Zoetis Inc. — Q2 2019 Form 10-Q
Business context and period: Zoetis is a global animal-health medicines, vaccines and diagnostics company serving livestock and companion-animal markets. This unaudited filing covers the quarter and six months ended June 30, 2019; amounts are in millions of dollars except per-share data. Zoetis reports U.S. and International segments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $1,547 (+9%) | $1,415 | $3,002 (+8%) | $2,781 |
| Income before tax | $455 (+4%) | $437 | $836 (-2%) | $854 |
| Net income attributable to Zoetis | $371 (-3%) | $384 | $683 (-7%) | $736 |
| Diluted EPS | $0.77 (-3%) | $0.79 | $1.41 (-7%) | $1.51 |
| Adjusted net income (non-GAAP) | $436 (+16%) | $375 | $860 (+16%) | $740 |
| Adjusted diluted EPS (non-GAAP) | $0.90 (+17%) | $0.77 | $1.78 (+18%) | $1.51 |
Q2 gross profit was $1,082, about 69.9% of revenue, versus $968, about 68.4%, in the prior-year quarter. For the six-month period, gross profit was $2,019, about 67.3% of revenue, versus $1,887, about 67.9%. Net margin was about 24.0% in Q2 (27.1% prior year) and 22.8% for the six months (26.5% prior year). The six-month effective tax rate rose to 18.3% from 14.3%; Q2 was 18.5% versus 12.6%.
- Revenue drivers: Operational revenue growth, excluding foreign exchange, was 14% in Q2 and 12% for the six months. The Abaxis acquisition contributed approximately 5% in each period; price growth was approximately 4%. Companion-animal sales were strong, while livestock was broadly flat operationally for the six months. Foreign exchange reduced reported growth by about 5% in Q2 and 4% year to date.
- Cash flow: Six-month operating cash flow was $707, up from $656. Capital expenditures were $166; operating cash flow less capital expenditures was approximately $541 (calculated). Investing used $82 and financing used $469. Cash increased $153 to $1,755.
- Liquidity and debt: Current assets were $4,484 and current liabilities $1,075; working capital was $3,409 and the current ratio 4.17:1. Long-term debt, net, was $6,446; short-term borrowings were zero. Cash less reported long-term debt was approximately $4,691 of net debt. The $1.0 billion revolving facility was undrawn, and the company reported compliance with its debt covenants.
- Capital returns: Six-month treasury-stock purchases were $300 and dividends paid were $157. Dividends declared were $0.164 per share in Q2, versus $0.126. Approximately 3 million shares were repurchased in the first half.
Material changes versus the prior period
- U.S. revenue rose 15% in Q2 and 14% in the first half; International revenue rose 2% in Q2 and was approximately flat for the half, with currency effects masking operational growth.
- Companion-animal revenue growth, including Abaxis and dermatology products, offset livestock softness. African Swine Fever negatively affected swine sales in China; U.S. livestock results also reflected distributor purchasing patterns.
- Reported GAAP earnings declined despite revenue growth. Higher amortization following the Abaxis acquisition, acquisition integration and restructuring costs, higher interest expense, and a higher tax rate contributed. Interest expense rose 20% in Q2 and 19% year to date, partly reflecting $1.5 billion of senior notes issued in August 2018.
- For the first six months, cost of sales included a $68 million change-in-estimate charge related to inventory costing. The filing identifies this as a significant item excluded from adjusted results.
Outlook, commentary and risks
- The supplied filing text refers to 2019 financial guidance but does not provide a clear numerical guidance range or a specific revision; no numerical outlook is summarized here.
- Management said cash, operating cash flows, available credit and market access should support foreseeable funding needs, while noting that economic weakness could affect liquidity or future financing access.
- Principal risks include foreign-exchange volatility (about 45% of first-half revenue was denominated in foreign currencies), disease outbreaks, product safety or quality issues, manufacturing and supply disruptions, competition and generics, regulatory changes, customer-channel shifts, cybersecurity, and tax and legal matters. African Swine Fever has already affected swine-product sales in China.
- Legal matters include environmental litigation in Brazil and ongoing U.S. litigation relating to alleged lascadoil feed contamination; Zoetis was dismissed from the consolidated Michigan cases, subject to possible later appeal. Management said it could not estimate reasonably possible losses above amounts accrued for its legal contingencies and did not expect these matters to materially affect financial position.
- Uncertain tax-position liabilities were $177 million, plus $11 million of related interest and penalties. The company did not expect a significant reduction in uncertain tax positions within the next 12 months.
- The interim financial statements received an independent accountant’s review, not an audit. The review reported no material modifications needed for U.S. GAAP conformity.
Investor verification points
- Confirm the latest 2019 guidance and the assumptions behind its revenue, earnings, tax and foreign-exchange outlook.
- Assess the sustainability of companion-animal growth and the effects of African Swine Fever, livestock demand and distributor buying patterns.
- Reconcile GAAP and adjusted earnings, particularly the $68 million inventory-costing estimate change and Abaxis-related amortization and integration costs.
- Review debt maturities, interest-rate exposure, repurchase pace and cash needs alongside the company’s capital-return plans.
- Monitor legal and tax contingencies, foreign-exchange exposure and Abaxis integration and internal-control progress.