碩騰 (ZTS) 2015 Q1 法說會逐字稿

Welcome to the first-quarter 2015 financial results conference call and webcast for Zoetis. Hosting the call today is John O'Connor, Vice President 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's 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 first quarter 2015 earnings call. I'm joined today by Juan Ramon Alaix, our Chief Executive Officer; and Paul Herendeen, our Chief Financial Officer.

Before we begin, I'll remind you that 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 2014 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. 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, May 5, 2015. We also cite operational results, which exclude the impact of foreign exchange.

We have a significant amount of details to cover today, including specific details of our financial outlook through 2017. We will be posting both Juan Ramon and Paul's prepared remarks on the Investor section of zoetis.com following the call to help clearly disseminate these details.

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

Thank you, John. Good morning, everyone. In my remarks today, I will briefly comment on our performance for the quarter and then I will provide details of the operational efficiency program that we announced this morning. Paul will then walk you through our results for the quarter and discuss the financial impact of the operational efficiency program, including an update to guidance for 2015, 2016, and 2017.

During the first quarter, we generated operational growth over 6% in revenue and 14% in adjusted net income, delivering adjusted diluted EPS of $0.41 per share. During the quarter, half of our operational growth, or 3%, was attributed to price. New products such as Actogain and acquired products from Abbott Animal Health, accounted for 2%, while in-line products contributed to 1% of revenue growth for the quarter.

As a note, all the following growth rates that I will discuss are operational. In livestock, we grew 7%, to $715 million, with all species (inaudible) contributing to growth. Cattle revenue grew 7% to $397 million. We've had favorable market conditions in the US and Brazil driving growth across the portfolio, while weather and reduced herd size led to declines in Australia and New Zealand.

Swine revenue, which grew 13% to $170 million, is benefiting from increasing [herd] size in the US after a winter of lower piglet mortality from PEDv plus positive industry momentum in the CLAR region. Poultry revenue grew 1%, to $129 million, as the US introduction of ZOAMIX, a medicated feed additive, help to upset a negative impact from the timing of pro-rotations in several countries.

Turning to animal health and companion animal health, revenues grew 4%, to $377 million, due to the continued performance of key brands and overall strong growth in China and Latin America markets. We closed on the purchase of our animal health assets in middle of February, so sales of newly acquired [Abbott products] also contributed to results. They were recorded primarily in the US where we have seen additional competition in the [pain] and (inaudible) markets.

These results continue to demonstrate the strength of the business model as defined by our three interconnected capabilities: the largest and most capable field force in the industry, with direct customer interactions investing more in innovation than any other company, and having the highest quality products and most reliable supply at the competitive cost. These three capabilities form an essential foundation for long-term success in animal health.

Going forward, we are committed to investing in these capabilities, but also seeing an opportunity to use them in more focused ways to enhance competitiveness and drive greater value for our customers and shareholders. Over the last two years, since becoming an independent company, we have delivered on our operating and financial targets, created shareholder value, and continue to meet our customer needs while [standing up] a new global company and infrastructure.

We are certainly proud of what we have achieved, and as we transition out of our standup phase, we are focus on driving efficiency and reducing complexity that is a barrier to productivity. The [program] we announced today is a comprehensive plan that is designed to simplify operations, improve our cost structure, and better allocate resources. We enter this next stage building on solid business performance and will emerge as a stronger, simpler, and more cost-efficient organization.

We expect to generate that cost savings of $300 million in 2017 and see our adjusted EBIT margin improve from 25% in 2014 to approximately 34% in 2017 as we reduce our complexity and achieve a greater focus on key [brands] and markets. We are fully aligned to achieve these goals and have the plans in place to incentivize our leaders to exceed these targets. These initiative will allow us to realize additional value by taking full advantage of our [scale]. It will allow us to invest in the [products], markets, and infrastructure that will drive for profitable growth and continued leadership in the animal health industry.

There are several important reasons why we are [indicating] this program. First, after two years of separating from Pfizer, we now have full control over our operations, manufacturing and corporate systems, and we have identified significant opportunities for improvement. Second, while the breadth of our portfolio and our global footprint remains strength of our business, we have seen certain elements of our breadth generate complexity that is a barrier to delivering value to our customers and to generating that long-term growth.

Third, we are beginning to see the benefits of implementing our ERP system. The resulting standardization and potential to simplify our business through our new ERP system will allow us to increase productivity and streamline operations. Finally, we remain focused on growing revenues and finding the most productive ways to allocate resources to determine investments and business development activities.

We offer three main objective for this operational efficiency initiative: first, we want to reduce complexity that does not add value for our customers and our business; second, we want to optimize our resource allocation and efficiency; and, third, we want to better position Zoetis for long-term profitable goals.

We will deliver our first objective to reduce complexity by enhancing our focus on the products, markets, and manufacturing plants that are most important to our future. We will eliminate approximately 5,000 lower revenue and lower margin product SKUs out of a total of 13,000. This will drive higher focus and more reliable supply of our products and services, will enhance our manufacturing operations and accelerate the implementation of our Supply Network Strategy. We plan to sell or exit about 10 manufacturing sites over the long term.

Reflecting the strategic importance of manufacturing to our business model, Roman Trawicki, President of Global Manufacturing and Supply, will now report directly to me as part of the executive team. We will change our selling approach in approximately 30 markets by shifting to our new indirect sales model or reducing our presence in certain countries.

We will reduce the number of regional reporting segments from four to two: the US and International. We expect these changes to result in greater decision-making authority, closer to the customers, while liberating our scale through efficiency in deliver marketing and other operational support. The US region will be led by Kristin Peck, and the International region will be led by Clint Lewis. Both are current members of our executive team and will continue reporting to me.

To deliver on our second objective to optimize resource allocation and efficiency, we'll take the following actions. We'll leverage the efficiency and the standardization of our newly implemented ERP system to significantly reduce general and administrative costs in corporate functions. In addition to the ERP benefits, another important efficiency driver will be a reduction of managerial layers and increase span of control through [organization].

We'll improve our ability to be more dynamic and [energized] in responding to customer needs by shifting marketing resources closer to the customer and simplifying all areas of non-customer-facing commercial infrastructure. And we'll enhance our R&D focus to support a smaller portfolio of our products as well as better prioritize the R&D portfolio to invest in price with the highest returns.

In the past, we have demonstrated our commitment to improving operations and being more efficient. In 2009, we achieve a successful transformation when we became the world's largest animal health business through [several creations]. Then, in 2013, we became a large, global independent company, followed by two consecutive years of industry-leading performance. Through each of these changes, we have made ourselves better, include how we serve our customers and create new and greater volume to our stakeholders.

I'm confident that the comprehensive plan we have announced today will allow us to transform again, building on our successful business model to deliver high-quality, profitable revenue growth and becoming a more competitive company. These are significant initiatives that will drive us to be a more focused and streamlined company. As a result, we see a reduction in the number of positions at Zoetis of approximately 2,000 to 2,500 over the next 12 to 18 months, subject to any consultation with work councils and unions in certain markets.

With implementation of this initiative, we will better align Zoetis' resources and operate in a structure with our three interconnected capabilities: supply products where reliable and at competitive costs; increase capacity to invest in future business drivers; and, finally, (inaudible) portfolio and improve efficiency of the operating model so we can pursue the next horizon of opportunity as the world leader with a single focus on animal health.

Through this process we'll be more competitive and better positioned to achieve long-term profitable growth. Before Paul cover the financial details, I would like to thank all of our colleagues who have contributed to our success through an environment of intense change. Our next [formation] will be key to supporting our future success, and I know that we have the capabilities and the team to implement these significant changes. Paul?

Thank you, Juan. And good morning, everyone. We have lots of important things to talk about on this call as we just revealed our plans to improve the efficiency of our operating model. But before we get to that, I don't want us to lose sight of the terrific quarter that we just put on the board.

So, let's get started. As you remember, our fourth quarter of 2014 featured strong operational growth, and we were able to carry that momentum forward into Q1 of 2015 and give us a good start to the year. We delivered on our primary value drivers, posting revenue and adjusted net income growth on an operational basis of 6% and 14%, respectively. Pretty good, right?

Like other US multi-national companies, FX rates had a major impact on our reported results. On a reporting basis, FX rates decreased our reported revenue by $58 million, resulting in our reported revenue growth being flat with Q1 of 2014. The impact on our adjusted net income was $16 million and so reduced our growth and adjusted net income from 14% on an operational basis to 8% on a reported basis. So FX impacted our top line by some 600 basis points and adjusted net income by 600 basis points.

I said this before and I'll say it again today, we can't control FX rates. We manage our business on an operational basis, and, on that basis, we're continuing to deliver strong, fundamental growth in revenue and profits. You can read about the regional segment results in the press release and tables, so I won't spend too much time on them here, but I do want to cover a few highlights.

The US continued to perform very well, up 9% versus Q1 of 2014, with strong livestock performance, which was up 14%. We continued to gain share in the US livestock segment, especially cattle, based on producers' confidence in the reliability of our products to protect their investment in their animals. In companion animal, which was up 3%, we anticipate even more positive results for the balance of the year as we now have increased supply for APOQUEL.

CLAR also continues performing well, with revenue up 13% on an operating basis, and that's driven by Brazil and other emerging markets. Later, when I talk about our go-forward plans to streamline and adjust our global footprint, I'll speak to our plans to de-emphasize our efforts in Venezuela, where the business in economic climates are becoming more challenging.

In APAC, where we posted 1% operating growth in revenue, we're seeing good performance in emerging markets like China, but drought conditions in developed markets, including Australia and New Zealand, are having an impact. In the EuAfME where revenue was flat compared with Q1 of 2014, the takeaway is that good performance on our key brands in companion animal are being offset by declines in anti-infectives, primarily due to legislative changes in France.

Now, let me turn to what I will call our operational efficiency initiative. This initiative is a natural next step in the evolution of our Company as a stand-alone entity with a singular focus on animal health. While we enjoy an enviable position in the animal health today, our current product portfolio, footprint, animal [usation] came about in ways that were, to some extent, unplanned.

The makeup of our product portfolio was heavily influenced by human health acquisitions made by Pfizer that had animal health components. These were very important to building our scale and portfolio, but the animal health assets were not the focus of those deals. And, while we've spent a lot of time and energy standing up for our own organization and building our own culture, we quite naturally carried across organizational designs, processes, and practices that worked well when we were a division of Pfizer, but may not represent the best options for a pure-play animal health company.

Said another way, it's doubtful that we serendipitously came upon the best possible structure and organization to maximize our opportunity in the animal health industry. Our first priority over the last few years has been to build out the functions that we need to support our business on a stand-alone basis. We had to establish our own supply chain, build our own IT infrastructure, and put in place the G&A functions like finance, HR, and legal to support a global public company.

While we did that, we elected to leave our commercial and R&D organizations largely as is to minimize the impact of our standup on our customers and on our business. I think our track record of revenue and profit growth over the last two years, and so far into 2015, support the wisdom of that approach. But now, with the completion of the standup activities in sight, it's time to look at the entirety of our current state and take steps to improve the design and efficiency of our Company.

Importantly, we are not questioning the fundamental elements of our business model. Our model relies on what we refer to as our three interconnected capabilities: one, face-to-face interaction with our customers to drive revenue; two, investment in product innovation to sustain our revenue base and our growth prospects; and, three, the ability to meet our customers' demands with quality products.

These capabilities form the basis of our competitive advantage in the global animal health industry, and changes to these areas will fall into the category of continuous improvement, not major changes. The bulk of our future cost savings will not impact these areas. Our field force, the personnel on the front lines with our customers, will remain largely intact. The scope of our activities in R&D will also remain substantially the same, and we will continue to invest in programs to build and improve our supply chain.

Let me separate the 2015 program into two parts, as I see them, and then add on the previously announced Supply Network Strategy to think about three areas of focus. Part one is what I'll call rationalizing our footprint. Part two is driving improved efficiency in our operating expenses. And part three is streamlining and improving the efficiency of our supply chain.

Start with rationalizing our footprint. This work included a review of the number of SKUs that make up our product portfolio, consideration of moving to indirect sales models in a number of markets where we currently have a direct presence, and devaluation of markets where we might choose to reduce our efforts. The headline here is that we will be eliminating nearly 40% of our total SKUs. These SKUs create significant complexity across multiple functions within our Company.

Of course, this will reduce our revenue and gross profits in the near term, but it will enable us to substantially improve the efficiency of our operations, from our supply chain and sales support, to G&A expenses and the product maintenance costs that are part of our R&D. With a leaner portfolio comprised of our more profitable product assets, we will have better growth prospects.

We also intend to move from direct sales models to indirect distributor models in certain countries, and reduce our efforts or exit some markets. When complete, the streamlining of our portfolio and global footprint will reduce our expected 2017 sales by some $280 million and gross profit by about $100 million. For the avoidance of doubt, those numbers are based on current FX rates. The estimated revenue of gross profit impacts are reflected in our revised guidance for 2016 and 2017.

Part two of the initiative is driving improved efficiency within our SG&A expenses and our investment in R&D. We're collapsing from four regions to two as we go forward. We're reorganizing the support for countries, including enabling functions like finance, IT, HR, and legal, but also the non-customer-facing resources that support our field sales forces. We're taking steps to improve the focus of our R&D activities, supporting a smaller portfolio of products, identifying greater efficiency in our regulatory practices, and better prioritizing our R&D spend.

And, yes, our expected spend for customer-facing resources will be less as well, mainly driven by the reduction in the number of markets where we'll have a direct presence and a de-emphasis of certain other markets, but also through improvements in efficiency. In total, by calendar 2017, we expect our total operating expenses -- that is, the sum of SG&A plus R&D -- to be roughly $300 million less than it would have been but for this initiative.

As I said just a moment ago, we are not changing our business model here and that's reflected in the way you should think about the sources of the $300 million of future savings. Roughly one-third is expected to come from reduced G&A and another one-third from commercial resources that are not customer facing. That's roughly two-thirds of the expected savings coming from areas that should not impact our ability to deliver near-term and long-term revenue growth.

Of the remaining cost savings, about 10% is expected to come from improvements in efficiency within our R&D organization; about 5% is expected to come from a reduction of our field resources tied to our revised global footprint and reduced emphasis in some emerging markets; and the balance of the cost savings is expected to come from reducing complexity and increasing efficiency in other areas.

The third and final piece of the initiative is a Supply Network Strategy that Kristin Peck outlined at our Investor Day last November. Most of the benefits of that work will be realized after 2017, so, for now, let's set the Supply Network Strategy aside and focus on the activities that will impact our results in the period from 2015 to 2017. But keep in mind that the Supply Network Strategy initiative is expected to add some 200 basis points to our gross margin by 2020, on top of the improvements driven by the 2015 initiative.

You've heard me say this many times in the past, that, when we're looking at our operating efficiency, there are opportunities for us to do better. Today we back those words up, providing you with the full work of our plans to improve the operating performance of Zoetis, while preserving the key elements of our value proposition. In our to-be state in calendar year 2017, we'll be an even better company than we are today -- more profitable on a slightly smaller revenue base, positioned to deliver better growth from a more-focused product portfolio, and working off of a lean -- excuse me, working off of a leaner cost structure that can be leveraged to support revenue and profit growth over the long term.

After completing the change we are announcing today, we'll still be the leader in animal health, and we'll continue to be the biggest investor in innovation in animal health. And, we will continue to have the largest direct sales network in the industry. Our improved efficiency will provide us with more flexibility to allocate resources where we can best serve our customers' needs and to further distance ourselves from the competition.

The efficiency initiative adds an estimated $200 million to our expectations for pretax earnings in 2017, driven by the $300 million in operating expense savings, offset in part by the $100 million of projected decrease in gross profit attributable to the streamlining of our product portfolio and the rationalizing of our global footprint. This initiative adds roughly $0.28 to our prior estimate of 2017 adjusted net income per share.

So, the song remains the same, only better. We're a company that can grow its rebased revenues in line with or faster than the mid-single-digit growth of our markets, while holding the growth in our leaned-out operating expenses to the inflation rate, and thereby delivering long-term profit growth greater than our revenue growth. And that's off of a higher profit base -- and that's a winner.

Of course, the improvements in our future financial model don't come free, so I want to take a few minutes to talk about one-time costs, generally, and to specifically address the costs associated with the efficiency initiative. First, it's important for you to know that we have a high standard when it comes to cost we characterize as one-time and, therefore, are excluded it from adjusted net income.

Our policy limits such adjustments to purchase accounting, acquisition-related costs, and certain significant items that we evaluate on an individual basis. These include direct and incremental costs required to complete the standup of the Company and those direct costs that we will incur to execute our efficiency plan.

Next, we want to be transparent about the amount and nature of these costs, so our intention is to provide disclosure of our one-time costs in three buckets: the buckets of standup costs and another one-time costs that you're already familiar with; a new bucket for the efficiency initiative that we announced today; and a third bucket for the costs associated with the longer-term elements of the Supply Network Strategy.

We estimate our remaining pretax standup and other one-time costs at $180 million to $210 million, with those costs to be recorded primarily in the remainder of 2015 and through 2017. These are primarily all-cash costs. We estimate the one-time pretax cash costs associated with the efficiency initiative to be in the range of $340 million to $400 million and to be incurred in 2015, 2016, and with some modest portion moving into 2017.

We expect actual cash payouts to occur over the next few years. Note that there will also be non-cash charges triggered by this initiative. We are not providing an estimate of these charges, as both the amounts and timing could vary widely. As we incur these non-cash charges, we'll call them out for you when recognized.

Finally, the Supply Network Strategy one-time pretax cash costs are currently estimated at $60 million to $100 million and are expected to be incurred over the term of the plan. It's worth noting that we are still in the early phases of architecting the Supply Network Strategy and the final one-time cost for this activity could be substantially different, depending on the final outcome of our ongoing analysis of our supply network and the timing or nature of any specific site exits.

There will also be non-cash charges triggered by the Supply Network Strategy, and we will call those out to you when recognized. Note that the estimates of one-time, pretax costs for both the efficiency initiative and the Supply Network Strategy ignore the possible proceeds that we may receive from the sale of certain assets, which could potentially offset some of the one-time cash costs.

We provided a webcast slide that summarizes our current estimates of the one-time pretax cash costs associated with each of the three buckets over the period from 2015 to 2017. We will refresh our view of the various buckets of one-time costs as appropriate.

I want to call your attention now to an unrelated change to our go-forward outlook, and that's our decision to decrease our activities in Venezuela. The animal health industry in Venezuela features solid underlying fundamentals and our business there has performed well. However, recent economic developments necessitate an evaluation of our efforts there.

While our business in Venezuela is profitable, it has become increasingly difficult to realize those profits in US dollars. Unless and until that environment changes, sales and profits there will drive low-quality earnings. So, we're significantly paring back our activities there. To be clear, Venezuela is a solid local market and we will maintain a presence there, as we believe that the environment will improve over time. However, in the interim, we believe it's prudent to reduce our activities and exposure there.

The decision to reduce our activities in Venezuela impacts our revenue and profit expectations for 2015, 2016, and 2017. The impact on 2015 can be seen in the exhibit to our press release that bridges from our prior guidance to our revised guidance. We've also provided a slide on the webcast that shows the impact of Venezuela on 2017, which decreases our expectations for adjusted net income in 2017 by $0.07 per share.

Now, let me provide an update on our guidance for the full year of 2015 in light of the changes in FX rates since our last guidance update, the anticipated impacts in the efficiency program, and our decision to reduce our efforts in Venezuela. I also want to update you on our expectations for 2016 and 2017, and provide you with more detail about those years. We felt it was important to say more about 2016 and 2017 as there are a lot of moving parts here and we want you to have a clear picture of our expectations.

First, 2015 full-year guidance. In our press release and in a webcast slide, we've provided a bridge from our prior guidance to our revised guidance. The headline is, that, despite the continued headwinds from changes in FX rates and our decision to reduce our business in Venezuela, we are holding our guidance for adjusted debt income per share for 2015 in the range of $1.61 to $1.68 per share. This includes pluses and minuses.

FX is a minus, again. The changes in the FX rates from late January, underlying our last updated guidance, to late April, decreased our revenue expectation for 2015 by some $75 million, or 155 basis points, while the impact on adjusted net income was much less, only about $5 million, or 60 basis points. Then, our decision to pare back our efforts in Venezuela reduces our revenue expectations by $50 million, operating expenses by $5 million, and decreased our expectations for adjusted net income by $25 million.

Finally, the big plus, and that's the impact of the efficiency initiative, which reduced our expectations for operating expenses by $45 million compared with our prior guidance and increased our expected adjusted net income by $30 million. So, when the dust settles, we expect our reported revenue to be down by $125 million from our prior guidance range and our adjusted net income to be consistent with our prior guidance -- $1.61 to $1.68 per share.

It's worth pointing out that we decreased our 2015 guidance for revenue growth on an operational basis by 100 basis points, to the range of 5.5% to 7.5%. The reduction on the growth rate is due to the expected reduction in sales in Venezuela. We translate Venezuela revenues at the fixed official exchange rate of 6.3 bolivars to the dollar. So, the $50 million expected reduction in revenue hits the operational growth rate. And, the adjusted net income operational growth rate is estimated to increase 1% as a contribution from our efficiency program should more than offset the impact of Venezuela.

Turning to 2016 and 2017. We've provided a lot of detail for you so you that can recalibrate your expectations for us through 2017. As you consider how this longer-term guidance compares with your prior expectations, I submit that you must first revise your prior expectations to reflect the changed FX rates. To help you do that, the change in FX rates from late January to late April should reduce your 2016 and 2017 revenue expectations by roughly 215 basis points, cost of goods sold by 260 basis points, and operating expenses -- including both SG&A and R&D -- by 170 basis points, with the result being a roughly 235-basis-point decrease in projected adjusted net income driven by the changes in FX rates.

Using that rebased forecast in comparison with our revised guidance for 2016 and 2017 will enable you to isolate and evaluate the impacts of the 2015 efficiency initiative together with our decision to reduce our efforts in Venezuela. In a nutshell, and looking at 2017, when the full benefits of our efficiency initiative are expected to be realized, the efficiency initiative increases our expectations for 2017 pretax income by roughly $200 million. Meanwhile, the Venezuela action reduces our pretax expectations by $55 million.

Net, we [add] $145 million to our pretax expectations for 2017, roughly $100 million in adjusted net income, or $0.20 per share. As Juan Ramon mentioned, the steps we are taking over the next several years are expected to enable us to improve our EBIT margin by some 500 basis points in 2017, to circa 34%.

Here are a few other factors for you to consider. Our guidance does not reflect any future currency devaluation in Venezuela. We expect a slightly higher effective tax rate for the remainder of the year 2015, higher than the 27% that we had in the first quarter of 2015. The operating expense benefits we are seeking will begin to be most evident in Q4. And our guidance assumes a constant diluted share count of approximately 502 million shares outstanding. This includes share repurchases totaling an estimated $100 million in the first half of 2015, which are partially offset by actual and projected dilution related to employees' equity-based compensation.

We also assumed a comparable level of diluted weighted-average shares outstanding for 2016 and 2017, as we intend for our share repurchase program to at least offset projected dilution from future employee compensation programs, including the acceleration impacts of our operational efficiency initiative. All the other details of our guidance are included in the table attached to our press release.

Finally, we covered a lot of ground on this call. To assist in clear communications, as John said, we will be posting copies of Juan Ramon's and my scripts to our Investor Relations website following this call.

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

The floor is now open for questions.

(Operator Instructions)

Thank you. And we'll take our first question from Louise Chen with Guggenheim. Please go ahead.

Hi. Thanks for taking my question. My question is on your organic sales growth and also your gross margin once you lap on the headwinds from getting rid of some of these lower margin SKUs. Thanks.

Thank you, Louise. Definitely our plan is to have our growth in terms of revenues in line or faster than the market. The market is expected to roll about 5% in the medium and long term, and we are also targeting along the line of this growth or to exceed this growth.

In terms of gross margin, we also plan to significantly increase our gross margin, so eliminating these low margin SKUs will represent 200 basis point of gross margin improvement. And also the price increases on also the discipline on the reduction of a trends also ameliorate a significant improvement in gross margin. So on top of that, as Paul mentioned, our plan and work strategy that we announced at the time of the Investor Day will also generate another 200 basis points of gross margin improvement.

Yes, Louise. It's Paul. I'll just follow on that and just point you to the slide on the webcast for the 2015 to 2017 guidance. And you can see the impact, or an expected improvement in our gross margin there where we're looking out to 2017, after -- as I say, after the dust settles and we get to a margin that we're currently projecting in the range of 32% to 33% and with the opportunity to do better than that as we continue progress on our supply network strategy.

So next question now.

And we can take that question from Kevin Ellich with Piper Jaffray. Please go ahead.

Good morning. Thanks for taking the question.

So looking at the operational improvement initiative, Paul, you laid out a lot of good information. A combination question: in 2016 operational growth looks a little bit light, that negative 1% to plus 2%. Is that really due to getting out of Venezuela, because it looks like you expect some pretty decent growth from that market.

And I guess strategically have you embedded much in terms of M&A acquisitions? Where do your interests really lie within diagnostics? It looked like a new product launch in diagnostics may have helped drive some of the companion animal growth we saw in the US. Just wondering if that's the feline Rapid test and wondering if you have other plans in that category? Thanks.

Thanks. Yes, thanks for the question, Kevin. It's Paul.

I'll start with talking about the growth rate in 2016. One of the reasons why we felt compelled to provide a lot of detail around 2016 and 2017 is, you know, as we go about the what I'll call the rationalization of our portfolio, the timing of when those sales go away will certainly have an impact on what you should expect as what we expect for 2016 and then we turn to what I'll call a rebased model in 2017.

So two things effecting 2016: one, as you correctly point out, is Venezuela hitting the operational rate, and the second is the timing of SKUs that we're pruning from the portfolio when we start to see a decrease in sales. You note that we, for the balance of 2015 expect -- did not show you a line item reducing our revenue expectations associated with the reduction in the SKUs in the portfolio. That really starts to come into play in 2016 and we should enter 2017 clean.

So let me answer the question on the M&A. So definitely each part of our study and we would be considering any M&A opportunity that will increase the value of this Company and will support our objective in terms of generating higher margins in our operations.

So where is our interest? Any opportunity which is in the animal health domain. We think that we have all the capabilities and also now we have even much better ratios in terms of cost and in terms of expenses at revenue, so we can really maximize opportunities of any potential acquisition. And the next question now?

We can take that question from Chris Schott with JPMorgan. Please go ahead.

Thanks very much. Just trying to elaborate a little bit more on the operational efficiency initiative here. In the past you talked a lot about your direct selling model being a competitive advantage versus some of your peers.

Can you elaborate a little bit more with the decision today in these smaller markets to move to more of an indirect model? What's changed in terms of that view? Is it just that these are markets that were never going to get the scale you needed to justify the investments you're making? I'm trying to understand a little bit more of the strategic shift you're making on those.

Second question is just with the new kind of plan you're outlining in your approach here. Are there any management incentives that you're putting in place or any changes to management incentive that are going to come about as a result of this operational efficiency plan as we think about the 2015 targets, et cetera?

Thank you, Chris. What we are trying with this initiative, it's to be much more focused. And we mentioned many times that our diversity of the breadth of our business, it was a competitive advantage, but we have also identify some areas or some elements of this diversity. We choose to add in a complexity; we choose a value to our customers and also to create a value to Zoetis.

What we are trying, we've now been much more focused on the countries and also their products that will generate the highest value to Zoetis. It's to really move away from our model, which is a model that will be 100% applicable to those markets and we have now in these -- as more markets, we are -- we don't see that the model, it's efficient in terms of applicability and moving to a model that will be direct and will be relying more on distributors to support our revenues.

So the strategy is not changing. While we are -- it is really focused on the markets that will generate the highest opportunities, therefore, for Zoetis and also the products that will generate the highest revenues to our Company and the most profitable growth.

In terms of the management incentive, we have in place programs to incentivize our leaders Zoetis for exceeding the $300 million target we have in our program. So we have these plans and we are convinced that we will be working there to meet or exceed our objective.

Next question, please.

We'll take that question from Erin Wilson with Bank of America. Please go ahead.

Thanks for taking my question. Does the new guidance on the top line include contributions from Sarolaner? Could that still prove upside? And do you have cash flow forecasts for us? I think you gave some color here, but does your guidance include share repurchases and plans for deleveraging?

Let me answer the first question and then Paul will answer the second one. Thank you, Erin, for both your questions. The new product, Sarolaner AL-31, not part of our guidance today. So we are still in process of discussing with the FDA and the USDA and other regulators. So when we have more understanding of the timing of these probable launches we will incorporate in our guidance.

It's Paul. I'll speak to the cash flow guidance.

We've provided an awful lot of detail on the operating side here through 2017. We're not, at this time, providing a forecast of cash flow and our balance sheet, but suffice it to say that we've talked in the past about our desire to improve our asset efficiency. For example, you know, through the implementation of our global ERP system and SAP, we expect that over time we will be able to reduce our investment in our inventory and unlock some cash there.

Frankly, by paring down our Business and pruning our portfolio with the SKUs, that will unlock some cash, as well. We do have an awful lot of calls on our cash here coming up in the very near term. If you think about it, in the first quarter we completed the acquisition of the Abbott Animal Health assets. We do continue to use cash to fund the one-time costs associated with our separation from Pfizer and we provided an estimate of the remaining amount of that to be somewhere in the range of $180 million to $210 million.

We provided you with an estimate of the costs of the efficiency initiative that we announced today and the early stages of our supply network strategy. And those costs are estimated in the range of $400 million to $500 million over the next several years, and we have -- I'll call it out for you -- $400 million debt maturity coming up next spring and we have our regular dividend coming up. So we do have some sizeable calls on our cash.

We have, actually, provided you also with some guidance, a little bit of guidance at this stage around our share repurchases and we indicated we expect to purchase, in aggregate, $100 million worth of shares over the first half of 2015, and we can expect to continue acquiring shares in the amount that will at least offset the ongoing dilution from our equity-based compensation plans.

I said it in the past, I'll say it again, the share repurchase will be an ongoing part of our plans for our capital allocation. I think of the share repurchase activity that underlies our 2017 guidance as a baseline for that activity. As we generate either free cash or debt capacity, we'll adjust our plans there as appropriate.

Did I cover all -- sorry. The deleveraging question as well. Yes. We have stated in the past that we have kind of a notional -- when we talk about our capital structure, a notional floor of gross debt to trailing 12 months EBITDA of 2.5 times. So I want to reiterate there's a permanent role for debt in our capital structure and when you think about that cap structure, you know, we remain committed to being responsible stewards of our shareholders' capital.

And our hierarchy for that capital allocation will be, first and foremost, inside our business; second, for business development activity that is value generative; and lastly, transactions and shareholders including both the regular dividend and the ongoing share repurchases. So, again, think of that 2.5 as -- 2.5 times as a floor and think of our hierarchy of capital allocation as I outlined it for you. I hope I answered the question.

And we can take our next question from Alex Arfaei with BMO Capital Markets. Please go ahead.

Good morning, folks. Congratulations on the quarter and we appreciate all the details on the efficiency program. Your Asme sales were below expectations. Could you comment on the impact of the new anti-infective legislation in France and whether you think it's going to spread to other developed markets?

And, Paul, I'm not sure if you addressed this, but how much of your lower OpEx this quarter was driven by FX as opposed to other savings? And finally, could you comment on the launch of APOQUEL and whether your prior guidance still stands? Thank you.

Thank you, Alex.

So the situation in Europe (inaudible) revenues were affected by the French performance. So they announced the new regulation related to anti-[addicton] legislation; it's eliminating rebates offered by animal health manufacturers to both wholesalers and veterinarians, and as a result of this elimination of rebates there was an adjustment in the market that -- in terms of (inaudible).

We expect that this will be in the next quarter compensated and back to normal situation. And now Paul will answer the comment and solve the impact of FX.

Yes, Alex, there's really two ways you can think about this. First is you can see the impact -- the impact on the first quarter alone on SG&A expenses in the quarter was -- roughly 5% change was due to FX and in R&D it was 2%.

I think a more helpful way to think about it might be to look at our guidance bridge slide going from our previous guidance in February to our updated guidance today. You can see the expected impact on the full year relative to that February guidance is roughly $20 million on SG&A expenses and none on R&D.

And then the comment on the APOQUEL, on the first quarter of this year, the revenues of APOQUEL has been still facing finite supply. But from EPI we shall be able to meet the demands of our customers in US, also UK and Germany and we expect that the product will meet our expectations in 2015 of delivering $150 million to $175 million in 2015.

We also are planning now in launching APOQUEL in additional markets that will be also making [conditions] to meet these expectations for the product. Next?

And we'll take that next question from Mark Schoenebaum with Evercore. Please go ahead.

Thank you. It's -- (No audio.)

We've got some problem there with the line?

I'm sorry. Can you hear me?

Yes, we can.

(Inaudible) of HealthMark. So the question about M&A and the tax matters agreement with Pfizer that I believe expires next month. So is your new cost production plan and tax matter agreement expiration, whether this will change your overall strategy for future acquisitions M&A? And whether you're still open for targets of various size and think about Vidius as more as a net acquirer, not acquisition target, as well as if you are still open for potentially inversion transaction as an avenue to reduce effective tax rate. Thank you.

So let me mention on the tax rate agreement, that you're right, this tax agreement will end on June 24. We mentioned on previous calls that is something that we eliminate any restrictions, but we didn't think this was a significant restriction for any type of transaction related to accretion or licensing or any other investments.

In terms of the new program is changing our strategy, we think that our strategy has been always to consider M&A opportunities that will create value to our facilities, and will create more value to our shareholders. Definitely the new program will generate more cash and more cash also will help us to consider any kind of opportunity. In terms of inversion, again, so we are open to a new opportunity that will increase the value to our shareholders and is something that will be always open, but we don't know that there are not too many options that we can consider in terms of inversion or accretion of our Companies that will facilitate this kind of tax strategy.

I'll just follow on and add I think that with our leaned-out structure, we will be better positioned to realize value from acquisitions that we might consider. I mean, as looking backwards, use it as a great example, the Abbott Animal Health assets, when you have a better cost structure and you can absorb those and realize the synergies, you can gain better value over assets you're able to acquire.

As Juan Ramon said, I want to buttress that as well, we're always thinking about ways we can build value here and one of those ways is through smart business development activity. Next question, please.

We can take that question from Jami Rubin with Goldman Sachs. Please go ahead.

Thank you. Just to follow up on an earlier question, you both will try to take this, but, clearly what you're doing makes common sense, simplifying a very complex cost structure. It's reasons why companies spin off assets and those assets tend to perform much better as separate companies. But I'm actually kind of surprised, Juan, when you say your expectation is that revenue gross -- you reiterated the type of organic growth that we have been anticipating which is the market growth of 5% and 7%. I would think with shrinking your revenue base and getting out of solar growth or less profitable businesses, that would give you an opportunity to accelerate topline growth, and wondering if you could just talk about that. Thanks.

Thank you, Jami. And I think you are right in your comments. We are doing that because we think it would be much more focused, will be an opportunity to accelerate growth in those markets that will be important to our future profitable growth and that's something that definitely we will be working to ensure that the products that will stay in our portfolio will generate maximum opportunities.

The other important thing is we also want to make sure that we increase our supply to our customers on those products that really matter to them and we want to have a reliable supply and to eliminate the risk of problem supply issues that always very near to our customers. So with being much more focused, we are convinced that we can generate a higher profitable growth. Next?

Our next question comes from John Kreger with William Blair. Please go ahead

Hi. Thanks very much. You talked about a changing approach to R&D. Can you just elaborate a little bit on that, and one specific one, do you still expect Sarolaner to reach the market by spring of 2016? But then more broadly, what are the sort of products you're refocusing the R&D efforts on? Is there any criteria around, let's say, region or animal species? Thanks.

Thank you for the question, John. In terms of R&D, so we are eliminating 5,000 SKUs. So we are eliminating about 40% of our total SKUs. You can also assume that we will be eliminating some of the products that are a very important part of our investment.

Just to remind you, almost 60% or even more of our R&D investment is related to life cycle management. So if we are eliminating 40% of SKUs, we should be also eliminating the products in life cycle management that are supporting this part of the portfolio. We also think that it's a good opportunity also for us to identify the future programs that would generate the highest potential in the animal health industry.

We have been extremely successful in defining these opportunities and APOQUEL is a good example, but also our progress on bringing vaccines to the market, like the PEDv vaccine and many other vaccines that we have been introducing. It's a good example of being focused and defining opportunities; it is a great opportunity for us like this. We will remain doing that and we are not changing our approach in R&D, but we are trying to identify those projects that would generate the highest of return to our Company. In terms of Sarolaner, we are working with the FDA. We are presenting all the information that FDA is requesting and we expect that the product will be launched in 2016.

Before we ask the next question -- it's Paul again. I just want to jump in. R&D is, as I said in my prepared remarks and Juan Ramon referenced as well, that's one of our three key interconnected capabilities and one where we're not changing substantially here. What we're looking for is ways that we can improve the process by which we select projects to go into the queue and then come out on the other end. And the way you phrased your question was almost exactly the way I talked about this inside, it's an assignment of our portfolio around our key brands and around our key regional strategies for growth.

And ensuring this close alignment of our R&D strategy around those key brands and regional strategies, and as I'll say, I say all the time, any process we have and we've been very productive in R&D, any process we have can be improved. And that's what we're doing here, call it continuous improvement.

Next question, please.

Our next question comes from Kathy Miner with Cowen and Company. Please go ahead.

Thank you for taking my question.

Just to follow up a little more on the 5,000 SKUs that will be eliminated. Can you give us a little more color on them, such as how many product this might include? And will we see a change in your therapeutic product mix post the elimination of these products? And second, just a quick question on the antibody for atopic dermatitis that you expect conditional approval for: is that still on track for the end of this year?

Thank you.

Thank you, Kathy.

And definitely these 5,000 SKUs and not 5,000 products. The number of products is much lower. I don't think we have provided the number of products that will be affected. It's something that definitely we planned that to provide this information to our customers in the next coming weeks, and we also plan to send a communication to our customers on those products that will be affecting every market.

In terms of the change of the mix, well, the mix will improve in terms of profitability. So these products, as we mentioned, are low margin. So by eliminating these low margin products, we will improve our margin [make], and this will have a positive impact in our operations. IL-31, we are still on a track for conditional approval in 2015. We are working with the USDA and we expect this conditional license approval any time at the end of the year.

Next question, please.

Our next question comes from Liav Abraham with Citi. Please go ahead.

Good morning. Just a quick question on the sales force.

If I understood correctly, the reduction in the sales force that you propose is only from the sales force that's associated with products or regions that you're exiting and you don't anticipate any declines in sales force in the regions that will remain ongoing, is that correct? I just want to make sure that I understood that correctly.

Thank you for the question.

I'll take it. Thanks.

No, the reduction on the field force, it's mainly related to those markets that we are planning to change our model, moving from direct to indirect. Also in some of the markets we are also adjusting our field force to the real potential of our portfolio. We are not changing our field force in key markets like the US.

We have some more adjustments in some markets in Europe, which is also the reflect of the market potential of those markets, but basically we are maintaining our presence in the market, so we are convinced that our direct interaction with that customer will represent a significant competitive advantage and we are planning to protect these interactions and continue interacting with customers on a daily basis.

And, again, I want to insist that in most of the markets there is not any change in the infrastructure or our field force. It's something that it's applicable not only to the field force, but to the rest of the organization. We are also continuing being much more efficient in times of a span of control and this will imply some elimination of layers also in the field force, but not in the people that are customer facing interactions. Next?

We'll take our next question from David Risinger with Morgan Stanley. Please go ahead.

Thanks very much. And congratulations on the business updates. I just wanted to ask about the two segments of the Company, companion and livestock. Could you just characterize the different margins for the two business segments?

I don't know how much detail you can provide, but I was hoping that you could help to provide a baseline for us in terms of where the operating margins stand for each of the segments? And then looking ahead, which of the two is the one that will experience greater margin expansion over the next three years? Thank you.

Thank you, David.

So let me start by mentioning the difference between the companion animal and livestock in terms of gross profit. So in terms of gross profit, companion animal, it's generating the highest margins and you know that we have a margin of -- a gross profit of 65%, then that companion animal is much higher than the 65%.

And then livestock we have different margin depending on cattle, swine or poultry. Meaning that poultry the lowest in terms of gross profit and cattle the highest in terms of gross profit in the livestock. But then we also need to add what is the costs to bring these products to the customers.

And then in that case, I think the total margins are much more equalized, so companion animal require a significant much more field force and promotional activities because the number of customers in companion animal is much higher than in livestock. And then poultry is the most consolidated industry, so it requires fewer individuals to reach the customers, while customers still require a significant number of people to reach these customers.

So even with gross profit is different in different species, in terms of the total margin, the margins are much more similar. We think there are opportunities in both. We have been growing livestock faster than companion animal in the recent years.

Now with APOQUEL, with Sarolaner, with Abbott, with IL-31, we expect that the companion animal will generate significant growth in our operations. Next?

(Operator Instructions)

We can take our next question from Kevin Ellich with Piper Jaffray. Please go ahead.

Hello. Just a quick followup here. Going back to the SKUs that are going to be eliminated, Paul, did I miss, did you provide how much revenue those products are going to generate or what the impact would be from the SKU elimination in 2016?

And then also in the press release you talked about the feed additive for poultry, Zoamix, just wondering how big that could get? And what's your thought, Juan Ramon, on the scrutiny and some of the restaurant companies eliminating use of antibiotics in the chickens, especially -- oh, and also thoughts on Avian flu? Thanks.

I'll start.

The first question with respect to the pared SKUs, we did not provide a specific amount for the impact on our 2016, just to say that, by definition, we included the impact as we provided the detailed guidance for 2016, and then call your attention to 2017 where we call it out. And it's really $280 million of top line that we expect relative to our prior expectations for 2017.

And the way I would think of it is $100 -- is a curious thing with this $10 million of OpEx that maps the cost of goods sold, so the table, you'll see the $290 million versus $300 million. But $300 of OpEx, you can think of it $280 million and $100 million, that's the impact on 2017 when it's fully reflected in our rebased revenues, and that's how I think about it.

And the majority of these SKU immunizations will take place in 2016, so we should expect there will be an impact in terms of revenues in 2016 that would be very close to this $280 million that Paul is mentioning. So we have not mentioned the factor revenues of Zoalmix in the US, but what we mention is this has been compensating the rotation of the products in the industry. It's used as a way to protect the animal health in the industry.

In terms of -- you also ask about the comments on poultry and antibiotics of a recent company that has been issuing their press release in the US. Definitely we are fully aligned with the AVA objective to reduce the impact of the resistance of antibiotics in (inaudible) health. These two companies has announced they will eliminate the use of hemocoels products in poultry.

In some cases, like Tyson, we have been already working with Tyson some years ago to eliminate these products, and because we have in our portfolio alternative tool, the products of which are important for human health, we think that we will be able to supply to companies in the poultry in the US that will be eliminating gradually the use of hemoceols which are important for human health with all alternative that we have in our portfolio that will also keep the poultry industry productive and also protecting animals against infections. So next question, please.

Our next question comes from Chris Schott with JPMorgan. Please go ahead.

Great. Thanks for the follow-up.

Just trying to dig a little bit more into the motivating factor that's leading you to this broad restructuring. My question, are you seeing the market changing, or is this really just as you've gotten out of Pfizer, you've had a chance to review the broader strategy that you're just having time now to dig into these business units and really try to focus the organization over all?

I'm just trying to understand, higher level, what led you down this path to begin with? Thanks very much.

This product has been a part of our plan since the beginning. Since we separated from Pfizer we had in our thinking that we should generate greater efficiencies and also identify cost saving opportunities. We also knew in the first two years as a public company we would need to focus on extending up our infrastructure and also making sure we're meeting our objective in terms of revenue growth, also our objective in terms of profit growth.

We also needed to have full control of our operations, and when I mean full control of our operations, have full understanding of our corporate functions, also full understanding of manufacturing, and also very important, control over our idea systems. We also decided early in the process of separating from Pfizer to invest in the new ERP and now that the ERP has been already implemented in certain markets in Europe and went live in the US at the end of April, we see that we are in the process to finalize all this implementation in the first quarter of 2016.

With all these elements, I think we are in the position to identify these opportunities to be more efficient, and not only opportunities have to be more efficient, but the opportunity is to be much more focused. And I want to insist that the complexity that we have in some of our operations is a barrier to deliver value to our customers, and this is one of the objectives that we have as part of this program to ensure that we deliver higher volume to our customers by being much more focused on certain problems in certain markets. Next?

And it appears we have no further questions at this time. So I'll turn the floor back over to Juan Ramon for any additional or closing remarks.

Thank you very much for joining us on today's call. We had the opportunity to share with you a lot of information and will be pleased to have follow-up conversations with you if you need some additional understanding of all the plans that we are announcing and also all the progress that we are making as independent Company. Thank you very much.

This does conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-723-0389 for US listeners and 402-220-2647 for international. Please disconnect your lines at this time and have a wonderful day.