Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

And how does that work right now? If I'm a veterinary customer in the United States, let's say, I'm considering a switch away from, let's say, Antech do you have the capacity to handle additional volume? How quickly are you adding capacity? Sort of is this something that you're already approaching your vets with saying, "Hey, we have -- if you're using Abaxis in-house, do you have reference lab capabilities?" Or is it something that's going to take a lot of time to build out?

So in certain geographies where the capacity still exists, we'll be able to sort of approach the veterinarians today. We do believe that it will take a little more time to really get that full national geographic presence and be able to provide the response time that might be anticipated from the veterinarian. But where we have acquired that capacity in local areas that we can, we will be doing that, and we'll try to expand as quickly as possible. But we want to do it in a measured way and make sure that we're able to provide the right level of service to our customers before we just expand too rapidly.

And what's the rest of the landscape beyond IDEXX and Antech? I mean, how many more of these independent labs there? Sort of what's the runway to keep bolting?

Yes, there aren't that many more at a significant scale within the U.S. So there may be a couple more that we could do, but it will mostly be organic build at this point in time. Internationally, there are some opportunities, and we'll continue to seek those out and then look to build organically as well.

Okay. Moving on to perhaps what's probably been the biggest question we've gotten in the last 1.5 years. You got a small drug launch coming up in the near term, not -- probably not that meaningful. Anything you want to talk about there, sort of...

What drug are you talking about?

Yes.

So obviously, we're very excited about Simparica Trio. And just to reiterate some of the things that we said on the call, we do expect, obviously, subject to approval, but we expect approval in Q1. Typically with a new product, it would take about 6 to 8 weeks to get fully prepared for a launch in terms of shipping a tablet, packaging, things of that nature. Obviously, based on the importance of this product, we're doing everything we can to shorten that time frame and expect to be able to do that. But really, the focus -- we get a lot of questions is going to be Q1 is going to be Q2. This is a significant product for us for the long term. Obviously, we want to have the product available for as much as possible for the peak season, which we see as Q2 or Q3. But again, the real importance of this product is the long-term benefit and the long-term sales that we expect to get out of it. So we want to make sure that we're launching it as successfully as we possibly can.

And talking about that sensitivity and the 2Q, the 3Q season specifically, can you walk us through the purchasing pattern, the order patterns you've seen in the past with Simparica or potentially with Revolution Plus in terms of when do people stock up? When do the purchases get made? Sort of what's the lead time there?

Yes, so we typically see that the peak sales are in Q2 and Q3. However, to your point, some of those orders are sometimes taken within the Q1 time frame. However, with Simparica Trio, there is significant awareness in the marketplace that this product is coming soon when we think that may influence a little bit of the -- of that pattern. And again, with the peak sales being in Q2 and Q3, we expect to be in the market in during that time frame. Would we have liked to have been a little earlier? Absolutely. But overall, we expect to be on the market for the majority of the season.

And what about additional markets for like Europe and Canada? You've already got approval in both. Are you waiting to just have a synchronized global launch? Or...

No, so we've actually -- we've already launched the product in Spain, Italy and the U.K., and we'll launch in the different -- in additional markets in the coming weeks. So we are launching the product internationally. And then subject to the approval in the U.S., we'll get the product on the market as quickly as possible.

Okay. Can you -- have you seen any sort of -- ahead of the launch, have you seen any response by some of the other players? I mean, it's a very competitive landscape: NexGard, Bravecto, Credelio. And also even internationally, NexGard SPECTRA in Europe and Canada. Have you seen any steps taken by some of the other players in terms of pricing or any bundling dynamics?

Yes, absolutely. As anticipated, with the excitement around Simparica Trio and the expectations that the marketplace has for it, our competitors have been out there, obviously, offering discounts and other things on their product. But that's, again, has to be expected. And again, that may have an impact in a quarter basis or something of that nature. But for the long-term success of the product, which is what we're focused on, we don't see it having a significant impact.

As we look forward to the approval in the next coming weeks, sort of what are the key factors that you keep an eye on? I mean, we've talked about the puppy label and the age that it comes in. That could play a big role. Is there anything else in the label that we should be monitoring that will give us some sense of -- is there upside to the $150 million in year 1? Is there downside?

As we talked about, we do expect to have the puppy claim at approval. The rest of the label, as we get final approval, we'll have a better understanding of. I don't think there's anything in particular that you need to look for in terms of the sensitivity to the $150 million. Obviously, the $150 million is our base case forecast. It's a new product launch. There could be sensitivity up or down around that, depending on our success in launching the product and the receptivity in the market to it. But again, we're confident with the work we've done to come up with that estimate and the market research we've done that supports that $150 million estimate.

Okay. And from some of the channel checks we've done, I was a little surprised actually at how much -- I mean, vets are definitely aware of it. But the most common answer I get back when I talked to vets about it is, well, it depends on how they price it. And we talked about aren't you excited there's now a lot of opportunity there? They're like, "Well, it depends on how they price it." So have you thought about that? And can you talk about how you've priced some of -- how do determine pricing from your other products in the past? I realize you may not have a final number set, but if you look at sort of Simparica stand-alone, ProHeart stand-alone, sort of what are the criteria you're taking?

Right. So there are a number of steps that you do when you establish a pricing for a major product that you expect to be launching. And obviously, you do a lot of market research as well with surveys to vets, trying to get a sense of, if it's priced at this point -- what will be the level of adoption if it's priced at this point? And then you try to come up with that optimum point of price and volume that maximizes, not only revenue but margin. So when we look at Simparica Trio overall, we have been pretty clear that it will be priced at a significant premium to Simparica. And then the benchmarks that you would look at would be Simparica and ProHeart, also the 2 leading parasiticide and heartworm medication out there, where are they priced at? And then where would you price around that. So we haven't disclosed the pricing yet. So I don't want to be -- don't want to do that here. But overall though, that would be what we would look at.

If you want to do it here, I won't stop you. So by all means. The other thing that comes back a lot is the -- is people's reception to ProHeart 12. From vets, we -- I think that's one area -- I mean, you touched on it earlier. That's one area where we were pleasantly surprised in terms of the impact in 2019. Because given you've had ProHeart 6 on the market for such a long time, we thought that it would be sort of an incremental, but not that meaningful. But the response from that really was striking, and that just gives them another option. When we think about the Trio opportunity, a lot of it comes from not necessarily displacing the existing flea and tick players, but it comes from displacing HEARTGARD given sort of the stranglehold they have on the heartworm market. Do you think ProHeart 12 gives you an added advantage there where you're already talking to vets about it? Are you getting them to consider Zoetis more and more than they may have in the past and, therefore, makes sort of the Trio conversation as the next step even easier?

No, I think it does. And I think also the improvement that we've had with Simparica as well gives us that next step. I mean, if you take a step back a few years, we were significantly underrepresented in the parasiticide space as well as the heartworm space. But with the innovation that we bring with Simparica and the level of market share that we've been able to gain being the third player into that marketplace, and then also the momentum that we have right now with ProHeart 12 and the adoption that's gone very well. And we're not just cannibalizing ProHeart 6 with ProHeart 12. We're taking share from competitors with ProHeart 12. So our relevance in this space has increased significantly over the last number of years, which I think sets us up well for then introducing Trio, which will be a significant innovation into the marketplace.

And when we think about the overall parasiticide market and how that $150 million falls into it, I mean, we think of it as about a $4.5 billion to $5 billion market, growing roughly mid-single digit, maybe mid- to high single digits. But yet, you've got a ton of share gainers and losers. If you think about the orals versus the topicals over the last couple of years, is Trio -- do you see Trio as sort of a continuation of that trend? Or is it going to be dramatically different in terms of -- are you expecting a lot more market expansion versus a lot more share gains or losses? Sort of how do you fill the marketplaces out over the next couple of years, not just 2020?

Yes, so I think when you look over the next number of years, I think it's where is the revenue going to be sourced from? And when we look at Trio, I think there are a couple of different areas. Obviously, there are the orals. That will be one area where we'll be able to source. But also how much that's gone OTC, how much of that can you bring back to the vet channel because of the convenience and the efficacy that we would expect from the product. How much of that can you bring back into the vet channel? And I think over time, that'll determine the overall level and how big of a market expansion that Trio creates.

And you think -- and what about compliance and utilization? A lot of the stats we've seen, is that -- compliance for both flea and tick and for internal parasites are incredibly low, running 2 to 3, 3 to 4 months, every year, when it should be 6 to 12. Do you think Trio gives you an added advantage there? Or is that a potential headwind? And then if people aren't -- still uncompliant after all these years, is it going to even harder to drive them higher.

Yes. So we do think it gives us an added benefit there. This is a product that needs to be taken monthly and like to your point, right now, the average use is well below what it should be from a compliance perspective. So if you can move that 3 months to 4 months or the 4 months to 5 months or the 5 months to 6 months, over time, that'll generate a significant level of sales. And also, a lot of the alternative channels that are being developed have better tools to encourage compliance, and we're excited about that and what that'll mean for Trio as well as our other products.

Okay. I guess, if we think beyond some of the high-growth drivers, Simparica Trio, beyond the diagnostics portfolio, beyond derm, the rest of the companion animal portfolio really surprise the upside in 2019. I think relative to our model, if we look back to where we were a year ago, that was where the majority of the outperformance came as the other companion products, whether that's Revolution Plus and ProHeart or RIMADYL, Cerenia. I mean is there anything that really stands out to you as to why you have such a strong level of outperformance there?

Yes, I'd say I think there are a couple of factors: a, just globally, is the breadth of the portfolio and being able to leverage the breadth of portfolio. Sometimes we'd laugh. We'd get questions, "If you exclude Apoquel, if you exclude Cytopoint, if you exclude Simparica, if exclude Revolution Plus." Like you -- we have a very broad portfolio, which is -- it's actually a good question to get. The other thing that really stands out is our growth in emerging markets. Very strong growth in emerging markets from a companion animal perspective, and I use China as a great example. China in 2019, we had the impact of African Swine Fever, which was about a $50 million impact. Yet the growth in China was essentially flat from 2019, and that was because of tremendous growth in our companion animal portfolio. We did launch Apoquel in China. That was a contributor as well. But it was really from products that have been on the market for a long period of time. But just the investments we've made in the marketplace, the penetration we're able to have in the clinics, that drove tremendous growth in companion animal, and China is becoming one of our largest companion animal markets. And we're seeing growth in companion animal in other markets as well, such as Brazil, Simparic in Brazil. It's our largest international market, the level of sales that we have for Simparica, or Simparic as it's called in Brazil. So we're really seeing the benefit of that growth as well, the growth in emerging markets and companion animal.

Sure. And if we think about some of the major products that are contributing to growth. You talk about Apoquel and Cytopoint, for example. It's been an area that others are obviously investing, have been for a while. I think one of the things we've been most surprised then is how long it's been without a competitive entrant in the derma space. So sort of what are your views there? And do you see any particular part of the portfolio that's overexposed to a potential area of risk in 2020 or beyond from competition?

Yes. So we look at the derm portfolio, we're not really expecting competition in 2020 based on the information that we have. But again, it's very hard to get an understanding of where competitors are because not many are public, and we don't really disclose that much information in terms of where we are with our R&D programs. But based on what we know today, we would not expect competition in 2020. But to that point, we built a $750 million franchise. We've shown the market opportunity. We would expect competition to be coming over time. With that, what I'll say is we have 2 products that have shown very strong efficacy and a very strong safety profile. So there's a pretty high bar that we set in terms of competition and being able to really have a significant impact on our overall share.

Any other parts of the portfolio, any major products from livestock or anything else that we should be keeping an eye on as potential IP running?

Yes, I mean, the major product that we have from the generic perspective, not in 2020, but coming in 2020 or '21, we would expect generic competition for DRAXXIN coming in 2021. Again, like we do with all of our products, we make life cycle innovation enhancements to try to minimize the impact of that generic competition. And again, just to reemphasize, the impact of generics in animal health is very different than what you would see in human health. So we would expect, for DRAXXIN, typical of what we see with other products, about a 20% to 40% impact on revenue over time.

And I think you've seen that in the past with things like RIMADYL, for example.

Yes.

There are a number of generic entrants in the like 2007-2010 range. And every year, you saw RIMADYL go down, maybe 10% and then recovered.

Yes, and then recovered. In certain years, it actually grows, in certain years, it goes down. You don't see similar to that, you would see in human health. You don't see an 80%, 90% decline in sales the first year and then no recovery after.

Fair. Are there any questions from the audience? Time for a couple. There. Yes.

You talked about the $150 million incremental from the Trio this year. Just based on what you've seen typically with product launches and kind of the curve that it goes at, would you expect that number to be higher in the second year?

Yes, absolutely. We would expect incremental revenue in the second year.

Not the $150 million. Like above that number on an incremental basis?

So not -- so we haven't disclosed what we expect 2021 sales to be specifically for Trio. A couple of reasons. We also haven't disclosed a peak sales estimate. And part of that comes back to the competition question in terms of knowing when a competitor will be entering the market. We don't have anticipation currently that there'll be a competitor entering the market in 2020. That's not built into the $150 million incremental. But to really get into revenue projections beyond 2020 without having an understanding of what level of competition we may or may not be facing from a triple combination, wouldn't be appropriate at this point in time.

All right. Going back to the 2020 outlook. I think one of the things we also talked about is all the investments you're making in the P&L, both SG&A, R&D, and you've also got some unique one-timers in terms of incremental effects on the gross margin line, things like that, of the M&A angle, for example. When I think about this relative to your prior years, still guiding to some decent margin expansion but not quite to the prior range, is this more of a catch up, an investment catch up in spend? Or is it more of a onetime? Or is this sort of the new level of spend that we should expect going forward? Sort of what's the long-term Zoetis model look like?

Yes. So I think I'll step back to 2019 a little bit as well, and 2019 was a year of investment. As we were preparing for the launch of Simparica Trio, we did incremental investments in Apoquel DTC, which I think you saw paid out a lot of benefits, and we had a very high return on that. Made the investments in reference labs as well as some acquisitions. So really making sure that we're not only investing for the short term but also investing for the medium and long term. And also from a CapEx perspective, you saw that in 2019, we had elevated CapEx to the range of about $450 million as we're looking to bring more of our manufacturing capacity in-house for some of the critical APIs and critical products. As we move into 2020, again, continued investment in certain key areas from an SG&A perspective, a little less benefit at the gross margin perspective, as you mentioned, primarily driven by foreign exchange. But still, margin expansion coming from the fact that our expenses are expected to grow at a slower pace than revenue. The other factor to point out when you look at 2020, in particular. So in 2019, we had 10% growth in revenue with about 14% growth in adjusted net income. The guidance that we have for 2020 is 7% to 9.5% growth and revenue and 8% to 11% growth in adjusted net income. A big reason why we're at 8% to 11% is the change in tax rate year-over-year. We had a lot of favorable discrete items in 2019 that we don't expect to recur in 2020, and that lowers our growth in income by about 300 basis points, which is why you see a little different spread between revenue and income than you would see in any particular year, and we wouldn't expect that to repeat as we move beyond 2020.

Got you. And then just another question, something that's come up a lot that's topical is coronavirus and your exposure to China. Obviously, you talked about your overall revenue exposure at length given all the ASF impact. So first one to ask, is there any direct exposure that you would think of or that you've seen either in the companion animal or the livestock business? But then also what about indirect exposure in terms of API, sourcing, supply chain?

Yes, yes. So sure, as you size the market for China, for us, it's about a $200 million market. What we've seen and what we've heard to date in terms of the impact of coronavirus that could have an impact on that direct revenue, as you mentioned, will be 2 things: a, from a companion animal perspective, our customers bring in their pets into the vet for visits, and we expect that traffic to be slower now, obviously, based on the impact of the coronavirus. The other factor and what we're hearing a lot is the food and beverage industry has been negatively impacted based on the coronavirus obviously due to less travel into the markets and also people just going out less for dinner and things of that nature. So that, from a short-term perspective, will limit the amount of protein consumption. So those are 2 areas that we expect will impact our direct business. We don't expect it at a material level to date. But again, based on the amount of time that the virus stays out there, that can have an impact over time, but it's a little too early to tell the magnitude of that. From an other area perspective in terms of our supply chain, APIs, things of that nature, we typically carry, for the most of our products, over 6 months of inventory of API. So we don't expect a disruption to our overall supply chain based on what we know today.

Okay. Any other questions from the audience? All right.

Can you just maybe flesh out that compliance point on the flea and tick market. You said that there's a lot of room for growth. Just why is the compliance so low? Is it that -- maybe just some factors behind that and why it might have changed.

Yes. So I mean, I think if you ask most, they'll say that the compliance should be 12 months, right? That you should have flea and tick compliance for 12 months and you should have heartworm compliance for 12 months. I think there is a belief though that there's a season for where flea and ticks are much more prevalent, and that's where they're used more rapidly is within that peak season. And part of the education is that, no, flea and ticks do exist throughout the year, and the compliance and the usage should be for that 12 month. And you should be protecting heartworm for 12 months as well.

I guess I'll take the last one as we're winding down. What are we not asking? Sort of what are we overlooking? What do you think are the biggest risks or potential surprises to either the upside or the downside in 2020? Because, I mean, obviously, Simparica, I feel like we've -- Simparica Trio, the derm portfolio, diagnostics, livestock market, feels like we've sort of covered everything, but I'm always wary of what it is that we're not asking. So what are you thinking about that we're not?

So no, I mean, obviously, those are the key areas of focus for us as well as we move into 2020: having a successful launch of Simparica Trio, continuing to grow our derm portfolio. But also what we're excited about for 2020, as we said on the call, we expect to return to growth on all of our core species as well, right? And that, again, drives the benefit of the diversity of our portfolio, the geographic presence that we have. And that's one of the very strong areas for Zoetis. We are incredibly diverse. And our revenue is very durable. So if there's upsides or downsides in any particular area, we're usually able to offset that in others. I think 2019 was a great example of that. The impact of African Swine Fever, a very challenging U.S. cattle market, and we still performed very well because of the innovation we bring to the market, because of the diversity of our portfolio, we were able to offset the impacts that we had there.

Okay. That's great. And with that, I think we're out of time. So thank you so much.

Great. Thank you.