Zoetis Inc. (ZTS) Earnings Call Transcript & Summary

Good morning, everyone. My name is Balaji Prasad, I'm the senior analyst for the spec pharma coverage. Continuing the spec pharma track for the day, I'm delighted to have Wetteny Joseph, the Chief Financial Officer from Zoetis, to join us today. Wetteny, thank you so much for taking the time out to attend the conference and appreciate your presence here. Thank you.

Thank you, Balaji. It's great to be with you today.

Great. So to kick start the proceedings, I think you recently announced your results, provided guidance. And we're almost into the end of the third month of the year. So help me understand the top priorities, some of the key items within the 2024 guidance and the push and pulls towards the growth and the margin guidance that you provided, and we can take it from there.

Yes. Look, we're positioned, once again, to grow above market with our guidance of top line growth expectations between 7% and 9% on an operational basis. And that's something we've done over a decade straight, growing and outpacing the market by about 3 points on average over the last 10 years. And clearly, we have momentum as we enter into 2024, driven across our companion animal innovation portfolios. And really, if you look at whether it's osteoarthritis pain franchise with Librela and Solensia price, we're positioned again to be able to drive through -- our expectations to be able to drive growth through Trio even in the face of competition as well as our derm franchise. It was great to see livestock return to growth last year, posting 6% operational growth on the year, started out very hot at 12% in the first quarter last year. And we're once again positioned to grow livestock though it would be in line with the market and the market tends to grow in the low single digits, closer to 2% to 4%, right? And so as we sit here today, we're also positioned to drive bottom line growth above top line growth with 9% to 11% adjusted net income guidance for 2024, even as we make investments across the business to position us to continue to lead the way and to lead the next decade across animal health. And so we're making investments across R&D, across our manufacturing and supply chain platform, making investment and capabilities across our colleagues, et cetera, and we're still positioned to be able to drive that growth, essentially 2 points depending on where you look across the range of growth at the bottom line faster than the top. And so our priorities here are really to launch Librela in the U.S. as well as continuing to drive the momentum we've already experienced across our international markets. And to defend -- continue to defend Trio, which we're doing a great job of so far and to defend our derm franchise as well.

Got it. Great. So I think Librela is where, naturally, we have received the most amount of questions from investors recently. So I want to start there. So you had a pretty compelling print for 4Q when you announced results recently. There was some stocking impact within it, too. But as we think about 2024, help us understand the ramp that we should think about for Librela, maybe an actual organic growth, and how -- what kind of cadence should we expect for Librela?

Yes. Look the OA pain franchise is the latest major area of innovation for us that is positioned to drive the next $1 billion franchise for Zoetis. And while in animal health, the tendency is -- a blockbuster is $100 million, we are talking about essentially the third area of $1 billion here. So clearly, something that's very important in terms of our trajectory over the next several years. We launched Librela first across our European markets and then other markets around international. We're in Australia, Japan, Brazil, et cetera. And it's done exceptionally well for us. So that really positioned us to have very high expectations in the U.S. And we have these innovative portfolios, whether you look at key derm, et cetera. About 2/3 of the overall value of pie is in the U.S. So clearly, although the product has done exceptionally well across international markets, generally speaking, it tends to be about 1/3 of the total. So the U.S. is clearly very, very important. And we couldn't be more pleased to see the initial performance of the product in the first 2.5 months or so. We launched officially in October, I think it was the second week of October. And we posted $44 million of revenues in the fourth quarter for Librela, and that was above our expectations that we went into the quarter with. And the higher the number, essentially, the more of those stocking, and by the way, we also outpaced the penetration levels in terms of how many clinics have ordered the product and have it in hand. The trajectory of Librela is faster than any other product we've ever launched in terms of the percentage. And therefore, the higher the percentage of penetration, the more of those initial sales that are really stocking levels for those clinics, right? And as we exited the year, having a much higher number, that translates to a higher percentage that is stocking. And by the way, stocking is an element that we're very used to across our products, clearly. But it's not a precise science. It's more of a triangulation around what that might be as we don't have direct access to every point-of-care system [indiscernible] pens system across our customer base. But we're reasonably confident around what that range is, and we believe it's somewhere between 1/4 and 1/3 of the $44 million is stocking. And so as we have penetrated fairly significantly, fairly quickly, we've actually already started to do direct-to-consumer advertising for the product, which essentially is going to raise awareness for pet owners to go to the clinic and so on. So in terms of the pace across the year, we don't try to get too detailed around guidance on a specific product, right, on individual product. Clearly, we have a broad portfolio, lots of diversification and several levers that are going to drive our growth this year as they have in prior years. Clearly, Librela is a critical focal point. And as we come into the year, it's -- suffice it to say, as we go through the year, the contribution will be more and more as we ramp the product, right, naturally. But I think as you look at Q1, something approaching what we did in the fourth quarter, particularly when you back off the stocking element, something approaching that essentially is about a 25% to 33% increase, if you will, if you look at it on that basis in the first quarter. And that would be, I would say, a very well-received sort of performance for us in the first quarter. And again, the ramp continues. And because we've penetrated a significant percentage of clinics already, there'll be more stocking into the quarter, but clearly not the same level of what we would have seen in the first quarter -- in the fourth quarter rather.

So as we think about multiple moving parts trading, including earlier than anticipated DTC efforts, which have been launched, clearly, that's a positive. So with these costs involved and the COGS that you also called out in the recent quarter, the variation on the gross margin, the impact on margins. How should we think about EBITDA contribution from Librela for the course of the year?

Yes. Look, the way I look at it, it's not just Librela, it's across mAbs, broadly speaking. And our commentary here is very consistent. Since about the time we did the Investor Day back in May, we've been talking about what the expectations are around mAbs and their contribution with respect to margins. So at scale, our mAbs are accretive, certainly to the overall Zoetis gross margins, which run about 70%, give or take, right? And so they're accretive to that. And they get to what I call the innovative companion animal levels, which are above the company gross margin levels. So that's at scale. We have come into this, again, given the expectations coming out of the international and European launches, we have prepared ourselves to be able to have confidence that we can capitalize and maximize the demand that is to come. And therefore, we've built a platform and a base in terms of manufacturing capacity, et cetera, that is bigger, right, to prepare for that. And therefore, it takes longer to get to that scale. And that's exactly as we expected. In 2023, that $44 million, if you will, in the fourth quarter, and then a $3 million in the third quarter. So in the U.S., and of course, we continue to ramp up across international, that was dilutive to the overall company gross margin levels. And that's exactly what we said. In 2024, the -- I would say, the manufacturing ramp and scale that we're already running at would absorb enough of the cost base, if you will, where the unit cost would drive us to be accretive to the overall company gross margin levels, but still not quite at those innovative companion animal levels. And so as we exit '24 and beyond, we will get there, but we already are running at a rate in terms of manufacturing, which, by the way, is not just for this year, it's for next year because mAb manufacturing is a fairly long-cycle process, right? It takes about 10 months. So as we're already in March, effectively, the new products that we're sitting down now are going to be starting to cross over to the next year. And so we're already manufacturing at that level, which again absorbs the cost and the unit costs will drive our margins, even for 2024, that's accretive to the overall Zoetis levels. And of course, we've already made significant investments in prior years into our field force. And so if you think about what that means, as you go from top to the middle to the bottom line, it's actually already accretive when it comes to contribution margin towards the bottom line because we're not having to make those additional investments. Even as we make investments in DTC, you see accretion at the contribution margin level.

Fair enough. I think both the lead time for the manufacturing and the impact on gross margins, including both the group level and the companion animal level, I think, is well received and well understood. There's one more issue that I want to address head on with Librela, which is commentary around side effects on social media, which is surprising because 1.5 years in Europe, we did not hear so much about ataxia or side effects on social media, but where you've heard that now. So would you want to tackle that and address it?

Look, I've only been with Zoetis for just under 3 years. Adverse event reporting or potential adverse events is commonplace. And it's not that surprising because we've seen similar sort of activity around other launches that we've done in the company. And so when we look at the pharmacovigilance data, which we track very detailed and so on, we don't see any signals or any events that are outside of our expectations here. And so we are very confident in the impact the product is having to help animals that have osteoarthritis pain. I think there's been a significant amount of compensation around ataxia specifically. So if you look at adverse event reporting, which happens every time you launch a new product, the overall level of events we've been reporting is what's considered uncommon. And there's a fair bit of discussion on ataxia, which is neurological reporting. And if you look at that specifically, we have now more than 11 million doses that we discussed on -- back in February, we'll update those numbers, of course, as we report our results for the first quarter. But 11 million doses globally and the reporting of ataxia as a potential adverse event is between 1 and 2 cases per 10,000, which effectively is categorized as rare. And so again, we don't see any signals here that would give us any concern, and we continue to be very much supportive and confident about the safety and efficacy profile of the product.

Fantastic. Getting back to the guidance. I want to dig into 2 things, which could have probably impacted the level of veterinary visits and built into the guidance and also FX impact that you see when I look at where the dollar index has been in the first 3 months of the year.

Yes. So look, if you look at vet visits, which we track in more specificity in the U.S., we don't have quite the same level of detail outside the U.S. But if you look at vet visits, as we've been saying for a number of quarters now, there's not a very high correlation between vet visits and what our earnings revenue growth has been. And certainly, we've demonstrated an ability to grow the business even in flat or slightly down vet visits periods as you saw last year. So we came into this year with the expectation that vet visits will be somewhere between flat to 1% growth. The first quarter, particularly with some weather patterns in January and February, you've seen visits moderate a bit. But keep in mind, even as you go through last year, and then we've shared data, if you look at the CAGR in terms of growth over the last 4 years versus the vet visits have been relatively flat to up 1%, we've grown our companion animal business double digits in the face of that. And it's because when you see vet visits moderate, it tends to be more around wellness vet visits and not so much on therapeutics. So our business is largely driven by therapeutics, and we have a number of chronic conditions, et cetera, that you can -- you still see growth. I mean we're looking at derm, for example, where pruritic patient visits are actually be slightly up in the face of down vet visits overall. So clearly, we have an ability to grow faster, and you see revenue in the clinics also increasing even as visits are flat to down. You see mid-single-digit to high single-digit revenue growth for clinics in the U.S. One last point I'll make, and then I'll pivot to the second part of your question, which is really around FX is that we also have alternative channels in terms of retail, which tends to even drive and fuel our growth above what we're seeing happening in the clinic itself. And you've seen robust growth across that channel over the last number of years from us, and that continues to really propel our growth. Pivoting to FX. Clearly, coming into this year, we're watching the U.S. dollar. And when we give expectations around FX, we don't try to forecast FX on a forward basis. What we do is we say, here's where the spot rate is today, and this is what it would mean versus the average rates that we saw in the prior years and what the impact is on us in the current year. So as we've been watching that, you've seen the dollar strengthen even since we did the earnings and issued our guidance, the dollar stiffened a bit, and it's given back a bit in the last week or so. So we're back to about where we were when we gave guidance, I would say, overall for the year. However, if you look at the spot rate where it is today against the first quarter, for example, it has a meaningful negative impact to the top line to the tune of about 2%, 2.5%. It's close to $50 million of headwind on FX on the top. And if you go all the way down to the bottom line, it's about 5 full points or so of impact at the ANI. And that's really driven by Argentina, Turkey, et cetera, that are driving some of the impact for us, and we've been talking about those. But from an operational basis, we're very, very pleased with not only been able to issue the guidance that we did, but walking into a very good quarter from an operational perspective that we'll be looking forward to sharing once we close the quarter.

And just to clarify, the 2% to 2.5% impact to the top line? Is it incremental to what you had stated before? Or is it the net impact? And is it just for the quarter or for the full year?

That's just for the quarter. I think when I look at the full year, again, given where spot rates are right now. It's not as big of an impact. It's about 1 point of headwind on the year. But on the quarter, it's more pronounced.

Got it. Shifting towards the competitor's entry that's something debated a lot, again, both on parasiticides and derms, your core franchises. How are you thinking about the potential impact from Credelio Quattro coming into this? So this will be the third player into the combination parasiticide market. BI didn't really do much to dent your growth prospects last year. And I think Trio's guidance for this year with a mid-single digit to high single-digit range, which is fairly wide enough, how do you also think about the impact?

Yes. Look, we couldn't be more pleased with how Trio is performing so far in the face of competition. And the way I look at parasiticides is, it's the biggest sort of category within animal health, right? It's north of $6 billion, call it, about $6.5 billion globally. And parasiticides has always been a very competitive space. And I get a lot of questions around this, and it sounds like it's a new phenomenon around competition in parasiticides. It's always been very competitive, okay? And so what we've done over the last number of years is we've gained significant share in the space. We've gone from fifth in global parasiticides to second. And so we brought the competition fairly heavily to others who participate in our space, and we are now talking about triple combinations, which is still in early phases, if you will, as a standard of care. We're only about 4 years in, as we launch in the U.S. that is, as we launched Trio in around, I think, April 2020. And so we're still relatively early when you think about the context of parasiticides and what is the standard of care. And as more and more competitors come into the space, and again, we're very pleased with how we performed -- or Trio is performing against competition here, more competitors coming into the triple combination space is going to drive more voice in the market with pet owners and their awareness of this as a standard of care and driving them to the clinic, which means the whole segment of triple combinations will outpace the growth of parasiticides in general. And we've seen that play out before. The previous standard of care was to go to oral medications that are prescribed. And the safety and efficacy sort of performance of those products has driven growth that's faster than the overall parasiticides category, and we've seen players even those that were first -- especially those who were first and second, continue to grow even as third, fourth and fifth players that come into the space. And we expect the same sort of phenomenon to play out here. Now we don't have an exact label with respect to Credelio to speak of. But given, again, 4 years of sort of first-to-market advantage in the U.S., the biggest market in parasiticides, which is, again, about 2/3 of the space is in the U.S. We're very confident in terms of how we're positioned. Our share that we continue to gain patients over the last couple of quarters even in the face of competition. And so we'll react based on what that label exactly is. But again, very pleased with how the product is performing.

Got it. I want to put in a question around pricing, tying up both the parasiticides and the derm franchise, considering that you'll be seeing competition in both of these. How rational do you expect competitive price behavior to be in both of these categories? And will that have any bearing on the pricing equation of your guidance for the year?

Look, the way I look at price, it's typically not the first sort of lever we look at when it comes to preparation for competition in terms of our playbook, particularly when you think about derm, we have 3 products. And one of them has been in the market for a decade. The other has been for 7 years. And so the level of satisfaction, millions of pets that are being treated with the product are in a very, very high level of satisfaction, not only with vets, but with pet owners, puts us in a very, very strong defendable position as competition comes. And because we have those products with a preference on pet owners for the chewable format, if you will, which is just launched at the same time we launched Librela, by the way, which I don't get a lot of questions on the chew, I'm shocked, compared to the questions that I get on Librela, but they launched at the same time. And so the conversion from film-coated to chewable because pet owners have that preference is going to be an important part of our equation here as we look ahead. And then Cytopoint has been outpacing the growth of Apoquel, again, another element here that will certainly have an impact. And then we continue to evaluate elements with this because currently, the product is sold direct to clinics in the U.S. as well as across the retail platform, that is the Apoquel product, Cytopoint has to be in the clinic. And among the things that we can look at, again, long before we get to overall prices, what is the go-to-market strategy around distribution and so on with the Apoquel chewable, et cetera. So we have lots of levers to look at. Price will be something we'll look at once we know what the label is and how competitors come out. Generally speaking, we would expect some relatively aggressive promotional activity that maybe, in the short term, impact price. We don't see that having a meaningful impact on our expectations for the year around our price expectations globally for the company. And we'll be disciplined around how we react to what we see based on those initial elements that competitors may do.

Got it. So do I want to ask about chewables. So help us understand the role of Apoquel chewables in terms of providing a moat around your derm franchise and the current penetration levels that you're seeing. How do you expect for those chewables to continue to increase penetration levels?

Yes. Look, I think, chewable, because of the preference on pet owners, it may, over time, drive even more penetration across the franchise. From a compliance standpoint, it's easy to give the dog a treat versus having to put it in peanut butter or et cetera, and so that is something that over time we expect initially, we think this is mostly a conversion from Apoquel, which is, again, important for our defense and important for pet owners who want that compliance. So there are long-term potential tailwinds that may come from this. The conversion of chewables, by the way, if we look across our European markets where the chewable has been available for a couple of years now is up to about 40% across our European markets. And that's with the product on price parity with Apoquel, right? And so that's naturally showing what I've said, which is that pet owners have that preference, without any sort of incentive to drive chewable versus film-coated, we've seen about 40% conversion already.

Great. In terms of -- basically the 2 minutes left, I do want to address China. I think this has had an outsized impact over the last couple of years in terms of top line deceleration order. So what are you seeing currently on the ground, both on the companion animal side and the livestock side and maybe roll it up into the broader livestock expectations, too.

Yes. Look, if you look at China, which, by the way, has gone to about 50-50 companion animal and livestock. And even in 2022, companion animal was higher than livestock as a percentage of our sales. So clearly, over the last decade, we've seen tremendous growth in China. As we look ahead into the future, you continue to expect very positive developments as you get higher and higher medicalization rates and more of our innovative products are introduced there, et cetera. But currently, we've been very consistent around our views on what we're seeing in China, and those really haven't changed. We expect to have some meaningful headwinds in China, particularly in the first half of 2024, and we factored those into the guidance that we issued last month, right? Now we've seen a bit of stability, particularly as we look across the companion animal side of things in China, stable but yet with relative headwinds versus the strong comps that we had in the prior year. So I'm not changing that expectation, but it's good to see some stability there. And then on the livestock side with consumption on swine and pricing of pork in China that's remaining relatively depressed. And so overall, no real meaningful change versus what we thought coming in. But again, a relatively stable on that and very consistent with what we've been talking about.

Got it. Wetteny, probably the last question from me. Last year on the Investor Day, you highlighted multiple therapeutic areas where you see scope for pipeline expansion and growth, renal, cardio, oncology. We haven't heard much since then. And as investors tend to do, what next is always a question. You're just in the first full quarter launch of Librela in the U.S, but what next? When can we expect some updates on these pipelines, Wetteny?

Look, we have the OA pain franchise that we're very pleased about launching and having those scale over the next 3 to 5 years. We have meaningful life cycle innovation, which tends to be about 50% of our spend in R&D. When we've seen an uptick like we've seen recently, it's a little bit more new versus life cycle innovation, I would say. But generally speaking, it's about 50-50. So we're very excited about what those will look like. And then you mentioned the new therapeutic areas, whether it's renal, cardiology, oncology, et cetera. And look, we generally don't go into a ton of detail in terms of what, specifically, where things are. And given we just gave more color just in May, I want to set the expectation here that we're not going to go into quarterly updates on what those look like, no more detail than that. But clearly, we're very pleased and we have a track record of performance across not only R&D, but how our commercial teams then take the innovation to grow and expand markets. And those capabilities are very poor to what's driven our performance in the past and what will drive it in the future. But it is R&D. So the very nature of it is there's no guarantee that everything you work on is going to be successful. But our track record, I think, speaks for itself, and we're very pleased with the progress we're making.

P Fantastic. We look forward to more updates on that when the time comes. But Wetteny, thank you so much for joining us today. It's a pleasure having you here. And I also wish you a very productive day at the conference today.

Thank you, Balaji.