Johnson & Johnson Down Small on Huge Loss -- What Gives?

On this episode of the Market Foolery podcast, Chris Hill chats with Jim Mueller from Stock Advisor and Motley Fool Options and Abi Malin of Hidden Gems about the biggest news in the market today.

Johnson & Johnson (JNJ -0.69%) lost almost $11 billion this quarter, but the market doesn't seem too worried. Netflix's (NFLX -3.92%) revenue and profit came in about expected, but the stock is popping more than 10% on huge subscriber gains. Elon Musk's new compensation plan is raising some eyebrows and might possibly be setting him up to cede his position in the not-too-far-off future. And a group of hospitals are taking drug pricing and supply issues into their own hands. Tune in to hear more.

A full transcript follows the video.

This video was recorded on Jan. 23, 2018.

Chris Hill: It's Tuesday, Jan. 23. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, from Stock Advisor and Motley Fool Options, Jim Mueller; and from Hidden Gems, Abi Malin. Happy Tuesday!

Jim Mueller: Hey, Chris!

Abi Malin: Thanks for having us!

Hill: Thanks for being here! It's Academy Award nominations day, so I spent at least a little bit of my morning watching the Academy Award nominations. It's appropriate that Netflix reported, so that's what we're going to lead with. We're also going to get into an interesting new compensation plan for Elon Musk and some news out of Johnson & Johnson. But let's start with, shares of Netflix up more than 10% this morning. Fourth-quarter profits and revenue, Jim, came in about as expected. But Netflix, this is one of those companies where it's clear that subscriber growth is the No. 1 metric, and they kind of crushed it.

Mueller: They did crush it. They guided for about 6.3 million subscribers growth year over year in Q4, and they beat that by about 2 million, so like a 33% beat on this number. And management for Netflix has been really good about predicting what their subscriber growth will be. They tend to under-predict a little bit, but I think even this one surprised them a little bit.

Hill: I was going to say, there's a long history of the successful companies sandbagging their numbers. At some point, the really great ones, the true artists -- this was one more thing that Steve Jobs was great at -- the true artists, in my mind, walk the fine line of sandbagging just a little so that they have a better-than-expected beat. But I think you're right. In the past, we've seen, they came in and guided for one number and they beat it for a couple hundred thousand. Two million.

Mueller: Yeah. I've been tracking their guidance for over the last 10 years' worth of quarters or something like that, and they've missed less than a handful of times, where the actual number came in lower. They're about 1% low on the guidance, so you can really rely on what they do. But this one, 2 million extra, which boosted things all the way down the line.

Hill: Abi, what stood out to you when you looked at Netflix this quarter?

Malin: I think when you think about those subscriber growth numbers relative to the number of people in the U.S. -- they added almost 2 million customers in the U.S. alone. They say they now have more than half of U.S. broadband households. I think when you think about that number, that seems pretty staggering. You assume every household has between two and four or five or six people. I think their reach is really hard to deny at this point.

Mueller: And the penetration in the U.S. is still lower than where they're expecting it to end up. They said a few years ago, and CEO Reed Hastings brought this up again in the call last night, saying, "We think we can reach between 60 and 90 million households in the U.S." There's only like 110 [million]-115 million households in the country. So they're really going for the high penetration. They're now at 55 or so. So they're still under where they think they can get.

Hill: We've talked before about their content costs. And that appears to be a line item that a lot of investors and a lot of analysts watch. I'm not saying that's not something to be noticed this time around. What caught my attention, though, was their marketing spend, and on the call talking about how they're increasing their marketing spend this year by more than 50%. I suppose that's another fine line they have to walk, because it's not just a matter of they're spending more money. It's where they're spending it. Aren't they going to be spending that money on Facebook and YouTube, who, on some level, are in competition with Netflix?

Mueller: Exactly. Well, on some level, in that Facebook has their own ad-supported user-produced video, so does YouTube. But they're more competing against the other over-the-top streaming on demand sites like Hulu and Amazon Prime. But they're a test and learn company, just like we are here at the Fool, and they've tested out some ads on, like with the latest movie, Bright. And they said, "These are working pretty well. We're getting a bump up in our numbers, so we'll continue testing that and expanding." They've how they've approached a lot of things. That's how they approached streaming in the very beginning, they tested it out and said, "Here's something we think we can do," and it turned out really well for them.

Hill: How tough must it be if you work at -- I'm glad you mentioned that, once upon a time, they were testing out streaming, because this was the DVD-by-mail business. How depressing do you think it is to work in that division right now at Netflix? Because it seems like every quarter, that gets to be a smaller number of people. There are still people subscribing to the DVD-by-mail business.

Mueller: Interesting you should say that. There was an article out today, I can't remember which organization put it out, looking at that very thing. DVD.com is the name of the company, a holding of Netflix. And the workers there said, "We're still very much focused on the customer and making a good customer experience. We've gotten a lot more efficient on delivering DVDs. But we've also pulled back the number of distribution centers." I think they have 17 left out of a high of 50 at one point. And it's kind of a sad experience, as you watch these subscriber numbers slowly decline.

Hill: Last thing on Netflix before we move on, I know it's early in 2018, but I think we have the clubhouse leader in best one-time charge for a company. Here's your leading candidate in 2018 right now. I don't know if you guys saw this. One of the things Netflix reported was a $39 million non-cash charge, and these are their words, "related to the societal reset around sexual harassment," which I think is their wordsmithing of, "Oh, yeah, Kevin Spacey. We had this whole thing with Kevin Spacey, who's a star and executive producer of House of Cards, and oh, yeah, there's that." There's your clubhouse leader in that.

Tesla doesn't report earnings for another month, but they are making headlines today with a new compensation plan for CEO Elon Musk. Here are the broad strokes, Abi: no guaranteed salary or stock vesting over time. Instead, under this new plan, Elon Musk is going to get shares of stock by meeting various benchmarks, one of them being market cap for the company. Right now, the market cap is just under $60 billion. Once they hit the $100 billion mark, and then for every additional $50 billion thereafter, he's going to get some grant of stock. That's part of it, right?

Malin: They made 12 tranches. There's two metrics that they're looking at. The first is market cap. The first tranche is that $100 billion that you mentioned, and then it's $50 billion increments after that. Then, the second group of that first tranche is what they're calling operational milestones. That's revenue targets and adjusted EBITDA, which is only adjusted for stock-based comp. But, basically, there's targets in both of those categories, and he has to meet the target, the first milestone in A and the first milestone in B, to get paid anything.

Hill: Operational goals that, as best I can tell, do not include vehicle production. [laughs] 

Malin: I mean, that's tied to revenues, right?

Hill: I suppose it's tied to revenues. Although, as long as they keep doing this thing where it's like, "Give us the money up front and we'll get you the vehicle when we can."

Malin: Yeah. I mean, I don't assume that would be able to work for the next 10 years. But I agree, it's a little bit convoluted, given what investors are currently concerned about with this company.

Hill: I'm not a shareholder of the company, but there is a part of this plan that I look at and think, directionally -- this is something we talk about a lot: To what extent are the leaders of a company, are their incentives tied to those of the investors? If you're a shareholder of this company, you want to see the market cap going up, so tying part of his compensation to the market cap, that's alignment that works. But I would be more impressed with this plan, Jim, if there was an operational goal that was tied specifically to vehicle production.

Mueller: I'd rather see a compensation plan that's tied to something that, as you said, is operational, and in the manager's control. Market cap is not at the whim of the manager, but getting vehicles produced or getting solar panels produced, that's Elon Musk's job.

Malin: I guess I would argue, though -- I actually like this plan. I think in these high-flying tech businesses, it's really easy to heavily compensate your CEOs; it's easy to justify that number. I think no one would argue that he's probably one of the greatest minds of this generation. So I actually don't mind this plan. Full disclosure: I am a shareholder, but I also like, not only does he get 1% for every step that he reaches, he also has to hold those shares for five years once they vest. So I think there's a long-term incentive here. I think if he wins, we all win. I like that aspect of this plan. I actually like this plan.

Mueller: That is good. I do like that five-year holding period. And he is the biggest shareholder already, isn't he?

Malin: Currently, yeah.

Hill: Let me ask you this. This plan is contingent upon Elon Musk remaining CEO or becoming executive chairman and chief product officer. And some people are already speculating, this plan paves the way for him to go to that chairman role full time and install someone else as CEO. Three years from now, do you think Musk is still the CEO of this company? Or do you think he's moved on to spend more time on SpaceX, he's executive chairman, and he's installed someone else as CEO?

Malin: I think it was a while back, he actually made comments about how he wanted to stay CEO until the introduction of the Model 3, and then he said, we'll see from there. And we've obviously passed that point. So I don't think he's someone who necessarily ties himself down. I think he goes where opportunities are. Obviously, SpaceX is a huge project for him. I think he has a lot of visions and a lot of things that he's dabbling in, so I wouldn't be surprised to see him step away. But even if that were to happen, I feel comfortable with this plan.

Mueller: Plus, if he ever gets to Mars like he wants to, it's kind of hard to be the CEO from that far away.

Hill: That's a tough distance.

Yesterday, Monday, Johnson & Johnson shares hit a 52-week high. Today, those shares are falling a little bit after the healthcare giant posted a -- do I have this right? -- a fourth-quarter loss of nearly $11 billion?

Mueller: Technically, yes.

Hill: [laughs] Walk me through that. I feel like the shares would be falling more than 2% if it was a serious $11 billion loss.

Mueller: You may remember something called the tax bill from the end of last year.

Hill: I do.

Mueller: That's why they posted a big loss. It became law, so now, one of the provisions is, they have a bunch of unremitted earnings from overseas that is now subject to tax, but at the lower rate. This is a set-aside contingency amount of money, about $13.6 billion or so. Though they did take pains to point out that, as more details come forward and things work out, they'll be adjusting that. But that's a one-time hit to their earnings. So if you back that out, then they actually saw about a 10% increase in net income for the year.

Hill: Anything stand out to you, Abi?

Malin: Sometimes it's hard when companies are so big, sometimes it's surprising to see numbers move at such staggering rates. I actually think this was a great quarter and a great year for them, actually, surprisingly.

Hill: Yeah, there was a pretty healthy stretch of time where Johnson & Johnson, their earnings report was essentially a game of which division are they going to apologize for? Which division is going to have the recall? And I don't want to jinx them, but they really have been in a pretty good stretch operationally. Even in quarters where they haven't hit the ball out of the park, at least they're not having the massive writedowns that they've had in the past.

Malin: Yeah. Pharmaceutical sales were up more than 8%. Medical devices were up almost 6%, and worldwide consumer sales were up about 2.2% -- sort of the weak spot this quarter, especially with their baby care and oral care business. But over-the-counter products and beauty products were a huge bright spot for them, so even in that segment, not anything too apologetic, I don't think.

Hill: Jim, you had mentioned a story to me the other day that popped up last week. Help me unpack this, because I think this could be a very interesting thing to watch in the healthcare industry. As I understand it, it's a group of hospitals led by one based in Colorado -- I think it's Intermountain Healthcare. And essentially, leading a group of hospitals who have gotten fed up with the price of drugs, and they've said, "You know what? We're going to start making some of these on our own."

Mueller: Yeah. It really shouldn't be that surprising. Making generic drugs requires some expertise, but it's pretty much a recipe at this point. You just have to get the manufacturing approved by the FDA and make sure the drug is working exactly as it should. But this is a group of four hospital groups, controlling about 450 hospitals in the U.S., out of a little over 5,300 or so all told. So about 10% or so. And they said, look, after the Mylan increase of the EpiPen price, and Turing increased the price on Daraprim 5,000% to $750 a pill. And many of the generic drugs are seeing shortages because the profits aren't very high on them, so the manufacturers, of course, don't want to make them because they're not very profitable. But it really affects people's health. And they said, "We're fed up with this. We're going to take aim and put together a not-for-profit company to supply a steady supply of certain generics," which they haven't named. I think it's a great idea. And they have some powerful people sitting on their, I don't know if you call it a board of directors, guiding council or whatever you call it --

Hill: Yeah, they have an advisory board.

Mueller: They have Clayton Christensen of Innovator's Dilemma, and they have a former governor and senator from, I think it's Nebraska.

Hill: Yeah, Bob Kerrey.

Mueller: Yeah.

Hill: Do you think they're anticipating some interactions with the FDA?

Mueller: Yeah, I think they are. But with an experienced politician like that, they have some firepower behind them. And what's even more interesting is, the Veterans Administration hasn't given them any money, but they're very, very interested in what they're doing and will probably be one of their biggest customers.

Hill: A couple of things before we wrap up. I teased this out on Twitter yesterday. We're coming to San Francisco and putting together a listener meet-up in early February at the Golden Gate Tap Room. That's in downtown San Francisco. Wednesday, Feb. 7. Save the date, people, if you're in the San Francisco area. Wednesday, Feb. 7, 5-7 p.m., we're going to be at the Golden Gate Tap Room. Just a meet-up; just a casual meet-up. You can email [email protected] and we'll send you a reminder. I'm going to be there. Our man behind the glass, Dan Boyd, is going to be there. Matt Argersinger, Kristine Harjes from Industry Focus. Abi Malin, are you going to be there?

Malin: I haven't booked my flight yet, but I'll let you know. [laughs] 

Hill: OK. A potential Abi Malin sighting. We'll see. Wednesday, Feb. 7, if you're in the San Francisco area, we'd love to meet up with you.

Again, because it's Netflix, because it's Academy Award nominations day, let's wrap up with some sort of viewing recommendation. It doesn't have to be a movie. It doesn't even have to be a movie that's been out in the last 12 months. Abi, what's something that you would recommend to our listeners?

Malin: I'm a huge Wes Anderson film fan. So if you haven't looked at it yet, Moonrise Kingdom is on Netflix right now, and so is The Life Aquatic with Steve Zissou. I haven't watched that one, either, but I --

Hill: Bill Murray.

Malin: Yeah. They're both on my watch list. Moonrise Kingdom I've already seen a million times, but they stay there.

Hill: Moonrise Kingdom, good enough. Jim Mueller?

Mueller: You scare me, Chris. [laughs] Just, instantly, "Bill Murray."

Hill: For those not familiar, Jim Mueller, not a huge go-to-the-movies kind of guy.

Mueller: No.

Hill: A lot of other passions in your life.

Mueller: Yes.

Hill: Movies, not one of them.

Mueller: Probably not.

Hill: There's got to be something you watched, though, that you can recommend.

Mueller: I watched the remake of Tinker Tailor Soldier Spy with, who was it -- Gary Oldman, Colin Firth, and Benedict Cumberbatch. Really enjoyed it. A quirky view. If you're like me, I like to eat, unfortunately, [laughs] but I started watching Somebody Feed Phil, which has Philip Rosenthal traveling around the world and eating things. He's the producer of -- Chris, help me out here!

Hill: Phil Rosenthal is the producer of the highly successful sitcom Everybody Loves Raymond.

Mueller: That's it.

Hill: And I haven't seen Somebody Feed Phil. I think I saw maybe a teaser for it, maybe an ad on YouTube, something like that. But Phil Rosenthal is the star of a hilarious documentary called Exporting Raymond, and it's about him, because, as happens in the world of television, if a show is popular in one country, it'll get exported to another. Maybe the best recent example is The Office, which started as a limited series in the UK on the BBC --

Mueller: And is really helping Netflix, by the way. [laughs] 

Hill: Yes. And then it comes to America, and it's, with Steve Carell, this huge, huge show. So, Everybody Loves Raymond with Ray Romano, huge success in the U.S. And other countries say, "We want to do that." So, the executive producer Phil Rosenthal goes to Russia --

Mueller: Oh, awesome!

Hill: -- and is trying to explain ... it's such a great fish-out-of-water documentary with incredibly uncomfortable and hilarious moments with Phil Rosenthal.

Mueller: He looks like a really fun guy to hang out with, because he's boating around Bangkok on their waterways and he's going to a food market and getting, quote-unquote, "street food," waterway food. And he goes to Gaggan in Bangkok, which unfortunately has since closed, but it was rated the No. 1 restaurant in Asia and the seventh best restaurant in the world. Gaggan Anand, top chef from India, on this place on the show. And just watching him eat and enjoy it and say, every time, "This is the best thing I've ever eaten! And I know I've said that before!"

Hill: [laughs] That's great! I haven't seen Coco yet. We were talking about this, Abi, that we haven't seen Coco, but --

Malin: On the list.

Hill: It's on the list. And congrats to our friend, Steve May, at Pixar, and the whole team at Pixar, for that nomination, Best Animated Feature. I'm going to recommend a movie, a documentary that also got nominated for Best Documentary Feature, and that's Abacus: Small Enough to Jail. Last year on Motley Fool Money, we had Steve James, the director, come on and talk about this. This is a gripping story about a small, family-run bank in New York City that was the one bank prosecuted in the wake of the Great Recession.

Mueller: Oh, man!

​Hill:​ And I will say this. The most surprising thing about the documentary -- and it's fantastic storytelling -- was how funny it was, because it's a family-run bank, so it's this older gentleman and a couple of his adult daughters who are involved in the bank. And there are some wonderful, funny family moments, but it's a great movie. I'm totally, totally rooting for Abacus to win.

Mueller: Is that on Netflix?

Hill: I don't know yet, but we'll check right after we're done taping, right when the credits roll. Jim Mueller, Abi Malin, thanks for being here!

Mueller: Thanks, Chris!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!