Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Good morning, everyone. My name is Balaji Prasad. I lead the specialty pharmaceuticals coverage for Barclays, and a part of that responsibility is also the privilege of covering the animal health sector. So today, we have with us Zoetis. And from Zoetis, Wetteny Joseph, the Chief Financial Officer. Wetteny, welcome to our conference.

Thank you, Balaji.

It's -- we're glad to do it in person. And I know it's also your first in-person conference since you joined Zoetis, so I'm glad to have you here. Maybe just to kickstart, it's probably been around 10 months since you joined Zoetis.

That's right.

So I'd love to get your take on what's been probably the most positive surprise that you've had at Zoetis, and what have been the negative surprises that you have seen, too?

Yes. Look, Zoetis is a phenomenal company. And coming in, there were really 2 areas that I paid particular attention to that are important to me. First and foremost, what's the culture of the company like? And I have to say, just phenomenal colleagues that care a lot about each other and care a great deal about the impact that we make on the world and particularly for health of animals and how we advance care for those. So that was very much something that I assessed. But certainly, coming into the company and actually experiencing it has just been validating in every way in terms of what I was expecting. And then the second one is how did the company become the leader in the space? It is certainly a $45 billion addressable market. We're a leader in this market. We've gotten there through innovation and demonstrating the ability to fully integrate R&D with commercial in terms of developing markets and then executing at scale, which is something that I value and have a lot of, I would say, have had a lot of exposure to coming from a company that is manufacturing for a living to come here and see the complex dosage forms that we're able to manufacture at scale in the pet care space has been absolutely phenomenal. So couldn't be more pleased.

Okay. Great. So as we think about Zoetis for 2022 and beyond, some of the key topics that I keep getting questions from investors are sustainability of growth, competitive landscape and innovation. We can probably explore all 3 of it. As we ended the year, we started seeing anecdotal reports about pets being returned to shelters and I was thinking about how is this going to play out? We had the pet pandemic post-COVID, a significant spike in volumes. And then we are seeing these reports and if this is going to impact our [indiscernible] rate growth that we have seen and then you came out with your survey that you had done in the Q4 call. I just wanted to compare and contrast these 2, and see if there is a real movement happening here where we can see some pet volumes decline?

Yes. Look, you referenced a survey that was done by the Human Animal Bond Institute and Zoetis. 16,000 pet owners, and what we found was, first and foremost, I think the number was about 92%, 93% of the pet owners could see no reason that they would give up their pet. And then it was about 86% who said they would spend whatever it takes for their pets in terms of veterinary care. And what that did was really reinforce something we already do. This has been a long, longstanding trend of pets coming from the backyard into the home, into the bed. And really, people treat pets like members of their family. And demographically, if you look at structurally around the industry, demographics have gotten to a point where you have more millennials and gen Z who actually place a premium on the health of their pets. And the standard of care has been elevated in large part due to innovation coming from Zoetis. And once you get to a standard of care for how you treat various elements for your pet, it's difficult to go backwards. And we've seen significant resiliency in that regard, and we're very well positioned as a company to take advantage of what we're seeing in terms of trends. We delivered 15% operational growth last year. We're positioned to deliver 9% to 11% on the back of that this year. And the fundamentals are exceptionally strong, and we're really well positioned to do that.

Okay. Maybe diving a bit more specifically into some of the products and key launches. Librela, you had a pretty strong Q4. I think no one expected you to exit at a $15 million run rate per quarter just from Europe. And when you came out with your guidance, I think one of the standout in the -- standout point was you calling out Librela as a blockbuster in literally in its first full year. So as we look out there, where are you currently with the U.S. approval phase and in terms of launch preparations? And what part of U.S. contribution do you think goes into this $100 million a blockbuster size for the product?

Yes. Look, Librela has gotten off to a really, really strong start. It's been phenomenal to see. And just in Europe, as you referenced, it's already the #1 OA pain product in Europe. The statistics that we're seeing in terms of expansions, for example, we're seeing about 40% of the dogs getting on Librela being new to the category. So that bodes well in terms of our outlook for expansion of the market, and then they're staying on from a compliance perspective longer than we would initially have anticipated. And then, of course, there's price that plays into it as well. So we see opportunity to continue to grow this market. The product's gotten off to a really, really strong start. And we expect it to be a blockbuster in Europe along without factoring the U.S. Now you mentioned -- you referenced the U.S. We continue to expect that the agencies -- we continue to work with the agency and prepare, manufacture, et cetera, for the product in the U.S. But as we interact with the agency, our expectation is that sometime this year, they will conduct an inspection of a facility outside the U.S. in time to be able to get the products approved this year. It's not likely that the product would actually launch in the U.S. in 2022, so that's not part of our guide for the year, essentially, but we expect to be a blockbuster product in 2022 just from the European market.

Just from Europe alone. And you'll probably have some incremental launches in Europe or OUS this year?

Not that we have talked about it in terms of incremental launches. Of course, as we look across our portfolio of products, there are other products that we're launching throughout. We continue to innovate across, for example, derm, where we have Apoquel chewable that will launch in Europe this year. We have Trio launching in Japan. So a number of markets where we continue to launch and we continue to invest in the innovation across our products.

Great. Maybe just on the subject of pain itself, Solensia, how has the initial approval been? Have you -- how have pet owners or cat owners taken to getting the cats to the vets to be able to treat this? And how is that traction coming?

Yes. Look, we're very excited about bringing innovation in feline. Cats are [indiscernible] compared to dogs, not only in the U.S. but across the globe. And there hasn't been enough innovation there and they're more difficult to handle and bring to the clinic, et cetera, so we want to give pet owners a reason to bring cats to the clinic. In terms of OA pain, it's not an established market. Cats are not able to tolerate the NSAIDs, et cetera, that are used. They have gastrointestinal challenges with that. So it's not an established market, but we believe we can grow this market over the next 5 to 7 years, could be a $200 million market. It will be slower development compared to dogs where there's an established market for OA pain. But this is, we believe, the start of bringing innovation that will bringing cats to the clinic more and more in our pipeline to continue to innovate to drive a higher standard of care and medicalization for cats. So the product is going really well. We started off with early expense program in Europe. The demand has been very strong for their product for us across Europe as well, and we'll continue to drive that in Europe and then with the launch in the U.S. and elsewhere as well.

Got it. Great. Maybe one final question on the pain management space with Librela and what you've seen in terms of ordering dynamics and everything else. Is growth mostly coming at a cost of established players like RIMADYL, which is your own, or Galliprant? Or is it more of new market, newer volumes that you're seeing in the market?

Yes, we're seeing both. Look, we think given the safety profile and efficacy of the product, all kinds of pet owner sharing that on social media, et cetera, veterinaries have been extremely pleased with the product as well. And so as you're in the first year of the product we're seeing really strong momentum in terms of expansion, where 40% of the dogs are new to the category, meaning they weren't being treated before. So that is selling new sort of pets on the product in addition to those that were being treated otherwise.

Okay. Shifting to the derm side, atopic dermatitis, you've had a fantastic run now for the past 5, 6 years. No competitor on the monoclonal side, and one of your competitors has called out that they expect to be in the derm space with monoclonal. So any thoughts on what the -- what you expect this to be? And how could it impact the market for you, for Apoquel and Cytopoint, specifically? Or do you see that there's enough of the market out there that you can have multiple players being able to grow?

Yes, absolutely. Look, in 2021, our key derm franchise grew 24% on the year. We continue to see significant more room to expand this market. If you look at the U.S., there's an estimated 6 million dogs that suffer from itchiness that are not being treated at all. And there are about, call it, 8 million, if I round up, that are being treated, and we have about 2/3 of those in terms of dogs that are on our products. So there's still room for us to expand within those that are being treated and then there's another 6 million that are not being treated as well. If you look outside the U.S., the number could be more than that. So there is substantial more room to grow derm, and we are expecting -- we have been expecting competition. We'll continue to expect competition. And with or without competition, we're going to continue to drive the expansion of the space, which you've seen that in the growth that we've demonstrated. We're also going to continue to innovate in this space. You've seen us get approval for a chewable version of Apoquel in Europe. And we're -- with our $500 million that we spent in R&D last year that we continue to increase and make investments in this, and extremely productive for the company historically, we'll continue to make investments to innovate in the space of derm. It is a very important market for us.

Great. And maybe just shifting to Trio and Simparica Trio again. You've had a phenomenal growth since you launched mid-Q2, Q2 2020. And so since you had phenomenal growth at Trio and Simparica, and you have called out that you expect to see a competitor coming in H2 of 2023. Any further competitors that you expect to enter? And again, what is the market post 2 products or 2 triples going to look like?

Yes. So Trio has done really well for us since the launch extremely well. In 2021, we have $475 million of sales in Trio. But if you look broader than just Trio, our entire pet care parasiticides franchise grew significantly. I think we grew about -- almost 40% last year across that. Our Simparica franchise grew sizably in the year, I think about 80% if you look at Simparica in total. Certainly, Trio last year grew 170 or so percent last year. So Trio is growing, but Simparica as a franchise as well is growing in other markets as well where heartworm is not particularly prevalent, for example. And Trio itself will continue to launch. We'll launch Trio in Japan and so on. So the upshot here is we see more room to continue to expand. Parasiticides is a $5 billion plus, a portion of the animal health sector. So it's a very big and growing segment. It's important to us. We were behind, quite frankly, if you look back a few years ago. We've made significant traction. We still have more room to grow in the space and more room for Trio to continue to grow and more expansion as you have compliance. You have a simpler, a triple combination, if you will. We're seeing an expansion of use and efficacy here that we believe, even with competitors coming into the space, we'll continue to expand that market for us and for others, and we'll continue to invest as well in the parasiticide space.

Great. We did the animal health symposium [ industry-wide ] last year. And one of the findings which came -- 2 key findings that came out from the vets that we spoke to was one, there is an increased culture of compliance. And two, that there is probably they have limited ability to stop multiple SKUs. Both, of course, bode well for incumbents, but I do want to get your take of how you see the culture of compliance evolving and how vets are addressing this, especially as pet parents start to get back to office environments and not be at -- working from home. How will this play out now in 2022, 2023? And basically, the shift in time and skill.

Yes. So look, I think you start with a shift in demographics in terms of who the pet parents are, which are more millennials and gen Z that have placed a premium on the health of their pets. And so you get to this level of compliance that's driven also by different channels, et cetera. I was at a conference recently and got a chance to sit down with vets, some coming from places up in the Northeast U.S., where weather in the winter. And so I wonder about what that looks like in terms of compliance and said they don't see an issue at all. They're sending customers home with multiple months of supply, et cetera. So we do think that what we see in terms of compliance has been very encouraging. And as we innovate and you have a triple combination, it makes it easier as well, and then the channels that products are being distributed are also contributing to more compliance. So I think the standard of care that pet owners have gotten used to for their pets which, over the pandemic, has accelerated as they've got more pets into their homes, we were talking about that earlier. They're spending more time with the pets. And even as people go back to work, it's not likely they're going to go back to the old 5, 6 days a week. I think we'll see more couple -- few days in the office and more time at home, but it's difficult once you get to a standard of care to just step backwards from that. And so we believe there's continued room to maintain or enhance compliance as well as expand the market in the space and we've enjoyed the phenomenal growth, and we'll continue to drive that in terms of DTC and innovation as well.

Right. One challenge which veterinarians have been expressing over the past year really has been about labor, about being able to have the workflows more than enough to meet the demand that they're getting, which is a significant challenge and especially as you come from your meeting and conference with the veterinarians. Any insights that you're getting in terms of how they're addressing these challenges? And is this going to be a bottleneck for growth? Or will act as a tailwind for further acceleration?

Yes. And look, this is certainly not a new challenge. It may be a little bit more pronounced as we've looked at over the last couple of years. Despite that, you're seeing vet visits increase significantly over the last -- I looked at numbers across the last 8 quarters or so. You continue to see significant increase in vet visits. But more importantly, you're seeing more spend per visit, driving growth for vets in terms of revenue growth and demand for our products. Last year, we delivered 15% operational growth. 14% of that was volume, so we are seeing significant volume growth as well. So while this is a challenge in terms of labor, the entire industry is working on ways to attract more talent and retain more talent in this space, whether it's vets or tests, et cetera, to be able to deliver services and have been innovative in terms of being adaptive in ways to do that with customers and giving care to pets. So it is a bit of a challenge that the whole industry is aware of and working on to continue to drive the demand and deliver on the demand that pet owners having more pets, aging population of pets that will continue to require [ needed ] services and the premium that they place on their health.

Understood. And from what we've been seeing in terms of our monthly trackers, I mean, December last year was the lowest in terms of vet visits. January was, again, low. But we have seen a pickup since then in March, in Feb and then March. Is it your sense that this is probably the trend for the rest of the year? Or are we going to look at any kind of [ distortion ] in visits again? So -- and since that?

Yes. Certainly, when you look across December, January, a combination of weather, absenteeism with COVID and Omicron, et cetera, contributed to lower vet visit traffic. But by all accounts, this is not a demand signal. We continue to see strong demand for vet visits, but their ability to do that during those periods was more impacted, and we've seen an uplift since then in February. If you go back last year Q1, vet visits were down 2%. Revenue per visit was up double digits, and you still saw growth for vet clinics and then rebound in terms of vet visits the next 3 quarters or so. So I think throughout the last 2 years, we've seen periods. In fact, there were 2 quarters that we saw down of vet visits and one that was flat out of the last 8, where you're seeing strong growth in terms of spend per visits and then a rebound in the following quarter. So we believe that the levels that we've seen over the last 2 years, we may see some moderation of that over time, but we believe they'll remain above pre-pandemic levels given more pets and more time that people are spending on pets and demand for those services and more innovation that's driving them to the clinic. We talked about Solensia, for example, as innovation that's driving more cats into the clinic. And the innovation is going to continue to drive traffic into clinics, et cetera.

Sure. On the subject as a CFO, as you think about where to allocate your next incremental dollar in terms of R&D, innovation will, of course, play a huge role, and you always led there. But what are the areas that you want to develop next over the next couple of years? You had your third monoclonal -- 2 monoclonals on the pain side, and I suspect that you would have additional monoclonals maybe on the oncology side that you have spoken to in the past, but not disclosed specifically. Anything that you can disclose there, and maybe the next level of innovation that we can expect to see from you?

Sure. When we look at capital allocation, certainly, investments in organic investments in R&D are right on top of the list. We've demonstrated really high productivity of our R&D dollars. Last year, it was $500 million of R&D. And so we look across the spectrum in terms of our existing products that we're continuing to innovate and continue to enhance. And so I equally look at new products as I do existing products that we have more room to continue to expand. So when you look at examples like Apoquel Chewable, as we look to extend the existing platforms that we have in products, that's part of it. I think monoclonal antibodies as a platform is very important, not only in terms of R&D spend to continue to develop more products on that platform because we've demonstrated we can not only get those products through development and approval, but also manufacture them at scale. And so we're investing not only in R&D but also in CapEx as we expand our capacity for the products that we are launching now and products that are in our pipeline. So those are areas that certainly are right on top of the list. And then we have other areas in terms of digital innovation. We're innovating in the diagnostics space. You've seen what we've done with [ respect to ] IMAGYST and we continue to bring more indications on that platform, et cetera. So very excited about what we're doing from an organic perspective. And then also, of course, we look at our business development, both in terms of partnerships that we can do from an [ extra ] innovation standpoint and then acquisitions as well, which are more likely to be tuck-in type deals, but certainly disciplined when it comes to executing on business development that are on strategy. But what's not 100% in our control is the actionability and timing of when these things happen, but certainly is right behind the organic investments we're making.

Got it. On the question of tuck-ins and building additional capabilities, I think, in the past, you've called out maybe adding on a couple of reference labs to what you have currently. And are there any other specific technologies that you think you want to acquire, build? What are you looking forward to in terms of deploying your next dollar?

Look, we're investing in terms of technology and digital across IMAGYST and -- that I just talked about. But on the livestock side, if you look at what we're doing with genetics, if you look at BLOCKYARD, which we just announced the launch of, that's using blockchain technologies and able to track from genetics all the way through the life cycle of cattle, in this example, that can go all the way through the different marketplace to be able to enhance the value of those. So those are a couple of examples of where we're investing from a digital perspective. We're investing in our field force as well. And as we talked about, for example, when we issued our guidance for this year, we're expecting to grow 9% to 11% on the year. We said Q1 will be a bit below what the growth rate is for the year, probably around 3 points lower than what we're looking at for the full year, given DRAXXIN a sort of generic competition that didn't start into late last year, and then where swine was last year this time versus where it is for China, for example. But we're also making significant investments in our field force, investments in R&D, investments in tech and digital. Some of those are front-loaded, and so they'll have implications for what we see in the bottom line. So we expect the bottom line to be flattish in Q1. Although, for the year, we're expecting [ 10 to 13 ], so we'll be looking to drive operational expansion -- margin expansion for the year. But going back to your question, investments in across the business where we see the opportunity to drive long-term sustainable growth on the backdrop of a very solid market with respect to demand for our products and innovation and compliance, et cetera, and we're very, very well positioned to capitalize on those, and capitalizing on those will mean continuing to drive these investments that we're seeing and high confidence that they will drive high returns for us.

Got it. Great. I probably have 2 specific questions on the livestock side. [indiscernible] one will lead with China and what you've seen in terms of now the latest numbers in terms of [indiscernible], if you have any updates about the net additions of swine population in China for 2021? And what are your expectations are for 2022? And second is, of course, avian flu. We have been seeing sporadic news flows now. What are your expectations of how this is going to play out in 2022?

Yes. So to go in the order you asked the question. I think across the emerging markets, we're expecting strong growth in 2022 as we saw in 2021. That's both on livestock and companion animal. It's been phenomenal to see the level of growth in companion animal across emerging markets as well. To get more specific in terms of China, we continue to see really depressed pricing on pork in China, particularly in the first half of this year. So we continue to see that being a little bit of a headwind when it comes to swine, but companion animal, continue to see really strong growth in China. When we look across Brazil, the export market continues to be very strong. I was just in Brazil last week actually, and that's a phenomenal market where, if you look at China, for example, the demand for beef consumption in China has gone up to almost make up for some of the consumption that you might see on the swine side. And so we continue to see really strong growth across that. In terms of bird flu, we've seen cases in various states this year, but they have been contained. I think if you look at the biosecurity in terms of taking wherever there have been cases and calling on those flocks and keeping it from spreading on the ground, that's been really successful so far. We'll continue to monitor that situation. But so far, they've been very successful in terms of managing the cases that we're seeing.

Great. We've run out of time, but I do want to get one more question on the macro side and inflation and its impact on both on the livestock side and on the companion animal side. Where do you see better ability to pass pricing through? And secondly, Russian and Ukraine, with the situation there, what kind of exposure do you have both on the supply chain side and as an end market in itself?

So I'll start broadly and briefly on inflation. We've seen inflation throughout 2021. We've seen inflation in certain markets more pronounced like I was just talking about Brazil and Turkey and places like that. We've certainly demonstrated an ability to take price to offset inflation across those markets in time, and we continue to be well positioned to do that with our portfolio. Now there are places, for example, if you look at DRAXXIN, where you won't see that, right, in terms of price which [indiscernible] pressure, but net-net across our business is the opportunity to take price to offset inflation. In terms of Russia and Ukraine, from an exposure perspective, Russia is about 1% of our revenues. I think -- we're really transparent in terms of our top markets. If you look at the top 12 markets, you don't see Russia listed there. And so it's not a top 12 market for us, but it's roughly 1% of our sales. Ukraine sales are substantially below that. We don't have any manufacturing exposure in those countries nor do we have specific manufacturing from third parties in those markets as well. So our exposure is very much limited in those markets as well.

Got it. Great. With that, we'll wrap up the session. Wetteny, it's a pleasure to have you here. Thanks for joining us.

Thanks for having me, Balaji.

Absolutely.

Appreciate it. Thank you.