Zoetis Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. This annual filing also reports fourth-quarter results. Amounts are U.S. dollars unless noted.
Business context
Zoetis develops, manufactures and sells animal medicines and vaccines for livestock and companion animals. Revenue is reported in U.S. and International segments. The company operates in more than 100 countries; 51% of 2015 revenue came from outside the United States. Livestock represented about 62% of revenue and companion animals about 37%.
Financial performance
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Revenue | $4.765 billion | $4.785 billion | Approximately flat reported; operational growth of 8% |
| Gross margin | Approximately 64% | Approximately 64% | Cost of sales was 36% of revenue in both years |
| Operating expenses: SG&A | $1.532 billion | $1.643 billion | Down 7% |
| Research and development | $364 million | $396 million | Down 8% |
| Restructuring and certain acquisition-related costs | $320 million | $25 million | Up $295 million |
| Net income attributable to Zoetis | $339 million | $583 million | Down 42% |
| Diluted EPS | $0.68 | $1.16 | Down 41% |
| Adjusted net income (non-GAAP) | $889 million | $790 million | Up 13% |
| Operating cash flow | $664 million | $626 million | Up 6% |
Operational revenue rose 8%, comprising 5% volume and 3% price growth, but foreign exchange reduced reported revenue by about $393 million, or 8%. U.S. revenue grew 13%; International revenue declined 11% reported, but increased 4% operationally. Companion-animal revenue grew 14% operationally, while livestock revenue grew 4% operationally.
Net income included substantial unusual costs: $373 million related to the operational-efficiency and supply-network initiatives, $93 million of Venezuela revaluation charges, and other significant items. Adjusted net income excludes purchase-accounting adjustments, acquisition-related costs and specified significant items; it is a non-GAAP measure and is not a substitute for GAAP results.
Fourth-quarter revenue was $1.274 billion versus $1.320 billion in 2014. Net income attributable to Zoetis was $22 million, compared with $126 million; diluted EPS was $0.04 versus $0.25.
Cash, debt and liquidity
- Cash and cash equivalents were $1.154 billion at year-end, up from $882 million.
- Long-term debt was $4.463 billion on the balance sheet; total debt principal was $4.9 billion. Short-term borrowings were $5 million, and $400 million of notes matured in 2016 and were repaid in February 2016.
- Working capital was $2.049 billion, down from $2.379 billion; the current ratio declined to 2.15 from 3.19.
- Operating cash flow was $664 million; investing activities used $1.115 billion, principally reflecting the Pharmaq and Abbott Animal Health acquisitions. Financing activities provided $755 million, largely from the November debt issuance.
- Capital expenditures were $224 million. The company reported no borrowings under its $1.0 billion revolving credit facility at year-end and said it was in compliance with financial covenants.
- Dividends paid were $168 million. Zoetis repurchased about 4 million shares during 2015, with approximately $301 million remaining under its $500 million authorization.
Material changes, outlook and risks
- Acquisitions: Zoetis acquired aquaculture-vaccine company Pharmaq for net cash consideration of $668 million and certain Abbott Animal Health assets for $254 million. The acquired businesses’ post-acquisition revenue was not material to consolidated results in 2015.
- Efficiency program: The company planned to eliminate about 5,000 product SKUs, sell or exit ten manufacturing sites over time, and reduce positions by approximately 2,000–2,500. About 1,200 positions had been eliminated by year-end. Execution, transition costs and potential supply disruption remain risks.
- Venezuela: A fourth-quarter remeasurement at the SIMADI exchange rate resulted in an $89 million loss; additional inventory and asset charges were $4 million and $3 million. Revenue there declined to about $65 million from $77 million, and the company planned to reduce activity further in 2016.
- Tax matter: After year-end, the European Commission concluded that Belgium’s excess-profit tax scheme constituted illegal state aid. Zoetis expected a first-quarter 2016 net charge of up to $45 million, subject to possible appeal and recovery-method details.
- Guidance: The filing refers to 2016 financial guidance but the provided filing text does not give clear numerical guidance values. Management said existing cash, operating cash flows and financing arrangements were expected to meet foreseeable needs, while noting economic and financing uncertainties.
- Key risks: Foreign exchange and currency controls; restrictions on livestock antibacterials; disease outbreaks and weather impacts; generic competition and customer consolidation; product safety, manufacturing and supply reliability; regulatory and litigation exposure; and substantial debt. Livestock antibacterial products generated approximately $1.3 billion of 2015 revenue.
- Contingencies and controls: Management considered the likelihood of material impact from pending proceedings remote, but said outcomes could still affect results or cash flows. The auditor issued unqualified opinions on the financial statements and internal controls; the internal-control assessment excluded Pharmaq, representing about 8% of consolidated assets.
Most important facts for investors to verify
- Whether operational growth can continue despite currency headwinds, and whether International performance improves.
- How much of the 2015 GAAP earnings decline reflects nonrecurring charges versus underlying operating performance; review the non-GAAP reconciliation.
- Progress, realized savings, remaining costs and supply effects from the efficiency program and planned facility and workforce reductions.
- Debt maturities, covenant headroom after the Pharmaq acquisition and the impact of financing costs on cash available for dividends and repurchases.
- The outcome and financial impact of the Belgian tax decision, Venezuela currency exposure, and material product, environmental and litigation matters.
- Whether new products and acquired businesses, particularly Pharmaq, deliver the growth and returns anticipated by management.