Zoetis Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter ended June 28, 2015; six-month comparison is with the period ended June 29, 2014. Zoetis develops, manufactures and sells animal health medicines and vaccines. It reports U.S. and International segments. Amounts below are U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $1.175B | $1.158B | $2.277B | $2.255B |
| GAAP net income attributable to Zoetis | $(37)M | $136M | $128M | $291M |
| Diluted EPS | $(0.07) | $0.27 | $0.25 | $0.58 |
| Adjusted net income (non-GAAP) | $216M | $189M | $423M | $380M |
| Adjusted diluted EPS (non-GAAP) | $0.43 | $0.38 | $0.84 | $0.76 |
| Operating cash flow | Not separately presented | Not separately presented | $182M | $136M |
Revenue rose 1% reported in both comparisons. Excluding foreign exchange, operational revenue grew 11% in Q2 and 8% in the first half; currency movements reduced revenue growth by 10 and 7 percentage points, respectively. Consolidated gross margin, calculated from reported revenue and cost of sales, was approximately 63.7% in Q2 versus 64.3%; first-half margin was approximately 63.9% versus 64.9%. GAAP operating costs included significant restructuring charges.
- Segments: Q2 U.S. revenue increased 17% to $539M and segment earnings rose 24% to $319M. International revenue fell 9% reported to $622M, including a 15% foreign-exchange headwind; operational revenue grew 6% and segment earnings fell 8% to $242M. First-half U.S. revenue rose 13% and International revenue fell 8% reported, but grew 5% operationally.
- Revenue mix: Q2 companion-animal revenue increased 7% reported to $471M, supported by dogs and cats; livestock revenue declined 2% reported to $690M but grew 8% operationally. Apoquel and the Abbott Animal Health acquisition contributed to companion-animal growth.
- Cash and liquidity: Cash was $544M at June 28, 2015, down from $882M at year-end. Working capital was $1.744B (year-end $2.379B); current ratio was 2.11 versus 3.19. First-half operating cash flow was $182M, investing cash outflow $318M and financing cash outflow $185M, leaving a $338M net decrease in cash.
- Debt: Total debt carrying value was approximately $3.647B, including $400M of 1.150% senior notes due in 2016 classified as current. Long-term debt was $3.243B; short-term borrowings were $4M. The company had no borrowings under its $1.0B revolving facility and reported compliance with its financial covenants.
Material changes and unusual items
- Q2 GAAP results were reduced by $266M of restructuring charges and certain acquisition-related costs; first-half charges were $267M. The broader operational-efficiency and supply-network initiatives generated $281M of total related costs in Q2 and $297M in the first half, including costs recorded in other expense lines.
- The May 2015 efficiency program targets approximately 5,000 product-SKU eliminations, sale or exit of ten manufacturing sites over time, and a workforce reduction of about 2,000–2,500 positions, primarily over 18 months. Management expects approximately $300M in annual cost savings by 2017, alongside estimated 2017 revenue and gross-profit reductions of $280M and $100M. Expected pre-tax charges are $400M–$500M.
- Management’s non-GAAP adjusted net income was up 14% in Q2 and 11% for the first half, excluding purchase-accounting adjustments, acquisition-related costs and certain significant items. This measure is not a substitute for GAAP results.
- Zoetis acquired certain Abbott Animal Health assets for a stated purchase price of $254M ($229M cash plus contingent consideration). The acquisition added companion-animal products; post-acquisition revenue and earnings were not material to the reported statements. Preliminary goodwill recorded was $200M.
- The company repurchased approximately 2.1M shares for about $100M during the first half. Approximately $402M remained under its $500M authorization at June 28.
Guidance, commentary and risks
Management’s 2015 guidance called for revenue of $4.700B–$4.775B and operational revenue growth of 6.0%–7.5%; adjusted net income of $820M–$845M and adjusted diluted EPS of $1.63–$1.68; and reported diluted EPS of $0.81–$1.02. Guidance also included an adjusted tax rate of approximately 29% and $410M–$490M of certain significant items and acquisition-related costs. These are forward-looking estimates, not guarantees.
- About 49% of first-half revenue was denominated in foreign currencies. Management cited currency volatility, including euro and Brazilian-real depreciation, and reduced Venezuelan activity; it expected 2015 Venezuelan revenue to decline from $77M in 2014. Zoetis continued using the Venezuelan CENCOEX exchange rate of 6.3 bolivars per U.S. dollar and disclosed potential recoverability and currency-control risks.
- Management said it did not expect PEDv or the U.S. avian-influenza outbreak to have a significant impact on 2015 revenue, while noting continued monitoring. Disease outbreaks can also disrupt demand, exports or production.
- Risks include antimicrobial-use restrictions, manufacturing interruptions and capacity constraints, product liability and patent matters, international regulation and currency controls, and execution risks for the efficiency program. The filing also describes ongoing litigation and investigations, including PregSure-related claims, a Brazilian environmental matter, claims related to Mexican poultry-vaccine lots, and a U.S. lascadoil/feed contamination lawsuit. Management reported strong defenses but could not estimate reasonably possible losses above accrued amounts for legal contingencies.
- Controls and procedures were reported effective at a reasonable level of assurance. A U.S. ERP implementation had caused temporary customer billing disruptions and increased receivables; broader system implementations were ongoing.
Investor verification points
- Track whether operational growth converts to reported growth as foreign-exchange effects change, especially in International markets and Venezuela.
- Assess the timing, cash costs and execution of restructuring, including whether projected savings offset planned revenue and gross-profit reductions.
- Monitor cash conversion, inventory growth, receivables and billing-system stabilization, as well as the $400M 2016 debt maturity and refinancing or repayment plans.
- Compare full-year results with the stated guidance and examine the reconciliation between GAAP and adjusted earnings.
- Follow Abbott acquisition integration and contingent consideration, share repurchases, and developments in disclosed legal, product-supply, regulatory and currency exposures.