Zoetis Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended April 2, 2017; comparable period ended April 3, 2016. Zoetis develops, manufactures, and sells animal-health medicines and vaccines for livestock and companion animals through U.S. and International segments.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $1.231 billion | $1.162 billion | +6% |
| Income before taxes | $337 million | $332 million | +2% |
| Net income attributable to Zoetis | $238 million | $204 million | +17% |
| Diluted EPS | $0.48 | $0.41 | +17% |
| Adjusted net income | $261 million | $239 million | +9% |
| Adjusted diluted EPS | $0.53 | $0.48 | +10% |
| Cash provided by operating activities | $119 million | $51 million | +$68 million |
Margins and expenses: Cost of sales rose 14% to $443 million, increasing to 36% of revenue from 33% (reported rounded figures). Management attributed the increase mainly to manufacturing and supply-cost timing, higher volume, and unfavorable foreign exchange, and expected cost of sales as a percentage of revenue to improve in the second half versus 2016. SG&A declined 2% to $309 million; R&D was flat at $90 million. The effective tax rate fell to 29.1% from 38.6%, chiefly reflecting a $35 million discrete tax expense in Q1 2016 and changes in earnings mix.
Revenue mix and segments: U.S. revenue increased 4% to $605 million; International revenue increased 8% to $615 million, including 9% operational growth partly offset by currency. Companion-animal revenue grew 11% overall, led by dogs and cats; livestock revenue grew 3%. Product-category gains included parasiticides (+27%), other pharmaceuticals (+23%), and vaccines (+6%); anti-infectives declined 8% and medicated feed additives declined 11%. Apoquel growth and new launches, including Simparica and Cytopoint, were cited as important drivers. Foreign exchange reduced total reported revenue growth by $4 million.
Cash, debt, and liquidity
- Cash and cash equivalents were $629 million at April 2, 2017, down from $727 million at year-end 2016. Operating cash flow was $119 million; investing activities used $48 million and financing activities used $176 million. The net decrease in cash was $98 million.
- Capital expenditures were $42 million. Cash returned included $125 million of share repurchases and $52 million of dividends paid. About 2.3 million shares were repurchased under the public program, with approximately $1.4 billion remaining under authorization.
- Debt had $4.5 billion principal outstanding, with $750 million due in 2018 classified as current. Balance-sheet debt was $750 million current plus $3.718 billion long-term, net of discount and issuance costs. Interest expense was $41 million, down from $43 million.
- Working capital was $1.653 billion versus $2.273 billion at December 31, 2016; the current ratio was 1.96 versus 3.03. The filing attributes the change in current debt classification to the upcoming 2018 maturity.
- No borrowings were outstanding under the $1.0 billion revolving facility, which expires in December 2021; Zoetis reported compliance with its debt covenants. Management said cash, operating cash flow, and financing access should meet foreseeable needs, while noting economic conditions could affect future financing.
Material changes, outlook, and risks
- Reported net income benefited from a lower tax rate; adjusted net income, which excludes specified purchase-accounting and other items, grew more slowly than GAAP net income. Q1 2016 included a $33 million pretax gain from divestitures; no comparable gain occurred in Q1 2017.
- The operational-efficiency program had eliminated approximately 2,200 positions, including through divestitures, against a planned reduction of approximately 2,000–2,500. Further reductions were expected primarily over the next three months. The program also includes product rationalization and planned manufacturing-site exits.
- No quantitative full-year revenue or earnings guidance is provided in the supplied filing text. Management expected elevated manufacturing and supply costs in the first half, with improvement in the cost-of-sales ratio in the second half versus 2016. Management expected the 2017 revenue impact from U.S. avian-influenza developments to be insignificant.
- Zoetis agreed to sell its Guarulhos, Brazil manufacturing site and enter a five-year supply agreement; closing was expected in the second half of 2017. Q1 also included consolidation of a European livestock-monitoring company and acquisition of a Norwegian fish-vaccination company.
- Key disclosed risks include foreign-exchange movements (47% of Q1 revenue was denominated in foreign currencies), animal-disease outbreaks, weather and livestock-market variability, generic competition and patent expirations, regulation of animal medicines and food-producing animals, tax uncertainty, and litigation. Legal matters include PregSure-related claims, Brazilian environmental proceedings, and claims associated with alleged lascadoil contamination of animal feed. Management said it could not estimate reasonably possible legal losses in excess of accruals.
- The independent accountant performed an interim review, not an audit, and reported no awareness of material modifications needed for GAAP conformity. Management concluded disclosure controls were effective at a reasonable level of assurance.
Most important facts for investors to verify
- Whether the expected second-half improvement in manufacturing costs and cost-of-sales ratio materializes.
- Revenue and earnings durability behind growth in companion-animal products and international markets, including effects of currency, competition, product rationalization, and the Veterinary Feed Directive.
- The refinancing or repayment plan for the $750 million 2018 debt maturity, and the effect of ongoing repurchases and dividends on cash and liquidity.
- Progress and realized savings from the efficiency program, including remaining position reductions and manufacturing-site dispositions.
- Developments in uncertain tax positions and disclosed litigation, including any changes to potential exposure or accrued amounts.