碩騰 (ZTS) 2013 Q2 法說會逐字稿

Welcome to the second-quarter 2013 financial results conference call and webcast for Zoetis. Hosting the call today from Zoetis is Vice President of Investor Relations, Dina Fede. The presentation materials and additional financial tables are currently posted on the Investor Relations section of Zoetis.com. The presentation slides can be by managed by you, the viewer and will not be forwarded automatically. In addition the replay of this call will be available approximately two hours after the conclusion of this call via dial in or the Investor Relations section of Zoetis.com. At this time all participants of the placed on listen only mode and the floor will be open for your questions following the presentation.

(Operator Instructions)

In interest of time, we ask that you limit yourself to one question and then one queue up for any follow-ups.

(Operator Instructions)

It is now my pleasure to turn the floor over to Dina Fede, Vice President of Investor Relations. Dina, you may begin.

Thank you, Josh, good morning and welcome to the Zoetis second quarter 2013 earnings call. I am joined today by Juan Ramon Alaix, our Chief Executive Officer; and Rich Passov, our Chief Financial Officer. Before I begin, let me remind you that the earnings press release and financial tables can be found on the Investor Relations section of the Company 's website. We are also providing a simultaneous webcast of this morning's call. Advancement of the slides on the webcast is user-controlled. As such, the slides will advance only on your prompting. A PDF version of the slides we're presenting and a transcript of the call will be available on the website later today.

Our remarks today will include forward-looking statements and actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statement in today's press release and our SEC filings including, but not limited to, our 2012 10-K, and Q1 2013 10-Q. Our remarks today will also include references to certain financial measures which were not prepared in accordance with generally accepted accounting principles, or US GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP the measures is included in the financial tables that accompany our earnings press release and in the Company's 8-K filing dated today, August 6, 2013. With that, I will turn the call over to Juan Ramon.

Thank you, Dina, and hello, everyone. Welcome to our earnings call. I will share highlights of the progress Zoetis is making now that we are in a fully independent Company. But to start, let me go right to the numbers. I am very pleased with our 4% operational revenue growth and diluted EPS of $0.36. I believe this performance further illustrates the continuing strength of our Company and what we are creating. I will now share some of the highlights of these results and then Rick Passov, our Chief Financial Officer, will provide further details of our performance.

First to the regions -- in Asia-Pacific, the drought conditions impacted our livestock business in Australia and New Zealand, while we have seen growth in Asia market. In Canada/Latin America, we saw positive growth driven by companion animals in Brazil and Mexico and we also saw growth in our swine business across the region. In Europe/Africa/Middle East, the performance in Western Europe continued to be affected by tough economic conditions and a long, cold winter that impacted the [parasitic campaign] for companion animals and also cattle. Our poultry and swine businesses performed well during this quarter in this region.

Finally, in the US, we continue to see good momentum, driven by companion animal, poultry, and swine. We also have seen recovery in our cattle business, based on the improvements on the 2012 drought conditions. In terms of species, on an operational basis, companion animal and livestock both contributed 4% second quarter growth in revenues. We saw operational growth of 5% in companion animal, largely driven by performance in the US and emerging markets and operational growth of 3% in livestock, driven by swine and poultry.

While weather conditions and economic challenges in certain countries were a factor in our overall results, the financial performance for the quarter continues to demonstrate how our Global scale, local presence, and diverse portfolio can help us deliver steady revenue growth across the year. With all these factors, we reaffirm our full-year guidance for 2013. Economic and business-related factors for some of our customers are improving. For example, we are starting to see some encouraging signs of the easing of the drought impact in the US. With the price of the corn now lower than in 2012, we anticipate a positive evolution in the livestock industry. We expect to see the impacts of this improvement over the second half of the year and for the market to start to return to pre-drought activity in the coming 12 months.

We are also aware of new factors which are emerging and negatively impacting our customers. Swine producers in the US are experiencing an outbreak of the porcine epidemic diarrhea virus. A similar virus impacted the swine industry in China in 2012. We are committed to supporting the US pork producers in understanding and controlling PD. We are partnering with stakeholders, including various academic institutions such as the University of Minnesota. The performance of this quarter has been achieved while we have been working through many of the challenges of becoming independent.

Since our last call Zoetis, formally separated from Pfizer. The separation was officially completed as of June 24, generating a significant number of new investors in our Company. The separation was also the culmination of two years journey to create the world's largest independent Company solely dedicated to animal health. While Pfizer continues to provide a number of services to our business through a range of professional service agreements and a master manufacturing and supply agreement, we are actively building the resources we need to operate on our own and at a cost base that is appropriate for our business. We are equipping Zoetis with the right size infrastructure to meet our Global business needs.

For example, we are making progress on the implementation of our own Global Shared Services and our HR systems. We also relocated our Global headquarters and in doing so, reduced the cost associated with this office space. I am proud of what the team has achieved and the way in which we are managing the different transitions with appropriate levels of rigor and discipline. I am particularly proud that through all these work we have remained focused on keeping our commitments to our customers. We continue strengthening our business model with this commitment to our customers and also to innovation.

For example, in April of this year, we launched an e-commerce site for our US customers. The new shopping site enables our customers to order products they need it directly from Zoetis, 24/7. We have seen strong customer feedback on the convenience and performance of the site and a steady increase in volumes through this channel. As of the end of July, we have more than 3,250 US-based customers registered and more than 2,700 of them have already ordered through the site. We continue to make progress on bringing innovation to market through new products and the proactive lifecycle management of our existing brands.

In this quarter, there are many examples of this approach. I am pleased to share with you some of these. [Overall] the outcome of the process that delivers strong results and continues to deliver innovation for our customers and in the animal health industry. We make our strategic investments in research & development based on four criteria -- strategic fit and the importance to our current portfolio; technical feasibility of development and manufacture; return on investment; and the needs of customers and the market. Colleagues in commercial manufacturing and R&D work together to ensure that all needs are considered in our investment decisions.

This approach provides sustainable productivity and enables us to deliver an industry-leading portfolio. For example, an investment decision we made six years ago was to develop novel product, with a first in class mechanism of action. This product is APOQUEL. The US FDA approved this asset in May of this year. In July, the European Committee for Veterinary Medicinal Products, or CVMP, adopted a positive opinion recommending the granting of market authorization for APOQUEL. This represents an important step in the product's approval process in the European Union.

APOQUEL is indicated for the control of pruritis associated with allergic dermatitis and the control of the atopic dermatitis in dogs who are at least 12 months of age. Pruritis or itching is the most common sign of allergies in dogs. Developed by Zoetis researches, APOQUEL is the first Janus kinase inhibitor approved for veterinary use that targets the itch and inflammation pathway and also provides fast-acting relief. In the US alone, there are an estimated 8.2 million dogs that suffer from short or long-term allergic skin conditions. We understand that these are a serious issue for dogs and are very frustrating and a distressing issue for pet owners.

APOQUEL was recently the topic of the symposium at the American Veterinary Medical Association annual meeting. The reaction we saw from veterinarians was very encouraging and there was a lot of engaging in discussions about the product and the very real benefits it will bring once launched. We are not only investing in industry-leading research, but also in the lifecycle management of our existing portfolio. This enables us to achieve the greatest value for both, Zoetis and for our customers. For example, in this quarter, BOVI-SHIELD GOLD ONE SHOT, a vaccine for cattle to help prevent respiratory disease, was approved in July for the US market. Lifecycle investments over the past 30 years have continued a significant percentage of the total revenues for the BOVI-SHIELD product growth.

RespiSure-ONE a secure and meaningful [care] extension in Japan, making the product available to protect piglets from one day of age. DRAXXIN 25 injectable solution, an anti-infective already used in cattle and swine was approved in the US at a new, lower concentration that is more suitable for pigs. Again, our commitment to brand lifecycle management within this franchise has contributed a meaningful percentage to total DRAXXIN revenue over the years. We have successfully registered POULVAC IB QX in a number of new markets this quarter, including Germany, Romania, Bulgaria, and South Africa. This vaccine was first approved in France in 2010 and is indicated to reduce respiratory infections in poultry.

Finally, I am pleased to confirm an important milestone with our joint venture in China. July saw the approval for RUI LAN AN, a new high standard of innovation against a highly pathogenic porcine reproductive and respiratory syndrome. The vaccine combines the Global expertise of Zoetis and a strong local vaccine and developmental program to address the needs of swine producers in China. They're also leading the pork production in the nation. Each of these examples further demonstrate our ability to leverage the three core interconnected capabilities of Zoetis -- our direct sales and marketing model, our leadership in product research & development, and high-quality products and reliable supply.

As we look ahead, we remain confident in our ability to demonstrate profitable growth and now, as a fully independent Company. I am excited about the opportunities and also the challenges that lie ahead and I know we are prepared for them. With that, let me thank you for your attention and your interest in Zoetis and I will now hand the call over to Rick and ask him to walk us through the financial results. Rick?

Thank you, Juan Ramon.

As you mentioned, we've become a fully independent Company since our last earnings call. With more than 400 million shares exchanged in the Pfizer offer, we have many new shareholders in Zoetis and hopefully, many of you are joining us today. This is just our second earnings call, so let me take a minute to recap the basis of how we're presenting our financials before we get into the results. While our results are reported in accordance with US GAAP, our commentary will largely speak to financial results on an adjusted basis. These adjusted figures, including adjusted net income and adjusted earnings per share, are non-GAAP measures. They exclude the impact of purchase accounting adjustments, acquisition-related costs, and certain significant items, such as the nonrecurring costs of becoming a standalone public Company.

We also cite operational results. These figures exclude the impact of foreign exchange and demonstrate the underlying performance of our business. Operational results are used by Management to evaluate the Business and we believe that providing the use of our performance will enhance your understanding of our financial results. In addition to the Company's overall income statement, our financial reports and discussion also reflect how we manage our business on a regional basis. As you can see in the tables accompanying our press release, we provide revenue and pretax earnings for our four regional operating segments, as well as our consolidated results. We also provide supplemental revenue breakdowns by livestock and companion animal categories for the regions to provide additional insight into our quarterly and year-to-date results.

As you know, Zoetis was not a standalone Company in 2012, so our financial statements for 2012 and prior years and our public filings have been derived from the consolidated financial statements and accounting records of Pfizer. These include allocations for direct costs and indirect costs that were attributable to the Animal Health business of Pfizer. As we noted, the combined financial statements for 2012 do not necessarily reflect what the results of operations would have been had we operated as a standalone Company. As a result, this can make comparisons to the prior year difficult in certain instances.

Turning to our financial results for the second quarter now, revenue was approximately $1.114 billion; an increase of approximately 2% year-over-year, including a negative impact of 2 percentage points from foreign exchange. Excluding this FX impact, revenue grew 4% and I will discuss the key drivers in a minute. Let me turn to net income, reported net income of $128 million and diluted earnings per share of $0.26, both decreased by approximately 26%. This decrease was primarily driven by certain stand-up cost associated with our full separation from Pfizer, as well as a nonrecurring one-time benefit in the year-ago quarter related to our allocated portion of a Pfizer tax settlement.

On an adjusted basis, net income of $178 million and diluted earnings per share of $0.36 showed an increase of approximately 1% and 3%, respectively. The adjusted net income excludes the impact of $9 million of purchase accounting adjustments, $6 million of acquisition-related costs, and $35 million of certain significant items. Turning now to our adjusted net income statement, revenue was up about 4% operationally, excluding the impact of foreign exchange. Adjusted cost of sales was approximately 35.9% of revenues versus approximately 34.9% in the year-ago quarter. Cost of sales was negatively impacted by approximately 50 basis points related to increased sales associated with certain third party manufacturing agreements.

These agreements are related to mandated divestitures from prior acquisitions and the sales the reported in our Europe, Africa, Middle East segment. Adjusted SG&A and R&D expenses decreased operationally 2% and 1%, respectively. Adjusted interest expense was $32 million in the second quarter of 2013, a significant increase from the year-ago quarter reflecting our debt issuance in January of this year. Adjusted other income and deductions in the quarter decreased to income of $3 million in the second quarter of 2013 from income of $7 million in the second quarter of 2012.

Our effective adjusted tax rate for the second quarter was approximately 29.4% and our adjusted net income increased approximately 1% to $178 million for the second quarter. Onto our segment results, which I'll discuss on an operational basis, segment earnings are pre-tax numbers and being reported on an adjusted basis, as I described earlier. Beginning with the US, second quarter revenue was $437 million; an increase of 4%. Livestock revenue growth in the US was 6%. Growth was achieved across all species, with contributions from cattle, swine, and poultry products. Sales of cattle products returned growth this quarter, primarily based on the favorable impact of annual price increases taken in the first quarter of 2013, while volume was relatively flat reflecting the continued impact of last year's drought.

Meanwhile, sales of swine and poultry products grew at a faster rate than cattle, due largely to continued customer acceptance of new products and targeted marketing programs. Companion animal revenue growth was driven by a combination of annual price increases and marketing programs, which were partially offset by the favorable impact of weather in the year-ago quarter and the return of a competing product to the market. US segment earnings increased by 12% due to revenue growth, product mix, and operational efficiencies.

In EuAfME, second quarter results are $278 million; an increase of approximately 1% operationally. As we expected, second quarter results in EuAfME were impacted by the unseasonably cold spring weather, which delayed the start of the parasiticide season for both livestock and companion animal products. Livestock revenue in EuAfME declined 2% operationally, largely due to declines in cattle and sheep products, which offset growth in swine and poultry. Companion animal revenue grew 6% operationally. This growth, however, was largely driven by the third-party manufacturing sales I mentioned earlier. Without these sales, underlying companion animal product sales were relatively flat.

The timing of price increases year-over-year, which had a positive impact in the first quarter of 2013, resulted in a negative impact in the second quarter due to purchases being made in advance of price increases. Overall marketing conditions, primarily in Southern Europe, remain challenging due to a continued weak economic environment. Finally, EuAfME second earnings increased 1% operationally based on lower expenses in the third quarter.

In CLAR, second quarter sales were $213 million; an increase of approximately 4% operationally. Livestock revenue growth grew 4% operationally, driven by swine and poultry products, while cattle product sales declined, primarily in Brazil. Companion annual revenue grew 6% operationally, driven by increased demand and successful marketing programs in Brazil and Mexico; partially offset by the favorable impact in Canada of a competitor supply issue in the year-ago quarter. CLAR segment earnings increase by 7% operationally. This increase was primarily driven by revenue growth, while expenses were relatively flat.

In APAC, second quarter sales were $186 million, an increase of 7% operationally. Livestock revenue grew 5% operationally, driven primarily by higher demand and the continued acceptance of new swine products. This growth was achieved despite challenging market conditions for pork producers in Southeast Asia. Companion animal revenue grew 13% operationally, due to the increased penetration of key brands, as well as the successful launch of new products in the region. APAC segment operating earnings increased 11% operationally, this reflects revenue growth and flat operating expenses, which were partially offset by unfavorable mix.

Now, let us return to guidance for full-year 2013. We remain confident in our ability to deliver on our financial guidance and are reaffirming all aspects of our 2013 financial guidance for the full year, which calls for adjusted EPS of between $1.36 and $1.42 per share. As part of certain significant items, we continue to expect nonrecurring costs, largely related to standing up the Company, up between approximately $200 million and $240 million in 2013, which will be excluded from adjusted numbers. The reaffirmation of our guidance for one-time costs of $200 million to $240 million includes two largely offsetting items in the second quarter.

First, as noted in our prior filings, the completion of our separation from Pfizer triggered the accelerated vesting certain equity awards, generating an additional expense of $31 million in the quarter. In addition this quarter, we had a change to our restructuring plan that had been reserved for in 2012 while we were part of Pfizer. The reversal of this reserve of $27 million was accounted for as part of the restructuring charges related to our nonrecurring costs. Due to evolving local requirements, we believe we can achieve our objectives in a more cost-efficient manner. As a result of these two offsetting items, our guidance for non-recurring costs also remains unchanged. Including all of these items, our reported diluted EPS for the full year is expected to be between $1 to $1.06 per share.

While our quarterly results are subject to variability related to weather patterns and herd Management decisions, among other things, our annual guidance reflects our confidence in the diversity of our portfolio, the strength of our business model, and our view of the evolving market conditions for animal health products this year. That concludes my prepared remarks and now we'll open the line for your questions. Dina?

Operator, we are ready for our first question please.

(Operator Instructions)

Robert Willoughby, Bank of America.

This is Erin Wilson in for Bob today. My first question is on SG&A. What were the key factors attributable to the SG&A margin leverage in the quarter? How should we think about the quarterly progression of administrative expenses in the second half and near-term cross-structure initiatives now that you're separate or officially separate from Pfizer?

We define our expenses based on market opportunities and also the activities that we think that will be needed to support our revenues. That's why in this second quarter, you saw some decline of expenses. But this is the result of really amplified opportunities that we need to really to maximize during the quarter and then allocating the resources based on these opportunities. Maybe, Rick, you can expand on some of these comments?

A couple of things to note in our expenses to date, there are a couple of what I would call program changes as we went into 2013, to lower compensation and other costs as a percent of revenue. You'll see the benefit of that throughout the year. In addition, as Juan Ramon said, there's been good expense control into this year and also, spend on advertising and promotional campaigns not occurring as a result, for example, because of the parasiticide season in Europe being delayed. Finally, for the second half of the year, we expect the same seasonality in our expenses as a percent of revenue in 2013 that you saw in 2012, aside from some carve out anomalies, particularly in the fourth quarter of 2012.

Louise Chen, Guggenheim.

Basically, I was curious as to if you could give more color on when you expect recovery for your cattle sales and what do you have Incorporated into your 2013 guidance for that? Thank you.

Definitely, we anticipated that in 2013 that we'll see the impact of the drought. The drought has been having a lower impact than expected in poultry and swine and cattle, it's in line with the industry expectations in terms of the drought impact. Positive signs on the cattle industries that the price of grain and especially corn, is now much lower than in 2012 and also projected to be lower in the last part of the year. This is a good indicator that we'll see a significant movement of animals from pasture to feedlot and this will increase the opportunities for animal health products.

We see that the recovery of cattle will be happening in the second half. Definitely, the number of animals is lower than in 2012, but at the same time, because of the price of beef, it's still positive. The value of these animals also is higher. We expect that producers will invest really to keep these animals healthy and proactive.

Louise, this is Rick. I'll just add two points to that. With respect to your comment on how this is baked into our guidance, I'd just point out that Q3 of 2012 was the quarter where we really experienced the impact of the drought, especially in the cattle market. In Q3 of 2013, we are expecting relatively good growth quarter-over-quarter and then in Q4 of 2012, you saw, I don't want to say an anomaly, but the decisions that livestock producers were making to cull herds made Q4 relatively a good quarter for us. So if you balance those two things across 2012 and compare them to 2013, that's included in our guidance that we're reaffirming today.

Chris Schott, JPMorgan.

Just a bigger picture question here, you're seeing some nice leverage in your P&L over the past two years. As we think about the longer term model for Zoetis, is there any reason we should anticipate that your margin progression or improvement slows or even stabilizes at any point in the next few years, if in fact, the Company is able to, let's say, grow in line with an mid-single digit type of top line growth we're maybe seeing more broadly for the industry?

We have provided guidance for 2013, we have not provided yet guidance for 2014, definitely we'll provide at the end of the year, this guidance. In 2013, the guidance that we are providing is showing a significant improvement in our margins. We are convinced that the price leverage will have a positive impact in our gross margin. Our efforts in terms of being more efficient for manufacturing of our products also will have a positive impact and the discipline in managing our expenses and lowering our expenses lower than our revenues will have a positive impact in our earnings per share. In summary, we are convinced that we have the elements to make progress in terms of margin and we'll provide guidance for 2014 at the end of this year.

Kevin Ellich, Piper Jaffray.

Could you maybe talk about capital allocation and potentially, what you guys could be looking at on the acquisition front? I was also wondering if you could also mention what's driving that weakness in equine and when you expect that to recover?

Let me answer this question in general and maybe Rick will provide some additional comments. In the next couple of years, we'll be funding certain one-time cost, which are related to standing up Zoetis as an independent Company, including new systems, including the infrastructure, also including the separation of some of the plants that were also co-located with Pfizer. We also have some obligations in terms of our debt. This debt is coming due between 2016 and 2018 for more than $1 billion. Definitely after all these couple of years or three years, we'll be really discussing what will be the allocation of capital. Definitely, in terms of long-term, we'll follow a prudent cash management philosophy to ensure that we meet our commitments and also, we balance the needs of our key shareholders. We expect to be a Company that strikes the right balance when allocating capital for long-term growth and returning cash to investors.

Rick, maybe some additional comments on the one-time cost or maybe the debt situation?

Kevin, you also asked about the equine market? The only thing I would add to the point Juan Ramon made is just to say that yes, after we get through a period of elevated cost, we would like to be a Company that demonstrates very strong capital discipline in how we allocate capital. On the equine market, we are seeing a couple of factors. First of all, in Canada, a very significant slowdown in equine sales, due to perhaps a cyclical or maybe a longer-term impact in the horse racing industry. Economic and similar factors also impacting on sales in the US and generally in a few other regions as well. It's a profitable business for us, but we are certainly watching what happens in that market to understand the permanence of some of the trends that we're seeing now.

Jeff Holford, Jefferies.

Now that you're separate from Pfizer, are you able to comment at bit more about 2015 and some of the service agreements and step ups that are there and just how you're thinking about how you might be able to mitigate some of those increases in charges that come with those agreements? Thank you.

You are relating to the service that we have for manufacturing?

In manufacturing SG&A and R&D, I think there's some levels there, but particularly in manufacturing.

Lets then focus on manufacturing. The manufacturing we have an agreement for which Pfizer is producing for us some products at cost for the next two years from the separation. After these two years, the agreement is also including a margin increase of 15%, one-five, and this, at the time of the separation was evaluate about $30 million. The team has been already working on reducing these $30 million and I am pleased to see that this amount has been reduced by half already and we are working really to reduce even further before 2015 came. So you see that it's something that we are working hard, really, to minimize the impact and the impact has been already reduced significantly.

Maybe I'll just comment on some of the other areas that you mentioned. On R&D, R&D's been standalone in animal health since about 2003. I think that the majority of the relatively small amount of transitional services that Pfizer was providing to the animal health organization are pretty much behind us. On SG&A, there is a good amount of work, a significant amount of work, that remains to move us to our own transactional financial service organizations, as well as to move us off of the BT, the information technology services that Pfizer's providing to us. That will be generally complete by the end of 2015 for the IT services and generally by mid- to late 2014 for the transactional finance services.

Alex Arfaei, BMO Capital Markets.

First, on the US companion animal business, it appears a bit slower than we expected, I think only 2% operational growth. I was wondering if you could comment on that further and whether it was related to the entry of the competitor product and your outlook for that business? A follow-up if I may, how much improvement do you see in manufacturing and could you comment on your longer-term product mix expectations? Thank you.

I will answer the first question and then Rick will answer the improvement in manufacturing. In companion animal, I will describe that in the second quarter, we had two impacts. The most important one was related to the cold weather and we already described this cold weather also affecting Europe companion animal parasitic campaign. The cold weather, also the US, delayed the implementation of parasitic products to protect animals against ticks and fleas and this had an impact in our companion animal segment. We also saw that a competitor was back to the market and for our product evolution, this had an impact on the dog segments; although on the feline segment, the impact was insignificant.

Overall, I think the performance of the companion animal has been, in our opinion, positive and we expect also that in the second half of the year, will remain a positive evolution. The companion animal, we have seen that a number of adoptions is in line with expectations. We also have seen the number of visits to clinics, it's growing and also the amount that pet owners are spending per animals is also increasing. All these indicators are providing a good prediction for the second half of the year.

On your question on manufacturing and our outlook going forward, I'll just say a couple things. There's good progression from Q1 to Q2 and I think that shows good, continuous improvement, good cost containment. We continue to outlook opportunities to increase the load on our network as we make decisions on how we'll transition product made for us by Pfizer today either to a third-party manufacturer or to ourselves and then, it's capabilities that we're demonstrating now that will apply to our long-term goals beyond 2015, which we haven't enumerated at this point.

Liav Abraham, Citi.

Just a question on the porcine epidemic diarrhea virus that has recently emerged in the US. Can you comment on your exposure to swine within your US livestock revenue and whether you anticipate the impact of this virus to be material at all on your US livestock business in 2013? Thank you.

Definitely, this [P] diarrhea outbreak is a concerning situation for many of our producers. There are a couple of elements which are important to understand from this disease. First, it's not affecting the sows, it's affecting only the piglets. Second, there is not any food safety issue. That also can be a concern from consumers. These are two elements that are important that really to consider, when we discuss about this PDB. The PDB is not a new disease.

It has been already in many markets and in China, had been impacted in 2012. We don't predict any significant impact in our revenues in 2013 and the impact has been already incorporated in our guidance. But definitely, we continue working with our customers, with the producers to ensure that we minimize the impact of this disease in their operations, that can have in some of them, an impact in terms of profitability and in terms of really making sure that the operation is generating the revenues and they profits that they are expecting. Second, we are working with different stakeholders including academic institutions and one of these institutions is the University of Minnesota. We are partnering with the University of Minnesota, really, to identify ways really to protect animals and ensure that this disease is not affecting our producers. But I want really to confirm that all these impacts have been incorporated into our 2013 guidance and we do not expect a significant impact in our revenues and profits.

Mark Schoenebaum, ISI Group.

This is Wes Nurss on behalf of Mark. I have two questions of the revenue side. First is, based on the midpoint of the 2013 guidance, you're forecasting higher revenues in the second half versus first half. You mentioned the recovery of cattle sales and I just wanted to know, what are the other key operational regions for the pick up or if it may just be due to seasonality? Second question I had is, continuing to see, as you mentioned weakness in Europe. When you see that abating and what strategies, including potential M&A, do you have in place to grow the European business?

According to our guidance for 2013, definitely the second half, we grow faster than the first half. The main reason for this growth is that in 2012, we had a significant impact because of the drought. The third quarter and also the fourth quarter was impacted by the drought and the drought affected not only cattle, but also affected swine and poultry in 2012. We have seen, already, that the poultry and the swine are responding very well to these market conditions and we expect cattle to recover in the second half of the year. We have positive signs the price of the corn and also our interaction with customers are indicating that cattle will be performing better in the second half than in the first half. All these elements are really included in our guidance and are predicting stronger growth in revenues in the second half.

In Europe, definitely the economic conditions in Southern Europe are affecting Western Europe, but in our reporting segment, we are including Europe/Africa/Middle East. While in Western Europe we have seen the significant impact of the economic crisis and also the cold conditions in the second quarter that affected companion animal and also cattle, in terms of parasitic campaigns. We have markets in these regions that are growing very nicely, so countries like Russia or Middle East or countries in Africa, South Africa especially, are growing very fast. We are confident that the combination of markets in Europe also will provide positive growth in the future. Maybe a comments that is related to what are the projections that the [producers] are making for Europe for the next five years. They are predicting that the Europe/Africa/Middle East will be growing around 4% to 5%. Again, we expect that Europe/Africa/Middle East will be positive region for Zoetis.

Let me just add just a couple of points on your comment about seasonalization. Just going back to what Juan Ramon had said, Q3 in 2012 was the first quarter where we felt a significant impact of the drought.Q4, to a degree, rebounded from that, based not on any easing of the drought but on the decision that livestock producers made to cull their herds. There is, in addition to that, a degree of natural seasonality in the business where Q4 tends to be a stronger quarter and to some degree, Q2 as well. Hopefully, that helps as well.

Tony Butler, Barclays.

If I may stay with seasonality, because parasiticides in the US and Europe have been delayed in Q2, would you expect them or are you seeing signs that those are actually helping Q3 again in the US and Europe? If you expect that to be robust in Q3 relative to last year, does that actually cause a mix shift especially in the US and hurt profits, yet help profits in Europe? Thanks very much.

Thank you, Tony. We have seen that weather conditions in terms of world conditions, both in the US and Europe, are back to normal situation and pet owners and veterinarians are protecting now animals with anti-parasiticides in a normal way. This means that definitely it will must see that Q3 will be a normal quarter in terms of the use of parasiticide. Maybe you can answer in terms of the second question of Tony?

Yes, Tony, maybe I'll just add a little bit in the sense that, say, in Europe, to the extent you have an absolutely shorter season because cold weather did last longer, you may not make that up over the course of the year. The mix impact, it's not significant enough to really drive anything at the overall level. Yes, relatively speaking, there's been a little bit of a mix impact because we're not getting the sales in parasiticides, we are getting them somewhere else, but not enough at the combined levels to really change the flow of the numbers.

David Krempa, Morningstar.

Can you talk a little bit more about what was causing the decline in gross margin? I know you called out one factor causing the 50 basis point decline, but what was causing the other decline, especially after you raised prices in the first quarter?

Sure. I think the decline that you're referring to is versus the prior year. If I just start progression Q1 versus Q2, you see a nice improvement in gross margin, over 50 basis points, and that's on track with our expectations for the full year and we believe gets us to our guidance for the full year, which is between 35% and 36 percent. As I called out in my comments, we have a third-party manufacturing business that almost exclusively relates to our having to supply product for divested products to those companies that bought those products. These were mandated divestitures as part of the Pfizer acquisition of Wyeth and our acquisition of Fort Dodge, which was a part of that.

Seasonalization of those orders versus the prior year causes a year-over-year comparison that's unfavorable and then finally, the carve out financials in the prior year have some anomalies in them; in part, the progression of just better understanding how to allocate center costs Pfizer to animal health and some one-time impact from changes in mark-up and system programs that were reflected more in the second quarter than in other quarters, which made the number that we show you in Q2 2012 and our carve outs, somewhat anomalous versus the progression in 2012 and cost of goods sold for the full year. Hopefully that helps. I think the main point, from my perspective, is looking at Q1 to Q2, we're still on track for our target of 35% of 36% for the full year.

Jami Rubin, Goldman Sachs.

Either to Richard or Juan, just sort of a macro industry question. Your first half revenue growth was up 3%, you're expecting a recovery in the second half, because of the waning of the drought, to I believe about 5%. When I look across the industry, some of your competitors have reported below industry average growth. Are you still comfortable with 5% to 7% industry growth going forward, recognizing it's important to predict the weather, global warming, et cetera? But it just seems to me that as you adjust for all these one timers, we should get to 5% to 7%, but on the other hand we're going to have one-timers every year going forward. Can you just help us to think about, long-term, what is industry growth for animal health? Thanks.

Based on industry projections and [established] sources their projecting that the animal health will be growing between 5% to 7%, as you mentioned. We are confident that the fundamentals of this growth are valid. Operational growth and also emerging markets increasing significantly the consumption of animal proteins will drive this growth that will be positive in livestock, but also more option of pets in emerging markets that will increase companion animal. We are confident that this growth is realistic and we're also confident that we can be growing in line or slightly ahead of this growth depending on the years. On 2013, as we mentioned, even if the first quarter has been affected by the drought conditions, we have seen positive signs that make us confident that the second half of the year will be much positive the industry and we are reaffirming our guidance for 2013.

Kevin Ellich, Piper Jaffray.

I just had two quick follow-ups here. Curious about the cattle growth in the US and then down in Latin America. Just wondered if you have any explanation what's going on in those two markets? Juan Ramon, I just was wondering on the e-commerce business, what's your expectations and maybe you can provide a little bit more color? Is that going to be something like Vetstreet in the industry?

Let me start with the e-commerce and then I will go to the question on cattle. Definitely, the e-commerce, it's not like Vetstreet, it's a different tool. What we're doing is really providing customers the opportunity, really, to place orders directly through the system. Rather than sending the orders on paper, now they can place the order or orders to this e-commerce and this is really actually a much easier way to really order from Zoetis. The other advantage is that the system is open 24/7, so they can place orders any time they need. Definitely, this is something that we see as complementary with all the interactions that we have with our customers. We'll remain having face-to-face interactions, but in terms of this administrative work of orders we can do it in a way that it's easier and more efficient for them and also for us.

In terms of cattle in the US and in both regions, the drought has been up affected. Because even if the drought was related to the US, the drought in the US drove the price of grains and drove the price of corn, which is a key element for feeding the animals and also achieving the quality of the meat that the consumers are demanding. Definitely, in the US, we had some additional opportunities in the second quarter and that's why you may see some difference in terms of growth in these two regions. Overall, I think the market for both US and CLAR, in our opinion, its showing positive signs and we'll see also growth in the second half in CLAR and also in the US. Also, the US has been having positive evolution in terms of exports and this also has a positive impact in the revenues of the US.

That concludes our call. Thank you for your participation and interest and have a good day.

Thank you, Dina. To those joining us on today's call, we appreciate your questions and the time spent with us today. Thank you very much.

Thank you. This does conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-688-7945 for US listeners and 402-220-1370 for international. Please disconnect your lines at this time and have a wonderful day.