Zoetis Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods. Zoetis is a global animal-health medicines, vaccines and diagnostics company, operating through U.S. and International segments. Financial statements are unaudited; KPMG performed an interim review, not an audit.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $1.786B | $1.584B | $4.868B | $4.586B |
| Net income attributable to Zoetis | $479M | $433M | $1.279B | $1.116B |
| Diluted EPS | $1.00 | $0.90 | $2.67 | $2.31 |
| Adjusted net income (non-GAAP) | $524M | $455M | $1.406B | $1.315B |
| Adjusted diluted EPS (non-GAAP) | $1.10 | $0.94 | $2.94 | $2.73 |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $1.408B | $1.213B |
- Q3 revenue rose 13% reported and 15% operationally; nine-month revenue increased 6% reported and 9% operationally. Foreign exchange reduced growth by approximately 2% and 3%, respectively.
- Q3 revenue growth reflected in-line product volume growth, new product volume, pricing and acquisitions. Nine-month growth had similar contributors.
- Q3 pretax income was $597M versus $528M; nine-month pretax income was $1.576B versus $1.364B. Effective tax rates were 19.8% and 18.9%, versus 18.0% and 18.2%, respectively.
- Q3 cost of sales was 30.6% of revenue versus 30.2%; for the nine months it was 29.9% versus 31.9%. The filing attributes the quarterly increase partly to inventory charges and foreign exchange, and the nine-month improvement partly to the prior-year inventory-costing adjustment.
- Nine-month investing cash outflow was $395M, including $301M of capital expenditures; financing cash inflow was $720M. Cash increased by $1.720B to $3.654B.
Segments and material changes
- Q3 U.S. revenue increased 18% to $996M; International revenue increased 6% reported (11% operationally) to $767M. Nine-month U.S. revenue rose 11% to $2.605B; International revenue rose 1% reported (6% operationally) to $2.203B.
- Companion-animal products were the main growth driver, led by parasiticides and dermatology. U.S. livestock sales improved in Q3 as cattle buying patterns recovered; swine and poultry faced pressures. International livestock results benefited from swine and fish, while currency reduced International revenue.
- Q3 GAAP net income grew 11%; nine-month net income grew 15%. Non-GAAP adjusted net income grew 15% in Q3 and 7% year to date. These adjusted measures exclude purchase-accounting adjustments, acquisition costs and certain significant items.
- Q3 other income was flat versus $26M of income in 2019, partly because the prior-year period included proceeds related to the 2016 sale of manufacturing sites. Nine-month other income was $15M versus $46M.
Liquidity, debt and capital allocation
- At September 30, cash and cash equivalents were $3.654B; working capital was $4.357B and the current ratio was 2.82:1. Current and long-term debt were $1.100B and $6.595B, respectively. Total debt carrying value was approximately $7.7B.
- In May 2020, Zoetis issued $1.25B of senior notes: $750M at 2.000% due 2030 and $500M at 3.000% due 2050. It redeemed $500M of 3.450% notes on October 13, 2020, after quarter end. Interest expense increased 11% in Q3 to $62M and 4% year to date to $173M.
- The $1.0B revolving credit facility was undrawn and financial covenants were met. Management said available cash, operating cash flow and financing arrangements were expected to support future needs, while noting economic and market uncertainty.
- Share repurchases were suspended beginning in Q2 2020. The company declared $0.40 per share in dividends during the first nine months, compared with $0.328 in 2019.
Outlook, risks and unusual items
- The filing provides no specific numeric 2020 guidance in the supplied text. Management said COVID-19 had significantly affected results and could continue to affect demand for the remainder of 2020; the ultimate impact remained uncertain.
- COVID-19 risks include reduced veterinary visits and livestock customer activity, processing-plant disruption, supply-chain or workforce constraints, delayed clinical studies and product approvals, and broader recession and financing-market effects. Zoetis continued manufacturing, R&D and supply-chain operations as an essential business.
- Other stated risks include foreign-exchange movements, animal disease outbreaks, generic competition and patent expirations, product safety or supply issues, regulatory and tax changes, and substantial indebtedness. The filing notes anticipated U.S. generic entry for tulathromycin products no earlier than February 2021.
- Unusual items included CEO-transition costs, restructuring and integration costs, acquisition-related purchase-accounting charges, and proceeds associated with the 2016 manufacturing-site sale. The company also disclosed tax uncertainties and ongoing legal matters; management said it could not estimate reasonably possible losses above accrued amounts for substantially all legal contingencies.
- Acquisitions completed in 2020 included Fish Vet Group, Virtual Recall, Performance Livestock Analytics and Ethos Diagnostic Science; the company said these transactions did not significantly affect consolidated financial statements.
Investor verification priorities
- Track whether COVID-19 demand, customer operations and supply-chain effects persist, and whether the lack of specific numeric guidance changes.
- Assess the durability and mix of companion-animal growth, livestock recovery and product-level performance, including generic competition and upcoming patent expirations.
- Reconcile cash generation with elevated inventories, debt maturities, interest expense and future capital allocation; note the post-quarter $500M note redemption.
- Review the non-GAAP adjustments against GAAP results, especially purchase-accounting charges and significant items.
- Monitor currency exposure, uncertain tax positions and legal matters, including the lascadoil appeal and the ongoing tax-related proceedings.