Mead Johnson Nutrition Co
Item 1. BUSINESS.
Our Company
Mead Johnson Nutrition Company is a global leader in pediatric nutrition with approximately $3.7 billion in net sales for the year ended December 31, 2016. 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, and accounted for approximately 80% of our net sales for the year ended December 31, 2016. 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 category-defining products across our product portfolio. Our singular focus on pediatric nutrition and our implementation of a business model that integrates nutritional science with health care and consumer marketing expertise differentiate us from many of our competitors.
We market our portfolio of more than 70 products to mothers, health care professionals and retailers in more than 50 countries in Asia, North America, Latin America and Europe. Our three reportable segments are Asia, Latin America and North America/Europe, which comprised 50%, 17% and 33%, respectively, of our net sales for the year ended December 31, 2016. See “Item 8. Financial Statements and Supplementary Data-Note 5. Segment Information” for additional financial information by segment and geographical area. For the year ended December 31, 2016, 72% of our net sales were generated outside of the United States.
We believe parents and health care professionals associate the Mead Johnson name and our Enfa family of brands with quality, science-based pediatric nutrition products. Our products are marketed around the world through our global sales and marketing efforts. We believe that the strength of our brands allows us to create and maintain consumer loyalty across our product portfolio.
In this Annual Report on Form 10-K, we refer to Mead Johnson Nutrition Company and its subsidiaries throughout as “the Company,” “MJN,” “Mead Johnson,” “we” or “us.” For purposes of this Annual Report on Form 10-K, the term China refers to the Company’s businesses in mainland China and Hong Kong.
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 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 expanded our operations into extensive geographies outside of the United States 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.
In 1967, we became a wholly-owned subsidiary of Bristol-Myers Squibb Company (“BMS”). In February 2009, we completed our initial public offering of common stock, following which BMS retained a significant ownership interest in the Company. BMS then completed a split-off of its remaining interest in Mead Johnson in December 2009 making Mead Johnson an independent public company. The Company is currently headquartered in Glenview, Illinois and is scheduled to relocate its corporate headquarters to Chicago, Illinois in the first half of 2017.
Merger Agreement
On February 10, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Reckitt Benckiser Group plc, a company incorporated in England and Wales (“Reckitt Benckiser”), and Marigold Merger Sub, Inc., a Delaware corporation and a wholly owned indirect subsidiary of Reckitt Benckiser (“Merger Sub”), pursuant to which Reckitt Benckiser will indirectly acquire the Company by means of a merger of Merger Sub with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement (the “Merger”). The Merger Agreement and the consummation of the transactions contemplated by the Merger Agreement have been unanimously approved by the Company’s board of directors.
At the effective time of the Merger (the “Effective Time”), on the terms and subject to the conditions set forth in the Merger Agreement, each share of the Company’s common stock outstanding immediately prior to the Effective Time (other than (i) each share held by the Company as treasury stock (other than shares held for the account of clients, customers or other persons), (ii) each share held by Reckitt Benckiser or by any subsidiary of either the Company or Reckitt Benckiser and (iii) each share held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has demanded appraisal for such shares in accordance with Delaware law) will be converted into the right to receive $90.00 in cash, without interest.
Consummation of the Merger is subject to the satisfaction or waiver of certain customary closing conditions, including, among others: (i) the affirmative vote of the holders of a majority of the Company's outstanding shares of common stock; (ii) the affirmative vote of a simple majority of Reckitt Benckiser’s shareholders at a shareholder meeting; (iii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of certain other non-United States regulatory approvals required to consummate the Merger; and (iv) in the case of Reckitt Benckiser's obligations to consummate the Merger, the absence of a Company Material Adverse Effect (as defined in the Merger Agreement). Reckitt Benckiser and Merger Sub's respective obligations to consummate the Merger are not subject to any financing condition or other contingency.
Additional information about the Merger Agreement is set forth in our Current Report on Form 8-K filed with the United States Securities and Exchange Commission (the “SEC”) on February 13, 2017.
Our Product Portfolio
Our product portfolio, which addresses a wide range of pediatric nutritional needs, consists of two principal product categories: infant formula and children’s nutrition, which represented 59% and 40%, respectively, of our net sales for the year ended December 31, 2016. Our product categories can be separated into the following general product types: (i) routine infant, (ii) solutions, (iii) specialty, (iv) children’s nutrition and (v) other. Our routine infant formula is intended for healthy consumers while our solutions and specialty products are offered for infants with common feeding problems and special nutritional needs. Our children’s nutrition products are designed to meet the nutritional needs of children at different stages of development. Our other products (representing approximately 1% of net sales) include maternal nutrition products, vitamins, supplements and oral electrolyte solutions for infants and children. We market products under different names in various regions across the world based on marketing strategies and brand recognition.
Our most prominent product form around the world is milk-based powder. We also produce several products in liquid form for sale primarily in North America. In relevant markets, liquids are available in routine, solutions, specialty and children’s nutrition products. In addition, we have introduced certain non-GMO products in an effort to provide parents with options that meet a variety of preferences.
Routine Infant Formula. We design routine infant formula 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. Our key routine infant formula products include Enfamil Premium, Enfamil A+, Enfalac Premium and Enfapro A+. We endeavor to develop routine infant formula that includes the most beneficial attributes of breast milk. Each product is referred to as a “formula,” as it is formulated for the specific nutritional needs of an infant at a given age. Generally, our routine infant formulas have 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 docosahexaenoic acid (“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. In certain geographies, we have introduced a premium-priced product (Enfinitas in China and Enspire in the United States). This premium-priced formulation has two innovative components, lactoferrin and milk fat globule membrane (“MFGM”), both of which are naturally found in human breast milk and provide important benefits (lactoferrin to support immune health and MFGM to foster cognitive development). MFGM is also present in our Enfa products in several other markets.
Solutions Products. We design several solutions formulas to address common feeding tolerance problems, including spit-up, fussiness, gas and lactose intolerance. Our primary solutions products include Enfamil Gentlease (for fussiness and gas), Enfamil A.R. (to reduce spit-up), Enfamil ProSobee (a soy-based formula) and Enfamil LactoFree (for lactose intolerance).
Specialty Products. We design specialty formulas to address certain conditions or special medical needs, including Nutramigen (for cow’s milk protein allergies) and Puramino (an amino acid formula for severe cow’s milk protein allergies or multiple other food allergies). We design products such as Enfamil Premature to meet the unique needs of premature and low birth weight infants under the supervision of a doctor, most often in the hospital, and EnfaCare, a hypercaloric formula for premature babies at home. 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). Certain of these products are intended for infants and young children while others are suitable for children and adults.
Children’s Nutrition Products. We design our children’s products to meet the changing nutritional needs of children at different stages of development (i.e. toddlers and older children). Our primary children’s nutrition products include Enfagrow, Sustagen and Lactum. These products are not breast milk substitutes and are not designed as a sole source of nutrition but instead are designed to be a part of a child’s appropriate diet. MFGM is present in certain of our children’s Enfa products as well. We also offer “milk modifiers” (ChocoMilk and Cal-C-Tose) that, when added to a glass of milk, enhance the milk’s nutritional value. In China, we have introduced a premium-priced, children’s nutrition product (Enfinitas, discussed above).
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 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. Our Enfalyte product, sold in North America, is an oral electrolyte solution designed for infants and children to quickly replace electrolytes and water to help restore hydration.
The following table shows sales for each of the above-described product types as a percentage of our total net sales over each of the past three fiscal years.
% of Total Net Sales
Routine Infant Formula
%
%
%
Solutions Products*
%
%
%
Specialty Products*
%
%
%
Total Infant
%
%
%
Children’s Nutrition Products
%
%
%
Total Children’s
%
%
%
Other
%
%
%
Total Other
%
%
%
* These products can be consumed by children; however, a majority of such products are consumed by infants.
Global Supply Chain
We manage sourcing, manufacturing and distribution of our product portfolio through our global supply chain.
Sourcing. We source approximately 75% of our materials from approximately 40 suppliers worldwide. Through our suppliers, we obtain key raw materials and primary packaging materials on a global basis. These raw materials are subject to review and approval by our regional teams to ensure compliance with regulatory requirements and quality standards. Certain raw materials, while managed and purchased by contract on a global basis, are subject to regional and local variations in price under the terms of these supply agreements. For example, the cost of dairy, agricultural oils, and packaging materials are affected by global commodity changes. As such, we are often exposed to price volatility related to market conditions outside of our control. Dairy products, consisting primarily of milk powders, non-fat dry milk, lactose and whey protein concentrates, accounted for approximately 32% of our global expenditures for raw materials and approximately 19% of our cost of goods sold for the year ended December 31, 2016.
Manufacturing and Finishing Locations; Quality Departments. We currently operate in-house production facilities at different locations around the world. Our manufacturing and finishing facilities are located in the United States, the Netherlands, Mexico, Brazil, Singapore, Thailand, China and the Philippines. See “Item 2. Properties” for a description of our global manufacturing facilities. We also use third-party manufacturers for a portion of our production requirements. As the production process advances, regional or sub-regional teams support the global team by overseeing manufacturing activities such as the finishing of our products. As we adapt to Chinese consumers’ shifting demand for fully imported products, we increasingly manufacture and finish our products in the Netherlands for shipment to China.
Our four regional quality departments located in the United States, the Netherlands, Mexico and Singapore perform regional and manufacturing site quality control and assurance. The quality assurance work in the regions is supported by a Global Quality Assurance group which provides additional expertise for specific areas. Our products undergo extensive quality and safety checks throughout the manufacturing process, from raw materials to finished product. Our regional quality departments perform routine manufacturing site inspections focused on regulatory requirements, food safety, continuous quality improvement, ingredient supplier quality and third-party compliance. Our products meet all local and nationally required regulatory, safety and nutrition requirements, including the Codex Alimentarius, or food code, standards where applicable, the U.S. Infant Formula Act in the United States and specific national, local and regional requirements elsewhere (See “-Regulatory and Legal” below for further details). Nevertheless, the Company is constantly driving improvement in quality and, as such, these regulations are seen as the minimum requirements; our internal rigorous standards and quality ambition meet or exceed such requirements.
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.
Sales and Marketing
We conduct regional marketing within a strategic framework focused on both parents and health care professionals in accordance with country-specific regulatory requirements. We maintain both a health care professional sales force and a retail sales organization within our regions 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-creation programs. The marketing teams work with external agencies to create marketing campaigns for consumers, health care professionals and retail sales organizations, where permitted.
Consumers. Parental preference plays an important role in brand selection. Where permitted, we participate in a variety of evidence-based marketing activities for consumers that emphasize our superior nutritional science, including digital, print and television advertising, direct mail, internet and promotional programs. In particular, we have invested in targeted digital marketing programs that allow us to attract new or prospective parents’ attention online, engage with potential consumers by connecting them to relevant content reflective of their needs and then provide targeted, specific information and product offers. We have developed technology platforms to support e-commerce and mobile commerce within our regions across the globe. Moreover, we have invested significant resources to support trends in consumer preference for premium products in key markets.
Health Care Professionals. Our health care professional sales force educates health care professionals, as permitted, 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. Our retail sales force markets our products to each of the retail channels where our products are purchased by consumers, including mass merchandisers (e.g. Walmart), e-commerce retailers, baby stores, 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, emphasis on e-commerce, shopper trends and the regulatory environment.
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 46% of all infants born in the United States during the 12-month period ended December 31, 2016 benefited from the WIC program. The USDA program is administered individually by each state.
Most state WIC programs provide vouchers that participants use at authorized food stores to obtain the products covered by the program, including infant formula. Following a sealed, competitive bidding process, state WIC agencies enter into contracts with manufacturers, pursuant to which the state WIC agency provides mothers with vouchers for a single manufacturer’s brand of infant formula and, in return, the manufacturer gives the state WIC agency a rebate for each unit 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 state WIC agency for infant formula at authorized retailers. The retailer is then reimbursed the full retail price by the state 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 units of infant formula for which vouchers were redeemed by the state WIC agency and reimbursed to retailers during the month multiplied by the agreed rebate per unit.
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 usually awarded the contract. WIC contracts are generally three years in duration with some contracts providing for extensions. Specific contract provisions can vary significantly from state to 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. As of December 31, 2016, we held the contracts that supplied approximately 43% of WIC births in the United States. WIC sales represented approximately 16% of our global gross sales in the year ended December 31, 2016. After taking into account the rebates we paid to the state WIC agencies, net WIC sales represented approximately 1% of our global net sales in the year ended December 31, 2016. The general benefits that we derive from holding the WIC contract in a particular state extend beyond the actual sales made in connection with the WIC program in the relevant state. Such benefits include full price sales from product purchased in excess of the rebated volume and the increased presence of our products in hospitals and at retailers. See “
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.
Risk Factors Related to the Merger
The Merger may not be completed within the expected timeframe, or at all, and the failure to complete the Merger could adversely affect our business and the market price of our common stock.
On February 10, 2017 we entered into the Merger Agreement with Reckitt Benckiser and Merger Sub, a wholly owned subsidiary of Reckitt Benckiser. The Merger Agreement is an executory contract subject to closing conditions beyond our control, and there is no guarantee that these conditions will be satisfied in a timely manner or at all. Completion of the Merger is subject to various conditions, including approval of the Merger by an affirmative vote of the holders of a majority of the outstanding shares of the Company’s common stock, approval of the Merger by an affirmative vote of a simple majority of Reckitt Benckiser’s shareholders and the receipt of required antitrust approvals, among other things. If any of the conditions to the Merger are not satisfied (or waived by the other party), the Merger may not be completed. In addition, the Merger Agreement may be terminated under certain specified circumstances, including a change in the recommendation of our board of directors or our termination of the Merger Agreement to enter into an agreement for a superior proposal (as defined in the Merger Agreement).
Failure to complete the Merger could adversely affect our business and the market price of our common stock in a number of ways, including the following:
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If the Merger is not completed, and there are no other parties willing and able to acquire the Company at a price of $90 per share or higher, on terms acceptable to us, our stock price will likely decline as our stock has recently traded at prices based on the proposed per share consideration for the Merger.
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We have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger, for which we will have received little or no benefit if the Merger is not completed. Many of these fees and costs will be payable by us even if the Merger is not completed and may relate to activities that we would not have undertaken other than to complete the Merger.
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A failed Merger may result in negative publicity and a negative impression of us in the investment community.
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Upon termination of the Merger Agreement by the Company or Reckitt Benckiser under specified circumstances, we would be required to pay a termination fee of $480 million.
The Merger Agreement contains provisions that could discourage or make it difficult for a third party to acquire us prior to the completion of the Merger.
The Merger Agreement contains provisions that restrict our ability to entertain a third party proposal to acquire us. These provisions include the general prohibition on our soliciting or engaging in discussions or negotiations regarding any alternative acquisition proposal, subject to certain exceptions. We are also required to pay a termination fee of $480 million if the Merger Agreement is terminated in specified circumstances, including if we enter into a definitive agreement for a superior proposal. These provisions might discourage an otherwise-interested third party from considering or proposing an acquisition transaction, even one that may be deemed of greater value than the Merger to our stockholders. Furthermore, even if a third party elects to propose an acquisition, the requirement on our part to pay a termination fee may result in that third party offering a lower value to our stockholders than such third party might otherwise have offered.
The announcement of the Merger could adversely affect our business, financial condition, and results and operations.
The announcement and pendency of the Merger could cause disruptions in and create uncertainty surrounding our business, which could have an adverse effect on our business, financial condition, and results and operations, regardless of whether the Merger is completed. These risks to our business include the following, all of which could be exacerbated by a delay in the completion of the Merger:
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the diversion of significant management time and resources towards the completion of the Merger;
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the impairment of our ability to attract, retain, and motivate key personnel, including our senior management;
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difficulties maintaining relationships with customers, suppliers, and other business partners;
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the inability to pursue alternative business opportunities or make appropriate changes to our business because of requirements in the Merger Agreement that we conduct our business in the ordinary course of business consistent with past practice and not engage in certain kinds of transactions prior to the completion of the Merger; and
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litigation relating to the Merger and the costs related thereto.
Risks Relating to Our Business
We operate in an intensely competitive business where many factors, including competitive price-based promotional activity, may impact demand for our products.
Our primary competitors have substantial financial, marketing and other resources. They have diversified product portfolios and may benefit from greater economies of scale due to their size and global footprint. In most product categories, we compete not only with other widely advertised branded products, but also with private label and store brand products that are generally sold at lower prices. We compete based on the following factors: innovation and nutrition science; brand recognition and loyalty; product quality; effectiveness of marketing, promotional activity and the ability to identify and satisfy consumer preferences; price; distribution and availability of products. Continued price-based promotional activity has negatively impacted, and may continue to negatively impact, revenues and demand for our products. Competitive pressures may lead us to reduce product prices. Such pressures may also restrict our ability to increase prices in response to commodity, wage and other cost increases. If we are unable to compete effectively, our financial condition and operating results may suffer.
Our China operations are subject to risks that could negatively affect our business.
A significant portion of our revenue is derived from operations in China. Consequently, our overall financial results are dependent on this market and our business is exposed to significant risks, particularly with regard to China’s evolving regulatory landscape as it applies to our business. Our success may be adversely affected by the need to adjust our product manufacturing, distribution, labeling and marketing to comply with China’s evolving laws and regulations, including those related to trade restrictions, product quality requirements, product labeling rules, advertising regulations and limitations on the number of brands and formulations manufactured in one location. Risks associated with our China operations also include changes in economic conditions (including potential slowdowns in China’s economy, wage and cost inflation, currency exchange rates, consumer spending and employment levels), changes in tax rates, potential tariffs, duties and other trade barriers and increased competitive promotional activity. Moreover, our success in China depends on our ability to predict, identify, interpret and react to changes in consumer product and sales channel preferences. The shift in consumer demand towards fully imported products and the increased interest in premium-priced products has negatively impacted, and may continue to negatively impact, demand for our locally manufactured products.
Moreover, as consumer demand for fully imported products evolves and we expand direct shipments of such products into the region, ongoing sales channel shifts have, and may continue to, negatively impact our Hong Kong sales. Our Hong Kong sales have traditionally been weighted towards retail sales to non-local consumers from mainland China. Due to regulations, political factors and a decrease in visitors from mainland China, we have experienced a decline in traditional retail sales. This trend has been exacerbated by consumer demand for fully imported products through e-commerce channels. While we have begun to transition to fast growing online sales channels, we have, and may continue to, experience lower than expected sales from Hong Kong to mainland China customers. There can be no assurance as to the future effect of any such risks and uncertainties on our results of operations, financial condition or cash flows.
We are subject to extensive governmental regulations, and it can be costly to comply with these regulations. Changes in governmental regulations or other policies could harm our business.
As an infant nutrition company, our business is subject to extensive government regulation with respect to product manufacturing and labeling, the environment, employee health and safety, hygiene, quality control, advertising, marketing, privacy and tax laws. It can be costly to comply with these regulations. Global regulatory provisions that govern our ability to bring innovative formulas to market have become increasingly stringent with regard to requirements for scientific substantiation for innovation. Similarly, regulatory criteria with respect to safety and quality requirements have become increasingly stringent. A failure to comply with such laws and regulations could subject us to sales bans, product recalls, lawsuits, administrative penalties and other remedies. In addition, changes in laws or regulations could further restrict our actions and significantly increase our cost of doing business, causing our results of operations to be adversely affected. For example, government regulations impacting how and where we manufacture or source product may cause unfavorable cost outlay, pricing pressure, a significant change in our offerings or geographic earnings mix and/or an adverse effect on the related global tax liability. See also “Our China operations are subject to risks that could negatively affect our business.” Barriers or sanctions imposed by countries or international organizations limiting international trade may limit our cross-border activities and sales. Governmental pricing actions may limit our ability to increase, or force us to reduce, prices in various jurisdictions throughout the world. Moreover, regulations that restrict marketing, promotion, availability and sale of our products, interactions with health care professionals, product content (including the regulations related to genetically modified organisms), as well as the manufacture, labeling and intellectual property rights for our products, could have a material adverse impact on our business.
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.
We may 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. Powdered infant formula and powdered milk products are not sterile. A risk of contamination or adulteration exists at each stage of the production cycle, including the purchase and incorporation of raw food materials/ingredients into the final product, the processing and packaging steps in making the product and upon handling and use by health care professionals, hospital personnel and consumers. In the event that our products are found, or are alleged, to have suffered contamination or adulteration, whether or not such products were under our control, our brand reputation and business could be materially adversely affected. Furthermore, whether real or perceived, contamination or spoilage, product mislabeling or product tampering could result in product recalls. No such recalls have been material to our global business. However, a future product recall could be material and have a negative impact on our sales and profitability.
Whether real or perceived, reports of inadequate quality control (with respect to either our products or those of other manufacturers in our segment) could adversely impact our business by contributing to a perceived safety risk throughout the industry. The risk of reputational harm is magnified through rapid, digital dissemination of information through news reports, social media or otherwise. Federal, state and local governments and municipalities could also propose or pass legislation banning the use of our products.
Our business is subject to anti-infant formula policies and legislation in various jurisdictions, many of which may impact our operations and effectiveness.
Certain advocates and governmental and non-governmental organizations (particularly in Hong Kong, Mexico, the Philippines, Thailand, Malaysia, Vietnam, Indonesia, Colombia and Singapore) have advocated for heightened restrictions on the marketing, labeling and even the sale of some pediatric nutrition products as well as trademark restrictions, restrictions on interactions with health care providers and bans on claims for products covering children up to three years of age, including the “Guidance on Ending the Inappropriate Promotion of Foods for Infants and Young Children” that was published by the WHO in 2016. We and other industry participants were unable to persuade the WHO to modify its guidance to recognize the scientifically proven benefits of infant formula products. The WHO guidance is now under consideration for potential legislation in several countries where we market our products. Because our success depends, in large part, on our ability to define the benefits of our products, to effectively communicate our science-based benefits and to connect with our consumers, any such restrictions or prohibitions could have a material adverse effect on our sales, profitability and market share.
Our significant international operations are subject to extensive risk.
For the year ended December 31, 2016, 72% of our net sales were generated outside of the United States. Our significant international operations are subject to a number of risks related to doing business internationally, any of which could materially harm our business. These risks include:
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multiple regulatory requirements that could restrict our ability to manufacture, market or sell our products;
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foreign currency exchange rates;
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compliance with anti-corruption regulations;
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differing local product preferences and product requirements;
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programs and policies intended to discourage the use of our products;
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trade protection measures and exchange controls;
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price controls;
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unauthorized sales of our products through parallel markets;
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restrictions on the transfer of funds to and from foreign countries, including potentially negative tax consequences;
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political and economic instability;
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changes in foreign medical reimbursement policies and programs; and
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diminished protection of intellectual property.
Our operations and financial results face significant foreign currency exchange exposure.
Our financial performance measured on a U.S. dollar denominated basis is subject to fluctuations in currency exchange rates. A substantial portion of our sales are outside of the U.S. and the U.S. dollar has recently been strengthening in relation to many relevant currencies. These fluctuations could cause material variations in our results of operations, particularly as the U.S. dollar strengthens or does so at an accelerated pace. 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 impacts on our financial statements. Currency rates in some markets could impact our results due to high exchange rate volatility, potentially or actually requiring us to apply inflationary accounting. For example, our business in Argentina may be subject to hyperinflationary accounting in the future, the impact of which on our consolidated financial statements is dependent upon movements in the exchange rate, including devaluations. Operating in high inflationary environments could subject us to additional government actions, devaluations and other business restrictions (see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk”).
Moreover, foreign governments may 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 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.
Economic downturns could limit consumer demand for our products.
The willingness of consumers to purchase premium brand pediatric nutrition products (and, in particular, premium-priced products) depends in part on local economic conditions. For example, consumers may shift their purchases from our higher-priced premium products to lower-priced products or delay having children. During economic downturns, a decrease in the number of working mothers could constrict our customer base, further reducing our sales.
Commodity price increases raise our operating costs and may reduce our profitability.
Our business is particularly vulnerable to commodity price increases in 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. Commodity price volatility is caused by conditions such as fluctuating commodities markets, currency fluctuations, availability of supply, weather, consumer demand and changes in governmental agricultural programs. Dairy costs are the largest component of our cost of goods sold. Increases in commodity costs generally impact our gross margins if we are unable to offset such increases by raising prices, changing our product mix or other efforts. Price increases, in turn, could weaken demand for our product. We monitor our exposure to commodity prices as part of our risk management program and attempt to mitigate risk with commodity hedging activities or contractual agreements; however, continued commodity price volatility and ineffective commodity risk management could lead to lower profitability.
Our business is subject to the risks inherent in global manufacturing and sourcing activities.
We manufacture and source products and materials on a global scale; therefore, we are subject to risks inherent in these activities such as:
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raw material, product quality or safety issues, and related shortages or recalls by either us or our third-party suppliers;
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supply chain disruptions due to weather, natural disaster, fire, terrorism, strikes, various contagious diseases, changes in government regulations or other factors over which we have no control;
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loss or impairment of key global manufacturing sites or a failure to maintain compliant manufacturing practices at either our sites or third-party manufacturing sites;
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limits on production and manufacturing capabilities due to physical capacity limitations, regulatory requirements, or export / import restrictions associated with the transport of raw goods or material;
•
significant difficulties with the highly exacting and complex processes required to manufacture our products, including equipment malfunction, failure to follow specific protocols and the related need to discard product batches; and
•
strikes, labor disputes, industrial accidents or other occupational health and safety issues.
Reduced manufacturing capacity without adequate redundancy could result in an inability to meet market demand and lost market share. While we have business continuity plans in place for certain manufacturing sites and the supply of raw materials, significant disruption in global manufacturing and sourcing activities for any of the above reasons could interrupt our business and lead to increased costs, lost sales, reputational damage and expense. If not remedied, these factors could have a material adverse effect on our business. Moreover, such significant disruptions may limit our ability to introduce and distribute products, including our existing pipeline of new or improved products, or otherwise take advantage of opportunities in new and existing markets.
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. We may be unable to manufacture our products in a timely manner, or at all, if any of our third-party suppliers should cease or interrupt production or otherwise fail to supply us, or if the supply agreements are suspended, terminated or otherwise expire without renewal, resulting in a material adverse effect on our business. We also use third-party distributors in many countries throughout the world, including in developing countries. We could experience disruptions that lead to a loss of sales or claims against the Company and irreparable damage to our reputation if any of our third-party distributors either fail to deliver on their commitments in a timely manner or at all (whether due to financial instability, non-compliance with applicable regulations, disruptions in local infrastructure or otherwise) or purport to represent the Company in an unauthorized manner. While we utilize a third-party due diligence process, in light of our global distributor network and the related risks of doing business in developing countries, it is possible that our due diligence process may not successfully identify all relevant risks. See also “Our global operations are subject to political and economic risks of developing countries, and risks associated with doing business in developing markets.” Moreover, if our distribution agreements are suspended, terminated or otherwise expire without renewal, our sales and profitability could be materially adversely affected.
We are increasingly dependent on information technology. Increased IT security threats could pose a risk to our systems, networks, products, solutions, services and data integrity.
We rely on our information technology, administrative and outsourcing systems (including cloud or partner systems and third-party providers) to effectively manage our business data, communications, supply chain, order entry and fulfillment and other business processes. We also rely on such systems to protect employee and, at times, customer data, including personally identifiable information, which we may collect and retain. These systems may be susceptible to damage or interruption due to system failures, computer viruses, security breaches, telecommunication failures, user error, catastrophic events or other factors. If our information technology, administrative and outsourcing systems suffer severe damage or interruption or intrusion, and our business continuity plans do not effectively resolve the issue in a timely manner, our business could suffer as we could experience business disruption, transaction errors, processing inefficiencies, a loss of customer or employee data and a loss of sales or customers. Moreover, increasing global 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. We invest in training and security technology to protect our data and business processes against risk of data security breach and cyber attack. There can be no assurance, however, that our efforts will prevent breakdowns or breaches that could adversely affect our business. Such threats, if they materialize, could compromise confidential information or lead to the improper use of our systems and networks, the manipulation and destruction of data, defective products, production downtimes and operational disruptions. If we are unable to prevent security breaches or disclosure of confidential information, we may suffer financial and reputational damage.
Our growth depends on certain demographic trends as well as scientific opinion regarding our products.
Our growth plan relies on favorable demographic trends in various markets, including birth rates, rising incomes in emerging markets, increasing number of working mothers and increasing consumer global awareness of the importance of pediatric nutrition. If any of these demographic trends change in an adverse way (due to macroeconomic factors, epidemics such as the Zika virus or other factors beyond our control), our business could be materially impacted. In addition, an adverse change in scientific opinion regarding our products, such as the health benefits of DHA, could materially adversely affect our business.
Our sales and marketing initiatives may be unsuccessful and our sales and marketing practices may be challenged by consumers and competitors, which could harm our business.
We participate in a variety of trade and marketing activities, where permitted. We work with external agencies to create marketing campaigns for consumers, health care professionals and retail sales organizations. We may increase spending on marketing, advertising and new product innovation to maintain or increase market share. The success of these initiatives is subject to risk, including uncertainties about trade and consumer acceptance of our efforts, our ability to communicate our key brand and corporate messages to a growing number of social media users and inventory levels. The success of these initiatives is also subject to potential restrictions on our product marketing (see “-We are subject to extensive governmental regulations, and it can be costly to comply with these regulations. Changes in governmental regulations or other policies could harm our business” and “-Our business is subject to anti-infant formula policies and legislation in various jurisdictions, many of which may impact our operations and effectiveness.”) Further, although our marketing is evidence-based and emphasizes our nutritional science, consumers and competitors have and may challenge certain of our practices by claiming, among other things, false and misleading advertising. A significant claim or judgment against us could result in monetary damages, limit our ability to maintain current sales and marketing practices and negatively impact our profitability. Even if such claim is unsuccessful or unwarranted, the negative publicity surrounding such assertions could negatively impact our business.
Our global operations are subject to political and economic risks of developing countries, and risks associated with doing business in developing markets.
We operate our business and market our products internationally in more than 50 countries. We focus on increasing our sales and operations in various regions throughout the world, which are less developed, have less stability in legal systems and financial markets, and are potentially more uncertain business environments than the United States, and therefore present greater political, economic and operational risks. We have in place controls, policies and procedures, which include ongoing training of employees with regard to business ethics and many key legal requirements, such as applicable anti-corruption laws (e.g. the United States Foreign Corrupt Practices Act (“FCPA”) and the UK Bribery Act (“UKBA”)). However, there can be no assurance that our employees will adhere to our standards of business conduct and ethics or any of our other policies, applicable anti-corruption laws or other legal requirements. If we fail to enforce our policies and procedures, detect violations in a timely manner or maintain adequate record-keeping and internal accounting practices, we may be subject to regulatory sanctions and suffer damage to our reputation. If we believe or have reason to believe that our employees have or may have violated applicable anti-corruption laws or other laws or regulations, we investigate or have outside counsel investigate the relevant facts and circumstances. If violations are suspected or found, 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.
Our current and historical effective tax rate may not be indicative of future rates.
In light of our global earnings mix, our current and historical effective tax rate may not be indicative of future rates due to changes in domestic and international tax laws (including potential U.S. tax reform), changes in our global earnings mix, the need to repatriate future earnings to the United States to satisfy U.S. cash needs, and changes to our tax positions by taxing authorities in the various jurisdictions in which we operate. For example, at the present time, the United States generally taxes a company’s foreign earnings upon the repatriation of such earnings, and these tax rules may change in the foreseeable future. Moreover, given the organization of our business and the locations of our manufacturing operations, cross border transactions among our affiliates are a significant part of the manner in which we operate. Although we believe that we transact intercompany business in accordance with arms-length principles, taxing authorities may not view such transactions as satisfying such arms-length principles and our tax positions may not be upheld by taxing authorities upon audit of our results. Additionally, the impact of the base erosion and profit shifting (“BEPS”) project undertaken by the Organization for Economic Cooperation and Development (“OECD”) and the European Commission’s investigations into illegal state aid may result in changes to long-standing tax principles which could adversely impact our effective tax rate.
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. The general benefits that we derive from holding the WIC contract in a particular state extend beyond the actual sales made in connection with the WIC program in the relevant state. Such benefits include full price sales from product purchased in excess of the rebated volume and the increased presence of our products in hospitals and at retailers. See “Item 1. Business-The Special Supplemental Nutrition Program for Women, Infants and Children (“WIC”)” for a full description of the WIC program and competitive bidding process.
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 U.S. sales based on the general benefits of holding these contracts. A number of state WIC contracts expire and are subject to renewed bids by the end of 2017, which could negatively impact future results if we are not successful in retaining currently held WIC contracts. Moreover, under recently awarded WIC contracts, trends have been towards higher rebate levels. If these trends continue, the cost of retaining WIC contracts could adversely affect our U.S. sales and/or operating results. Finally, any changes to how the WIC program is administered, any changes to rebate levels and renewal patterns for WIC contracts, any changes to the eligibility requirements and/or overall participation in the WIC program and any failure to maintain fulfillment or other obligations in connection with current WIC contracts could also 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 and our ability to translate these insights into commercially viable new products. This requires significant investment in research and development and testing of new ingredients, formulas and new production processes. The R&D process is expensive and prolonged and entails considerable uncertainty. Products may appear promising in development but fail to reach market within the expected time frame, or at all. We may face significant challenges with regard to a key product launch. Further, products also may fail to achieve commercial viability. Finally, there is no guarantee that our development teams will be able to successfully respond to competitive products that could render our products obsolete. 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 time periods varies considerably from product to product and country to country. Because of the complexities, uncertainties and cost associated with R&D, 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. New regulations or changes to existing regulations may have a negative effect on innovations in our pipeline, especially late-stage pipeline products. In addition, even when important, clinically demonstrated benefits are achieved in our innovations, regulations in specific countries may not allow us to communicate these benefits, or may severely restrict our ability to do so, even to health care professionals.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products and brands.
Given the importance of brand recognition to our business, we have invested considerable effort in trademark protection for our brands, including the Enfa family of brands. In addition, we rely on a combination of security measures, confidentiality policies, contractual arrangements and trade secret laws to protect our proprietary formulas and other valuable trade secrets. We also rely on patent, copyright and trademark laws to further protect our intellectual property rights. Uncertainties inherent in enforcing our intellectual property rights make the outcome and associated costs difficult to predict. A failure to obtain or adequately protect intellectual property rights, or any change in law or other change that serves to lessen or remove the current legal protections of our intellectual property, may diminish our competitiveness and could materially harm our business. In addition, 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. Despite our efforts to enforce our intellectual property rights on a global basis, counterfeit product or product associated with the illegal use of our intellectual property could cause significant reputational harm.
There can be no assurance that third parties will not assert infringement claims against us or that any infringement claim will not result in costly litigation, substantial damages, the need to refrain from selling our products or the need to obtain a license to use third-party intellectual property (which license we may be unable to obtain on favorable terms, or at all). Even if we prevail against such claims, intellectual property litigation could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations.
If we are not able to successfully implement our productivity program referred to as “Fuel for Growth,” our consolidated results of operations could be negatively affected.
We have implemented a productivity program referred to as “Fuel for Growth” designed to improve operating efficiencies and reduce costs. While we expect this program to improve profitability and create additional investments behind brand building and growth initiatives, there are no assurances that such measures will prove to be successful or that the results we achieve through Fuel for Growth will be consistent with our expectations. We cannot provide assurance that we will realize cost savings, operating efficiencies or earnings growth in connection with Fuel for Growth. As a result, our results of operations could be negatively impacted. Finally, the timing and implementation of these plans require compliance with numerous laws and regulations, including local labor laws, and the failure to comply with such requirements may result in damages, fines and penalties which could adversely affect our business.
Labor disputes may cause work stoppages, strikes and disruptions.
Our manufacturing workforces in Zeeland, Michigan (U.S.); Evansville, Indiana (U.S.); Chonburi, Thailand and Singapore are not unionized. The manufacturing workforces in Guangzhou, China are unionized, but operate without a collective bargaining agreement. The manufacturing workforces in Delicias, Mexico, and São Bernardo do Campo, Brazil, are unionized and covered by collective bargaining agreements that are negotiated annually. The manufacturing workforce and non-supervisory sales force in Makati, Philippines are unionized and covered by a three-year collective bargaining agreement that was renewed effective January 2017. In addition, European Works Councils represent the manufacturing workforce in Nijmegen, the Netherlands, and the commercial organizations in France, Spain and Poland. Any labor disputes, including work stoppages, strikes and disruptions, could have a material adverse impact on our business.
Failure to comply with our debt covenants could have an adverse effect on our ability to obtain future financing at competitive rates and/or our ability to refinance our existing indebtedness.
There are various financial covenants and other restrictions in our debt instruments. If we fail to comply with any of these requirements, the related indebtedness could become due and payable prior to its stated maturity and our ability to obtain additional or alternative financing may be adversely affected. Further, we could incur an adverse impact on our effective tax rate if we need to repatriate earnings to the United States in order to repay such debt.
We may not successfully identify or complete acquisitions, joint ventures or other strategic initiatives.
From time to time, we evaluate potential acquisitions, joint ventures and other strategic initiatives and complete such transactions. We may consider divesting businesses that do not meet our strategic objectives or growth / profitability targets. We may also consider expanding our product portfolio by adding new product categories or expanding our operations through acquisitions of manufacturing and other facilities. For instance, on February 27, 2017, the Company announced that it has reached an agreement to acquire assets from Bega Cheese Limited (“Bega”). In connection with this transaction, the Company is acquiring from Bega a spray dryer and a finishing plant in Australia and entering into a service agreement to support the operation of those assets. The aggregate consideration
for this asset purchase is approximately AUD $200 million. The Company expects the transaction to close in the second quarter of 2017.
These activities may present financial, managerial, and operational risk including diversion of management’s attention from our existing business, business integration challenges, effective control implementation across a diverse employee population, the failure to achieve anticipated synergies, unanticipated liabilities and potential disputes. These activities may also include inherent risks associated with entering a geographic area which has less political, social or economic stability, less developed infrastructure and legal systems and in which we have no or limited prior operating experience. In addition, we may not be able to complete desirable transactions or initiatives for various financial, regulatory, technological or other reasons. Any of these factors could materially and adversely affect our financial condition and operating results.
Risks Related to Our Relationship with Our Former Parent
If our split-off from BMS fails to qualify for non-recognition of gain and loss, we may in certain circumstances be required to indemnify BMS for any resulting taxes and related expenses.
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 through the relevant audit years, we believe that such payment could be material and could have a material adverse effect on our financial condition and operating results.
Item 1B. UNRESOLVED STAFF COMMENTS.
None.
Item 2. PROPERTIES.
Our corporate headquarters are located in Glenview, Illinois, where we lease office space. We have committed to a long-term lease obligation related to a planned relocation of our corporate headquarters to Chicago, Illinois in the first half of 2017.
We maintain our global supply chain and R&D headquarters in Evansville, Indiana, where we own office, operations and laboratory buildings comprising approximately 1,269,000 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:
Location
Square Feet
Segment(s) Served
Owned / Leased
Zeeland, Michigan, United States
698,773
All segments
Owned
Evansville, Indiana, United States
458,595
All segments
Owned
Nijmegen, The Netherlands
205,134
All segments
Owned
Delicias, Mexico
134,549
North America / Europe
Latin America
Owned
São Bernardo do Campo, Brazil
64,583
Latin America
Leased
Singapore
466,077
Asia
Owned(1)
Chonburi, Thailand
158,456
Asia
Owned
Guangzhou, China
149,944
Asia
Owned(1)
Makati, Philippines
85,487
Asia
Owned(1)
(1) 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. As of December 31, 2016, we were still named as a “potentially responsible party,” or were involved in investigation and remediation, at one third-party disposal site. With regard to such matter, the substantive issues have been resolved, and management believes that any actual or expected additional remediation cost related to such matter, individually or in the aggregate, would be immaterial.
Litigation Related to the Merger
On February 14, 2017, a stockholder of the Company filed a purported stockholder class action lawsuit in Cook County, Illinois, captioned Kirkham v. Altschuler, et al., 2017-CH-02109. The defendants are the Company, its board of directors, Reckitt Benckiser and Merger Sub. The lawsuit alleges that the Company’s board of directors violated their fiduciary duties and that the Company, Reckitt Benckiser and Merger Sub aided and abetted such breaches, in each case in connection with the transactions contemplated by the Merger Agreement. The lawsuit seeks, among other things, to enjoin consummation of the Merger. The Company and its directors intend to vigorously defend against the allegations in the complaint.
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 impact on our business or financial condition, results of operations or cash flows.
Item 4. MINE SAFETY DISCLOSURES.
Not applicable.
Executive Officers of the Registrant
Set forth below are the names each of the Company’s executive officers and their ages and positions as of February 27, 2017. Also included below is biographical information relating to each of the Company’s executive officers. Each of the executive officers is elected by and serves at the pleasure of the board of directors.
Name
Position(s)
Peter Kasper Jakobsen
President and Chief Executive Officer; Director
Michel Cup
Executive Vice President and Chief Financial Officer
Charles M. Urbain
Executive Vice President and Chief Operating Officer
Patrick M. Sheller
Senior Vice President, General Counsel and Secretary
James Jeffrey Jobe
Senior Vice President, Global Operations
Dirk Hondmann, Ph.D.
Chief Scientific Officer
Ian E. Ormesher
Senior Vice President, Global Human Resources
James E. Shiah
Senior Vice President, Finance and Controller
Peter Kasper Jakobsen
Age 54
Mr. Jakobsen has been our President and Chief Executive Officer since April 2013, prior to which he served as the Company’s Executive Vice President and Chief Operating Officer since January 2012. Mr. Jakobsen previously had been our President, Americas from January 2009 through December 2011 and has been employed continuously by Mead Johnson since March 1998 in various capacities. From October 2006 to January 2009, he served as Senior Vice President, Asia Pacific. From February 2004 to October 2006, Mr. Jakobsen served as Vice President, South Asia, and from June 2001 to June 2004, he served as General Manager, Philippines. He currently serves as a member of the Company’s Board of Directors and as a member of the board of directors of SC Johnson.
Michel Cup
Age 47
Mr. Cup has been our Executive Vice President and Chief Financial Officer since September 2015. Before joining the Company, through January 2015, Mr. Cup was the Chief Financial Officer of D.E Master Blenders 1753, an international coffee and tea business headquartered in the Netherlands. Prior to joining D.E Master Blenders 1753, Mr. Cup served as Chief Financial Officer of Provimi from 2010-2011 and as Finance Director of Akzonobel’s Decorative Paints business in Europe from 2009-2010. Mr. Cup has also held senior finance roles in Numico’s Baby and Medical Nutrition business from 1999-2008, including CFO Baby Nutrition Asia Pacific. Mr. Cup began his career with Deloitte where he held various audit and accounting roles from 1993-1999.
Charles M. Urbain
Age 62
Mr. Urbain has been the Company’s Executive Vice President and Chief Operating Officer since September 2015. He previously served as the Interim Chief Financial Officer from March 2015 through August 2015, as well as serving as the Interim Controller and Treasurer from May 2015 through August 2015. Before holding these positions, Mr. Urbain had served as our Senior Vice President, Stakeholder Relations and Chief Development Officer since January 2012, which role included leadership of the Company’s global human resources function. Mr. Urbain previously had been our President, Asia and Europe from January 2009 through December 2011 and has been employed continuously by Mead Johnson or BMS since February 1987 in various capacities. From June 2008 to January 2009, he served as Senior Vice President, North America, Latin America and Europe. From June 2007 to June 2008, Mr. Urbain served as Senior Vice President, North America and Europe. From January 2004 to June 2007, Mr. Urbain served as Senior Vice President, International, and from January 2001 to January 2004, he served as Senior Vice President, Latin America, Canada and Europe. From January 1999 to December 2000, Mr. Urbain served as Chief Financial Officer of the Mead Johnson division of BMS.
Patrick M. Sheller
Age 55
Mr. Sheller has been our Senior Vice President, General Counsel and Secretary since January 2015. Prior to joining the Company, Mr. Sheller served as Senior Vice President, General Counsel, Secretary and Chief Administrative Officer of Eastman Kodak Company (‘‘Kodak’’). He served as Kodak’s General Counsel since 2011, as its Chief Administrative Officer since 2012 and as Secretary to Kodak’s Board of Directors since 2009. In 2011, Mr. Sheller was named Kodak’s Deputy General Counsel, and from 2005 to 2011, he served as Kodak’s Chief Compliance Officer. Prior to that time, Mr. Sheller held various senior counsel roles with Kodak, including Chief Antitrust Counsel, division counsel to the Health Group and international commercial counsel to the Europe, Africa & Middle East Region. He also held operational roles in Kodak’s Health Group as Director of Strategic Planning and Business Development of the Health Care Information
Systems business and Director of Operations for the Health Informatics business. Before joining Kodak, Mr. Sheller was in private law practice with the firm of McKenna Conner & Cuneo (now Dentons) and served as an attorney advisor with the Federal Trade Commission, both in Washington, D.C.
James Jeffrey Jobe
Age 57
Mr. Jobe has been our Senior Vice President, Global Operations since December 2016, before which time he served as our Senior Vice President, Technical Operations since October 2014. Previously, Mr. Jobe served as our Senior Vice President, Global Supply Chain since November 2005. Mr. Jobe has been continuously employed by Mead Johnson since 1988. From May 2003 to November 2005, Mr. Jobe served as Senior Director, North America Supply Chain. From March 2000 to May 2003, Mr. Jobe served as Senior Director, International Supply Chain.
Dirk Hondmann, Ph.D.
Age 53
Dr. Hondmann has been our Chief Scientific Officer since October 2014, prior to which time he served as our Senior Vice President, Global Research and Development since joining Mead Johnson in October 2005. From October 2002 to October 2005, Mr. Hondmann served as vice president, research and development of Slimfast, an affiliate of the Unilever Group, an international manufacturer of food, home care, and personal care products.
Ian E. Ormesher
Age 54
Mr. Ormesher has been our Senior Vice President, Global Human Resources since September 2014. Before joining the Company, Mr. Ormesher served as the Vice President, Human Resources - Western Europe at Carlsberg Breweries A/S from October 2012 to September 2014. From January 2011 to September 2012, he was the Vice President, Human Resources - Asia at Carlsberg Breweries. Prior to that time, Mr. Ormesher spent 12 years with SABMiller, where he served in a variety of HR and organizational development roles of increasing responsibility, including as HR Director of its business in China, and ultimately as its Group Marketing Capability Director from October 2008 to January 2011.
James E. Shiah
Age 57
Mr. Shiah has been our Senior Vice President, Finance and Controller since December 2015, prior to which time he served as our Senior Vice President, Finance since June 2015. Before holding this position, Mr. Shiah served as the Senior Vice President, Chief Accounting and Compliance Officer of Coty Inc. from 2011 to 2014. In this position, Mr. Shiah was Coty’s principal accounting officer responsible for overseeing various activities including financial reporting, systems of internal control and other compliance programs. Mr. Shiah was Coty’s Senior Vice President Finance and Global Controller from 2006 to 2011 and its Vice President and Corporate Controller from 2001 to 2006. Mr. Shiah began his career at Deloitte & Touche and is a Certified Public Accountant.
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.
Market Price for
MJN Common Stock
Dividends
Declared
Per Share
High
Low
First Quarter
$
105.45
$
97.09
$
0.4125
Second Quarter
$
104.34
$
89.26
$
0.4125
Third Quarter
$
91.89
$
69.20
$
0.4125
Fourth Quarter
$
84.49
$
69.31
$
0.4125
First Quarter
$
85.25
$
65.53
$
0.4125
Second Quarter
$
92.01
$
81.53
$
0.4125
Third Quarter
$
94.40
$
76.26
$
0.4125
Fourth Quarter
$
81.91
$
70.25
$
0.4125
Under the Merger Agreement described in “Part I. Item 1. Business-Merger Agreement,” we are prohibited from declaring, setting aside or paying any dividend or other distribution in respect of our common stock or other securities, except for our regular quarterly dividend of up to $0.4125 per share per quarter with record and payment dates consistent with the quarterly record and payment dates in 2016.
Holders of Common Stock
The number of record holders of our common stock at December 31, 2016 was 1,065. 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, 2016:
(Dollars in millions, except per share data)
Period
Total Number of
Shares Purchased
(1)
Average Price
Paid per Share
(2)
Total Number of
Shares Purchased
as Part of Publicly
Announced Programs
Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Programs
(3)
October 1, 2016 through October 31, 2016
-
$
-
-
$
500.0
November 1, 2016 through November 30, 2016
1,380,155
72.46
1,380,155
400.0
December 1, 2016 through December 31, 2016
-
-
-
400.0
1,380,155
$
72.46
1,380,155
$
400.0
(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 and discounts.
(3)
On October 22, 2015, the Company announced that, on October 20, 2015, its board of directors approved a share repurchase authorization of $1,500.0 million of the Company’s common stock (the “2015 Authorization”). The 2015 Authorization does not have an expiration date. As of December 31, 2016, the Company had $400.0 million remaining available under the 2015 Authorization.
Under the Merger Agreement described in “Part I. Item 1. Business-Merger Agreement,” we are prohibited from redeeming, repurchasing or otherwise acquiring or offering to redeem, repurchase, or otherwise acquire our common stock or other securities, other than shares surrendered to us to pay the exercise price in connection with the exercise of employee stock options and shares surrendered to us 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.
Performance Graph
Comparison of Cumulative Total Return
The following graph compares the cumulative total return on an investment in our common stock with the cumulative total return on an investment in each of the Standard & Poor’s 500 Stock Index (“S&P 500 Index”) and the S&P 500 Packaged Foods Index. The graph assumes that the value of the investment in our common stock and in each index was $100 and that all dividends were reinvested.
Comparison of 5-Years Cumulative Total Return
Among Mead Johnson Nutrition Company, the S&P 500 Index
and the S&P 500 Packaged Foods Index
Assumes Initial Investment of $100
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
Mead Johnson Nutrition Company
100.00
97.39
126.00
153.73
123.06
112.66
S&P 500 Stock Index
100.00
116.00
153.57
174.60
177.01
198.18
S&P 500 Packaged Foods Index
100.00
110.39
144.43
161.07
189.07
206.34
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 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 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 category-defining products across our product portfolio. We operate in four geographies which represent our operating segments: Asia, North America, Latin America and Europe. Due to similarities between North America and Europe, we aggregated these two operating segments into one reportable segment. As a result, the Company has three reportable segments: Asia, Latin America and North America/Europe.
Our financial results continue to be significantly affected by changes in foreign currency exchange rates. With a global footprint, we have faced challenges throughout 2016 from weakness in many economies throughout Asia and Latin America and the devaluation of their respective currencies. Adverse foreign exchange impacts were prominent in markets such as China, Mexico and Argentina. We remain cautious of the impact of such exchange rates on our reported results because a substantial portion of our business is outside of the U.S. and the U.S. dollar has recently been strengthening in relation to many relevant currencies. We have implemented certain measures to offset some of the impact of adverse foreign exchange. However, if the U.S. dollar continues to strengthen or does so at an accelerated pace, we may experience a greater impact to our business.
Merger Agreement
On February 10, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Reckitt Benckiser Group plc, a company incorporated in England and Wales (“Reckitt Benckiser”), and Marigold Merger Sub, Inc., a Delaware corporation and a wholly owned indirect subsidiary of Reckitt Benckiser (“Merger Sub”), pursuant to which Reckitt Benckiser will indirectly acquire the Company by means of a merger of Merger Sub with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement (the “Merger”). The Merger Agreement and the consummation of the transactions contemplated by the Merger Agreement have been unanimously approved by the Company’s board of directors.
Consummation of the Merger is subject to the satisfaction or waiver of certain customary closing conditions, including, among others: (i) the affirmative vote of the holders of a majority of the Company's outstanding shares of common stock; (ii) the affirmative vote of a simple majority of Reckitt Benckiser's shareholders at a shareholder meeting; (iii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of certain other non-United States regulatory approvals required to consummate the Merger; and (iv) in the case of Reckitt Benckiser's obligations to consummate the Merger, the absence of a Company Material Adverse Effect (as defined in the Merger Agreement). Reckitt Benckiser and Merger Sub's respective obligations to consummate the Merger are not subject to any financing condition or other contingency.
Additional information about the Merger Agreement is set forth in our Current Report on Form 8-K filed with the SEC on February 13, 2017.
Results of Operations
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Summary of Results:
The results for the years ended December 31, 2016 and 2015 included several items that affected the comparability of these results. These items include significant expenses/(income) not indicative of underlying operating results (“Specified Items”) and are listed in the table below:
For the year ended December 31, 2016, Specified Items included $81.8 million of long-lived asset impairment charges, foreign exchange losses and other asset write-offs in Venezuela. Restructuring, severance and other related costs include $29.2 million of charges related to the Company’s ongoing Fuel for Growth initiatives. Specified Items also includes gains of $7.4 million related to the remeasurement of defined benefit pension and other post-employment benefit plans. The remeasurement gains were driven by a $5.5 million gain on remeasurement of the Mead Johnson & Company Retirement Plan in the United States (“U.S. Pension Plan”) net liability due to higher than expected asset returns. Within Other, the Company recognized charges associated with relocation and consolidation of administrative offices. The income tax on Specified Items includes a $14.7 million tax benefit relating to the forgiveness of Venezuela’s intercompany payables.
For the year ended December 31, 2015, Specified Items included restructuring charges of $25.1 million related to the Company’s ongoing Fuel for Growth initiatives, payments of $12.0 million made in connection with the SEC settlement disclosed by the Company in July 2015, losses of $8.2 million related to the remeasurement of defined benefit pension and other post-employment benefit plans and a $5.6 million gain due to the sale of marketable securities. The remeasurement losses of pension and other post-employment benefit plans were mainly driven by the U.S. Pension Plan as lower than expected asset returns of $16.4 million only partially offset by a $12.1 million gain from an increase in discount rates.
For additional information on these Specified Items, see “Item 8. Financial Statements and Supplementary Data-Note 6. Restructuring, -Note 8. Pension and Other Post-Employment Benefit Plans, -Note 17. Marketable Securities, and -Note 20. Venezuela Currency Matters.”
It is the Company’s policy to consistently include gains and losses, as incurred, related to the remeasurement of defined benefit pension and post-employment benefit plans within Specified Items. The remeasurement reflects changes in the pension assets and liabilities above what was estimated and included in periodic costs. Factors beyond our control such as changes in discount rates, market volatility and mortality assumptions drive the remeasurement amount. Additionally, the majority of our pension and post-
employment plans are frozen, and therefore the benefits provided to participants in the plans are not related to our underlying operations.
Net Sales
The Company recognizes 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 gross sales to net sales is as follows:
The total gross-to-net sales adjustments increased as a percentage of gross sales to 27% in 2016 from 25% in 2015, primarily driven by an increase in sales discounts. Sales discounts increased due to trade investments supporting product launches and channel investments in China.
Net sales by reportable segment and principle product category are shown in the tables below:
Asia
Volume declined 6% in Asia. In China, sales volume represented a 3% decline in the segment as reduced demand for locally manufactured products and a shift to e-commerce in the Hong Kong channel due to regulation changes were only partially offset by improved market share within growing channels and the successful launch of imported premium products. In addition, the Philippines had a 3% adverse impact on sales volume in the segment, two-thirds of which was driven by market share losses and another one-third of which was due to the adverse effect of retail inventory adjustments.
Price/Mix increased 1% in Asia due to price increases in a number of emerging markets, most notably the Philippines. In China, a 2% benefit from favorable sales mix due to newly launched product innovation offset a 2% adverse impact from increased trade investment.
Foreign exchange adversely impacted sales in Asia by 4%, approximately half of which was due to currency devaluation in China with the remaining decrease across the other markets in the segment.
Latin America
Volume declined 10% in Latin America. Venezuela contributed 6% to this volume decline following the Company’s 2015 decision to suspend shipments to distribution channels in Venezuela. This decision was made due to constraints placed by the Venezuelan government on the release of U.S. dollars to settle intercompany payables associated with product shipments. Macroeconomic challenges in Ecuador and Brazil contributed a 2% volume loss, in aggregate, to the segment.
Price/Mix increased 9% in Latin America as a result of price increases, most notably in Mexico and Argentina which each contributed a 3% increase in segment sales.
Foreign exchange adversely impacted sales in Latin America by 14% due to a strengthening U.S. dollar, most notably 6% in Mexico and 5% in Argentina.
North America/Europe
Volume declined 4% in North America/Europe. The U.S. contributed 5% to this volume decline due to market share weakness and increased promotional activities by competitors. Canada contributed a 1% gain in segment sales volume due to continued market share gains in both infant and children’s products.
Price increased 2% in North America/Europe due to favorable pricing driven three-fourths by the U.S. and one-fourth by Canada.
Foreign exchange adversely impacted sales in North America/Europe by 1% due to currency devaluations in Canada and the U.K.
The U.S. business is subject to variability from changes to our participation in the WIC program described in “Item 1. Business- The Special Supplemental Nutrition Program for Women, Infants and Children (“WIC”).” Such variability includes changes in renewal patterns, rebate levels, product presence and volume of full price sales from product purchased in excess of the rebated volume. See “Item 1A. Risk Factors-“Changes in WIC, or our participation in it, could materially adversely affect our business.”
Gross Profit
Gross margin percentage decreased slightly in 2016 compared to 2015. Gross margin was favorably impacted by lower dairy costs (+2.9%), which was offset by sales of less profitable products (-2.0%) and adverse impact from foreign exchange (-1.2%).
Operating Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased in 2016 compared to 2015 due to approximately $80 million of incremental savings generated from the Fuel for Growth program in 2016, primarily from streamlined use of third-party services and lower headcount. Additionally, expenses were lower as a result of a $40.2 million benefit from foreign exchange.
Advertising and Promotion Expenses
Advertising and promotion expenses decreased slightly in 2016 compared to 2015 mainly as a result of favorable foreign exchange of $27.2 million and lower spending of $8.6 million in North America/Europe and $7.0 million in Latin America in 2016. This decrease was offset by increased spending of $28.0 million in Asia, as investments made to increase consumer awareness of Enfinitas, an enhanced digital presence and support channel investments in China of $37.2 million were offset by more lower investments across other Asian markets.
Research and Development Expenses
Research and development expenses decreased in 2016 compared to 2015 mainly due to approximately $9 million of incremental Fuel for Growth savings in 2016 from increased efficiencies in the use of third-party services and lower headcount.
Other (Income)/Expenses-net
Foreign exchange (gains)/losses - net includes $32.9 million of currency losses within our subsidiary in Venezuela. See “Item 8. Financial Statements and Supplementary Data-Note 10. Other (Income)/Expenses - Net, -Note 20. Venezuela Currency Matters, and -Note 6. Restructuring” for additional information.
Earnings before Interest and Income Taxes
EBIT from the three reportable segments, Asia, Latin America and North America/Europe, is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment benefit plans; and income or expenses incurred within the operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results.
EBIT in Asia decreased by $122.7 million in 2016 compared to 2015 partially due to $43.2 million of adverse foreign exchange rates and lower sales volumes which resulted in lower gross profit of $42.2 million. Also impacting gross profit was disadvantageous sales mix which had an adverse impact of $32.1 million and increased manufacturing costs of $18.5 million, partially offset by lower dairy and commodity costs of $42.0 million. Higher advertising and promotion spending of $28.0 million was primarily related to increasing consumer awareness of Enfinitas and channel investments in China. The decrease in EBIT was partially offset by fixed asset write-offs of $8.4 million in 2015 as the Company optimized the supply chain network in Asia which did not recur in 2016.
EBIT in Latin America decreased by $18.5 million in 2016 compared to 2015 mainly due to $36.4 million of adverse foreign exchange rates. Lower earnings related to a $48.0 million reduction in sales in Venezuela as a result of suspended shipments were offset by price increases in Mexico and Argentina of $47.2 million, lower dairy costs of $10.5 million, reduced advertising and promotion spending of $7.0 million and approximately $4 million of incremental savings from Fuel for Growth in 2016.
EBIT in North America/Europe increased by $18.5 million in 2016 compared to 2015. The increase was primarily due to gross margin improvements from lower dairy and commodity costs of $14.9 million and manufacturing related productivities of $21.5
million, as well as Fuel for Growth savings on operating expenses of approximately $14 million, reduced advertising and promotion expenditures of $8.6 million and lower incentive compensation of $7.0 million. These increases more than offset the reduced gross profits from lower sales volume of $31.9 million as well as adverse changes in foreign exchange rates of $15.2 million.
Corporate and Other expenses decreased by $5.2 million. Items resulting in lower Corporate and Other expenses include approximately $60 million of incremental savings from Fuel for Growth in 2016, $7.4 actuarial gains in 2016 related to the remeasurement of defined benefit pension and other post-employment benefit plans compared to $8.2 million actuarial losses in 2015, and $12.0 million of payments in connection with an SEC settlement in 2015 which did not recur in 2016. The decrease in Corporate and Other expenses was partially offset by $81.8 million of long-lived asset impairment charges, foreign exchange losses and other asset write-offs in Venezuela in 2016.
Interest Expense-net
Net interest expense increased $40.4 million in 2016 compared to 2015 primarily driven by $46.4 million of interest expense on the $750.0 million of 3.0% Senior Notes due November 15, 2020 (the “2020 Notes”) and the $750.0 million of 4.125% Senior Notes due November 15, 2025 (the “2025 Notes”), both issued in November 2015. Partially offsetting the interest expense from these notes is a benefit from an interest rate swap on the 2020 Notes which reduced interest expense by $6.8 million.
Income Taxes
The Company’s Effective Tax Rate (“ETR”) for both the 2016 and 2015 periods differs from the statutory tax rate predominantly due to the favorable impact of tax rulings and agreements in various foreign jurisdictions. See “Item 8. Financial Statements and Supplementary Data-Note 4. Income Taxes” for additional information. The ETR for the year ended December 31, 2016 and 2015 was 23.0% and 24.8%, respectively. The ETR decrease was driven 5.2% by tax credits from the repatriation of foreign earnings to the United States, offset 2.8% by the Company’s Venezuelan subsidiary which incurred a remeasurement loss on its monetary assets and an impairment charge on its long-lived assets in 2016 (both of which provided no tax benefit - see “Item 8. Financial Statements and Supplementary Data-Note 20. Venezuela Currency Matters” for additional information) and 0.6% from a series of additional items which are insignificant both individually and in the aggregate.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of a 11%, 10% and 10% interest held by third parties in our operating entities in China, Argentina and Indonesia, respectively. See “Item 8. Financial Statements and Supplementary Data-Note 18. Equity” for additional information.
Net Earnings Attributable to Shareholders
Net earnings attributable to shareholders for the year ended December 31, 2016 decreased 17% to $544.9 million compared with the year ended December 31, 2015.
Results of Operations
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Summary of Results:
The results for the years ended December 31, 2015 and 2014 included Specified Items and are listed in the table below:
For the year ended December 31, 2015, Specified Items included restructuring charges related to the Company’s Fuel for Growth initiative ($25.1 million), payments made in connection with the SEC settlement disclosed by the Company in July 2015 ($12.0 million) and a marketable securities gain ($5.6 million).
Specified Items consistently include the remeasurement of defined benefit pension and post-employment benefit plans. Such re-measurement reflects changes in the pension assets and liabilities above what was estimated and included in periodic costs. Factors beyond our control such as changes in discount rates, market volatility and mortality assumptions drive the remeasurement amount. Additionally, the majority of our pension and post-employment plans are frozen, and, therefore the benefits provided to participants in such plans are not related to our underlying operations. In 2015, the re-measurement loss ($8.2 million) was driven by returns on plan assets that were lower than anticipated. In 2014, the re-measurement loss ($51.5 million) was primarily driven by a change in mortality assumptions and discount rate movements.
For the year ended December 31, 2014, the legal, settlements and related costs included legal ($12.0 million) and professional expenses ($1.5 million), partially offset by an insurance loss recovery ($3.2 million).
Net Sales
The Company recognizes 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 gross sales to net sales is as follows:
The total gross-to-net sales adjustments increased as a percentage of gross sales in 2015 compared with 2014, largely due to price-based promotional activity in 2015 in China.
Net sales by reportable segment and principle product category are shown in the tables below:
Asia sales decreased 11% in 2015 compared to 2014 and accounted for 50% of our net sales. Volume (3%) decreased in China as consumer demand shifted to digital purchasing channels and faster-growing imported products in which the Company has historically had lower representation. Adverse foreign translation (3%) and increased price-based promotional activity enabled by lower dairy costs also contributed to lower sales in China, Thailand and Malaysia (3%, 2% and 1%, respectively). In the second quarter of 2015, the Company launched a range of fully-imported products in China, available through all channels, which has shown positive results. Sales in the Philippines were higher in 2015 than 2014 primarily as a result of favorable product mix (1%).
Latin America sales decreased 13% in 2015 compared to 2014 and accounted for 19% of our net sales. Foreign currency adversely impacted sales by 16% primarily due to the strengthening of the U.S. dollar against the Mexican peso (6%), Venezuelan bolivar (3%) and Brazilian real (2%). Strategic price increases in Argentina (3%) and Colombia (1%) fully offset sales volume decline of 4% which was due in part to the increase in competition within the milk modifier category in Mexico. Sales volume decline was mainly from intentionally reduced shipments to Venezuela (3%) during the latter part of 2015 as a result of the constraints placed by the Venezuelan government on the release of U.S. dollars. Share gains were seen following select strategic investments.
North America/Europe sales increased 1% in 2015 compared to 2014 and accounted for 31% of our net sales. Sales growth was driven by share gains (1%), higher realized prices and favorable product mix (3%). Children’s nutrition growth in this segment reflected investments made to build the children’s brand. Foreign exchange translation (3%), most notably in Canada (1%), partially offset the sales increase.
Gross Profit
Gross margin percentages benefited primarily from lower dairy costs (+3.3%). Productivity savings (+1.3%) were offset by increases in other commodity and production costs (-1.8%).
Operating Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased 9% in 2015 compared to 2014 primarily due to lower actuarial losses ($27.8 million) in 2015 related to the defined benefit pension and other post-employment benefit plans compared to prior year. Lower incentive based compensation in 2015 ($10.0 million) and initial savings from Fuel for Growth (approximately $20 million) also reduced selling, general and administrative expenses compared to 2014.
Advertising and Promotion Expenses
Advertising spending includes television, print, digital and other consumer media. Promotion activities include product evaluation and education related materials provided to health care professionals and consumers, where permitted by regulation. Advertising and promotion expenses reflected higher demand-creation investments ($20.5 million) in support of our strategic growth initiatives including the fully imported products in China and high value product offerings in the U.S.
Research and Development Expenses
Research and development expenses include continued investment in our innovation capability, product pipeline and quality programs. In addition, research and development expenses decreased due to changes in employee related costs as lower actuarial losses ($4.8 million) in 2015 related to the defined benefit pension and other post-employment benefit plans compared to 2014.
Other (Income)/Expenses-net
For the year ended December 31, 2015, severance charges were primarily related to Fuel for Growth ($25.1 million). Also recognized in other (income)/expenses were payments made in connection with the SEC settlement disclosed by the Company in July 2015 ($12 million) and fixed asset disposal write-offs ($8.4 million) as the Company optimizes its Asia supply chain strategy. In 2014, the recorded gain was related to the revision of a defined benefit plan outside of the United States ($5.4 million) and the sale of an investment ($4.0 million).
Earnings before Interest and Income Taxes
EBIT from the three reportable segments, Asia, Latin America and North America/Europe, is reduced by Corporate and Other expenses. Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment benefit plans; and income or expenses incurred within the operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results.
EBIT in Asia decreased 17% primarily due to lower sales in 2015, which were partially offset by lower dairy costs ($94.1 million). Additionally, operating costs were higher due to advertising and promotional investments to support the new product launches in China ($19.5 million), the establishment of plastic packaging formats across a number of markets and fixed asset write-offs ($8.4 million) as the Company optimized its supply chain network in Asia.
Latin America EBIT decreased 12% due to lower sales and investment spending ($13.4 million) partially offset by an improved gross margin ($59.6 million). On a local currency basis, EBIT increased primarily due to lower commodity costs, namely dairy ($20.6 million), and improved productivity ($7.0 million). This was offset by adverse foreign translation impacts ($59.9 million). In addition, 2014 comparably included foreign exchange gains generated from cash received at the official Venezuelan government rate compared to the SICAD rate adopted by the Company in February 2014. See “Item 8. Financial Statements and Supplementary Data-Note 20. Venezuela Currency Matters” for further information regarding exchange rate variability in Venezuela.
EBIT in North America/Europe increased 24% primarily due to gross margin improvement resulting from both higher realized pricing ($32.6 million) and lower dairy costs ($19.4 million). Demand-creation investments led to increased sales volume ($9.4 million). Lower operating expenses were attributable to a lower provision of incentive based compensation ($1.6 million). Adverse foreign exchange movements ($12.5 million) partially offset the increase in EBIT.
Corporate and Other expenses decreased in 2015 compared to 2014 primarily due to lower 2015 actuarial losses ($43.3 million) related to the defined benefit pension and other post-employment benefit plans, lower incentive compensation ($6.3 million) and savings from Fuel for Growth, partially offset by Fuel for Growth charges ($25.1 million).
Interest Expense-net
Net interest expense for the year ended December 31, 2015 increased compared to 2014 primarily as a result of interest expense ($8.7 million) on the 2020 Notes and the 2025 Notes, both issued in November 2015. These expenses were partially offset by gains ($5.2 million) related to fixed to floating rate fair value hedges on both the 2020 Notes and our $700.0 million of 4.90% Notes due November 1, 2019 (the “2019 Notes”).
Income Taxes
The Company’s ETR for both the 2015 and 2014 periods differs from the statutory tax rate predominantly due to the favorable impact of tax rulings and agreements in various foreign jurisdictions. The ETR for the years ended December 31, 2015 and 2014 was 24.8% and 21.5%, respectively. Unfavorable geographic earnings mix contributed 3.4% to the ETR increase, which was offset slightly by a series of additional items which are insignificant both individually and in the aggregate.
Net Earnings Attributable to Noncontrolling Interests
Net earnings attributable to noncontrolling interests consists of approximately 11%, 10% and 10% interest held by third parties in our operating entities in China, Argentina and Indonesia, respectively.
Net Earnings Attributable to Shareholders
Net earnings attributable to shareholders for the year ended December 31, 2015 decreased 9% to $653.5 million compared with the year ended December 31, 2014.
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash on hand, cash from operations and available borrowings under our $750.0 million 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 computer software, equipment and buildings. Cash flows used in financing activities primarily represent proceeds and repayments of long-term and short-term borrowings, dividend payments and share repurchases.
Cash and cash equivalents totaled $1,795.4 million at December 31, 2016, of which $1,594.2 million was held outside of the United States. Cash and cash equivalents totaled $1,701.4 million as of December 31, 2015, of which 1,512.5 million was held outside of the United States.
During 2016, we repatriated cash associated with earnings and profits not permanently invested abroad of approximately $276 million to the United States from multiple jurisdictions. During 2015, we repatriated cash associated with earnings and profits not permanently invested abroad of approximately $59 million to the United States from multiple jurisdictions.
As a result of the evaluation of our global cash position, management has asserted that earnings and profits in certain foreign jurisdictions are permanently invested abroad. We will continue to evaluate our global cash position and whether earnings and profits of these and other foreign jurisdictions are permanently invested abroad. The amount of cash associated with permanently invested foreign earnings was approximately $1,388 million and $1,124 million as of December 31, 2016 and 2015, respectively. 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, 2016, 2015 and 2014 were $308.8 million, $326.0 million and $296.6 million, respectively. Dividend payments were lower in 2016 due to the retirement of shares repurchased primarily under an accelerated repurchase agreement.
Cash Flows
We believe that cash on hand, cash from operations and the available revolving 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, 2016 Compared to Year Ended December 31, 2015
For the year ended December 31, 2016, cash flow provided by operating activities was $691.6 million and lower than the prior year due to reduced net earnings of $106.0 million, a $56.0 million reduction in income taxes payable, lower non-cash charges of $29.4 million, lower accrued expenses, rebates and returns of $26.8 million and $23.0 million of reduced cash advances from customers. Offsetting these decreases was $44.0 million of lower contributions to pension and other post-employment benefit plans, net of tax impacts. For the year ended December 31, 2015, cash flow from operating activities was $909.9 million and primarily driven by net earnings and increased rebates related to price-based promotional discounting mainly in Asia, as well as increased provisions for restructuring and interest. Cash flow from operating activities was reduced in 2015 by an $84.0 million discretionary contribution to the U.S. Pension Plan.
Cash flow used in investing activities was $24.5 million lower in 2016 compared to 2015. The decrease was largely the result of lower spending in 2016. For the year ended December 31, 2016 and 2015, cash flow from investing activities included capacity expansion for manufacturing facilities in the U.S. and Europe to accommodate demand for new products.
Cash flow used in financing activities was $399.6 million for the year ended December 31, 2016, and included $308.8 million of dividend payments and $100.4 million of share repurchases. Cash flow used in financing activities was $286.8 million for the year ended December 31, 2015, consisting primarily of $326.0 million of dividend payments, $1,002.9 million repayments of short-term borrowings and $1,437.0 million of share repurchases. Financing activities in 2015 also included the issuance of our 2020 Notes and 2025 Notes and repurchases of Company stock under the 2013 Authorization and 2015 Authorization, discussed below, which resulted in a net cash inflow of $50.7 million.
For the year ended December 31, 2016, the effects of changes in exchange rates on cash and cash equivalents primarily includes the devaluation of the Venezuelan Bolivar.
Year Ended December 31, 2015 Compared to Year Ended 2014
For the year ended December 31, 2015, cash flow provided by operating activities was $909.9 million and primarily driven by net earnings and increased rebates related to price-based promotional discounting mainly in Asia, as well as increased provisions for restructuring and interest. Cash flow from operating activities was reduced in 2015 by an $84.0 million discretionary contribution to the U.S. Pension Plan. For the year ended December 31, 2014, cash flow from operating activities was $793.4 million and primarily driven by net earnings, partially offset by an increase in working capital, defined as accounts receivable plus inventory less accounts payable (excluding capital related items), and $45.0 million of payments related to the settlement of interest rate forward swaps.
Cash flow used in investing activities was $9.2 million lower in 2015 compared to 2014. The decrease was largely the result of spending in 2014 related to the Singapore manufacturing and technology facility. Investing activities in 2015 included capacity expansion for manufacturing facilities in the U.S. and Europe to accommodate demand for new products.
Cash flow used in financing activities was $286.8 million for the year ended December 31, 2015, consisting primarily of $326.0 million of dividend payments, $1,002.9 million repayments of short-term borrowings and $1,437.0 million of share repurchases. Financing activities in 2015 also included the issuance of our 2020 Notes and 2025 Notes and repurchases of Company stock under the 2013 Authorization and 2015 Authorization, discussed below, which resulted in a net cash inflow of $50.7 million. Cash flow used in financing activities was $325.5 million for the year ended December 31, 2014, consisting primarily of $296.6 million of dividend payments, $0.6 million repayments of short-term borrowings and $54.1 million of share repurchases.
Short-Term Borrowings
As of December 31, 2016 and 2015, the Company had short-term borrowings of $3.9 million and $3.0 million, respectively, which consisted primarily of borrowings made by its subsidiary in Argentina.
Capital Expenditures
Capital expenditures and the cash outflow for capital expenditures were as follows:
Capital expenditures in 2016 and 2015 relate primarily to facilities involved in the manufacturing of fully-imported products for China and liquid product offerings in the United States. Capital expenditures in 2014 included investments primarily in our spray dryer in Singapore and research and development capabilities which were placed in-service during the second and third quarters of 2014. For 2017, we expect capital expenditures to approach our long-term target of 4% of sales.
Revolving Credit Facility Agreement
The Company has an unsecured, five-year revolving credit facility agreement (the “Revolving Credit Facility”) which is repayable at maturity in June 2019, subject to annual extensions if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at any one time under the Revolving Credit Facility is $750.0 million, which may be increased from time to time up to $1,000.0 million at the Company’s request, subject to obtaining additional commitments and other customary conditions.
The Revolving Credit Facility contains financial covenants, whereby the ratio of consolidated adjusted total debt to consolidated EBITDA cannot exceed 3.50 to 1.0, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.0 to 1.0. The Company was in compliance with these financial covenants as of December 31, 2016. Borrowings from the Revolving Credit Facility are used for working capital and other general corporate purposes. During 2015, the Company borrowed approximately $446.0 million under the Revolving Credit Facility primarily to repurchase shares of common stock. The Company repaid these amounts in November 2015. As of December 31, 2016 and 2015, we had no borrowings outstanding under the Revolving Credit Facility. We had $750.0 million available as of December 31, 2016.
Borrowings under the Revolving Credit Facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period or (b) a floating rate based upon JPMorgan Chase Bank’s prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company’s credit rating. The margin can range from 0% to 1.375% over the base rate. In addition, the Company incurs an annual 0.125% facility fee on the entire facility commitment of $750.0 million.
The Company has guaranteed the obligations of all of its subsidiaries that may from time to time become borrowers under the Revolving Credit Facility. If our corporate credit rating falls below (i) Baa3 by Moody's Investors Service, Inc. (“Moody's”) or (ii) BBB- by Standard & Poor's Ratings Service (“S&P”), Mead Johnson & Company, LLC shall automatically be deemed to guarantee the obligations under the Revolving Credit Facility in addition to the guarantee provided by Mead Johnson Nutrition Company. Moody's credit rating for MJN is currently Baa1. S&P's credit rating for MJN is currently BBB.
Long-Term Debt and Interest Rate Swaps
The components of our long-term debt are detailed in the table below:
During the year ended December 31, 2015, the Company entered into a $1,000.0 million short-term loan agreement (the “Term Loan Agreement”) with various financial institutions, including Citibank, N.A., as Syndication Agent, and JPMorgan Chase Bank, N.A. (“JPMCB”), as Administrative Agent. The Company repaid all borrowings under the Term Loan Agreement and terminated the Term Loan Agreement during the year ended December 31, 2015. The payoff amount of $1,000.3 million included principal, accrued and unpaid interest and a facility fee.
During the year ended December 31, 2015, the Company issued and sold the 2020 Notes and 2025 Notes at a public offering price of 99.902% and 99.958%, respectively. The Company received net proceeds of $1,487.7 million from the sale of both the 2020 Notes and 2025 Notes, after deducting underwriters’ discounts and offering costs. Interest is payable on each of the 2020 Notes and 2025 Notes on May 15 and November 15 of each year. Proceeds from the 2020 Notes and 2025 Notes were used to repay the Term Loan Agreement and borrowings under the Revolving Credit Facility. The remainder of the net proceeds was for general corporate purposes.
During the year ended December 31, 2015, the Company entered into six interest rate swaps with multiple counterparties to mitigate interest rate exposure associated with the 2020 Notes. The swaps have an aggregate notional amount of $750.0 million of outstanding principal. This series of swaps effectively converts the $750.0 million of 2020 Notes from fixed to floating rate debt for the remainder of their term. As of December 31, 2016, these swaps were in a loss position with a fair value of $6.3 million.
During the year ended December 31, 2014, the Company issued and sold $500.0 million 2044 Notes at a public offering price of 99.465%. Net proceeds from the sale of the 2044 Notes, after deducting underwriters’ discounts and offering expenses, were $492.0 million. Interest on the 2044 Notes is payable semi-annually on June 1 and December 1 of each year. Proceeds from the 2044 Notes were used to redeem all $500.0 million of our 3.50% Notes due in 2014 (“2014 Notes”). The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million.
In the fourth quarter of 2013, prior to the issuance of our 2044 Notes, we entered into a series of interest rate forward swaps to lock in an interest rate, reflecting then-prevailing rates, in anticipation of the offering. The fair value of these interest rate forward swaps was dependent on the movements in thirty-year interest rates. As a result of a rise in interest rates leading up to December 31, 2013, these interest rate forward swaps were in a gain position with a fair value of $19.4 million as of that date. However, as a result of a subsequent decline in thirty-year interest rates, the fair value of these interest rate swaps declined $64.4 million, resulting in a loss position with a fair value of $45.0 million upon our settlement in May 2014. This $45.0 million is a deferred loss being amortized into interest expense over the life of the 2044 Notes.
During the second quarter of 2014, the Company entered into eight interest rate swaps with multiple counterparties, which have an aggregate notional amount of $700.0 million of outstanding principal. This series of swaps effectively converts the $700.0 million of 2019 Notes from fixed to floating rate debt for the remainder of their term. As of December 31, 2016, these swaps were in an asset position with a fair value of $1.1 million.
The Company’s 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, the Company may be required to repurchase the notes for 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 and interest rate swaps, see ‘‘Item 8. Financial Statements and Supplementary Data-Note 15. Debt and -Note 16. Derivatives.’’
Merger Agreement
The Merger Agreement, described in “Part I. Item 1. Business-Merger Agreement,” provides for certain termination rights for both the Company and Reckitt Benckiser. The Company is obligated to pay Reckitt Benckiser a $480 million termination fee in certain circumstances, including, without limitation, if we enter into a definitive agreement for a superior proposal.
In addition, under the Merger Agreement we are prohibited from creating, incurring, assuming or otherwise becoming liable with respect to any indebtedness for borrowed money or guarantee thereof, other than (i) indebtedness solely between the Company and a wholly owned subsidiary of the Company or between wholly owned subsidiaries of the Company in the ordinary course of business consistent with past practice, (ii) borrowings in the ordinary course of business consistent with past practice under our revolving credit facility and guarantees of such borrowings to the extent required under the terms of the facility and (iii) in connection with letters of credit issued in the ordinary course of business consistent with past practice in an amount not to exceed $1,000,000 individually or $5,000,000 in the aggregate.
Share Repurchases
In September 2013, the Company’s board of directors approved a share repurchase authorization of up to $500.0 million of our common stock (the “2013 Authorization”). During the year ended December 31, 2016, the Company repurchased $0.4 million of our common stock which completed all purchases remaining under the 2013 Authorization. During the year ended December 31, 2015, the Company repurchased $437.0 million of our common stock under the 2013 Authorization.
In October 2015, the Company’s board of directors approved the 2015 Authorization, a share repurchase authorization of an additional $1,500.0 million of our common stock. The 2015 Authorization does not have an expiration date. On October 22, 2015, the Company entered into an accelerated share repurchase agreement (the “ASR Agreement”) with Goldman, Sachs & Co. (“Goldman”) to repurchase $1,000.0 million (the “Repurchase Price”) of our common stock. Under the terms of the ASR Agreement, the Company paid the Repurchase Price in advance in exchange for 10,725,552 shares of our common stock which were received by the Company on October 27, 2015 (which shares are equivalent to approximately 85% of the number of shares of our common stock that could be purchased with an amount of cash equal to the Repurchase Price based on the closing price of our common stock on October 22, 2015). Upon final settlement of the ASR Agreement in June 2016, an additional 2,086,050 shares were delivered to the Company for no additional consideration based generally on the daily volume-weighted average prices of our common stock over the term of the ASR Agreement. The total shares received and retired under the terms of the ASR Agreement was 12,811,602 shares with an average price paid per share of approximately $78.05. In addition to the shares delivered upon final settlement of the ASR Agreement, during the year ended December 31, 2016, the Company repurchased $100.0 million of our common stock pursuant to the 2015 Authorization. As of December 31, 2016 and 2015, the Company had $400.0 million and $500.0 million remaining available under the 2015 Authorization, respectively.
Under the Merger Agreement described in “Part I. Item 1. Business-Merger Agreement,” we are prohibited from redeeming, repurchasing or otherwise acquiring or offering to redeem, repurchase, or otherwise acquire our common stock or other securities, other than shares surrendered to us to pay the exercise price in connection with the exercise of employee stock options and shares surrendered to us 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.
Fuel for Growth
During 2015, the Company approved a plan to implement a business productivity program referred to as “Fuel for Growth,” which is expected to be implemented over a three-year period. Fuel for Growth is designed to improve operating efficiencies and reduce costs. Fuel for Growth is expected to improve profitability and create additional investments behind brand building and growth initiatives. Fuel for Growth focuses on the optimization of resources within various operating functions and certain third-party cost reduction activities across the business. For the year ended December 31, 2016, total charges associated with Fuel for Growth were $29.2 million.
During 2016, additional savings of approximately $60 million were identified within the Fuel for Growth Program, resulting in total expected cost savings of approximately $180.0 million by the end of 2018. The Company achieved approximately $90 million cost savings in 2016 of which approximately $80 million was due to lower selling, general and administrative expenses, $9 million was due to lower research and development spending and the balance was due to lower manufacturing expenses. For additional information on the Fuel for Growth program, see “Item 8. Financial Statements and Supplementary Data-Note 6. Restructuring.”
Contractual Obligations
As of December 31, 2016, 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. Purchase obligations are for unconditional commitments related to a master service agreement with IBM for information technology, accounting and indirect procurement services, and purchases of materials used in manufacturing and promotional services. The future interest payments include coupon payments on our long-term debt.
Additionally, liabilities for uncertain tax positions, pension and other post-employment benefits and derivative contracts 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 and Supplementary Data-Note 4. Income Taxes, -Note 8. Pension and Other Post-Employment Benefit Plans, and -Note 16. Derivatives” for additional 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 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
The Company prepared the accompanying consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”), which requires the Company to make estimates and assumptions that affect the reported amounts and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Significant estimates include sales rebates and return accruals, impairment testing of goodwill and indefinite-lived intangible assets, impairment of long-lived assets, deferred tax assets and liabilities and income tax expense, as well as the accounting for stock-based compensation and retirement and post-employment benefits, including the actuarial assumptions. Actual results may or may not differ from estimated results. Future results may differ from our estimates under different assumptions or conditions. Management believes the following are the most critical accounting policies that could have an affect on the Company’s reported results.
For information on the Company’s accounting policies, see “Item 8. Financial Statements and Supplementary Data-Note 2. Accounting Policies.”
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is not recognized until title and risks of loss have transferred to the customer. The shipping terms for the majority of revenue arrangements are FOB destination. Provisions are estimated at the time of revenue recognition for returns and WIC rebates 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 sales discounts, trade promotional supports and consumer coupons. Provisions are estimated for these sales incentives at the later of the date at which the Company has sold the product or the date at which the program is offered, based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. Revenue is recorded
net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.
WIC Rebates-The Company 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, the Company reimburses these entities for the difference between the list price and the contract price on eligible products. The Company accounts for WIC rebates by establishing an accrual in an amount equal to its estimate of WIC rebate claims attributable to a sale. The Company 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. WIC rebate accruals were $212.5 million and $205.1 million at December 31, 2016 and 2015, respectively, and are included in accrued rebates and returns on the balance sheet. Rebates under the WIC program reduced revenues by $751.5 million, $763.0 million, and $790.0 million in the years ended December 31, 2016, 2015 and 2014, respectively.
Sales Returns-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. Sales return accruals were $57.1 million and $52.6 million at December 31, 2016 and 2015, respectively, and are included in accrued rebates and returns on the balance sheet. Returns reduced sales by $94.2 million, $89.8 million, and $86.1 million for the years ended December 31, 2016, 2015 and 2014, 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. United States federal income taxes are provided on foreign earnings that are not permanently invested offshore.
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.
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
Goodwill is not amortized but is tested for impairment annually and whenever events or changes in circumstances indicate that impairment may have occurred. 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. Goodwill is tested for impairment at the reporting unit level. A reporting unit represents an operating segment or a component of an operating segment. Goodwill is tested for impairment by either performing a qualitative evaluation or a two-step quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company may elect not to perform the qualitative assessment for some or all reporting units and perform a two-step quantitative impairment test. 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. The Company also makes 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. The Company completed the annual goodwill impairment assessment during the third quarter of 2016, 2015 and 2014 and no impairment of goodwill was required as the Company determined that the fair values of the reporting units were in excess of respective carrying amounts.
Goodwill recognized as a result of the acquisition of our business in Argentina was $60.9 million as of December 31, 2016, which represents a majority of our goodwill balance. 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. Additionally, if the Argentine economy becomes hyperinflationary there may be an accelerated decline in the fair value of the entity which may result in an impairment of the recorded goodwill.
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. Indefinite-lived intangible assets are also tested for impairment at the reporting unit level. No impairment of indefinite-lived intangible assets was required in 2016, 2015 or 2014.
Pension and Other Post-Employment Benefits
The Company’s pension plans and other post-employment benefit plans are accounted for using actuarial valuations. Management, in consultation with the 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 other post-employment benefit expense could vary within a range of outcomes and have a material effect on projected benefit obligations. The Company’s 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 other post-employment 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, the Company estimates returns for individual asset classes with input from external advisers. The Company also considers 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.
During 2015, the SEC staff expressed its acceptance for companies applying an alternative approach for using discount rates to measure the components of net periodic benefit cost for postretirement benefit plan obligations. Specifically, the SEC staff stated that it would not object to companies’ use of an alternative approach that focuses on measuring the service cost and interest cost components of net periodic benefit cost by using individual spot rates derived from a high-quality corporate bond yield curve and matched with separate cash flows for each future year instead of a single weighted-average discount rate approach. Further, the SEC staff stated it would not object to companies treating the change in approach as a change in estimate. The Company determined it was appropriate to change our estimate in the determination of discount rate assumptions to determine periodic benefit costs for both our defined benefit pension and other postretirement plans.
The Company’s principal pension plan is the U.S. Pension Plan, which is a frozen plan and represents approximately 87% and 71% of our total pension and other post-employment assets and obligations, respectively. 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
4.25
%
3.89
%
Expected long-term return on plan assets
6.20
%
6.60
%
Used to determine benefit obligation as of December 31,
Discount rate
4.04
%
4.25
%
The obligation for the U.S. Pension Plan decreased by $27.4 million during 2016, primarily due to a $15.0 million discretionary contribution and $20.7 million of returns on assets.
The following table shows the impact on pension expense of hypothetical changes in the rates assumed for the U.S. Pension Plan:
See “Item 8. Financial Statements and Supplementary Data-Note 8. Pension and Other Post-Employment Benefit Plans” for additional information on our pension and other post-employment 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 our 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. In addition, actual results may differ materially from those projected as a result of certain risks and uncertainties, including but not limited to: the possibility that the Merger will not be consummated or delays in consummating the Merger; adverse effects on the market price of Mead Johnson's common stock and on Mead Johnson's operating results because of a failure to complete the Merger; negative effects relating to the announcement of the Merger or any further announcements relating to the Merger or the entrance into or consummation of the Merger on the market price of Mead Johnson's stock; unanticipated difficulties or expenditures relating to the Merger; legal proceedings instituted against Mead Johnson and others in connection with the Merger; disruptions of current plans and operations caused by the announcement and pendency of the Merger; potential difficulties in employee retention as a result of the announcement and pendency of the Merger; and the response of customers, distributors, suppliers and competitors to the announcement of the Merger. 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 ongoing 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 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 Mexican peso, the Philippine peso, the Thai baht, the Euro, the Malaysian ringgit and the Canadian dollar. In addition to these primary exposures, as a global business, we are exposed to foreign currency translation risk in all countries in which we do business whose local reporting currency is not the U.S. dollar. 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 exposures that we will not be able to manage through effective hedging or the use of other financial instruments.
We use foreign currency contracts to hedge anticipated transactions in certain foreign currencies and designate these derivative instruments as foreign currency cash flow hedges. Changes in the fair value of the derivative for cash flow hedges are 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 income of $6.9 million, $23.8 million and $2.0 million in the years ended December 31, 2016, 2015 and 2014, respectively. Ineffectiveness related to the Company’s foreign exchange hedges on earnings was $1.2 million and $0.9 million for the years ended December 31, 2016 and 2015, respectively, and insignificant for the year ended December 31, 2014.
We use foreign exchange forward contracts to hedge exposures, and the total notional amount of these contracts was $202.1 million at December 31, 2016, with a fair value in a net asset position of $10.7 million.
The following table summarizes the foreign exchange forward contracts outstanding and the related weighted-average contract exchange rates as of December 31, 2016:
All of these derivatives were hedges of anticipated transactions and the majority mature within 12 months. Assuming a 10% strengthening or weakening of the U.S. dollar at year-end, the fair value would have increased by $17.4 million or decreased by $21.2 million, respectively. A 10% weakening of the U.S. dollar would switch our asset to be in a payable position. The unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.
Venezuela Risk
Discussion of Venezuela Exchange Rates
In January 2014, the Venezuelan government enacted changes affecting the country’s currency exchange and other controls, and established a new foreign currency administration, the National Center for Foreign Commerce (“CENCOEX”). CENCOEX assumed control of the sale and purchase of foreign currency in Venezuela, and established the official exchange rate (“Official Rate”) of 6.3 Bolivares Fuertes (“VEF”) to 1.0 U.S. dollar (“USD”). Additionally, the government expanded the types of transactions that may be subject to the weekly auction mechanism under the Complimentary Currency Administration System (“SICAD I”). For a period of time, the Venezuelan government announced plans for the Alternative Foreign Exchange System, also known as SICAD II, which was intended to more closely resemble a market-driven exchange.
In February 2015, the Venezuelan government combined the SICAD I and SICAD II (“SICAD”) exchange rate mechanisms and created a new market based SIMADI rate, which was based on supply and demand. The changes created a three tiered system. As of December 31, 2015, CENCOEX traded at 6.3 VEF to 1.0 USD, the SICAD auction markets traded at 13.5 VEF to 1.0 USD and the SIMADI traded at 198.7 VEF to 1.0 USD.
In March 2016, the Venezuelan government devalued its currency and reduced its existing three tiered system to a two tiered system by eliminating the intermediary SICAD rate. The CENCOEX Official Rate, which continues to be used for purchases of certain essential goods, was changed to 10.0 VEF to 1.0 USD and is now referred to as DIPRO. Additionally, the SIMADI rate was replaced by a new market based rate known as DICOM, which governs all transactions not covered by DIPRO. The VEF as measured by the DICOM rate has continued to devalue against the USD throughout 2016.
The rates were as follows:
Effect on the Company’s Results
Currency Matters
Due to the elimination of the SICAD rate in March 2016, the Company adopted the DICOM rate for purposes of remeasuring the monetary assets and liabilities of its Venezuela subsidiary, effective March 10, 2016, because the Company believes the DICOM rate would now be used to settle future intercompany dividend remittances. The remeasurement impact of this adoption was a loss of $32.3 million, recognized during the first quarter of 2016 as a component of other (income)/expenses - net. Additional losses in the amount of $0.6 million was recognized during the year ended December 31, 2016, related to remeasurement of the monetary assets and liabilities due to the continued devaluation of VEF as measured at the DICOM rate against the USD.
For the years ended December 31, 2015 and 2014, currency devaluation within Venezuela resulted in losses of $2.3 million and $6.1 million, respectively.
During the years ended December 31, 2016, 2015 and 2014, the Company received U.S dollars to make payments for intercompany purchases of inventory at the CENCOEX Official Rate that was more favorable than the SICAD rate used to remeasure net monetary assets of MJN’s Venezuela subsidiary, which resulted in recognized gains of $3.4 million, $2.4 million and $14.0 million, respectively.
Long Lived and Other Assets
As a result of the change in the Venezuelan exchange rates, the Company concluded that an impairment indicator existed at March 31, 2016 and evaluated the carrying value of the long-lived assets of its Venezuela subsidiary for impairment, which includes administrative office space, land and a partially completed distribution warehouse facility. Based on this evaluation, the Company concluded that the carrying value of the long-lived assets was no longer recoverable and recorded an impairment charge of $45.9 million to write down the carrying value of the assets to their fair value, which was recognized during the first quarter of 2016 as a component of other (income)/expenses - net. The fair value measurements were based on market quotes from local real estate broker service firms as well as internal assessments of the best information available about the local business conditions and the political environment, including the risks associated with the local currency that would be indicative of what the assets could be sold for and are considered to be Level 3 measurements.
In addition, the changes in Venezuelan exchange rates resulted in the Company incurring charges in the amount of $3.0 million during the year ended December 31, 2016 related to prepaid and other assets in Venezuela that can no longer be utilized.
Intercompany Payable
During the year ended December 31, 2016, the Company wrote-off a $52.0 million intercompany payable from its Venezuelan subsidiary to its subsidiaries in Mexico and the U.S. The decision was based on a reduced level of local currency which has resulted in the Venezuelan subsidiary no longer having sufficient cash to satisfy this payable, the continued inability to access the currency exchange and the Company’s view that sales in Venezuela are unlikely to return in the near term to a level that would generate adequate liquidity to satisfy this payable. The write-off of the payable had no impact on the Company’s results of operations on a pre-tax basis as the payable in Venezuela and the receivables in Mexico and the U.S. were held in U.S. dollars. The tax impact of this write-off was calculated based upon the tax rules in each of the impacted jurisdictions and resulted in a gain of $14.7 million recognized within Provision for Income Taxes.
Remaining Exposures
Net sales in the Venezuelan subsidiary were negligible as a percent of total Company net sales for the year ended December 31, 2016. In addition, the Venezuelan subsidiary’s earnings were not a material component of MJN’s consolidated results during the year ended December 31, 2016.
The Venezuelan subsidiary had net monetary assets and net non-monetary assets that were negligible individually and in aggregate to the Company’s total net assets as of December 31, 2016.
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 or ranges of 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. As of December 31, 2016, the Company had no outstanding commodity contracts.
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 approximately $3.0 billion as of December 31, 2016. For information on our debt obligations, see “
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Consolidated Financial Statements of Mead Johnson Nutrition Company:
Consolidated Statements of Earnings for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Balance Sheets as of December 31, 2016 and 2015
Consolidated Statements of Equity/(Deficit) and Redeemable Noncontrolling Interest for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
Notes to Consolidated 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, 2016 and 2015, 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, 2016. 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, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, 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, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 27, 2017
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 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, 2016 AND 2015 AND FOR THE YEARS ENDED
DECEMBER 31, 2016, 2015 AND 2014
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 distributors and retailers 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 the Company and its majority-owned and controlled subsidiaries. Inter-company 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.
Use of Estimates-The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Significant estimates include sales rebates and return accruals, impairment testing of goodwill and indefinite-lived intangible assets, impairment of long-lived assets, deferred tax assets and liabilities and income tax expense, as well as the accounting for stock-based compensation and retirement and post-employment 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 persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is not recognized until title and risks of loss have transferred to the customer. The shipping terms for the majority of revenue arrangements are FOB destination. Provisions are estimated at the time of revenue recognition for returns and Women, Infants and Children (“WIC”) rebates 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 sales discounts, trade promotional support and consumer coupons. Provisions are estimated for these sales incentives at the later of the date at which the Company has sold the product or the date at which the program is offered, based on historical experience, updated for changes in facts and circumstances, as appropriate. Such provisions are recorded as a reduction of revenue. Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.
WIC rebate accruals were $212.5 million and $205.1 million at December 31, 2016 and 2015, respectively, and are included in accrued rebates and returns on the Company’s balance sheet. The Company 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, the Company reimburses these entities for the difference between the 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. The Company 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 $751.5 million, $763.0 million, and $790.0 million in the years ended December 31, 2016, 2015, and 2014, respectively.
Sales return accruals were $57.1 million and $52.6 million at December 31, 2016 and 2015, 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 $94.2 million, $89.8 million, and $86.1 million for the years ended December 31, 2016, 2015 and 2014, 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. United States federal income taxes are provided on foreign earnings that are not permanently invested offshore.
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 are all incorporated or domiciled outside the U.S., are not subject to the enactment of daily floating net asset value calculation, liquidity fees or redemption gates and continue to meet the classification of cash and cash equivalents. Money market funds totaled $1,022.0 million and $510.1 million at December 31, 2016 and 2015, 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 reflected in Other Intangible Assets - Net, and are 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-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. Goodwill is tested for impairment at the reporting unit level. A reporting unit represents an operating segment or a component of an operating segment. Goodwill is tested for impairment by either performing a qualitative evaluation or a two-step quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company may elect not to perform the qualitative assessment for some or all reporting units and perform a two-step quantitative impairment test. 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 annual goodwill impairment assessment during the third quarter of 2016. No impairment of goodwill was required in 2016, 2015 or 2014.
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. Indefinite-lived intangible assets are tested for impairment at the reporting unit level. No impairment of indefinite-lived intangible assets was required in 2016, 2015 or 2014.
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. The Company has elected to classify the cash flows from derivative instruments in the same category as the cash flows from the underlying hedged items.
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-employment Benefits-The funded status of the Company’s defined pension and other post-employment 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-employment plans, the benefit obligation is the accumulated post-employment benefit obligation. The net over- or under-funded status is recognized as an asset or a liability on the balance sheet.
Changes in assets or liabilities are recognized in the consolidated statements of earnings upon plan remeasurement in the fourth quarter of each year, or more frequently if a remeasurement occurs. Certain of the Company’s pension plans allow participants the option of settling their vested benefits through the receipt of a lump-sum payment. In the period in which lump-sum payments exceed annual service and interest costs, the Company applies settlement accounting and remeasures the pension obligation, with the resulting gain or loss being recognized immediately.
During 2015, the Company changed the method used to estimate the interest cost components of net periodic benefit cost for defined benefit pension and other post-retirement benefit plans. Historically, the interest cost components were estimated using a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation at the beginning of the period. The Company elected to use a full yield curve approach in the estimation of these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the projected benefit obligation to the relevant projected cash flows. The Company made this change to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates and to provide a more precise measurement of interest costs. This change does not affect the measurement of total benefit obligations as the change in interest
cost is completely offset in the actuarial loss reported in the period. The Company accounted for this change as a change in estimate and, accordingly, accounted for it prospectively starting in the third quarter of 2015. The reduction in interest cost for the year ended December 31, 2015 associated with this change in estimate was approximately $2.0 million.
Shipping and Handling Costs-The Company typically does not charge customers for shipping and handling costs. Shipping and handling costs, including warehousing expenses, were $99.6 million, $114.1 million, and $118.2 million in the years ended December 31, 2016, 2015, and 2014, respectively, and are included in selling, general and administrative expenses.
Advertising Costs-Advertising costs are expensed as incurred and were $223.8 million, $218.7 million, and $206.2 million in the years ended December 31, 2016, 2015, and 2014, respectively.
Research and Development-Research and development costs are expensed as incurred.
Stock-Based Compensation-Stock-based compensation expense for stock options is measured based on the estimated grant date fair value and recognized over the vesting period for options that are expected to vest. The Company estimates forfeitures at the time of grant based on historical experience, updated for changes in facts and circumstances, as appropriate, and in subsequent periods if actual forfeitures differ from those estimates. The Company uses the Black-Scholes option-pricing model to value stock options granted. The expected volatility assumption is 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. The historical volatility is calculated over a period of time commensurate with the expected term of the options being valued. The risk-free interest rate assumption is based upon the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on the Company’s expectation of dividend payouts. The Company has determined that it has enough historical option exercise information to be able to accurately compute an expected term for use as an assumption in the Black-Scholes option pricing model. As such, its computation of expected term was calculated using the Company’s historical data.
The Company also grants shares of restricted stock units and performance awards. Restricted stock units generally vest on the third or fourth anniversary of the grant date, and are entitled to dividend equivalent payments during the vesting period. Performance share awards vest based on varying performance, market and service conditions.
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 loss.
Recently Adopted Accounting Standards-In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statement-Going Concern (Subtopic 205-40). This update requires management to assess the Company’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a
definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The updated standard was effective for the Company in the annual period ending December 31, 2016. The adoption of this updated standard did not have an impact on the consolidated financial statements.
Recently Issued Accounting Standards-In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350). This update simplifies goodwill impairment testing by eliminating step two from the goodwill impairment test. Under the updated standard, the Company still has the option to perform its annual, or interim, goodwill impairment test using the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The quantitative impairment test is to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The updated standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update is intended to reduce diversity in practice in the classification of certain cash receipts and payments in the statement of cash flows. The updated standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update simplifies several aspects of the accounting for share-based compensation arrangements, including accounting for income taxes, forfeitures and statutory tax withholding requirements as well as classification of related amounts on the statement of cash flows. The Company has evaluated the effect that the updated standard will have on its consolidated financial statements and related disclosures. The Company will recognize excess tax benefits within the consolidated statements of earnings. As this amount is currently recorded as a reduction to additional paid-in capital, this could potentially cause volatility in the Company’s earnings and calculation of effective tax rate going forward when employees exercise options and when stock units become vested. The Company will record the excess tax benefit within the operating activities in the statement of cash flows. These amendments will be adopted prospectively with no adjustment to prior periods required. Additionally, the Company will continue to present cash paid for tax withholdings under financing activities within the statements of cash flows and the Company has elected to continue to estimate for forfeitures and to not withhold more than the minimum statutory tax rate. The updated standard is effective for fiscal years beginning after December 15, 2016, with early adoption permitted.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The updated standard requires most leases to be reflected on the balance sheet. It also aligns many of the underlying principles of the new lessor model with those of ASC No. 606, Revenue from Contracts with Customers. The updated standard is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (Topic 330). This update simplifies the guidance on the subsequent measurement of inventory. GAAP currently requires an entity to measure inventory at the lower of cost or market. Previously, market could be replacement cost, net realizable value or net realizable value less an approximate normal profit margin. Under the new standard, inventory should be valued at the lower of cost or net realizable value. The updated standard is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company has evaluated the effect that the updated standard will have on its consolidated financial statements and related disclosures. The updated standard will be adopted prospectively. Given the Company has not experienced markdowns of inventory due to lower of cost or market considerations, the impact of implementing the updated standard is not expected to be material.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). In 2016, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12 to clarify, among other things, the implementation guidance related to principal versus agent considerations, identifying performance obligations, and accounting for licenses of intellectual property. The updated standard and related clarifications will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. The updated standard becomes effective for the Company in the first quarter of 2018. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. From the results of the preliminary review, the Company believes the impact of adopting the updated standard primarily relates to the timing of the recognition of variable consideration. Under current guidance, the Company accounts for sales incentives offered to its customers at the later of the date at which the Company has sold the product or the date at which the program is offered. The new guidance requires earlier recognition if the sales incentive is implied by the Company’s customary business practice, even if the Company has not yet explicitly communicated its intent to make the payment to the customer. Analysis of the Company’s historical and future trends and use of judgment are required. The Company is in the process of quantifying such impact. The Company anticipates using the modified retrospective adoption method.
3. EARNINGS PER SHARE
The Company uses the two-class method to calculate 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 3.4 million, 2.5 million and 2.5 million as of December 31, 2016, 2015 and 2014, respectively, of which 3.1 million, 2.1 million and 1.9 million were not included in the diluted earnings per share calculation for the years ended December 31, 2016, 2015 and 2014, 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, 2016, 2015 and 2014 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 deferred income tax assets/(liabilities) were:
During the year ended December 31, 2016 the Company wrote-off a $52.0 million intercompany payable from its Venezuelan subsidiary to its subsidiaries in Mexico and the U.S. (see “-Note 20. Venezuela Currency Matters” for additional information). As a result of this write-off, Mexico and the U.S. realized losses that are either currently tax deductible or tax deductible in the future. A deferred tax asset of $12.5 million has been recorded to reflect the portion of the losses that are deductible in the future.
As of December 31, 2016, the Company had definite-lived and indefinite-lived gross foreign net operating loss (“NOL”) carryforwards of $50.8 million. Indefinite-lived NOL carryforwards totaled $44.2 million with the remainder being definite-lived. An immaterial amount of these definite-lived NOL carryforwards will begin to expire in 2017, with the remainder of the definite-lived NOL carryforwards to expire no later than 2020. The valuation allowance recorded for NOL carryforwards is $14.8 million as of December 31, 2016.
As of December 31, 2016, the Company had various definite-lived U.S. state tax credit carryforwards of $9.4 million, net of the federal tax benefit. An immaterial amount of these state tax credit carryforwards will begin to expire in 2017, with the remainder of the state tax credit carryforwards to expire no later than 2026. The valuation allowance recorded for state tax credit carryforwards is $6.0 million, net of the federal tax benefit, as of December 31, 2016.
As of December 31, 2016, the Company incurred a statutory loss on the investment in its Russian business of $42.1 million. This loss will be tax deductible in the Netherlands when the Russian entity is fully liquidated on a tax basis, and a deferred tax asset of $10.5 million has been recorded as of December 31, 2016. The Company expects to utilize $1.6 million of this deferred tax asset, and a valuation allowance of $8.9 million has been recorded for the remainder.
As of December 31, 2016, the Company incurred charges in the amount of $48.9 million related to long-lived asset impairments and other asset write-offs in its Venezuelan business (see “-Note 20. Venezuela Currency Matters” for additional information) for which the Company held a deferred tax asset of $7.9 million. The Company does not expect to utilize any amount of this deferred tax asset, and a full valuation allowance has been recorded.
Income taxes paid net of refunds were $219.3 million, $134.2 million, and $183.7 million in the years ended December 31, 2016, 2015 and 2014, respectively. The income taxes were paid to or received from federal, state and foreign taxing authorities and Bristol-Myers Squibb Company (“BMS”) pursuant to the terms of the Amended and Restated Tax Matters Agreement, described below.
As of December 31, 2016, U.S. taxes have not been provided on approximately $2,500 million of foreign earnings as these undistributed earnings have been indefinitely 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 $868.0 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, 2016, the Company’s 2011 and 2012 U.S. income tax returns were under IRS examination, and the 2009 through 2014 period is under income tax audit in Hong Kong. The Company was notified in early 2016 that the China tax authorities will commence an audit of tax years 2008 through 2014; however, that audit is now expected to commence in early 2017. The Company was also recently notified that the IRS will commence an audit of the 2013 and 2014 U.S. income tax returns in early 2017. At December 31, 2016, tax years remaining open to examination outside the U.S. include 2006 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 approximately $53 million reasonably possible in the next 12 months due to the running of statutes of limitations and settlements with various taxing authorities, of which up to approximately $28 million would impact the effective tax rate. The amounts of recorded uncertain tax positions that impacted the effective tax rate were $117.1 million, $88.3 million and $69.8 million as of December 31, 2016, 2015 and 2014, 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 $35.1 million and $25.8 million, as of December 31, 2016, and 2015, 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 $9.5 million, $7.0 million and $4.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
On December 18, 2009, the Company and 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. Based on this operating segmentation, the chief operating decision maker regularly assesses information for decision making purposes, including allocation of resources. Due to similarities between North America and Europe, the Company aggregated these two operating segments into one reportable segment. As a result, the Company has three reportable segments: Asia, Latin America and North America/Europe.
Corporate and Other consists of unallocated global business support activities, including research and development, marketing, supply chain costs, and general and administrative expenses; net actuarial gains and losses related to defined benefit pension and other post-employment plans; and income or expenses incurred within the operating segments that are not reflective of underlying operations and affect the comparability of the operating segments’ results.
The Company’s products are sold principally to distributors and retailers. Wal-Mart Stores, Inc. (including Sam’s Club) accounted for 12%, 12% and 11% of the Company’s consolidated gross sales for the years ended December 31, 2016, 2015, and 2014, respectively, primarily in the North America / Europe segment. DKSH International Ltd., a distributor serving primarily Asia, accounted for 14%, 14%, and 16% of the Company’s consolidated gross sales for the years ended December 31, 2016, 2015, and 2014, respectively.
The Company's segment, product and geographic results consisted of:
(1) For purposes of this disclosure, the term China refers to the Company’s businesses in mainland China and Hong Kong.
(2) Sales by country are based on the country that sold the product.
6. RESTRUCTURING
During the third quarter of 2015, the Company approved a plan to implement a business productivity program referred to as “Fuel for Growth,” which is expected to be implemented over a three-year period. Fuel for Growth is designed to improve operating efficiencies and reduce costs. Fuel for Growth is expected to improve profitability and create additional investments behind brand building and growth initiatives. Fuel for Growth focuses on the optimization of resources within various operating functions and certain third-party costs across the business.
A summary of restructuring charges and related reserves associated with Fuel for Growth is as follows:
(1) Included in accrued expenses on the balance sheet.
(2) Included in accrued expenses and other liabilities on the balance sheet.
(3) Included in accounts payable on the balance sheet.
Restructuring charges are included in Corporate and Other. Reserves related to severance and employee benefits and other costs will be paid out during the next twelve months. The contract termination costs will be paid over a period from 2017 to 2019.
7. EMPLOYEE STOCK BENEFIT PLANS
Long Term Incentive Plan-The Company’s Long Term Incentive Plan (“LTIP”) 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 LTIP. Twenty-five million shares of stock were approved and registered with the Securities and Exchange Commission (the “SEC”) for grants to participants under the LTIP. The shares reserved may be used for any type of award under the LTIP. Stock-based compensation expense is based on awards ultimately expected to vest. Forfeitures are estimated based on the historical experience of participants in the LTIP since its inception in February 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 a certain threshold is 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 LTIP. Restrictions generally expire over a 1- to 4-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.
Stock Options-The fair value of stock options granted in 2016, 2015, and 2014 was estimated on the date of grant using the Black-Scholes option pricing model. No stock options with market conditions were granted in 2016, 2015, or 2014. The following assumptions were used in the valuations:
The 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. The historical volatility was calculated over a period of time commensurate with the expected term of the options being valued.
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 Company has determined that it has enough historical option exercise information to be able to accurately compute an expected term for use as an assumption in the Black-Scholes option pricing model. As such, its computation of expected term was calculated using the Company’s historical data.
Stock option activities were as follows:
The weighted-average grant date fair value of stock options granted is $13.88, $20.21 and $17.71 for 2016, 2015 and 2014 respectively.
Cash proceeds received from options exercised during the years ended December 31, 2016, 2015 and 2014 were $15.0 million, $16.2 million and $37.0 million, respectively. The tax benefit realized from stock options exercised was $0.8 million in 2016, $3.4 million in 2015 and $8.3 million in 2014.
At December 31, 2016, total unrecognized compensation cost related to stock options of $9.9 million is expected to be recognized over a weighted average period of 1.9 years.
Performance Share Awards-The fair value of performance share awards is based on the closing market 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 forfeitures. Performance shares outstanding at December 31, 2016 is adjusted for actual plan achievement level for each completed performance period. Company performance in 2015 was below the minimum threshhold for shares to be earned. At December 31, 2016, total unrecognized compensation cost related to the performance share awards outstanding of $2.3 million is expected to be recognized over a weighted average period of 1.5 years.
Restricted Stock Units-The fair value of restricted stock units is determined based on the closing market price of MJN’s common stock on the grant date. A summary of restricted stock unit activity is as follows:
At December 31, 2016, total unrecognized compensation cost related to nonvested restricted stock units was $31.3 million and is expected to be recognized over a weighted average period of 2.4 years.
Stock-Based Compensation Expense-The following table summarizes stock-based compensation expense related to stock options, performance share awards and restricted stock units for the years ended December 31, 2016, 2015 and 2014:
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.
8. PENSION AND OTHER POST-EMPLOYMENT BENEFIT PLANS
The principal pension plan is the Mead Johnson & Company Retirement Plan in the United States (“U.S. Pension Plan”) which represents approximately 87% and 71% of the Company’s total pension and other post-employment assets and obligations, respectively. The benefits of this plan are frozen as of February 9, 2014. The Company also provides comprehensive medical and group life benefits for substantially all U.S. and Canadian retirees who elect to participate. The retiree medical plan is contributory and participation is limited to those employees who participate in their respective country’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 other post-employment 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 other post-employment benefit plans includes:
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 Aon Hewitt AA Above Median yield curve is used in developing the discount rate for the U.S. Pension Plan. Compensation rate increases represent the weighted average of plans that are not frozen and therefore excludes 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 discount rate used to determine periodic service cost and interest costs of the overall benefit costs for the year ending December 31, 2017 will be based on spot rates derived from the same high-quality corporate bond yield curve used to determine the December 31, 2016
benefit obligation matched with separate cash flows for each future year.
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 costs for the year ending December 31, 2017 is 6.20%.
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, 2016 was 50% public equity and 50% fixed income. Cash flow (i.e., cash contributions, benefit payments) is used to rebalance back to the targets as necessary. Investments are well diversified within each of the two major asset categories. All of the U.S. equity investments are actively managed. Investment strategies for international pension plans are typically similar, although the asset allocations are usually more conservative.
The fair values of the Company’s pension plan assets by asset category were as follows:
Level 1 cash and cash equivalents, which excluded money market funds, are recorded at closing prices in active markets. Money market, equity, and fixed income funds recorded at the net asset values per share, which were determined based on quoted market prices of the underlying assets contained within the funds are excluded from the fair value hierarchy. The 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
The Company is not required to make contributions to its U.S. Pension Plan in 2017. However, the intention is to fund the plan to avoid potential benefit restrictions and penalties, therefore, an estimated $5.0 million is expected to be contributed in 2017 to the U.S. Pension Plan. Furthermore, the Company plans to fund current service and past service liabilities for other pension plans. There is not expected to be any cash funding for other post-employment benefit plans in 2017, except funding to cover benefit payments. MJN contributed $19.3 million, $90.1 million and $5.2 million to its pension and other post-employment benefit plans in 2016, 2015 and 2014, respectively.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Lump Sum Settlements
A lump sum settlement window was offered to approximately 300 terminated, vested participants in the U.S. Pension Plan. This window expired on September 30, 2016 and approximately 40% of these participants accepted the offer. Payments to participants who accepted the offer were made in the fourth quarter of 2016 and totaled $15.7 million. This amount is included in the Settlements and curtailments line of the table above which details the changes in benefit obligations, plan assets, funded status and amounts recognized in the balance sheet. There was no impact to the Company’s results of operations related to this settlement.
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 was $22.2 million, $23.4 million and $22.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.
9. NONCONTROLLING INTERESTS
Net earnings attributable to noncontrolling interests consists of approximately 11%, 10% and 10% interests held by third parties in operating entities in China, Argentina and Indonesia, respectively.
See "-Note 18. Equity" for further discussion of Argentinian noncontrolling interest.
10. OTHER (INCOME)/EXPENSES-NET
The components of other (income)/expenses-net were:
During the first quarter of 2016, the Company recognized impairment charges of $45.9 million on long-lived assets of its Venezuelan subsidiary. See “-Note 20. Venezuela Currency Matters” for additional information.
Foreign exchange (gains)/losses-net includes the re-measurement of U.S. dollar denominated intercompany loans, payables, and royalties as well as foreign currency devaluation and transactional foreign exchange gains recognized in the Company’s Venezuelan subsidiary. The re-measurement of the intercompany payable from the Venezuelan subsidiary to subsidiaries in Mexico and the U.S. resulted in a $7.7 million gain during the year ended December 31, 2016. Currency devaluation within Venezuela resulted in losses of $32.9 million, $2.3 million and $6.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. Transactional foreign exchange gains
were $3.4 million, $2.4 million and $14.0 million for the years ended December 31, 2016, 2015 and 2014. See “-Note 20. Venezuela Currency Matters” for additional information.
For the years ended December 31, 2016 and 2015, restructuring, severance and other costs-net included $29.2 million and $13.7 million, respectively, of restructuring costs associated with the Fuel for Growth program. See “-Note 6. Restructuring” for additional information.
For the year ended December 31, 2015, (gain)/loss on asset disposals related to fixed asset write-offs as the Company optimized its supply chain network in Asia. The marketable securities (gain)/loss for the year ended December 31, 2015 is described further in “-Note 17. Marketable Securities.” Legal, settlements, and other-net included payments made in connection with the SEC settlement disclosed by the Company in July 2015.
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 - net
The major categories of property, plant and equipment - net were as follows:
During the year ended December 31, 2016, the Company recognized an impairment charge of $45.9 million on long-lived assets of its Venezuelan subsidiary. See “-Note 20. Venezuela Currency Matters” for additional information.
For the year ended December 31, 2016, both buildings and improvements and machinery, equipment and fixtures increased primarily due to the Company’s investments in North America and Asia manufacturing sites. Depreciation expense was $85.3 million, $83.7 million and $75.9 million for the years ended December 31, 2016, 2015 and 2014, respectively, and is primarily included in costs of products sold. Interest capitalized during the year was $1.0 million, $0.5 million and $1.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company’s liability for asset retirement obligations was $7.9 million and $7.3 million at December 31, 2016 and 2015, respectively.
Other Intangible Assets - net
The gross carrying value and accumulated amortization by class of other intangible assets-net were as follows:
(1) Changes in balances result from currency translation.
(2) Changes in balances result from currency translation and amortization (10 year life).
Amortization expense for other intangible assets was $14.3 million, $15.4 million and $15.7 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Expected amortization expense related to intangible assets is as follows:
Non-Cash Activity
Capital expenditures and the cash outflow for capital expenditures were as follows:
14. GOODWILL
For the years ended December 31, 2016 and 2015, the change in the carrying amount of goodwill by reportable segment was as follows:
As of December 31, 2016 and 2015, the Company had no accumulated impairment loss.
15. DEBT
Short-Term Borrowings
As of December 31, 2016 and 2015, the Company had short-term borrowings of $3.9 million and $3.0 million, respectively, which consisted primarily of borrowings made by its subsidiary in Argentina. The short-term borrowings in Argentina had a weighted-average interest rate of 29.3% as of December 31, 2016.
Term Loan Agreement
During the year ended December 31, 2015, the Company entered into a $1,000.0 million short-term loan agreement (the “Term Loan Agreement”) with various financial institutions, including Citibank, N.A., as Syndication Agent, and JPMorgan Chase Bank, N.A. (“JPMCB”), as Administrative Agent. The Term Loan Agreement was unsecured and all loans thereunder were payable at maturity in April 2016. The amounts borrowed under the Term Loan Agreement were used to fund repurchases of common stock pursuant to an accelerated share repurchase agreement described in “-Note 18. Equity.” Following the offering of $750.0 million of 3.0% Senior Notes due November 15, 2020 (“2020 Notes”) and $750.0 million of 4.125% Senior Notes due November 15, 2025 (“2025 Notes”), further discussed below, the Company repaid all borrowings under the Term Loan Agreement and terminated the Term Loan Agreement during the year ended December 31, 2015. The payoff amount of $1,000.3 million included principal, accrued and unpaid interest and a facility fee.
Revolving Credit Facility Agreement
The Company has an unsecured, five-year revolving credit facility agreement (the “Revolving Credit Facility”) which is repayable at maturity in June 2019, subject to annual extensions if a sufficient number of lenders agree. The maximum amount of outstanding borrowings and letters of credit permitted at any one time under the Revolving Credit Facility is $750.0 million, which may be increased from time to time up to $1,000.0 million at the Company’s request, subject to obtaining additional commitments and other customary conditions. The Revolving Credit Facility contains financial covenants, whereby the ratio of consolidated adjusted total debt to consolidated Earnings Before Interest Income Taxes, Depreciation and Amortization (“EBITDA”) cannot exceed 3.50 to 1.00, and the ratio of consolidated EBITDA to consolidated interest expense cannot be less than 3.00 to 1.00. The Company was in compliance with these financial covenants as of December 31, 2016.
Borrowings under the Revolving Credit Facility bear interest at a rate that is determined as a base rate plus a margin. The base rate is either (a) LIBOR for a specified interest period or (b) a floating rate based upon JPMorgan Chase Bank’s prime rate, the Federal Funds rate or LIBOR. The margin is determined by reference to the Company’s credit rating. The margin can range from 0% to 1.375% over the base rate. In addition, the Company incurs an annual 0.125% facility fee on the entire facility commitment of $750.0 million.
There were no borrowings under the Revolving Credit Facility during the year ended December 31, 2016. During the year ended December 31, 2015, the Company had borrowings and repayments of $446.0 million under the Revolving Credit Facility. Such borrowings were used to repurchase shares of the Company’s common stock and for general corporate purposes, and were repaid following the issuance of the 2020 Notes and 2025 Notes, described below. As of December 31, 2016 and 2015, the Company had no borrowings under the Revolving Credit Facility and the Company had $750.0 million available at December 31, 2016.
Long-Term Debt
As of December 31, 2016 and 2015, respectively, the components of long-term debt were as follows:
During the year ended December 31, 2015, the Company issued and sold the 2020 Notes and 2025 Notes at a public offering price of 99.902% and 99.958%, respectively. The Company received net proceeds of $1,487.7 million from the sale of both the 2020 Notes and 2025 Notes, after deducting underwriters’ discounts and offering costs. Interest is payable on each of the 2020 Notes and 2025 Notes on May 15 and November 15 of each year. Proceeds from the 2020 Notes and 2025 Notes were used to repay borrowings under the Term Loan Agreement and borrowings under the Revolving Credit Facility.
During the years ended December 31, 2015 and 2014, the Company entered into a series of fair value interest rate swaps that effectively convert the Company’s 2019 Notes and 2020 Notes from a fixed rate structure to a floating rate structure. See “-Note 16. Derivatives” for a discussion of the fair value swaps.
During the year ended December 31, 2014, the Company issued and sold $500.0 million of 2044 Notes at a public offering price of 99.465% (“2044 Notes”). Net proceeds from the sale of the 2044 Notes, after deducting underwriters’ discounts and offering expenses, were $492.0 million. Interest on the 2044 Notes is payable semi-annually on June 1 and December 1 of each year. Proceeds from the 2044 Notes, together with cash on hand, were used to redeem the $500.0 million of 3.50% Notes due in 2014 (“2014 Notes”), as described below.
During the year ended December 31, 2014, the Company redeemed all of its 2014 Notes. The redemption price, which was calculated in accordance with the terms of the 2014 Notes and included principal plus a make-whole premium, was $503.5 million.
Using quoted prices in markets that are not active, the Company determined that the fair value of its long-term debt was $3,092.5 million (Level 2) as of December 31, 2016.
The Company’s 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, the Company may be required to repurchase the notes for 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 components of interest expense-net were as follows:
The increase in interest expense-net during the year ended December 31, 2016 was driven by interest expense on the November 2015 issuance of the 2020 Notes and the 2025 Notes, the proceeds of which were used primarily to fund purchases of common stock pursuant to an accelerated share repurchase agreement. See “-Note 18. Equity” for additional information.
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 in the fair value hierarchy at December 31, 2016 and 2015, 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:
While certain derivatives are subject to netting arrangements with the Company’s counterparties, the Company does not offset derivative assets and liabilities within the consolidated balance sheets presented herein.
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 at hedge inception 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, 2016 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, 2016 and 2015, the Company has cash flow hedges which qualify as hedges of forecasted cash flows, with the effective portion of changes in fair value temporarily reported in accumulated other comprehensive income (loss). During the period that the underlying hedged transaction impacts earnings, the effective portion of the changes in the fair value of the cash flow hedges is recognized within earnings. The Company assesses effectiveness at inception and on a quarterly basis. These assessments determine whether derivatives designated as qualifying hedges continue to be highly effective in offsetting changes in the cash flows of hedged items. Any ineffective portion of the change in fair value is included in current period earnings. Cash flow hedges are valued using quoted prices in markets that are not active.
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 year ended December 31, 2016, the Company discontinued cash flow hedge accounting for an insignificant number of hedges with an immaterial net impact to the income statement as the underlying transactions were no longer probable. For the years ended December 31, 2015 and 2014, 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 15 months and designates these derivative instruments as foreign currency cash flow hedges when appropriate. When the underlying intercompany purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold, and ineffectiveness related to the Company’s foreign exchange hedges on earnings is recognized within other (income)/expenses - net. The ineffective portion of the hedges was $1.2 million and $0.9 million for the years ended December 31, 2016 and 2015, respectively, and insignificant for year ended December 31, 2014.
The table below summarizes the Company’s outstanding foreign exchange forward contracts at December 31, 2016. 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 were as follows:
At December 31, 2016, the balance of the effective portion of changes in fair value on foreign exchange forward contracts that qualified for cash flow hedge accounting included in accumulated other comprehensive income was $10.1 million, $8.9 million of which is expected to be reclassified into earnings within the next 12 months.
Interest Rate Forward Swaps
During 2013, the Company entered into interest rate forward starting swaps with a combined notional value of $500.0 million. The forward starting rates of the swaps ranged from 3.79% to 3.94% and had an effective date of October 31, 2014. The forward starting swaps effectively mitigated the interest rate exposure associated with the Company’s offering of the 2044 Notes, the proceeds of which were used to redeem all of the Company’s 2014 Notes. These derivative instruments were designated as cash flow hedges at inception and were highly effective in offsetting fluctuations in the benchmark interest rate. During 2014, and around the time of the issuance of the 2044 Notes, the Company paid $45.0 million to settle the outstanding forward swaps. This payment was recognized in accumulated other comprehensive loss and will be amortized over the life of the 2044 Notes. There was $0.5 million of ineffectiveness related to the forward swaps through the date of settlement, which was recognized as a loss within other (income)/expenses-net during the year ended December 31, 2014. During the years ended December 31, 2016, 2015 and 2014, $1.4 million, $1.4 million and $0.9 million of amortization of the settlement amount was recognized as incremental interest expense within interest expense-net, respectively.
Commodity Hedges
The Company utilizes commodity hedges to minimize the variability in cash flows due to fluctuations in market prices of the Company’s non-fat dry milk purchases for North America. The maturities of the commodity contracts are scheduled to match the pricing terms of the Company’s existing bulk purchase agreements. When the underlying non-fat dry milk purchases impact the Company’s consolidated earnings, the effective portion of the hedge is recognized within cost of products sold.
As of December 31, 2016, the Company had no commodity contracts outstanding for forecasted non-fat dry milk purchases. The effective portion of commodity derivatives qualifying as cash flow hedges is deferred in accumulated other comprehensive income (loss), and the ineffective portion is recognized within other (income)/expenses - net. The effective portion of the hedges were insignificant for the each of the years ended December 31, 2016 and 2015, and the ineffective portions of the hedges were insignificant for the each of the years ended December 31, 2016, 2015, and 2014.
Fair Value Hedges
Interest Rate Swaps
During the second quarter of 2014, the Company entered into eight interest rate swaps with multiple counterparties, which have an aggregate notional amount of $700.0 million of outstanding principal. This series of swaps effectively converts the $700.0 million of 2019 Notes from fixed to floating rate debt for the remainder of their term. These interest rate swaps were outstanding as of December 31, 2016, and the conversion of fixed to floating rate resulted in a reduction in interest expense of $7.1 million and $10.0 million for the years ended December 31, 2016 and 2015, respectively. See “-Note 15. Debt” for additional information regarding the 2019 Notes.
In the fourth quarter of 2015, the Company entered into six interest rate swaps with multiple counterparties to mitigate interest rate exposure associated with the 2020 Notes. The swaps have an aggregate notional amount of $750.0 million of outstanding principal. This series of swaps effectively converts the $750.0 million of 2020 Notes from fixed to floating rate debt for the remainder of their term. These interest rate swaps were outstanding as of December 31, 2016, and the conversion of fixed to floating rate resulted in a reduction in interest expense of $6.8 million and $1.1 million for the years ended December 31, 2016 and 2015, respectively. See “-Note 15. Debt” for additional information regarding the 2020 Notes.
The following table summarizes the interest rate swaps outstanding as of December 31, 2016. The interest rate swaps for the 2019 Notes have a hedge inception date of May 2014, and the interest rate swaps for the 2020 Notes have an inception date of November 2015. The expiration dates of the interest rate swaps are equal to the stated maturity dates of the underlying debt. Interest rate swaps are valued using third party valuation models.
See “-Note 15. Debt” for additional information regarding the Company’s debt.
Other Financial Instruments
The Company does not hedge the interest rate risk associated with money market funds, which totaled $1,022.0 million and $510.1 million as of December 31, 2016 and 2015, 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. MARKETABLE SECURITIES
The Company sold its investments in debt securities during 2015 for $21.7 million. As of December 31, 2016 and December 31, 2015, the Company held no investments in debt securities. During the year ended December 31, 2015, the Company recognized a net gain on trading securities of $5.6 million, resulting from fluctuation in fair value and foreign exchange.
Debt securities have been classified as trading securities and are carried at fair value based on quoted market prices and classified as Level 1 in the fair value hierarchy. The cost basis for the Company’s debt securities is determined by the specific identification method. Realized and unrealized gains and losses on trading securities are included in other (income)/expenses - net.
18. 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.
Share Repurchase Authorizations and Accelerated Share Repurchase Agreement
In September 2013, the Company’s board of directors approved a share repurchase authorization of up to $500.0 million of the Company’s common stock (the “2013 Authorization”). During the year ended December 31, 2016, the Company repurchased $0.4 million of its common stock which completed all purchases remaining under the 2013 Authorization. During the year ended December 31, 2015, the Company repurchased $437.0 million of its common stock under the 2013 Authorization.
In October 2015, the Company’s board of directors approved a new share repurchase authorization of an additional $1,500.0 million of the Company’s common stock (the “2015 Authorization”). The 2015 Authorization does not have an expiration date. On October 22, 2015, the Company entered into an accelerated share repurchase agreement (the “ASR Agreement”) with Goldman, Sachs & Co. (“Goldman”) to repurchase $1,000.0 million (the “Repurchase Price”) of its common stock. Under the terms of the ASR Agreement, the Company paid the Repurchase Price in advance in exchange for 10,725,552 shares of its common stock received by the Company on October 27, 2015 (which shares are equivalent to approximately 85% of the number of shares of its common stock that could have been purchased with an amount of cash equal to the Repurchase Price based on the closing price of its common stock on October 22, 2015). Upon final settlement of the ASR Agreement in June 2016, an additional 2,086,050 shares were delivered to the Company for no additional consideration based generally on the daily volume-weighted average prices of its common stock over the term of the ASR Agreement. The total shares received and retired under the terms of the ASR Agreement was 12,811,602 shares with an average price paid per share of approximately $78.05. The par value of the retired shares were reflected as a reduction to common stock and the payment made to Goldman was recorded as a reduction to retained earnings within shareholders’ equity. In addition to the shares delivered upon final settlement of the ASR Agreement, during the year ended December 31, 2016, the Company repurchased $100.0 million of its common stock pursuant to the 2015 Authorization. As of December 31, 2016 and 2015, the Company had $400.0 million and $500.0 million remaining available under the 2015 Authorization, respectively.
Share repurchases made pursuant to the ASR Agreement were primarily funded by the issuance of the 2020 Notes and 2025 Notes. See “-Note 15. Debt” for additional information regarding the Company’s debt.
Redeemable Noncontrolling Interest
On March 15, 2012, the Company acquired 80% of the outstanding capital stock of Nutricion para el Conosur S.A. (“Nutricion”) 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 had 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. The Put Right was to be exercisable once from September 15, 2015 to September 15, 2018 and the
decision to exercise was not within the control of MJN. The price paid upon exercise was to be determined based on established multiples of sales and earnings of the acquired business. As a result of the Put Right, the noncontrolling interest was presented as redeemable noncontrolling interest outside of equity on the balance sheet. Accretion to the redemption value of the Put Right was being recognized through equity using an interest method over the period from March 2012 to June 2015.
On June 30, 2015, the noncontrolling partner exercised its single trigger put option and MJN acquired an additional 10% of the outstanding capital stock of the local entity, thereby increasing MJN’s ownership interest to 90%. The agreed upon purchase price paid to the noncontrolling interest owner was $24.4 million as of June 30, 2015 (based upon the agreed local currency price). The purchase price was settled during the second and third quarters of 2015. Following the impact of foreign exchange, the cash outflow associated with the acquisition was $24.2 million.
As a result of the transaction, the noncontrolling interest owner no longer has a Put Right and the Call Right was amended. The amended Call Right gives the noncontrolling interest owner the right to require MJN to sell up to 10% of the outstanding capital stock of Nutricion, exercisable from June 30, 2015 to June 30, 2022. Due to the termination of the Put Right, the remaining noncontrolling interest was recharacterized from redeemable noncontrolling interest outside of equity to noncontrolling interests within equity on the balance sheet beginning on June 30, 2015.
Accumulated Other Comprehensive Loss
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:
19. 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, 2016, were:
Operating lease rental expenses were $36.1 million, $37.4 million and $39.5 million in the years ended December 31, 2016, 2015 and 2014, respectively. At December 31, 2016 and 2015, the Company had capital lease obligations outstanding in the amount of $3.1 million and $2.0 million, respectively.
20. VENEZUELA CURRENCY MATTERS
Discussion of Venezuela Exchange Rates
In January 2014, the Venezuelan government enacted changes affecting the country’s currency exchange and other controls, and established a new foreign currency administration, the National Center for Foreign Commerce (“CENCOEX”). CENCOEX assumed control of the sale and purchase of foreign currency in Venezuela, and established the official exchange rate (“Official Rate”) of 6.3 Bolivares Fuertes (“VEF”) to 1.0 U.S. dollar (“USD”). Additionally, the government expanded the types of transactions that may be subject to the weekly auction mechanism under the Complimentary Currency Administration System (“SICAD I”). For a period of time, the Venezuelan government announced plans for the Alternative Foreign Exchange System, also known as SICAD II, which was intended to more closely resemble a market-driven exchange.
In February 2015, the Venezuelan government combined the SICAD I and SICAD II (“SICAD”) exchange rate mechanisms and created a new market based SIMADI rate, which was based on supply and demand. The changes created a three tiered system. As of December 31, 2015, CENCOEX traded at 6.3 VEF to 1.0 USD, the SICAD auction markets traded at 13.5 VEF to 1.0 USD and the SIMADI traded at 198.7 VEF to 1.0 USD.
In March 2016, the Venezuelan government devalued its currency and reduced its existing three tiered system to a two tiered system by eliminating the intermediary SICAD rate. The CENCOEX Official Rate, which continues to be used for purchases of certain essential goods, was changed to 10.0 VEF to 1.0 USD and is now referred to as DIPRO. Additionally, the SIMADI rate was replaced by a new market based rate known as DICOM, which governs all transactions not covered by DIPRO. The VEF as measured at the DICOM rate has continued to devalue against the USD throughout 2016.
The rates were as follows:
Effect on the Company’s Results
Currency Matters
Due to the elimination of the SICAD rate in March 2016, the Company adopted the DICOM rate for purposes of remeasuring the monetary assets and liabilities of its Venezuela subsidiary, effective March 10, 2016, because the Company believes the DICOM rate would now be used to settle future intercompany dividend remittances. The remeasurement impact of this adoption was a loss of $32.3 million, recognized during the first quarter of 2016 as a component of other (income)/expenses - net. Additional losses in the amount of $0.6 million were recognized during the year ended December 31, 2016, related to remeasurement of the monetary assets and liabilities due to the continued devaluation of the VEF as measured at the DICOM rate against the USD.
For the years ended December 31, 2015 and 2014, currency devaluation within Venezuela resulted in losses of $2.3 million and $6.1 million, respectively.
During the years ended December 31, 2016, 2015 and 2014, the Company received U.S dollars to make payments for intercompany purchases of inventory at the CENCOEX Official Rate that was more favorable than the SICAD or DICOM rate used to remeasure net monetary assets of its Venezuela subsidiary, which resulted in recognized gains of $3.4 million, $2.4 million and $14.0 million, respectively.
Long Lived and Other Assets
As a result of the change in the Venezuelan exchange rates, the Company concluded that an impairment indicator existed at March 31, 2016 and evaluated the carrying value of the long-lived assets of its Venezuela subsidiary for impairment, which includes administrative office space, land and a partially completed distribution warehouse facility. Based on this evaluation, the Company concluded that the carrying value of the long-lived assets was no longer recoverable and recorded an impairment charge of $45.9 million to write down the carrying value of the assets to their fair value, which was recognized during the first quarter of 2016 as a component of other (income)/expenses - net. The fair value measurements were based on market quotes from local real estate broker service firms as well as internal assessments of the best information available about the local business conditions and the political environment, including the risks associated with the local currency that would be indicative of what the assets could be sold for and are considered to be Level 3 measurements.
In addition, the changes in Venezuelan exchange rates and ongoing deterioration of the business resulted in the Company incurring charges in the amount of $3.0 million during the year ended December 31, 2016 related to prepaid and other assets in Venezuela that can no longer be utilized.
Intercompany Payable
During the year ended December 31, 2016, the Company wrote-off a $52.0 million intercompany payable from its Venezuelan subsidiary to its subsidiaries in Mexico and the U.S. The decision was based on a reduced level of local currency which has resulted in the Venezuelan subsidiary no longer having sufficient cash to satisfy this payable, the continued inability to access the currency exchange and the Company’s view that sales in Venezuela are unlikely to return in the near term to a level that would generate adequate liquidity to satisfy this payable. The write-off of the payable had no impact on the Company’s results of operations on a pre-tax basis as the payable in Venezuela and the receivables in Mexico and the U.S. were held in U.S. dollars. The tax impact of this write-off was calculated based upon the tax rules in each of the impacted jurisdictions and resulted in a gain of $14.7 million recognized within Provision for Income Taxes.
Remaining Exposures
Net sales in the Venezuelan subsidiary were negligible as a percent of total Company net sales for the year ended December 31, 2016. In addition, the Venezuelan subsidiary’s earnings were not a material component of MJN’s consolidated results during the year ended December 31, 2016.
The Venezuelan subsidiary had net monetary assets and net non-monetary assets that were negligible individually and in aggregate to the Company’s total net assets as of December 31, 2016.
21. CONTINGENCIES
In the ordinary course of business, the Company is subject to lawsuits, investigations, government inquiries and claims, including, but not limited to, product liability claims, advertising disputes and inquiries, consumer fraud suits, other commercial disputes, premises claims and employment and environmental, health and safety matters.
The Company records accruals for contingencies when it is probable that a liability will be incurred and the loss can be reasonably estimated. Although the Company cannot predict with certainty the final resolution of lawsuits, investigations and claims asserted against the Company, MJN does not believe any currently pending legal proceeding to which the Company is a party will have a material impact on the Company’s business or financial condition, results of operations or cash flows.
22. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(a) When aggregated, earnings per share for the four quarters may not equal the full year earnings per share figure due to the variability of quarterly earnings and the timing of share repurchases.
23. SUBSEQUENT EVENTS
Merger Agreement
On February 10, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Reckitt Benckiser Group plc, a company incorporated in England and Wales (“Reckitt Benckiser”), and Marigold Merger Sub, Inc., a Delaware corporation and a wholly owned indirect subsidiary of Reckitt Benckiser (“Merger Sub”), pursuant to which Reckitt Benckiser will indirectly acquire the Company by means of a merger of Merger Sub with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement (the “Merger”). The Merger Agreement and the consummation of the transactions contemplated by the Merger Agreement have been unanimously approved by the Company’s board of directors.
At the effective time of the Merger (the “Effective Time”), on the terms and subject to the conditions set forth in the Merger Agreement, each share of the Company’s common stock outstanding immediately prior to the Effective Time (other than (i) each share held by the Company as treasury stock (other than shares held for the account of clients, customers or other persons), (ii) each share held by Reckitt Benckiser or by any subsidiary of either the Company or Reckitt Benckiser and (iii) each share held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has demanded appraisal for such shares in accordance with Delaware law) will be converted into the right to receive $90.00 in cash, without interest.
Consummation of the Merger is subject to the satisfaction or waiver of certain customary closing conditions, including, among others: (i) the affirmative vote of the holders of a majority of the Company's outstanding shares of common stock; (ii) the affirmative vote of a simple majority of Reckitt Benckiser's shareholders at a shareholder meeting; (iii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of certain other non-United States regulatory approvals required to consummate the Merger; and (iv) in the case of Reckitt Benckiser's obligations to consummate the Merger, the absence of a Company Material Adverse Effect (as defined in the Merger Agreement). Reckitt Benckiser and Merger Sub's respective obligations to consummate the Merger are not subject to any financing condition or other contingency.
Litigation Related to the Merger
On February 14, 2017, a stockholder of the Company filed a purported stockholder class action lawsuit in Cook County, Illinois, captioned Kirkham v. Altschuler, et al., 2017-CH-02109. The defendants are the Company, its board of directors, Reckitt Benckiser and Merger Sub. The lawsuit alleges that the Company’s board of directors violated their fiduciary duties and that the Company, Reckitt Benckiser and Merger Sub aided and abetted such breaches, in each case in connection with the transactions contemplated by the Merger Agreement. The lawsuit seeks, among other things, to enjoin consummation of the Merger. The Company and its directors intend to vigorously defend against the allegations in the complaint.
Australian Asset Acquisition
On February 27, 2017, the Company announced that it has reached an agreement to acquire assets from Bega Cheese Limited (“Bega”). In connection with this transaction, the Company is acquiring from Bega a spray dryer and a finishing plant in Australia and entering into a service agreement to support the operation of those assets. The aggregate consideration for this asset purchase is approximately AUD $200 million. The Company expects the transaction to close in the second quarter of 2017.
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, 2016. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of December 31, 2016, 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, 2016 based on the Internal Control-Integrated Framework (2013) 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, 2016, 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, 2016, which appears below.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Mead Johnson Nutrition Company
Glenview, Illinois
We have audited the internal control over financial reporting of Mead Johnson Nutrition Company and subsidiaries (the "Company") as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) 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, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) 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, 2016 of the Company and our report dated February 27, 2017 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 27, 2017
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, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. OTHER INFORMATION.
Due to the Company’s entry into the Merger Agreement, the Company’s current expectation is that its 2017 Annual Meeting of Stockholders (“2017 Annual Meeting”), previously expected to have been held in early May 2017, will be called at a later date or cancelled. The Company will provide further information regarding the 2017 Annual Meeting in due course.
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this Item 10 is set forth under the headings “Board of Directors and Corporate Governance-Board of Directors,” “Board of Directors and Corporate Governance-Code of Ethics,” “Board of Directors and Corporate Governance-Committees of the Board of Directors,” and “Section 16(a) Beneficial Ownership Reporting Compliance,” which will be filed in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement in connection with the solicitation of proxies for the election of directors at our 2017 Annual Meeting of Stockholders within 120 days after the end of our 2016 fiscal year. See Part I, “Executive Officers of the Registrant” of this Annual Report for information regarding executive officers of the Company.
Item 11. EXECUTIVE COMPENSATION.
The information required by this Item 11 is set forth under the headings “Board of Directors and Corporate Governance - Compensation Committee Interlocks and Insider Participation,” “Executive Compensation-Compensation and Management Development Committee Report,” “Executive Compensation” and “Board of Directors and Corporate Governance-Compensation of Directors” which will be filed in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement in connection with the solicitation of proxies for the election of directors at our 2017 Annual Meeting of Stockholders within 120 days after the end of our 2016 fiscal year.
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” which will be filed in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement in connection with the solicitation of proxies for the election of directors at our 2017 Annual Meeting of Stockholders within 120 days after the end of our 2016 fiscal year.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this Item 13 is set forth under the headings “Certain Relationships and Related Person Transactions” and “Board of Directors and Corporate Governance-Board of Directors-Director Independence” which will be filed in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement in connection with the solicitation of proxies for the election of directors at our 2017 Annual Meeting of Stockholders within 120 days after the end of our 2016 fiscal year.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required by this Item 14 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” which will be filed in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement in connection with the solicitation of proxies for the election of directors at our 2017 Annual Meeting of Stockholders within 120 days after the end of our 2016 fiscal year.
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.
Item 16. FORM 10-K SUMMARY.
None.
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 27, 2017
By:
/s/ Michel Cup
Michel Cup
Executive Vice President and Chief Financial Officer
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 27, 2017
By:
/s/ Peter Kasper Jakobsen
Peter Kasper Jakobsen
President, Chief Executive Officer and Director
(Principal Executive Officer)
Date:
February 27, 2017
By:
/s/ Michel Cup
Michel Cup
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Date:
February 27, 2017
By:
/s/ James E. Shiah
James E. Shiah
Senior Vice President, Finance and Controller
(Principal Accounting Officer)
Date:
February 27, 2017
By:
/s/ James M. Cornelius
James M. Cornelius
Chairman of the Board of Directors
Date:
February 27, 2017
By:
/s/ Steven M. Altschuler, M.D.
Steven M. Altschuler, M.D.
Director
Date:
February 27, 2017
By:
/s/ Howard B. Bernick
Howard B. Bernick
Director
Date:
February 27, 2017
By:
/s/ Kimberly A. Casiano
Kimberly A. Casiano
Director
Date:
February 27, 2017
By:
/s/ Anna C. Catalano
Anna C. Catalano
Director
Date:
February 27, 2017
By:
/s/ Celeste A. Clark, Ph.D.
Celeste A. Clark, Ph.D.
Director
Date:
February 27, 2017
By:
/s/ Stephen W. Golsby
Stephen W. Golsby
Director
Date:
February 27, 2017
By:
/s/ Michael Grobstein
Michael Grobstein
Director
Date:
February 27, 2017
By:
/s/ Peter G. Ratcliffe
Peter G. Ratcliffe
Director
Date:
February 27, 2017
By:
/s/ Michael A. Sherman
Michael A. Sherman
Director
Date:
February 27, 2017
By:
/s/ Elliott Sigal, M.D., Ph.D.
Elliott Sigal, M.D., Ph.D.
Director
Date:
February 27, 2017
By:
/s/ Robert S. Singer
Robert S. Singer
Director
EXHIBIT INDEX
Exhibit
Number
Description
Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession
2.1
Agreement and Plan of Merger, dated as of February 10, 2017, among Mead Johnson Nutrition Company, Reckitt Benckiser Group plc and Marigold Merger Sub, Inc. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on February 13, 2017)
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 December 14, 2016)
3.2
Amendment No. 1 to the Amended and Restated Bylaws of the Company, adopted on February 9, 2017 (incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed on February 13, 2017)
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 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)
4.4
Second Supplemental Indenture, dated as of May 13, 2014, between Mead Johnson Nutrition Company and The Bank of New York Mellon Trust Company, N.A., as trustee (including form of the 4.60% Senior Notes due June 1, 2044) (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on May 13, 2014)
4.5
Third Supplemental Indenture, dated as of November 3, 2015, between Mead Johnson Nutrition Company and The Bank of New York Mellon Trust Company, N.A., as trustee (including forms of the 3.000% Senior Notes due 2020 and 4.125% Senior Notes due 2025) (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 3, 2015)
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
First Amendment, dated June 27, 2014, to Five Year Revolving Credit Facility Agreement among Mead Johnson Nutrition Company, Mead Johnson & Company, LLC, various subsidiaries of the Company party thereto from time to time, various financial institutions and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 30, 2014)
10.6
Amendment No. 2 to Five Year Revolving Credit Facility Agreement, dated as of November 5, 2015, among Mead Johnson Nutrition Company, various financial institutions and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.6 to Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed on February 17, 2016)
10.7*
Mead Johnson Nutrition Company Long Term Incentive Plan (incorporated by reference to Appendix A to Definitive Proxy Statement on Schedule 14A filed on March 23, 2015)
10.8*
Mead Johnson Nutrition Company Senior Executive Performance Incentive Plan (as Amended and Restated Effective as of January 1, 2015) (incorporated by reference to Exhibit 10.7 to Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed on February 27, 2015)
10.9*
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)
10.10*
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)
10.11*
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)
10.12*
Second Amended and Restated Mead Johnson & Company, LLC Senior Executive Severance Plan (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 5, 2014)
10.13*
Third Amended and Restated Mead Johnson & Company, LLC Executive Change in Control Severance Plan (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on June 13, 2014)
10.14*
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)
10.15*
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)
10.16*
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)
10.17*
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)
10.18*
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)
10.19*
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)
10.20*
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)
10.21*
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)
10.22*
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)
10.23*
Form of Performance Share Award Agreement (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 13, 2014)
10.24*
Form of Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2015 filed on July 23, 2015)
10.25*
Form of Employee Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2015 filed on July 23, 2015)
10.26*
Form of Non-Employee Director Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2015 filed on July 23, 2015)
10.27*
Form of Performance Share Award Agreement (incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2015 filed on July 23, 2015)
10.28*
Form of Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2016 filed on April 28, 2016)
10.29*
Letter Agreement between the Company and Mr. Peter G. Leemputte (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 5, 2015)
10.30*
Amendment No. 1 to Letter Agreement, dated May 20, 2015, between the Company and Mr. Peter G. Leemputte (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2015 filed on July 23, 2015)
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
*
Compensatory plan or arrangement.