Zoetis Inc. (NYSE:ZTS) Q4 2022 Earnings Call Transcript

Zoetis Inc. (NYSE:ZTS) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Welcome to the Fourth Quarter and Full Year 2022 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, and 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 the Investor Relations section of zoetis.com. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Steve Frank: Thank you, operator. Good morning, everyone and welcome to the Zoetis fourth quarter and full year 2022 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Wetteny Joseph, our Chief Financial Officer. Before we begin, I will 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 statements in today’s press release and our SEC filings, including, but not limited to, our annual report, 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 the company’s 8-K filing dated today, Tuesday, February 14, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin.

Kristin Peck: Thank you, Steve and welcome everyone to our fourth quarter and full year 2022 earnings call. Today, we reported strong full year results for 2022, in line with the high-end of our guidance from November and thanks to our diverse portfolio, global scale and talented colleagues. Our 8% operational revenue growth for the year was driven by our innovative companion animal portfolio, which grew 14% operationally while our livestock portfolio declined 2% operationally, primarily due to generic competition and market challenges, especially in the U.S. Thanks to our broad global scale and diversity, we delivered well-balanced operational growth across our U.S. and international segments, which grew 7% and 9% respectively.

For the year, we generated operational growth in all of our top 13 markets despite the economic challenges, continued COVID recovery and political uncertainty created by the war in Ukraine. Reflecting our longstanding value proposition, we grew our adjusted net income faster than sales for the year with an operational increase of 11% for the full year and we use this performance and financial strength to continue investing in the R&D, manufacturing capacity and sales and marketing resources to support our future growth and pipeline. As we begin 2023, we will stay adaptable to the evolving macroeconomic factors and geopolitical tensions around the world and focus on executing our plans. We remain very confident in the fundamental and resilient global demand for animal care.

And most importantly, we are confident in Zoetis’ ability to continue delivering solid sustainable growth as we resolve our prior supply constraints and build share of our market-leading franchises. Looking ahead, we are committed to our track record of value creation and above-market performance even in the face of today’s economic uncertainty. We are well positioned with our strategic priorities and capabilities to expand in large and growing product areas like parasiticides, dermatology products, monoclonal antibodies, vaccines and diagnostics. We are guiding to a range of 6% to 8% operational growth for revenue in 2023 and adjusted net income growth in the range of 7% to 9% operationally, which reflects our increased investment plans for R&D and manufacturing to support growth.

As the world leader in animal health, a market that has grown on average of 5% to 6% through various economic cycles over the last two decades, we feel very positive about how our portfolio, pipeline and strategy can drive long-term sustainable growth and create value for our customers and shareholders. Wetteny will discuss more details about the 4Q results and full year 2023 guidance, but let me provide some additional perspective on our business and set the stage for some of our growth drivers for the year. First, we have remained the world leader in animal health over the last decade, outperforming the market and bringing groundbreaking innovation to veterinarians, producers and pet owners who care for animals. We marked our 10-year anniversary as a public company on February 1, a decade, which saw us bring more than 2,000 new products and lifecycle innovations to market, build a diverse portfolio, featuring market-leading franchises and 15 current blockbusters generate consistent above-market revenue growth and deliver a total shareholder return of more than 500% all while increasing our market cap from $16 billion in 2013 to about $75 billion today.

While we celebrate those accomplishments, I am even more excited about where we can go in the next decade and by the talented colleagues, innovative pipeline and best-in-class capabilities we have brought together at Zoetis. Our colleagues’ purpose-driven mindset and steady performance in the face of adversity give me confidence in the continued execution, innovation, growth and durability of our business. As we turn to 2023, we are focused on five key growth catalysts for the year. In dermatology, we see excellent growth opportunities even after nearly a decade of game-changing innovation that began with the introduction of Apoquel in 2014 and has continued with the success of our first monoclonal antibody, Cytopoint, as well as recent lifecycle innovations like Apoquel chewable.

We continue to see even more opportunities to grow and expand in this market. In pet parasiticides, the largest single product area in animal health, we continue to gain share and are now the second largest in revenue for this category. We have improved supply in 2023. We expect to continue expanding share in this market and supporting our diverse global portfolio beating Simparica Trio, our triple combination product. In the area of pain, we are off to a great start with our two monoclonal antibodies for osteoarthritis pain, Librela for dogs, which became our latest blockbuster in 2022 and Solensia for cats. We are once again revolutionizing care in this category and seeing very positive early reaction to both products in their large markets as we continue to expand geographies and supply.

In terms of the U.S. approval for Librela, we remain confident in receiving approval in the first half of €˜23 with a leasing plan for late in the year. In diagnostics, we continue to generate solid above-market growth in international markets above our go-to-market model in the U.S. and drive greater global adoption for VETSCAN IMAGYST, our AI-based diagnostics platform. And finally, as population growth and economic mobility drive more demand for animal protein and pets, we see major opportunities in fast-growing emerging markets outside the U.S., where our portfolio is well suited to meet those evolving needs. Overall, our business continues to be weighted towards higher growth, innovation-driven areas in companion animal and these will remain our growth drivers for the foreseeable future.

Meanwhile, our livestock portfolio will remain a valuable cash-generating piece of our business as we continue to recover in the U.S. from generic competition and show solid growth in emerging markets. As always, we will stay disciplined yet adaptable, and our approach to the new market opportunities, potential challenges and economic shifts that could occur. And in conclusion, Zoetis remains well positioned in terms of our market leadership, financial strength, investment strategies and diverse portfolio to deliver sustainable growth in 2023. Thank you. And I will hand this off to Wetteny.

Wetteny Joseph: Thank you, Kristin and good morning everyone. As Kristin mentioned, we had a strong year in 2022 with revenue of $8.1 billion and adjusted net income of $2.3 billion both in line with the high end of our November full year guidance range. Full year revenue grew 4% on a reported basis and 8% operationally with adjusted net income increasing 3% on a reported basis and 11% operationally. Looking deeper into the operational growth for the year, price contributed 3% to full year operational revenue growth with volume contributing 5%. Volume growth consisted of 4% from new products, including Simparica Trio and our monoclonal antibodies, Librela and Solensia, and 2% from key dermatology products, partially offset by a decline of 1% from other in-line products.

Revenue growth was broad-based with positive operational growth in each of our top 13 markets, which make up approximately 85% of our total revenues with international growing 9% operationally and the U.S. growing 7%. Our growth was driven by continued demand for our innovative new products in our companion animal portfolio, which grew 14% operationally. Our companion animal portfolio now makes up 64% of our global revenues. This growth was partially offset by our livestock business, which declined 2% operationally, primarily due to the generic competition, supply constraints as well as challenging market conditions in certain geographies. Performance in companion animal was driven by our small animal parasiticide portfolio, which grew 20% on an operational basis.

Simparica Trio generated $744 million in sales, growing 58% on an operational basis. Our Simparica franchise reached $1 billion in global revenue for the first time in 2022. Our key dermatology products generated $1.3 billion in sales posting strong growth of 17% operationally with double-digit growth in both international and the U.S. Key derm growth in our international markets was especially strong at 27% operationally. We continue to see solid growth in our monoclonal antibodies for osteoarthritis pain. As expected, sales of Librela eclipsed the $100 million mark on the year, marking Zoetis’ 15th blockbuster product. We look forward to Librela’s expected launch in the U.S. in late 2023. Solensia contributed $30 million in sales in 2022, primarily from international markets, with solid penetration in the U.S. after a launch late in the year.

Our companion animal diagnostics portfolio declined 2% operationally in the year, with declines in the U.S., partially offset by growth internationally. Our livestock business declined 2% on an operational basis. Our portfolio continues to be challenged by generic and cheaper alternatives to DRAXXIN in cattle as well as Zoamix in poultry. We do expect the generic impact to begin to moderate in 2023. Additional declines were driven by supply challenges on certain livestock products as well as unfavorable market conditions, especially the U.S. cattle and China swine markets. Moving on to our Q4 financial results, which was another strong quarter. We closed Q4 with revenue of $2 billion, representing an increase of 4% on a reported basis and 9% on an operational basis.

Adjusted net income of $539 million is an increase of 14% on a reported basis and 27% operationally. Of the 9% operational revenue growth, 3% is from price and 6% from volume. Volume growth consisted of 3% from new products, which includes Simparica Trio as well as Librela and Solensia and 2% from key dermatology products, while other in-line products grew 1%. Companion animal products grew 15% operationally while our livestock portfolio was flat in the quarter. Simparica Trio was the largest contributor to growth in the quarter, posting global revenue of $171 million, representing operational growth of 39% for the quarter. We expect Simparica Trio to continue to grow the addressable market for fleet taking hardware globally and drive the conversion from collar and top parasiticides to oral combination products.

These dynamics will provide additional run-rate for future expansion of the broader market and revenue growth for Trio even once competing triple combination products enter the market. Our key dermatology products, Apoquel and Cytopoint, had solid global growth in the quarter, posting $347 million of revenue, representing 14% operational growth against a robust prior year in which key derm grew 23% operationally in the fourth quarter of 2021. Our monoclonal antibodies for osteoarthritis pain in dogs and cats continue to grow posting $39 million of revenue in the quarter, primarily in international markets. Meanwhile, sales of livestock products were flat on an operational basis in the quarter, with growth in fish and poultry offset by the impact of generics and supply constraints on cattle and swine products.

Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.1 billion in the quarter, growing 7% with companion animal sales growing 12% and livestock sales declining by 6%. Focusing first on companion animal, we returned to double-digit growth in the quarter, as we resolved the majority of our supply issues from earlier in the year. In the U.S. veterinary practice revenue is growing approximately 6% and spending per visit remained strong again this quarter, increasing 10% despite a 4% decline in clinic visits in the quarter. The visit decline reflects comparison to the peak visit numbers in 2021, driven by pandemic after-effects and increased adoption of pets as well as the impact of veterinary workforce challenges that have limited some clinic capacities.

Absolute clinic visits remain above pre-pandemic levels. We continue to see growth in the retail segment outpacing other channels. In Q4, sales to our retail partners grew by 49%. Simparica Trio continues to drive growth in the quarter with sales of $158 million in the U.S., growing 39%. With the supply constraints from earlier in the year largely resolved, we were able to leverage promotional efforts to drive growth and regain market share in the quarter. Key dermatology product sales in the U.S. were $239 million for the quarter, growing 11% with Apoquel and Cytopoint, each growing double-digits. We expect to continue the expansion of the market for the foreseeable future. U.S. livestock declined 6% in the quarter as expected, with sales of cattle products impacted by supply restocking for certain products in the third quarter of 2022 as well as the impact of generic competition in cattle and poultry.

Moving on to our International segment, where revenue was flat on a reported basis and grew 12% operationally in the quarter. International companion animal revenue grew 21% operationally and livestock grew 4% operationally. Increased sales of companion animal products resulted from growth in our parasiticides portfolio, our key dermatology products and our monoclonal antibodies for alleviation of osteoarthritis pain. Our international small animal parasiticide portfolio had a very strong quarter. Growth was driven by revolution franchise, which rebounded well from supply challenges, especially in China. Our key dermatology products contributed $108 million to revenue and grew 22% on an operational basis in the quarter, with growth in Cytopoint across all key markets and continued double-digit growth of Apoquel.

We continue to be pleased with the performance of our oral pain portfolio with Librela generating $26 million and Solensia delivering $7 million in fourth quarter sales internationally. Librela sales in the quarter dipped slightly below the prior quarter due to the removal of supply allocation in certain markets, which led to higher inventory levels at the end of Q3. We expect to see significant contribution to growth in 2023 coming from Librela across our International segment. Moving on to our International Livestock segment, which grew 4% operationally in the quarter. Our fish portfolio grew 25% operationally due to increased demand for vaccines in key salmon markets, including Norway and Chile. Sales of poultry products grew due to increased demand for poultry protein.

Growth was partially offset by swine sales, which declined due to supply constraints in certain vaccines across international. The slight decline was partially offset by growth in China, driven by a weak comparative quarter in the prior year and improved swine market conditions. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 68.1% decreased 150 basis points on a reported basis compared to the prior year, resulting primarily from unfavorable foreign exchange impacts. Operationally, gross margin declined 60 basis points, driven by higher inventory charges as well as higher manufacturing and freight costs, which were partially offset by favorable price and mix. Operationally, adjusted operating expenses decreased 6% with SG&A declining 9% driven by lower compensation-related expenses and lower advertising and promotion, partially offset by higher freight and logistics related expenses.

R&D expenses increased 10% operationally due to higher compensation costs and higher project spend. The adjusted effective tax rate for the quarter was 20.8%, an increase of 220 basis points, primarily due to lower net discrete tax benefits in the quarter and a lower benefit in the U.S. related to foreign-derived intangible income. Adjusted net income grew 27% operationally and adjusted diluted EPS grew 30% operationally for the quarter. Capital expenditures in the fourth quarter were $171 million. In the quarter, we repurchased approximately $400 million of Zoetis shares and returned over $0.5 billion to shareholders through a combination of share repurchases and dividends. For the year, we have repurchased almost $1.6 billion of Zoetis shares and returned over $2.2 billion to shareholders.

In December, we announced a 15% annual dividend increase, continuing our commitment to grow our dividend at or faster than the growth in adjusted net income. Now moving on to our guidance for the full year 2023, please note that guidance reflects foreign exchange rates as of late January. We are expecting foreign exchange to have a minimal impact versus the prior year, with the full year impact neutral at revenue and slightly accretive at adjusted net income. The foreign exchange impact in the first half will be unfavorable versus prior year, particularly in the first quarter. In the second half of the year, foreign exchange is expected to be favorable based on the late January exchange rates. For 2023, we are projecting revenue between $8.575 billion and $8.725 billion, representing a range of 6% to 8% operational growth.

Volume will be 1% to 2% at the low end of our guidance range and 3% to 4% at the high end. We again expect companion animal to be the primary growth driver in 2023 with the continued strength of our diverse Simparica Trio portfolio, the adoption of our monoclonal antibodies for OA pain and further expansion of our key dermatology products. Despite the decline in vet planning visits last year, industry fundamentals remain strong. Business remain above pre-COVID levels and clinic revenue is at an all-time high as the standard of care continues to increase. We anticipate modest livestock declines in 2023, driven by the generic impact on DRAXXIN sales, particularly in the first half as well as unfavorable market conditions in U.S. cattle. These declines will be partially offset by growth in poultry, driven by increased demand for poultry protein and new product launches as well as fish.

The fundamental trends which make livestock an essential business remain intact. I’d like to touch upon the key assumptions that underpin our expectation for revenue growth. For companion animal, we assume a triple combination product we will launch in the U.S. in the first half of 2023 to compete against Simparica Trio. We expect this entrant will help Trio drive the conversion from topicals and collars to triple combination or parasiticides and still project significant growth for Trio. We do not expect competitive entrants in 2023 for our key dermatology products, Apoquel and Cytopoint. We expect another year of robust growth of our key derm portfolio coming from continued expansion of the dermatology market and price. We are excited about the continued growth in our OA franchise and plan to launch in several new markets next year.

For the remainder of the P&L, adjusted cost of sales as a percentage of revenue is expected to be in the range of 29.5% to 30%, where favorable foreign exchange price increases and product mix are partially offset by higher input costs. Adjusted SG&A expenses for the year are expected to be between $2.06 billion and $2.1 billion, with the increase from 2022 focused on supporting primary drivers of revenue growth. Adjusted R&D expenses for 2023, is expected to be between $635 million and $660 million. R&D spend can fluctuate year-over-year. This increased investment is reflective of both new projects as well as those advancing in our pipeline. Zoetis is the leader in animal health because of the disruptive innovation, novel products and life cycle enhancements we bring to the market.

This increase in R&D expenses reflects our commitment to ensuring our capital allocation prioritizes innovation. Adjusted interest and other income reductions are expected to be approximately $170 million. Our adjusted effective tax rate for 2023 is expected to be in the range of 20% to 21%. Adjusted net income is expected to be in the range of $2.49 billion to $2.54 billion, representing operational growth of 7% to 9%. Our guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. We expect adjusted diluted EPS to be in the range of $5.34 to $5.44 and reported diluted EPS to be in the range of $5.03 to $5.14. We are anticipating capital expenditures in 2023 to increase to $950 million to $1 billion.

We continue to make investments to support our future growth, including manufacturing capacity for monoclonal antibodies as well as oral solid dosage. Finally, Zoetis and the animal health industry remain resilient in the face of economic headwinds. Our 2023 guidance range is reflective of uncertain macroeconomic conditions and the impact of veterinary clinic labor challenges. While guidance represents our expectations for the full year, Q1 revenue is expected to be below the low end of the operational growth rate in our full year guidance due to a variety of reasons. First, Q1 2022 was a strong comparable quarter as we saw robust growth with limited impact from vet clinic labor constraints as well as minimal disruption from our diagnostics field force model change, which began in Q2.

Additionally, in the quarter, we expect to see lingering impacts of the latest COVID wave in China. Lastly, the return of supply on certain products, including Simparica Trio, and subsequent channel restocking as well as promotions to regain share in Q4 2022 modestly increased inventory levels in the channel in the short-term. In Q1, we expect a modest decline in adjusted net income versus the prior year as a result of the timing of our 2022 sales force extension in the U.S., which did not start until Q2, as well as the R&D investment noted earlier, which is also off a low base in Q1 2022. Now to summarize. 2022 was another strong year despite some challenges, we significantly outperformed the market and continue to take share, all while growing the bottom line faster than the top line.

As we begin 2023, we once again expect to grow faster than the market, driven by the strength of our innovative portfolio, our ability to successfully launch new products and expand existing markets and our confidence in the end market dynamics for the spaces we compete in. Now I’ll hand things over to the operator to open the line for your questions. Operator?

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Q&A Session

Operator: We will take our first question from Michael Ryskin from Bank of America.

Michael Ryskin: Great. Thanks for taking the question and congrats on the quarter, guys. I’m going to throw in a couple of just real quick. First, I would have to get your latest thoughts on NexGard plus BI triple combo now that it’s been unveiled at VMX. Just what are your expectations for Simparica Trio growth this year, if you could give us a ballpark for that? And then second, I want to talk about R&D spend in 2023. It seems to have jumped quite a lot year-over-year, and that’s a big part of why operating margins aren’t expanding as much as we’re used to. Any specific programs you want to highlight? And anything you can say in terms of when that R&D spend will translate into future launches? Is this something that’s sort of in the regulatory phase or weight clinical phase? Just give us a sense of where the extra $100 million year-over-year is going? Thanks.

Kristin Peck: Sure. Thanks, Mike. I’ll take those and let’s see if Wetteny has anything to add. The first, on Trio, obviously, we had a phenomenal year with 58% growth. We’re really proud of that. Obviously, we got back in clinics after some of the supply problems, and we’re fully back there. We’ve got 90% penetration with an 80% reorder rate and are now the number two fleet tick heartworm there. We are expecting competition from NexGard Plus sometime in the first half. We actually assure you don’t know exactly when that will be but we continue to expect the market to expand, and we continue to expect Simparica Trio to be growing on the year. I mean, albeit probably not at 58%, but we expect to have a very strong year. I think what you’re going to see is really moving more customers from collars and topicals into what is a best-in-class fleet to heartworm combined oral products.

So we expect to continue to go through this as we’ve continued to say, we don’t have any more information on the exact timing there. But we’re going to be aggressive. As you’ve seen us in Q4 and Q1, really investing behind this brand doing DTC, etcetera. So we expect strong growth there continuing even with a new entrant. And when you think about R&D spend, and I’ll start and I’ll see Wetteny wants to build there. We’ve gotten questions often from you and from a lot of our investors. Why don’t you spend more in R&D or if you had a program would you invest in it? And I think what we’re demonstrating is we see a very strong pipeline here. These incremental investments to your question are certainly the bigger ones are in late-stage development going into development that cost that, but also some great new technologies in the research side as well.

So it’s brought across the portfolio. It is a significant investment. And hopefully, it’s assigned to all of you of our confidence in our pipeline and the strength of our R&D engine and our willingness to invest in that for the short and the long-term across their €“ we see obviously really big platforms there in parasiticides continuing to invest there, in dermatology and across our monoclonal antibody franchise, certainly, looking at long-acting as we’ve talked about, but also new disease areas. So I don’t know if I missed anything, Wetteny, do you want anything?