Zoetis Inc. — Q2 2020 Form 10-Q
Business context and reporting period
Zoetis develops, manufactures and sells animal health medicines, vaccines and diagnostics for companion animals and livestock. This unaudited quarterly report covers the three and six months ended June 30, 2020; financial comparisons are against the corresponding 2019 periods.
Financial performance and position
- Revenue: Q2 revenue was $1.548 billion, essentially flat year over year; operational growth was 4%, offset by a 4% foreign-exchange headwind. First-half revenue was $3.082 billion, up 3% reported and 5% operationally.
- Profit and EPS: Q2 net income attributable to Zoetis was $377 million, up 2%; diluted EPS was $0.79 versus $0.77. First-half net income was $800 million, up 17%, and diluted EPS was $1.67 versus $1.41. Adjusted net income, a non-GAAP measure, was $427 million in Q2, down 2%, and $882 million for the first half, up 3%.
- Margins and costs: Cost of sales was 29.1% of revenue in Q2 versus 30.1%; for the first half it was 29.5% versus 32.7%. Management cited pricing, manufacturing costs and product mix as contributors to improvement. International segment gross margin declined to 67.8% in Q2 from 70.6%, while U.S. segment gross margin increased to 81.3% from 79.7%.
- Cash flow: First-half operating cash flow was $846 million versus $707 million. Capital expenditures were $184 million; operating cash flow less capital expenditures was $662 million. Cash and cash equivalents rose to $3.353 billion from $1.934 billion at year-end 2019.
- Liquidity and debt: Working capital was $4.474 billion and the current ratio was 3.47:1 at June 30. Long-term debt, net of discount and issuance costs, was $7.194 billion, plus $500 million current debt. Zoetis issued $1.25 billion of senior notes in May: $750 million at 2.000% due 2030 and $500 million at 3.000% due 2050. The revolving credit facility was undrawn, and the company reported compliance with its financial covenants.
- Capital returns: First-half dividends paid were $190 million; dividends declared were $0.20 per share in Q2 versus $0.164 a year earlier. Zoetis temporarily suspended share repurchases beginning in Q2.
Material changes versus the prior comparable period
- Q2 U.S. revenue rose 6%, led by companion-animal products, up 19%; U.S. livestock revenue fell 18%. International revenue declined 5% reported but grew 3% operationally, with currency reducing reported growth by 8%.
- Across product categories in Q2, dermatology revenue rose to $227 million from $185 million and parasiticides to $307 million from $266 million. Vaccines fell to $336 million from $370 million, and anti-infectives to $241 million from $293 million.
- First-half reported net income growth benefited from lower cost of sales and comparison with 2019 items, including a $68 million inventory-costing estimate change. Q2 adjusted net income declined despite reported net income growth.
- Debt increased following the May note issuance; cash increased substantially. Inventory rose to $1.584 billion from $1.410 billion, which management attributed to a new product launch, lower-than-anticipated sales for some products and higher safety stocks.
Outlook, management commentary, risks and unusual items
- Management said COVID-19 significantly affected Q2 results and anticipated demand impacts to continue through the remainder of 2020. It could not predict the pandemic’s full effect; the filing provides no clear numerical 2020 guidance in the supplied text.
- Reported pressure points included livestock customers’ processing disruptions and reduced profitability, and lower veterinary-clinic traffic in some international markets. Zoetis said manufacturing and supply-chain operations continued as it was designated an essential business.
- Key risks include further COVID-19 disruption to customer demand, operations and supply chains; foreign-exchange movements (about 43% of first-half revenue was denominated in foreign currencies); animal disease outbreaks; product safety or supply issues; R&D and acquisition execution; generic competition; and substantial indebtedness. Management noted that LIBOR discontinuation could affect floating-rate debt.
- Unusual items included a first-half $18 million net gain, primarily related to proceeds from the 2016 sale of manufacturing sites; CEO-transition-related costs; and small intangible-asset and equity-investment impairments. The company also completed acquisitions including Performance Livestock Analytics and Ethos Diagnostic Science; these did not significantly affect the financial statements.
- Legal and tax matters remain uncertain. The company said it had accrued probable, estimable legal losses but could not estimate reasonably possible losses above accruals. It did not expect the disclosed legal matters to materially affect financial position, though outcomes could affect results or cash flows. Uncertain tax-position liabilities were $186 million, excluding $13 million of related interest and penalties.
Important facts for investors to verify
- Whether COVID-19 demand effects persisted through the rest of 2020, especially in livestock and veterinary services, and whether any formal guidance was issued separately.
- Whether companion-animal growth and launches offset livestock weakness, foreign-exchange effects and competitive pressure.
- How cash conversion, inventory levels and operating cash flow developed after the first half.
- Debt repayment and refinancing plans, leverage and interest costs, including exposure to floating rates and LIBOR transition.
- Developments in generic competition, product approvals and supply, and the outcomes or estimates for significant legal and tax contingencies.