Zoetis Inc. — Q3 2017 Form 10-Q Summary
Business context and reporting period
Zoetis is a global animal-health medicines and vaccines company serving livestock and companion-animal markets. This unaudited quarterly filing covers the three and nine months ended October 1, 2017, compared with periods ended October 2, 2016. Unless otherwise indicated, amounts are in millions of dollars. The independent accountant performed an interim review, not an audit.
Financial results and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1,347 | $1,241 | $3,847 | $3,611 |
| Income before taxes | $413 | $333 | $1,095 | $997 |
| Net income attributable to Zoetis | $298 | $239 | $783 | $667 |
| Diluted EPS | $0.61 | $0.48 | $1.59 | $1.34 |
| Adjusted net income (non-GAAP) | $322 | $258 | $844 | $743 |
| Adjusted diluted EPS (non-GAAP) | $0.65 | $0.52 | $1.71 | $1.49 |
- Revenue increased 9% in Q3 and 7% year to date. Reported net income rose 25% and 17%, respectively; adjusted net income rose 25% and 14%. Adjusted measures exclude purchase-accounting adjustments, acquisition costs and certain significant items; they are not GAAP results.
- Q3 gross margin was approximately 67.7%, versus 67.0% a year earlier; nine-month gross margin was approximately 65.7%, versus 66.8%. These are calculated from reported revenue less cost of sales.
- Operating cash flow was $738 for the first nine months, compared with $427 in 2016. Capital spending was $141; acquisitions used $82. Cash and cash equivalents were $1,981 at October 1, versus $727 at year-end 2016.
- At October 1, current assets were $4,894 and current liabilities $1,746; working capital was $3,148 and the current ratio 2.80:1. These compare with $2,273 and 3.03:1, respectively, at December 31, 2016.
- Debt principal outstanding was $5,750 at October 1, including $750 current; the balance-sheet carrying amount was $5,702. The company issued $1,250 of notes in September, at 3.00% due 2027 and 3.95% due 2047. In October, after quarter-end, it redeemed the $750 1.875% notes due 2018 for $754 including make-whole premium and accrued interest. No revolving-credit-facility or commercial-paper borrowings were outstanding at quarter-end.
- Nine-month cash financing included $375 of share repurchases and $155 of dividends paid. Approximately $1.1 billion remained authorized for repurchases at October 1.
Material changes and business drivers
- Companion-animal revenue was a key growth engine: up 18% in Q3 and 13% year to date, led by dogs and cats, dermatology products and launches including Simparica. Livestock revenue grew 3% in Q3 and 3% year to date, with product and regional variation.
- By product category, Q3 growth was led by other pharmaceuticals (+19%), parasiticides (+21%) and vaccines (+12%); anti-infectives declined 7%. Year-to-date anti-infectives declined 5%, while vaccines, parasiticides and other pharmaceuticals grew.
- U.S. revenue rose 6% in Q3 and 5% year to date; International revenue rose 12% and 8%, respectively. Operational growth drove most of the increases; currency added $3 in Q3 but reduced year-to-date reported revenue by $8.
- SG&A fell 5% in Q3 and 3% year to date, reflecting efficiency savings and lower certain compensation, consulting and standalone-company costs. R&D spending increased 7% in Q3 and 1% year to date. Year-to-date cost of sales increased 10%, faster than revenue, partly due to timing of manufacturing and supply costs.
- The effective tax rate was 28.3% in Q3 and 28.6% year to date, versus 28.8% and 33.3% in the prior-year periods. The year-to-date comparison benefited from a $38 prior-year discrete tax expense related to Belgium tax rulings, among other factors.
Outlook, risks, contingencies and unusual items
- The filing provides no specific full-year revenue or earnings guidance. Management expects the adverse U.S. effect of Veterinary Feed Directive implementation on certain cattle and swine medicated-feed products to continue through the remainder of 2017. It said the 2017 impact of avian influenza on global revenue was not expected to be significant.
- Management describes the operational-efficiency program as substantially complete: approximately 2,200 positions had been eliminated by October 1, against a planned range of 2,300–2,800. Further reductions may result from planned divestitures over several years. Q3 included $8 of restructuring and acquisition-related costs; nine-month expense was $7, versus a $15 reversal in 2016.
- The planned sale of the Guarulhos, Brazil manufacturing site was expected to close in Q4 2017 and includes a five-year manufacturing and supply agreement. The company recorded a $3 impairment to the disposal group and $2 of anticipated-disposal costs in Q3.
- Principal risks include animal-disease outbreaks, restrictions on antibacterials, generic competition and patent expirations, foreign-exchange movements, supply and manufacturing disruption, regulatory and international-market risks, tax uncertainty, and substantial indebtedness. Approximately 47% of nine-month revenue was denominated in foreign currencies. Management reported compliance with debt covenants and said available cash, operating cash flows and financing arrangements should meet foreseeable needs, while noting economic and financing-market uncertainty.
- Legal matters include approximately 266 PregSure-related claims in Europe and New Zealand; about 168 had been settled, with no causal connection between the vaccine and the rare syndrome established. In the lascadoil-related Michigan litigation, the court granted Zoetis’s motion for summary disposition on October 10, 2017, dismissing claims against the company; plaintiffs could appeal. The company said it could not estimate reasonably possible losses above amounts accrued across certain contingencies.
- Other unusual year-to-date items included prior-year divestiture gains, current-year divestiture losses, a $4 insurance recovery related to older Mexico commercial settlements, and foreign-currency losses. Uncertain tax-position liabilities were $81, plus $12 of related interest and penalties.
Most important facts for investors to verify
- Whether companion-animal product momentum can offset pressure in livestock, including the ongoing effects of the Veterinary Feed Directive and competition.
- Whether gross-margin pressure from manufacturing and supply costs persists as sales grow.
- The post-quarter debt redemption’s effects on cash, interest expense and debt maturity profile, and the company’s leverage relative to its covenant limits.
- Execution and final proceeds of the Guarulhos site sale, and any remaining restructuring or supply-network costs.
- Developments in patent expirations, generic competition, product-related litigation and uncertain tax positions.
- Cash-flow conversion and share repurchases, including whether repurchases remain consistent with liquidity and debt priorities.