Zoetis Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months ended July 2, 2017, compared with the periods ended July 3, 2016. Zoetis develops, manufactures and sells animal-health medicines and vaccines for livestock and companion animals. The interim financial statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Three months ended July 2, 2017 | Six months ended July 2, 2017 |
|---|---|---|
| Revenue | $1.269 billion, up 5% year over year | $2.500 billion, up 5% |
| Net income attributable to Zoetis | $247 million, up 10% | $485 million, up 13% |
| Diluted EPS | $0.50, versus $0.45 | $0.98, versus $0.86 |
| Adjusted net income (non-GAAP) | $261 million, up 6% | $522 million, up 8% |
| Adjusted diluted EPS (non-GAAP) | $0.53, up 8% | $1.06, up 9% |
- Revenue drivers: Operational revenue grew 6% in both periods; foreign exchange reduced reported growth by about 1%. Dermatology, new product launches and in-line products supported growth. Dogs and cats revenue increased 9% in Q2 and 11% for the six months. Companion-animal sales were a major growth contributor.
- Margins and costs: Cost of sales rose 10% in Q2 and 12% in the first half, faster than revenue; it was 34.7% and 35.3% of revenue, respectively, versus 33.0% and 33.2% a year earlier. Approximate consolidated gross margin declined to 65.3% in Q2 and 64.7% for the six months. SG&A declined 2% in both periods; R&D declined 2% in Q2 and 1% for the six months. Management cited higher manufacturing and supply costs, inventory obsolescence and unfavorable currency effects.
- Profit and taxes: Pretax income was $345 million in Q2 and $682 million for the six months. Effective tax rates were 28.4% and 28.7%, down from 32.5% and 35.5%, primarily reflecting earnings mix and the absence of a prior-year Belgian tax charge.
- Cash flow: Six-month operating cash flow was $299 million, versus $188 million; capital expenditures were $93 million. Cash and cash equivalents were $705 million at July 2, down from $727 million at year-end. Cash flow improvement reflected timing of receipts and payments and higher earnings, partly offset by higher U.S. tax payments.
- Liquidity and debt: Working capital was $1.80 billion, down from $2.27 billion; the current ratio was 2.01, versus 3.03. Debt carrying value was approximately $4.57 billion, including $100 million of commercial paper; $750 million of senior notes was classified as current and matures in February 2018. The $1.0 billion revolving facility was undrawn, and Zoetis reported compliance with its financial covenants.
- Capital returns: The company repurchased approximately $250 million of shares and paid $103 million in dividends in the first half. About $1.3 billion remained under the share-repurchase authorization. Dividends declared were $0.105 per share for Q2.
Material changes and management commentary
- U.S. revenue grew 5% in Q2 and 4% for the first half; International revenue grew 5% and 7%, respectively. International growth was partly offset by currency depreciation. Segment earnings increased in both regions.
- Management said first-half manufacturing and supply costs were elevated and anticipated improvement in cost of sales as a percentage of revenue in the second half compared with 2016. This is a stated expectation, not formal full-year financial guidance.
- The operational-efficiency program was substantially complete, with approximately 2,200 positions eliminated, including divestitures. Zoetis expects further reductions through supply-network divestitures over the next several years.
- The company agreed to sell its Guarulhos, Brazil manufacturing site, with closing expected in the second half of 2017, and a five-year manufacturing and supply agreement planned with the buyer. The sale of a Shenzhou, China site generated approximately $2 million in pretax gain. Q2 also included a $4 million insurance recovery related to prior commercial settlements in Mexico.
Risks, contingencies and unusual items
- Implementation of the U.S. Veterinary Feed Directive adversely affected certain cattle and swine medicated-feed-additive sales; management expected the effect to continue for the remainder of 2017. The company also identified restrictions on livestock antibacterials, generic competition, product-patent expirations, disease outbreaks, weather, foreign exchange and quarterly variability as risks.
- Legal matters include approximately 264 PregSure-related claims in Europe and New Zealand; approximately 168 had been settled for amounts not material individually or in aggregate. Other disclosed matters include environmental proceedings in Brazil and litigation related to alleged lascadoil contamination of animal feed. Management said it could not estimate reasonably possible losses above recorded accruals for its contingencies.
- Uncertain tax positions totaled $75 million, excluding $11 million of related interest and penalties. Tax authorities’ resolutions could affect results; the company did not expect a significant reduction in uncertain positions within the next twelve months.
- Zoetis reported that foreign currencies accounted for approximately 47% of first-half revenue. It also disclosed a $750 million 2018 debt maturity and reliance on refinancing plans, alongside continuing exposure to interest-rate, currency and market-access risks.
Important facts for investors to verify
- Whether the anticipated second-half improvement in manufacturing costs materialized and restored gross-margin performance.
- The effect of Veterinary Feed Directive implementation, antibacterial regulation and generic competition on livestock and established-product sales.
- Cash generation, working-capital trends, share repurchases and the company’s plan for the February 2018 $750 million note maturity.
- Developments in uncertain tax positions and the disclosed legal matters, including any changes to potential exposure or accruals.
- Progress and economics of the Guarulhos site sale and related supply agreement.