Tuesday, April 18, 2023

Johnson & Johnson filed its first-quarter earnings report this week — and thanks to a mammoth litigation settlement that cost the company billions, J&J reported the biggest adjustment to earnings we’ve seen in a long while.

First, the backstory. Johnson & Johnson ($JNJ) had been mired in litigation for years over allegations that its baby powder and other talc products contained chemicals that cause cancer. Earlier this month the company announced that it had reached a settlement in the dispute, where J&J will pay $8.9 billion over the next 25 years to end thousands of lawsuits that had been filed against the company.

Then came J&J’s first-quarter earnings report, released on Tuesday. It provides an eye-popping glimpse into how that $8.9 billion will be reflected in the company’s disclosures.

Johnson & Johnson enjoyed respectable gains in revenue (up 4.9 percent from one year ago to $24.7 billion) and gross profit (up 3.3 percent to $16.3 billion). But that $8.9 billion litigation cost sank the bottom half of the income statement, so J&J ended up reporting a loss of $68 million for the quarter ($0.03 EPS loss) versus $5.15 billion in net income ($1.93 EPS) in first-quarter 2022.

So that’s yucky, but that’s GAAP.

In the world of non-GAAP adjustments, however, J&J reported a very different tale. It excluded $6.9 billion of litigation expenses, as well as another $2.3 billion in assorted other exclusions; and then added back a $2.06 billion tax benefit. When you total up all the adjustments, J&J ends up with adjusted net earnings of $7.07 billion, just a hair below $7.13 billion in adjusted earnings reported in the year-earlier period.

Figure 1, below, shows the math.

This is all perfectly legal, and one sees the sense in adjusting for the litigation expense; it’s a single, discrete item that won’t appear in future periods. That’s what non-GAAP adjustments are for.

The sheer size of it, however, is mammoth. For example, last year Calcbench cooked up a research project to tally up non-GAAP adjustments that 123 S&P 500 firms made in 2021. Litigation adjustments for all those companies added up to $230 million. J&J’s adjustment is more than 38 times larger than that.

Subscribers can track non-GAAP adjustments in various ways in Calcbench, such as using the standardized metrics field on our Multi-Company search page. And clearly tracking such disclosures is worth doing, because as Johnson & Johnson shows, sometimes those adjustments really add up.

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