碩騰 (ZTS) 2016 Q3 法說會逐字稿

Good day and welcome to the third-quarter 2016 financial results conference call and webcast for Zoetis. Hosting the call today is Steve Frank, 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 is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Thank you, operator. Good morning and welcome to the Zoetis third-quarter 2016 earnings call. I am joined today by Juan Ramon Alaix, our Chief Executive Officer, and Glenn David, our Chief Financial Officer. Before we begin, I'll remind you that the slides presented on this call are available on the investor relations section of our website, and that our remarks today will include forward-looking statements, and that 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 2015 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, November 2, 2016. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon.

Thank you, Steve. Good morning, everyone. There has been a lot written lately about the animal health industry, livestock in particular, and the cycles we face as a part of the global food supply chain.

Let me start by saying that I'm very pleased with the positive result we have reported in the third quarter because it reaffirms that we understand the cycles of our customers and businesses. And as in the past, we continue to be resilient in our ability to adapt and steadily grow our business despite the growth of agricultural market changes.

At Zoetis we have regularly grown faster than the market, and we are very well positioned to achieve predictable growth during busy cycles because of our diverse portfolio and global scope. We remain focused on the long term full-year view of our business since quarterly results can be misleading about the cycles in our customers' markets.

Our strength in all relevant geographies, species, and veterinarians help us offset many of the economic business challenges that can affect parts of the animal health industry in the near term. We also maintained improvements in our cost structure and we are locating resources to the most important growth opportunities in animal health from veterinarians and geographical respective.

I'm pleased to say we have nearly completed our operational efficiency initiative, and we can confirm that we expect to exceed the target of $300 million in cost savings by the end of 2017. We also now expect to achieve an adjusted EBIT margin of 34% to 35% in 2017, higher than our original projection.

And we expect to lower our revenues [flat to the market] again in 2017. This quarter we deliver strong results. We grew our revenue 4% operationally, with a particular strength in our companion animal portfolio.

When you exclude the impact of our operational efficiency initiative, foreign exchange and acquisitions, or what we call normalized organic operational growth, our growth in the third quarter was 6%. On the same normalized basis, our companion animal products grew 11% and our livestock products grew 2%.

The companion animal growth was driven by food supply of APOQUEL and interaction of all the new products. And in livestock the main driver of growth was a strength in our international markets which were able to offset the impact of product rationalization changes across the livestock portfolio.

Moving forward, we expect companion animal to be the main contributor to growth in the fourth quarter and in 2017. And in terms of livestock, we expect improved growth as we get beyond the product rationalization impacts this year. Moving on to earnings, we grew adjusted earnings 6% operationally reflecting the negative impact of higher adjusted effective tax rate.

Glenn will discus this in more detail, but excluding the tax and interest our EBITDA growth was 17%. As we finish up 2016, we are increasing our 2016 earnings guidance to reflect the strong performance we have achieved through the first nine months of the year.

And based on the market trends we see and the confidence in our business, we are also improving our guidance for 2017 despite the recent negative evolution of currencies compared to the US dollar. Let me provide additional business update on some key products and discuss the investments we're making to support that growth.

For the first nine months of 2016 we have generated approximately $180 million in revenue for APOQUEL, with about $70 million coming in the third quarter. We have here an excellent response from veterinarians and pet owners using APOQUEL and we increase our penetration in new markets.

Our research indicates that we are achieving a greater [warranty] and satisfaction among veterinarians as well as more frequent proactive requests from pet owners. APOQUEL has now been launched with unrestricted supply in all our proven markets, and we are working on further expanding its market share.

In the US we have seen growth of new patients since achieving food supply in May. APOQUEL has been doing very well in treating dogs with chronic allergies, and we are increasingly seeing it used for more seasonal and acute allergy causes, an important part of our expansion plans. As we look ahead, with APOQUEL we are trying to reach in other ways to support these and promote growth. For example, in the US we are developing and testing direct to consumer, or DTC advertising, and we expect to launch a national advertising campaign for APOQUEL in 2017.

Also to support the growth of our companion animal business, we have also been expanding our [prone] portfolios and [fill forth] in China and Brazil. These are a great examples on how our efficiency initiative is ultimately about better allocating resources to generate sales growth.

Meanwhile SIMPARICA, our new oral parasiticide for dogs, is available in the US and most of the EU countries and is being further deployed in markets like Canada and Brazil. In 2017 SIMPARICA will be available for the full flea and tick season in the US and the EU.

We are planning to support SIMPARICA with additional promotional investment to ensure it has a positive impact on our revenue growth in 2017. We are also getting ready for the brother launch of our canine antibody therapy targeting IL-31. This therapy is currently only available in the US under conditional license.

In October we expanded our effort beyond dermatology specialties and made it available to all veterinarians in the US. We'll broaden this [position] in the weeks ahead, and we expect to receive a full USDA license by the end of the year with Europe to follow next year.

We've also seen good progress with the farm market position that we made one year ago. We have posted $64 million in fish revenue through the first nine months of the year despite the toxic allergy bloom that has been impacting the fish farmers in Chile.

PHARMAQ has achieved rapid adoption of its Alpha Ject LiVac SRS vaccine for farmers in Chile. Fish farmers who needed a more predictable and reliable means of protection, have responded very favorably to recent information that LiVac SRS has already demonstrated protection up to 11 months after vaccination, and we continue testing for long duration of efficacy.

Fish farmers also view these vaccines as an important way to reduce the use of antibiotics in their operations. Now let me turn to the R&D innovations that continue supporting our future growth and value creation. New product interactions like APOQUEL the IL-31 antibody therapy, SIMPARICA, and the Alpha Ject LiVac SRS vaccine are very important.

Continuous innovation over the lifecycle of our products is also critical to our long-term success. In the third quarter we had several accruals of new indications on formulations for key livestock drugs. In swine we obtained approvals in the US for new combinations of our FluSure XP vaccine.

This now helps guard against additional flu strains that threaten swine herd health. We also expanded our Fostera swine vaccine with additional indications and approvals in markets like Brazil, Mexico, and Korea. Our premium injectable anti-infective DRAXXIN received additional indications and approvals in Japan in Canada.

We also obtained approval in Japan for BOPRIVA, a unique vaccine that temporarily reduces testosterone in bulls providing their farmers with a highly effective way to manage aggressive behavior. We also make investment and showing progress in our diagnostic portfolio.

In other words, we acquired Scandinavian Micro Biodevices, or SMB. They are pioneers in developing and manufacturing microfluidic lab on a chip diagnostic products, which are used for maintaining point of care services. SMB's promising product line has helped our existing diagnostic business, which obtain approval for values and test kits in the third quarter in new markets such as Mexico, Japan, and Korea.

Lots of good news to share about our new products, lifecycle innovation, and business development activities. In summary, we have continued to demonstrate this triumph of our diverse portfolio across geographies and species, and this time we see particular strength in our companion animal portfolio.

We're realizing the benefits of a disciplined approach to R&D and business development which is strengthening our business for the long term. And we expect to achieve our operational efficiency initiative target in 2017 and set ourselves on a path to increase profitability, cash generation, and value creation while maintaining our revenue growth. With that, let me turn things over to Glenn. Glenn?

Thank you, Juan Ramon. Before I get into the financials, I wanted to thank many of you for reaching out and speaking with me since I became CFO in August. I'm very excited to take on this role and work with the rest of Zoetis leaders to continue driving the performance of our Company.

As CFO I am committed to maintaining our reputation for financial integrity and transparency, and continuing an ongoing dialogue with the investment community. We remain focused on achieving our updated financial guidance for 2016 and 2017, building our capacity for long-term revenue and earnings growth and delivering the innovation and financial performance that people have come to expect from Zoetis.

I am pleased to say that in my first quarter as CFO that we're making excellent progress on all of those fronts, and we are raising our earnings guidance for 2016 and improving our earnings guidance for 2017, despite the negative impact of foreign currency which was approximately $0.03. The consistent performance we've delivered over time through recent periods of major efficiency initiatives and change is a testament to the quality and commitment of our Zoetis colleagues.

So what are the key takeaways for the third quarter results? Continued strong operational revenue growth from our diverse portfolio; continued improvement in our adjusted EBIT growth and margin; a meaningful contribution from several new product launches, lifecycle innovations, and targeted business development activities; and finally an update to guidance for 2016 and 2017 that reflects our recent performance and confidence in the future.

Now let me walk you through the major pieces of our third-quarter income statement and provide some color. We generally talk to operational growth, which excludes the impact of foreign currency. You can also see once again in the tables on our website that we are providing additional detail on impacts related to our operational efficiency initiative, M&A, and in the case of the year-to-date charts the extra days in our first quarter relative to the prior year.

We refer to the revenue growth excluding these items as normalized organic operational growth. For the third quarter operational revenue growth was 4%, which excludes a 2% negative impact of foreign exchange. Now let me take you through the key elements of our performance and bridge that to our normalized growth.

First APOQUEL and a number of other new products contributed 5% of our revenue growth. The in-line portfolio grew 1%, with price contributing 2% and volume declining 1%. Recent M&A contributed 3% to our growth, while operational efficiency initiative reduced our growth by 5% due to product rationalizations and changes to our business in markets like Venezuela and India.

Accounting for all of these factors, we delivered normalized organic operational growth of 6% in the quarter. And for the first nine months of the year our revenue growth on this basis was 7%, in line with our view of 7% to 8% growth for the full year.

Turning now to our segment performance, in terms of the US we generated 1% operational growth compared to a very strong third quarter in the previous year. Just a reminder, the US grew 19% in Q3 2015, with livestock growing 13% and companion animal growing 27%.

In the third quarter of 2016, US companion animal products grew 5% driven by APOQUEL, SIMPARICA, and other new product launches like our new vaccines. This growth was partially offset by a decline in surgical fluid products. In US livestock we declined by 2% against a very strong year-ago quarter when we grew 13%.

The decline was primarily due to the impact of SKU eliminations, lower sales of our swine products where we continued to see increased competition, as well as the impact of a challenging market environment especially for our cattle and swine customers. We partially offset this decline with growth in our cattle business where successful promotional activity drove increased volumes.

Shifting back to a normalized organic operational growth basis, US grew 3% with companion animal growing 6% and livestock growing 1%. Turning to international, revenue grew 6% operationally. We delivered very strong operational growth of 15% in companion animal and 2% in livestock.

Our international business saw significant impact from our operational efficiency initiative which reduced growth by 8%. By species group the impact was 9% in livestock and 6% in companion animal. M&A activity, primarily PHARMAQ, contributed 5% to our international revenue growth.

Based on these factors, our normalized organic operational growth for international was 9%, with companion animal growth of 21% and livestock growth of 4%. You can see the full results for our top 11 markets in the tables, but let me highlight a few items.

Growth in markets like Japan, Brazil, Germany, and Australia was primarily from companion animal products and launches of APOQUEL. In Japan we a saw significant benefit from the initial stocking of APOQUEL with wholesalers in the quarter.

France in Canada both saw a mix of companion animal and livestock sales driving their growth, including sales of APOQUEL and a more stable environment in France around antibiotic usage and prior regulatory changes. Meanwhile we continued to see livestock supported with growth in cattle in Brazil and swine in China where we currently have favorable market conditions, as well as growth in companion animal in China where we have seen positive trends in medicalization rates for pets.

Overall we have been very pleased with the strong growth we have seen in emerging markets, particularly China and Brazil, where we have invested in expanding our field force and product portfolios to effectively capitalize on the fast-growing trends in these countries. We will continue to deploy selling resources in these and other markets where we see significant and sustainable growth drivers combined with high returns on our investments.

Wrapping up the revenue picture, there are five key takeaways for the third quarter. Our diversified model continues to deliver steady, predictable, and meaningful revenue growth with the strong product lines and geographies balancing the effect of certain market challenges and cycles.

Product rationalization continues to impact revenue growth. However, we continue to deliver strong growth on a normalized basis. APOQUEL once again was a significant growth driver, with launches in new markets and a continued expansion of the customer base in existing markets.

Other companion animal products like SIMPARICA and recent additions to our vaccine portfolio are contributing to growth. And finally when it comes to revenue we are improving the base business in various emerging markets by expanding our product portfolio and adding to our direct sales capabilities.

Turning to the rest of the P&L, adjusted gross margin improved 120 basis points primarily due to a more profitable mix of products, while foreign exchange had a negative impact of 70 basis points this quarter. Adjusted operating expense also declined, reflecting the continued realization of our operational efficiency changes and continued discipline around SG&A, which included the addition of PHARMAQ expenses this year.

Improved gross margin and a reduction of operating expenses enabled us to grow our adjusted EBIT by 17% operationally versus the 4% operational revenue growth. Our adjusted effective tax rate in the third quarter was 31.6% versus 25.1% in the year-ago quarter.

This difference was primarily driven by the impact of the European commission tax ruling earlier this year and the benefit of certain discreet items in the year-ago quarter. As a result, adjusted net income grew 6% operationally, reflecting the change to our adjusted tax rate and higher interest expense which offset much of our adjusted EBIT growth.

For the quarter GAAP net income grew 26% on a reported basis, aided by a reduction in standup costs and restructuring charges as well as the revaluation of deferred tax assets we rated to the establishment of our new international operating model. Moving to guidance, for full-year 2016 we are narrowing to the high end of our revenue range and increasing our adjusted diluted EPS to reflect our ongoing confidence in the momentum of our new products and the sustainable cost benefits of our operational efficiency initiative.

As you model out the remainder of 2016, remember that we have five fewer days in Q4 2016 than 2015, and this is usually our highest quarter in terms of operating expenses as a percent of revenue and our lowest quarter for gross margin due to the seasonal nature of our product mix. For the year we expect to achieve operational revenue growth, including the impact from product rationalization, of 4% to 5% and adjusted EBIT margin of approximately 32%, and operational growth and adjusted net income of 12% to 15%.

The significant increase in our guidance for reported diluted EPS is due to our increased outlook for the business and the favorable tax items realized in Q3. Moving to 2017, since our last update in August changes in FX rates have lowered our useful revenue by $50 million and adjusted diluted EPS by $0.03.

However, the overall evolution in our business over the past year has been positive on balance, as our companion animal dermatology portfolio continues to grow and several livestock markets in our international business are strengthening. These changes are allowing us to increase the lower end of our revenue range and maintain the high end while absorbing the negative impact of foreign exchange.

Cost of goods remains the same at 32% to 33%, as we have been successful in our cost reduction efforts as well as our SKU rationalization that has brought an improved mix. On SG&A, FX changes were slightly in our favor.

However, we are increasing the lower end of our range and maintaining the high end as we allocate a portion of our cost savings to promising investment opportunities such as advertising and promotional investments in key companion animal franchises like APOQUEL and SIMPARICA that will drive revenue starting in 2017 and over the next several years, field force expansions in Brazil and China where we see sustainable growth drivers and opportunities for increased market share, and enhancements to our diagnostics commercial capabilities following the acquisition of SMB.

We're also taking on the necessary R&D investments to develop SMB's pipeline as well as investing additional R&D dollars toward some of our key international growth markets. When you take all of these changes together, we are increasing the lower end of our adjusted EPS range, maintaining the high end of $2.38 despite the negative impact of foreign currency, while also improving our view for adjusted EBIT margin to be between 34% and 35%.

While we don't provide quarterly guidance, we do want to point out that we are currently expecting the delivery of full-year 2017 adjusted diluted EPS growth to be more heavily weighted to the second half of the year for a few reasons. First, we will have some lingering effects from the operational efficiency initiative in the first two quarters as we continue to sell out remaining inventory from Q1 and Q2 of 2016.

Second, a portion of our revenue growth is dependent upon the ramping up of new product launches which we expect to build throughout the year. Finally, many of the incremental investments we're making on the SG&A line are weighted towards the first half of the year and begin to deliver results in the revenue line as the year goes on.

A final point on capital allocation, we're continuing to repurchase shares at a steady rate of $75 million per quarter. At this rate we would exhaust our current plan at the end of this year. Share repurchases will continue to be an important element of our capital allocation framework, and we will provide a more specific update later this year.

So wrapping up, we've improved our outlook for revenue, we've achieved our targeted cost structure, we're prudently taking on investments in long-term growth, we've improved our outlook for adjusted EBIT margin, and we've improved our view for EPS. It has been a tremendous effort to get where we are.

We are proud of what we have achieved to date, and we are excited to continue moving the business to new heights. With that, I'll hand things over to the operator to the open the line for your questions. Operator?

(Operator Instructions)

Louise Chen with Guggenheim Securities.

Thanks for taking my question. My question here is on livestock. How should we think about Zoetis's ability to grow livestock sales through pricing pressures in the US for cattle? And can you provide more details on the herd size, US feed lot sales, and producer profitability and the puts and takes here? Thanks.

Thank you, Louise, it is Juan Ramon. On the question on the livestock and how we plan to grow this business in price or other volume growth, definitely we continue applying the same strategy in terms of pricing that can be justified through outcome and providing the value to our customers. We continue having these prices vary constantly over the years and we also plan to continue increasing these prices in the future.

In the US as we reported, livestock in this quarter grew by 1% in terms of normalized growth. So excluding the impact of SKU or currency or M&A if we go to the tales of the drivers of this growth, cattle grow by low single-digit, swine decline, and poultry have double-digit growth.

So talking about the cattle and also the situation on the feed lots and all different drivers that are affecting this segment, I may describe the factors that are impacting the cattle business in the US. So one, it is more animals, which is a positive. We have seen also in this quarter higher placement of animals in feed lots, another positive element.

But there are other elements which are negative, and we have seen that in the quarter. So first the producers are losing money. Animals are entering heavier into the feed lots, and also we have experienced mild weather conditions in the US that are driving lower disease incidence.

So net-net compared to one year ago we think that the situation is less positive, but still with this situation we have been able to grow the business. And the reason why we are growing is because of our portfolio, the ability also to increase prices, and also the team which is interacting with customers.

The last comment I want to make here is that this is a business, livestock, which is affected by cycles, cycles that have been affecting in the past and will continue affecting in the future. Despite these cycles, the animal [healthing bill] has been very slim and showing very steady growth.

In the past 5% to 6%, and we expect also in the future despite of those cycles we will continue growing at the same rate. And definitely we see Zoetis also growing in 2017 in livestock in line with the market.

Jon Block with Stifel.

Thanks, good morning and maybe I'll just try to ask both questions up front. So the first one on APOQUEL I think it's down a $280 million run rate before the DTC. So how do you feel about that north of $300 million goal?

Is that now possibly $400 million? And maybe if you can talk about what prior DTCs have done to other Zoetis products like RIMADYL. And then just a follow up on the US livestock, you mentioned up 1% after the adjustments in the SKU rationalization.

In the comments I think you called out some promotions in the quarter, so just wondering is the thought of positive US livestock growth for the year still intact? Just trying to get the fluctuations between 3Q and 4Q. Thanks.

Thank you, Jon, for the question on APOQUEL. We expect definitely to exceed the $300 million. We want to make sure that we have full understanding of the market reaction, not only the US but also in all the rest of the markets the product has been now made available with full availability.

We also need to have full understanding of what will be the impact, not only in chronic but also in seasonal and acute. And we said the DTC campaign definitely we expect to grow the access of -- expanding the access of the product to more patients and also bring pet owners to the clinics then the client can prescribe the product.

In terms of other DTC investments, we mentioned also that we're considering also DTC for SIMPARICA as something that we will consider in the US when we have the right level of penetration in the market. In terms of cattle, so cattle in the US we expect that at the end of the year we will be growing, and we stated many times that it's important not to look at our business on a quarterly basis, but on a full-year basis.

And on a full-year basis we still expect the cattle business showing positive growth. We know that some cycles that can be negative at a certain point will turn into positive in the following phases or the following quarters or months. So we're confident also that the cattle business in the US will be showing growth in 2017.

And this is Glenn. Just to add on to APOQUEL in terms of the DTC, since we don't have a lot of experience with DTC with a lot of our other products, we did run specific pilots for APOQUEL that give us strong confidence in the return that we are going to get on that investment in the future. And then the other thing in terms of the peak sale, we really do want to stress to look at that from a dermatology portfolio perspective. We are very excited about IL-31 and the future that's going to bring for us.

Jeff Holford with Jefferies.

Thanks very much for taking my question. Just for Glenn, I wonder if you can just tell us around some of the inventory management you have, you have the SKU focus, you quite clearly guided for that in 2017. Could you just tell us if there could be further inventory movements from the integration of SAP, and is that included in the 2017 guide?

And then quick add-on of you noticed -- you mentioned an update on the share repurchase. Would that be part of our capital markets day later this year? Thank you.

From an inventory perspective we definitely still do see significant opportunity to reduce our inventory moving forward. We currently sit at 10-plus months of inventory on the balance sheet, and that's definitely an area of opportunity that we see and we will start to see benefits from the additional visibility we have in SAP. We will start to see those benefits in 2017 and beyond.

So definitely an area of opportunity for us to increase our cash generation. The other question in terms of share repurchase, so we have a $500 million share repurchase program in place that started last year.

We will be complete with that program by the end of the year, and we will come back to the market later in the year with our intentions for that moving forward. But share repurchase does maintain -- remain a very important part of our capital allocation priorities.

Derik De Bruin with Bank of America.

Good morning. Could you talk a little bit about the swine business and how much of headwind has that been to organic revenue growth the last year or so? And I guess when can we think about new product timing and concentrations of that? I mean just talk a little bit more about how you are thinking about rebuilding that business or expanding the business.

Yes, let me describe this swine business, not only in the US but also international. Internationally the swine business has been showing double-digit growth, which is very strong growth, while in the US we saw in this quarter a decline.

The main reason of the decline was some challenge in terms of one important vaccine that is used in the swine industry, which is the PCV2 vaccine. We expect to update this vaccine and having a positive impact in terms of growth in 2017.

The rest of the markets outside of the US, the performance has been very strong, especially in China. And where we continue seeing the benefits of more of the swine flu action and we are very well-positioned to maximize the opportunities in this market. We also after we explain that, we are expanding our portfolio in the country in China, and definitely we see swine generating growth in 2017.

John Scotti with Evercore ISI.

Thanks for taking my question. I wanted to ask on operating margin, because given the increase in 2017 guidance, Glenn in your new seat would appreciate any thoughts on where you see operating margin growth beyond 35%. And specifically, where do you think the upper bound of operating margin expansion is? Is about 40% realistic here?

And then also can you comment specifically on the contribution of the manufacturing initiative in future years? And then really fast, sorry, just a follow up on APOQUEL.

You mentioned you plan to exceed $300 million, can you provide any detail on timelines for that? Is that a 2017 event? Thank you.

In terms of the $300 million, I'll take that question first. That is a 2017 event. Exceeding the $300 million is baked into our projections for 2017. In terms of operating margins, we are not targeting a specific operating margin going forward.

We're focused on income generation and cash generation, and that is our focus. However, when you look at what we articulate as our long-term strategy, the ability to grow revenue at a faster pace than our cost, that definitely does lead to increased margins as we move forward.

And in terms of the benefit that we expect to get from the Supply Network Strategy moving forward. So we have articulated and we're still committed to by 2020 we do expect to achieve an extra 200 basis point improvement in our margin from that strategy. So when you take all those factors together that definitely leads to improved margin, but again our focus is on cash generation.

Jami Rubin with Goldman Sachs.

Good morning. This is Jonathan on the call for Jamie. If protein prices continue to fall and are sustained at lower levels as a result of your cyclical factors, would that potentially cause you to revise your expectations, particularly in cattle and swine?

And a second question, some of your competitors have cited challenges in their dairy segment, and give that you discussed cattle is a consolidated figured, I was hoping that you could comment on trends seen in that particular group? And further can you elaborate on the progress of the SKU rationalization program and when that will begin tapering off, and whether you will see operational growth in US livestock remain positive net of these rationalizations? Thank you.

Thank you for your question, Jonathan. I will start with the comment on the protein pricing and how this can be affecting our business. So we have seen that these prices are going up and down, it is part of cycles that have been affecting our industry for decades.

And we have been managing that very well, this situation. We saw prices going down for poultry, and then the next cycle going up. It always depends on the supply. The demand continues growing and is something that will help the industry to continue generating more revenues.

We don't think that the current situation is specifically negative. It is something that we expect that will be a reverse in the near future, and we will see that this is not having a negative impact in our projections.

And again, this [inbivic] has been very predictable and showing steady growth even in situations with significant negative factors. Including the drought or even including the economic crisis in 2008, the animal health industry was probably one of the few industries showing growth in this negative environment.

Daily we have seen that prices have been down significantly at the beginning of the year. Now these prices are recovering, and very important is that we have not seen any reduction of a herd in terms of cows, which is an indication that producer is still keeping the animals to ensure that they will be able to supply market demands in the next cycle. So we expect those daily having a positive trend in 2017. And then Glenn will talk about the SKU rationalization.

In terms of the SKU rationalization, we are essentially complete with that program. However, we did have some sales of these products in Q1 and Q2 of 2016.

That does pose a challenge in the comparative for 2017. We estimate that impact to be about 1% for 2017 and more disproportionally weighted to the first half of the year.

John Kreger with William Blair

Thanks very much. Glenn, can you expand a bit more on the supply chain optimization plan? You've talked in the past about a couple hundred basis point goal, but could you maybe just lay out a little more specifically, the timeline and the strategy to get there? And then secondly can you give us an update on how the livestock antibiotic portfolio did in the quarter? Thanks.

In terms of the supply chain optimization, there are a number of sites that we are still in the process of divesting or changing our strategy, three sites essentially, that we'll need to ship product from one site to another. That occurs over time, so the progression of that 200 basis point improvement that we talked about through 2020 will come over a number of years.

You will see that in 2018, 2019, and 2020. It won't be an automatic shift, it's based on the timing of shifting the products from those three plants. In terms of livestock antibiotic growth year to date, we are seeing positive growth year to date in those products. There are some shifts with M&A, within MFE, but overall our antibiotics are growing year to date.

Alex Arfaei with BMO Capital Markets.

Good morning, this is Frank DiLorenzo on behalf of Alex. Thanks for taking my call. Regarding business development, will Management continue to look towards small opportunities such as the recent Scandinavian Micro Biodevices deal, or are you it willing to consider larger deals. Also along those lines, are there any particular areas of interest that you are focusing on? Thanks.

We are not limiting our target M&A to small acquisitions, but we are targeting is that will support our strategy and also will create value. And we have significant experience in integrating companies.

We think that any accretion that is supported by the strategy and the value creation will generate synergies in terms of cost and also revenues. We are also defining what are the areas of interest for M&A. We will continue (inaudible) in our core business, but also we will consider in diagnostics also in genetics and in devices as a way to complement our portfolio and maximize the already existing infrastructure that we have that we will be using these problems also will leave a higher volume to our customers.

(Operator Instructions)

Kathy Miner with Cowen and Company

Thank you, good morning. Two questions, first on APOQUEL, I think you've talked in the past that the APOQUEL sales have been largely three-quarters US and one-quarter OUS. How has that shifted and how do you see that trending going forward?

Also on APOQUEL are you able to tell us how many dogs in the US have been treated with APOQUEL so far? And then secondly just a broader question on pricing trends, as you look into 2017 can you remind us what you're pricing expectations are, both US and OUS and whether there's been any change from 2016? Thank you.

Let me start with the comment on prices. So on prices, we are consistent also with the animal health projections. And the animal health projections it's growing prices 2% to 3%, and this has been always vacancy in the past, and we continue applying these 2% to 3% in our projections.

And we expect that 2017 also will be in line with these percentages. Not to be different in terms of US or international, the only difference in some international markets with high inflation rates, the price increases can be higher and in line with this inflation. You also ask about the use of APOQUEL in the US mainly.

So far until very recently the use of APOQUEL has been mostly for on chronic we have seen already this quarter that it's already APOQUEL in the US, which is where we have more recent market research. The use has been also extended to seasonal and chronic and acute.

And we expect also this to continue not only in the US, but also in international markets. And we are very confident that the expansion of the product will be driven by the use in all the different categories; chronic, acute, and seasonal.

You also ask about what is the situation of APOQUEL US, international. This quarter on the $70 million, $40 million came from the US and $30 million international. This is something that is probably not representative of the true potential of international and the US.

What we can also show in the market through market research is that the new patients is growing constantly in the US, which is very positive, and we expect that this will continue. And if the results of the pilot are showing positive for the DTC that we are testing in the US, then we expect that this will be also activating the use of APOQUEL in the US. As you know, not in all markets who have DTC it's available, because there are some restrictions in terms of regulatory or direct to consumer advertising in many markets in the world.

Derik De Bruin with Bank of America.

Thanks, this is Mike on for Derek just with a quick follow up. In the last couple of months there's been a lot of movement in the competitive landscape with companies moving ahead with proposed asset swaps, some divestitures. Can you talk a little bit about how have you seen any change in the competitive landscape, if you've been able to gain any share, and especially in the last quarter there was a lot of mixed results from competitors, particularly in companion animal in the US. Some promotional changes with flea and tick; can you just talk about if you've been able to capitalize on any of those disruptions in the market?

Let me start saying that we believe we have the best portfolio in the animal health industry in both companion animal and livestock. We had significant new products launch initially, and also very important, our R&D investment in our current portfolio is also showing very positive results.

So we don't think the consolidation of the industry will be taking place from now until the end of the year. We've changed significantly the competitive landscape.

We compete not on a global basis, but also on a country basis and also on a species basis, and there is not too significant difference because of these configurations. We are very confident that we remain very competitive, and the products that we are introducing and also this report in terms of promotional activities and R&D and even manufacturing quality and delay of supply will help us maintain and expand our market share.

It does appear we have no further questions at this time. I will return the floor to you, Juan Ramon, for any additional or closing remarks.

Thank you very much for joining us today. And as we said, we reported very strong results in the quarter. We are very confident on the projections that we are making for 2016 and 2017, and we will connect again in the next earnings release. Thank you very much

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