Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Great. So good morning, everybody. On behalf of Morgan Stanley, this is Dave Risinger. I cover both major and specialty pharmaceuticals. And it's very much my pleasure to welcome the 2 leaders of the Zoetis management team this morning. I do need to refer you to disclaimers at www.morganstanley.com/researchdisclosures. And just note that if you're a member of the press, we ask that you disconnect and reach out to Morgan Stanley Public Relations. So this morning, I want to welcome Kristin Peck, who is the CEO of Zoetis; and Glenn David, who's Executive Vice President and CFO. And we are going to get right into it.

So I guess, to start off, Kristin, so congratulations on the exceptional business execution despite COVID during your inaugural year as CEO. Could you just discuss how Zoetis has been able to execute so well despite all of the disruptions and continue to outperform its peers?

Sure. First of all, thanks for having us, David. It's good to be here. I think it starts off with our colleagues, who have a single focus on animal health and have been very focused on our customers throughout this. Whether those were our manufacturing workers who kept all the essential medicines we have in full supply during the entire period or our sales colleagues who have been partnering with our customers to make sure that they support them in their businesses and innovate new ways of serving their customers or R&D, which has stayed on track, as you know, throughout this process. We have a diverse and global portfolio that has served us well. Thirdly, we've seen great strength in the companion animal space throughout COVID, more pet adoption, as you've seen, we'll talk about probably later, increasing spend on their pets. But the livestock sector has seen some challenges. But I think what you've seen is great support for customers, a strong portfolio, as we've said, through different economic downturns, certainly, never a pandemic and a recession simultaneously, but our business has demonstrated throughout the last 8 years, given its diversification and global nature, that we can withstand these things, and I think our outperformance has everything to do with our culture at Zoetis and the strength of our colleagues.

Great. And could you then just go into a little bit more detail on companion animal trends? So if you could just update us on the momentum and give us a sense for where the business is trending? Obviously, you've provided an update on the 2Q call. But things have continued to progress, and there has been even more of a return to normal. So perspective on that would be helpful.

Sure. I'll start and then, I think, Glenn can kick in with some stuff there, too. We've seen what you've been reporting largely, which is a return to sort of normal vet visits. We say they're about flat for last year. They go up and down week to week. Obviously, last week with the fires on the West Coast, they went down a little bit as some of those visits. But overall, we say vet visits are where they were a year ago, which is just, by the way, an incredible recovery and says so much about our -- the creativity of our customers to do curbside pickup and other approaches. But we are seeing some increased trend in spend per visit. So Glenn, do you want to sort of build on that?

Yes. To the point, right, we've seen very strong performance in companion animal, particularly in the second quarter where we grew 13% and saw strong momentum towards the end of the quarter. And we've seen that momentum continue into Q3 as well with the visits stabilize as well as the increased spend per visit. Also we're benefiting from the strength of our portfolio and the innovation we brought to the market; a, with continued growth in our dermatology portfolio and also with strong performance in Simparica Trio. And when we talked about our guidance for 2020 on the Q2 call, we indicated that one of the things that would bring us towards the higher end of the guidance was continued strong performance in the companion animal sector. And that is something that we're continuing to see in Q3. So the momentum has been very positive.

And could you speak to the increased spend per visit a little bit more to help us understand that?

Sure. I mean, I think we're all trying to figure out a little bit what's driving that. I think there's a few things that we're starting to see in that. The first is still a fear of a potential second wave, so people are buying more doses often at each vet visit. I think the vet visits are also -- the vet is recommending a course of action. And since they call the vet and they're not there, I think you're seeing more upticks. They're starting to realize that if they make a recommendation, they're seeing more uptick in those recommendations, and I think you're seeing strong growth in diagnostics. So it's hard to know exactly how long that will last. But I think well, they're buying doses ahead often, so I think we should be careful in the sense that is that really going to be a sustained trend. But I think we are seeing a positive sense of like people are taking more of the vet's recommendations. And the vets are getting more comfortable recommending [ without. ] In the beginning, it was sort of low because they weren't having that conversation with the pet owners since they're in the car, but they found creative ways of dealing with that through calling the pet owner in the car, et cetera. So we are seeing it's the spend for that on diagnostics as well as on making -- taking recommendations and then sometimes buying additional doses per visit.

Okay. And with respect to pricing, maybe we'll just stay on companion animal for now. Your long-term expectation has been for positive net price of 2% to 3%. Is that what you continue to see this year?

Actually, it is. And the pricing is trending really very much in line with those long-term expectations. So year-to-date, we've seen a little over 2% net price benefit and that's been very consistent across U.S. and international as well as across companion animal and livestock, with all of those areas realizing net price increase of around 2% to 3% on a year-to-date basis. So price is very [Technical Difficulty]

And so that's helpful. So you touched on livestock being in that 2% to 3% range as well. Given that the farmers have had a very difficult time, why don't they ask for lower prices? And why hasn't COVID impacted pricing this year?

So in terms of the pricing, right, that is something that we said at the beginning of the year, and that's something that we manage throughout the year. It's important to understand that overall pharmaceuticals are a relatively low percentage of the overall cost of raising the animals. And because of the benefit we bring and also the technical services we're able to provide to our customers, we are able to maintain our price.

Okay. Great. So then another high-level question, Kristin, please. Could you talk about alternate channels? Explain how much of Zoetis' companion animal revenue is currently generated outside of the vet clinics? I assume it's an extremely small percentage, but I don't know how you quantify that? And then also provide some perspective on balancing your support of vet clinics with pursuing additional business in alternate channels?

Sure. I can start, and then Glenn can build on it. If you looked at 2019, it was about 5% of our U.S. business. It was very small, as we've always said. We are seeing significant growth, however, in that spend. I also say, like it's a very -- it's a U.S. trend. It also is a trend in some other markets around the world, such as Australia, et cetera. But it's not the sort of alternative channels defined as retail and online, the e-commerce channel. It's a much more of a U.S. trend right now than in other markets. There are a few markets outside the U.S., such as Brazil and Australia that do a significant business in retail or online. The growth we've seen this year has been dramatic. We saw the trend going, but I think COVID has certainly accelerated it. But Glenn, do you want to put some of that into more context?

Yes. No, absolutely. So as you said, Kristin, right, the alternate channels are really most relevant to our U.S. companion animal business. And just to break out the numbers a bit. In 2019, U.S. companion animal was about $2 billion. But it's important to understand that about 50% to 60% of that portfolio needs to be administered within the vet clinic. It's also important to understand that all of our portfolio or pretty much all of our portfolio does still require the prescription from a veterinarian. So the veterinarian is still at the center of that decision. In terms of the alternative channels, in 2019, to Kristin's point, it was about 5% of our U.S. companion animal business, so call it around $100 million. And we have seen that rapidly increasing in 2020. So for context, in Q2 alone, we sold about $50 million through that alternative channel. You also asked about supporting the vets while supporting the alternative channels. One way we do that is through minimum advertised pricing. And that really establishes a level playing field across all of the channels.

So can you explain that a little more? The -- you mentioned minimum advertised pricing?

Sure. A minimum advertised pricing is when we sell -- the agreement to sell to the channel. Historically, go back 1 year, 1.5 years, we didn't actually sell to retail stores or to online since we weren't sure sort of how they were treating the customer, their processes, et cetera. We verified everyone we sell to. But the agreement is that for each product, there is a minimum advertised price. In other words, if they're selling Apoquel or Simparica, the price they need to charge for that, and they can't advertise a price lower than that so that it moves away from the vet. The vet can price anywhere they want, but the vet is aware what the minimum advertised price or MAP price is and so the point is it ensures that each of the channels has an opportunity for profit, but that they can't undercut the other channel. So it ensures -- now anyone can price above that, we don't -- that's up to every channel how they do it. But it creates a more level playing field. It's common across our industry. So as you look at all the major pharmaceutical companies who sell, they all have the same exact process of the minimum advertised price across channels. Again, you have the opportunity to charge more if the channel wants to do so but they can't charge under that.

Okay. And then you mentioned minimum advertised price, what about real price?

So they could offer, for example, we're running a special this month that if you spend over $100, we'll give you $50 off, that actually would be a reduction in overall price, but it wouldn't be specific to our product. So they can run specials that -- to their customers for different promotions they want to do, but it can't be specifically on our product. They could be -- if you buy my product, you get a discount on your basket, for example, that's what I mean.

Okay. And...

They can't say example of Apoquel, let's say, $1, they can't say Apoquel on sale for $0.75, no. If they want to give you $0.25 off for spending $100 of Apoquel, then they can do that. But they can't advertise our product at a lower than the MAP pricing.

Okay. So -- and then -- sorry, I haven't had my coffee this morning. So I just want to understand this a little bit better. So you had mentioned the ability to discount on a basket, is that something that the manufacturer would typically drive and participate in? Or is that just something...

No. No. That's, of course, if they want to get a customer to move to their channel or their company, let's say, if Chewy wanted to get a customer, they'd say, for your first purchase get 10% off. So it's not driven by manufacturer. It's driven normally by them on a special they want to run. Now we can choose to run a special if we wanted on our products, but then everyone would have the same specials, if you see what I'm saying.

Yes. And Dave, also just for context, the price that we realize as Zoetis is pretty consistent across these channels. It's not a deterioration to our overall price going into these channels.

Yes. Okay. All righty, that's helpful. Okay. So then let's turn to the franchises and products. Could you just discuss Zoetis' unique dermatology portfolio and the potential for further innovation, please, Kristin?

Sure. We are quite proud and quite excited about the success of our dermatology portfolio. There's 2 main products in that globally, Apoquel, which is a small molecule, oral as well as Cytopoint, which is a monoclonal antibody, and vets have a choice between the 2, and they make a decision based on what the best product is based on the specific conditions the dog has, whether it's acute or chronic, how well the dog seems to tolerate a product, how compliant a pet owner is in providing the product, et cetera. So right now, we have a significant share in the dermatology space which, as you probably recall, 5 or 6 years ago was a very small market since there was really no innovation that was terribly effective. But with both Apoquel and Cytopoint, we brought significant innovation to the category, and we've continued to see great growth. As a result, we've been investing heavily behind these products. Certainly, with direct-to-consumer as you've seen quite successfully in the U.S. We're looking at potential innovation in different ways, obviously, expansion of the products we have now as we look at this incremental innovations there with potentially also new products and new species in that sector as well. As you know, to date, we have not had competition. But as we said before, we certainly do expect competition at some point. This is a huge market. We would be surprised if somebody else doesn't enter the market soon. We know a few people working. But at this point in time, the favorite question, I know you're going to ask me is when is competition coming? And as always, in our space, we don't have great data, but we can confidently say we don't expect any competition for the rest of 2020 and at least for the first half of 2021 since we haven't heard any noise certainly in the channel of anyone coming too soon. I would say, I don't know that for sure, but that is our expectation at the moment.

Okay. And then with respect to the market, so you said 5 to 6 years ago it was a very small market. How big is the market today?

So from a revenue perspective, we have the great majority of the share. So last year in 2019, we did about $750 million in revenue for this portfolio -- for our derm portfolio. And our market share data is really mostly in the U.S., but from a dollar perspective, in the U.S., we are well over 80% share. So we are the great majority of the market as the alternatives of steroids, which is priced very low. So we really are a big proportion of the market.

Got it. And then could we pivot to Simparica Trio, please? If you could talk about the launch ramp so far and the market opportunities as you see them in the U.S. and ex U.S.?

Sure. So for Simparica Trio, the launch ramp has been very positive. We mentioned for Q2, we saw sales of around $44 million and year-to-date, we've had sales of almost $60 million or $59 million. We also, at that point, because of the impact of COVID, we had revised our guidance for the incremental sales for Simparica Trio, down from our initial expectation of around $150 million to about $100 million to $125 million. What we're seeing today is that while we haven't been able to penetrate as many clinics as we might have if COVID didn't happen, our share within those clinics have been more positive. We're also seeing that Simparica continues to perform very well. And even on a year-to-date basis with the Trio launch, Simparica is up 13% in the first half of the year. So with that and what we're seeing now, we would expect the Simparica incremental revenue probably to be more in line with our initial expectations of around $150 million or $125 million to $150 million. So the launch has been going very well, especially when you consider the impact of COVID-19 and obviously, we're very excited about the potential for this product launching into a very large market. The market for parasiticides is over $4 billion, with the majority of that being in the U.S. and heartworm also being much bigger factor within the U.S. than it is outside of the U.S.

Okay. Got it. And -- so those figures that you were providing were obviously global figures for Trio and Simparica. Is that right?

Yes. Correct.

All righty. Could you just discuss ProHeart 12 and how it dovetails with regular Simparica?

Sure. I think they're very symbiotic. And the decision on whether to give Simparica Trio or Simparica with ProHeart is really often dependent on the risk of the dog. And then as well as individual patients and pet owner lifestyle. For those who don't know, ProHeart 12 is an injectable for heartworm. So if you have a pet owner that's not great with compliance, sometimes this is a really good recommendation as they're being given at the vet clinic and it lasts a full year. So if you want to ensure 100% compliance and health, a lot of vets will select that. It really depends on just the pet owner. So -- and the vet's perspective on sort of the risk, the relative risk of both fleas and ticks as well as intestinal worms. So it goes quite well. You either can do Simparica Trio or you can do a Simparica with a ProHeart.

Got it. Then pivoting to new innovation. Obviously, you're planning to launch monoclonal antibodies for pain for both cats and dogs next year. With respect to the mechanism, so obviously, anti-NGFs have been associated with worsening osteoarthritis risk in humans. But I believe that Zoetis has been able to rule this out in companion animals. Can you just confirm that? And then provide some more perspective on when in 2021, you can launch these products for cats and dogs?

Sure. I can start and Glenn certainly build on this. We were very happy to get a positive CVMP opinion in the EU on Librela, which is the dog version. We received that last week. So which -- with another 60 days, we're in the administrative period, we're hopeful that we would get an approval this year and a launch sometime in Q1 of next year in the EU. We continue to expect the exact same timing for the U.S. we've given before, which is sometime in 2021 for an approval in the U.S. So we're quite excited. You asked a question about comparing dogs to humans. We haven't seen some of those same risks in different species with a different biology. And so obviously, they can have different potential patterns. We haven't seen those. We have very rigorous requirements with our regulators as per the packages that we present to them for all of our products. So, so far, we have not seen any of those safety issues in our products. We would continue to watch as would regulators. But we haven't really seen that. We remain excited about this space as well for cats. For dogs, the value of this space is around $400 million today, and we're hoping that we can grow that market with a truly innovative product. The category doesn't really exist today in cats at all. I don't know, Glenn, if you'd add anything to that?