Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Good afternoon, everybody. My name is Erin Wright. I cover life sciences tools diagnostics at Crédit Suisse, and welcome to our 2020 Healthcare Conference. It's obviously in a virtual format this year. So a little bit different. If you do have questions, feel free to e-mail me at erin.wright@credit-suisse.com. We'll be happy to pass them along to management here. We do have Zoetis with us for this presentation. And it's a fireside chat format, so we'll get right into Q&A. But with us, we have EVP and CFO, Glenn David. I think we also have Steve Frank, who heads up the IR effort on the line as well. But we're happy to get started. And -- but welcome. Thank you for coming.

Great. Thanks for let me be here with you, Erin.

And just to kick it off, let's talk about fundamental demand trends across the companion animal segment first. What have you seen quarter-to-date as well as in the third quarter? There was an element of pent-up demand. Can you help us break down some of the components of sort of the underlying demand trends in the quarter? What you're seeing in areas such as like underlying spending per animal as well as potential tangible evidence of increased pet ownership trends?

Yes. So obviously, we've seen very strong performance in companion animal. As you mentioned, we grew 20% in the quarter. In companion animal, we've grown 15% year-to-date. So really demonstrating strong resiliency during the pandemic. A couple of trends that we saw in the quarter. We did see vet business start to stabilize, whereas in Q2, vet visits were down. We saw that relatively flat versus last year, which was a positive trend. But equally encouraging was the revenue per visit that was up significantly. So while the vet business were relatively flat, we saw revenue per clinic up almost 12%, which would indicate that people are spending a lot more when they are visiting the vet, which is a very positive trend. We think there are a couple of factors that are driving that: a, people are home a lot more and spending a lot more time with their pets, and they might be witnessing some more of the elements that they're seeing and then bringing those up with the vet when they go for the vet visit. Also, we have seen, obviously, as been mentioned, an increase in the number of adoptions. So we do believe that, that's helping as well. And also a little bit of pent-up demand, as you mentioned, in the quarter, as some of the visits may have been delayed from the past, so they might have been picking up on some of their spending from a pharmaceutical perspective. But overall, the underlying trends remained very positive for the market. And then for us, in particular, a big part of our growth continues to be driven by our innovation. And obviously, really excited by the launch of Simparica Trio and the continued growth we see in that product. We did about $50 million for Simparica Trio in the quarter, and we continued to also see strong performance from Simparica as well, growing 5% in the quarter. So really strong overall performance from the breadth of our portfolio, the launch of Trio, Simparica, the rest of our parasiticide portfolio and as well as our derm portfolio, which also performed very well.

Okay. Great. And then switching gears or switching species here to our groups to livestock. So on the 9%, I believe, operational growth in the most recent quarter. What were the key drivers of that? I think you mentioned like an expedited kind of cattle run that we saw that helped the trends there, but what are you seeing in terms of underlying demand trends across that segment as well?

Yes. So there were a number of key factors for our livestock growth. As you mentioned, the U.S. cattle performed very well in the quarter. But a big portion of that impact was somewhat seasonal. We did see a catch-up in buyer patterns with our customers returning to more historical buying patterns in Q3, where they're a little more hesitant in Q2 with the uncertainty around the pandemic. We also saw an acceleration of the fall cattle run, so moving some sales from -- that we would typically see in Q4 into Q3. So because of that, we do expect a weaker Q4 in U.S. cattle. Some of the positive underlying trends that we saw, though, particularly in swine in China. We saw very rapid growth in our swine business in China, almost 159% growth in swine in China for the quarter as we recover from the impact of African Swine Fever. Q3 was a challenging quarter last year, so it was somewhat a relatively easier comp, but on a year-to-date basis, our swine business in China continues to grow and performed very well as the larger producers continue to increase the size that they're heard, and we do very well in our performance in the larger producers.

Okay. And then can you quantify how much the cattle run impacted the third quarter so we can frame how that impacts the fourth quarter? Because I mean, this is the timing dynamic that we've seen in the past. And maybe you could reference maybe historical trends that we've seen in terms of it shifting from the third quarter to the fourth quarter and vice versa?

Yes. So when you look at the overall U.S. cattle performance, we grew a little over 20% in the quarter, right? And if you want to break that out, about half of that was driven by the cattle, around about half of that was driven by the normalization of buying patterns. I think a better indication of performance is probably looking at some of the year-to-date growth. We've seen the year-to-date growth in our U.S. cattle of about 2%, and we expect it for the year to be relatively flat, which is probably a better indication of underlying demand in that segment.

Okay. And then we were also hearing some kind of noise in the channel about sort of the poultry and aquaculture markets internationally. Obviously, aquaculture is almost all international anyway. Is -- what are you seeing across those businesses?

Yes. So we're seeing very strong performance in our aquaculture business. On a year-to-date basis, we've grown 16% in aquaculture, really driven by some of the innovation we've brought there, particularly with our Alpha Flux product in Chile. But also, we also in the quarter, we acquired a company called Fish Vet Group, which added some sales as well, and they're focused on diagnostics for aquaculture, so that represented about half of the growth that we saw in the quarter for aquaculture. And poultry was a little more challenged in the quarter globally, both in the U.S. and in international markets. And what we saw there is a little bit of a rotation from our products that are used within the poultry setting. And that's something that's standard in the industry to prevent disease resistance. They do rotate from products occasionally. We've been very fortunate that we have a very broad portfolio, and we've seen consistent growth there, but we have seen some impact from a rotation away for some of our products in the quarter. That will probably continue as we move into Q4, but something that will recover from as they rotate back to our products.

Yes, your annual guidance does assume, I guess, at 7% to 8% operational top line growth for 2020. It does assume somewhat of a step down in the fourth quarter and naturally with some of the things that you just mentioned. But is there any sort of lingering COVID headwind embedded in there?

So in terms of the companion animal performance, right, I don't think there's too much of a lingering COVID impact. Obviously, we have a range of outcomes, and it does depend on severity of the impact of some of the lockdowns that we're recently seeing in many different markets across the globe as well as some of the geographies within the U.S. So obviously, our range of performance for the year is 7% to 8%, but it's a bigger range when you look at just 1 quarterly impact. So there is a range of outcomes from an impact of COVID. But we do, in general, we anticipate things to be relatively consistent with what we've seen in Q3. And obviously, from a livestock perspective, we expect our producer and customers to be able to operate pretty much at normal capacity like they happen to date. But again, the guidance that we provided does provide for a range of outcomes related to the COVID impact.

Okay. And switching gears to innovation. I wanted to first talk on Simparica Trio. So how the traction has been relative to your initial internal expectations and how cannibalization has played out relative to your expectations as well, particularly in a COVID environment? And I guess, we'll start there and then I have follow ups.

So overall, our parasiticide portfolio is performing well and performing either in line or even slightly above our expectations on an overall perspective, right? Simparica year-to-date has grown 11%, and that's even with the launch of Trio and the incremental $110 million of sales we've had from Trio year-to-date. Trio itself, when we started the year, we said we expected $125 million to $150 million of incremental sales. With the impact of COVID-19, we brought that down to $100 million to $125 million because of the fact that we thought it'd be more challenging to penetrate clinics during the COVID environment and to be able to get patients to switch to a new product when they weren't necessarily having the same interaction with the vet that they were in the past. However, what we've seen is while the penetration in terms of the number of clinics adopting Trio has been lower than we expected, the actual market share once we've gotten into those clinics has exceeded our expectations. And because of that, we brought our guidance back up to incremental sales of Trio to $125 million to $150 million. So we're very encouraged by the launch. We've also invested heavily behind the product with direct-to-consumer advertising, which we believe has also benefited the sales, and we're very excited for the future of Simparica Trio as well and the trends that we're seeing. In terms of the cannibalization of Simparica. As I mentioned, very strong performance of Simparica on a year-to-date perspective. So it's actually been a lot less than we initially anticipated in terms of the cannibalization, with Simparica growing 11% year-to-date and growing 5% still in the quarter.

Is that a function of you think the -- any sort of competitive dynamics that have changed in the market? Or is it the fact that you have several different now modalities across parasiticides that you're able to bundle together and that becoming a competitive advantage for you?

Yes. I think it's the latter, right? It's the breadth of our portfolio being a competitive advantage, right? We're able to offer vets multiple solutions to treat their patients. If they want the convenience of Simparica Trio, that's obviously something that they can choose. If you're very concerned about heartworm protection and one guaranteed 12-month heartworm protection, you can use ProHeart 12 and then combine that with Simparica as well. So we really think the breadth of our portfolio has really helped drive the sales for the Simparica and the overall parasiticide franchise. As we mentioned on the Q3 earnings call in the U.S. as an example, we've increased our market share in the parasiticide area by 6 market share points in the quarter versus the same quarter of the prior year.

Okay. And then how do you think that Simparica Trio is matching up or competing with NEXGARD SPECTRA and other geographies?

So we're early in the launch outside of the U.S. as we are in the U.S. as well. We've been on the market for around in 6 months at this point. And we think it's performing very well in the markets that we have launched. We've launched in a number of markets in the EU. We've launched in Canada. We've launched in Australia, and the product is performing well there and exceeding our expectations there. So we do expect it to do very well and be very competitive in those markets.

And do you anticipate a competitor? Is that embedded in your internal expectations over the next 12, 24 months?

So in terms of competition, as we mentioned, it's difficult to have a lot of competitive intelligence in the animal health market. Our current expectations are that we would not expect competition in the U.S. until the later part of 2021 at the earliest, but that's something that we'll continue to monitor. And as we provide guidance in February for 2021, we'll also be clear with what our expectation is and what's embedded in the guidance.

Okay. And then your update on monoclonal antibodies. You've had already success with injectables. How does that help you in terms of your launch in this category? And how should we think about the market opportunity associated with each of your candidates there?

So I think, to your point, our history with our success in monoclonal antibodies, also in our success in the dermatology space with growing an existing market by bringing significant innovation, we think, sets us up well for the monoclonal antibodies for pain, and we're very excited about both of those products, Librela for dogs and [indiscernible] for cats. We received positive verbal opinion in September for Librela for the EU. We expect final approval to occur this year with launch in the first half of next year. And we expect approval for [indiscernible] as well in 2021 in the EU. And also, obviously, in the U.S., for both Librela and [indiscernible], we expect approvals to come in the latter part of 2021, right? We see those as both large markets that have the opportunity to expand significantly, and we believe both of the products have blockbuster potential, which, as you know, in animal health, is in excess of $100 million.

Okay. Great. And then, yes, we're -- and more on the K9 segment, we're kind of are aware that the [ D-line ] segment is a little bit more of an unmet -- critical unmet need kind of across veterinary. But on the K9 segment, I mean, RIMADYL is still a very big product for you. Is -- how are you going to market this differently? This is obviously a vastly better safety profile than RIMADYL, well, presumably and how should we think about cannibalization of that product, given they are very different? But RIMADYL has been around for a very long time and vets are also very brand loyal. So how do you kind of weigh those different dynamics?

Yes. So RIMADYL, as you said, has been a very successful product. It's been around a long time. It certainly has a place in the market even as we do launch Librela. But we don't have a final label yet. So it would be a little premature to talk about exactly how we're going to position the 2, but we do believe that with Librela, we'll bring significant innovation to the marketplace and that will have the opportunity to expand the market significantly.

Okay. And then switching a little bit to the competitive dynamics for DRAXXIN. I know this seems to be a bit of a bigger topic, and I don't want to get too much into the minutia because you're a bigger, broader, diversified company. But I do have to ask, just given this is a larger product for you, you will be facing generic competition. How will this play out differently than other generic competitors that you've seen in the past across your different business lines? This is obviously going to be several generic players, not just 1 branded generic launch. So how is this going to play out any differently relative to your initial thinking?

So as you mentioned, DRAXXIN is a very large product in the animal health industry, one of the largest. In 2019, we had sales of about $350 million for DRAXXIN. So we do expect there to be significant generic competition for DRAXXIN really early on when we lose exclusivity in 2021. What we typically say is that we expect about an impact of 20% to 40% from generic competition, and we expect that to occur over a number of years. Based on the level of competition, we expect to see with DRAXXIN, it might occur more rapidly than we typically anticipate. But we do also think there is an opportunity to expand the market and expand the usage of DRAXXIN. Right now, a lot of times, customers may trade down to products that may not be considered as effective as DRAXXIN from a price perspective. To the extent that there are price concessions because of DRAXXIN, we do believe that might help grow the market overall for DRAXXIN, which should help offset a little bit the impact from generic competition. But again, based on the size and scale of the product, we would expect significant competition, and we would expect that 20% to 40% impact to occur at a much more rapid rate than we typically see.

Yes. And then the underlying profit profile for DRAXXIN, it is one of your higher-margin products across the livestock segment. Do you have any sort of details on that front? And in terms of the 20% to 40%, how much is like price versus volume?

Yes. So in terms of the overall profile for DRAXXIN. We don't disclose margin by product, obviously, but it is one of our higher-margin products, particularly on the livestock side. We do expect there will be price concessions with generic products available. But even with that, because it is a high-margin product, we expect it to continue to be a high-margin product, even as we take price concessions. So in terms of the exact percentage of the 20%, 40% that will come from price versus volume, that's something that will evolve over time. But we're confident that this product will remain a high-margin product moving forward.

And does your guidance assume any sort of meaningful destocking of the product in the fourth quarter?

Yes. So obviously, if the guidance does anticipate effects of the DRAXXIN LOE in Q4, we do expect that with the anticipation of generic competition coming early in 2021 that our customers may not maintain the same level of inventory as they had in the past. So we do anticipate that, that will negatively impact our U.S. cattle business in the quarter, and that is fully included in our guidance as well as the anticipation of what occurred with the fall cattle run accelerating into Q3, slowing down our growth in Q4.

Okay. And then thinking about sort of longer term in light of sort of the DRAXXIN dynamic as well as like commercial initiatives across Simparica Trio and commercial -- and new commercial launches across the mAb segment, how should we be thinking about underlying margin leverage across your business in 2021?

Yes. So when you look at margin, right, we always say that over time, we have opportunity to continue to expand that margin, right, as we get some additional leverage from a gross margin perspective. Over the next few years, we would expect companion animal to continue to grow at a pace faster than livestock. And because of our global scale and size, we would expect that we'd be able to grow expenses at a pace somewhat slower than revenue. 2021, in particular, has a couple of unique circumstances that need to be taken into consideration. Obviously, the impact of COVID-19 through our expense base in 2020, we've seen significant savings in T&E, and we've reinvested a lot of that in direct-to-consumer advertising behind Simparica Trio as well as APOQUEL, which we've seen a very positive return with the momentum we've seen in Trio as well as the 21% growth we've seen year-to-date from our derm portfolio. So we will most likely continue those investments from a direct-to-consumer advertising perspective to continue to grow those brands. If we do see a recovery from COVID-19, an acceleration in our T&E expenses, that would be a challenge in terms of expense growth as we move into 2021, but the timing of that is still somewhat unknown. Also from a margin perspective, again -- we'll see from a gross margin perspective, we'll see the benefit of the continued growth of companion animal. But the DRAXXIN LOE will be somewhat of a challenge from a margin perspective as well as the build-out of some of our strategic initiatives, particularly our reference lab strategy, where we will be beginning to build out additional labs that will not be running at efficient levels at the beginning but will grow to a much better margin profile over time. So there are a number of puts and takes from a margin perspective. Obviously, we're working through our plans for 2021, and we'll share that guidance in February as we typically do.

Okay. That's helpful. And I do want to get to the diagnostic strategy in a second. But I'm curious in terms of broader disruption in the market, there's obviously a larger transaction that took place. There was with Bayer, and long ago, there were subsequent sales force defections. I mean can you benefit from any of that sort of disruption in the market and have you?

So -- yes. So we don't really see that changing our competitive dynamic substantially, right? Obviously, we're very focused on our portfolio and the growth that we have moving forward with a lot of the innovation that we brought to the marketplace. Also very pleased, we have very good turnover rates within our organization. So we are not seeing significant disruption from that.

Okay. And then atopic dermatitis or your derm portfolio, you've seen a lot of success there. You spoke to that as well. But what's the further opportunity for greater penetration with specifically APOQUEL, that's obviously a little bit more mature. And then as well as CYTOPOINT, it sounds like there's still a long runway there in terms of better penetration. But how should we think about growth trends across those 2 segments into 2021 and also the competitive landscape evolving in that segment?