JUPITER, FL (Oct. 19, 1999) -- While many West Coast Fools were still asleep this morning, Johnson & Johnson (NYSE: JNJ) announced an earthquake of an earnings report.

In the third quarter, sales at the jolly J&J giant rose 17.9% year-over-year to $6.7 billion, while net income rose 14.4% to $1.1 billion and earnings per share (EPS) gained 14.3% to $0.80. All of J&J's business lines showed strength in almost all geographic areas. Domestic sales shined brightest as revenue at home rose 24.1% from last year, while international sales gained 10.7%.

Continuing to rebound from a lackluster 1998, Johnson & Johnson has managed to put more spring in its step than was anticipated. One primary reason: pharmaceuticals.

Following a 25.4% year-over-year jump in the second quarter that was partially attributed to early pharmaceutical buy-ins, third-quarter worldwide pharmaceutical sales gained an impressive 23.9% to $2.6 billion, with heady 35.7% growth in domestic revenue. Best-selling drugs continue to include Procrit (anemia), Duragesic (pain), Risperdal (antipsychotic), and Levaquin (anti-infective). On deck to help sales grow and expand J&J's drug pipeline is the recent $4.9 billion acquisition of biotech Centocor, alongside new FDA approval for Aciphex and FDA approval of additional uses for Topamax, both of which were received in the third quarter.

Following an especially stagnant 1998, J&J's professional products division has cleared a path of impressive growth this year as well. Part of it is fueled by last year's DePuy acquisition, which should add to EPS next year and is adding to sales right now. Going against the recent trend, international sales growth in this division topped domestic growth, up 20.8% compared to a 19.2% gain domestically. During the quarter, J&J received government approval to sell its new CrossFlex coronary stent.

Even the sometimes sleepy but solid consumer products division isn't washed up anymore. Neutrogena soaps, bifocal contact lenses, Tylenol, Benecol, Aveeno, and other products in the division are all selling well. Something made by J&J is sold every second (half second? quarter second?) somewhere in this bright blue world. In the third quarter, worldwide consumer product sales rose 7.4% to $1.7 billion. Domestic sales lathered up 14.3%, while international sales bubbled 7% -- although this was almost entirely offset by a negative currency translation of 6.7%. (Other than attempt to hedge currencies, there's not much a company can do about this.)

Of J&J's key measures that we look at each quarter, gross margin rose to 69.9%, near the top of the company's historic range -- strong and steady. The company's cost of goods needed to produce what it sells is declining or holding steady. That's good. Next, selling, marketing, and administrative expenses totaled 38% of sales, up sequentially from Q2 (37%) and Q1 (36%), but still within our expected range of 35% to 41%. Reasons for the sequential increase each quarter could be anything: the marketing of new products, a growing sales staff, keeping up with Brian's incessant calls for information on Risperdal, Fools requesting annual reports (they're online), and so forth.

Operating margin was 22.4% and net profit margin was 16.3%, both within the expected range. (Net profit margin landed at the high end of historic results.) On another positive note, research expenses rose to $613 million this quarter, or 9.1% of sales. This compares to a research expense of 8.4% of sales last quarter, and 8.1% in the quarter prior to that. As long as more research expenses result in more new and profitable products, we don't mind the jump -- we actually encourage it. Over our 20-year investment in J&J, the company will ideally spend well over $2.5 billion per year on research, on average, or at least $50 billion total. That is a lot of clams, but it should result in a lot of sales.

Although the company's Q3 balance sheet isn't yet available, the company's debt-to-equity position and cash flow are certainly strong enough to support continued acquisitions, via cash or equity, and we wouldn't be surprised by one or two before 1999 closes -- even following the $4.9 billion acquisition last quarter. Finally, J&J's sales and earnings growth visibility is favorable, with sales momentum, cost-cutting programs, product innovation, acquisitions, and new product approval suggesting 12% to 14% EPS growth each of the next two to three years, with 10% to 12% sales growth -- or so the projection goes.

In separate news, The Wall Street Journal reported that J&J and biotech partner Genset have discovered a candidate gene associated with schizophrenia that could lead to a cure. Currently, treatments for the disorder exist, but no cure. The market potential is very large, but a candidate gene alone means that years likely remain before a solution could be on the market, if one is indeed found. Other companies are searching, too.

In summary, another strong quarter now makes three straight winners for J&J. Revenue is expected to top $7 billion in Q4, and $27 billion total for 1999. Mellon Bank (NYSE: MEL) also announced record results today; we'll cover those tomorrow or Friday.

Related Links:
Johnson & Johnson Q3 Press Release
Fool coverage of J&J's Q2 Earnings
Fool coverage of J&J's Q1 Earnings
Fool Special: The Doctor is Online?
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