Zoetis Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended July 3, 2016; comparative periods ended June 28, 2015. Results are unaudited. Zoetis develops, manufactures and sells animal-health medicines and vaccines for livestock and companion animals, operating through U.S. and International segments. The first half of 2016 included six more calendar days than the comparable 2015 period, affecting year-over-year comparisons.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $1.208 billion | $1.175 billion | $2.370 billion | $2.277 billion |
| GAAP net income attributable to Zoetis | $224 million | $(37) million | $428 million | $128 million |
| Diluted EPS | $0.45 | $(0.07) | $0.86 | $0.25 |
| Adjusted net income (non-GAAP) | $246 million | $216 million | $485 million | $423 million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $188 million | $182 million |
Revenue and margins: Reported revenue rose 3% in Q2 and 4% in the first half. Excluding foreign exchange, operational revenue growth was 6% and 9%, respectively; currency reduced reported growth by $33 million in Q2 and $110 million in the first half. Consolidated gross margin, calculated from revenue less cost of sales, was approximately 67.0% in Q2 versus 63.7%, and 66.8% for the first half versus 63.9%.
Drivers: U.S. revenue grew 10% in Q2 and 11% in the first half, led by companion-animal products, including Apoquel. International revenue declined 3% and 2% as reported, but grew 2% and 7% operationally; foreign exchange was a significant offset. Livestock revenue was pressured by product and market rationalization, while companion-animal sales increased. Vaccines and other pharmaceuticals also contributed to product-category growth.
Costs and earnings: Q2 cost of sales fell 7% and SG&A fell 9%; first-half cost of sales fell 4% and SG&A fell 10%. R&D expense increased 5% in Q2 and 9% in the first half. Lower restructuring costs were a major factor in the GAAP profit improvement: 2015 included $266 million of Q2 restructuring and acquisition-related charges, compared with a $21 million benefit in Q2 2016. First-half 2016 included a $19 million benefit versus $267 million of charges in 2015. Higher interest expense partly offset the improvement, increasing to $41 million in Q2 and $84 million in the first half.
Cash, debt and liquidity
- Cash and equivalents were $658 million at July 3, 2016, down from $1.154 billion at year-end 2015. First-half operating cash flow was $188 million; investing used $31 million and financing used $651 million, including $400 million of debt principal payments, $151 million of share repurchases and $94 million of dividends paid.
- Long-term debt was $4.465 billion, with no current portion at quarter-end; short-term borrowings were $4 million. The company repaid $400 million of notes that had been current at year-end. It reported compliance with debt covenants and no amounts drawn on its $1.0 billion revolving credit facility.
- Working capital was $2.289 billion and the current ratio was 3.20:1. Management said cash, operating cash flows and available financing were expected to meet foreseeable needs, while noting that economic conditions could affect future access to financing.
- The board’s $500 million repurchase authorization had approximately $150 million remaining at quarter-end. The company declared a $0.095-per-share dividend in Q2.
Changes, outlook and notable items
- Pharmaq, acquired in November 2015, expanded the aquaculture portfolio and contributed to revenue and costs. The company also acquired a livestock business in South America in Q1 2016, with a $38 million purchase price including $33 million of contingent milestone payments.
- As part of its efficiency program, Zoetis sold several manufacturing sites, product portfolios and its 55% interest in a Taiwan joint venture. First-half divestiture proceeds were approximately $88 million; the company recorded a net $27 million gain for the half, partly offset by a Q2 loss.
- The efficiency program targeted reductions of approximately 2,000–2,500 positions. About 1,600 positions had been eliminated by July 3, with further reductions expected primarily over the following 12 months. The company also planned to sell or exit ten manufacturing sites over the long term.
- The European Commission’s adverse decision on Belgian excess-profits tax rulings resulted in an approximately $38 million net tax charge for the first half. Uncertain-tax-position liabilities were $111 million at quarter-end; Zoetis said it expected approximately $50 million of reserves could decrease within 12 months due to the anticipated payment related to Belgium.
- Management reported that the 2016 U.S. avian-influenza vaccine contract was awarded for the National Veterinary Stockpile and said it did not currently expect the outbreak situation to have a significant impact on 2016 global revenue. The USDA would determine whether to implement a vaccination program.
- No formal numeric revenue or earnings guidance is stated in the supplied filing text. Key risks include foreign-exchange movements, animal disease outbreaks, regulation and competition, product and patent litigation, tax disputes, and variability in demand. The filing describes several legal matters and says it cannot estimate reasonably possible losses above accrued amounts; management did not believe the matters discussed would materially affect financial position, though outcomes could affect results or cash flows.
Important facts for investors to verify
- Whether operational growth and margin gains persist after considering foreign exchange, the extra first-half calendar days and product rationalization.
- How much reported earnings improvement reflects recurring operations versus prior-year restructuring charges, 2016 restructuring benefits, divestiture gains and tax items; review the non-GAAP adjusted-net-income reconciliation.
- Cash conversion, inventory growth and working-capital movements, alongside continued repurchases, dividends and debt-service requirements.
- Progress and realized savings from the efficiency program, including remaining site exits and planned workforce reductions.
- Resolution and cash impact of the Belgian tax matter, as well as developments in disclosed product, environmental and commercial litigation.