $0.3 million for the years ended December 31, 2011 and 2010, respectively. No interest or penalties were included as a component of provision for income taxes for the year ended December 31, 2009 pursuant to the Amended and Restated Tax Matters Agreement.
The Company believes that it has provided adequately for all uncertain tax positions. Pursuant to the Amended and Restated Tax Matters Agreement, BMS maintains responsibility for all uncertain tax positions which may exist in the pre-IPO period or which may exist as a result of the IPO transaction. Pursuant to the Amended and Restated Tax Matters Agreement, the Company continues to maintain responsibility for all uncertain tax positions which may exist in the post-IPO period. It is reasonably possible that new issues may be raised by tax authorities and that these issues may require increases in the balance of uncertain tax positions.
7. 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 in the economics, products offered, production process, customer base, and regulatory environment, these operating segments have been aggregated into two reportable segments: Asia/Latin America and North America/Europe.
Corporate and Other consists of unallocated general and administrative expenses; global business support activities, including research and development, marketing and supply chain costs; 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.
The Company's products are sold principally to the wholesale and retail trade. One customer of both the Asia/Latin America and North America/Europe segments accounted for 12% of the Company's gross sales for each year ended December 31, 2011, 2010, and 2009; one customer of the
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
7. SEGMENT INFORMATION (Continued)
Asia/Latin America segment accounted for 14%, 12%, and 11% of the Company's gross sales for the years ended December 31, 2011, 2010, and 2009, respectively.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
7. SEGMENT INFORMATION (Continued)
8. EMPLOYEE STOCK BENEFIT PLANS
MJN 2009 Stock Award and Incentive Plan-The MJN 2009 Stock Award and Incentive Plan (MJN 2009 Plan) provides for the grant of stock options, performance share awards, restricted stock units and other stock-based awards. Executive officers and other key employees of MJN, and non-employee directors and others who provide substantial services to MJN, are eligible to be granted awards under the MJN 2009 Plan. Twenty-five million shares of stock were approved and registered with the Securities and Exchange Commission for grants to participants under the MJN 2009 Plan. Shares used for awards assumed in an acquisition or combination will not count against the shares reserved under the MJN 2009 Plan. The shares reserved may be used for any type of award under the MJN 2009 Plan. Stock-based compensation expense is based on awards ultimately expected to vest. Forfeitures are estimated based on the historical experience of participants in the stock-based compensation plans of our former parent, BMS.
MJN may grant options to purchase common stock at no less than 100% of the market price on the date the option is granted. Stock options generally become exercisable in installments of either 25% per year on each of the first through the fourth anniversaries of the grant date or 33% per year on each of the first through the third anniversaries of the grant date. Stock options have a maximum term of 10 years. Generally, MJN will issue shares for the stock option exercises from treasury stock, if available, or will issue new shares.
MJN may also grant performance share awards, which are delivered in the form of a target number of performance shares and have a three-year performance cycle. The performance share awards have annual goals set at the beginning of each year, at which time the awards are considered granted. The maximum payout is 200%. If targets are not met for a performance period, no payment is made under the plan for that annual period.
MJN may also grant restricted stock units to Executive officers, key employees and non-employee directors. Restrictions generally expire over a one- to five-year period from the date of grant. Stock-based compensation expense is recognized over the restricted period. A restricted stock unit is a right to receive stock at the end of the specified vesting period. A restricted stock unit has non-forfeitable rights to dividends and has no voting rights.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
8. EMPLOYEE STOCK BENEFIT PLANS (Continued)
MJN Stock Options-The fair value of stock options granted in 2011 and 2010 was estimated on the date of grant using the Black-Scholes option pricing model. No stock options with market conditions were granted in 2011 or 2010. The fair value of stock options granted in 2009 was estimated on the date of grant using the Black-Scholes option pricing model for stock options with a service condition, and the Monte Carlo simulation model for options with service and market conditions. The following assumptions were used in the valuations:
The 2011 expected volatility assumption required in the Black-Scholes model was calculated based on an equal weighting between the Company's historical volatility and implied volatility from publicly-traded options on the Company's stock with a 6.0-year look back period ending on the grant date. The 2010 expected volatility assumption required in the Black-Scholes model was calculated based on a combination of peer group analysis of stock price volatility and implied volatility from publicly-traded options on the Company's stock with a 6.0-year look back period ending on the grant date. The 2009 expected volatility assumption required in the Black-Scholes model and Monte Carlo model was calculated based on peer group analysis of stock price volatility with a 6.3-year and 10-year look back period ending on the grant date, respectively.
The risk-free interest rate assumption in the Black-Scholes model is based upon the U.S. Treasury yield curve in effect at the time of grant. The risk-free interest rate assumption in the Monte Carlo model is based upon the 10-year U.S. Treasury yield curve. The dividend yield assumption is based on MJN's expectation of dividend payouts. The expected life is based on the vesting period and the contractual term for each grant, or for each vesting tranche for awards with graded vesting. The selection of this approach was based on MJN's assessment that this simplified method is appropriate given the terms of the stock option granted and given that there is not sufficient historical stock option exercise experience upon which to estimate expected terms.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
8. EMPLOYEE STOCK BENEFIT PLANS (Continued)
Stock option activities were as follows:
The weighted-average grant date fair value of stock options granted is $14.73, $10.31 and $6.13 for 2011, 2010 and 2009 respectively.
Cash proceeds received from options exercised during the years ended December 31, 2011 and 2010 were $4.5 million and $2.2 million, respectively. No options were exercised during the year ended December 31, 2009. The tax benefit realized from stock options exercised was $1.8 million in 2011 and $0.8 million in 2010.
At December 31, 2011, total unrecognized compensation cost related to stock options of $6.9 million is expected to be recognized over a weighted average period of 1.8 years.
MJN Performance Share Awards-The fair value of performance share awards is based on the closing trading price of MJN's stock on the date of the grant, discounted using the risk-free interest rate as the awards do not participate in dividends. Information related to performance share awards activity is summarized as follows:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
8. EMPLOYEE STOCK BENEFIT PLANS (Continued)
Shares granted and earned in the table above assumes 100% plan performance adjusted for the actual plan achievement level for completed performance periods. At December 31, 2011, total unrecognized compensation cost related to the performance share awards granted of $10.0 million is expected to be recognized over a weighted average period of 1.5 years.
MJN Restricted Stock Units-The fair value of restricted stock units is determined based on the closing trading price of MJN's common stock on the grant date. A summary of restricted stock unit activity is as follows:
At December 31, 2011, total unrecognized compensation cost related to nonvested restricted stock units was $12.4 million and is expected to be recognized over a weighted average period of 2.6 years.
BMS Employee Stock Benefit Plans-Prior to the separation, BMS sponsored employee stock plans in which certain MJN employees participated. Expense recognized for these stock-based compensation plans resulted in an increase of equity (deficit). As part of the separation from BMS, all participation in the BMS employee stock benefit plans by MJN employees was terminated. All outstanding BMS stock options, BMS long-term performance share awards and BMS restricted stock units held by MJN employees were either accelerated vested, pro-rata vested or forfeited based on the type of award. For the year ended December 31, 2009, the accelerated and pro-rata vesting increased expense by $3.3 million. Non-retirement eligible MJN employees had a limited time to exercise the BMS stock options that had accelerated vesting. To compensate for the lost value in the BMS-sponsored employee stock plans, these employees were awarded MJN restricted stock units totaling 0.3 million units included in the table above.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
8. EMPLOYEE STOCK BENEFIT PLANS (Continued)
Stock-Based Compensation Expense-The following table summarizes stock-based compensation expense related to MJN stock options, MJN performance share awards, MJN restricted stock units, and BMS stock benefit plan awards for the years ended December 31, 2011, 2010, and 2009:
Stock-based compensation expense was recognized in the consolidated statements of earnings as follows:
There were no costs related to stock-based compensation that were capitalized.
Accuracy of Fair Value Estimates
The Company's determination of fair value of stock-based compensation awards on the date of grant using an option pricing model is affected by the Company's stock price, as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company's estimated stock price volatility over the term of the awards and estimated employee stock option exercise behaviors. Option pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company's employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can affect the estimated value, the value may not be indicative of the fair value observed in an orderly transaction between market participants.
9. EMPLOYEE BENEFITS
Pension and Other Post Retirement Benefits
Pension-The principal pension plan is the Mead Johnson & Company Retirement Plan in the United States (U.S. Pension Plan) which represents approximately 80% of the Company's total pension assets and obligations. The benefits of this plan are frozen and benefits are no longer accrued for service.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
9. EMPLOYEE BENEFITS (Continued)
Other post retirement benefits-The Company also provides comprehensive medical and group life benefits for substantially all U.S. and Canadian retirees who elect to participate in its comprehensive medical and group life plans. The retiree medical plan is contributory. Contributions are adjusted periodically and vary by date of retirement. The retiree life insurance plan is non-contributory.
Changes in benefit obligations, plan assets, funded status and amounts recognized in the balance sheet were as follows:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
9. EMPLOYEE BENEFITS (Continued)
The Company's defined benefit pension and post retirement benefit plans with an accumulated benefit obligation in excess of plan assets were as follows:
The net periodic benefit cost of the Company's defined benefit pension and post retirement benefit plans includes:
The estimated net actuarial loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2012 are:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
9. EMPLOYEE BENEFITS (Continued)
Actuarial assumptions
Weighted-average assumptions used to determine benefit obligations are established as of the balance sheet date and were as follows:
The discount rate was determined based on the yield to maturity of high-quality corporate bonds and considering the duration of the pension plan obligations. The Citigroup Pension Discount Curve is used in developing the discount rate for the U.S. Pension Plan.
Weighted-average assumptions used to determine net periodic benefit cost are established at the beginning of the plan year and were as follows:
The yield on high-quality corporate bonds that matches the duration of the benefit obligations was used in determining the discount rate. The Citigroup Pension Discount Curve is used in developing the discount rate for the U.S. plans. The expected long-term return on plan assets was determined based on the target asset allocation, expected rate of return by each asset class, and estimated future inflation.
For the U.S. Pension Plan, the expected long-term return on plan assets assumption to be used to determine net periodic benefit cost for the year ending December 31, 2012 is 6.25%. The expected long-term return on plan assets was determined based on the Company's target asset allocation, expected rate of return by each asset class, and estimated future inflation.
Gains and losses have resulted from changes in actuarial assumptions, such as changes in the discount rate, and from differences between assumed and actual experience, such as differences between actual and assumed returns on plan assets. These gains and losses are adjusted for the difference between the fair value and the market-related value of the plan assets and are amortized to the extent they exceed 10% of the higher of the market-related value or the projected benefit obligation for each respective plan. The majority of the remaining actuarial losses are amortized over the life expectancy of the plans' participants for the frozen U.S. plans and expected remaining service periods for the other plans.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
9. EMPLOYEE BENEFITS (Continued)
Assumed health care cost trend rates were as follows:
Assumed health care cost trend rates affect the amounts reported for the retiree medical plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
Plan assets
The Company's investment strategy for the U.S. Pension Plan assets consists of a mix of equities and fixed income in order to achieve returns over a market cycle which reduces contribution and expense at an acceptable level of risk. The target asset allocation of 40% public equity and 60% fixed income is maintained and cash flow (i.e., cash contributions, benefit payments) is used to rebalance back to the targets as necessary. Investments are well diversified within each of the two major asset categories. All of the U.S. equity investments are actively managed. Investment strategies for international pension plans are typically similar, although the asset allocations are usually more conservative.
The fair values of the Company's pension plan assets by asset category were as follows:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
9. EMPLOYEE BENEFITS (Continued)
Level 1 cash and cash equivalents, which excluded money market funds, are recorded at closing prices in active markets. Level 2 money market, equity, and fixed income funds are recorded at the net asset values per share, which were determined based on quoted market prices of the underlying assets contained within the funds. The Level 2 hedge fund is recorded at the net asset value per share, which was derived from the underlying funds' net asset values per share; this diversified hedge fund may be redeemed quarterly with 60 days notice.
Contributions
In 2012, the funding policy for the pension plans is to contribute amounts to provide for current service and to fund past service liability. MJN contributed $9.5 million, $55.4 million and $27.1 million to the pension plans in 2011, 2010 and 2009, respectively. The Company is not required to make any contributions to its pension plans in 2012, however the Company may elect to make a discretionary contribution of approximately $20 million. There will be no cash funding for other post retirement benefits in 2012.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Defined Contribution Benefits
Employees who meet certain eligibility requirements may participate in various defined contribution plans. Total cost recognized for all defined contribution benefit plans were $19.3 million, $19.2 million and $16.4 million for the years ended December 31, 2011, 2010, and 2009, respectively.
10. NONCONTROLLING INTERESTS
Net earnings attributable to noncontrolling interests consists of an 11% interest in the Company's China legal entity and a 10% interest in the Company's Indonesia legal entity held by third parties.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
11. RECEIVABLES
The major categories of receivables were as follows:
12. INVENTORIES
The major categories of inventories were as follows:
13. LONG-LIVED ASSETS
Property, Plant, and Equipment
The major categories of property, plant, and equipment were as follows:
Depreciation expense was $57.2 million, $54.6 million and $50.3 million for the years ended December 31, 2011, 2010 and 2009, respectively, and is primarily included in costs of products sold. Interest capitalized during the year was $0.2 million, $2.6 million and $0.9 million for the years ended December 31, 2011, 2010 and 2009, respectively.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
13. LONG-LIVED ASSETS (Continued)
Other Intangible Assets
Other intangible assets primarily consist of computer software.
Amortization expense for other intangible assets was $18.1 million, $10.1 million and $8.6 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Expected amortization expense related to intangible assets is as follows:
The Company's liability for asset retirement obligations was $1.6 million at December 31, 2011 and 2010.
14. GOODWILL
The carrying amount of goodwill was $117.5 million at December 31, 2011 and 2010. Of the total carrying amount of goodwill, $115.8 million is related to the Asia /Latin America segment and $1.7 million is related to the North America/Europe segment.
15. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Short-Term Borrowings
There were no short-term borrowings as of December 31, 2011. Short-term borrowings were $1.2 million as of December 31, 2010, and consisted of short-term loans.
In June 2011, the Company entered into a five-year revolving credit facility agreement (2011 Credit Facility). The 2011 Credit Facility replaces the Company's three-year revolving credit facility agreement dated February 17, 2009 (2009 Credit Facility). Borrowings from the 2011 Credit Facility are to be used for working capital and other general corporate purposes. The 2011 Credit Facility is unsecured and repayable on maturity in June 2016, subject to annual extensions if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
15. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (Continued)
any one time under the 2011 Credit Facility is $500.0 million, which may be increased from time to time up to $750.0 million at the Company's request and with the consent of the lenders, subject to satisfaction of customary conditions. The 2011 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 3.25 to 1.0, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.0 to 1.0. As of December 31, 2011, the Company was in compliance with these covenants.
Borrowings under the 2011 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 0.075% to 1.45% over the base rate. In addition, the Company incurs an annual 0.2% facility fee on the entire facility commitment of $500.0 million.
The borrowings from the 2011 Credit Facility and 2009 Credit Facility had a weighted-average interest rate of 1.6% for the year ended December 31, 2011. The borrowings from the 2009 Credit Facility had a weighted-average interest rate of 2.73% for the year ended December 31, 2010. There were no borrowings from the 2011 Credit Facility as of December 31, 2011. There were no borrowings from the 2009 Credit Facility as of December 31, 2010.
Long-Term Debt
The components of long-term debt were as follows:
Based on the Company's assessment of current market conditions for debt of similar maturity, structure and risk, the estimated fair value of the Company's debt was $1,647.3 million as of December 31, 2011.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
15. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (Continued)
Interest expense, interest income and cash payments for interest and under interest rate swaps were as follows:
16. DERIVATIVES
The Company is exposed to market risk due to changes in 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. These financial instruments are classified as Level 2 of the fair value hierarchy for both periods presented. For the years ended December 31, 2011 and 2010, there were no transfers between levels in the fair value hierarchy. Derivative financial instruments are not used for speculative purposes.
The following table summarizes the Company's fair value of outstanding derivatives designated as hedging instruments:
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 December 31, 2011 failed to perform according to the terms of its agreement. At this time, the Company does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative financial instruments.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
16. DERIVATIVES (Continued)
Cash Flow Hedges
The Company uses foreign exchange contracts to hedge forecasted transactions, primarily intercompany purchases for up to 18 months, on certain foreign currencies and designates these derivative instruments as foreign currency cash flow hedges when appropriate. For the contracts that qualify as hedges of probable forecasted transactions, the effective portion of changes in fair value is temporarily reported in accumulated other comprehensive income (loss) and recognized in earnings when the hedged item affects 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. For the years ended December 31, 2011, 2010, and 2009, the impact of hedge ineffectiveness on earnings was not significant.
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 years ended December 31, 2011, 2010, and 2009, the Company did not discontinue any cash flow hedges of this nature.
Foreign Exchange Contracts-The effective portion of changes in the fair value of foreign exchange contracts is recognized in earnings when the hedged item affects earnings, in cost of products sold, or deemed ineffective, in other expenses/(income)-net. The majority of the Company's foreign exchange contracts qualify as hedges of probable forecasted cash flows.
The table below summarizes the Company's outstanding foreign exchange forward contracts at December 31, 2011. 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.
At December 31, 2011, 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 (loss) was $4.3 million, $4.1 million of which is expected to be reclassified into earnings within the next 12 months.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
16. DERIVATIVES (Continued)
The change in accumulated other comprehensive income (loss) and the impact on earnings from foreign exchange contracts that qualified as cash flow hedges for the years ended December 31, 2011 and 2010, were as follows:
Fair Value Hedges
The Company may, from time to time, enter into fixed-to-floating interest rate swaps as part of its interest rate management strategy. The gain or loss on these swaps is recognized in current earnings and is offset by the loss or gain on the hedged item. The swaps are recorded at fair value. The fair value of the interest rate swaps is the present value of the future cash flows calculated based on forecasted LIBOR rates from a third party bank including credit value adjustments.
Interest Rate Swaps-In November 2009, the Company executed several interest rate swaps to convert $700.0 million of the Company's newly-issued fixed rate debt to be paid in 2014 and 2019 to variable rate debt. In November 2010, the Company terminated $200.0 million notional amount of fixed-to-floating interest rate swaps for cash of $15.6 million. In July 2011, the Company terminated the remaining $500.0 million notional amount of fixed-to-floating interest rate swaps for cash of $23.5 million. The related basis adjustments of the underlying hedged items are being recognized as a reduction of interest expense over the remaining life of the underlying debt. The Company had no interest rate swaps outstanding at December 31, 2011.
(Gain) loss on marked to market of fair value hedges during the years ended December 31, 2011 and 2010 was as follows:
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
16. DERIVATIVES (Continued)
The impact on earnings from interest rate swaps that qualified as fair value hedges was as follows:
See Note 15 for discussion on the Company's long-term debt.
Non-Qualifying Foreign Currency Forward Contract
The Company may, from time to time, enter into foreign currency forward contracts to hedge foreign currency denominated monetary assets and liabilities. The primary objective of these contracts is to protect the U.S. dollar value of foreign currency denominated monetary assets and liabilities from the effects of volatility in foreign exchange rates that might occur prior to their receipt or settlement in U.S. dollars. These contracts are not designated as hedges and are adjusted to fair value through other expenses/(income)-net, other assets and accrued expenses as they occur and substantially offset the change in fair value of the underlying foreign currency denominated monetary asset or liability. For the year ended December 31, 2010, the impact on earnings from foreign currency forward contracts of this nature was a gain of $1.0 million. There were no foreign currency forward contracts of this nature as of December 31, 2010. The Company had no foreign currency forward contracts of this nature during the year ended and as of December 31, 2011.
17. EQUITY
Changes in common shares and treasury stock were as follows:
Treasury stock is recognized at the cost to reacquire the shares. Shares issued from treasury are recognized using the first-in first-out method.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
18. LEASES
Minimum rental commitments under all non-cancelable operating leases, primarily real estate leases for offices, manufacturing-related leases and vehicle leases, in effect at December 31, 2011, are:
Operating lease rental expenses were $35.5 million, $24.1 million and $23.0 million in the years ended December 31, 2011, 2010, and 2009, respectively. At December 31, 2011 and 2010, MJN had capital lease obligations outstanding in the amount of $3.1 million and $1.7 million, respectively.
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 is not aware of any environmental, health or safety-related litigation or significant environmental, health and safety-related financial obligations or liabilities arising from current or former operations or properties that are likely to have a material impact on the Company's business, financial position or results of operations. Liabilities or obligations, which could require the Company to make significant expenditures, could arise in the future, however, as the result of, among other things, changes in, or new interpretations of, existing laws, regulations or enforcement policies, claims relating to on- or off-site contamination, or the imposition of unanticipated investigation or cleanup obligations.
On November 14, 2011, the Company's subsidiary Mead Johnson & Company, LLC (MJC) obtained final court approval of a nationwide class settlement with plaintiffs in eight putative consumer class actions that had been consolidated and transferred to the U.S. District Court for the Southern District of Florida. The suits all involved allegations of false and misleading advertising with respect to certain Enfamil LIPIL infant formula advertising, and the settlement will resolve all claims in all of the pending suits. In its final order approving the class action settlement (the Final Order), the court found the settlement to be fair, reasonable and adequate. The settlement allows consumers who purchased Enfamil LIPIL infant formula between October 13, 2005, and March 31, 2010, to receive infant formula or cash. The amount each consumer can receive depends on how long the consumer purchased the formula; consumers who received their formula through the Women, Infants and Children (WIC) program are not eligible to participate. The period within which class members could file claims
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
19. CONTINGENCIES (Continued)
expired on November 25, 2011. As of the close of the claims period, the total amount claimed by class members was less than $8.0 million. As a result and consistent with the Company's previously recorded obligations under the settlement agreement, MJC received court approval on January 9, 2012, to distribute the difference between $8.0 million and the total amount claimed in the form of infant formula to Feeding America, the nation's largest domestic hunger-relief charity. MJC also agreed not to oppose, and the court approved in its Final Order, attorneys' fees and expenses to plaintiffs' counsel of $3.5 million and $140,000, respectively. As previously reported, MJC agreed to pay costs of notice and settlement administration. Two class members have separately appealed the court's Final Order to the U.S. Court of Appeals for the Eleventh Circuit. Briefing in the appeal has not yet started. Until the appeal has been resolved, distribution of benefits to class members will be delayed. MJC expects distribution of benefits would begin shortly after a successful resolution of the appeal.
The Company records accruals for such contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although MJN cannot predict with certainty the final resolution of these or other lawsuits, investigations and claims asserted against the Company, MJN does not believe any currently pending legal proceeding to which MJN 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 December 31, 2011, with respect to one or more of these proceedings could have a material effect on the Company's results of operations or the periods in which a loss is recognized.
20. RELATED-PARTY TRANSACTIONS
The Company was engaged in transactions with its former parent, BMS. These transactions primarily consisted of sales to BMS, as it served as the primary distributor in the European region for a portion of 2011, and fees for services under a Transitional Services Agreement (TSA). The Company had related-party transactions with BMS from the time of the IPO in February 2009 through the separation from BMS on December 23, 2009. As of the split-off, BMS is no longer a related party. Activities while BMS was a related party are detailed below.
MEAD JOHNSON NUTRITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
AS OF DECEMBER 31, 2011 AND 2010 AND FOR THE YEARS ENDED
DECEMBER 31, 2011, 2010 AND 2009
21. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
SCHEDULE II
MEAD JOHNSON NUTRITION COMPANY
MEAD JOHNSON NUTRITION
VALUATION AND QUALIFYING ACCOUNTS
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer of the company (its principal executive officer and principal financial officer, respectively), we have evaluated our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rule 13a-15(e) and 15d-15(e)) as of December 31, 2011. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, management assessed the effectiveness of internal control over financial reporting as of December 31, 2011, based on the framework in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management has concluded that our internal control over financial reporting was effective at December 31, 2011, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Deloitte & Touche LLP, an independent registered public accounting firm, has audited our financial statements included in this Annual Report on Form 10-K and issued its report on the effectiveness of our internal control over financial reporting as of December 31, 2011, which is included herein.
Changes in Internal Control Over Financial Reporting
During the quarter ended December 31, 2011, we concluded a two-year, phased global implementation of a new Enterprise Resource Planning ("ERP") system and transaction processing services. The new ERP system and transaction processing services were part of a global initiative to transition, replace or retire the ERP, administration and outsourced services provided to us by BMS under various transition services agreements. Specifically, we transitioned processes and procedures for the remainder of our Asia operations to this new ERP system and transaction processing services. This transition has involved changes to certain internal controls over financial reporting, which we believe were material.
Except as noted above, there has been no change in our internal control over financial reporting during the quarter ended December 31, 2011, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is set forth under the heading "Directors, Executive Officers and Corporate Governance" in our 2012 Proxy Statement to be filed with the U.S. Securities and Exchange Commission (the "SEC") in connection with the solicitation of proxies for our 2012 Annual Meeting of Stockholders (the "2011 Proxy Statement") and is incorporated herein by reference. Such Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year to which this report relates.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the headings "Executive Compensation" and "Compensation Discussion and Analysis" in our 2012 Proxy Statement and is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is set forth under the headings "Security Ownership of Certain Beneficial Owners and Management" and "Securities Authorized for Issuance under Equity Compensation Plans" in our 2012 Proxy Statement and is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is set forth under the headings "Review, Approval or Ratification of Transactions with Related Persons" and "Director Independence" in our 2012 Proxy Statement and is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is set forth under the heading "Fees Paid to Auditors" in our 2012 Proxy Statement and is incorporated herein by reference.
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
The financial statements and schedule filed as part of this Annual Report on Form 10-K are listed in the accompanying Index to Financial Statements and Financial Statement Schedule on page XX. The exhibits filed as a part of this Annual Report on Form 10-K are listed in the accompanying Exhibit Index on page XX.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: February 17, 2012
By:
/s/ STANLEY D. BURHANS
Stanley D. Burhans
Vice President and Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Date: February 17, 2012
By:
/s/ STEPHEN W. GOLSBY
Stephen W. Golsby
President and Chief Executive Officer
(Principal Executive Officer)
Date: February 17, 2012
By:
/s/ PETER G. LEEMPUTTE
Peter G. Leemputte
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: February 17, 2012
By:
/s/ STANLEY D. BURHANS
Stanley D. Burhans
Vice President and Controller
(Principal Accounting Officer)
Date: February 17, 2012
By:
/s/ JAMES M. CORNELIUS
James M. Cornelius
Chairman of the Board of Directors
Date: February 17, 2012
By:
/s/ STEVEN M. ALTSCHULER, M.D.
Steven M. Altschuler, M.D.
Director
Date: February 17, 2012
By:
/s/ HOWARD B. BERNICK
Howard B. Bernick
Director
Date: February 17, 2012
By:
/s/ KIMBERLY A. CASIANO
Kimberly A. Casiano
Director
Date: February 17, 2012
By:
/s/ ANNA C. CATALANO
Anna C. Catalano
Director
Date: February 17, 2012
By:
/s/ CELESTE A. CLARK, PH.D.
Celeste A. Clark, Ph.D.
Director
Date: February 17, 2012
By:
/s/ PETER G. RATCLIFFE
Peter G. Ratcliffe
Director
Date: February 17, 2012
By:
/s/ ELLIOTT SIGAL, M.D., PH.D.
Elliott Sigal, M.D., Ph.D.
Director
Date: February 17, 2012
By:
/s/ ROBERT S. SINGER
Robert S. Singer
Director
EXHIBIT INDEX
Exhibit
Number
Description
Articles of Incorporation and Bylaws
3.1
Second Amended and Restated Certificate of Incorporation of Mead Johnson Nutrition Company (incorporated by reference to Exhibit 3.1 to current report on Form 8-K filed on January 8, 2010)
3.2
Amended and Restated By-laws of Mead Johnson Nutrition Company (incorporated by reference to Exhibit 3.1 to current report on Form 8-K filed on January 30, 2012)
Instruments defining the rights of the security holders, including indentures
4.1
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to registration statement on Form S-1 (Registration No. 333-156298) filed on January 14, 2009)
4.2
Indenture, dated as of November 1, 2009, by and between Mead Johnson Nutrition Company and The Bank of New York Mellon Trust Company, N.A., as trustee (incorporated by reference to Exhibit 4.1 to current report on Form 8-K filed on November 12, 2009)
4.3
First Supplemental Indenture, dated as of November 5, 2009, by and among Mead Johnson Nutrition Company, Mead Johnson & Company and The Bank of New York Mellon Trust Company, N.A., as trustee (including forms of the 3.50% Notes due 2014, 4.90% Notes due 2019 and 5.90% Notes due 2039 Notes) (incorporated by reference to Exhibit 4.2 to current report on Form 8-K filed on November 12, 2009)
Material Contracts
10.1
Separation Agreement by and between Bristol-Myers Squibb Company and Mead Johnson Nutrition Company, dated January 31, 2009 (incorporated by reference to Exhibit 10.1 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.2
Employee Matters Agreement between Bristol-Myers Squibb Company and Mead Johnson Nutrition Company, dated January 31, 2009 (incorporated by reference to Exhibit 10.2 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.3
Second Amended and Restated Transitional Services Agreement between Bristol-Myers Squibb Company and Mead Johnson Nutrition, dated December 18, 2009 (incorporated by reference to Exhibit 10.4 to annual report on Form 10-K for the fiscal year ended December 31, 2009 filed on February 25, 2010)
10.4
Amended and Restated Tax Matters Agreement between Bristol-Myers Squibb Company and Mead Johnson Nutrition Company dated December 18, 2009 (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on December 23, 2009)
10.5
Amended and Restated China Services Agreement between Bristol-Myers Squibb Company and Mead Johnson Nutrition Company, dated December 18, 2009 (incorporated by reference to Exhibit 10.2 to current report on Form 8-K filed on December 23, 2009)
Exhibit
Number
Description
10.6
Five Year Revolving Credit Facility Agreement, dated as of June 17, 2011, among Mead Johnson Nutrition Company, Mead Johnson & Company, LLC, the borrowing subsidiaries, the lenders named therein, Bank of America, N.A., The Bank of Tokyo-Mitsubishi UFJ, Ltd. and Royal Bank of Canada, as Co-Documentation Agents, Citibank, N.A., as Syndication Agent, and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to quarterly report on Form 10-Q for the quarter ended June 30, 2011 filed on July 28, 2011)
10.7
Supply Agreement by and between Mead Johnson & Company and Martek Biosciences Corporation, dated as of January 1, 2006 (incorporated by reference to Exhibit 10.18 to registration statement on Form S-1 (Registration No. 333-156298) filed on December 19, 2008)
10.8
Amendment No. 1 to Supply Agreement by and between Mead Johnson & Company, LLC and Martek Biosciences Corporation, made and entered into effective as of June 1, 2010 (incorporated by reference to Exhibit 10.1 to quarterly report on Form 10-Q for the quarter ended June 30, 2010 filed on July 29, 2010)
10.9*
Mead Johnson Nutrition Company 2009 Amended and Restated Stock Award and Incentive Plan (incorporated by reference to Addendum A to definitive proxy statement on Schedule 14A filed on April 2, 2010)
10.10*
Mead Johnson Nutrition Company 2009 Senior Executive Performance Incentive Plan (incorporated by reference to Exhibit 10.29 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.11*
Mead Johnson & Company Benefit Equalization Plan-Retirement Plan (incorporated by reference to Exhibit 10.31 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.12*
Mead Johnson & Company Benefit Equalization Plan-Retirement Savings Plan (incorporated by reference to Exhibit 10.32 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.13*
Mead Johnson & Company Key International Pension Plan (incorporated by reference to Exhibit 10.33 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.14*
Mead Johnson & Company LLC Senior Executive Severance Plan (incorporated by reference to Exhibit 10.3 to current report on Form 8-K filed on December 23, 2009)
10.15*
Mead Johnson & Company LLC Senior Executive Change In Control Severance Plan (incorporated by reference to Exhibit 10.4 to current report on Form 8-K filed on December 23, 2009)
10.16*
Form of Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.34 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.17*
Form of Performance Shares Agreement (incorporated by reference to Exhibit 10.35 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
Exhibit
Number
Description
10.18*
Form of Director Restricted Stock Units Agreement (incorporated by reference to Exhibit 10.36 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.19*
Form of Employee Restricted Stock Units Agreement (incorporated by reference to Exhibit 10.37 to annual report on Form 10-K for the fiscal year ended December 31, 2008 filed on March 27, 2009)
10.20*
Form of Restricted Stock Units Agreement (incorporated by reference to Exhibit 10.5 to current report on Form 8-K filed on December 23, 2009)
Subsidiaries of the Registrant
21.1
Subsidiaries of the Registrant
Consents of experts and counsel
23.1
Consent of Deloitte & Touche LLP
Rule 13a-14(a)/15d-14(a) Certifications
31.1
Certification of the Chief Executive Officer
31.2
Certification of the Chief Financial Officer
Section 1350 Certifications
32.1
Certification of the Chief Executive Officer
32.2
Certification of the Chief Financial Officer
Interactive Data File
101**
The following financial statements and footnotes from the Mead Johnson Nutrition Company Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Earnings; (ii) Consolidated Balance Sheets; (iii) Consolidated Statements of Comprehensive Income and Equity (Deficit); (iv) Consolidated Statements of Cash Flows; (v) the Notes to Consolidated Financial Statements; and (vi) Schedule II-Valuation and Qualifying Accounts
Confidential treatment has been granted for certain portions which are omitted in the copy of the exhibit electronically filed with the SEC. The omitted information has been filed separately with the SEC pursuant to our application for confidential treatment.
*Compensatory plan or arrangement
**In accordance with Rule 406T under Regulation S-T, the XBRL-related information in Exhibit 101 shall be deemed to be "furnished" and not "filed."