Zoetis Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended April 3, 2016, compared with the three months ended March 29, 2015. Zoetis’s fiscal 2016 first quarter included six additional days, affecting year-over-year comparability. The interim financial statements were reviewed by KPMG, not audited.
Business context and performance
Zoetis is a global animal-health medicines and vaccines company, operating in U.S. and International segments and serving livestock and companion-animal markets.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $1.162 billion | $1.102 billion | +5% reported |
| Income before taxes | $332 million | $230 million | +44% |
| Net income attributable to Zoetis | $204 million | $165 million | +24% |
| Diluted GAAP EPS | $0.41 | $0.33 | +24% |
| Adjusted net income | $239 million | $207 million | +15% |
| Adjusted diluted EPS | $0.48 | $0.41 | +17% |
Operational revenue growth, excluding foreign exchange, was 12%, including an estimated 6% contribution from the extra six days. Foreign exchange reduced reported revenue growth by approximately 7%, or $77 million. GAAP net income included a $33 million pretax gain on divestitures; adjusted net income is a non-GAAP measure that excludes specified items.
Revenue, margins and segment trends
- Consolidated gross profit was $773 million versus $708 million; gross margin was approximately 66.5%, up from 64.2%. Cost of sales declined 1% despite higher revenue.
- U.S. revenue rose 12% to $582 million; segment earnings increased 14% to $359 million. Companion-animal sales, particularly Apoquel and acquired products, grew, while livestock revenue declined.
- International revenue was $567 million, down 1% reported but up 13% operationally. Segment earnings rose 13% to $260 million. Currency reduced regional revenue by about 14%.
- Companion-animal revenue increased to $466 million from $377 million, while livestock revenue declined to $683 million from $715 million. By product category, vaccines and other pharmaceuticals grew; anti-infectives and parasiticides declined.
Cash flow, debt and liquidity
- Operating cash flow was $51 million, versus $60 million. Capital expenditures were $45 million, implying approximate free cash flow of $6 million before other investing items.
- Investing activities provided $18 million, including $75 million of proceeds from U.S. and India site/product divestitures; the company also paid $12 million for an acquired livestock business.
- Financing activities used $543 million, including repayment of $400 million of notes, $76 million of share repurchases, $47 million of dividends paid and $22 million of contingent acquisition consideration.
- Cash and equivalents were $675 million, down from $1.154 billion at year-end. Long-term debt, net, was $4.464 billion; short-term borrowings were $4 million. Approximate net debt was $3.793 billion.
- Working capital was $2.144 billion and the current ratio was 2.84:1. No borrowings were outstanding under the $1.0 billion revolving facility; the company reported compliance with its debt covenants.
- Interest expense rose to $43 million from $28 million. Dividends declared were $0.095 per share, versus $0.083.
Material changes, outlook and risks
- The effective tax rate rose to 38.6% from 28.3%, principally reflecting earnings mix and a $35 million net discrete tax expense related to the European Commission’s decision on Belgian excess-profits tax rulings. Uncertain-tax-position liabilities increased to $120 million, excluding interest and penalties; appeal outcomes and recovery methodology remain uncertain.
- Management gave no specific company-wide revenue or earnings guidance in the provided filing text. It said the 2016 global revenue impact from avian influenza was currently expected to be not significant, while noting disease and foreign-exchange uncertainty.
- The operational-efficiency program includes rationalizing products and markets, plans to exit ten manufacturing sites, and an expected reduction of approximately 2,000–2,500 positions. About 1,400 positions had been eliminated by April 3. Divestitures generated the quarter’s $33 million gain; the Taiwan joint venture sale closed April 29 for approximately $13 million, subject to working-capital adjustments.
- Key operating risks include currency movements, animal disease outbreaks, weather, competition and generic products, regulation of animal medicines, R&D and acquisition execution, and legal, tax and intellectual-property matters. The company said it could not estimate reasonably possible legal losses in excess of accrued amounts.
- Zoetis early-adopted new share-based-payment accounting guidance in 2016; a $4 million tax benefit was recognized in earnings. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much reported and operational growth reflects the six extra days, acquisitions, product volume and pricing, versus ongoing underlying demand.
- Whether foreign-exchange headwinds and product/market rationalization continue to offset growth, especially internationally and in livestock.
- The sustainability of earnings excluding the $33 million divestiture gain, and the impact of the elevated effective tax rate and Belgian tax dispute.
- Cash conversion, debt-service capacity and planned capital allocation following the $400 million debt repayment, buybacks and dividends.
- Execution, costs and expected savings from site exits and workforce reductions, as well as the status of material legal and tax contingencies.