Zoetis Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 29, 2015; comparable period ended March 30, 2014. Zoetis is a global animal-health medicines and vaccines company serving livestock and companion-animal markets. The interim financial statements are unaudited; KPMG conducted a review, not an audit.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $1.102 billion | $1.097 billion | Reported approximately flat; operational growth 6% (volume +3%, price +3%), offset by 6% adverse foreign exchange |
| Net income attributable to Zoetis | $165 million | $155 million | +6% |
| Diluted EPS | $0.33 | $0.31 | +6% |
| Adjusted net income (non-GAAP) | $207 million | $191 million | +8% |
| Adjusted diluted EPS (non-GAAP) | $0.41 | $0.38 | +8% |
| Operating cash flow | $60 million | $(23) million | Improved |
Cost of sales rose 4% to $394 million; as a share of revenue it increased to 35.8% from 34.5%. SG&A declined 1% to $354 million, while R&D declined 8% to $80 million. Pretax income was $230 million (21% of revenue); net income margin was approximately 15%, versus 14%. The effective tax rate fell to 28.3% from 31.7%, primarily due to a $9 million discrete tax benefit in 2015, an $8 million discrete tax expense in 2014, and changes in earnings mix.
Operational revenue growth reflected livestock growth of 7% and companion-animal growth of 4%. U.S. revenue increased 9%; CLAR operational revenue increased 13%; EuAfME was flat operationally; and APAC operational revenue increased 1%. Segment earnings rose 13% in the U.S. and 26% operationally in CLAR, but declined 9% in EuAfME and 6% in APAC on a reported basis.
Cash flow, balance sheet and debt
- Cash and equivalents were $559 million at March 29, 2015, down from $882 million at year-end. Operating cash flow was $60 million; investing cash outflow was $274 million, including the Abbott Animal Health acquisition; financing cash outflow was $94 million, including $48 million of share repurchases and $42 million of dividends paid.
- Total assets were $6.430 billion and total liabilities $5.125 billion. Working capital was $1.740 billion, down from $2.379 billion; the current ratio was 2.27:1 versus 3.19:1. The $400 million 2016 note moved into current debt classification.
- Debt totaled approximately $3.645 billion, including $400 million current and $3.243 billion long-term. The $3.65 billion senior-note principal is primarily fixed-rate, with maturities in 2016, 2018, 2023 and 2043. The $1.0 billion revolving facility was undrawn; the company reported compliance with its covenants. Cash exceeded short-term borrowings.
- The board’s $500 million repurchase authorization had approximately $453 million remaining at quarter-end. Quarterly dividends declared were $0.083 per share, up from $0.072.
Material changes, outlook and risks
- On February 10, Zoetis acquired certain Abbott Animal Health assets for $255 million: $230 million cash plus up to $25 million contingent consideration. The acquisition added companion-animal anesthesia, pain-management and diabetes-diagnostic products; preliminary goodwill was $200 million. Its post-acquisition revenue and earnings were not material to the quarter.
- On May 5, after quarter-end, Zoetis announced an operational-efficiency program: eliminate about 5,000 product SKUs, sell or exit ten manufacturing sites over time, and reduce positions by approximately 2,000–2,500, primarily over 12–18 months. Management expects $300 million of cost savings by 2017, alongside estimated 2017 revenue and gross-profit reductions of $280 million and $100 million. Expected program pre-tax charges are $400–$500 million, with additional primarily non-cash site-exit charges possible. Execution, consultation and savings are uncertain.
- 2015 guidance: revenue of $4.675–$4.775 billion and operational growth of 5.5%–7.5%; adjusted diluted EPS of $1.61–$1.68 and adjusted net income of $810–$845 million; reported diluted EPS of $0.79–$1.02. Guidance reflects current exchange rates and reduced Venezuela sales. It includes estimated $410–$490 million of certain significant items and acquisition-related costs.
- Foreign exchange is a significant headwind: approximately 48% of quarterly revenue was denominated in foreign currencies. Management cited continued currency volatility and Venezuela’s multiple exchange rates; Zoetis continued using the 6.3 bolivar-per-dollar rate for reporting and planned to reduce Venezuela sales for the rest of 2015. Revenue from Venezuela was approximately $21 million in the quarter, using the subsidiary’s February 22 reporting data.
- Other risks include animal-disease outbreaks, regulation of animal medicines, competitive and product risks, weather, and international operating and currency-control exposures. Management said PEDv and H7N9 were not expected to materially affect 2015 revenue, while continuing to monitor both.
- Legal matters include approximately 240 PregSure-related claims, with more than half settled; the cause of the associated cattle syndrome remains unestablished. In Brazil, a municipality’s environmental cleanup claim remains under investigation; Zoetis said it could not estimate reasonably possible losses beyond accrued amounts across its disclosed contingencies. Management did not expect the matters to materially affect financial position, but outcomes could affect results or cash flows.
Most important facts for investors to verify
- Whether operational growth and margins can persist despite foreign-exchange pressure and higher cost of sales.
- Whether the efficiency program delivers its projected savings, and the ultimate charges, revenue reductions and timing of site exits and workforce changes.
- Whether Venezuela’s exchange-rate regime, sales reductions or restrictions affect asset recoverability, cash or reported results.
- The timing and funding of the $400 million 2016 note maturity, alongside liquidity, debt covenants and continued capital returns.
- Final purchase accounting for Abbott Animal Health and developments in the disclosed legal and tax contingencies.