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 $4.2 billion in net sales for the year ended December 31, 2013. 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 North America, Europe, Asia and Latin America. Our three reportable segments are Asia, Latin America and North America/Europe, which comprised 52%, 20% and 28%, respectively, of our net sales for the year ended December 31, 2013. See “Item 8. Financial Statements - Note 5. Segment Information.” For the year ended December 31, 2013, 77% 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 39% of our net sales for the year ended December 31, 2013, 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 commitments to support good nutrition early in life and 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 more than a century. 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, and we have positioned them as providing unique, clinically supported health and developmental benefits. The Enfa infant formula products often include docosahexaenoic acid (“DHA”) and other key nutrients to support brain and immune system development. Our Enfa family of brands accounted for approximately 80% of our net sales for the year ended December 31, 2013 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 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) links 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.
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), the nutritional needs of children (such as Lactum) 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 globally. The general stages of pediatric development are illustrated below:
Outside of the United States, 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). In the United States, our business is primarily focused on the infant formula category (including newborn and infant), but the children’s nutrition business is growing rapidly. This strategy allows us to take advantage of brand loyalty developed in the early stages 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%, 39% and 2% of our net sales for the year ended December 31, 2013, respectively.
Infant Formula
General
Our infant formula products include routine feeding formula, solutions formulas for mild feeding problems 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 FORMULAS FOR
COMMON FEEDING PROBLEMS
SPECIALTY INFANT FORMULAS
AND SUPPLEMENTS
•
Enfamil Premium
•
Enfamil Gentlease: for gas/fussiness
•
Nutramigen: for mild to moderate cow’s milk or soy allergies
•
Enfamil Premium Newborn
•
Enfamil ProSobee: soy formula
•
Puramino: for severe cow’s milk protein or multiple food allergies
•
Enfamil A+
•
Enfamil LactoFree: for lactose intolerance
•
Pregestimil: for fat malabsorption
•
Enfalac A+
•
Enfamil AR: for anti-regurgitation
•
Enfamil Premature: for premature infants
•
SanCor Bebé
•
Enfamil HA: for infants at risk of cow’s milk protein allergy
•
Enfacare: for premature infants when they are able to go home
•
SanCor Bebé Premium
•
Enfamil Comfort: for gas/fussiness
•
Enfamil Human Milk Fortifier: liquid supplement added to human milk for premature and low birth weight infants
•
Enfamil for Supplementing: for when mothers choose to introduce formula
•
Other Medical Nutrition Products: for children with metabolic disorders
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.
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 and arachidonic acid (“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 formulas are consumed by newborn infants up to six months of age (up to three months of age in the case of Enfamil Premium Newborn). Stage 2 formulas are generally consumed by infants from age 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, Canada and Argentina.
We market the same product under different names in different regions, based on regional marketing strategies and regional brand recognition. For example, our premium 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, we use the brands Enfamil A+ and Enfalac A+ for our DHA and ARA supplemented formulas.
Routine infant formula products comprised 41% of our total net sales for each of the years ended December 31, 2013, 2012 and 2011.
Solutions Infant Formulas for Common Feeding Problems
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 10% of our total net sales for each of the years ended December 31, 2013, 2012 and 2011.
Specialty Infant Formulas and Supplements
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 formulas comprised 8% of our total net sales for each of the years ended December 31, 2013, 2012 and 2011.
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 cow’s milk protein allergies. Nutramigen with LGG infant formula is a variant of Nutramigen. 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. Puramino infant formula is an amino acid formula that we formulated with fully broken-down proteins, which 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 and Supplements 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. Enfamil Premature is an infant formula used primarily in the hospital. EnfaCare infant formula is a hypercaloric formula available through retail channels for
premature babies when they are able to go home. Furthermore, we designed our Enfamil Human Milk Fortifier product as a supplement to a mother’s breast milk that improves nutritional density.
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 17 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
•
Enfagrow
•
Sustagen KID
•
Enfagrow A+
•
Lactum
•
Enfagrow Premium
•
Alacta
•
ChocoMilk
•
Cal-C-Tose
•
SanCor Bebé
•
SanCor Bebé Premium
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. Enfa branded children's nutrition products comprised 29%, 27% and 27% of our total net sales for the years ended December 31, 2013, 2012, 2011, respectively.
Other Children’s Nutrition Products
We also offer other children's products in select markets to meet specific nutritional needs. We offer products at Stages 3, 4 and 5 designed to complete children's dietary requirements. Sustagen Kid is a nutritionally-balanced milk supplement for children targeting unique nutritional needs during specific stages of development. Lactum and Alacta are also powered milk supplements intended to ensure that essential nutrients are incorporated into children's diets.
We make ChocoMilk and Cal-C-Tose which are “milk modifiers” in powder form that, when added to a glass of milk, maximize the milk's nutritional value. These products contain a unique blend of important vitamins and minerals, including iron and calcium, and are intended to ensure that essential nutrients are incorporated into children's diets.
Other children's products comprised 10%, 11% and 11% of our total net sales for the years ended December 31, 2013, 2012, 2011, 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 and EnfaMama. 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 development. These products also supplement the mother’s diet by providing DHA with increased proteins, as well as 24 vitamins and minerals. Our pediatric vitamin products sold in some geographies, such as Enfamil Poly-Vi-Sol, provide a range of benefits for infants, including multivitamins and iron supplements. Other products comprised 2%, 3% and 3% of our total net sales for the years ended December 31, 2013, 2012, 2011, 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 51% of all infants born in the United States during the 12-month period ended December 31, 2013 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 6% of our U.S. net sales and 1% of our global net sales in the year ended December 31, 2013.
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 redeemed 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 for which vouchers were redeemed by the agency and reimbursed 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, 2013, we held the contracts that supplied approximately 39% of WIC births in the United States.
As of December 31, 2013, we held the exclusive WIC contract for the following states:
State
Date of Expiration
% of Total
WIC Infant
Participation (1)
California (2)
July 31, 2015
14.3%
Colorado (2)
December 31, 2014
1.1%
Connecticut (2)
September 30, 2014
0.7%
Illinois (2)
January 31, 2016
3.7%
Louisiana (2)
September 30, 2015
1.9%
Maine (2)
September 30, 2014
0.3%
Massachusetts (2)
September 30, 2014
1.4%
Michigan
October 31, 2016
3.2%
Missouri (2)
September 30, 2014
1.9%
Nebraska (2)
September 30, 2014
0.5%
New Hampshire (2)
September 30, 2014
0.2%
New Jersey (2)
September 30, 2015
1.9%
New York (2)
June 30, 2014
5.9%
North Dakota (2)
June 30, 2015
0.2%
Rhode Island (2)
September 30, 2014
0.3%
South Dakota (2)
September 30, 2014
0.2%
WSCA Consortium - Soy Infant Formula Only (2) (3)
September 30, 2015
1.1%
(1)
As of October 2013, as reported by the United States Department of Agriculture Food and Nutrition Service (the “USDA FNS”).
(2)
Contract contains extension provisions.
(3)
The WSCA (Western States Contracting Alliance) Consortium includes the states of Alaska, Arizona, Delaware, District of Columbia, Hawaii, Idaho, Kansas, Maryland, Montana, Nevada, Oregon, Utah, Washington, West Virginia and Wyoming.
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 “WHO 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 consumer insights to determine strategy for brand communication, product innovation and demand-generation programs. The marketing teams work with external agencies to create strong marketing campaigns for consumers, health care professionals and retail sales organizations, as permitted under the WHO Code and individual countries’ laws and regulations.
Consumers
Parental preference plays an important role in brand selection with influence from health care professionals. We participate in a variety of marketing activities, where permitted by regulation and policy, including print and television advertising, direct mail, online / internet, digital and promotional programs. Our marketing is evidence-based and emphasizes our superior nutritional science. In particular, our digital marketing program provides new or prospective parents with many resources to help them with their newborns, including free samples, nutritional and developmental information for mothers and widely accepted instantly redeemable coupons, where permitted by regulation and policy. We are increasing our investment in direct marketing with a focus on emerging channels such as social media and mobile.
Health Care Professionals
Our 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. 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 also support health care professionals by organizing continuing medical education programs, symposia and other educational interfaces.
Retail Sales Organization
Our 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, shopper trends and the regulatory environment. In North America, Eastern Europe, Latin America and Asia, we focus on all retail channels, while in Western Europe we focus primarily on specialty products sold through pharmacies. We have entered into logistics partnerships with distributors and wholesalers in most of our markets.
Global Supply Chain
We manage sourcing, manufacturing and distribution through our fully integrated global supply chain. We currently 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 manufacturing and finishing facilities are located in the United States, Mexico, the Netherlands, China, the Philippines, Thailand and Brazil. Our new manufacturing and technology center in Singapore is currently under construction and is expected to be operational in the second half of 2014. See “Item 2. Properties” for a description of our global manufacturing facilities.
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 52 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. These raw materials are subject to review and approval by our regional teams to ensure compliance with regulatory requirements. For example, milk prices vary at the local level around the world partly due to government pricing regulation. We saw a significant rise in dairy prices in 2013. Dairy products, consisting primarily of milk powders, non-fat dry milk, lactose and whey protein concentrates, accounted for approximately 43% of our global expenditures for raw materials in the year ended December 31, 2013.
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, DKSH International Ltd. (primarily in Asia and including sales to its regional affiliates) and Wal-Mart Stores, Inc. (including sales to Sam’s Club), accounted for approximately 16%, 15% and 14%, and approximately 10%, 11% and 12% of our gross sales for the years ended December 31, 2013, 2012, and 2011, 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 and Nestlé S.A.
Other companies, including manufacturers of private label, store brand and economy products, manufacture and sell one or more products that are similar to those marketed by us. We believe sources of our competitive advantage include clinical claims for efficacy and product quality, brand 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
Continuing to invest in research and development (“R&D”) capabilities is an important part of our business. Our R&D organization consists of professionals, many of who have extensive industry experience and advanced educational backgrounds. Our global R&D operations are headquartered in Evansville, Indiana, and our additional key R&D facilities are located in Mexico, Thailand, China and the Netherlands. Our Pediatric Nutrition Institutes ("PNI") are located in Evansville, Indiana; Mexico City, Mexico and Guangzhou, China. In 2014 we expect to complete our new manufacturing and technology center in Singapore which will include a fourth PNI.
We organize our research and development on a global basis because our science-based products address nutritional needs that are broadly common around the world. We then rely on our regional R&D teams to incorporate any 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 $102.4 million, $95.4 million, and $92.5 million in the years ended December 31, 2013, 2012, and 2011, respectively.
Intellectual Property
Patents
We own or license approximately 56 active U.S. patents and 370 active non-U.S. patents and have 88 pending U.S. patent applications and 775 pending non-U.S. patent applications as of December 31, 2013.
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 6,100 trademark registrations and applications in more than 100 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 country, regional and global policy, guidance and regulations.
United States Food and Drug Administration
One of the main regulatory bodies in the United States is the United States Food and Drug Administration (“U.S. FDA”). The U.S. FDA’s Center for Food Safety and Applied Nutrition is responsible for the regulation of food, including infant formula. 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 market introduction of any infant formula that differs fundamentally in processing or in composition from any current or previous formulation produced by the manufacturer.
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 compositional criteria, quality criteria and labeling, as well as other specific standards with which manufacturers must comply, including requirements for placing new formulas on the market. Most country regulatory provisions are comparable to or will refer to the general conditions defined by Codex Alimentarius (“Codex”) standards, described below, or will refer to globally recognized regulatory authorities (e.g. the European Commission and the U.S. FDA) and the scientific opinions issued by expert authorities (e.g. the European Food Safety Authority).
Global Policy and Guidance
WHO
The World Health Organization (“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, 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 WHO Code. The WHO 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 WHO 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 WHO Code. While the WHO Code is not international law, it is our policy to comply with all applicable laws and regulations and take guidance from the WHO Code in developing countries.
Codex
The Codex, or the food code, has become the global reference point for consumers, food producers and processors, national food control agencies and the international food trade. The Codex system, established in 1963 by the United Nations Food and Agriculture Organization and the WHO, presents a unique opportunity for all countries to join the international community in formulating and harmonizing food standards and fostering their global implementation. It also allows them a role in the development of codes governing hygienic processing practices and recommendations relating to compliance with those standards. The Codex regulatory provisions have been established for formulas and foods for infants and young children. It is usual practice for countries in Latin America, Africa and Asia to incorporate Codex standards either directly or with minor modifications into national law. It is our policy to comply with all national laws and with Codex standards where national regulatory requirements have not yet been enacted.
International Association of Infant Food Manufacturers
The International Association of Infant Food Manufacturers (“IFM”) is an international association of some of the leading global and regional infant food manufacturers. We are a member of the IFM and, in 2013, signed the IFM Rules of Responsible Conduct (the “IFM Rules”). The IFM Rules are a set of voluntary commitments detailing how IFM member companies will conduct themselves in most markets around the world with regard to topics such as safety, marketing, interactions with health care professionals and disaster aid. The IFM Rules were drafted by IFM members in order to clarify and bring specificity to the aims and principles of the WHO Code. We are committed to respecting and adhering to all local laws and regulations related to topics addressed in the IFM Rules.
Environmental, Health and Safety
Our facilities and operations are subject to various environmental, health and safety ("EHS") laws and regulations in each of the jurisdictions in which we operate. We have programs that are designed to ensure that our operations and facilities meet or exceed standards established by applicable EHS rules and regulations globally. Each of our manufacturing facilities undergoes periodic internal audits relating to EHS requirements and we incur operating and capital costs to improve our facilities or maintain compliance with applicable requirements on an ongoing basis.
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, 2013, we employed approximately 7,200 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 effective January 2014. 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 website 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 United States Securities and Exchange Commission (the “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 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 our products or those of other manufacturers of pediatric nutrition products could adversely impact our sales. Such reports or allegations could contribute to a perceived safety risk for our products or for pediatric nutrition products generally and adversely impact our 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, unfounded media reports in late 2011 alleging 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 product manufacturing, 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. In particular, if government regulations (e.g. China’s new food safety law and related regulations) impact how and where we are able to manufacture or source product, we may face unfavorable cost pressure and a significant change in our geographic earnings mix. Because we operate in markets with significant variances in effective tax rates, such change in geographic earnings mix could have a material adverse effect on our global tax liability. Further, our activities may be subject to barriers or sanctions imposed by countries or international organizations limiting international trade. For example, in 2013, the Hong Kong government imposed a regulation designed to limit the flow of products out of the territory. Regulations may also dictate the specific content of our products and limit information and advertising about the benefits of products that we market. 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.
Our business is particularly vulnerable to commodity price increases. 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. We recently saw a significant rise in dairy prices which we expect to impact our gross margin in the short term. In general, increases in the price of dairy and other raw materials negatively impact our gross margins if we are unable to offset such increases by raising 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 and, from time to time, attempt to mitigate some of this risk with commodity hedging activities, 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; as such, we may be unable to offset increased commodity costs with price increases if such price increases were to weaken demand for our product.
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 and Nestlé S.A., 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 brand 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. Market share losses could also lead to higher than necessary inventory levels held by our customers. 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 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 Philippine peso, the Malaysian ringitt and the Mexican peso. 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 non-U.S. currencies may negatively affect the value of these items in our financial statements, even if their value has not changed in their original currency. Currency rates in smaller markets, such as Venezuela and Argentina, could also impact our results due to high volatility in exchange rates in such markets. 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 exposure.
High volatility in exchange rates may also require us to apply inflationary accounting. For example, we apply highly inflationary accounting to our business in Venezuela, the impact of which on our consolidated financial statements is dependent upon movements in the official exchange rate, including devaluations, between the Bolivares Fuertes and the U.S. dollar. The operating environment in Venezuela could include high inflation, governmental restrictions in the form of currency exchange, price and margin controls, and the possibility of further government actions such as further devaluations or other business intervention. In addition, the foreign exchange controls in Venezuela limit our ability to repatriate earnings and our Venezuela subsidiary’s ability to remit dividends and pay intercompany balances at
any official exchange rate or at all. For additional information, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Venezuela Risk”.
Foreign governments may also restrict our ability to exchange local currencies for more marketable currencies and may limit our ability to pay dividends, to pay non-local currency accounts payable or to obtain currencies (other than the local currency) which may be more desirable to hold. Foreign governments may also simultaneously restrict our ability to increase prices in inflationary environments where local currencies are under significant pressure. Without the ability to increase prices to offset the impact of local currency devaluation, our ability to manage foreign exchange risk may be further limited.
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, 2013, 2012, and 2011, 77%, 75%, and 72%, 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 earnings;
•
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.
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, the Indian subcontinent and eastern Europe, 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 standards of business conduct and 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, detect violations in a timely manner 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. If violations are found or suspected, we 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. See Item 3. Legal Proceedings for further information regarding the company’s ongoing investigation. 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 portion of our revenue and profit is derived from sales in China. Consequently, our overall financial results are dependent on this market, and our business is exposed to risks there. These risks include changes in economic conditions (including wage and commodity inflation, consumer spending and unemployment levels), tax rates, laws and consumer preferences, changes in the regulatory environment and increased competition, and potential non-compliance with local laws and regulations. In 2013, China's National Development and Reform Commission ("NDRC") assessed a $33.4 million administrative penalty against us in connection with their antitrust review of the infant formula industry's resale pricing practices. In addition, the translation into U.S. dollars of our operating results and asset value in China is 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 China’s relations with the U.S. and other countries 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 to develop, offer and communicate the benefits of new products rapidly enough to meet those changes.
Our success depends on our ability to define the benefits of our products and to effectively communicate these benefits in the current regulatory environment. Our success also 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. 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, Royal DSM N.V. (“DSM”) (which acquired Martek Biosciences Corporation) 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 DSM, 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. In addition, quality concerns could result from contamination, spoilage or other adulteration of raw materials shipped to us by third-party suppliers and utilized in our products. An ensuing recall by either us or our supplier could have a material adverse effect on our business.
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, such batch 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 (such as our manufacturing and technology center in Singapore) 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. In particular, if government regulations (e.g. China’s new food safety law and related regulations) impact how and where we are able to manufacture or source product, we may face unfavorable cost pressure and a significant change in our geographic earnings mix. Because we operate in markets with significant variances in effective tax rates, such change in geographic earnings mix could have a material adverse effect on our global tax liability.
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. For example, we are currently in the process of completing the construction of our new manufacturing and technology center in Singapore; any potential delays could have an adverse impact on 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, changes in government regulations 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, 2013, we held the contracts that supply approximately 39% of WIC births in the United States. 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 to 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;
•
failure of one or more of our products to achieve or maintain commercial viability; or
•
changing and increasing obstacles to achieving regulatory approval in key markets.
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 were named as a “potentially responsible party,” or were involved in investigation and remediation, at three third party disposal sites (see “Item 3. Legal Proceedings”). 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 canceled 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 consumers, health care professionals and retail sales organizations. 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.
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 both health care costs and health care regulation, 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 effective January 2014. In addition, European Works Councils represent the manufacturing workforce in Nijmegen, the Netherlands, and the commercial organizations in France and Spain. 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, DKSH International Ltd. and Wal-Mart Stores, Inc. (including sales to Sam’s Club), accounted for approximately 16% and 10%, respectively, of our gross sales for the year ended December 31, 2013. 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 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, 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 $1.5 billion as of December 31, 2013. See “Item 8. Financial Statements - Note 15. Debt” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
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 could incur substantial cost if we need to repatriate earnings to the United States in order to repay such debt. Further, we may not be able to borrow money, sell assets or otherwise raise funds on acceptable terms, or at all, to refinance our debt. Specifically, $500M of our long term debt comes due November 2014; if we are unable to refinance this debt on favorable terms, or at all, our results of operations may be materially affected. Further, if the terms of the debt cause our existing hedge to be ineffective, all or a portion of the hedge instrument would need to be recognized immediately, which may also have a material impact.
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 Bristol-Myers Squibb Company (“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, 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 to BMS, we believe that the payment could have a material adverse effect on our financial condition and results of operations.
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 effect on our business and results of operations. Any such adverse effect 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 1,200,000 square feet. We also own or lease the manufacturing facilities identified in the table below. For additional information related to our 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 global manufacturing locations, the approximate square footage of the facilities, the reportable segment served by such locations and whether the facility is owned or leased:
(1) Powder manufacturing facility.
(2) Liquid manufacturing facility.
(3)
Our new manufacturing and technology center in Singapore is currently under construction and is expected to be operational in the second half of 2014.
(4)
The land on which this facility is built is subject to a long term lease.
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.
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 were named as a “potentially responsible party”, or were involved in investigation and remediation, at three third-party disposal sites. As of December 31, 2013, two of these matters have been settled in their entirety. With regard to the third such matter, the substance of this matter has been resolved, and management believes that any actual or expected remediation cost related to such matter, individually or in the aggregate, would be immaterial.
We were served with a lawsuit filed on October 16, 2012 in St. Clair County (Illinois) Circuit Court under the caption Shelby Schrack, et al. v. Mead Johnson Nutrition Company and Mead Johnson & Company, which lawsuit alleges that certain bacteria in powdered formula were responsible for the death of one infant and serious illness in two others and seeks unspecified monetary damages. These events were widely publicized in December 2011 and January 2012. The infants allegedly consumed formula from batches that were extensively tested by the Company, the Centers for Disease Control (“CDC”) and the U.S. FDA. These tests detected no bacteria in our infant formula. The CDC further noted that while these bacteria have sometimes been found in formula, they also exist in the environment and may potentially cause illness through person to person contact or through contamination of infant feedings at the point of use. We believe that the claims in this matter are without merit. Nevertheless, in November 2013, the Company and the plaintiffs agreed to settle the disputed claims asserted in this litigation, and on December 12, 2013, we obtained court approval of the proposed settlement and release of all such claims. The settlement did not materially affect our consolidated financial position, results of operations or cash flows.
We record accruals for 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 lawsuits, investigations and claims asserted against us, 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, 2013, with respect to one or more of these proceedings could have a material effect on our results of operations and cash flows for the periods in which a loss is recognized.
Following an SEC request for documents relating to certain business activities of the Company’s local subsidiary in China, the Company is continuing an internal investigation of such business activities. The Company’s investigation is focused on certain expenditures that were made in connection with the promotion of the Company’s products or may have otherwise been made. Certain of such expenditures were made in violation of Company policies and may have been made in violation of applicable U.S. and/or local laws, including the U.S. Foreign Corrupt Practices Act (the “FCPA”). The investigation is being conducted by outside legal counsel and overseen by a committee of independent members of the Company’s board of directors. The status and results of the investigation are being discussed with the SEC and other governmental authorities. At this time, the Company is unable to predict the scope, timing or outcome of this ongoing matter or any regulatory or legal actions that may be commenced related to this matter. If a violation of the FCPA or other laws is determined to have occurred, the Company could become subject to monetary penalties as well as civil and criminal sanctions.
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 our common stock at December 31, 2013 was 1,357. 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
The following table includes information about our stock repurchases during the three-month period ended December 31, 2013:
(1)
The total number of shares purchased does not include shares surrendered to the Company to pay the exercise price in connection with the exercise of employee stock options or shares surrendered to the Company to satisfy tax withholding obligations in connection with the exercise of employee stock options or the vesting of restricted stock units and performance share awards.
(2)
Average Price Paid per Share includes commissions.
(3)
On March 17, 2010, we announced that our board of directors authorized the repurchase of up to $300.0 million of Company common stock (the “2010 Authorization”). The 2010 Authorization ends on May 1, 2015; however, during the three-month period ended December 31, 2013, we completed all purchases remaining under the 2010 Authorization. On September 11, 2013, we announced that our board of directors approved a new, additional share repurchase authorization of up to an additional $500.0 million of Company common stock (the “2013 Authorization”). The 2013 Authorization does not have an expiration date. As of December 31, 2013, we had $490.3 million remaining available under the 2013 Authorization.
Performance Graph
Comparison of 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 (S&P 500) Stock Index, the S&P 500 Packaged Foods Index and the Mead Johnson custom performance peer group index described below. Starting with the year ended December 31, 2013, for comparative purposes, Mead Johnson is converting from a custom performance peer group index to the commonly used S&P 500 Packaged Foods Index. We have reviewed our post-IPO practices with regard to this graph and have concluded that the utilization of a published index, and, in particular, the S&P 500 Packaged Foods Index, is consistent with the practice of a majority of our peers.
The Mead Johnson custom performance peer group index consisted of the following corporations considered to be comparable companies 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. Sara Lee Corp is included through its last day of trading prior to June 29, 2012, when Sara Lee effected a 1-for-5 reverse stock split of Sara Lee common stock and changed its name to The Hillshire Brands Company. This occurred immediately after Sara Lee's separation of certain businesses and prior to the market open on June 29, 2012. The Hillshire Brands Company is not a comparable peer to Mead Johnson for this purpose and is not included in the Peer Group Index. Additionally, on June 7, 2013, H. J. Heinz Company was acquired by H.J. Heinz Holding Corporation, a Delaware corporation controlled by Berkshire Hathaway Inc. and 3G Special Situations Fund III, L.P. As a result of the merger, H.J. Heinz Company common stock is no longer publicly traded, and is included in this graph through its last day of trading prior to June 7, 2013.
The graph assumes $100 invested on February 11, 2009, the date shares of our common stock commenced trading, in each of Mead Johnson common stock, the S&P 500 Index, the S&P 500 Packaged Foods Index as well as our custom performance peer group index, and the reinvestment of all dividends for each of the reported time periods.
Comparison of Cumulative Total Return
Among Mead Johnson Nutrition Company, the S&P 500 Index, S&P 500 Packaged Foods Index and a Peer Group
Assumes Initial Investment of $100
2/11/2009
12/31/2009
12/31/2010
12/31/2011
12/31/2012
12/31/2013
Mead Johnson Nutrition Company
100.00
168.49
244.03
273.70
266.55
344.86
S&P 500 Index
100.00
136.57
157.14
160.46
186.13
246.42
S&P 500 Packaged Foods Index
100.00
122.78
142.87
167.43
184.83
241.83
Peer Group
100.00
128.16
140.86
161.10
181.97
227.55
Item 6. SELECTED FINANCIAL DATA.
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. Previously, we aggregated these four geographic segments into two reportable segments: Asia/Latin America and North America/Europe. In the fourth quarter of 2013, we expanded the number of reportable segments to three as we separated the Asia/Latin America segment into two reportable segments: Asia and Latin America. The North America/Europe reportable segment remains unchanged. This change in segment reporting presentation does not change any consolidated totals. We made this segment reporting change because we believe that the new presentation will provide investors with greater insight into our consolidated results and operating performance. Throughout this filing, all segment information for the years ended December 31, 2012 and 2011 has been recast to conform to the new segment reporting presentation.
Executive Summary
For the year ended December 31, 2013, sales grew 8% compared to 2012. Sales increased by double-digits from category growth and market share gains and higher pricing throughout each of our Asia and Latin America segments offset in part by unfavorable currency impacts. North America/Europe sales decreased slightly compared to the prior year period driven by the impact of the late 2012 exit of certain non-core businesses and the continued decline of U.S. category consumption, partially offset by U.S. price increases.
Earnings per share grew by 8% in 2013. This growth was primarily attributable to sales growth and an improved gross margin, which was driven by higher pricing as well as strong productivity. These increases were partially offset by higher demand-generation investment and costs for an administrative penalty assessed by China’s NDRC as described below.
Results of Operations
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Below is a summary of comparative results of operations for the years ended December 31, 2013 and 2012:
The results for the years ended December 31, 2013 and 2012 included several items that affect the comparability of our results. These items include significant expenses/(income) not indicative of on-going results (“Specified Items”) and are listed in the table below:
For the year ended December 31, 2013, the Specified Items after taxes increased compared to the prior year. In 2013, the Company incurred costs for an administrative penalty assessed by China’s NDRC in connection with the NDRC’s antitrust review of the infant formula industry’s resale pricing practices (the “China Antitrust Review”), and had higher legal, settlements and related costs primarily due to costs associated with our ongoing internal investigation.
The 2012 IT/other separation costs related to the completion of our stand-alone operating structure. The 2012 severance and other costs related primarily to the relocation of our regional office in Asia and the implementation of our new business model in Europe.
Net Sales
Our net sales by reportable segment:
(1) Our 2012 acquisition in Argentina represented 2% of Latin America net sales increase.
Asia sales increased 11% compared to the prior year and accounted for more than 50% of MJN's net sales. The growth was largely driven by volume attributable to market share gains, including the recovery of market share in China and category growth. The impact of higher prices in a majority of markets in the segment were partially offset by slightly lower prices in China.
Latin America sales increased 14% in comparison to the prior year. Sales volume grew due to continued category growth and market share gains throughout the segment. Price grew by 11% with the largest contribution from high inflation in the markets of Venezuela and Argentina, but were largely offset by weaker local currency rates in these markets. At this time, we are unable to predict with certainty how recent and future developments in Venezuela and Argentina will affect our sales growth or operations in 2014.
North America/Europe sales decreased 2% compared to the prior year. Volume was lower by 5%, with 3% of this decline due to the impact of the late 2012 exit of certain non-core businesses. The balance of the volume reduction was primarily driven by the continued decline of U.S. category consumption, partially offset by market share gains in Canada. Price increases were realized primarily in the U.S.
Our net sales by product category are shown in the table below:
In 2013, Infant Formula accounted for the large majority of our sales in North America/Europe and approximately half of our sales in each of our Asia and Latin America segments. Given this product category mix, lower sales in North America/Europe reduced the year-over-year growth rate of Infant Formula products. At the same time, stronger growth in each of our Asia and Latin America segments positively impacted the year-over-year growth of Children’s Nutrition products. Other category sales declined due to the prior year exit of certain non-core products primarily in the North America/Europe segment.
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:
The total dollar amount of WIC rebates in the United States decreased due to the loss of certain WIC contracts during late 2012.
Gross Profit
Gross margin improvement versus the prior year was driven by pricing as well as strong productivity. In the fourth quarter of 2013, MJN saw a significant rise in dairy prices which we expect to have a negative impact on our gross margin for 2014.
Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses (“SG&A”) increased year over year due to higher sales force, performance-based compensation and marketing expenses. Such higher expenses were partially offset by the elimination of prior year expenses for IT/other separation costs related to the completion of our stand-alone operating structure, the relocation of our regional office in Asia and the implementation of our new business model in Europe.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product evaluation and education provided to health care professionals and consumers, where permitted by regulation. The increase in advertising and promotion expenses reflected demand-generation investments in support of our strategic growth initiatives.
Research and Development Expenses
Our R&D expenses include the continued investment in our innovation capability, product pipeline and quality compliance programs.
Other Expenses-net
In 2013, we had higher cost related to pension settlements and curtailments as a result of higher lump-sum settlements made to retirees in the U.S. pension plan as compared to 2012. In addition, an administrative penalty was assessed by China’s NDRC in connection with the China Antitrust Review.
Earnings before Interest and Income Taxes
Earnings before interest and income taxes (“EBIT”) from our three 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 R&D, 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 Asia increase in EBIT was primarily related to sales growth and improved gross margin, partially offset by higher demand-generation investments.
The Latin America increase in EBIT was primarily related to sales growth and improved gross margin, partially offset by higher demand-generation investments.
The North America/Europe increase in EBIT was primarily related to an improved gross margin due to pricing and our new business model in Europe, offset by higher demand-generation investments.
Corporate and Other expenses increased compared to the prior year period primarily as a result of the $33.4 million charge related to the administrative penalty assessed by China’s NDRC in connection with the China Antitrust Review, increased pension settlement expense and current year foreign exchange transaction losses. These increased expenses were partially offset by the elimination of prior year IT/other separation costs related to the completion of our stand-alone operating structure, the prior year relocation of our regional office in Asia and the 2012 implementation of our new business model in Europe.
Interest Expense-net
Interest expense-net for the year ended December 31, 2013 totaled $50.6 million, down $14.4 million from the prior year. The decrease in interest expense is primarily a result of the July 2013 retirement of the short-term note payable incurred in connection with our 2012 acquisition in Argentina (the “Argentine Acquisition”), increased capitalization of interest expense associated with the construction of our new manufacturing and technology center in Singapore and higher interest income. The weighted-average interest rate on our long-term debt, including the impact of terminated interest rate swaps and the 2013 retirement of the note payable related to the Argentine Acquisition (the “Argentine Acquisition Note Payable”), was 4.2% and 4.5% for the years ended December 31, 2013 and 2012, respectively.
Income Taxes
The effective tax rate (“ETR”) for the year ended December 31, 2013 and 2012 was 25.1% and 23.9%, respectively. The higher effective tax rate was primarily attributable to favorable adjustments in 2012 associated with prior years' tax filings and the 2013 administrative penalty related to the China antitrust review, which is non-deductible for tax purposes.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of approximately 20%, 11% and 10% interest held by third parties in the our operating entities in Argentina, China and Indonesia, respectively.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the year ended December 31, 2013 increased 7% to $649.5 million compared with the year ended December 31, 2012.
Results of Operations
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Below is a summary of comparative results of operations for the years ended December 31, 2012 and 2011:
The results for the years ended December 31, 2012 and 2011 included Specified Items and are listed in the table below:
The decrease in specified items reflects the completion of our stand-alone operating infrastructure.
Net Sales
Our net sales by reportable segment are shown in the table below:
(1) Our acquisition in Argentina represented 10% of Latin America net sales increase.
Asia sales accounted for more than 50% of our net sales in 2012 and grew 8% year over year primarily as a result of price increases throughout the segment. Volume increased due to broad-based category growth but was offset in its entirety by market share loss in China that occurred towards the end of the second quarter. However, during the second half of 2012, we made significant progress in recovering this market share. In addition, although distributors’ inventory levels increased in China in the first half of 2012 as a result of the market share decline, by year end they had returned to levels similar to those seen at the beginning of the year.
Latin America sales increased 21%, of which 10% was due to the Argentine Acquisition. The increase in volume was driven by broad gains in market share across the segment. Price increases in Venezuela, Mexico and Brazil helped mitigate the impact of high inflation in these markets.
The decrease in sales in North America/Europe reflected lower U.S. market share as well as lower category consumption and births, partially offset by higher prices. Market share was lower in comparison to the prior year when we benefited from a competitor’s recall and due to the impact in 2012 of the unfounded media reports in December 2011 alleging product contamination in the United States. Investigating governmental agencies found no contamination in sealed containers of our product, but the resulting uncertainty caused some consumers to switch away from our brand.
Our net sales by product category are shown in the table below:
Infant formula accounts for approximately 90% of our sales in North America/Europe and approximately half of our sales in each of our Asia and Latin America segments.
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:
Total gross-to-net sales adjustments were consistent as a percentage of gross sales with the prior year. The total dollar amount of WIC rebates in the United States increased due to retail list price increases and changes in certain WIC contracts during 2012 and the second half of 2011.
Gross Profit
The gross margin decline was attributable entirely to the North America/Europe segment and resulted from higher commodity costs, primarily dairy inputs, and unfavorable manufacturing variances attributed largely to lower production volumes. These factors were partially offset by increased prices and productivity gains.
Expenses
Selling, General and Administrative Expenses
SG&A decreased due to the completion of our stand-alone operating infrastructure and lower performance-based compensation expense, partially offset by an increase in sales force and distribution expenses supporting sales growth.
Advertising and Promotion Expenses
Our advertising spending primarily includes television and other consumer media. Promotion activities primarily include product evaluation and education provided to health care professionals and consumers, where permitted by regulation. The increase in advertising and promotion expenses reflected demand-generation investments in support of our strategic growth initiatives.
Research and Development Expenses
Our R&D expenses include the continued investment in our innovation capability, product pipeline and quality compliance programs.
Other Expenses-net
In 2012, we had higher cost related to pension settlements and curtailments primarily as a result of lump sum payments made to retirees in the U.S. pension plan.
Earnings before Interest and Income Taxes
EBIT from our three 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 R&D, 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 increase in EBIT for Asia was primarily related to sales growth and a higher gross margin, partially offset by higher expenses, such as advertising and promotion and sales force growth.
The increase in EBIT for Latin America was primarily related to sales growth, partially offset by higher expenses, such as advertising and promotion.
The North America/Europe decline in EBIT was primarily attributable to a decline in sales, along with a lower gross margin due to higher commodity costs, primarily dairy inputs, and unfavorable manufacturing variances attributed largely to lower production volumes in the United States.
Corporate and Other expenses decreased due to the completion of our stand-alone operating infrastructure and lower performance-based
compensation expense.
Interest Expense-net
Interest expense for the year ended December 31, 2012 primarily represented interest incurred on $1.5 billion of long-term notes and the short-term note payable related to our Argentine Acquisition. The increase in interest expense reflected the prior year's termination of our fixed-to-floating interest rate swaps and the Argentine Acquisition Note Payable. The weighted-average interest rate on our long-term debt, including the impact of the swaps and Argentine Acquisition Note Payable, was 4.5% and 4.0% for the years ended December 31, 2012 and 2011, respectively.
Income Taxes
The ETR for the year ended December 31, 2012 and 2011 was 23.9% and 28.1%, respectively. The ETR was primarily attributable to favorable adjustments associated with prior years’ tax filings, changes in management’s assertion that certain current and prior years’ foreign earnings and profits are permanently invested abroad and changes in the geographic earnings mix.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of approximately 20%, 11% and 10% interest held by third parties in our operating entities in Argentina, China and Indonesia, respectively.
Net Earnings Attributable to Shareholders
For the foregoing reasons, net earnings attributable to shareholders for the year ended December 31, 2012 increased 19% to $604.5 million compared with the year ended December 31, 2011.
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 net of the outflow of cash for raw material purchases, manufacturing, operating expenses, interest and taxes. Cash flows used in investing activities primarily represent capital expenditures for equipment, buildings and computer software and acquisitions. Cash flows used in financing activities primarily represent dividend payments, proceeds and repayments of short-term borrowings and share repurchases.
Cash and cash equivalents totaled $1,050.8 million at December 31, 2013 of which $692.5 million was held outside of the United States. Cash and cash equivalents totaled $1,042.1 million as of December 31, 2012, of which $486.7 million was held outside of the United States.
During 2013, we repatriated approximately $74 million of cash to the United States from multiple jurisdictions whose earnings and profits are not permanently invested abroad. During 2012, we repatriated approximately $660 million of cash to the United States from multiple jurisdictions of which approximately $409 million was repatriated as a return of basis. We have no current plans to repatriate cash in a similar return of basis transaction.
As a result of our evaluation of our global cash position, management has asserted that current and prior year earnings and profits in certain foreign jurisdictions are permanently invested abroad. We will continue to evaluate our global cash position and our determination as to whether earnings and profits of certain other foreign jurisdictions are permanently invested abroad. As of December 31, 2013, approximately $343 million of cash and cash equivalents were held by foreign subsidiaries whose undistributed earnings are considered permanently invested. Our intent is to invest these earnings in our foreign operations and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. If we decide at a later date to repatriate these earnings to the United States, we 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, 2013, 2012 and 2011 were $267.7 million, $236.7 million and $205.7 million, respectively.
Our board of directors previously authorized the repurchase of up to $300.0 million of our common stock (the “2010 Authorization”). The 2010 Authorization was primarily intended to offset the dilutive effect on earnings from stock-based compensation. The 2010 Authorization ends on May 1, 2015; however, during the year ended December 31, 2013, we completed all purchases remaining under the
2010 Authorization. From the date of such authorization through December 31, 2013, 4.2 million shares were repurchased at an average cost per share of $71.21.
In September 2013, our board of directors approved a new share repurchase authorization of up to an additional $500.0 million of our common stock (the "2013 Authorization"). The 2013 Authorization is intended to offset the dilutive effect on earnings per share from stock-based compensation and allow for opportunistic stock purchases to return capital to stockholders. The 2013 Authorization does not have an expiration date. From the date of such authorization through December 31, 2013, 0.1 million shares were repurchased at an average cost of $84.06. As of December 31, 2013, we had $490.3 million available for further repurchases 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, 2013 Compared to Year Ended December 31, 2012
Cash flow provided from operating activities increased by $113.9 million in 2013 compared to 2012. Higher net earnings, along with lower cash paid for income taxes and performance-based compensation as well as lower cash contributions to our U.S. defined benefit pension plan partially offset a higher requirement for working capital, defined as accounts receivable plus inventory less accounts payable.
Cash flow used in investing activities increased $11.7 million in 2013 compared to 2012 due primarily to higher capital expenditures partially offset by the Argentine Acquisition.
Cash flow used in financing activities was $545.7 million for the year ended December 31, 2013, consisting primarily of $267.7 million of dividend payments, $165.4 million repayments of short-term borrowings and $106.0 million of treasury stock repurchases. Cash flow used in financing activities was $267.5 million for the year ended December 31, 2012, primarily from dividend payments of $236.7 million, treasury stock repurchases of $154.9 million and the Argentine Acquisition Note Payable of $52.6 million, offset by revolver borrowings of $161.0 million.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Cash flow provided from operating activities increased by $59.9 million in 2012 compared with 2011. Higher earnings and lower requirements for working capital were offset partially by higher cash paid for income taxes. The 2012 decrease in inventories reflected the impact from the December 2011 advance purchase of approximately $80 million for select dairy inputs.
Cash flow used in investing activities increased $116.2 million in 2012 compared to 2011 due primarily to the Argentine Acquisition.
Cash flow used in financing activities was $267.5 million for the year ended December 31, 2012, primarily from dividend payments of $236.7 million, treasury stock repurchases of $154.9 million and the Argentine Acquisition Note Payable of $52.6 million, offset by revolver borrowings of $161.0 million.
Capital Expenditures
Capital expenditures and the cash outflow for capital expenditures were as follows:
Capital expenditures included investments primarily in a new spray dryer and research and development capabilities. In December 2011, we announced a three-year planned capital expenditure for a new manufacturing and technology center in Singapore. In 2013, we spent approximately $142 million for the second year of the capital expenditure in Singapore bringing our spending to date for the project to $220 million. In 2014, we expect capital expenditures to be approximately $180 million, including $35 million for the third year of the capital expenditure in Singapore, and continued emphasis on growth and innovation. We expect to fund capital expenditures from our cash flow generated by operations.
Revolving Credit Facility Agreement
In June 2011, the Company entered into a five-year revolving credit facility agreement (“Credit Facility”). Borrowings from the Credit Facility are to be used for working capital and other general corporate purposes. The Credit Facility is unsecured and repayable at 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 Credit Facility is $500.0 million, which may be increased from time to time up to $750.0 million at our 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 financial covenants as of December 31, 2013.
Borrowings under the Credit Facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period, or (b) a floating rate based upon JPMorgan Chase Bank's prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company's credit rating. The margin can range from 0.075% to 1.45% over the base rate. In addition, we incur 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. Moody's credit rating for MJN is currently Baa1. S&P's credit rating for MJN is currently BBB.
As of December 31, 2013, we had no borrowings outstanding under our Credit Facility. As of December 31, 2012, we borrowed $161.0 million against our Credit Facility for general corporate purposes, including payment for acquisition debt obligations and funding of current and future capital expenditures.
Argentine Acquisition Note Payable
On March 15, 2012, we completed the Argentine Acquisition (See “Item 8. Financial Statements - Note 8. Redeemable Noncontrolling Interest” for discussion of the Argentine Acquisition). Of the ARS850.7 million purchase price payable, ARS377.6 million was financed through a note payable. The remaining balance of the note payable was paid on July 10, 2013. Through March 15, 2013, the annual interest rate for the note payable was 14%. Effective as of March 16, 2013, the note was converted to U.S. dollar-denominated indebtedness, the annual interest rate was automatically reduced to 0.85%, and the note accrued interest at that rate through our final payment.
Long-Term Debt
The components of our long-term debt are detailed in the table below:
Our long-term debt has a principal value of $1,500 million, of which $500 million is considered current as it matures on November 1, 2014. As we plan to refinance a portion of our long-term notes in 2014, we entered into interest rate forward starting swaps with a combined notional value of $500 million. The forward starting rates of the swaps range from 3.79% to 3.94% and an effective date of October 31, 2014. The forward starting swaps effectively mitigate the interest rate exposure associated with our planned refinancing of a portion of our long-term debt.
Our long-term debt 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. Interest on the notes are due semi-annually, and the notes are not subject to amortization.
For additional information on our long-term debt, acquisition and interest rate swaps, see “Item 8. Financial Statements - Note 15. Debt and Note 16. Derivatives.”
Contractual Obligations
As of December 31, 2013, 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 include coupon payments on our long-term debt.
Additionally, liabilities for uncertain tax positions and pension and other post retirement benefits are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of a cash settlement of such liabilities. See “Item 8. Financial Statements - Note 4. Income Tax and Note 7. Employee Benefits” for more information.
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 our 2009 initial public offering (“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 - Note 2. Accounting Policies.”
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 MJN’s products are received 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 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 $199.7 million and $206.5 million at December 31, 2013 and 2012, respectively, and are included in accrued rebates and returns on our balance sheet. Rebates under the WIC program reduced revenues by $702.3 million, $730.0 million, and $700.7 million in the years ended December 31, 2013, 2012 and 2011, 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 $44.8 million and $46.4 million at December 31, 2013 and 2012, respectively, and are included in accrued rebates and returns on our balance sheet. Returns reduced sales by $81.0 million, $82.5 million, and $81.8 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Income Taxes
The ETR reflects statutory tax rates in the various jurisdictions in which we operate, including tax rulings and agreements, 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 ETR and in evaluating the uncertainty in tax positions.
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.
Goodwill and Indefinite-lived Intangible Assets
Goodwill is not amortized but is tested for impairment annually and whenever events or changes in circumstances indicate that impairment may have occurred. We utilize a two-step quantitative assessment to test for impairment. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second step of the process involves a comparison of the implied fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a reporting unit exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. In evaluating the recoverability of goodwill, it is necessary to estimate the fair value of reporting units, which is generally based on a discounted cash flow model. In making this assessment, the Company relies on a number of factors to discount anticipated future cash flows including operating results, business plans and present value techniques. Growth rates for sales and profits are determined using inputs from our annual planning process. We also make estimates of discount rates, perpetuity growth assumptions and other factors. Many of the factors used in assessing fair value are outside the control of the Company and it is reasonably likely that assumptions and estimates can change in future periods. These changes can result in future impairments. We completed the annual goodwill impairment assessment during the first quarter of 2013, 2012 and 2011 and no impairment of goodwill was required as we determined that the fair values of our reporting units were substantially in excess of respective carrying amounts. During the third quarter of 2013 we changed our annual impairment testing date from January 1 to July 1 to better align with the timing of our annual and long-term planning process, which is a significant input in the testing process. As a result, we completed impairment testing again in the third quarter of 2013 and no impairment of goodwill was required as we determined that the fair values of our reporting units were substantially in excess of respective carrying amounts.
As a result of our Argentine Acquisition in 2012 we recognized $172.8 million of goodwill as of the acquisition date, which represents a majority of our goodwill balance as of December 31, 2013. Although management currently believes operations in reporting units to which goodwill was allocated can support the value of recorded goodwill, a change in assumptions driven by macro-economic conditions or degradation in the Argentine consumer market that undermines the reporting unit's ability to achieve targeted profit levels may result in an impairment of the recorded goodwill.
Similarly, impairment testing of our other indefinite-lived intangible assets, primarily one trademark, requires a comparison of carrying value to fair value of that particular asset annually and whenever events or changes in circumstances indicate that impairment may have occurred. To test these assets for impairment, we estimate the fair value of each asset based on a discounted cash flow model using various inputs, including projected revenues, an assumed royalty rate, and a discount rate. Changes in these estimates and assumptions could impact the assessment of impairment in the future.
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 projected benefit obligations. 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, LLC in the United States (“U.S. Pension Plan”), which is a frozen plan and represents approximately 75% of our 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:
Used to determine net periodic benefit cost for the years ended December 31,
Discount rate
3.00
%
3.75
%
Expected long-term return on plan assets
6.00
%
6.25
%
Used to determine benefit obligation as of December 31,
Discount rate
4.00
%
3.00
%
The obligation for the U.S. Pension Plan decreased by $57.5 million during 2013, primarily due to the increase in the discount rate. The change in the discount rate assumption reflected higher 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 - Note 7. Employee Benefits” 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, capital expenditures, 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 Philippine peso, the Malaysian ringitt and the Mexican peso. 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. Currency rates in smaller markets, such as Venezuela and Argentina, could also impact our results due to high volatility in exchange rates in such markets.
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 $5.4 million, $0.8 million, and $2.9 million in the years ended December 31, 2013, 2012 and 2011, 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.
We use foreign exchange forward contracts to hedge exposures and the total notional amount of these contracts was $201.4 million at December 31, 2013, representing a fair value asset of $3.7 million.
The following table summarizes the foreign exchange forward contracts outstanding and the related weighted-average contract exchange rates as of December 31, 2013:
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 $27.7 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.
Venezuela Risk
We apply highly inflationary accounting to our business in Venezuela. Under highly inflationary accounting, the functional currency of the entity is aligned with the reporting currency of the Company. Exchange gains and losses from the remeasurement of monetary assets and liabilities are reflected in current earnings, rather than accumulated other comprehensive loss on the balance sheet. The impact of applying highly inflationary accounting for Venezuela on our consolidated financial statements is dependent upon movements in the official exchange rate, including devaluations, between the Bolivares Fuertes (“VEF”) and the U.S. dollar. The operating environment in Venezuela could include high inflation, governmental restrictions in the form of currency exchange, price and margin controls, and the possibility of further government actions such as further devaluations or other business intervention. In addition, the foreign exchange controls in Venezuela limit our ability to repatriate earnings and our Venezuela subsidiary’s ability to remit dividends and pay intercompany balances at any official exchange rate or at all.
Through December 31, 2013, the Venezuelan government had established one official exchange rate for qualifying dividends and imported goods and services, equal to 6.3 VEF to one U.S. dollar. Transactions at the official exchange rate are subject to CADIVI (Venezuelan government’s Foreign Exchange Administrative Commission) approval. In addition to the official exchange rate, there are and have been parallel exchange markets controlled by the Central Bank of Venezuela as the only legal intermediary to execute foreign exchange transactions outside of CADIVI. Through February 12, 2013, the parallel exchange program was SITME, which had a published rate of 5.3 VEF to one U.S. dollar. When the government devalued its currency in February, 2013, it also eliminated SITME, but established a new auction-based exchange rate market program, referred to as SICAD. Through December 31, 2013, the notional amount of transactions and regulations that has run through these programs has been limited, which essentially eliminates our ability to access any foreign exchange rate other than the official CADIVI rate to pay for imported goods and/or manage our local monetary asset balances. Accordingly, we measure all of our net monetary assets for our Venezuelan subsidiary using the official 6.3 exchange rate. As of December 31, 2013, our subsidiary had approximately $24 million of net monetary assets.
In January, 2014, the Venezuelan government made a number of announcements related to the SICAD program, which could result in a devaluation of the rate at which our Venezuelan subsidiary is able to access U.S. dollars and the rate at which we translate results and balances denominated in VEF. This could have an unfavorable impact on our operating results. At this time, we are not able to predict the impact of these announcements and continue to monitor this situation, including the impact restrictions may have on our future business operations.
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. Our intent is to utilize supplier volatility management tools when available. However, when such tools are unavailable or financially prohibitive through a supplier, we will utilize financial instruments. The company entered into non-fat dry milk futures contracts on November 26, 2013. The notional value of the hedge was 0.2 million pounds, representing a value of $0.3 million as of December 31, 2013 which represents an insignificant portion of our total forecasted volume.
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.
Page
REPORT 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, 2013, 2012 and 2011
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Equity/(Deficit) and Redeemable Noncontrolling Interest for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011
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, 2013 and 2012, and the related consolidated statements of earnings, comprehensive income, equity (deficit) and redeemable noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2013. 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, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, 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, 2013, based on the criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 18, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 18, 2014
CONSOLIDATED FINANCIAL STATEMENTS
OF MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF EARNINGS
(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
(Dollars in millions)
The accompanying notes are an integral part of these financial statements.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED BALANCE SHEETS
(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 EQUITY/(DEFICIT) AND REDEEMABLE NONCONTROLLING INTEREST
(Dollars in millions)
The accompanying notes are an integral part of these consolidated financial statements.
MEAD JOHNSON NUTRITION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(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, 2013 AND 2012 AND FOR THE YEARS ENDED
DECEMBER 31, 2013, 2012 AND 2011
1. ORGANIZATION
Mead Johnson Nutrition Company (“MJN” or the “Company”) manufactures, distributes and sells infant formula, children’s nutrition and other nutritional products. MJN has a broad product portfolio, which extends across routine and specialty infant formulas, children’s milks and milk modifiers, dietary supplements for pregnant and breastfeeding mothers, pediatric vitamins, and products for pediatric metabolic disorders. These products are generally sold to wholesalers, retailers and distributors and are promoted to healthcare professionals, and, where permitted by regulation and policy, directly to consumers.
2. ACCOUNTING POLICIES
Basis of Presentation-The financial statements present the results of operations, financial position, and cash flows of MJN and its majority-owned and controlled subsidiaries. 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”). These financial statements consider subsequent events through the date of filing with the Securities and Exchange Commission.
In the Consolidated Statements of Cash Flows for the years ended December 31, 2012 and 2011, operating cash flow amounts reflected as pension and other postretirement benefit expense have been reclassified to conform to the presentation for the year ended December 31, 2013. These amounts were previously classified as a component of the change in other assets and liabilities.
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, impairment testing of goodwill and other indefinite-lived intangible assets, 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 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 MJN’s products are received 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 $199.7 million and $206.5 million at December 31, 2013 and 2012, 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 $702.3 million, $730.0 million, and $700.7 million in the years ended December 31, 2013, 2012, and 2011, respectively.
Sales return accruals were $44.8 million and $46.4 million at December 31, 2013 and 2012, 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 $81.0 million, $82.5 million, and $81.8 million for the years ended December 31, 2013, 2012 and 2011, 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 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 the Company 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.
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.
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 3 months or less at the time of purchase and are recorded at cost, which approximates fair value. Money market funds, which totaled $447.8 million and $520.7 million at December 31, 2013 and 2012, respectively, are classified as Level 2 in the fair value hierarchy.
Inventory Valuation-Inventories are valued at the lower of cost or market. The Company determines cost on the basis of the average cost or first-in, first-out methods.
Property, Plant and Equipment-Expenditures for additions and improvements, including capitalized interest, are recorded at cost. Depreciation is 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.
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 and Other Intangible Assets-During the third quarter of 2013 the Company changed its annual impairment testing date from January 1 to July 1, which did not result in any delay, acceleration or avoidance of an impairment charge. The Company believes that moving the goodwill impairment testing date to the third quarter is preferable because it better aligns with MJN’s annual and long-term planning timeline, which is a significant element in the testing process. The Company completed impairment testing in both the first and third quarters of 2013 and concluded that no impairment of goodwill exists (see Note 14).
The Company’s policy is to test Goodwill for impairment on an annual basis or when current facts or circumstances indicate that a potential impairment may exist. The Company compares the carrying value of a reporting unit, including goodwill, to the fair value of the unit. If the carrying amount of a reporting unit exceeds its fair value, the Company revalues all assets and liabilities of the reporting unit, excluding goodwill, to determine if the fair value of the net assets is greater than the net assets including goodwill. If the fair value of the net assets is less than the carrying amount of net assets including goodwill, impairment has occurred. The Company’s estimates of fair value are
primarily determined based on a discounted cash flow model. Growth rates for sales and profits are determined using inputs from the Company’s annual long-range planning process. The Company also makes estimates of discount rates, perpetuity growth assumptions, market comparables, and other factors. The Company completed its most recent goodwill impairment assessment during the third quarter and monitored for any potential impairment during the remainder of 2013. No impairment of goodwill was required in 2013, 2012 or 2011.
The Company evaluates the useful lives of its other intangible assets to determine if they are finite or indefinite-lived. Reaching a determination on useful life requires significant judgments and assumptions regarding the future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels), the level of required maintenance expenditures, and the expected lives of other related groups of assets. Intangible assets that are deemed to have definite lives are amortized on a straight-line basis, over their useful lives.
The Company’s indefinite-lived intangible assets are also tested for impairment annually and whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Estimates of the fair value of indefinite-lived intangible assets is based on a discounted cash flow model using inputs which included projected revenues from the Company’s annual long-range plan, assumed royalty rates that could be payable if MJN did not own the brands, and a discount rate. The Company completed its most recent indefinite-lived intangible asset impairment assessment during the third quarter and monitored for any potential impairment during the remainder of 2013, determining that no impairment was required.
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, interest rate and commodity pricing 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 the hedged assets or liabilities are sold, 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 loss and is recognized in earnings when the hedged item affects earnings or is deemed ineffective; 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 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 the 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 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 $119.1 million, $115.6 million, and $104.3 million in the years ended December 31, 2013, 2012, and 2011, respectively, and are included in selling, general and administrative expenses.
Advertising Costs-Advertising costs are expensed as incurred and were $226.7 million, $180.3 million, and $180.6 million in the years ended December 31, 2013, 2012, and 2011, 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 Adopted Accounting Standards-In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, requiring entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. For significant reclassifications related to net income, the ASU required disclosure in the consolidated statement of earnings or within the footnotes. For other amounts, the ASU required a cross-reference to other disclosures that provide additional detail about those amounts. This ASU did not change the current requirements for reporting the consolidated statement of earnings or other comprehensive income in the financial statements. The Company adopted the required financial reporting presentation effective January 1, 2013.
Recently Issued Accounting Standards-In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters (Topic 830), clarifying the applicable guidance for the release of the cumulative translation adjustment. ASU 2013-05 is effective for the Company in the period beginning January 1, 2014. The Company does not expect the adoption of this update to have a material impact on the consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists. ASU 2013-11 requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. ASU 2013-11 is effective for the Company in the period beginning January 1, 2014 and the Company does not anticipate that the adoption of this standard to have a material impact on its consolidated financial statements.
3. EARNINGS PER SHARE
The numerator for basic and diluted earnings per share is net earnings attributable to shareholders reduced by dividends and undistributed earnings attributable to unvested shares. The denominator for basic earnings per share is the weighted-average 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 from all stock-based awards were 2.8 million, 2.7 million and 2.9 million as of December 31, 2013, 2012 and 2011, respectively, of which 2.1 million, 2.0 million and 2.2 million were not included in the diluted earnings per share calculation for the years ended December 31, 2013, 2012 and 2011, respectively.
4. INCOME TAXES
The components of earnings before income taxes were:
The above amounts are categorized based on the applicable taxing authorities.
The provision (benefit) for income taxes consisted of:
Effective Tax Rate-MJN’s provision for income taxes in the years ended December 31, 2013, 2012 and 2011 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 ruling was superseded by a subsequent tax agreement effective July 26, 2012, whereby the Company and the Dutch tax authorities agreed to the appropriate remuneration attributable to Dutch manufacturing activities through the year ending December 31, 2019.
In addition, the Company negotiated a tax ruling effective from January 1, 2013, under which certain profits in Singapore are eligible for favorable taxation through the year ending December 31, 2027.
Deferred Taxes and Valuation Allowance-The components of current and noncurrent deferred income tax assets (liabilities) were:
As of December 31, 2013, the Company had definite-lived and indefinite-lived gross foreign net operating loss (“NOL”) carryforwards of $49.0 million. Indefinite-lived NOL carryforwards totaled $22.3 million with the remainder being definite-lived. An immaterial amount of these definite-lived NOL carryforwards will begin to expire in 2014, with the remainder of the definite-lived NOL carryforwards to expire no later than 2031. The valuation allowance recorded for NOL carryforwards is $5.0 million as of December 31, 2013.
As of December 31, 2013, the Company had various definite-lived U.S. state tax credit carryforwards of $6.9 million net of federal benefit. An immaterial amount of these state tax credit carryforwards will begin to expire in 2016, with the remainder of the state tax credit carryforwards to expire no later than 2023. The valuation allowance recorded for state tax credit carryforwards is $2.3 million, net of federal benefit as of December 31, 2013.
Income taxes paid net of refunds were $159.3 million, $226.8 million, and $174.3 million in the years ended December 31, 2013, 2012, and 2011, respectively. The income taxes were paid to federal, state and foreign taxing authorities and BMS pursuant to the terms of the Amended and Restated Tax Matters Agreement.
As of December 31, 2013, U.S. taxes have not been provided on approximately $1.4 billion of foreign earnings as these undistributed earnings have been permanently invested offshore. If, in the future, these earnings were to be repatriated to the U.S. additional tax provisions would be required. It is impracticable to determine a precise estimate of the additional provision required. However, the maximum potential estimated U.S. tax liability would be $494 million if these earnings were to be repatriated to the United States in such a manner that the entire amount of foreign earnings would be subject to the U.S. statutory tax rate with no U.S. tax relief for foreign taxes already paid. 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 (“IRS”) has completed examinations of the Company’s U.S. income tax filings through December 31, 2007. At December 31, 2013, the Company’s 2011 income tax return was under IRS examination. At December 31, 2013, 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:
Uncertain tax positions have been recorded as part of other liabilities with a reversal of up to $10 million reasonably possible in the next 12 months due to the expiration of statutes of limitations. The amounts of uncertain tax positions that, if recognized, would impact the effective tax rate were $48.6 million, $18.9 million, and $10.9 million as of December 31, 2013, 2012 and 2011, respectively. The Company believes that it has provided adequately for all uncertain tax positions. 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.
Interest and penalties related to uncertain tax positions were $14.8 million and $11.2 million, as of December 31, 2013, and 2012, 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 $3.0 million, $5.0 million and $0.6 million for the years ended December 31, 2013, 2012 and 2011, respectively.
On December 18, 2009, the Company and Bristol-Myers Squibb Company (“BMS”) entered into an Amended and Restated Tax Matters Agreement in anticipation of the separation from BMS. 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 MJN’s 2009 initial public offering (“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. Additionally, under the Amended and Restated Tax Matters Agreement, the Company continues to maintain responsibility for any tax positions which may exist for any taxable period ending after December 31, 2008.
5. SEGMENT INFORMATION
MJN operates in four geographic operating segments: Asia, Europe, Latin America and North America. In the fourth quarter of 2013, the Company revised its reportable segments. Previously the Company presented two reportable segments: Asia/Latin America and North America/Europe. In the fourth quarter of 2013, the Company expanded the number of reportable segments to three as it separated the Asia/Latin America segment into two reportable segments: Asia and Latin America. The North America/Europe reportable segment remains unchanged. This change in segment reporting presentation does not change any consolidated totals. The Company made this segment reporting change because it believes that the new presentation will provide investors with greater insight into the Company's consolidated results and operating performance. Prior year comparative information has been revised to conform to the current reportable segment presentation.
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 wholesalers, retailers and distributors. One customer in the North America/Europe and Latin America segments accounted for 10%, 11% and 12% of the Company’s gross sales for each year ended December 31, 2013, 2012, and 2011; a second customer in the Asia segment accounted for 16%, 15%, and 14% of the Company’s gross sales for the years ended December 31, 2013, 2012, and 2011, respectively.
The Company's segment, product and geographic results consisted of:
6. EMPLOYEE STOCK BENEFIT PLANS
MJN 2009 Stock Award and Incentive Plan-The MJN 2009 Amended and Restated Stock Award and Incentive Plan (“Award and Incentive 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 Award and Incentive Plan. Twenty-five million shares of stock were approved and registered with the Securities and Exchange Commission (the “SEC”) for grants to participants under the Award and Incentive Plan. Shares used for awards assumed in an acquisition or combination will not count against the shares reserved under the Award and Incentive Plan. The shares reserved may be used for any type of award under the Award and Incentive 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 Award and Incentive Plan since its inception in February of 2009.
MJN may grant options to purchase common stock at no less than 100% of the closing 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 granted in the form of a target number of performance shares to be earned and have a three-year performance cycle consisting of three one-year performance periods. The performance share awards have annual goals set at the beginning of each performance period, 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 under the Award and Incentive Plan. Restrictions generally expire over a 1- to 5-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 dividend equivalent payments and has no voting rights.
MJN Stock Options-The fair value of stock options granted in 2013, 2012, and 2011 was estimated on the date of grant using the Black-Scholes option pricing model. No stock options with market conditions were granted in 2013, 2012 or 2011. The following assumptions were used in the valuations:
The 2013 and 2012 expected volatility assumption required in the Black-Scholes model was calculated based principally on the Company’s historical volatility, and to a lesser extent, on implied volatility from publicly-traded options on the Company’s stock. As MJN has not yet accumulated six years of historical stock trading data, the full history of MJN over the period of February 2009 through December 2013 is used to calculate the expected volatility assumption required in the Black-Scholes model. 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.
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 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.
Stock option activities were as follows:
The weighted-average grant date fair value of stock options granted is $15.08, $17.55 and $14.73 for 2013, 2012 and 2011 respectively.
Cash proceeds received from options exercised during the years ended December 31, 2013, 2012 and 2011 were $13.6 million, $11.6 million and $4.5 million, respectively. The tax benefit realized from stock options exercised was $5.9 million in 2013, $4.8 million in 2012 and $1.8 million in 2011.
At December 31, 2013, total unrecognized compensation cost related to stock options of $7.4 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:
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, 2013, total unrecognized compensation cost related to the performance share awards granted of $6.5 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, 2013, total unrecognized compensation cost related to nonvested restricted stock units was $12.8 million and is expected to be recognized over a weighted average period of 2.5 years.
Stock-Based Compensation Expense-The following table summarizes stock-based compensation expense related to MJN stock options, MJN performance share awards and MJN restricted stock units for the years ended December 31, 2013, 2012, and 2011:
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.
7. 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 75% of the Company’s total pension assets and obligations. The benefits of this plan are frozen as of February 9, 2014 and benefits are no longer accrued for service.
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 and participation is limited to those employees who participate in the U.S. Pension Plan. 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:
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 loss into net periodic benefit cost in 2014 are:
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, 2014 is 7.00%. 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. The Company anticipates moving towards an asset mix that is more heavily focused on equity securities in 2014.
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.
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 as of December 31, 2013 was 40% public equity and 60% fixed income. Cash flow (i.e., cash contributions, benefit payments) was 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:
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 2014, the funding policy for the pension plans is to contribute amounts to provide for current service and to fund past service liability. MJN contributed $18.5 million, $28.2 million and $9.5 million to the pension plans in 2013, 2012 and 2011, respectively. The Company is not required to make any contributions to its pension plans in 2014 and does not foresee making a discretionary contribution. There will be no cash funding for other post retirement benefits in 2014, except funding to cover benefit payments.
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 $19.9 million, $21.3 million and $19.3 million for the years ended December 31, 2013, 2012, and 2011, respectively.
8. REDEEMABLE NONCONTROLLING INTEREST
On March 15, 2012, the Company acquired 80% of the outstanding capital stock of Nutricion para el Conosur S.A. which manufactures, distributes and sells infant formula and children’s nutrition products in Argentina under the SanCor Bebé and Bebé Plus brands (the “Argentine Acquisition”). Under the terms of an agreement related to the Argentine Acquisition, the noncontrolling interest owner has the right to require MJN to purchase (the “Put Right”) its remaining 20% interest or to sell (the “Call Right”) up to an additional 20% of the outstanding capital stock of Nutricion para el Conosur S.A. The Put Right is exercisable from September 15, 2015 to September 15, 2018 and the decision to exercise is not within the control of MJN. The price paid upon exercise will be determined based on established multiples of sales and earnings of the acquired business and is currently estimated to equate to fair value at the earliest exercise date. As a result of the Put Right, the noncontrolling interest is presented as redeemable noncontrolling interest outside of equity on the balance sheet. Accretion to the redemption value of the Put Right is being recognized through equity using an interest method over the period from March 15, 2012 to September 15, 2015.
9. NONCONTROLLING INTERESTS
Net earnings attributable to noncontrolling interests consists of approximately 20%, 11% and 10% interests held by third parties in operating entities in Argentina, China and Indonesia, respectively.
10. OTHER EXPENSES-NET
The components of other expenses-net were:
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 $63.7 million, $55.8 million and $57.2 million for the years ended December 31, 2013, 2012 and 2011, respectively, and is primarily included in costs of products sold. Interest capitalized during the year was $5.7 million, $0.6 million and $0.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The Company’s liability for asset retirement obligations was $3.6 million and $3.3 million at December 31, 2013 and 2012.
Other Intangible Assets
The gross carrying value and accumulated amortization by class of intangible assets were as follows:
(1) Changes in balances result from currency translation.
(2) Changes in balances result from currency translation and amortization.
Amortization expense for other intangible assets was $19.4 million, $21.1 million and $18.1 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Expected amortization expense related to intangible assets is as follows:
Non-Cash Activity
Additions to long-lived assets not yet paid were $89.5 million, $78.7 million and $32.8 million for the years ended December 31, 2013, 2012 and 2011, respectively.
14. GOODWILL
The Company tests goodwill for impairment on an annual basis and whenever an event occurs or circumstances change that would, more likely than not, reduce the fair value of a reporting unit below its carrying amount. Historically, the Company’s policy was to perform the annual impairment test for goodwill as of January 1 of each year. The Company completed its annual impairment test in the first quarter of 2013 in accordance with this policy and concluded that no impairment existed. During the third quarter of 2013 the Company changed its annual impairment testing date from January 1 to July 1 of each fiscal year to better align with the timing of its annual and long-term planning process, which is a significant input in the testing process. Accordingly, the Company believes this change is preferable. This change did not delay, accelerate or avoid an impairment charge. As a result of this change, impairment testing was completed during the third quarter of 2013 and the Company concluded that no impairment existed. This change was applied prospectively beginning July 1, 2013 and had no impact on the consolidated financial statements. The change was not applied retrospectively as it is impracticable to do so because retrospective application would have required the application of significant estimates and assumptions without the use of hindsight.
For the year ended December 31, 2013, the change in the carrying amount of goodwill by reportable segment, was primarily driven by the cumulative impact due to a correction of the currency denomination of the goodwill related to two reporting units. The revision had the impact of decreasing the Company’s total value of goodwill and decreasing the total currency translation adjustment included in the accumulated other comprehensive loss section of shareholders’ equity and other comprehensive income.
For the year ended December 31, 2013 and 2012, the change in the carrying amount of goodwill by reportable segment, including the cumulative impact of the revisions described above, was as follows:
A portion of the goodwill from the acquisition of Nutricion para el Conosur S.A. was attributed to the North America/Europe segment in consideration of expected benefits to be derived from the acquisition. As of December 31, 2013, the Company had no accumulated impairment loss.
15. DEBT
Short-Term Borrowings
Outstanding Borrowings
As of December 31, 2013, the Company’s short-term borrowings were $2.0 million and consisted of borrowings made by the Company’s subsidiary in Argentina. These short-term borrowings had a weighted-average interest rate of 22.00% as of December 31, 2013. The Company intends to repay these borrowings within 12 months and has the ability to do so.
As of December 31, 2012, the Company’s short-term borrowings totaled $161.0 million and were primarily from its 5-year revolving credit facility agreement (“Credit Facility”).
Five-Year Revolving Credit Facility Agreement
Borrowings from the Credit Facility are used for working capital and other general corporate purposes. The Credit Facility is unsecured, repayable at maturity in June 2016 and can be extended annually if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at any one time under the 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 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. The Company was in compliance with these covenants as of December 31, 2013.
Borrowings under the Credit Facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period, or (b) a floating rate based upon JPMorgan Chase Bank’s prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company’s credit rating. The margin can range from 0.075% 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.
As of December 31, 2013, the Company did not have any borrowings outstanding from the Credit Facility. For the year ended December 31, 2013, borrowings from the Credit Facility had a weighted-average interest rate of 1.52%.
Note Payable
On March 15, 2012, the Company acquired 80% of the outstanding capital stock of Nutricion para el Conosur S.A. See Note 8 for discussion of the acquisition. Of the ARS850.7 million purchase price, ARS377.6 million was financed through a note payable. The remaining balance of the note payable was paid on July 10, 2013.
Long-Term Debt
The components of long-term debt were as follows:
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, the Company may be required to repurchase the notes in an amount equal to 101% of the then outstanding principal amount plus accrued and unpaid interest. Interest on the notes are due semi-annually, and the notes are not subject to amortization.
The Company’s long-term debt has a principal value of $1,500 million, of which $500 million is considered short-term as it matures on November 1, 2014. MJN plans to refinance a portion of these notes in 2014. The Company determined the fair value of its long-term debt based on current market yields in the secondary market, classified as Level 2. As of December 31, 2013 fair value of the Company's long-term debt was $1,611.1 million.
The components of interest expense-net were as follows:
See Note 16 for discussion on the Company’s derivatives.
16. DERIVATIVES
The Company is exposed to market risk due to changes in foreign currency exchange rates, commodities pricing and interest rates. To manage that risk, the Company enters into certain derivative financial instruments, when available on a cost-effective basis, to hedge its underlying economic exposure. The Company does not enter into derivatives for speculative purposes. These financial instruments are classified as Level 2 of the fair value hierarchy at December 31, 2013 and 2012, and there were no transfers between levels in the fair value hierarchy during the periods then ended.
The following table summarizes the fair value of the Company's outstanding derivatives, all of which are cash flow hedges:
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, 2013 failed to perform according to the terms of its agreement. Based upon the risk profile of the Company's portfolio, MJN does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative financial instruments.
Cash Flow Hedges
As of December 31, 2013 and 2012 all of the Company’s cash flow hedges qualify as hedges of forecasted cash flows and the effective portion of changes in fair value are temporarily reported in accumulated other comprehensive income (loss). During the period that the underlying hedged transaction impacts earnings, the effective portion of the changes in the fair value of the cash flow hedges are recognized within earnings. The Company assesses effectiveness at inception and on a quarterly basis. These assessments determine whether derivatives designated as qualifying hedges continue to be highly effective in offsetting changes in the cash flows of hedged items. Any ineffective portion of the change in fair value is included in current period earnings.
The Company will discontinue cash flow hedge accounting when the forecasted transaction is no longer probable of occurring on the originally forecasted date, or 60 days thereafter, or when the hedge is no longer effective. For the years ended December 31, 2013, 2012, and 2011, the Company did not discontinue any cash flow hedges.
Foreign Exchange Contracts
The Company uses foreign exchange contracts to hedge forecasted transactions, primarily foreign currency denominated intercompany purchases anticipated in the next 1.5 years and designates these derivative instruments as foreign currency cash flow hedges when appropriate. When the underlying intercompany purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold. For the years ended December 31, 2013, 2012 and 2011, ineffectiveness related to the Company’s foreign exchange hedges on earnings was insignificant.
The table below summarizes the Company’s outstanding foreign exchange forward contracts at December 31, 2013. 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.
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, 2013 and 2012, were as follows:
At December 31, 2013, the portion of changes in cash flow hedges deferred into other comprehensive income that is expected to be reclassified into earnings within the next 12 months was $3.2 million.
Interest Rate Forward Swaps
During the fourth quarter of 2013 the Company entered into interest rate forward starting swaps with a combined notional value of $500.0 million. The forward starting rates of the swaps range from 3.79% to 3.94% and have an effective date of October 31, 2014. The forward starting swaps effectively mitigate the interest rate exposure associated with the Company’s planned refinancing of a portion of long-term debt in 2014, which is an anticipated transaction as a portion of MJN’s existing long-term debt will mature in 2014. These derivative instruments were designated as cash flow hedges at inception and were highly effective in offsetting fluctuations in the benchmark interest rate. As of December 31, 2013, all forward swaps were outstanding and had a fair value of $19.4 million, recognized in accumulated other comprehensive income. When the forward swaps are settled, which would be on or about the time of the issuance of long-term debt, any gain
or loss on the settlement will be recorded to accumulated other comprehensive income (loss) and will be amortized over the life of the notes. There was an immaterial amount of ineffectiveness related to the forward swaps which was recognized as a benefit within other expenses-net.
Commodity Hedge
During the fourth quarter of 2013, the Company began utilizing commodity hedges to minimize the variability in cash flows due to fluctuations in market prices of the Company’s non-fat dry milk purchases. The maturities of the commodity contracts are scheduled to match the pricing terms of the Company’s existing bulk purchase agreements. When the underlying non-fat dry milk purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold.
As of December 31, 2013, the Company had commodity contracts outstanding with a notional of 0.2 million pounds of forecasted non-fat dry milk purchases, representing a value of $0.3 million and an insignificant portion of the Company’s total forecasted volume. The effective portion of the hedge, which was recorded at fair value as a component of accumulated other comprehensive income, as well as the ineffective portion recognized within other income and expense were immaterial as of December 31, 2013 and for the period then ended.
Fair Value Hedges
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, 2013.
(Gain) loss on marked to market of fair value hedges during the years ended December 31, 2013, 2012, and 2011 was as follows:
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 debt.
Other Financial Instruments
The Company does not hedge the interest rate risk associated with money market funds, which totaled $447.8 million and $520.7 million as of December 31, 2013 and 2012, respectively. Money market funds are classified as Level 2 in the fair value hierarchy and are included in cash and cash equivalents on the balance sheet. The money market funds have quoted market prices that are generally equivalent to par.
17. EQUITY
Changes in common shares and treasury stock were as follows:
The Company may use either authorized and unissued shares or treasury shares to meet share requirements resulting from the exercise of stock options and vesting of performance share awards and restricted stock units. Treasury stock is recognized at the cost to reacquire the shares. Shares issued from treasury are recognized using the first-in first-out method.
On March 16, 2010, MJN’s board of directors approved the repurchase of up to $300.0 million of the Company’s common stock. From the date of such authorization through December 31, 2013, 4.2 million shares were repurchased at an average cost per share of $71.21. As of December 31, 2013, the Company has completed all purchases remaining under this authorization.
On September 10, 2013, MJN’s board of directors approved a new share repurchase authorization of up to an additional $500.0 million of the Company’s common stock. From the date of such authorization through December 31, 2013, 0.1 million shares were repurchased at an average cost of $84.06. As of December 31, 2013, the Company had $490.3 million available under this authorization.
Changes in accumulated other comprehensive loss by component were as follows:
1 Represents foreign currency translation adjustments.
Reclassification adjustments out of accumulated other comprehensive loss were as follows:
Dividends declared per share were $1.36, $1.20 and $1.04 for the years ended December 31, 2013, 2012 and 2011, respectively.
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, 2013, are:
Operating lease rental expenses were $39.7 million, $37.4 million and $35.5 million in the years ended December 31, 2013, 2012, and 2011, respectively. At December 31, 2013 and 2012, MJN had capital lease obligations outstanding in the amount of $2.9 million and $2.7 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 was served with a lawsuit filed on October 16, 2012 in St. Clair County (Illinois) Circuit Court under the caption Shelby Schrack, et al. v. Mead Johnson Nutrition Company and Mead Johnson & Company, which lawsuit alleges that certain bacteria in powdered formula were responsible for the death of one infant and serious illness in two others and seeks unspecified monetary damages. These events were widely publicized in December 2011 and January 2012. The infants allegedly consumed formula from batches that were extensively tested by the Company, the Centers for Disease Control (“CDC”) and the U.S. FDA. These tests detected no bacteria in our infant formula. The CDC further noted that while these bacteria have sometimes been found in formula, they also exist in the environment and may potentially cause illness through person to person contact or through contamination of infant feedings at the point of use. The Company believes that the claims in this matter are without merit. Nevertheless, in November 2013, the Company and the plaintiffs agreed to settle the disputed claims asserted in this litigation, and on December 12, 2013, the Company obtained court approval of the proposed settlement and release of all such claims. The settlement did not materially affect the Company’s consolidated financial position, results of operations or cash flows.
The Company records accruals for contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although the Company cannot predict with certainty the final resolution of lawsuits, investigations and claims asserted against the Company, MJN does not believe any currently pending legal proceeding to which the Company is a party will have a material effect on the Company’s business or financial condition, although an unfavorable outcome in excess of amounts recognized as of December 31, 2013, with respect to one or more of these proceedings could have a material effect on the Company’s results of operations and cash flows for the periods in which a loss is recognized.
The Company incurred costs for an administrative penalty assessed by China's National Development and Reform Commission ("NDRC") in connection with the NDRC’s antitrust review of the infant formula industry’s resale pricing practices (the “China Antitrust Review”) and was resolved during the third quarter of 2013. In connection with the China Antitrust Review, the NDRC assessed an administrative penalty of $33.4 million against the Company, which penalty was paid during the third quarter and is non-deductible for tax purposes.
Following an SEC request for documents relating to certain business activities of the Company’s local subsidiary in China, the Company is continuing an internal investigation of such business activities. The Company’s investigation is focused on certain expenditures that were made in connection with the promotion of the Company’s products or may have otherwise been made. Certain of such expenditures were made in violation of Company policies and may have been made in violation of applicable U.S. and/or local laws, including the U.S. Foreign Corrupt Practices Act (the “FCPA”). The investigation is being conducted by outside legal counsel and overseen by a committee of independent members of the Company’s board of directors. The status and results of the investigation are being discussed with the SEC and other governmental authorities. At this time, the Company is unable to predict the scope, timing or outcome of this ongoing matter or any regulatory or legal actions that may be commenced related to this matter. If a violation of the FCPA or other laws is determined to have occurred, the Company could become subject to monetary penalties as well as civil and criminal sanctions.
20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
SCHEDULE II
MEAD JOHNSON NUTRITION COMPANY
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 our Chief Executive Officer and the Chief Financial Officer (our principal executive officer and principal financial officer, respectively), we have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2013. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of December 31, 2013, the Company’s disclosure controls and procedures were effective in ensuring information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual 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, 2013, based on the framework in Internal Control-Integrated Framework (1992) 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, 2013, 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, our independent registered public accounting firm, has audited our financial statements included in this Annual Report on Form 10-K and has issued its attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2013, which appears below.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Mead Johnson Nutrition Company:
We have audited the internal control over financial reporting of Mead Johnson Nutrition Company and subsidiaries (the “Company”) as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) 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 Annual 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, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) 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, 2013 of the Company and our report dated February 18, 2014 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 18, 2014
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended December 31, 2013, 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 10 is set forth under the headings “Directors, Executive Officers and Corporate Governance - Board of Directors,” “Directors, Executive Officers and Corporate Governance - Code of Ethics,” “Directors, Executive Officers and Corporate Governance - Committees of the Board of Directors,” “Directors, Executive Officers and Corporate Governance - Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our 2014 Proxy Statement to be filed with the SEC in connection with the solicitation of proxies for our 2014 Annual Meeting of Stockholders (the “2014 Proxy Statement”) and is incorporated herein by reference. The 2014 Proxy Statement will be filed with the SEC within 120 days after the end of our 2013 fiscal year.
Item 11. EXECUTIVE COMPENSATION.
The information required by this Item 11 is set forth under the headings “Directors, Executive Officers and Corporate Governance - Compensation Committee Interlocks and Insider Participation,” “Executive Compensation - Compensation and Management Development Committee Report,” “Executive Compensation” and “Directors, Executive Officers and Corporate Governance - Compensation of Directors” in our 2014 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 12 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 2014 Proxy Statement and is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this Item 13 is set forth under the headings “Review, Approval or Ratification of Transactions with Related Persons” and “Directors, Executive Officers and Corporate Governance - Board of Directors - Director Independence” in our 2014 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 headings “Audit Related Matters - Fees Paid to Independent Registered Public Accounting Firm” and “Audit Related Matters - Pre-approval of Audit and Permissible Non-Audit Services” in our 2014 Proxy Statement and is incorporated herein by reference.
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
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 in “Item 8. Financial Statements and Supplementary Data.” The exhibits filed as a part of this Annual Report on Form 10-K are listed in the Exhibit Index immediately following the signature page to this report.
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 18, 2014
By:
/s/ Tom De Weerdt
Tom De Weerdt
Vice President, Corporate 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 18, 2014
By:
/s/ Peter Kasper Jakobsen
Peter Kasper Jakobsen
President, Chief Executive Officer and Director
(Principal Executive Officer)
Date:
February 18, 2014
By:
/s/ Peter G. Leemputte
Peter G. Leemputte
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Date:
February 18, 2014
By:
/s/ Tom De Weerdt
Tom De Weerdt
Vice President, Corporate Controller
(Principal Accounting Officer)
Date:
February 18, 2014
By:
/s/ James M. Cornelius
James M. Cornelius
Chairman of the Board of Directors
Date:
February 18, 2014
By:
/s/ Steven M. Altschuler, M.D.
Steven M. Altschuler, M.D.
Director
Date:
February 18, 2014
By:
/s/ Howard B. Bernick
Howard B. Bernick
Director
Date:
February 18, 2014
By:
/s/ Kimberly A. Casiano
Kimberly A. Casiano
Director
Date:
February 18, 2014
By:
/s/ Anna C. Catalano
Anna C. Catalano
Director
Date:
February 18, 2014
By:
/s/ Celeste A. Clark, Ph.D.
Celeste A. Clark, Ph.D.
Director
Date:
February 18, 2014
By:
/s/ Stephen W. Golsby
Stephen W. Golsby
Director
Date:
February 18, 2014
By:
/s/ Peter G. Ratcliffe
Peter G. Ratcliffe
Director
Date:
February 18, 2014
By:
/s/ Elliott Sigal, M.D., Ph.D.
Elliott Sigal, M.D., Ph.D.
Director
Date:
February 18, 2014
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
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 JP Morgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011 filed on July 28, 2011)
10.6†
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)
10.7†
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 fiscal quarter ended June 30, 2010 filed on July 29, 2010)
10.8*
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)
10.9*
Mead Johnson Nutrition Company 2009 Senior Executive Performance Incentive Plan (As Amended and Restated Effective as of January 1, 2011) (incorporated by reference to Exhibit 10.9 to Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed on February 21, 2013)
10.10*
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)
10.11*
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)
10.12*
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)
10.13*
Mead Johnson & Company, LLC Senior Executive Severance Plan (as amended and restated effective as of January 1, 2011)
10.14*
Mead Johnson & Company, LLC Executive Change in Control Severance Plan (as amended and restated effective as of September 13, 2011)
10.15*
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)
10.16*
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)
10.17*
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)
10.18*
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)
10.19*
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)
10.20*
Form of 2013 Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013 filed on April 25, 2013)
10.21*
Form of 2013 Employee Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013 filed on April 25, 2013)
10.22*
Form of 2013 Non-Employee Director Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013 filed on April 25, 2013)
10.23*
Form of 2013 Performance Share Award Agreement (incorporated by reference to Exhibit 10.4 to Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013 filed on April 25, 2013)
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.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
†
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.