Zoetis Inc. — Q1 2013 Form 10-Q
Business context and period. Zoetis is a global animal-health medicines and vaccines company serving livestock and companion-animal markets. This unaudited interim filing covers the three months ended March 31, 2013, compared with the three months ended April 1, 2012. The 2013 period includes both pre- and post-separation results; the 2012 comparison reflects Zoetis as a Pfizer business unit, with allocated costs. The company cautions that these periods—and the March 2013 and December 2012 balance sheets—are not fully comparable.
Key financial metrics
Amounts are in millions of dollars, except per-share data and ratios.
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $1,090 | $1,047 | +4% reported; +5% operational, offset by 1% adverse FX |
| Income before taxes | $192 | $171 | +12% |
| Net income attributable to Zoetis | $140 | $111 | +26% |
| Diluted EPS | $0.28 | $0.22 | +27% |
| Adjusted net income (non-GAAP) | $179 | $152 | +18% |
| Adjusted diluted EPS (non-GAAP) | $0.36 | $0.30 | +20% |
| Operating cash flow | $281 | $(4) | Improved |
| Capital expenditures | $22 | $31 | Lower |
Margins and costs. Gross margin was approximately 63% of revenue versus 62% a year earlier; net margin was approximately 12.8% versus 10.6%. SG&A was $357 million (33% of revenue) versus $338 million (32%); R&D was $90 million (8%) versus $102 million (10%). The effective tax rate fell to 27.1% from 34.5%. Interest expense rose to $22 million from $8 million, principally because of the new notes.
Liquidity and debt. Cash and cash equivalents were $468 million at March 31, up from $317 million at December 31, 2012; working capital was $1.655 billion and the current ratio was 2.29:1. Short-term borrowings were $6 million. Long-term debt, net of discount, was $3.640 billion, consisting of $3.65 billion principal in fixed-rate notes due 2016, 2018, 2023 and 2043. Zoetis also had a $1.0 billion revolving facility with no borrowings outstanding and a $1.0 billion commercial-paper program with no issuance reported.
Material changes versus the prior period
- Revenue growth was led by the U.S.; companion-animal revenue increased 8% overall, while livestock revenue increased 2%. U.S. revenue rose 7%; EuAfME 5%; CLAR fell 1% reported but grew 4% operationally; APAC rose 1% reported.
- Net income growth reflected higher revenue and a lower tax rate, partly offset by higher interest expense and other deductions. The 2013 period included a $9 million foreign-currency loss associated with Venezuela’s February devaluation.
- Operating cash flow improved substantially, primarily due to timing of receipts and payments and operational inventory reductions. Cash-flow comparisons are affected by the former Pfizer cash-management arrangements.
- The first-quarter separation and February IPO made Zoetis a standalone public company. Pfizer transferred substantially all animal-health assets and liabilities; Zoetis issued $3.65 billion of notes and paid Pfizer approximately $2.5 billion in cash from the offering proceeds. The IPO sold 99.015 million Class A shares at $26 per share; Zoetis received no IPO proceeds.
- Q1 included $34 million of standalone-company “stand-up” costs. Total significant items, acquisition-related costs and purchase-accounting adjustments reduced reported net income by $39 million after tax; adjusted results exclude these items.
Outlook, commentary and risks
2013 guidance. Management forecast revenue of $4.425–$4.525 billion; reported diluted EPS of $1.00–$1.06; and adjusted diluted EPS of $1.36–$1.42. Other adjusted guidance included cost of sales at 35%–36% of revenue, SG&A of $1.385–$1.435 billion, R&D of $385–$415 million, interest expense of approximately $115 million, and an adjusted effective tax rate of approximately 29.5%. Expected significant items and acquisition-related costs were $200–$240 million. Guidance depends on assumptions including foreign-exchange rates and is subject to the risks discussed in the filing.
- Management said the U.S. drought was affecting cattle-market performance and could continue to weigh on results through herd reductions and lower product demand. Cold European weather could delay the parasiticide season; Southern Europe remained economically challenging.
- Zoetis was monitoring reported H7N9 avian influenza cases in China and said it did not then expect a significant impact on 2013 global revenue.
- Risks include restrictions on livestock antibacterials, product safety and quality perceptions, animal disease outbreaks, adverse weather and resource constraints, competition, economic weakness, foreign-exchange movements, and execution as a standalone company.
- Pfizer retained 80.2% of Zoetis’s economic interest and 97.6% of director-election voting power at the time described. A possible Pfizer share distribution was uncertain, with no obligation or set timetable.
- Legal matters include Roxarsone-related claims, PregSure-related claims, patent litigation involving Advocin, and an environmental claim in Brazil. Management said it could not estimate reasonably possible losses in excess of accruals; it did not believe the matters would materially affect financial position, but outcomes could affect earnings or cash flow.
- The $1.0 billion revolving credit facility includes leverage and interest-coverage covenants. Fixed-rate notes have customary covenants and, under specified change-of-control and downgrade circumstances, a repurchase offer may be required.
Important facts for investors to verify
- How much reported earnings growth reflects underlying operations versus the lower tax rate, separation-related costs, and non-GAAP exclusions.
- Whether the $4.425–$4.525 billion revenue and $1.00–$1.06 reported EPS guidance remained achievable, and how standalone and transition costs tracked against estimates.
- Debt-service capacity, covenant headroom and liquidity after the separation-related financing and cash payment to Pfizer.
- The sustainability of regional and species-level growth, particularly U.S. cattle exposure to drought and the impact of currency movements.
- Potential outcomes and financial exposure from the disclosed litigation, tax contingencies and indemnifications.
- Pfizer’s continuing control, related-party arrangements and any subsequent decision concerning a distribution of its Zoetis ownership.
The independent accountant performed an interim review, not a full audit, and reported no material modifications needed for conformity with U.S. GAAP.