Edited Transcript of ZTS earnings conference call or presentation 6-May-20 12:30pm GMT
Operator [1]
Welcome to the First Quarter 2020 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, it will not be forwarded automatically. In addition, a replay of this call will be available approximately 2 hours after the conclusion of this call via dial in or on the Investor Relations section of zoetis.com.
(Operator Instructions)
It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.
Steven Frank, Zoetis Inc. – VP of IR [2]
Thank you. Good morning, everyone. I hope you are all doing well. Welcome to the Zoetis First Quarter 2020 Earnings Call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, our Chief Financial Officer.
Before we begin, I’ll remind you that the slides presented on this call are available on the Investor Relations section of our website and that our remarks today will include forward-looking statements and that actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statement in today’s press release and our SEC filings, including, but not limited to, our annual report on Form 10-K and our reports on Form 10-Q.
Our remarks today will also include references to certain financial measures, which were not prepared in accordance with generally accepted accounting principles, or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and in the company’s 8-K filing dated today, May 6, 2020. We also cite operational results, which exclude the impact of foreign exchange.
With that, I turn the call over to Kristin.
Kristin C. Peck, Zoetis Inc. – CEO & Director [3]
Thank you, Steve. Good morning, everyone. I hope you and your families are staying healthy and safe. I think it’s fair to say the past few months have been unlike any we have ever experienced in business or that any of us could have imagined for our families, friends and communities. The global COVID-19 pandemic has had such an incredible impact on our world and for many of us personally. It has given me a chance to reflect, not just on the financial numbers we reported today, but on the true value our business provides society, the role we play in public health, the support we deliver for our customers in crisis and the safety and security we provide to our colleagues. For Zoetis, we’re privileged to play an essential role in sustaining and protecting animal and human life during the outbreak.
Our products and services play a critical part in animal health, helping support pet care and the food supply, and we have continued to manufacture products and serve customers even in places that have imposed stringent limits on businesses in the wake of the coronavirus. Our colleagues are more committed than ever to supporting the nutrition and comfort that animals provide the world, and that purpose has motivated us to continue serving our customers and communities in these extraordinary times. I’m especially proud of the efforts of Zoetis colleagues in supporting our local communities, health care workers and businesses during the outbreak. We’ve been contributing surplus personal protective equipment from our operations. We’ve been increasing production of human health diagnostics and answering requests from local hospitals for a variety of assistance.
As far as the direct impact of COVID-19 on our colleagues, we’ve been fortunate to see only a small number of COVID-19 cases in our workforce of more than 10,000 colleagues, thanks to increased safety measures, hygiene protocols and adjustments to our operations. About 70% of our colleagues today are working remotely. They are being productive as they adjust to new arrangements, juggle new home and family responsibilities and benefit from the use of technology infrastructure that we’ve invested in and continue to enhance at this time. The other 30% of our colleagues are working at our sites, supporting essential operations such as manufacturing, distribution and logistics, clinical trials and research and technical services and support for customers.
Our teams in Zoetis sites are adhering to strict health and hygiene protocols recommended by the WHO and CDC. They are practicing social distancing, operating in staggered shifts and participating in health monitoring, all as part of the adjustments we have made at each plant to limit potential exposure. Our 30 manufacturing sites remain open around the globe today, and we’ve been able to maintain supply of critical product inventories. We’ve also shown excellent agility to deal with the local market changes in terms of border control, regulatory changes and freight operations.
I am also pleased to say that even under these difficult circumstances, we were able to meet our launch timing for Simparica Trio, our highly anticipated triple combination parasiticide. We launched Simparica Trio in the U.K., Spain and Italy in February, made initial shipments for distribution in the U.S. in March and initiated a full launch in the U.S. and Canada in April, with more markets to follow. We’ve seen significant interest in Trio, and we’ve been supporting its introduction with consumer ads in the U.S. this spring. While we’re excited about the introduction and the receptiveness of customers and pet owners, we’ve had to revisit full year projections for Simparica Trio, given the expected impact of COVID-19 and the recession. Glenn will speak more to this in his remarks.
We are grateful we’ve been able to keep our major R&D programs on track. We continue to advance our research in key areas such as monoclonal antibodies for osteoarthritis pain in cats and dogs and vector vaccines for poultry. We’re continuing with regulatory reviews, commissions are going in, and we’re maintaining momentum at our most critical projects for the future, all while keeping colleagues safe.
From a P&L perspective, in the first quarter, the pandemic had a limited impact on our results given the February quarter end for international markets and the timing of shelter-in-place across the U.S. We’ve generated 7% operational growth in revenue and 10% operational growth in adjusted net income, thanks to the strength of our diverse portfolio and global scope of our business. We expect a more significant revenue impact from COVID-19 in Q2 and for the year as the lockdowns and recession have a continued impact on our business, especially in terms of traffic at companion animal clinics, and reduction in demand for protein from their restaurant and dine-out sectors. We will need to watch carefully how the reopening of various markets in the coming weeks impacts veterinary services for companion animals as well as livestock. Glenn will discuss 2020 guidance in more detail in a few minutes, but I’m pleased to share that Zoetis remains a resilient company at times like these, given the essential nature of our business and our diverse portfolio. In most markets, our sales teams are working virtually to respect local government guidance and limit potential exposure of COVID-19 for colleagues and customers.
We’ve been keeping in regular contact with our customers, through phone calls, video conferences, webinars and surveys, and we’re responding as best we can to anticipate and address their most important needs. We are here to help them maintain critical care and supply for their customers at this time and adapt to a new normal for the future of animal care. For example, we’ve been advising customers on increasing digital content for their use with pet owners, offering telemedicine solutions through new partnerships, discussing their liquidity concerns, offering continuing education for veterinary staff and providing technical support services to deal with adjustments being made to food production. We are seeing many of the trends you are, in terms of animal health and food supply as well, as decreased traffic to veterinary practices. But history tells us that animal health medicines, vaccines and other products remain essential, even in a challenging economy.
On the livestock side of the business, the need for food hasn’t gone away, but with restaurants and hotels closed, consumer demand has shifted to supermarkets. There’s less demand for beef and dairy products, while poultry remains strong as people choose less expensive proteins. As with every frontline business today, the biggest challenge our livestock customers are having is maintaining their operations with enough healthy workers to handle processing, packing and delivering food. On the pet side of the business, veterinary traffic is down in places where containment measures are in place. Now many vets are leveraging curbside check-ins, home visits, telemedicine and online pharmacy distribution to take the place of in-clinic visits. As we look ahead, our business continuity plans are working well, and we continue to show great agility and responsiveness to this crisis. We are carefully managing our expenses and doing scenario planning for the medium and long term, including hiring freezes and reductions to discretionary spending such as travel, entertainment and consulting. We have not had to engage in furloughs or salary reductions for our colleagues, thanks to the resiliency and diversification of our business and our strong balance sheet. We continue to regularly assess any long term needs depending on the duration of the pandemic and the resulting recession. Like all companies, we’ve begun planning for the days when more of our colleagues will return to the workplace.
Over the last few months, we have safely maintained operations in our manufacturing, distribution and R&D facilities to ensure continuous supply to our customers, while maintaining strict quality standards and keeping our colleagues safe. We plan to leverage these enhanced policies and procedures for a phased return to work that helps ensure the safety of not just our colleagues, but the customers they interact with in the field. I am proud of our teams for their resourcefulness, flexibility and commitment to colleagues and customers. Their efforts are helping us to envision an even better way to work over the long term.
When we began this year, my first as CEO, I laid out 5 priorities for Zoetis, and those are as relevant today as they were then. Our priorities remain driving innovative growth, enhancing customer experience, leading in digital and data analytics, cultivating a high-performing organization and championing a healthier, more sustainable future. As we manage through the crisis to this new normal, we will find relevant new ways to adapt our strategies and tactics for the future. Even in the midst of COVID-19, we continue to act on opportunities to advance these priorities. Since February, we received approval of Simparica Trio in the U.S. and Australia and have launched it in several markets with the support of direct-to-consumer advertising and digital marketing where applicable. We acquired Performance Livestock Analytics, a company which brings us proven cloud-based management systems and data analytics for beef producers, and we announced Pumpkin, a new pet health start up, that’s offering pet insurance and preventative care in the U.S.
Once again, I’m very proud of the results we’ve been able to deliver this quarter, and I look forward to your questions. Now let me hand over to Glenn for more details on the first quarter results and our updated view for the rest of 2020. Glenn?
Glenn C. David, Zoetis Inc. – Executive VP & CFO [4]
Thank you, Kristin, and good morning. Echoing Kristin’s comments, we find ourselves in a world we never imagined. I am grateful for our colleagues as they balance new working arrangements, caring for their families and keeping our essential business running during this crisis.
Today, I will provide commentary on our Q1 results, provide clarity on our liquidity position and review our updated guidance for 2020. Historically, we know that Zoetis has remained a resilient company given the essential nature of our business and our diverse portfolio. But no one yet knows the full extent, duration or implications that this pandemic will have. Our updated guidance reflects our best estimates based on what we know today.
Beginning with the first quarter results, we generated revenue of $1.5 billion, representing an increase of 5% on a reported basis and 7% operationally. Adjusted net income of $455 million increased 7% on a reported basis and 10% operationally. Foreign exchange in the quarter drove an unfavorable 2% impact on revenue, driven by the strengthening of the U.S. dollar. Operational revenue growth of 7% was driven by 3% price and 4% volume. Volume growth of 4% includes 2% from key dermatology products, 2% from new products, 1% from acquisitions and a decline of 1% in other in-line products. The first quarter was not materially impacted by the outbreak of COVID-19, given the February quarter end for our international markets and the timing of quarantine guidelines in the U.S. However, as indicated in our updated guidance ranges, we anticipate a more significant impact for the full year, as the lockdowns and recessions have a continued impact on our business.
Companion animal products led the way in terms of species growth, growing 10% operationally, while livestock grew 3% operationally. Companion animal performance was driven by continued strength of our key dermatology products and our parasiticide portfolio, which includes initial sales of Simparica Trio in both the U.S. and certain European markets. Revenue from the acquisition of Platinum Performance, which was acquired in the second half of 2019, and its nutritional products also contributed to strong equine growth. Livestock growth in the quarter was primarily driven by strong poultry, swine and fish performance, partially offset by declines in cattle. New products contributed 2% to overall growth in the quarter driven by Simparica Trio and ProHeart 12 and our Alpha Flux parasiticide for fish in Chile. We remain very excited and confident in our ability to successfully launch Simparica Trio, beginning with key markets in Europe and the U.S. However, we are now anticipating the incremental revenue for the full year to be in the range of $100 million to $125 million. The initial response from veterinarians has been extremely encouraging, however, due to the current COVID-19 situation, clinic penetration and adoption will be more gradual than initially expected. Global sales of our key dermatology portfolio were $194 million in the quarter, growing 25% operationally and contributing 2% to overall revenue growth. The ongoing strength of this portfolio was driven by expanded usage of Apoquel, resulting from promotional investments, increased adoption of CYTOPOINT as well as entry into new markets and price. Recent acquisitions and commercial agreements contributed 1% growth this quarter, which includes Platinum Performance, our reference lab acquisitions, and the Stablelab diagnostic tests for equine. Other in-line products declined this quarter, primarily driven by declines in U.S. cattle related to ongoing beef and dairy market challenges.
Now let’s discuss the revenue growth by segment for the quarter. U.S. revenue grew 9%, with companion animal products growing 12% and livestock products growing 5%. Companion animal growth in the quarter was driven by increased sales of our key dermatology products, growth of the Simparica franchise and the impact of recent acquisitions. This growth was partially offset by declines in point-of-care diagnostics. U.S. key dermatology sales were $136 million for the quarter, growing 31%. Growth this quarter was driven by ongoing promotional investments and expanded usage of the CYTOPOINT in the clinic. Simparica Trio revenue in the quarter included initial sales to distribution channels, with product becoming available to veterinarians for prescribing in mid-April. We’re supporting the launch with strong field force engagement and direct-to-consumer advertising. We remain confident in the long-term success of this product despite launching within the current environment.
Diagnostic sales in the quarter were primarily impacted by distributor purchasing patterns and slower demand in March related to COVID-19. U.S. livestock returned to growth this quarter, supported by positive performance in poultry and swine, partially offset by cattle declines. Poultry continued to benefit from our portfolio of alternatives to antibiotics in medicated feed additives, driven by new customer adoption and efficacy challenges for a competitive product. Swine also had a strong quarter driven by increased sales of anti-infectives and the onetime replenishment of a classical swine fever vaccine stockpile by the USDA. Cattle product sales continued to be negatively impacted by unfavorable beef market conditions driven by feedlot placements of heavier and healthier animals with a lower-risk profile, and dairy continued to face headwinds from negative producer profitability and oversupply.
To summarize, U.S. performance was strong, despite ongoing challenges in U.S. beef and dairy cattle markets. Our International segment had operational revenue growth of 4% in the quarter. Companion animal operational revenue growth was 8% and livestock operational growth was 2%. Companion animal product growth resulted from increased sales of our Simparica franchise, including the launch of Simparica Trio in certain EU markets and growth in our key dermatology portfolio. New diagnostic customer accounts and strong performance in China also contributed to growth in the quarter despite the impact of social distancing measures in China.
International livestock growth in the quarter was driven primarily by swine, fish and poultry. Swine returned to growth in the quarter due to expanding herd production and key account penetration across emerging markets, including China. Our short-term outlook for China remains neutral to slightly positive, as they rebuild due to lower incidence of African swine fever. However, certain smaller markets in Asia continue to experience challenges related to ASF. The fish portfolio benefited from the continued uptake of the Alpha Flux parasiticide in Chile, while poultry growth was driven primarily by price. Overall, our international segment continues to be a positive contributor to revenue growth with all species flat to growing, including swine returning to growth even in the current challenging environment.
Now moving on to the rest of the P&L. Adjusted gross margin of 70.3%, increased slightly on a reported basis compared to the prior year due to price, partially offset by the mildly dilutive impact of recent acquisitions. Total adjusted operating expenses grew 7% operationally. The increase is primarily related to the impact of recent acquisitions, investments to support future growth of the business and direct-to-consumer advertising. The adjusted effective tax rate for the quarter was 16.8%. The decrease from the comparable 2019 period is primarily driven by the tax benefits from share-based compensation. Adjusted net income for the quarter grew 10% operationally, driven by revenue growth and a lower effective tax rate, and adjusted diluted EPS grew 10% operationally.
Next, I’d like to cover our liquidity position and our capital allocation priorities. We ended the first quarter with approximately $2 billion in cash and cash equivalents as well as access to a $1 billion revolving credit facility and a coinciding commercial paper program, both of which are undrawn. Given our strong cash flow and balance sheet, we remain committed to our capital allocation priorities of internal investment, M&A and returning excess cash to shareholders. Consistent with what I mentioned last quarter, we are anticipating elevated capital expenditures this year to support investments in manufacturing, information technology to support our recent acquisitions and capabilities in digital and data analytics. However, we are delaying expenditures that will not materially impact our medium and long-term growth strategy. Our strong liquidity also allows us to be opportunistic and continue executing on our M&A strategy. And consistent with what I’ve said before, our focus is on strategic tuck-in acquisitions, not large-scale transformational M&A. Our recent acquisitions of Performance Livestock Analytics is a good example.
With regards to returning excess cash to shareholders, we remain committed to our 2020 dividend, which represents a 22% increase over 2019. In Q1, we also repurchased $250 million in Zoetis shares, and we have approximately $1.4 billion remaining under our multiyear share repurchase program. However, in light of the current situation, we have decided to temporarily suspend our share repurchases and conserve cash.
Now moving on to our updated guidance assumptions for 2020. As I noted earlier, we cannot know the full extent of the COVID-19 pandemic as the situation continues to evolve daily. Our updated guidance reflects our current assumptions and may change materially as the situation progresses. Our guidance assumes that the economy begins to open up in the second half of the year, with pet care visits returning to more normalized levels as the year progresses and our livestock customers being able to maintain their operations. It also assumes a continued recession this year. We have increased the width of our ranges as the timing of returning to normal operations and the depth of the recession is still uncertain. Please note that guidance reflects foreign exchange rates as of late April, and movement in foreign exchange rate has had a significant impact on our revenue and adjusted net income since prior guidance, given our global footprint.
Our current guidance includes unfavorable foreign exchange at revenue of approximately $150 million and approximately $50 million at adjusted net income, primarily driven by the Brazilian real, Mexican peso and the euro. We are now projecting revenue between $5.95 billion and $6.25 billion, representing a 2% operational decline to 3% operational growth. Adjusted cost of sales as a percentage of revenue is now expected to be in the range of 30.5% to 31.5%, increasing slightly from February guidance due to increased manufacturing and freight costs related to COVID-19. Adjusted SG&A expenses for the year are now expected to be between $1.455 billion and $1.545 billion, with the decrease from the February guidance, driven by savings and compensation due to hiring freezes and reductions to discretionary spending, such as travel and entertainment and professional service spend.
As Kristin indicated, our key R&D programs are progressing, and so adjusted R&D expenses are now expected to be between $440 million and $465 million, consistent with our commitment to invest in pipeline opportunities. We’re also continuing to invest in strategic areas of focus, such as diagnostics, biodevices and precision livestock farming, and strategies to maximize the value of the continuum of care through integrated offerings. While we are taking measures to reduce expenses this year, we also remain committed to bringing medium and long-term growth and value to our shareholders. Adjusted interest and other income deductions is now expected to be approximately $250 million, with the increase over February guidance driven by lower interest income and other factors. Our adjusted effective tax rate for 2020 is expected to be in the range of 20% to 21%, consistent with February guidance. Adjusted net income is expected to be in the range of $1.52 billion to $1.64 billion, representing an operational decline of 2% to 9%. Adjusted diluted EPS is expected to be in the range of $3.17 to $3.42, and reported diluted EPS is expected to be in the range of $2.80 to $3.07. While our guidance represents full year expectations, we do anticipate revenue and adjusted net income to be most significantly impacted in Q2, based upon quarantine and shelter-in-place guidelines that have been put in place in most major markets around the world and the economic impact of a recession. We anticipate the second half of the year will be impacted, but to a lesser extent.
Now to summarize, before we move to Q&A. Pre-COVID-19, 2020 was off to a strong start and in line with our expectations, with 7% operational revenue growth and 10% operational growth in adjusted net income. The essential nature of our business, the diversity of our portfolio and the durability of our business will allow us to continue executing on our strategy during this period of uncertainty. We are confident we will be able to maintain strong liquidity and manage effectively through this challenging environment, given our strong cash flow and balance sheet. And despite managing our spend in the short term, as we navigate through the impact of the COVID-19 pandemic, we remain committed to medium and long-term profitable growth through responsible investment.
Now I hand things over to the operator to open the line for your questions. Operator?