Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

All right. Hi. Welcome, everyone. My name is Mike Ryskin. I'm on the life science tools and diagnostics team here at Bank of America. And I also have the privilege of covering animal health care for the past 5 years. It's now become a little bit of an annual tradition for us to host this animal health summit in late February. And I think it's a great opportunity to spend a full day focused just on the animal health space, really dig a little bit deeper into the topics and the issues that matter here. We've also had great participation from the companies in the space, and we do again this year, of course, and also great interest from clients and investors. I'm proud to say that attendance and participation has grown every year. It's up again significantly this year, showing the large amount of interest in the space. And hopefully, that you find this event to be useful and productive. Of course, the format is going to be a little bit different this year given the virtual environment, but we've got a great line of corporates, expert speakers with us today. So I'm really looking forward to it. If you've got any questions throughout the day, don't hesitate to reach out to anyone on the team. We'll do our best to help you. [Operator Instructions] And with that, I think we'll kick it off. Our first session this morning is Zoetis. And joining us is Glenn David, CFO. Glenn, thanks so much for being here.

Great to be here. Thanks, Mike.

So I think to kick things off, you just reported 4Q results a week ago. Can you give us a brief recap of the key points from the earnings print from the call and the 2021 guide?

Yes. So like you said, we just reported our results for the quarter. We had a very strong fourth quarter with operational revenue growth of 9%, which is really consistent with the revenue growth that we experienced for the year. We saw particularly strong growth in our companion animal business in the quarter with 25% growth, really driven by continued strength across many of our key products. The launch of Simparica Trio has performed very well. And even with the impact of the COVID-19 pandemic ended up exceeding our initial expectations for the product. We also saw a very strong continued performance of our dermatology portfolio and also strong growth in our diagnostics portfolio. So a lot of key factors driving our growth in companion animal. And that growth was also across many geographies as well, not just within the U.S., but also within the international business there. We did see a decline in livestock, but that was expected as we had a very strong Q3 for our livestock business. And we did expect it to slow down in the quarter. But overall for the year, obviously, which is what we focused on most, we had 9% revenue growth with 17% growth in our companion animal business and relatively flat growth in the livestock business as it was more impacted by the impact of COVID-19. With that, we delivered about 10% growth in income for the year. So very strong growth in income as well in a year where we made significant investments behind the launch of Simparica Trio, behind continued growth in our derm portfolio, really increasing our DTC spend for both of those brands, as we knew with the impact of the COVID-19 pandemic, we would need to utilize resources to help support our field force as they were more virtual than they have been in the past. So overall, a really good year. Very strong momentum in Q4, which we do believe will carry over into the full year. And as you mentioned, we provided guidance for 2021. We're expecting 9% to 11% growth in revenue operationally and 9% to 12% growth in income, really driven by, like I said, the momentum that we saw. We expect very continued strong performance in Simparica Trio, continued growth in our derm portfolio. Very excited about the launch of our monoclonal antibodies for pain in Europe and some other markets outside of the U.S. Also excited about our growth in diagnostics. And also some key markets that we really saw a very positive growth in 2020, which we expect to continue into '21 with markets such as China. China grew 34% in 2020. We expect continued strong performance in China. And also Brazil. We saw very positive growth in Brazil, and we expect that to carry forward into 2021 as well.

Great. That's a great overview. And there's a couple of things I want to follow up on there. But I think to start, I want to dig into some particular challenges or headwinds that have been called out by investors because I think most people we've spoken with have been a little bit surprised by the stock reaction. So the presence of people are trying to dig into what could be driving the negative reaction. Although, I think it's more technical than any type of fundamentals. But the 2 topics have been flagged. One has been DRAXXIN. I mean, the patents are coming off of it, and we've known about for a while. You've been very vocal about it for the last 6 months or so. What steps are you taking to maintain share? I mean, we realize it's a major product and it's a very profitable product that a lot of solid competitors are going after. But how should we think about this evolving? Sort of what can you do to sort of stem some of the bleeding there?

Yes. As you said, Mike, we've been very clear with DRAXXIN for the last 6 months to a year that we do expect a significant amount of generic competition for DRAXXIN, right. DRAXXIN is one of our largest products in livestock with about $350 million in sales. And because of that, there is significant interest from generics now that the LOE has expired. As we said, we expect about a 20% to 40% impact on revenue. We typically see that occur over time with generics. But because of the size and magnitude of DRAXXIN and the number of competitors we expect, we do expect that to occur more rapidly. That being said, we do have a defense plan in place to try to minimize that impact. Some of the strategies we would use was to leverage our broad portfolio to minimize the impact on DRAXXIN. But I want to emphasize that the impact of the DRAXXIN LOE obviously is fully incorporated within our guidance, and we're still able to deliver what we expect to be 9% to 11% growth in revenue for 2021, even with the impact of the DRAXXIN LOE. So our expectations haven't changed since we've started talking about this for the last 6 months or so, like you've indicated.

Okay. Is there any early indication on how the competitors are doing? How heavily they're investing into it? Because we've seen with other generics, occasionally, products hyped up and then it comes in, and it doesn't actually perform quite as well as you would expect, or maybe the brand support isn't there. Any early indication on how some of those new generic entrants are doing?

No, very, very limited indication yet. In the U.S., for example, we currently don't see anybody on the market yet. So there really hasn't been any way to validate whether their performance is as strong as ours.

Okay. All right. Makes sense. The other topic we've gotten a lot of focus on is the Librela, Solensia. Obviously, it's another area that you've been very vocal on for some time, and there's a lot of interest from investors. So I want to dig into the comments you provided on the earnings call as far as the U.S. status of those 2 products. Can we go through some of the specific timings you're expecting? What are the major hurdle points you still need to get from the FDA to get that approval?

Yes. So the one thing we do want to make sure that we reiterate. We are very -- remain very confident in both the safety and efficacy profile of the product and the eventual U.S. approval. I think that's evident by what we've seen with the approvals outside of the U.S. In terms of the time frame for the U.S., that is something that we continue to work through. We're working very closely with the Center for Veterinary Medicine as part of the U.S. FDA for the approval. This is the first time that see [Audio Gap] It is the first time it is creating somewhat of a delay in the regulatory process for getting that approval. We continue to have ongoing discussions, and we'll continue to update the market as we have better guidance and visibility into when the approval will come for those products in the U.S.

So on that U.S. approval, I mean, is this incomplete letter you received from the FDA? Or is this more just then sort of being a little bit slower to go through the usual process because of COVID?

Yes. So we haven't received an incomplete letter. So to your point, it's more just working through the process. Obviously, COVID -- it provides some challenges as well. We mentioned on the earnings call that there are site inspections that need to be done as well. And because of COVID, that has been delayed as well.

On those site inspections, I believe you mentioned that they were primarily outside the United States. Given sort of the importance and the expectation of how big Librela and Solensia could be, was there any thought of building U.S. manufacturing for that? Just sort of streamline the process a little bit? Or sort of what's the thinking going into the locations there?

Yes, absolutely. So when you look at both Librela and Solensia, the production for those products will be both within the U.S. and outside of the U.S., like you say, because of the size and scale of the products. Over time, we would intend to have production both in the U.S. and outside of the U.S.

Great. And then for both products, I mean, how should we think about -- sort of taking a step back from the recent update, how should we think about, in general, the opportunity here? And how to think about the markets? We've received very positive feedback from experts in some of our due diligence calls. But it's still a long jump from positive feedback to what is the revenue opportunity here. So for Librela, at least, you do have some other products in canine pain on the market today and been around for a while. So we get a pretty good sense for how big the market is. For canine, how do you think about taking share versus expanding the market with the monoclonal antibody? Because it is a very different sort of use case, right, with a monthly injectable.

Yes. So for canine, I think it's both, right? And as we've indicated in the past, we do expect both Librela and Solensia to be blockbuster products on their own. We talk about the canine market in particular. Currently, it's about a $400 million market. But many dogs with OA remain untreated. So just for some numbers, in the U.S., there's about 75 million dogs, and we estimate about 40% of those dogs have OA, but only 28% get treated. So there is a significant opportunity to expand the market in terms of treatment rates. We also think there's a significant opportunity from a pricing perspective, right? A lot of the treatment currently is generic, and we would expect bringing significant innovation to the marketplace that we would expect to be able to increase the average price in terms of treatment. So we do think there's significant market expansion. So between gaining share from existing products at a higher price, but also building the market and increasing the treatment rates, we do think there's significant opportunity to grow the dollar size of the market. We've also demonstrated an ability to do that with our dermatology portfolio, where, again, that was a market that was much more served by generic steroids at that point. And we've been able to increase both the number of patients being treated, but also convert them to a much higher price option, which significantly increased the market size.

Okay. Okay. And then for -- switching to Solensia for feline. Any prior examples you can think of in terms of market opportunity of a feline product versus a comparable canine product? I mean, I think, the only one we really have is parasiticides, but it's not exactly a fair comparison because incidence rates are different and things like that. But it's not just affected by the prevalence of the disease, but also by the behavior of the animal, the pet owners' approaches to that. So I think most people think that feline should be a smaller opportunity than canine, but could you give us some guardrails or some sort of thought process for how to go about sizing that market?

Yes. Yes. So some ways to think about it. I agree that the market size is smaller or will be smaller than it is for dogs, right? So, a, the number of cats is so much lower than the number of dogs. But more importantly, the medicalization rate for cats is significantly smaller. But that being said, to your point, it is a significant unmet need. And in the U.S., for example, there currently is no option for cats for pain. So while the market might be smaller, our opportunity to gain share in that market or to have a very strong share in the market is probably greater. So smaller market size, greater share. So the opportunity may end up being somewhat relatively similar, but probably smaller for cats just based on the overall market size.

Got it. That's very helpful. So switching topics a little bit. I want to move on to Simparica Trio, the other obviously major blockbuster you've got, in launch now, and we've got a lot of questions and a lot of interest. You've had a very strong first year despite all the COVID challenges for a new product launch. I mean, I think, originally, we were thinking something in the $150 million range. Then COVID hit. Expectation was that would come down. And then at the end of the year, you managed to hit that target and actually exceeded by a little bit in any case. So what do you think were the key factors that drove that strength despite the challenges to your sales force?

Yes. So I think there are a number of factors. So, a, we want to complement our field force for the ability to execute during such a challenging time and get the product off to such a strong start. As we mentioned throughout the year, initially, we're a little below our penetration rate target because of the impact of COVID-19, but we actually penetrated more clinics than we expected by the end of the year. So that was just a tremendous effort from our field force to still gain adoption for the product, even with the impact of COVID-19. The other key factor was direct-to-consumer advertising. So with the impact of COVID-19, we made a decision very early on to increase the amount of spend behind the launch of Simparica Trio using our DTC resources, TV, digital. And we saw a very positive return on that as well. The other thing that we witnessed with the launch of Simparica Trio is that the cannibalization for Simparica was below our expectations, and Simparica as a stand-alone product actually grew 16% globally. So we saw very strong performance of Simparica as well, really emphasizing the strength of the overall portfolio we have, not only parasiticides, but across our entire companion animal business. So we're very pleased with where we ended the year for Trio. And that also gives us very strong confidence as we move into 2021. So we ended the year with greater clinic penetration than we expected. But also within the clinics that we penetrated early, we had greater market share than we initially thought. So we think that carries us forward very well into 2021, where we do expect to continue to gain further adoption in clinics and continue to get market share expansion as well.

Got it. That's really helpful. And actually, you touched on cannibalization there, but I want to go a little bit deeper. Cannibalization versus Simparica, as you said, was meaningfully less than we expected. I think you said it only about $20 million or 10% of sales. We would have thought it would be more like 20%, 25%, 30%. So does that give you a sense that Trio strengthening this year and sort of the initial ramp was more about share gains versus competitors? Was it more about market share? Do you have any data you could share with us about where you did penetrate with Trio? Sort of where are you winning?

Yes. So we think we won across a number of different categories. So a, we did see that there are many new patients starts entrée. New patients could come from new adoptions, but also from people coming from over the counter as well. But also within the pharmaceutical space, we did also see an increase in share as well. So in the U.S., for example, between Q3 and Q4, we saw about a 7% to 8% share gain within the parasiticide portfolio, which does mean, to your point, we were taking share not only for Simparica, but from other competitors as well, either oral and topical as well. So it really came from a number of sources. And most importantly for us, the least of it came from our own product, which we always said that we expected that the majority of the sales would come outside of Simparica. But it is even below our initial expectations.

That's helpful. Anything you can say in terms of geographic distribution of Trio within the U.S.? One thing we've always been curious about a triple combo product is how uptake would differ by region just because there's parts of the U.S. that have significant areas of both internal and external parasites, like the Northeast and the Southeast. But then the West Coast has either one or the other. So anything you can comment there in terms of market geography and exposure like that?

Yes. So to your point, there are certain geographies that may have greater exposure. But it's also important to understand that heartworm can be a very deadly disease, if left untreated. And the American Heartworm Association (sic) [ Society ] does recommends the treatment for heartworm across all of the states within the U.S. We are penetrating significantly across all geographies and key accounts. And we've seen very strong performance across all of the states. So nothing unique in any particular state to call out at this point. It's not...

Okay. That's good to know. And then sort of looking forward to 2021, year 2 and beyond, I mean, you talked to at least the same contribution to growth this year as you had last year. What do you think are the key drivers of further expansion here? I mean, obviously, your sales force is going to be able to push this a little bit harder this year, assuming we can get back out there. With -- once COVID vaccines are rolled out and things like that, you're also emphasizing the DTC spend. Historically, when we look at other product launches across the space, it's typically a relatively linear ramp, $100 million year 1, $200 million year 2, $300 million, year 3. It seems like you're guiding to slightly above that. So sort of what are the key gating factors there?

Yes. So there are a number of factors. And I'll start with the simplest, which is that we'll have a full year of sales. And we really launched this product in March and April essentially in 2020. So as we move into 2021, we'll have a full year of sales for the product. Obviously, the other factor is we do expect to get continued clinic penetration as we continue to launch the product. And to your point, as our field force has more opportunity to be live and in clinics and convert the clinics over to Simparica Trio. As the product grows, we obviously are going to continue to enhance our DTC spend behind the product to drive further growth as well. So we think there are a number of opportunities for growth with Simparica Trio as we move into 2021. And because of the size of the category, we're going to make sure that we're investing significantly to drive that growth and to drive the increased adoption of Simparica Trio in 2021 and beyond. Particularly as we've indicated, our guidance doesn't assume that we'll have competition in 2021. So we want to make sure that we fully support the brand.

Okay. Okay. [Operator Instructions] We just had a question come in actually now. With respect to Simparica Trio, are you able to fully support demand from a manufacturing perspective? Could this be a reason as to why Simparica held up better than expected?

Yes. So we didn't have any challenges from a manufacturing perspective in 2020. So no, the performance of Simparica, I think, again, was really driven by the strength of the overall portfolio. Also, as we've indicated in the past, we saw the opportunity for Trio being more in the U.S. because the prevalence of heartworm outside of the U.S., particularly in Europe, isn't as prevalent in many markets. So Simparica as a stand-alone product, for example, in 2020, grew 28% outside of the U.S. and 7% in the U.S. Again, for Trio, we didn't have any supply constraints in 2020. We do not expect to have any supply constraints in 2021.

Okay. That's helpful. I want to move on to sort of -- move off the individual products and sort of looking at a little bit of the overall broader market for animal health. I think if we take a step back here, I mean, I think, we saw some pretty incredible changes to the overall market last year, driven by COVID, obviously. So one of the bigger questions we've gotten from investors on the overall space is how much of this is transient? How much is permanent? Sort of what's animal health going to look like post-COVID? I think that's sort of one of the themes of this summit this year that I want to really touch on, spend a lot of time digging deeper in. So if we start on the companion animal side, I think a couple of dynamics that we saw, much higher levels of adoptions, more pets as people spend more time at home. When they do go to the vet, there's been more money spend on pets for vet visits. There's been a little bit of a greater shift to online purchasing for products, things like Chewy. It's a trend that's been going on for years and years as some of the products shifting from the vets office into these alternate channels. That certainly accelerated this year as at-home delivery became easier. So those are all the changes, and there's many others. But those are some of the more prominent changes we saw this year. When you think forward to the latter half of this year as people sort of return to the office, return to work and the COVID vaccines are rolled out, as you think the next year, how much of this do you think is going to have a lingering impact, how much is permanent and how much is sort of going to revert to the old ways of doing business?

Yes. So we think there are a number of things that are going to have a lingering impact, right, maybe not to the same degree that we saw in 2020, but still having a greater impact than we may have seen in the past. So, a, the point of people spending more time at home with their pets. We do think that will continue, right? Will people go back full 5 days a week? Probably not, right? So we do think that people spending more time with their pets will continue as we move forward. More importantly, the increase of that pet owner bond will continue, right? And that was one of the things that we saw really driving continued growth in 2020. With people spending more time at home with their pets, that pet owner bond continue to increase. But more importantly, they also were witnessing more of the elements that their pets may have been experiencing, which we do think helped drove the increased spend per visit as they were going into the clinic. So just to put some numbers behind it. We typically would see visits in the U.S. up any year, probably around 2%, and spend per visit probably up in that 5% to 6% range. As we've discussed in the second half of 2020, while we saw visits up around 2% or so, the spend per visit was up more in the 12% to 13% range. So as we move into 2021, we do expect that probably to narrow somewhere between that 6% and 13%, probably not revert back to the 6%, but probably not remain anywhere near that 13%. So it will linger, but it will moderate to some degree. The other thing is the innovation that's been brought to the market. That's going to continue, and that's going to continue to have an impact on the overall market, with products like Simparica Trio, with the monoclonal antibodies for pain that we'll be launching as well as with the continued growth of specialty products, such as our derm portfolio of Apoquel and Cytopoint. That also leads to the continued growth that we've seen in animal health, particularly within companion animal. As you mentioned, we did see an increase in the online purchasing in the retail channels in 2020. So just to put some numbers to that. In 2019 for our U.S. companion animal business, that portion of sales represented about 5% of our U.S. companion animal sales. In 2020, that number grew to 7%. And that growth will probably continue. As we talk about that, though, and particularly for Zoetis, it's always important to understand that about 50% of our sales still needs to be administered within the clinic. So it does limit, to some degree, the amount that will move to those online and retail channels.