Zoetis Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing, not a standalone quarterly report; fourth-quarter results are included in the filing’s unaudited quarterly data. Zoetis is a global animal-health medicines, vaccines and diagnostics company, reporting U.S. and International segments.
Key financial results
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Revenue | $6.260 billion | $5.825 billion | +7% reported; +10% operational, excluding foreign exchange |
| Net income attributable to Zoetis | $1.500 billion | $1.428 billion | +5% |
| Diluted EPS | $3.11 | $2.93 | +6% |
| Adjusted net income (non-GAAP) | $1.755 billion | $1.525 billion | +15% |
| Adjusted diluted EPS (non-GAAP) | $3.64 | $3.13 | +16% |
| Operating cash flow | $1.795 billion | $1.790 billion | Approximately flat |
Cost of sales was $1.992 billion, or 32% of revenue, versus 33% in 2018; the implied gross margin was approximately 68%. Net income was 24% of revenue, versus 25% in 2018. SG&A was $1.638 billion (26% of revenue), and R&D was $457 million (7%). Income before taxes was $1.801 billion; the effective tax rate was 16.7%, compared with 15.7% in 2018. Capital expenditures were $460 million; operating cash flow less capital expenditures was approximately $1.335 billion.
At year-end, cash and cash equivalents were $1.934 billion, long-term debt was $5.947 billion, and $500 million of debt was classified as current. Total debt principal was $6.5 billion. Working capital was $2.942 billion, and the current ratio was 2.63, down from 3.60. The $1.0 billion revolving credit facility was undrawn, and the company reported compliance with its financial covenants.
Fourth-quarter snapshot
Q4 2019 revenue was $1.674 billion, compared with $1.564 billion in Q4 2018. Net income attributable to Zoetis was $384 million versus $345 million, and diluted EPS was $0.80 versus $0.71.
Material changes and business drivers
- Companion-animal revenue increased 20% to $3.145 billion, led by dermatology, parasiticides and diagnostics. Livestock revenue declined 4% to $3.030 billion.
- U.S. revenue rose 11% to $3.203 billion; International revenue rose 3% reported and 9% operationally to $2.972 billion. Foreign exchange reduced total reported growth by 3 percentage points.
- Dermatology revenue increased to $770 million from $607 million; diagnostics revenue rose to $268 million from $136 million, reflecting growth and the Abaxis acquisition.
- International swine sales declined, with African Swine Fever in China cited as a factor. U.S. cattle and dairy weakness weighed on livestock results.
- Acquisitions during 2019 included Platinum Performance, Phoenix Lab and ZNLabs. The company also expanded its reference-laboratory, nutrition and diagnostics businesses.
- Operating cash flow was nearly unchanged despite higher earnings, partly due to higher taxes, interest payments and inventory. Investing cash use fell to $504 million from $2.259 billion in 2018, when the Abaxis acquisition drove significant spending. Financing used $951 million, including share repurchases and dividends.
Outlook, commentary, risks and unusual items
- The filing refers to 2020 financial guidance but the supplied filing text does not provide clear numerical guidance. Management stated that cash, operating cash flow and available financing were expected to support foreseeable funding needs, subject to economic conditions.
- Key disclosed risks include generic competition and patent expirations, especially for Draxxin and Revolution/Stronghold; the five largest product lines generated approximately 29% of 2019 revenue. Antibacterial restrictions, animal-disease outbreaks, foreign exchange, customer consolidation and manufacturing or supply disruptions are also cited.
- Zoetis disclosed a February 2020 voluntary submission to the U.S. Treasury’s OFAC concerning potentially relevant transactions by the acquired Platinum Performance business involving individuals or entities with possible ties to Iran. The investigation was ongoing; whether sanctions violations occurred was not known.
- Leadership changed at year-end: Kristin Peck became CEO in January 2020 following Juan Ramón Alaix’s retirement. CEO-transition costs contributed to restructuring and other unusual items.
- Reported net income included $255 million of after-tax adjustments excluded from adjusted net income, chiefly purchase-accounting impacts, acquisition-related costs and significant items. The auditor highlighted tax-benefit estimates and rebate accruals as critical audit matters; gross unrecognized tax benefits were $182 million.
- Patent and regulatory risks include a U.S. generic selamectin approval in November 2019 and anticipated U.S. generic tulathromycin entry no earlier than February 2021, according to the company. Legal and environmental matters remain, though management said it considered a material adverse effect from existing proceedings remote; it could not estimate reasonably possible losses above accrued amounts.
Investor verification priorities
- Confirm the drivers and sustainability of companion-animal growth, particularly dermatology, parasiticides and diagnostics, and the continuing weakness in livestock.
- Review the timing and commercial impact of generic entry for key products, including Revolution/Stronghold and Draxxin.
- Assess acquisition integration and returns from Abaxis and the 2019 laboratory and nutrition acquisitions, including any outcome of the OFAC review.
- Reconcile GAAP and adjusted earnings, including purchase-accounting charges, tax items and the inventory-costing estimate change.
- Monitor debt maturities, interest-rate exposure, liquidity, working-capital movement and cash available after capital spending, dividends and repurchases.
- Seek the company’s numerical 2020 guidance and subsequent updates; the supplied filing text does not state the guidance values.
KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2019.