碩騰 (ZTS) 2014 Q3 法說會逐字稿

Welcome to the third-quarter 2014 financial results conference call and webcast for Zoetis. Hosting the call today is John O'Connor, Head of Investor Relations for Zoetis.

The presentation materials and additional financial tables are currently posted on the Investor Relations section of Zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of Zoetis.com.

(Operator Instructions)

It is now my pleasure to turn the floor over to John O'Connor. John, you may begin.

Thank you, operator. Good morning, and welcome to the Zoetis third-quarter 2014 earnings call. I'm joined today by Juan Ramon Alaix, our Chief Executive Officer, and Paul Herendeen, our Chief Financial Officer. Juan Ramon and Paul will provide an overview of our quarterly results, and then we will open the call for your questions.

Before we begin, let me remind you that the earnings press release and financial tables can be found on the Investor Relations section of Zoetis.com. We are also providing a simultaneous webcast of this morning's call, which can be accessed on the website as well. A PDF version of the slides used today will also be available on the website following the call.

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 2013 annual report on Form 10-K and our reports on Form 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. These non-GAAP adjusted figures exclude the impact of purchase accounting adjustments, acquisition-related costs, and certain significant items such as the non-recurring costs of becoming a stand-alone public company. A reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release and in the Company's 8-K filing dated today, November 4, 2014. We also cite operational results, which exclude the impact of foreign exchange.

I also want to remind you that, beginning with the first quarter, we realigned our segment reporting with respect to our client supply services organization, or CSS, which provides contract manufacturing services for third parties. The revenue and earnings associated with CSS are now reported within other business activities, separate from the four reportable segments. In 2013, CSS results were reported in the EuAfME segment.

With that, I will turn the call over to Juan Ramon.

Thank you, John. Thank you to those joining today's call.

Before beginning my comments on our third-quarter performance, I would like to introduce Paul Herendeen. Paul joins Zoetis as our new CFO this past September to lead the Company's finance and information technology organizations, in addition to being part of the Zoetis executive team. I'm delighted that Paul has joined Zoetis and is on the call today. Later he will speak with you as we review the details of our third-quarter performance.

A key element of our long-term valuable position is our ability to grow in line or faster than the market. Based on most recent data, Zoetis continued to grow faster than the animal health industry. Over the trailing 12 month ending with the second quarter, the animal health market grew by 3% according to industry sources, while Zoetis grew by 5%, with both percentages including the negative impact of foreign exchange.

Our ability to grow faster than the animal health market illustrate the fundamental strength of our business model. With the broadest product portfolio in the industry, the steady introduction of new products, and our top-ranked field force, we are able to bring value solution to veterinarians and livestock producers around the world.

Now, let's turn to our operational performance during the most recent quarter. During the third quarter, we generated operational growth of 10% in revenue and 21% in adjusted net income, delivering adjusted diluted EPS of $0.41. Revenue growth during the quarter was strong in all regions, and in both developed and emerging markets, with emerging markets delivering double-digit growth. These are a result of favorable market conditions, the strength of our diverse product portfolio, and the diversity of our global presence.

Let me now comment on our livestock performance. In livestock, we grew 13%, and growth was strong across all geographic segments. Producers are enjoying favorable market conditions in many parts of the world, with a high meat and meal prices, together with lower feed cost. On a global basis, the outlook for meat and dairy proteins remains strong. A growing middle class in China, India and all emerging markets continues to drive growth in worldwide demand for meat, eggs and dairy proteins.

Let's now take a closer look at our third-quarter performance by species, starting with cattle. Cattle is our largest species, and it grew 13%, with all regions delivering strong growth. In the United States, we saw strong demand for our premium products, while we also generated gains in market share.

Swine revenues grew 17% despite the challenge of Porcine Epidemic Diarrhea virus, or PEDv, in a number of countries. All regions contributed to this growth, and we continue to expand our swine product portfolio through the introduction of vaccines with new antigen combinations, as well as resistant and commercializing products in new markets.

Poultry revenue grew 7%, with strong contributions from the emerging markets within the European, Africa, Middle East region.

Now, turning to companion animal: Companion animal grew by 5%, aided by sales of Apoquel in the US and several European countries. Strong growth of key brands in the US and Europe was offset by the introduction of new products from competitors, and the impact of distribution changes in Japan.

While competition has affected our results in parasiticides and vaccines, we are confident in our ability to participate in these and other growing market segments, as we introduce innovative products to the market. For example, we are preparing for European launch in 2015 of Versican Plus, a new line of canine vaccines. I will cover Versican Plus in more details when I discuss new products and milestones.

We can also confirm that, in April 2015, we expect to significantly increase Apoquel supply. With a greater supply, we expect to begin offering Apoquel to new customers. We continue to receive very positive feedback from customers about this [result]. Based on current market conditions, we believe Apoquel can achieve annual sales of approximately $200 million to $300 million at peak sales, which normally it is five years after a product introduction.

Now, I would like to share with you several product milestones that illustrate how our singular focus on animal health and our core capabilities allow us to put our customers first and bring solutions to their most pressing animal health needs. Earlier in the quarter, we announced that we obtained a conditional license in the United States for our vaccine to help fight PEDv in pigs. Under a conditional license, we demonstrate safety in a field study, and provide [reasonable] expectations of efficacy. We are now conducting additional studies to demonstrate efficacy and to obtain a full license from the USDA.

The PEDv vaccine has been received very positively by swine customers, and is available to them ahead of the cold weather when the virus is more likely to spread. We were able to bring this vaccine to market in only 14 months by leveraging our three interconnecting, [tele-connected] capabilities. Our R&D capability and the expertise in biologics allow us to fast-track the development of a PEDv vaccine. Manufacturing and scale-up capability enable us to produce enough of the vaccine to meet projected customer demand.

Now that the product has been launched, Zoetis representatives and our field veterinarians are partnering with customers on how to incorporate the new vaccine into their protocols and biosecurity programs. Development of this vaccine is an example of how we leverage our capabilities to bring solutions to our customers.

This past quarter, Zoetis also received a full license for the first poultry vaccine targeting Georgia 2008 Type IBV. The full license followed the USDA conditional license that Zoetis received in late 2013. This is the first commercially available vaccine to help reduce diseases caused by the virus strain.

In our companion animal business, we received European approval for Versican Plus. This is a combination canine vaccine that provides [unmatch respiratory] protection, as well as a greater convenience and flexibility for veterinarians. It provides protection against 10 bacterial and viral infections in one vaccine dose. By offering multiple vaccine combinations, Versican Plus provides a comprehensive solution for European markets that accommodates a broad range of vaccination protocols. We are now preparing the launch of Versican Plus in European Union in 2015.

Also, we announced the formation of a new collaboration with Easter Bush Research Consortium that is focused on combating emerging infectious diseases in Europe. Zoetis will partner with other in this consortium to detect and identify emerging infectious diseases early, and to develop medicines and vaccines to treat and control them. Zoetis is the only animal health company in this consortium. Collaborations like this one contribute to our ability to be first-to-know about emerging infectious diseases, and aspires to be first-to-market with new products to diagnose and prevent diseases.

Before I ask Paul to walk us through the financials and provide details on our 2014 guidance, I would like to remind you of our upcoming investor day. We are very pleased to be hosting an investor meeting on November 18 at the New York Stock Exchange. The goal of the meeting is to enhance understanding of the animal health industry, the key drivers of Zoetis market leadership, and the strategies for future growth. I will be joined by the Zoetis executive team for a discussion of our regional businesses, R&D approach, manufacturing and supply chain operations, and financial goals.

With that, Paul?

Thank you, Juan Ramon, and good morning. It has been a very busy and productive first two months, and I'd like to say that the more I learn, the more confident I am that the fundamentals of our industry, our team here at Zoetis, and the strengths of our capabilities provide us with the opportunity to create value for our stakeholders. I will speak more about all this in two weeks at our investor day, but now let me dive in and review the third quarter a little more deeply and to discuss our guidance for 2014.

Turning first to the income statement slide: For the third quarter, revenue was approximately $1.2 billion, an increase of 10% year over year, on both a reported and operational basis. Reported net income was $166 million or $0.33 per diluted share in the third quarter, an increase of 27%. Adjusted net income was $207 million or $0.41 per diluted share, representing reported growth of 20% and 21%, respectively.

Adjusted net income from the quarter excludes the after-tax impact of $41 million or $0.08 per diluted share for purchase accounting adjustments, acquisition-related costs, and certain significant items, the majority of which were related to stand-up costs.

Now let's take a minute to discuss currencies. In the third quarter, foreign exchange did not have a material impact on our revenue or income growth. It is important to remember that our three international business segments have an earlier quarter close than the US segment. The third quarter for the international segments closed at the end of August, with the US segment closing at the end of September. Looking ahead, we expect to see a negative impact on revenue growth in the range of 250 to 300 basis points in the fourth quarter, based on current rates, and we expect to see a similar magnitude of impact in 2015.

Now, let's turn to our adjusted income statement slide, which I'll discuss on an operational basis. Again, because FX was not a significant factor in the third quarter, operational revenue growth was 10%, the same as reported. Livestock comprised 65% of sales in the quarter, and grew $88 million or 13% operationally. Companion animal comprised 34% of sales in the quarter, and grew $20 million or 5% operationally.

Adjusted cost of sales was 35.5% of revenue versus 34.7% in the year-ago quarter. That's due to the buildup of central manufacturing supply chain operations. This buildup was completed by the end of 2013, and those higher costs are now flowing through our cost of goods sold.

Adjusted SG&A, meanwhile, increased by 2% operationally in the third quarter. In other items, adjusted R&D expense was flat operationally. Interest expense was flat at $29 million in the quarter.

Our effective adjusted tax rate for the third quarter was 28.3%. I would not read too much into our tax rate in the quarter. What's important is that we expect our rate for the full-year 2014 to be consistent with our guidance, which is approximately 29%. Again, our adjusted net income was $207 million, representing a growth of 20%, or 21% operationally.

Now, let me talk for a minute about how we are tracking year to date on a few elements. This was a great quarter, but we always want to keep in mind the full year. That's because of the nature of our Business, the cycles in the animal health industry, and fluctuations in currencies in any given year. In looking at any quarter relative to the prior year, a lot of noise can creep in. The longer the time period you look at, the more that noise cancels itself out, and you can see a clearer picture of the underlying trends in our Business.

We focus on full calendar years, and do not guide or manage to quarterly results. While it feels great to put a quarter on the board with such strong revenue and profit growth, the bigger picture is that we are on track to deliver on our guidance for the full year.

That said, let's take a quick look at the nine months year to date, and compare that back to 2013. We are tracking in line with our revenue expectations through the first nine months, growing revenue 6% on an operational basis. Our guidance range implies full-year 2014 operational growth of 5% to 6%. Our adjusted cost of sales is at 34.9% of revenue on a year-to-date basis. As I said earlier, we continue to expect our cost of sales to increase as a percent of revenue for the year, bringing us in line with the full-year guidance of approximately 35.5% of revenue.

Finally, adjusted net income is also performing in line with our expectations, growing at 13% on an operational basis year to date. These year-to-date performances are in ranges that are consistent with our expectations. I'll discuss the implications on our full-year guidance in a moment.

Now, let's turn to our operating segment results. Again, I will discuss these on an operational basis, but it should be noted that the segment earnings are on a pre-tax basis, and are presented on an adjusted basis.

Beginning with the US, third-quarter revenue was $532 million, an increase of 7%. Sales of livestock products grew 12%, with cattle and swine as the main contributors. Growth in cattle products benefited from higher demand for our premium products, as producers continue to see strong market conditions.

With higher prices for beef, and lower input costs, producers are moving lighter animals into feed lots sooner to meet the market opportunity. These cattle can be more vulnerable to illness and disease, given their age and weight, and require more use of medicines and vaccines to maintain their health. These market conditions also mean our customers place more importance on using our premium products to protect their animals and investment.

Meanwhile, swine product sales were driven primarily by the success of several recent, new product introductions such as our Fostera PCV M. hyo combination vaccine, the Draxxin 25 anti-infective product for swine and our Engain ractopamine product for use in feed. This growth in swine was slightly offset by the continuing impact of PEDv, which Juan Ramon mentioned.

In companion animal products, we generated operational growth of 2%, driven by Apoquel and other key brands such as ProHeart 6, Cerenia and Convenia. This growth was offset, however, by increased competition in vaccines, pain products, and parasiticides. In summary, the US segment earnings increased by 10% based on the quarter's strong sales and lower expenses.

Now, turning to our Europe, Africa and Middle East region, or EuAfME. Revenue in EuAfME was $293 million, an increase of 12% operationally, compared to the third quarter of 2013. The growth was a combination of double-digit growth in both developed and emerging markets. Sales of our livestock products increased 13% operationally, as the region delivered positive results in France and the UK, as well as in emerging markets. The livestock growth was driven by increased sales across all species, with particular advances coming from cattle and poultry products.

In France, for example, we saw an increase in the sales of anti-infectives, as customers sought to buy product ahead of more restrictive legislative changes. In the UK, we saw strong demand for cattle products. Meanwhile, sales of companion animal products increased 11% operationally, primarily driven by sales of Apoquel in Germany and the UK, as well as growth in parasiticides such as the Stronghold brand. EuAfME segment earnings increased 28% operationally, primarily due to the revenue increase, improved gross margins, and lower operating expenses in the quarter.

Turning to our Canada and Latin America segment, or CLAR, third-quarter revenue was $194 million, an increase of 17% operationally compared to the third-quarter 2013. In this region, we saw significant growth in emerging markets such as Venezuela, Brazil and Argentina, and also in Canada.

Overall, for the segment, sales of livestock products grew 16% operationally, and sales of companion animal products grew 19% operationally. Sales in Venezuela and Argentina grew significantly across all species. In Brazil, there was significant growth driven primarily by sales of cattle products, including new product launches, and growth in key companion animal brands such as Vanguard, Cerenia, Revolution and Convenia, as this market continues to expand at a high rate.

Meanwhile, growth in Canada was primarily driven by sales of companion animal products. This was the result of a later spring season than last year, which had a positive impact on the growth of parasiticide sales for this quarter as compared to the last-year quarter. Strong volumes in cattle and swine products also contributed to growth in Canada. CLAR segment earnings increased 19% on an operational basis, driven by revenue growth, limited growth in operating expenses, and partially offset by a decline in gross margin.

In Asia-Pacific, or APAC, third-quarter sales were $179 million, an increase of 7% operationally compared to the third-quarter 2013. Sales of our livestock products grew 9% operationally, driven primarily by sales of cattle products in Australia, and growth in Southeast Asia from recently launched swine products. In Australia, we are seeing more cattle moving into feed lots and requiring more treatment, as Australia continues to see the impact of drought on its cattle businesses. In the swine, we continue to see strong sales, driven primarily by an increase in sales of our vaccine portfolio.

Sales of companion animal products, however, were flat operationally due to an inventory buyback related to the termination of a distributor agreement in Japan. Excluding this event, operational growth would have been 8%, driven by sales of parasiticides, equine vaccines in Australia, and increased sales of vaccines in China. APAC segment operating earnings increased 24%, due to revenue growth, improvements in gross margin, and a decline in operating expenses. That's on an operational basis.

Now, let me turn to guidance for the full-year 2014. As I mentioned earlier, we think about and manage our Business on an annual basis, and not quarterly. There can be a lot of variability in any individual quarter. For example, in revenue, the variability can be due to changes in weather patterns or seasonality associated with certain product lines.

In R&D expenses, for example, the quarterly variability may be based on project schedules and conditions needed to complete field trials. Our R&D spend, for example, tends to be heaviest in the fourth quarter. Over a full year, that variability, which you have seen in pockets this year, historically evens out, and we are able to deliver a steady and predictable performance when measured on an annual basis.

Remain confident on our ability to deliver on our full-year guidance for 2014, and we are reaffirming our adjusted earnings per share for the full year, and narrowing our revenue guidance towards the high end of the range. We now expect reported revenue of approximately $4.7 billion to $4.75 billion for the full year. This guidance would imply full-year reported growth of 3% to 4% for revenue, and includes a negative impact of 2 percentage points from foreign currency. This also implies an operational growth of 1% to 5% in the fourth quarter, and that's when compared with a strong fourth quarter in 2013. After taking into consideration the current FX environment, reported revenue growth could be 250 to 300 basis points below the operational growth rate in Q4.

Our guidance on adjusted cost of goods sold for the full-year 2014 remains approximately 35.5% of revenue, roughly flat year over year. This reflects the anticipated benefit of price, volume, and ongoing cost savings efforts, which is forecast to be offset by the full-year impact of costs incurred to build our central manufacturing and supply functions, as well as unfavorable mix. We understand this implies our fourth-quarter cost of goods sold as a percentage of revenue will be higher than what you've seen to date. However, we believe our 2014 full-year guidance of approximately 35.5% of revenue is a better reflection of our underlying cost of goods sold.

Adjusted SG&A expenses are now expected to be between $1.46 billion and $1.48 billion. We continue to see good OpEx discipline in the regions, which is helping to mitigate increased spending in our general and administrative functions, where we continue to build out the infrastructure to support our Business on a fully stand-alone basis.

Adjusted R&D expenses are expected to be between $385 million and $395 million. We continue to deploy resources responsibly in R&D, as this investment is fundamental to the enhancement and protection of our existing portfolio through lifecycle developments and the development of innovative new products to help fuel additional growth.

We continue to expect our effective tax rate on adjusted income to be approximately 29%. This guidance does not reflect the potential extension of the US R&D tax credit.

We continue to expect adjusted EPS of between $1.50 and $1.54 per share for the full year. This guidance would imply full-year reported growth of 6% to 9% for adjusted EPS, and reflects a negative impact of approximately 200 basis points coming from foreign currencies. Please note that our guidance does not reflect any further currency devaluation in Venezuela.

Separately, we now estimate pre-tax charges for 2014 of between $180 million and $195 million, primarily related to stand-up costs and acquisition-related costs. These charges are excluded from our adjusted earnings guidance. Including the impact of these items, as well as purchase accounting adjustments, our guidance for our reported diluted EPS for the full-year 2014 remains between $1.16 and $1.20 per share. This annual guidance reflects our confidence in the diversity of our portfolio, the strength of our business model, and our view of the evolving animal health market for the remainder of the year.

To sum up the quarter, we had a very strong revenue and earnings growth quarter in all regions, demonstrating the strength of our business model. We demonstrated an ability to drive gross margin improvements and operating expense containment in our regional segments, while continuing to absorb some of the impact of the build-up costs associated with our corporate functions. We saw no material impact from foreign currency on our growth this quarter, but anticipate more significant effects on our future results. We are reaffirming our guidance for the year, despite the expected currency headwinds in Q4.

That concludes my prepared remarks, and now we will open the line for questions. John?

Thank you, Paul. Operator, we are ready to take the first question.

(Operator Instructions)

Chris Schott, JPMorgan.

Thanks very much. Congrats on the quarter and the, Paul, congrats on the new role. Two questions here.

First, can you elaborate on the US companion business and the competitive dynamics there? I think last quarter you mentioned you were increasing some of your promotional investments.

Any sign those investments are having an impact? When should we think about that business starting to maybe turn around a little bit more?

Then a question for Paul, as your stepping into the CFO role, can you just elaborate a little bit more on your priorities? Specifically, what are the biggest opportunities you see at Zoetis when you look at the Company's margins, tax rate and capital structure? Thanks very much.

Sorry for the interruption, this is the conference coordinator. It appears that we're experiencing technical difficulties at this time. Please standby.

I hope now the line is fine and I will be able to answer your questions, Chris.

Sir, you may now proceed with your answer.

Okay. Chris, it is Juan Ramon. I will answer the question on US companion animal dynamics.

There are different factors driving the market in the US in companion animal. The interaction of new products, mainly in parasiticides.

Now the market is moving more to oral parasiticides compared to the previous more topical ones, with interaction of two main competitors in this market. We are participating in the market in the topical but not on the oral.

The other changes that we have seen is that the interaction of a new vaccines in the US, that also they are impacting our performance. Finally, in the pain market in where we participate with Remadyl based on the brand. There are also new factors affecting our performance.

One, it is a competitor that was out of the market in 2012. It was back in 2013, and now, its full revenues and also maybe part of the shares that we gain when this competitor was not participating in that market is now back to the more normal situation. Also, the interaction of generic competition for Remadyl on the chewable formulation, although this has not been represent in a significant impact so far.

Now, I will ask Paul to answer your question.

Thanks, Juan Ramon and Chris, thanks for the questions. I've been here about 60 days and I'll tell you that the first thing I see as an opportunity, or I should say more as a priority for me, is to help us get complete with the standup process. Until we get through that, I think that it is going to somewhat mask our Company's cash flow generation capabilities, because it obviously, while it doesn't affect adjusted net income, it obviously is a cash flow item. In terms of a priority, both getting us past that stand up activity and getting the G&A infrastructure built to the point where it can support this global business has been very high on my list.

That said, walking down through the income statement there are opportunities for us to continue to drive operating margin improvements over time. I think these are themes that you've heard from the other members of the team as you go back.

We've had very good expense control in our commercial groups. That's been a little bit masked by the build up of costs in G&A. Again, once we get through that we will get to a more of a more normalized run rate for our OpEx.

There are opportunities in the gross profit margin when we look at ability to continually benefit from price increases. Second, from improvements in efficiency in our plant network structure. Those are things that although they will happen here in the near term, I think that it will take us some time to generate the most meaningful portion of those margin expansion opportunities.

Part of your question was around the tax rate. When we spun out from Pfizer, we started with a tax rate -- or we could had a tax rate in the 40% range. We were able to put in place a structure that enables us to have that tax rate down in the neighborhood of 29%, so good from the perspective of a structure that allows us to have a much lower tax rate.

Thinking ahead, I think that our ability to manage that tax rate is based on opportunities to present themselves to us that fit within our structure. I would not expect to see revolutionary changes in our tax rate, although we will do our level best to manage that tax rate down over time.

I think your last question was around capital structure. This Company, we wanted to maintain a level of debt in their cap structure. You certainly know me from my prior employer, and I like debt. We like debt.

There's a role for debt in our capital structure. We've expressed a target of 2.5 times trailing 12-months EBITDA. That's an appropriate debt load, but I will say that's a target.

It is a target where, if there were an opportunity and we were called upon to lever up a little bit, we would do that. Then, we would endeavor to reduce our debt over time back towards the target.

And I will stop there. Could I get the next question please?

Kevin Ellich, Piper Jaffray.

Thanks for taking my questions. First, Juan Ramon, could you give us a little update on the competitive landscape? Sentinel Spectrum went to a competitor. Wondering what your thoughts are?

Also, you talked about oral parasiticides, just wondering what's on the horizon for your product portfolio? Then for Paul, you've been with the Company now for only a couple months, congratulations again. I'm sure it's been like drinking through a fire hose, but just wondering if you could give us your puts and takes from when you decided to join the Company until now?

And also, an update on the inventory issue in Japan with the distributor? Thanks.

Thank you, Kevin. I will answer the questions on Sentinel and oral parasiticides. Definitely, as a leader in this industry, we see any transaction or any potential transaction in the market and also we are active assessing any opportunity. Definitely, Sentinel was an opportunity that we explored and, as you see, we decided not to participate in this transaction.

We talk about what our programs or plan on oral parasiticide, definitely, we see oral parasiticides an important part of preventing animals, dogs and cats, against ticks and fleas and also heartworm. I would like to postpone the details of my answer to the investor day, when we have the opportunity to provide to investors and analysts a more comprehensive view of our R&D approach and also some of the areas in where we are investing.

Kevin, I will pick up from there. It is Paul.

Your question was around puts and takes from prior to joining. I've been here, it is almost exactly 60 day's I think. As of today it is 61 days.

When I first looked at the opportunity, I think the thing that attracted me to it was first, looking at the industry, a global industry that grows consistently over time, so solid underlying, macro trends. Then, you look at the Company Zoetis.

Here's the Company that's a market leader with the broad portfolio, very durable revenue streams. Remember, from my experience at Warner Chilcott, we had the opposite of the durable revenue streams.

Everybody was always concerned, and I looked at this and said, here's a company that has the opportunity to put consistent revenue growth on the board by levering its broad portfolio and driving growth of those assets through -- application of sales force is very similar to what I was used to at Warner Chilcott. Also, supporting those brands through productive R&D, both in terms of extending product life cycles, in terms of providing fuel to allow the sales forces to grow the overall revenue base. Lastly, to add of those truly innovative products that give you the opportunity to step up and accelerate your growth.

I looked at this as being a similar economic model to the pharma business but with those important differences of longer duration, revenue streams, less reliance on IP -- it's about the brands -- same levers to drive the business, using your field sales resources face to face with your customers to go out and drive revenue. Lastly, supporting that portfolio through productive investment in R&D.

I say that though that was my analysis coming in, and 61 days later, I think it is a terrific company. What I've been most impressed with is the ability of the Company to execute consistently and drive revenue that exceeds the overall market growth.

It is been quite an interesting couple of months here. Again, the most import thing was we have got a great team here that knows how to drive this business. I will stop there.

Oh, I'm sorry. You had a question about inventory in Japan. That was related to the termination of a distributor agreement. It is a normal course. It came to the end. We were called upon to buy back some inventory, and that's what's going on there.

Next question please.

Jami Rubin, Goldman Sachs.

Just a couple questions. Specifically on the outlook for gross margins. Paul, you talked about gross margins getting hit in fourth quarter. I imagine that's largely due to FX.

In light of global pricing pressure, maybe, Juan you can touch upon that up what you are seeing across all your different geographies? In light of that competitive dynamic, how do you see the outlook for gross margins? Do you think that gross margins can expand in 2015 and 2016, or should we assume that pricing pressures would offset volume growth and cost cutting or slimming down in manufacturing?

If you could just talk to number one, pricing, global pricing pressures? Number two, impact on gross margins?

The other question was, just to Paul, was there any channel loading in front of the new vaccine launches? Thanks very much.

Paul, congratulations on what sounds like a terrific opportunity for you.

Thank you, Jami. We continue seeing opportunities of applying price increases across all geographies in where we operate. Definitely in 2014, we have been increasing prices in the US, also in Europe, in Canada, Latin American and Asia-Pacific.

We also apply quite an aggressive approach in some markets with high inflation rates. This, I think, that we have been and seen a positive impact in our revenues, also because of this price study.

In terms of the expansion of gross margin, definitely we'll have the opportunity to cover that in our investor day. We will provide more details on what can be our objective for the future. I would like to delay the details until this investor day.

The last comment on the channel loading, so we are not loading the channel. This something that the vaccine launches will be next year. Normally, we apply a very strict procedures to avoid that we are increasing inventory that is not needed to meet customer demands.

Hi, Jami. It is Paul. You had a question regarding Q4 margin. I want to make sure I address that because it is an important point.

You said FX impact. Yes, there is FX impact across all of our line items through our P&L. However, the main reason for the expected increase in cost of goods sold as a percentage of revenue in Q4 is related to that timing of increased headquarters costs, which are flowing through our cost of goods sold in the second half of 2014.

I wasn't here when the folks articulated that, but I think that they provided some guidance that you should expect the cost of goods sold as a percentage of revenue to rise as the year went on. But, that the guidance level, which is, I think, the important statistic is, we do expect to be in line with our guidance for the full year, which was 35.5%. I say broadly, looking ahead without providing guidance, I think we have the opportunity to absorb those increased HQ costs in 2015 and beyond without having it have it deleterious affect on our margin.

Thank you.

Alex Arfaei, BMO Capital Markets.

Thank you for taking the questions. Congratulations on the quarter.

Regarding your investor day, you said that we're going to see some financial targets. I just want to clarify. Are you going to provide some sort of medium- to long-range guidance or targets beyond 2015?

The follow up, there have been a lot of reports about potential buyers for your business. Obviously, in 2015 after June 2015 this will become more of a factor.

Just could you comment on your overall strategic view about how relevant is that for you? How would you evaluate such opportunities?

Just give us an overall sense of how you would think about that? Obviously, in the second half of next year, there's going to be a lot of focus on that, so how should we think about your position on being a target of a potential acquisition? Thank you.

Let me ask Paul to answer this question.

Sure. I will start with the investor day. We will provide a look, what I'll call our normal guidance look at 2015. In addition, we will provide our thoughts around 2016 and 2017, not in the same level of detail, but in a way that would enable the market at large to get their arms around what our expectations are for the next several years. With respect to the second question?

We cannot really respond on other company's strategy. We think that we have a solid business, that we can provide significant value to our shareholders. We are showing that we are meeting our objective in terms of revenues, in terms of adjusted net income.

We are also, very important, growing faster than the market. All these, in my opinion, is a showing that this Company is well managed.

We also have a significant generation of cash over time. Then, this will be additional opportunity for investors.

John Kreger, William Blair.

Hi. Thanks very much. Paul, I think you said your first priority was to focus on the standup activities. Can you just elaborate on what's still left to do on that front?

Second question, I believe you guys have said previously that you expect about maybe 20 basis points of manufacturing cost headwind as we move into 2015. Is that still a decent expectation? Thanks.

Sure, it is Paul. First, the primary task that remains to be completed is the completion of the implementation of a global ERP system, where we are installing SAP. It is very important to us to have that backbone for our Company to support our decision making and the management of our business on a global basis, number one. It's also important to us because it is important that we stand on our own away from Pfizer.

That is a top priority for me now. It is not just the implementation, it is also the build out of the team, what we call it business technology, so BT. I will use the more familiar IT acronym. We are continuing to build out that function here in headquarters to support our business, and so that is the primary area where we continue to have some work to standalone away and apart from Pfizer.

Second, with respect to the manufacturing headwind. You recall that we have a supply agreement with Pfizer, which has some increases in cost that we need to absorb.

I think we are doing a good job of ringing efficiencies out of our manufacturing process that have enabled us to offset a solid part of those increases that are in that contract. We're not going to provide guidance today on what it looks like into 2015, but I will just give you the factoids that you should keep in your head.

We have the opportunity to pull the price lever. We have the opportunity to manage our global supply chain and drive better efficiency.

There's always a favorable mix to the extent that our higher-margin product lines provide more of our overall revenue base. I would say, yes, we are always facing headwinds or we are facing some headwinds looking into 2015, but those are challenges that we have a solid opportunity to overcome.

Great, thanks very much.

Louise Chen, Guggenheim.

Hi, thanks for taking my questions. I had a few. The first question for Paul is, since you've joined Zoetis, what are some new initiatives that you plan to implement at the Company that could help drive earnings well above the $2 per share mark?

Then secondly, as a Company, do you have any interest in companion animal oncology or biologic drugs? We've seen a lot of smaller companies develop these products. I'm just wondering if that's a truly good opportunity or not?

Then lastly just on Apoquel, is there any you can quantify what sales would have been in 2014 had you had enough supply? Then in 2015, how should we think about the sales ramp? I know you'd said $200 million to $300 million in peak sales over normally a five-year timeframe, but could you get there faster? Thank you.

Thanks, Louise. It is Paul, I will take the first part of that. New initiatives to drive growth, I'd say new the initiatives on me, I get to step in behind others who are already activating those sorts of strategies in order to drive longer-term growth, but as -- just referencing back to my past life. The similar sorts of levers that you would expect me to pull, and those include a focus on value-generative business development activity, that would include using our existing tax structure to manage that tax rate in a downward direction.

I think that things that I focus on, also, are the active management of our capital structure and thinking about ways that we can deliver value to our stakeholders, really, across the board, both from operations and from the management of our cap structure. Those are the initiatives that I've had.

Then, the second question was the companion animal?

Yes, just curious if you think the oncology or biologics opportunities that some of these smaller companies are pursuing are actually real opportunities? Because I haven't seen the larger companies go after that, so just curious?

I will take this question and let me say that in oncology, Zoetis was the first company launching a product that it was fully developed to treat cancer for dogs. This product was Palladia that we launched two or three years ago.

We see that oncology, it is important in companion animal. It is, today, in many cases veterinarians are still using products developed for human to treat cancer in dogs or cats, but we think that in the future maybe there will be new products that will be better targeted for treating this kind of diseases in companion animals. Definitely, we will be assessing this opportunity and considering the internal or external opportunities to complement our portfolio.

In terms of bios, I think it has been a key area for Zoetis. We have a very strong portfolio in both the companion animal and livestock. We continue investing in bringing new products of our portfolio and also to strengthening our offer to our customers.

Finally, on Apoquel. In 2014, we have communicated that our revenues will be around 1% of our total revenues. This has been because of the limitations in terms of our product supply. Speculating how much will be the sales of Apoquel with unrestricted supply, probably is not adding to much value.

What I think, in my opinion it is important, is that for 2015, we expect to generate more than $100 million in revenues. We expect definitely to generate these revenues, basically on nine month of full supply, because we expect to have this product available to more customers from -- so that's why we are now communicating that we expect that this product has a potential of $200 million to $300 million at peak sales.

Thank you.

Douglas Tsao, Barclays.

Hi. Good morning. Just to start, I think I'm trying to understand and I've gotten some questions trying to understand the sequential guidance in terms of revenues. Obviously, they were really strong this last quarter. If I look at your historical seasonality, 4Q seems to be up pretty meaningfully from 3Q.

Just understanding some of those dynamics as we move into the fourth quarter that we should be aware of? Certainly, the FX guidance seems to be a little bit more extreme than I would have expected.

Then, the other question is in terms of the PEDv vaccine. Just perhaps provide some perspective on how big an opportunity that can be for you and the timing of that coming or the revenues building on that product line? Because obviously, very impressive how quickly you were able to get a product approved and to market. Thank you very much.

It is Paul, I will take the fourth quarter and how do you get there. We have three quarters on the board, so the year-to-date number's on the board.

We have guidance. You can do the math and see what it implies with respect to revenue growth in the fourth quarter that's implied by that.

Mid point of the range it is, for on a reported basis, it's flattish. We did state that there's about a 250 to 300 basis point negative impact to our revenues in Q4 versus Q4 of 2013, so fairly significant FX headwinds. It does give me the opportunity to say look, we feel ike we are, from an operational perspective, we have a very strong quarter here and very strong guidance for the full year.

That's pretty good when you are facing those sorts of FX headwinds that will almost certainly, in fact I would say certainly, will hit us in Q4 of 2014 compared back to 2013. Frankly, as you think ahead to 2015 via 2014, you got to take this into account. For perspective, 45% of revenue comes from our US.

We're US-dollar denominated. We are exposed to the euro, the real, the Canadian dollar, Aussie dollar, sterling, yen.

From the perspective of a US-dollar denominated P&L, of those currencies I mentioned, there's not a lot of good news. There's a lot of headwind there, so we fill like our guidance for the full year and our guidance for Q4 is pretty strong given that we are facing those headwinds going into Q4.

I think I'll leave it at that. Juan Ramon?

I will answer the question on the PEDv. Just to provide a little bit of understanding of the market's potential.

First, this vaccine it's targeting sows. Then, by vaccinating the sows, it's transmitting the immunity to the piglets.

The number of sows in the US, it is a little bit less of 6 million compared to 100 million of pigs of the total market. You see that the potential is related to the number of animals that will get this vaccine, but will be less than the 6 million.

The second factor that is also important is that we obtain conditional license. Under the conditional license we have had some limitations in terms of the promotion. Definitely, we can go to the customers and work with them to ensure protection for the sow, but there are some limitations in terms of promotion.

What is important here is not the size of the revenues, but the confirmation that our business model is working very well. We have very strong capabilities in terms of R&D. Also, we have very strong capabilities in terms of our manufacturing to produce vaccine in a way that it's going to the market very fast.

In our opinion, we are bringing with this vaccine, significant value to our customers, that they are facing a significant challenge with this disease, and we are confirming that Zoetis has all the capabilities that are needed to succeed in this industry.

It's Paul. I just do want to follow up the one thing that I didn't say in the remarks about Q4 is, also take a look at the quarter you're comparing to back in 2013. Our Q4 was quite strong, if you go back to 2013 and you look sequentially, Q3 of 2013 like $1.1 billion, Q4 of 2013 $1.254 billion, I think it was. Yes, it was about little over $1.2 billion. One is, comparing back to last year's Q3, that certainly helped us in putting our good quarter on the board here in Q3 of 2014, but that's a tough comparison quarter, Q4 of 2013.

Paul, just to clarify, you don't think that necessarily that step up of $150 million sequentially is like a normal, seasonal trend that we should think about?

From 2013, what I would say is -- and I want to make this point over and over and over again. Because of the nature of our business in seasonality and how things can shift from September to October or across a month, the best way to look at us is the longest time period that your comfortable with, whether that's a year, a half a year, whatever. If you looked at the second half of 2014 versus 2013, it is a good solid second half of 2014.

Okay. Great, thank you very much.

Mark Schoenebaum, Evercore ISI.

Thank you for taking my question. It is actually [Voladin Kolenka] sitting in for Mark Schoenebaum.

The question -- sorry for maybe beating dead horse. The question about the Q4, the current full-year guidance implies that from Q3 to Q4 of this year, so your quarter-by-quarter growth, it is probably going to be down quarter for revenue and for EPS. So I'm wondering if you can explain that?

In terms of expenses what happens in Q4? Is it just seasonal stuff or something else?

In terms of revenue, we understand it will be a huge FX impact, but also just for FX just to understand better how it works for our models. I'm wondering if you can give more color about the type of hedging that you are using both for revenue for top line as well as for EPS? Thank you very much.

Okay, stay with me here, because I want to make sure I understand your question. I think you started by asking about sequentially from Q3 of 2014 into Q4 of 2014. If you take the midpoint of our range it would be up in Q4 versus Q3. So sequentially, at the midpoint of our range, you would have an increase in revenue, Q3 2014 into Q4 2014.

The other thing to point out is we talked about the impact in the quarter of the increased cost of goods sold as a percentage of revenue. The implied is it's going to be a high percentage, and we called that out, even in my prepared remarks. So, you've got that.

Then within SG&A, we typically do spend more towards the back half of the year. That's been a historically observed phenomenon within our business. Certainly, within R&D, there is seasonality in our spend there.

We talk about the timing of trials that we can do in the field. You need the right conditions in order to be able to do that. The timing of projects, generally, ours have seemed to cluster and have us with more expensive in R&D in Q4.

You put all of those things together, yes, and in looking at Q4 on a standalone basis, you could say, well, gee, against whatever comparator you want to have, whether it's Q3 of 2014 or Q4 of 2013, it is a tough comparison. Again, strong, full-year expectation for the Company.

You are looking for reported growth in the neighborhood of 3% to 4% at the top line, and that's on an operating basis taking FX out of the mix. Now, this is revenue, expecting 5% to 6%. Think of that reported 3% to 4% range as, but for FX, that's 5% to 6%, which is a very solid, full-year revenue growth 2014 via 2013.

I'm sorry, the second question?

The second question about the hedging. What type of hedging you guys using to hedge your top line and bottom line, if you do use hedging instruments? If you using specific instruments or rely on natural hedging? If there is natural hedging between regions, what is the delay between when currencies move and the impact when you can see?

A couple things. We have natural hedges built in to markets where we have a significant presence because, of course, our costs are denominated in the same currency as our revenue streams. We do not hedge our top-line nor our bottom-line results.

Like most companies, we don't. We are subject to the changes in exchange rates. Frankly, if you look at them, again, my favorite phase, over a long enough period of time, you see that those things sort themselves out.

Where we do hedge is our net asset exposures in our subsidiaries. So, to the extent that we have risk, when those balance sheets are translated that we can hedge that and keep those costs within a relatively narrow band. We do, do that. Those costs, as well as the FX gains or losses, would show up in our other income and deductions line within our P&L.

David Risinger, Morgan Stanley.

Yes, thanks very much. I have first some questions for Juan Ramon and then for Paul.

Juan Ramon, first, could you just talk about animals moving into feedlots sooner in a little bit more detail? Specifically, what I'm hoping for you to address is how durable that is? So for how many quarters will that be benefiting Zoetis?

Second, you've mentioned the Apoquel revenue for 2015 being over $100 million. Could you just help us benchmark that by providing a framework for what revenue you're going to be booking in 2014 for Apoquel?

Then third, for the PEDv vaccine, you mentioned 6 million sows as the opportunity, could you just tell us the price of the vaccine? I think it is given twice a year, but just remind us about that as well? Thanks.

Thank you, Dave. You are correct. It's two times per year. Maybe the first time it can be an opportunity of three vaccines, but then the following years would be two times. The price of the PEDv vaccine it is $7, about $7 the treatments, or it's $3.5 each vaccine.

In terms of Apoquel for 2014, we communicated that will be around 1% of our revenues. It is $4.5 billion, or $4.7 billion, so we expect that will be around $40 million in terms of revenues. This only limited because of the supply availability.

Then talking about the movement of animals and how long this movement will stay. It depends on the price of the grains. If the price of the grains are low, so the incentive of moving animals and keeping these animals in the feedlot with significant gain in terms of weight, I think it will be an opportunity for maintaining this current situation.

What we saw, in 2014, is even the number of animals moving to the feedlot maybe will be slightly lower than the 2013 because there are less animals because they are keeping animals. Also, to rebuild the herd, they have been moving animals at a younger age, which are lighter, more vulnerable to infections, more needs of vaccinations, and this been having a positive impact in our revenues.

We expect this situation of younger animals moved to the feedlots will stay in the future in 2015 because the price of feeding the animals remains very low. The profitability and the value of this animals is very high.

That's great. Thank you. Paul, congrats again.

My couple questions for you our first, when do expect to get through the standup costs? Second, what is the FX hit to EPS that you are expecting in the fourth quarter? Third, if the R&D tax credit is passed, what will the benefit be in the fourth quarter?

Okay, two out of the three I can answer. Thanks, David. The question about when we'll be through the standup costs, I would expect to be substantially complete towards the latter part of 2015, let's say the end of 2015. We will continue to be flipping switches on our ERP implementation into 2016, but the lion's share of the costs should be behind us after the year-end 2015.

The FX impact at the net income line implied for Q4 is in the range of 100 to 150 basis points negative. Then the last question about the R&D credit in Q4, if it were to be passed, it would have an impact of approximately 50 basis points to the full-year rate.

Great, thank you very much.

Thanks, David.

Jeff Holford, Jefferies.

Thanks for taking the questions. I've got two for Paul, please. Firstly, just on Apoquel, just trying to think about contribution margins of this product as it gets towards the peak of $200 million to $300 million, which you described. I would assume that this is a very high-margin product relative to the rest of the business, something more like a pharmaceutical contribution margin, probably possibility 50%, 60% or higher, in terms of the operating level. If you can comment around that?

Secondly, could you tell us if Zoetis has any kind of poison-pill type measures as bid defenses? If not, is the Company intending to introduce these into 2015? Thank you.

Let me answer the Apoquel. Our gross margin at Zoetis is 65%.

We communicated on companion animal has the highest margins in our total portfolio followed by cattle, then swine and the lowest is poultry. Even if we have not provided details of each species, you can extrapolate with the 65% that, companion animal being the highest, Apoquel has a good margin.

In terms of how much we need to invest to support this Apoquel launches, what we said is that we have the infrastructure to support the promotional activities of any new products. Maybe, in some cases, we need also to support this probably with some additional advertising and promotion, but in our opinion in the case of Apoquel the reaction on the markets has been so positive that we don't think that it will require any significant additional investment to support the objective that we have set for 2015 and also the long-term objective of $200 million to $300 million at peak sales.

Then, Paul will answer the question on the poison pill.

I will answer the question by saying, with respect to your specific question around poison pill, no comment on the that specifically. However, what I would say is we are public company. We're for sale every day.

To the extent that someone were to come in and be interested and think they could do better job with our collection of assets, there's certainly the opportunity for them to express that. What I would report back though is, we think we are the team to run this Company.

We are driving value for our shareholders. We are doing that by pulling all of the levers at our disposal, which includes being maniacal about deploying capital both inside and, hopefully, outside of our business. At the end of the day, if we deliver value that's what we rely on to continue to be the fellows and ladies that run this Company.

Thanks very much.

Erin Wilson, Bank of America.

Thanks for taking my questions. Livestock growth was impressive. Can you break out what was attributable to volume, price in new products such as the beta agonist? How sustainable is that growth?

Also, with consolidating competitors, there could also be some opportunities to potentially fill some holes in your portfolio. What are areas that you would find particularly interesting for you, any specific therapeutic categories?

Thank you, Erin, for the question. I think in my opinion we have a very strong portfolio. I believe that it is the strongest portfolio in the animal health industry.

We have always opportunities to fill some gaps, but we have a specific need to really cover areas which are important for animal health, which are not part of our portfolio. We are very strong in vaccines. We are very strong in parasiticides. We are strong in, also, all the therapeutic areas.

Definitely, we'll be always assessing opportunities to add more products to our portfolio, because we think that we have the infrastructure and we have the opportunity to achieve synergies in both revenues and also in terms of costs, by adding products or adding assets of our Company. But not because we have a specific need to fill any area where we feel that we are absent a significant gap in our business.

In terms of the livestock growth, definitely there has been very strong growth. Volume has been the most important part of the growth.

Price, we also mentioned that price is in line with the industry. The industry, in terms of price, is growing around 3%. It is consistent with our growth in terms of price. All the rest has been volume. Very strong performance in terms of value. That is also the result of excellent portfolio and also excellent execution from our teams to bring these drugs to the market.

As it relates to quel in the competing drug for Remadyl, are there relationships with distributors that you could establish there and that would potentially help to limit competition there? How big is the opportunity for Versican and is there an opportunity for that in the US?

We definitely partner with distributors. That also helping us to reach customers that we are not calling directly through our field force.

This partnership is working very well, and I think it is something we are happy with the declaration that we are having with distributors. We will continue, really, providing to them the products and also the kind of support that they need, also, to promote the product to customers that we have not directly targeting through our direct model.

There are no further questions at this time. I would like to the floor back over to Juan Ramon for any additional or closing remarks.

Thank you very much for joining today's call. I'm looking forward to see you on November 18 in New York, at the New York Stock Exchange. We will have the opportunity to go into more details of our business model and also more details on our guidance for 2015 and also for the period 2015, 2017. 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 1-800-723-2156 for US listeners, and area code 402-220- 2660 for international. Please disconnect your lines at this time and have a wonderful day.