Zoetis Inc. — Q1 2019 Form 10-Q
Business context and reporting period. Zoetis develops, manufactures and sells animal medicines, vaccines and diagnostic products for livestock and companion animals. This unaudited quarterly report covers the three months ended March 31, 2019, compared with the same period in 2018. Zoetis reports U.S. and International operating segments. The interim financial statements received an independent accountant’s review, not an audit.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $1,455 million | $1,366 million | +7% reported; +11% operational, excluding foreign exchange |
| Gross profit | $937 million | $919 million | Consolidated gross margin was approximately 64.4%, down from 67.3% |
| Income before taxes | $381 million | $417 million | -9% |
| Net income attributable to Zoetis | $312 million | $352 million | -11% |
| Diluted EPS | $0.65 | $0.72 | -10% |
| Adjusted net income (non-GAAP) | $424 million | $365 million | +16% |
| Adjusted diluted EPS (non-GAAP) | $0.88 | $0.75 | +17% |
| Operating cash flow | $389 million | $389 million | Flat |
Revenue growth reflected Abaxis, acquired in July 2018, contributing approximately 5 percentage points; price increases of approximately 4 points; in-line product volume growth of approximately 1 point net; and new product volume growth of approximately 1 point. Foreign exchange reduced reported revenue growth by approximately 4 points. Companion-animal revenue rose 24% reported (27% operational); livestock revenue declined 8% reported (3% operational).
U.S. revenue increased 13% to $718 million, led by companion animals, while U.S. livestock sales declined. International revenue was $718 million, down 1% reported but up 7% operationally; the reported decline reflected an approximately 8% foreign-exchange headwind. International livestock results were pressured by African Swine Fever-related declines in China swine sales. Segment gross margins improved: U.S. was 79.5% versus 77.9%, and International was 70.8% versus 67.8%.
Cost of sales rose 16% to $518 million, increasing from 32.7% to 35.6% of revenue. Management attributed the margin pressure mainly to a change in estimate related to inventory costing and Abaxis, partly offset by pricing, favorable mix, efficiencies and foreign exchange. SG&A rose 9% to $369 million; R&D rose 5% to $102 million. Intangible amortization increased to $38 million from $23 million, primarily due to Abaxis-related assets. Interest expense increased 19% to $56 million following the 2018 debt issuance. The effective tax rate was 18.1%, versus 16.1%, with GILTI and changes in geographic earnings mix among the cited factors.
Cash and cash equivalents were $1.728 billion at March 31, 2019, versus $1.602 billion at year-end. Working capital was $3.297 billion and the current ratio was 4.05:1. Property, plant and equipment purchases were $63 million. Financing cash outflow was $243 million, including $150 million of share repurchases and $79 million of dividends paid. Principal long-term debt was $6.5 billion ($6.444 billion carrying value); short-term borrowings were zero. The $1.0 billion revolving facility was undrawn, and the company reported compliance with its financial covenants.
Material changes, outlook and risks
- Earnings divergence and unusual item: GAAP net income fell while adjusted net income rose. Adjusted results exclude $66 million of pre-tax purchase-accounting adjustments, $5 million of acquisition-related costs and $70 million of certain significant items. The latter primarily included a $68 million pre-tax inventory-costing estimate change; these exclusions materially affect the adjusted-versus-GAAP comparison.
- Abaxis integration: The acquisition added veterinary diagnostics and increased purchase-accounting amortization and integration activity. Purchase-price allocation remained preliminary. Zoetis continued integrating Abaxis and extending controls over its operations.
- Outlook: The filing discusses forward-looking statements and refers to 2019 financial guidance, but the supplied filing text does not provide a clear numerical guidance range. Management said cash, operating cash flows and available financing were expected to support foreseeable funding needs, while noting economic and financing-market uncertainty.
- Principal risks: Animal disease outbreaks can affect livestock herds, demand and production; African Swine Fever had already reduced China swine-product sales. Other risks include foreign-exchange movements, competition and generic entry, product safety or supply issues, regulation, litigation, cybersecurity and economic conditions. Approximately 46% of quarterly revenue was denominated in foreign currencies.
- Contingencies: Zoetis said it did not expect disclosed legal matters to materially affect its financial position, but outcomes could affect results or cash flows; it could not estimate reasonably possible losses above accrued amounts. Uncertain tax-position liabilities were $187 million, excluding $12 million of related interest and penalties. A Brazilian environmental matter remained under investigation, with a technical proposal for further site assessments requested by July 10, 2019.
- Accounting change: Zoetis adopted the lease standard on January 1, 2019, recognizing $158 million of operating lease right-of-use assets and $167 million of lease liabilities at March 31. No opening retained-earnings adjustment was required.
Important facts for investors to verify
- Review the $68 million inventory-costing estimate change, its accounting basis, and whether similar adjustments recur.
- Reconcile GAAP earnings and margins with non-GAAP adjusted results, including the exclusions and tax effects.
- Assess Abaxis revenue contribution, integration progress, preliminary purchase accounting and resulting amortization.
- Monitor livestock performance, especially the continuing effects of African Swine Fever, and the balance of companion-animal growth.
- Track foreign-exchange exposure, debt maturities and interest costs, share repurchases, and the company’s full-year guidance in subsequent filings.
- Follow developments in the disclosed legal, environmental and tax contingencies, including whether potential losses or liabilities change.