Business context and reporting period
Zoetis Inc. filed this Form 10-K for the fiscal year ended December 31, 2014. The company is a global animal-health medicines and vaccines business serving livestock and companion-animal markets. It reports four geographic segments: United States, Europe/Africa/Middle East (EuAfME), Canada/Latin America (CLAR), and Asia/Pacific (APAC). The filing also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Revenue | $4.785 billion | $4.561 billion | +5% |
| Net income attributable to Zoetis | $583 million | $504 million | +16% |
| Diluted EPS | $1.16 | $1.01 | +15% |
| Adjusted net income (non-GAAP) | $790 million | $709 million | +11% |
| Cash from operating activities | $626 million | $681 million | −8% |
- Operational revenue growth, excluding foreign exchange, was 7%: volume increased 5% and price 2%. Foreign exchange reduced reported revenue growth by approximately 2 percentage points, or $96 million.
- Livestock revenue was $3.103 billion, up 6%; companion-animal revenue was $1.632 billion, up 3%. Livestock represented about 65% of revenue and companion animals 34%.
- Gross margin was approximately 64% of revenue, compared with 63% in 2013, based on reported cost of sales. Net margin was approximately 12.2%, versus 11.1%.
- Income before taxes was $820 million, up 19%; the effective tax rate rose to 28.4% from 27.1%.
- Capital expenditures were $180 million. Operating cash flow less capital expenditures was approximately $446 million, compared with approximately $497 million in 2013.
- At year-end, cash and cash equivalents were $882 million, working capital was $2.379 billion, and the current ratio was 3.19, versus $610 million, $1.942 billion, and 2.37, respectively, in 2013.
- Long-term debt was $3.643 billion and short-term borrowings were $7 million. The company had no borrowings under its $1.0 billion revolving credit facility and was in compliance with its financial covenants. Gross debt less cash was approximately $2.77 billion.
- Quarter four revenue was $1.320 billion, versus $1.254 billion in Q4 2013; net income attributable to Zoetis was $126 million versus $105 million, and diluted EPS was $0.25 versus $0.21.
Material changes versus the prior comparable period
- U.S. revenue grew 8%, supported by livestock products and Apoquel launches; U.S. segment earnings increased 13%. CLAR revenue rose 5% reported and 13% operationally, with currency reducing reported results by about 8%.
- EuAfME revenue increased 2% and APAC revenue 1% reported. Currency headwinds and weaker companion-animal sales in Japan constrained APAC growth.
- Operational livestock growth was 9%, driven by cattle, swine, and poultry. Companion-animal operational growth was 4%, including Apoquel launches in the U.S., U.K., and Germany.
- Cost of sales increased 3%, slower than revenue; SG&A increased 2%, and R&D expense declined 1% to $396 million. R&D spending was 8% of revenue.
- Reported results included $168 million of after-tax “stand-up” and other significant adjustments in the non-GAAP reconciliation, primarily costs of establishing Zoetis as an independent company. Adjusted net income excludes purchase-accounting adjustments, acquisition-related costs, and certain significant items.
- Operating cash flow declined mainly because of the timing of receipts and payments, settlement of payables with Pfizer, and lower other liabilities. Cash increased by $272 million during the year.
Outlook, management commentary, risks and unusual items
- 2015 guidance: Revenue of $4.8–$4.9 billion, with operational growth of 6.5%–8.5%; adjusted diluted EPS of $1.61–$1.68 and adjusted net income of $810–$845 million. Reported diluted EPS guidance is $1.32–$1.39. Guidance assumes current exchange rates and includes estimated significant and acquisition-related costs.
- Management identified growth priorities including emerging markets, new products and lifecycle extensions, manufacturing efficiency, and complementary businesses. The company expected the PEDv outbreak to have no significant impact on 2015 revenue, while continuing to monitor it.
- Antibacterial products for livestock generated approximately $1.3 billion of 2014 revenue; medicated feed additives contributed $479 million. The FDA’s voluntary three-year phase-out of medically important antibiotics for growth promotion, and possible further restrictions, pose a material business risk.
- In January 2015, FDA inspections at three manufacturing facilities resulted in Form 483 observations at two sites. The company was responding to those observations. Separately, the USDA had raised compliance issues at certain U.S. biological-product sites; corrective and preventive actions were underway, with no assurance the agency would accept the response or refrain from further action.
- A 2014 recall and commercial settlement involving specific poultry-vaccine lots in Mexico resulted in a $13 million charge, partly offset by a $1 million insurance recovery. The company said it did not expect significant additional charges.
- Other exposures include foreign exchange and currency controls, especially Venezuela; animal disease outbreaks, weather and livestock economics; generic competition and patent expirations; regulatory, product-safety, environmental and litigation risks; and reliance on Pfizer for certain manufacturing, transition services and licensed R&D/IP. Management considered the aggregate effect of disclosed legal proceedings unlikely to be material, but said outcomes are uncertain and excess losses could not be estimated.
- Zoetis had approximately $3.6 billion of debt. Its ratings were Baa2 from Moody’s and BBB− from S&P, both with stable outlooks. Debt covenants, refinancing needs, and restrictions related to the Pfizer separation could constrain financial flexibility.
- After year-end, Zoetis completed its acquisition of certain Abbott Animal Health assets on February 10, 2015, for $230 million cash plus a contingent $25 million payment, subject to product-supply conditions.
Most important facts for investors to verify
- Whether 2015 revenue, adjusted EPS, and reported EPS guidance were achieved, and how much foreign exchange affected results.
- Progress and final regulatory outcomes for the FDA Form 483 observations and USDA compliance actions, including any effect on manufacturing or product supply.
- The financial and commercial effects of antibiotic-use restrictions, PEDv and other disease events, and the Mexico vaccine recall.
- Cash conversion and capital allocation, including debt service, dividends, the $500 million repurchase authorization, and the completed Abbott asset purchase.
- How much of reported earnings growth depends on non-GAAP adjustments and whether recurring stand-alone costs, product concentration, or patent and generic competition change materially.