Zoetis Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Zoetis is a global animal-health medicines and vaccines company serving livestock and companion-animal markets. This unaudited quarterly report covers the three and six months ended June 30, 2018, compared with periods ended July 2, 2017. The interim statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $1.415 billion | $1.269 billion | $2.781 billion | $2.500 billion |
| GAAP net income attributable to Zoetis | $384 million | $247 million | $736 million | $485 million |
| Diluted EPS | $0.79 | $0.50 | $1.51 | $0.98 |
| Adjusted net income (non-GAAP) | $375 million | $261 million | $740 million | $522 million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $656 million | $299 million |
- Reported revenue rose 12% in Q2 and 11% in the first half. Excluding foreign exchange, operational growth was 9% and 8%, respectively; currency added about 3 percentage points to reported growth in each period.
- Q2 revenue growth reflected approximately 5% higher volume from in-line products, 3% from new products and 1% from price. First-half growth reflected about 5% in-line volume, 2% new-product volume and 1% price.
- Companion-animal revenue grew 18% in Q2 and 16% in the first half; livestock revenue grew 7% and 8%, respectively. Dermatology products and new products, including Simparica, were notable growth drivers.
- Cost of sales was 31.6% of revenue in Q2 versus 34.7% a year earlier, and 32.1% versus 35.3% for the first half. Management attributed the improvement to manufacturing efficiencies and favorable foreign exchange. SG&A and R&D expenses increased in dollars; R&D rose 19% in Q2 and 13% in the first half.
- Effective tax rates declined to 12.6% in Q2 and 14.3% for the first half, from 28.4% and 28.7%. The reduction reflected the lower U.S. federal tax rate, earnings mix and discrete Tax Act benefits, including a $33 million Q2 and $35 million first-half benefit from revising the provisional repatriation-tax estimate.
- First-half operating cash flow was $656 million, up from $299 million, attributed primarily to higher earnings and timing of receipts and payments. Investing used $121 million, including $126 million of capital expenditures; financing used $533 million, mainly for $405 million of share repurchases and $122 million of dividends.
Financial position and material changes
- At June 30, cash and cash equivalents were $1.558 billion; long-term debt, net of discounts and issuance costs, was $4.955 billion (approximately $5.0 billion principal). Working capital was $3.272 billion and the current ratio was 4.38:1.
- The existing $1.0 billion revolving credit facility was undrawn at quarter-end, as were the commercial-paper program and other short-term facilities. Zoetis reported compliance with its debt covenants.
- Zoetis repurchased approximately 5.0 million shares in the first half for $405 million; approximately $595 million remained under its $1.5 billion authorization. The quarterly dividend declared per share increased to $0.126 from $0.105.
- Foreign-currency translation reduced first-half other comprehensive income by $38 million; Q2 translation loss was $115 million.
Outlook, commentary and risks
- The supplied filing text does not provide a clear numerical 2018 revenue or earnings guidance range. Management cited continued product and market growth, manufacturing efficiencies and R&D investment, while noting quarterly variability from weather, herd-management decisions, disease, regulation, competition, product mix and investment timing.
- On July 31, 2018, after quarter-end, Zoetis completed its approximately $2 billion cash acquisition of Abaxis, a veterinary diagnostics company. In July, it borrowed $500 million under a new 364-day facility and issued $500 million of commercial paper to help fund the acquisition. These borrowings were subsequent to the June 30 balance sheet.
- Key risks include foreign-exchange movements, tariffs and trade-policy changes, disease outbreaks, product safety or efficacy concerns, regulation of animal medicines and food production, competition and generic products, R&D execution, litigation, tax uncertainty and substantial indebtedness. Zoetis said it could not estimate reasonably possible legal losses above accrued amounts. It reported that claims concerning contaminated animal feed had been dismissed against Zoetis; an appeal application was denied in July 2018.
- The company was still refining certain Tax Act accounting estimates. It also expected the new lease-accounting standard, planned for adoption in 2019, could materially affect balance-sheet assets and liabilities, though not income-statement results significantly.
Important facts for investors to verify
- How much of earnings growth reflects recurring operating performance versus the lower tax rate and discrete tax benefits; compare GAAP results with management’s non-GAAP adjustments.
- Whether companion-animal and new-product momentum persists, and how competition in certain in-line products affects sales.
- The post-acquisition funding, integration and performance of Abaxis, including the effect of the additional $1.0 billion in July borrowings and commercial paper.
- Future cash generation, capital spending, share repurchases and dividend capacity relative to approximately $5.0 billion of debt.
- Final Tax Act accounting, uncertain tax positions, currency and tariff exposures, and developments in legal and regulatory matters.