Zoetis Inc. — Q3 2019 Form 10-Q
Business context and reporting period. Zoetis is a global animal-health medicines, vaccines and diagnostics company serving livestock and companion-animal markets. This unaudited quarterly report covers the three and nine months ended September 30, 2019, compared with the same 2018 periods. The statements received an independent accountant’s review, not an audit.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $1.584 billion | $1.480 billion | $4.586 billion | $4.261 billion |
| Net income attributable to Zoetis | $433 million | $347 million | $1.116 billion | $1.083 billion |
| Diluted EPS | $0.90 | $0.71 | $2.31 | $2.22 |
| Adjusted net income (non-GAAP) | $455 million | $403 million | $1.315 billion | $1.143 billion |
| Adjusted diluted EPS (non-GAAP) | $0.94 | $0.83 | $2.73 | $2.34 |
- Reported revenue rose 7% in Q3 and 8% in the first nine months; management reported operational growth, excluding foreign exchange, of 9% and 11%, respectively. Currency reduced reported growth by approximately 2 and 3 percentage points.
- Q3 net income increased 25%; nine-month net income increased 3%. Adjusted net income grew 13% and 15%, respectively. Adjusted results are non-GAAP and exclude purchase-accounting adjustments, acquisition costs and certain significant items.
- Q3 cost of sales was 30.2% of revenue versus 32.0%; for nine months it was 31.9% versus 32.1%. Management cited favorable mix, pricing and foreign exchange, among other factors. SG&A was 25% of revenue and R&D 7% in both comparable periods.
- Interest expense was $56 million in Q3 and $167 million for nine months, up 4% and 14%, respectively, mainly reflecting debt issued in 2018. Effective tax rates were 18.0% and 18.2%, versus 17.0% and 15.2% in 2018.
- Operating cash flow for the first nine months was $1.213 billion, versus $1.206 billion. Capital expenditures were $294 million. Cash ended at $1.815 billion, up from $1.602 billion at year-end 2018.
- Investing cash outflow was $291 million, compared with $2.185 billion in 2018, when the Abaxis acquisition drove substantial spending. Financing cash outflow was $701 million, including $450 million of treasury-stock purchases and $235 million of dividends paid.
- At September 30, long-term debt was $6.447 billion; cash less long-term debt was approximately negative $4.632 billion. There were no short-term borrowings and no draws on the $1.0 billion revolving facility. Working capital was $3.566 billion and the current ratio was 4.39:1. The company reported compliance with debt covenants.
Material changes and business drivers
- Companion-animal revenue was the principal growth engine: up 21% globally in Q3 and 21% for nine months. U.S. companion-animal sales benefited from parasiticides, dermatology products, new launches and Abaxis diagnostics.
- Livestock revenue declined 6% in Q3 and 5% for nine months. Management cited weakness in U.S. cattle markets and African Swine Fever’s impact on swine sales in China and parts of Asia. Poultry products provided some offset.
- International revenue grew only 2% in Q3 and 1% for nine months as foreign exchange offset operational growth. U.S. revenue increased 11% in Q3 and 13% year to date.
- Abaxis, acquired in July 2018, contributed to growth and higher intangible-asset amortization. Zoetis acquired companion-animal nutrition business Platinum Performance in Q3 2019; the filing says its financial impact was not significant.
- Share repurchases reduced outstanding shares: approximately 4 million shares were repurchased in the first nine months. About $1.9 billion remained under the $2.0 billion authorization at September 30.
Outlook, risks and unusual items
- The filing discusses 2019 financial guidance but this filing text does not provide a clear numerical guidance range or a specific updated outlook.
- Management said existing cash, operating cash flow, financing arrangements and capital-market access were expected to support foreseeable funding needs, while cautioning that economic conditions could affect liquidity and future financing access.
- Key risks include animal-disease outbreaks—particularly African Swine Fever—foreign-exchange volatility, product safety or supply problems, competition and generic entry, R&D and acquisition execution, regulatory changes, litigation, cybersecurity, and changing tax rules.
- Q3 included $20 million of income from a contingent payment related to the 2016 sale of U.S. manufacturing sites. Nine-month results included a $68 million change in estimate related to inventory costing, reflected among significant items. These items affect interpretation of reported and adjusted results.
- Tax matters include $181 million of liabilities for uncertain tax positions, excluding interest and penalties. Zoetis reported uncertainty around an EU investigation of Belgium’s excess-profit tax rulings and other tax disputes. It stated it did not expect a significant reduction in uncertain tax positions within the next 12 months.
- Legal contingencies include environmental proceedings in Brazil and litigation related to animal-feed contamination; Zoetis said it had been dismissed from the consolidated Michigan cases, subject to possible appeal after final adjudication. The company could not estimate reasonably possible losses above accrued amounts for its legal contingencies.
Important facts for investors to verify
- Review the full 2019 guidance and subsequent disclosures; this filing text contains no clear numerical guidance range.
- Assess how much growth is organic and durable versus attributable to Abaxis, new product launches, pricing and foreign-exchange movements.
- Track African Swine Fever and livestock trends, especially whether companion-animal growth continues to offset livestock weakness.
- Evaluate debt maturities, interest expense and planned capital returns alongside cash flow and capital spending.
- Examine the $68 million inventory-costing estimate change, the $20 million contingent gain, and the reconciliation between GAAP and adjusted earnings.
- Monitor tax uncertainties and legal proceedings for changes to expected liabilities, cash flows or effective tax rates.