J&J's Earnings
Thoughts on the Q1 Report

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (April 20, 1999) -- The Drip Port's healthcare company of choice, Johnson & Johnson (NYSE: JNJ), reported its first quarter results this morning and the folks in New Brunswick, N.J. did not disappoint: First quarter revenues came in at $6.6 billion, up 15% year-over-year and 4% sequentially thanks to strong gains at the company's pharmaceutical and professional products businesses. Net income increased to $1.1 billion, a 12% rise from a year ago. Earnings per share were $0.82, up from $0.73 a year ago and two pennies ahead of the consensus estimate.

The strength of the results was a bit surprising, considering the company is coming off a somewhat lackluster 1998 marred by slowing worldwide economies and falling exchange rates. But like a strong tree after a sudden storm, J&J is snapping back and has all of its businesses moving again in the right direction.

Among the major moving parts we like to follow on a quarterly basis, J&J's gross margin (1 minus the result of cost of products sold divided by total revenues) ended up at 69% -- right in line with the historical trend over the past eight quarters. As a percentage of revenues, the company's selling, marketing and administrative expenses (SM&A) were 36%, at the low end of the recent 36% to 41% range.

On a slightly negative note, research expense as a percentage of revenues fell to 8.1% from 8.5% a year ago. We're not going to read too much into the decline, however, since the firm still ended up spending an impressive $536 million on research in the period. Moreover, J&J's research-to-revenue ratio has a tendency to be low in Q1 and consistently higher in the three subsequent quarters. We'll see if this year's research expenditures mimic that trend. (We won't be surprised if they do.)

Examining J&J's trio of business units, we find the pharmaceutical division leading the way yet again this quarter. Worldwide drug sales were $2.5 billion, up 18.4% from a year ago. In the U.S. alone, sales of J&J pharmaceuticals leapt 23.3% from last year's levels. We have grown accustomed to repeated quarterly sales growth for the company's big drugs, such as the red blood cell stimulator Procrit, the Risperdal antipsychotic medication, and the Duragesic chronic pain patch. Yet, the continued strength of Procrit warrants a closer look.

Despite the setback from Amgen's arbitration win last year concerning a once-a-week version of erythropoietin that may eventually compete with Procrit, the drug continues to gain in popularity. From all indications, more people are using Procrit every day. Even hockey star Eric Lindros is reportedly taking the drug to boost his red blood cell count after he lost three liters of blood and suffered a collapsed lung following a game last month.

Year-on-year sales of both Procrit and Risperdal increased 40% in the quarter, Jeff Leebaw in J&J's corporate communications office confirmed. That's a much higher rate than the 25% annualized growth rate forecasted by us and other analysts last year. If the Procrit sales growth in the most recent quarter can be sustained, it's not too far-fetched to predict that the drug could contribute $2 billion to J&J's topline this year. The company does not normally release specific drug data to the public, so we will have no way of knowing whether our estimates will end up being correct or not. I guess that's why they call 'em estimates.

Meanwhile, the professional products division handed in an 18.6% sales gain for the quarter (18.1% in local currency terms). Last year's acquisition of orthopedic products maker DePuy helped spur the increase, even though the added sales boost is not expected to translate into a corresponding earnings lift until next year or so. Nonetheless, we are encouraged by the way the unit is responding after a gloomy 1998, when the missteps of its Cordis stent business put the results of the whole division under a microscope.

"We'll be back," chairman and CEO Ralph Larsen promised in an interview with CNBC this morning, referring to the stent market share lost by Cordis over the past two years. Indeed, a step in that direction came yesterday when the company announced that the FDA has approved its MINI Crown stent for use in very small coronary vessels. We're talking vessels from 3.25 mm to as small as 2.25 mm -- about the size of Jeff's efficiency apartment.

If the MINI and other upcoming stents from Cordis can gain decent acceptance from cardiologists, our previous 6% annualized sales growth estimate for the professional products division this year may end up being too low. We'll see how the next quarter pans out, though, before making any hasty revisions to our expectations.

Rounding out the results, the consumer products unit posted respectable sales gains of 5.4% in the period, thanks to strength from the Neutrogena and Clean & Clear skin care lines and the Tylenol franchise. Again, sales in the U.S. fueled the overall growth, with domestic revenues up 10.4% year over year. That's pretty solid stuff.

All in all, it was a good report from J&J. After a somewhat shaky 1998, the company appears to be back to its old ways of consistently growing revenues and earnings across all of its business lines. Geographically, the U.S. and European markets continue to be strong, and business in Asia is starting to look up. That's music to our long-term, growth-friendly ears.

Tomorrow, we'll dig into the latest earnings report of holding Mellon Bank, which also released its results today.

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