Zoetis Inc - Class A (ZTS) — Q3 2021 Earnings Call Transcript

Thank you, Operator. Good morning, everyone. And welcome to the Zoetis Third Quarter 2021 Earnings call. I am joined today by Kristin Peck, our Chief Executive Officer, and Wetteny Joseph, 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 US GAAP. Reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release, and in the Company's 8-K filing dated today, Thursday, November 4th, 2021. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin.

Thank you, Steve, and welcome everyone to our third quarter earnings call. We delivered strong results again this quarter with 10% operational growth in both revenue and adjusted net income driven by our innovative portfolio of pet care parasiticides and dermatology products. Our US business grew revenue 7% operationally, while international grew revenue 14% operationally. In terms of species, our Companion Animal portfolio generated 19% operational revenue growth in the quarter with great performance in markets around the world. Our latest innovation in parasiticides, the triple combination Simparica Trio, is increasing its global adoption. Our groundbreaking dermatology products, Apoquel and Cytopoint, continue to redefine and expand the category. And we completed the first full quarter of sales for both of our new monoclonal antibody therapies for osteoarthritis pain in dogs and cats, Librela and Solensia. These new products are exceeding expectations and receiving very positive feedback from veterinarians and pet owners in European markets, where they've been launched. When you add all of this to our growth in diagnostics for Companion Animals, I see our business continuing to capitalize on the positive demographics for pets. Increased spending on pet wellness and treatment will be sustainable well beyond the pandemic. Our portfolio and pipeline are well-positioned to continue leading and innovating in this market. Livestock product sales continue to present a more complex picture for the industry and Zoetis with market dynamics varying widely by species and geographies. As we expected, our livestock portfolio declined 2% operationally in the third quarter, largely due to generic competition across cattle, poultry, and swine and most significantly in the US. We have taken proactive strategies to protect these product lines, including the introduction of a lifecycle innovation like drafting KP. But pricing pressure remains due to the increasing effects of generic competition. On the positive side, we saw 7% operational growth for livestock internationally, as markets like Brazil, Chile, and other emerging markets performed well. Our long-term advantage in livestock continues to be our diverse portfolio and strength across geographies and product categories like medicines, vaccines, and medicated feed additives. We also continue to invest in R&D programs that align with our customers' long-term needs for more efficient and sustainable production methods, which can be built anew therapies, analytics, and digital solutions. We remain on track for a record-setting year with updated guidance for operational revenue growth in the range of 14% to 14.5% and adjusted net income growth in the range of 16.5% to 18% for 2021. Our major catalysts for growth have performed well this year and have more runway ahead for 2022 and beyond. And when do we make the right investments and continue successfully executing our growth strategies. Our strength in pet care has an incredibly strong foundation across parasiticides, dermatology, and vaccine. To the first nine months of 2021, our Companion Animal portfolio has grown 29% operationally. We also remain very excited about the long-term blockbuster potential of our new monoclonal antibody franchises in pain, Librela and Solensia, as they grow in Europe and we make progress on approvals in the US. We currently expect approval of Solensia in the US in the first half of 2022, with Librela remaining more likely in the second half. Our revenue growth in international markets has been 20% operationally in the first nine months, driven by China, Brazil, and other emerging markets. We continue to expect growth to come across both our Companion Animal and livestock portfolios in these markets. Finally, our diagnostics portfolio remains a key catalyst for growth with 28% operational growth through the first nine months. We are gaining significant traction with our expansion of the point-of-care portfolio in markets outside the US. We always believed international expansion was one of the biggest value drivers for the Abaxis acquisition once we combine that portfolio with the global Zoetis footprint. The acceleration of international growth for diagnostics is a very positive sign and continues gaining momentum. We also recently added digital cytology testing to our VetScan images platform in the US, UK, Canada, Australia, and New Zealand. This means we can now offer a network of expert remote pathologists, in addition to artificial intelligence technology for fecal testing. We're seeing our strongest early adoption of VetScan images in Germany, Australia, Spain, and the UK. And we will continue developing additional applications for the platform over time. In addition to our ongoing investments in R&D programs and direct-to-consumer campaigns, we are investing in manufacturing capacity to meet increasing demands for our new parasiticide products and monoclonal antibody therapies. Expansions are underway at our sites in Kalamazoo, Michigan, Lincoln, Nebraska, and Tullamore, Ireland. All of these are significant multi-year projects to ensure we have ongoing reliable supply while maintaining a diverse global network of third-party contract manufacturers that give us the greatest flexibility and redundancy. Our supply chain team has done an excellent job over the last two years to optimize inventory levels of key products while minimizing the impact of a challenging global supply landscape. We continue to carefully monitor and manage our supply chain and inventories. And finally, before I hand things off to Wetteny, I wanted to note our recent news about changes in our R&D leadership team. Long-time R&D leader Cathy Knupp will be retiring at the end of the year and ensuring a smooth transition through February. I am very grateful to Cathy for building the most innovative and productive R&D organization in the animal health industry and for leaving us with a rich pipeline of future innovations and R&D talent, which includes her successor Rob Polzer. Rob has been with Zoetis since 2015, working on many of the innovations that have come to market recently in parasiticides and monoclonal antibodies. He has experience running our global therapeutics and biologics R&D organization and is the right leader for the future of innovation at Zoetis. In closing, I want to thank our colleagues for delivering another great quarter and bringing the value of Zoetis to our customers every day. We are confident in the updated guidance we have provided and see the fundamental growth drivers of our business continuing into 2022 and beyond. Now, let me hand things over to Wetteny.

Thank you, Kristin, and good morning, everyone. The focus of my comments today will be on our third quarter financial results, the contributing factors that drove our performance, and an update of our improved full-year 2021 guidance. In the third quarter, we generated revenue of $2 billion, growing 11% on a reported basis and 10% operationally. Adjusted net income of $597 million was an increase of 14% on a reported basis and 10% operationally. Operational revenue grew 10% with 2% from price and 8% from volume. Run growth is comprised of 5% from new products, including Simparica Trio, and 3% from our online portfolio, primarily our key dermatology franchise. Now let's dive further into the details of the quarter. Companion Animal products again led the way in terms of species growth, growing 19% operationally, with livestock declining 2% operationally in the quarter. Our parasiticide portfolio made the largest contribution to Companion Animal growth driven by sales of Simparica Trio and continued strength across our broader portfolio including the ProHeart franchise, Simparica, and Revolution Stronghold Plus. We also saw robust growth in our key dermatology products, Apoquel and Cytopoint. Simparica Trio had another exceptional quarter posting revenue of $122 million, representing operational growth of 140% versus the comparable 2020 period, with year-to-date sales of $350 million. We believe the global pet market will continue to expand and that our broad and innovative portfolio, which were 32% operationally in the quarter, has us well-positioned to capture share and outpace our competitors. Global sales of our key dermatology products were $321 million in the quarter, growing 26% operationally. Total sales exceeded $300 million for the first time in Company history. And we remain ahead of schedule to surpass $1 billion in dermatology sales for the year. Our diagnostics portfolio had operational sales growth of 7% in Q3 against a very challenging comparative period as the third quarter of 2020 had a sharp increase in wellness visits following clinic closures in the second quarter. Our International Diagnostics portfolio performed very well, which as Kristin mentioned, was a key component for the strategic rationale of the Abaxis acquisition. Diagnostics remains the key growth driver for Zoetis, and we will continue to make significant investments in new technology, expand our reference laboratory footprint, as well as provide flexible solutions to our customers. Our equine products delivered strong results with operational sales growth of 20% in the quarter as horse shows and racing returned to pre-pandemic levels and field growth in vaccines, as well as nutritional and pain products. The expected decline in livestock in the quarter was primarily driven by our US cattle and US poultry businesses as our international segment delivered operational growth across all species. Globally, our cattle business declined 5% operationally in the quarter driven by the impact of generic competition for DRAXXIN and a difficult comparative quarter resulting from COVID-19 dynamics and earlier fall cattle run in the US in the third quarter of 2020. Poultry also declined in the quarter as producers in the US rotated to lower-cost alternatives to our premium products as a result of current market dynamics. Sales were also negatively impacted by generic competition of Zoamix and BMD, our alternatives to antibiotics in medicated feed additives. The decline in cattle and poultry offset the growth in fish. Swine was essentially flat in the quarter as a decline in the US, primarily from pricing pressure on our anti-infective and vaccine portfolio as a result of generic competition, offset the growth internationally from further key account expansion. Overall, we delivered another strong quarter, benchmarked against a very difficult prior-year comparative period on both the Companion Animal and livestock sides of our business. Now, let's discuss the revenue growth by segment for the quarter. US quarterly revenue exceeded $1 billion for the second consecutive quarter, with revenue growth of 7%. Sales of Companion Animal products grew 17%, and livestock product sales declined by 13%. For Companion Animal, pet care trends continued to be robust. Vet clinic revenue and patient visits grew again this quarter against growth rates from the third quarter of last year, which were well above historical levels. Our view remains unchanged that certain trends will moderate, but we remain above pre-pandemic levels. Growth in US Companion Animal was led by our parasiticides portfolio and our key dermatology products. Simparica Trio continues to perform well, with US sales of $110 million and year-to-date sales north of $300 million. This quarter is also an excellent representation of our commitment to invest in the broader parasiticide portfolio as we launched the targeted DTC campaign for ProHeart in prevalent heartworm geographies. Key dermatology sales were $270 million in the US for the quarter, growing 20% with significant growth for Apoquel and Cytopoint. US diagnostic sales grew 2% in the quarter, which as I mentioned earlier had a very difficult comparative period. However, year-to-date performance has been strong at 23% growth. US livestock sales declined 13% in the quarter. Our US cattle business faced the comparative period that had robust growth as the third quarter performance of 2020 benefited from an early cattle run and pent-up demand work its way through the system. In addition, generic competition had not entered the market in the third quarter of 2020. Our generic defense strategy has been successful as we have been able to maintain a greater volume share of the market than originally expected. Although additional generics will likely enter the market in the coming quarters. From an end market perspective, producer profitability remains challenged by input costs, primarily feed and labor. US poultry sales declined in the quarter as smaller flocks resulted in lower disease pressure, allowing producers to expand usage of lower-cost alternatives through our highly efficacious premium products. In addition, generic competition is creating pricing pressure on our Zoamix and BMD franchises. To summarize, our US operations delivered another strong quarter driven by our innovative and robust Companion Animal products along with pet care markets, displaying very strong fundamentals. The near-term weakness in our US livestock business has been expected and has been more than offset by the strengthened Companion Animal performance, which demonstrates the importance of diversification across species. Now, turning to our international segment. Revenue of our International segment grew 14% operationally in the quarter with Companion Animal revenue growing 24%, and livestock revenue growing 7% operationally. In the second half of 2020, we saw a material uptick in medicalization rates and standard of care by pet owners, a trend which has continued through the third quarter of this year. We entered and made significant investments in advertising promotion to capitalize on favorable market conditions and drive growth. Companion Animal achieved broad-based growth internationally in the quarter, led by strong performance of our key dermatology products. Through three quarters of 2021, year-to-date sales are in excess of total sales of the entire prior year. In addition, we are in the early stages of a Direct-To-Consumer campaign for key dermatology, which we expect will create additional demand for our products. Parasiticides had a strong quarter internationally, led by significant growth in the Simparica franchise, which benefited from DTC campaigns and drove growth in Brazil, Eastern Europe, and Latin America. Librela, our monoclonal antibody for alleviation of pain in dogs, has done extremely well, generating $15 million in quarterly sales in a select number of markets. Feedback from veterinarians and pet owners on the quality-of-life improvement for the patients has been extremely encouraging. Our feline monoclonal antibody for alleviation of pain, Solensia, had positive feedback from the early experience programs in Q2 and launched in the EU this quarter. Pain management in cats is a significant unmet need in animal health, and our view is that Solensia will become a blockbuster product, with the pain market for cats becoming approximately a $200 million global category over time. Our international diagnostics portfolio grew 20% operationally in the quarter, with significant growth in consumable and instrument revenue. And strong growth across a number of geographies such as the UK, Australia, China, and various other markets. Moving onto livestock, our international business again delivered growth across all species, led by strong operational growth in cattle and fish. Cattle growth in the quarter was driven by further key account penetration and favorable export market conditions in Brazil and several other emerging markets. Our fish portfolio continues to perform very well, growing 21% operationally. Growth in our fish portfolio was primarily the result of increased sales of our Alpha Flux sea lice treatment product, as well as strong growth in vaccines. Performance in swine and poultry were also fueled by growth in key accounts, as well as overall market growth, primarily in emerging markets. At a market-level view for international segment, all major markets grew operationally in the third quarter except for France, which was essentially flat in Q3. Emerging markets were again a key contributor to our international performance, led by Brazil, which was 22% on an operational basis. As we expected, growth in China slowed in the third quarter as lower pork prices challenged profitability. However, the Companion Animal business in China, which grew double digits once again, offset the weakness in swine. Overall, total emerging markets have grown significantly in both the quarter and on a year-to-date basis. Our international segment again delivered strong results with robust growth in Companion Animal and growth across all species in livestock. On a year-to-date basis, our international segment has grown 20% operationally with our Companion Animal and livestock businesses, each growing double digits. While falling pork prices in China are creating a headwind that is moderating growth in swine, it is more than offset by the growth across other species and markets, demonstrating the importance of our diversity across species and geography. Now moving on to the rest of the P&L. Adjusted gross margin of 70.7% increased 110 basis points on a reported basis compared to the prior year as favorable product mix for an exchange, low inventory charges and price were partially offset by higher manufacturing costs, freight, and distribution costs. Adjusted operating expenses increased 19% operationally, with SG&A expenses growing 20% operationally resulting from increased compensation-related costs, as well as increased advertising and promotion expenses, freight, and travel and entertainment. Our expenses increased by 17% operationally driven by higher project spending. The adjusted effective tax rate for the quarter was 16.7%, a decrease of 330 basis points due to favorable changes to the jurisdictional mix of earnings including increased favorability related to foreign-derived and tangible income, and an increase in favorable discrete items compared to the prior year's comparable third quarter. Adjusted net income and adjusted diluted EPS grew 10% operationally for the quarter, primarily driven by revenue growth, gross margin expansion, and a lower effective tax rate. Our liquidity position remains very healthy. And in the third quarter we had $3.3 billion in cash and cash equivalents following a $600 million repayment of long-term debt in August. Our financial flexibility is in a very strong position, which allows us to make meaningful investments in our business while returning excess cash to shareholders, as demonstrated by our repurchase of Zoetis shares of approximately $200 million in the quarter. Now, moving on to our updated guidance for 2021, we are raising and narrowing our guidance range with projected revenue now between $7.7 billion and $7.75 billion and operational revenue growth between 14% and 14.5% for the full year versus the 12.5% to 13.5% in our August guidance. Adjusted SG&A expense for the year is expected to be between $1.91 billion and $1.94 billion versus $1.87 billion and $1.91 billion in our prior guidance. The guidance rate largely represents additional compensation-related costs, as well as increased advertising and promotion spend to support growth of new products and key franchises. Adjusted net income is now expected to be in the range of $2.2 billion and $2.225 billion, representing operational growth of 16.5% to 18% compared to our prior guidance of 13% to 15%. Adjusted diluted EPS is now expected to be in the range of $4.62 to $4.67, and reported diluted EPS to be in the range of $4.23 to $4.29. To summarize, before we move to Q&A, for three quarters, we've delivered strong operational top and bottom-line growth with revenue growing 17% operationally. And again, raised and narrowed our full-year 2021 guidance. We have achieved significant growth across our key franchises and are extremely excited about our new product launches and product pipeline.