碩騰 (ZTS) 2016 Q4 法說會逐字稿

Welcome to the fourth quarter and full year 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 fourth quarter and full year 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 statements in today's press release, in our SEC filings, including but not limited our 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 measure is included in the financial tables that accompany our earnings press release, and in the Company's 8-K filing dated today, February 16, 2017. 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. I am very pleased to say that in 2016, we delivered our fourth consecutive year of operational revenue growth, and improved our profitability since becoming a public company. We completed the significant initiative to shape our business for greater efficiency and cash generation, and we continue to make investment as we sustain our future growth, innovation, and market leadership.

Our growth in 2016 was driven by the successful launch of several new products, he strength of our diverse portfolio, and a deeper commitment to the direct customer relationships, productive R&D, and high quality manufacturing that are the definition of our business model.

Let me highlight some of the headlines for 2016. We delivered on our financial goal for the year, despite some challenging market conditions for livestock producers, especially in the US. We generated 5% operational growth in revenue for the full year, and 8% [net] growth based on our normalized organic operational view that Glenn will discuss in his remarks.

As expected, our companion animal portfolio led the way with 13% operational growth, thanks to Apoquel, and other new [product] launches. Our livestock portfolio grew 1% operationally, overcoming the negative revenue impact of our rationalization initiative, and business changes in Venezuela and India.

We posted 17% operational growth in adjusted net income, and improved our adjusted EBIT margin to 32%. These measures demonstrate the positive impact of our operational efficiency changes, and the benefits of our new product launches like Apoquel.

We were able to deliver these strong results and innovation, while implementing important changes to our business last year. For example, we completed the implementation of our [ERP] system, which has given us more efficient tools, and better visibility across our operations. We eliminated approximately 5,000 low revenue, low margin SKUs from our product portfolio, and we have sold or exited six manufacturing sites.

During 2016, we have strengthened our industry leadership with more than 200 product approvals, including Cytopoint in the US, the first monoclonal antibody approved to help dogs suffering from atopic dermatitis. Simparica, our new oral [parasiticide], and several new [Vanguard] vaccines. We continued to look at this productive R&D engine as critical to our future, and have spent more on R&D than any of our peers.

We also continue to see the value of investing in external business development opportunities. Last year, we acquired Scandinavian Micro Biodevices in the diagnostic space for approximately $[80] million, and our prior acquisition of PHARMAQ contributed $90 million in revenue in 2016 while achieving rapid adoption of it's ALPHA JECT LiVac SRS vaccine for (inaudible). Fish farmers in Chile have responded very favorably to the introduction of this vaccine.

Finally, we returned $488 million in [excess] capital to shareholders through dividends and share repurchases, and we announced plan for a multi-year $1.5 [billion] share repurchase plan beginning in 2017. All of these investments are consistent with the capital allocation priorities we have shared with you in the past.

All the work that we have done in 2016 and in previous years, such as building our infrastructure, investing in new systems and becoming more efficient, has positioned us for success in 2017 and beyond. In 2017, we'll target operational revenue growth of 5.5% to 7.5%, and continue improving our adjusted EBIT margin, as we realize the full benefit of our operational efficiency initiative this year.

All the major actions of the operational efficiency program that we announced in 2015 has been implemented, and we expect to exceed the initial target of $600 million in savings in 2017. This additional savings will be used to support our short- and long-term growth in several ways.

In 2017, we plan to initiate direct-to-consumer marketing and advertising campaigns in the US for two of our companion animal products. In the case of Apoquel, we want to increase awareness of atopic dermatitis among the pet owners, especially those whose dogs may be suffering from acute conditions. And in the case of Simparica, we want to demonstrate the advantages of our product, and increase our share of voice in the highly competitive parasiticide market.

These campaigns will include national television ads and their digital promotions online, and they are targeted to begin in the first half of this year. We will also support new product launches like Cytopoint, which was approved in the US last year, and Stronghold Plus which is expected to be launched this year in the European Union. The Stronghold Plus is topical parasiticide for cats that combines [Sarolaner], the active ingredient of our Simparica with [Selamectin], the active ingredient in our current Stronghold and Revolution product lines. This is our first combination product for [Sarolaner]. These are great example of how we use an R&D focus on lifecycle innovation to expand our platform, and maintain a durable and valuable product lines for [decades].

We also really made focus on improving the way we interact with and support our customers. Our people and technology are an important part of any customer experience, and they remain critical areas of investment. For example, we will be deploying the new tools and capabilities on our ERP system, and we have been expanding our field force in markets like Brazil and China, where we see significant and sustainable growth opportunities.

We also see R&D, manufacturing, and business development as areas where we will allocate increased capital this year to support our long-term growth plans. Our internal [R&D] products will help discover new products, as well as develop lifecycle innovation across our approximately 300 product lines.

Our business development team will continue exploring acquisitions, partnerships, and alliances that enable us to fill gaps in our portfolio, and expand further in complementary spaces and geographies. And we will continue executing our long-term supply network strategy, to improve the quality and the reliability of our key growth platforms in manufacturing. We have become the profitable business and market leader we always envisioned when we launched in 2013, and the outlook for Zoetis in 2017 is very positive.

We expect to see strong [net] growth from our companion animal portfolio again this year, driven by our dermatology portfolio, Apoquel and Cytopoint, further [penetration] of Simparica, and ongoing uptake of our new vaccines. And in our livestock portfolio, we expect a recovery and improved growth across our cattle, swine, and poultry business.

In the case of fish, we expect PHARMAQ to capitalize on the success of the new ALPHA JECT LiVac vaccine in Chile. And we recently received a favorable legal ruling in Norway, the world's largest farm [salmon] market, which we were asked to launch our vaccine for salmon pancreatic disease this year, a great result and opportunity that demonstrates the value we saw for this acquisition.

In closing, we are proud of our ability to deliver better than expected results in 2016, despite the market challenges we faced, and the business changes we implemented. I want to thank all of our Zoetis colleagues for their commitment and personal contribution to these results.

As we look ahead in 2017, we see a bright future. We have reshaped our business for long-term profitable growth, based on our diverse portfolio, [capital] focus, innovative R&D, high quality manufacturing and improved capital efficiency. I thank you, our shareholders, for your confidence in Zoetis, and look forward to reporting to you on our progress. With that, let me turn things over to Glenn. Glenn?

Thank you, Juan Ramon. Before discussing the fourth quarter and 2017 guidance, let me offer a quick perspective on the full year. We delivered revenue and adjusted EPS at the high end of our guidance ranges. Our new companion animal products, increased efficiency, and margin improvements all helped drive that performance throughout the year.

Operational revenue growth for the year was 5%, but a better indicator of our underlying performance is what we refer to as our normalized organic operational growth. That was 8% for the year. It excludes the negative impact of our operational efficiency initiative and the positive impact of M&A. You can find the details of these items in the tables on our website.

Of this 8% growth, 5 percentage points came from new products including Apoquel, 3 percentage products came from the in-line portfolio, with 2 points of that from price, and 1 from volume. This will be the last quarter that we will report our normalized revenue growth metric, as our operational efficiency initiative will have only a small impact on our revenue in 2017. There will be some continued drag in our revenue growth from product rationalizations, especially in the first [two] quarters of the year, and we will help you understand the magnitude of those items, as we go through 2017.

As we said in the past, we take a long-term view of our business, and prefer to assess our financial performance on an annual basis, rather than taking a quarterly focus. During the year, we saw many of the familiar seasonal fluctuations that occur in our industry, but as we progressed through the year, our expectations for outperformance steadily increased. Our team delivered on those higher expectations, with 17% operational growth in adjusted net income, compared to the 6% to 12% we expected at the beginning of the year.

This success demonstrates the strength of our diverse portfolio and business model, and it builds on many years of strong performance. We're especially pleased to have achieved these results, during a period of significant change in how we operate our Company.

Turning to the quarter, we delivered double-digit operational growth in adjusted net income, overcoming the negative impact to revenue of fewer calendar days, and business changes related to our operational efficiency initiative. Both reported and operational revenue growth were flat for the quarter. We saw no impact from foreign exchange to revenue, unlike many of our prior quarters.

Our operational efficiency initiative reduced revenue by 3%, and fewer calendar days in the quarter had approximately a 4% impact. M&A activity, primarily PHARMAQ, contributed 2% to our revenue growth. PHARMAQ was below our revenue projections for the year, but we feel very good about the value we are getting from this acquisition.

Our positive view is supported by the strong performance of our SRS vaccine in Chile, and a recent legal win in Norway that opens the door to an important category in the aquaculture market. These two PHARMAQ drivers represent a meaningful portion of the value we saw in this company. While market conditions in Chile were challenging in 2016, the long-term structural drivers of growth that attracted us to the aquaculture market remain intact.

Going back to our overall results, our normalized organic operational revenue growth was 5% in the fourth quarter. Again, this backs out the negative effects of our operational efficiency initiative, fewer calendar days in the quarter, and the benefit from M&A.

This growth was balanced between our geographic segments on a normalized basis, with international growing 6%, and the US growing at 5%. In both segments, the main growth driver was new companion animal products. We continue to see strong growth of Apoquel and our vaccine franchises, and we are steadily establishing Simparica in the US and other markets.

In the US, we continue to absorb the decline in surgical fluid products. This was partially offset, however, by additional sales in the quarter, as we expanded distributer relationships on other products. US companion animal grew 7% on a normalized basis.

US livestock grew 3% on a normalized basis, with growth in cattle and poultry offset by declines in swine. Market conditions in cattle continue to be difficult, and results were somewhat lighter than expected in the fourth quarter; however, our US cattle business delivered low to mid single-digit growth on the same normalized basis for quarter and year, despite very challenging market conditions for our beef and dairy customers. Again, this demonstrates the resiliency of the animal health industry and Zoetis, even in challenging market conditions.

International companion animal normalized growth of 16% was supported by new product contributions, as well as higher levels of medicalization in emerging markets, a fundamental long-term structural driver of our business. 2% normalized growth for international livestock was supported by growth in China, Mexico, and Brazil, offset by lower usage of antibiotics in Western Europe.

You can see the full results of our top 11 markets in the tables, but let me highlight a few items. Growth in key emerging markets like Brazil and China continues to be strong. Operational revenue growth in Brazil of 8% was driven by price, new companion animal products, and favorable cattle conditions. High demand for beef exports from Brazil, more than offset the difficult market conditions in poultry and swine, where producers saw higher input prices.

Operational growth in China of 17% was driven by continued strength in the swine market, and growth in companion animal vaccines due to increases in routine care. For the year, China grew 24% operationally, our fourth consecutive year of double-digit growth since becoming public. Our recent field force expansions in Brazil and China have been productive, and we'll 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.

Emerging market growth was not limited to Brazil and China. Our other emerging markets category grew 6% operationally.

Now turning to the rest of the P&L, I'll quickly cover a few items of note in the quarter, and then move to a review of guidance. Adjusted gross margin increased 110 basis points in the quarter on a reported basis, primarily due to favorable foreign exchange, which was partially offset by higher inventory charges. Adjusted other income included a $[15] million charge for the devaluation of the Egyptian pound that occurred in November, after our most recent guidance update.

The adjusted effective tax rate for the quarter was 25%. This rate included the effects of discrete items, and the jurisdictional mix of earnings. This brought our full year adjusted tax rate to 30%, which was 2 points below our guidance for the year.

Adjusted net income grew 13% operationally, despite the fewer selling days in the quarter. GAAP net income grew significantly on a reported basis in the quarter. This was due to the charge in the year ago quarter related to the currency devaluation in Venezuela, as well as lower stand-up and operational efficiency costs.

Versus our full year guidance, our one-time costs were above the range, as we settled a product dispute with poultry customers in Mexico, and had higher than expected severance costs associated with our efficiency initiative. In the quarter, we also incurred a net tax charge as a result of the implementation of certain operational changes, including the revaluation of tax assets associated with the change in our operating model.

All in all, Q4 was a good quarter, wrapping up a great year. We delivered normalized organic operational growth of 8%, adjusted gross margin improvement of almost 200 basis points, 23% operational growth in adjusted EBIT, and 17% operational growth in adjusted net income.

Now let's talk about guidance for full year 2017. We are updating our previous guidance for changes in foreign exchange rates, since our last update in November. Our guidance now reflects rates as of late January, which reduce revenue guidance by approximately $50 million and adjusted EPS by $0.03.

On an operational basis, our guidance is unchanged. We have, however, updated our growth rates to reflect the higher base of revenue and income achieved in 2016. For the year, we expect to achieve operational revenue growth of 5.5% to 7.5%, and adjusted EBIT margin of 34% to 35%, and operational growth and adjusted net income of 15% to 20%.

We continue to see companion animal driving much of our growth in 2017. We will have additional penetration of Apoquel, including its expansion into more acute and seasonal cases. We will continue to launch Cytopoint in the US, as we build our dermatology portfolio, and we will see additional market penetration of Simparica, as well as the launch of Stronghold Plus in Europe.

All of the necessary actions to deliver our 2017 efficiency goals were largely completed by the end of 2016. We expect to deliver more than the $300 million in savings we initially targeted, some of which we will be investing back in the business.

Despite the lower tax rate in the fourth quarter, our guidance for adjusted ETR is unchanged. We do not expect the favorable discrete items from Q4 to recur.

Our guidance for adjusted ETR is based on current US tax law, and does not take into account any potential changes being discussed in Washington. With more than half of our adjusted pre-tax income in the US, a lowering of the US corporate tax rate would have a meaningful benefit to us.

There are also other items that can impact our taxes going forward, such as border adjustability, and the impact of [deemed] repatriation. We will be in a position to articulate the potential effect of these items, as we gain more clarity.

While we don't guide for quarters, I do want to reiterate my comments from last quarter, that we expect to see our revenue and income growth weighted more significantly towards the second half of the year. As a reminder in 2017, we will face approximately $50 million drag on revenue growth from the product rationalization. This will disproportionately affect the first quarter.

We are expecting first quarter gross margin to be generally in line with the fourth quarter of 2016, due to the timing of recognition of cost of goods sold. We're also reinvesting a portion of our additional cost savings, in investments in product launches and key brands like Apoquel, Cytopoint and Simparica earlier in the year.

We expect to begin seeing revenue effect of these investments in the second half of the year. The result is that we currently see limited adjusted income growth in the first half, with significantly stronger growth later in the year.

A final point on capital allocation. We have completed our initial share repurchase program, and in December, we announced the $1.5 billion authorization. We view this repurchase plan as multi-year and flexible in nature, depending on other capital allocation priorities.

We have increased the pace of our repurchase from last year to $125 million per quarter. This pace is related to the improved cash flow we expect in 2017, now that we are beyond the cost of our operational efficiency initiative. Our guidance for adjusted diluted EPS assumes only that we offset dilution from equity awards.

As a general rule, we view 2017 adjusted net income as a good proxy for the operating cash flow we expect to generate. We do expect to maintain CapEx in line with the last few years, as we invest in manufacturing to deliver our in-line and new product growth.

So let me wrap up before we go to Q&A. We achieved our 2016 revenue and adjusted EPS guidance, and we affirmed our outlook for 2017 with updates for foreign exchange.

We continue to see a path to continued margin expansion, increased cash flow, and greater efficiency as we achieve the full benefit of our operational efficiency program. And we're prioritizing and funding investments in long-term growth in all of our core capabilities. With that, I'll hand things over to the operator, to open the line for your questions. Operator?

(Operator Instructions)

We'll take our first question from Louise Chen with Guggenheim.

Hi, thanks for taking my question. So I'm just curious on your priorities for capital allocation in 2017, and if you would continue to repurchase shares, even with your stock at this price? Thanks.

Thank you, Louise. We will maintain the same capital allocation philosophy that we already shared with you, so we will continue investing in the business. We see opportunities this year of reinforcing our presence in the market, with [different] campaigns, so expanding our field force in the markets. We will continue investing in R&D, because we consider that the productivity of R&D is very high, and we have been delivering very strong products, and we'll continue to support in our growth with this investment.

We will also invest in manufacturing, to ensure that we have the capacity, and the [capacity] that we'll need to support our future growth. And we'll also continue assessing the external opportunities, business and developmental opportunities that will reinforce our internal growth. And any excess capital, we'll return to the shareholders through dividends, or the program that we already announced for buying the shares back.

And to just add to that, Louise, we're currently in the market, purchasing this quarter, we expect to purchase about $125 million in shares this quarter.

Thank you. Our next question comes from Derik de Bruin with Bank of America Merrill Lynch.

Hi, good morning. So can you talk a little bit about the new product launches? I mean, we had some positive feedback on Cytopoint, talking to Vets at the NAVC conference, and just wanted to get your initial thoughts on that product, and sort of how we should look at expectations on that? And I guess, the other question is, like there was -- it did look like you tweaked down your core growth guide by about 50 bps. I'm just wondering what was behind that, given that the quarter sort of, the Q4 ended up exactly where we generally thought about it? Thanks.

Thank you, Derik. I will answer the first question, and then I will ask Glenn to provide an answer to your second question. Cytopoint definitely, the feedback from the market, it's really positive. But also, we want to consider, not Cytopoint or Apoquel as a separate. We want to consider now our dermatology portfolio, which is now even stronger than last year with Cytopoint. And we expect that the combination of these two products will cover all of the needs of the veterinarians when treating acute, chronic or seasonal atopic dermatitis or any type of skin condition.

So we are very excited about our portfolio. We are considering that Apoquel will continue growing, and we are supporting Apoquel this year with additional resources in terms of [DPC], and some additional activities in the market. And this also will have an impact in Cytopoint, because as I said, we consider the combined portfolio in dermatology as the way to deliver the value to our customers, and to cover their needs in terms of treating (inaudible) conditions of atopic dermatitis.

And Derik, in terms of the growth rates for 2017 on an operational basis, when we set the guidance back in November, since 2016 actuals were not final, we based the 2017 growth off the mid point of those ranges. Now that we have final 2016 actuals, and we came in towards the high end of those ranges, the growth rates naturally declined. I do want to make it clear, the operational numbers themselves have not changed, and the core expectations for the business have not changed, except for the update to foreign exchange that we've reflected.

And our next question comes from Gregg Gilbert with Deutsche Bank.

Yes, good morning. Can you update us on your progress, as you attempt to combine flea and tick and heartworm, and any possible time lines on that front? And then, in light of the [Mars] acquisition, can you provide some context on the long-term risks and opportunities associated with the consolidation of clinics? Thanks.

Okay, thank you. So well, we have the first news on the products, in terms of combining the flea, ticks and the heartworm, because now we have a topical [product], which is a combination of the active ingredient of Simparica, sarolaner, and with the active ingredient of Revolution Stronghold that is [selamectin]. And this product has been already approved in Europe and we plan to launch this product very shortly in the European markets.

Definitely, this is only the first step. We will continue working internally to combine the same principle of different agents, to have a broader spectrum of coverage in parasiticides, including internal parasiticides, in this case for dogs. We have not yet provided the timing of the launch, but definitely our R&D team is working in this combo, and also working in future [combinations] that can also include the injectable formulation and longer duration of protection. When we have more clarity on the timing, we will provide an update on this information.

And then in terms of the clinic consolidation. So now Banfield, that they have around 900 clinics in the US, will be consolidated with VCA that has another 800 clinics. So this will represent 1,700 to 1,800 clinics, of a total of [30,000] clinics in the US market for companion animals. We have good [collaboration] with both our companies, with Banfield and VCA, and we expect also to continue this collaboration.

Based on all comments that we got from Banfield, it seems that will keep these two networks independent, and we will continue working with Banfield as a group, and also with different clinics that are part of their [network] to promote and to support our portfolio.

Next question?

Our next question is from Erin Wright with Credit Suisse.

Great. Thanks for taking my questions. Can you speak to the recent shift in strategy, and the rationale behind your direct versus third-party distribution strategy, and how has there, or has there been an evolution sort of in the market, that makes direct distribution less favorable to you, now that vaccines and parasiticides are opened up? And how much did those distributer shifts impact you in the current quarter, as well as in the first quarter from a stocking perspective, how should we be thinking about the buying patterns? And then my second question, is what is your guidance, just in terms of underlying growth across livestock versus companion animal, and the underlying fundamental trends assumed in your 2017 guidance? Thanks.

Thank you, Erin. Well, let me start with your question about the distribution strategy, and this related, as you mentioned to companion animal. So in previous year, we had the exclusivity provisions for a few products, and we [set] certain distributors. So during 2016, we extended the collaboration with distributors in vaccines, but on a non-exclusive basis, in this case for the vaccines. So this year also, we included as part of the agreement with distributors, our parasiticide products. So for (inaudible) for heart ticks, Simparica, and this will be part now of the agreement with the distributors.

With this extended partnership with distributors, we are confident that we will be able to increase our share of voice, and also penetration in the -- clinics. And also the changes with distributors, with these changes we have considered that it's a much more attractive model, to have that [contract] with distributors based on total volume, rather than exclusivity for a small number of our products.

Having said that, we remain committed to our [commercial] model based on direct interaction with our customers, through highly qualified field force, who generate demand for our products. And the result of all these changes, is that we expect a positive impact in our business. And they'll look for generics, that is also something that may be some questions in the market, we remain unchanged from what we said in the past.

So in summary, so we are confident that this new model will be very effective. We'll also have better support from distributors, while we maintain our presence in the market with our direct interaction with the customers. Glenn will talk about what has been the impact of, in terms of historical net revenues related to the change on the distributors.

So in terms of the stocking impacts for Q4, we look at that, and if you compare that to our total sales for the quarter, it's less than 1%. So as you're looking at the companion animal growth, it's slightly less than 1% related to that. The offset to that, in evaluating the companion animal growth particularly in the US, is the impact of the surgical fluid business, and the decline we saw there, that was slightly greater than the impact of the destocking.

To your question on underlying trends in companion animal and livestock, as we've discussed, we do expect again, companion animal to grow stronger than livestock in 2017. I think when you look at it for 2016, on a normalized organic basis, growth in livestock was 4%, growth in companion animal was 14%. I think we'd expect that difference to come closer in 2017, but again, we'd expect companion animal to grow stronger.

Thank you. Our next question is from Jon Block with Stifel Nicolaus.

Great. Thanks, and good morning. Juan Ramon, maybe just qualitatively, if you could talk about how you feel about US livestock? And back in the summer, when conditions did not seem overwhelmingly favorable, you put up a good 3Q number, aided by promotions. This quarter, US livestock, I think you said up low single-digits operationally, although an easier comp, yet conditions seem to be getting better, especially as we enter 2017.

So maybe just any color on increasing momentum that you see in US livestock, specifically cattle? And then, quantitatively, Glenn, can you just provide Apoquel specific numbers to the US and international, and will we be getting that number going forward, or will it be combined under the atopic dermatitis portfolio with Cytopoint? Thanks, guys.

Thank you, Jon. And let me go through the different species in livestock in the US, starting with cattle. So we expect in the cattle business, for the market, the growth will be 2% to [3]%, and we expect to grow faster than the market in 2017. We expect also, and a slowdown in terms of a herd expansion. Still in 2017, we expect the herd will continue growing, but something that is new. And so, we expect that in 2018 and 2019, also [beef] herd expansion will be now stable.

[Seeing that] prices continue being challenged in the US market, but still we think that in the -- we expect a recovery in the second half of the year. And the (inaudible) segment it's, in terms of profitability is normalizing, which is also positive. So we will see also that the volume in terms of prevention and the productivity will continue growing. And maybe will be a slow down in terms of the use of anti-infective. But as I said, 2% to 3%, the market, and we are predicting that we will be growing faster than the market.

In poultry, we expect flat to 1% market growth, and we expect growth in this segment for [Zoetis]. So we will see continued pressure on [antibiotics], but we also have our portfolio that there can be an alternative to [antibiotics] which are considered as medical important for human, and we can offer alternatives that will generate growth in our portfolio.

And finally, pork, about 1% to 2% [net] growth in the market, and again we expect those to grow faster than the market, mainly driven by now the entrance of the new [PVC2] vaccines in our portfolio that we expect to grow during the year. And we'll continue working on new combinations of vaccines, or vaccines that we'll be adding [antigens] that is also will reinforce our position in pork.

And the next question, (multiple speakers) go ahead.

We have another question that Glenn will talk about.

So in terms of the sales for Apoquel and the evolution. So for Q4, we saw $70 million in sales of Apoquel, so in the US we had $50 million of sales, which was a nice pick up sequentially from Q3, as we work through the inventory issues we discussed in the prior quarter. So a nice sequential growth in the US.

Internationally, we had $20 million in sales, which was a drop from Q3 as we expected. In the Q3 call, we talked a lot about the fact that there was an initial stocking in Japan. So again for the quarter, a total of $70 million, and for the year we had $248 million in sales in Apoquel, with $170 million of that in the US, and $78 million international.

In terms of how we're going to disclose that moving forward, between Apoquel, Cytopoint or the derm portfolio, we're still early on in that. We want to see how the mix evolves, and then we'll determine what the best way to disclose the sales are moving forward.

And we'll go next to Brett Wong with Piper Jaffrey.

Great. Thanks, guys. Thanks for taking my question. Wondering if you can please talk to the expected growth in Brazil in 2017. You mentioned that it's going to continue to be strong, but should we expect ongoing high single-digit operational growth there, and what will drive double-digit growth in that region? If you can talk to both livestock and companion, that'd be very helpful.

So thank you, and without providing exactly rates of growth in Brazil, definitely we see Brazil a market that's -- will continue growing, growing in many different species, including the companion animal. And that's why we decided also to expand our field force for companion animal in 2016. And we're also expanding our field force for cattle in 2017. So we are investing in the market, because we see the opportunities that this market will continue growing. And we see that this market will also grow in terms of export.

So the projections for Brazil are continuing to being very positive. And still, one of the things that is difficult to predict in -- exactly how much will be the impact of the different discussions in terms of trade, but we are confident that maybe Brazil can have a benefit, on all of these trade discussions on increasing the export, that has been very strong in the past.

In companion animal, definitely we see the opportunity of increasing that medical position in dog. There will be also, having the benefit of having the entire portfolio of Zoetis now approved in Brazil. We have Apoquel, we have also Simparica, it's something that definitely will help us to generate even faster growth in companion animal in this market.

Next question?

We'll go next to John Kreger with William Blair.

Hi. Thanks very much. Juan Ramon, I think you said you guys exceeded your $300 million target for cost savings. Can you just maybe comment a bit on what were the lessons you learned there? What allowed you to beat -- that goal, and remind us what your plan is to optimize the manufacturing footprint over the next couple of years? Thanks.

Well, the lessons learned, and thank you for the question, John. The lessons that we learned, that we understood from the beginning, that there were opportunities for being much more efficient. But at the same time, we went through a process of our business infrastructure, implemented ERP on that, we considered that it was too much, trying to implement everything at the same time.

But when we have the full control of our operations, we really focused on improving our efficiency. And the result of this operational efficiency program, is that first, now we learn that managing so many SKUs is not adding any value to our customers. We, in the past, we tried to meet all customer needs, in terms of -- not only products that we remain with significant large number of [products] But meeting expectations in terms of dosages, from (inaudible) data in many cases, we're adding only complexity, and limiting our ability to be reliable in terms of supply. So this is one of the first lessons, that is reducing complexity in terms of SKUs, in terms of our market it's providing to us an opportunity to be much more focused, and provide more value to our customers.

And the second lesson is that the reaction of the Zoetis team, in terms of embracing all these opportunities, and really targeting all these savings with the objective of, not only being more efficient, but also supporting our future growth in a way that we'll be stronger.

And I think that it's the last lesson that we learned through the process, is that definitely there were significant opportunities of eliminating, the, not added value activities. And these were related to marketing, it was related to some of the activities that we were doing in terms of meetings and travel, that they were not adding value to our growth, and not adding value to our operations.

And we are very pleased with what we have achieved. Definitely we have now [models] that are much more efficient in commercial, also in finance, and in many other parts of the company. But definitely we learned that it's important to focus on improving the profitability, but even more important, than just improving the profitability, is ensuring the future growth of Zoetis. So then, you asked about the plans to optimize manufacturing going forward? Maybe Glenn can cover this question.

Yes, in terms of the plans to optimize manufacturing going forward, I think they're essentially three major plants that are still set to be transitioned by 2020. And as we go through that transition, and move a lot of those products, we expect to get another 200 basis points improvement in our gross margins, so that's really the next major initiative related to manufacturing.

Our next question is from Jami Rubin with Goldman Sachs.

Thank you. With this year marking the end of the SKU rationalization program, should we assume the Zoetis story becomes more focused on top line growth versus margin expansion? And Glenn, can you talk about how much more room you see for margins? I think you had guided to 34%, 35% this year. It's up about a 1,000 basis points since 2012. How much higher can that go, and what are the key drivers of that improvement? Thanks very much.

Thank you, Jami, for the question. The focus on the revenue growth has been always part of our objective. And what we achieved with this operational efficiency program, it's having a more better allocation of resources to generate the future growth. So the fact that now, we were able to exceed the $300 million target, it's allowing us to invest in [DPC], it's allowing us to expand our field force into other markets. And also to invest in technology that also will support the interactions with customers.

We are focused on revenue growth, and we know that the revenue growth will be only way to continue generating the adjusted net income faster than the revenue growth. But we also want to make sure that we generate that profitable revenue growth. Glenn?

And in terms of continued margin expansion, so we do expect this year 2017 to be between 34% to 35%, which is a significant improvement over where we've been historically. We do see further room for improvement. We talked about 200 basis points that we see in gross margin coming by 2020, and we also do expect to be able to grow our expenses slower than our growth in revenue moving forward. That being said, we're not targeting a margin.

We're going to look at the right investment opportunities, and do what makes the most financial sense, and provide us the highest return going forward. But those are some of the key areas that will provide some additional margin opportunity, as we move forward.

The next question?

Our next question is from Alex Arfaei with BMO Capital Markets.

Good morning, folks, and congratulations on a strong 2016. There's been some concerns about generic erosion in your base companion animal business in the US, excluding the new products like Apoquel, Simparica, et cetera. Could you comment on that, because I think you mentioned that the growth in the segment was driven by the newer products. So should we expect the base business to decline? And also just to follow up on Simparica. What were the sales of Simparica now, and what is the potential of this product in combination form? And forgive me, if you mentioned this, when should we expect approval in the US for the combination form as well? Thank you.

Thank you, Alex. So we don't see any change in the outlook for generics in 2017 or 2018. So we know that generics will capture part of the market. We have been managing very well in the past, and we don't see anything that it's both [creating] a change in terms of generic penetration. So we are very confident that there's many different aspects that will [also] support in our portfolio.

We have very strong brand equity. We are promoting many products in our portfolio, which is also allowing that, to also offer volume discounts. We are a Company that has been in significant innovation, which is also an important part of what, is our representation in the market. And we maintain a significant presence, in terms of direct interactions with our customers.

So all these elements, are in my opinion supporting our portfolio, and definitely we see that generic will get part of the market. But no different what we have communicated that over time, they can reach 20% to 40%. But definitely not in the first year, as we have been demonstrated many times. So it's a very different market, and it will help. And I don't see things are changing that will increase the penetration of generics significantly. At least, for companies that maintain a significant presence in the market, they promote a larger portfolio, and there they have [reputation] and the interaction with the customers.

Simparica combo, I guess, that you referred to the product that has been recently approved in Europe. That it was the topical formulation for cats. We expect also to introduce this product in the market in the US. We don't have yet details, or we have not provided the timing, definitely once we have more information, we'll provide these details.

We filed in the US, but it's a [FDA] filing, and we depend on the US reviews, and the timing of the approval, and the launch of the product. The rest of the portfolio, combining the combo products, sarolaner with other active ingredients, to include internal or external parasiticides for dogs. Again, so it's something we are working, and we'll provide more details when we are progressing in this product.

And, Alex, in terms of sales of Simparica, that is something that we haven't disclosed. The performance this year has been in line with our expectations, and we do expect peak sales for the product to be over $100 million. We expect it to be a blockbuster, and we're also very focused on the platform that it provides us to continue lifecycle enhancements related to that product.

Our next question is from David Risinger with Morgan Stanley.

Yes, thanks very much. Juan Ramon, I was hoping that you could talk about the competitive landscape. Some of your large competitors have merged in the past. My guess, is that the disruption at Lilly may be normalizing now, and maybe there will be a slightly stronger competitor in the next year or two. But that's just a guess on my part, would love to hear your perspective on that? And if you could talk about the other major consolidation, and whether that's good or bad for Zoetis? Thank you.

Well, I would say that -- rather than providing a general comment, maybe it's good to see what is the impact by species? First, on the consolidation of Boehringer-Ingelheim with [Merial]. So in companion animal, the majority of the portfolio will be Merial, they will be adding some products, especially [in pain], coming from BI. We don't see a significant change in the competition [lifescape], in terms of companion animal.

For cattle, it is where we see, that the combined portfolio will [express] in the position of the new company. In swine, basically the portfolio will be the portfolio BI had in the past, so no changes in the competitive landscape. And the same for the poultry. Poultry will be mainly the Merial portfolio. So we don't expect significant changes in terms of the competition, in terms of species. They will have, definitely a bigger (inaudible) than us. And this could help them, in terms of investments, and also especially in smaller markets, and they definitely will be a stronger competitor, than the two companies separated.

At the same time, so the combined company, they will need to manage high complexity, and I'm sure that they will be managing the future. But they will have to understand that, how to manage the diversity of these extended portfolio. And also they will be facing the distraction of the integration. So in that 2017, we see challenge and opportunities, not to be changes in terms of competition by species, and it's something that we are confident that we will be managing.

You asked about Elanco. Well, Elanco, it's also has been [reinforcer] in the recent acquisition, but this happened -- but it's already part of our competitive landscape. We don't see that Elanco in 2017, will have a different type of challenge in terms of the competition compared to 2016.

And our next question is from Mark Schoenebaum with Evercore ISI.

Thanks for taking the question. And sorry, if I missed this during the prepared remarks, or during the Q&A, but could you break out price, the impact of price versus volume if possible, on an organic operational revenue growth perspective for the full year? And it does look like on the margin, inflation is starting to pick up in the States, at least I haven't looked at rest of world data, but given the business model of Zoetis, do you think a pick up in core CPI is going to allow you to do a little bit more with price, or is that just not relevant? Thanks a lot, and good to hear your voice, Juan Ramon.

Well, thank you, Mark. I think probably these questions will be answered by Glenn. He has all of the details, and I'm sure he can provide the answer.

Sure. So in terms of the price volume growth for the year, so if we start with our normalized organic operational growth of 8% through the year, about 5% of that comes from new products. So we will classify that as volume, right. Then there's a remaining 3%. The remaining 3%, 2% of that comes from price, and 1% volume. So in total, 2% price and 6% volume for the year, in terms of the impact that we have on a normalized basis.

And in terms of the impact of inflation on price, that's something -- as we go across geographies, not just in the US, inflation is definitely a factor that we consider, when setting our price increases. So it definitely does have an impact on how we set those increases annually.

Our next question is from Chris Schott with JPMorgan.

Great. Just a couple quick ones here. Following up on the dermatology assets, can I get an updated view, in terms of peak sales potential, when we think about Cytopoint and Apoquel, how large do you think that portfolio can become over time? And the second was on tax reform. I think you've clearly articulated that the Company would benefit from a lower corporate, a US corporate tax rate. Can you just elaborate on border adjustment? I know you don't have details at this point, but can you just give us a little bit of color, in terms of when we think about that US business, how much of that is manufactured in the US, versus ex-US? So when we get more details here, how much of the franchise would be affected? Thanks very much.

Thank you, Chris. And we are not changing our [operation] that has been provided in the past for Apoquel, so we think that Apoquel will be generating more than $[300] million on peak sales. How much, is something that we see depending on also the market that we'll be also capturing with Cytopoint. And we also think that now that we have Cytopoint with a full license in the US, but still not Cytopoint in the rest of the world, I think it's important that we understand the full potential of Cytopoint. And then we provide guidance on the combined portfolio, when we have this information. But we see that Cytopoint will be adding revenues to the more than [$100 million] that we already communicated for Apoquel.

So Chris, specific to your question on border adjustability, when we look at that, and we lock at our imports and exports, and we're essentially net neutral between imports and exports in the US. So in terms of the impact on tax reform, it's really going to depend on what the tax rates are on imports, and exports to understand the impact of that. But from an overall number perspective, in terms of what we export and what we export, we are essentially net neutral.

We'll go next to Kathy Miner with Cowen and Company.

Thank you. Good morning. Just one question if you will. You mentioned the importance of R&D to the Company. Can you give us an update on some of the -- either key areas you're looking at, or I know you've mentioned biologics as being of importance to you going forward? Just any color you can provide going forward, would be helpful. Thank you.

So in terms of biologics, we continue investing heavily to develop new vaccine for the combination of vaccines, and we also reinforce our presence in cattle vaccines in Europe. We also want to develop larger portfolio vaccines in China, and we'll be developing a strategy to be -- have a stronger presence of vaccines in China, mainly for swine, but also with opportunities of other species.

So other areas of R&D investment, we are now using the platform of [Sarolaner] to develop new parasiticides. And we mentioned the approval of [Sarolaner] with [Selamectin] in Europe for cat, a topical formulation. And we will continue investing in this platform to ensure we are covering a broad spectrum of parasiticides.

And we also with Cytopoint, we had a quite significant knowledge in terms of monoclonal antibody, and these monoclonal antibodies also will be targeting all of the different indications, including pain, or including other [atopic] indications. And we also are targeting in livestock, opportunities of improving profitability, for productivity, improving the productivity in livestock. So we know that there are now [products] that are helping that [insufficiencies]. We think that there will be opportunities for adding new products that will support this additional productivity in livestock.

(Operator Instructions)

We can take a first follow-up from Erin Wright with Credit Suisse.

Hi, thanks. Just follow-up on biologics there. I guess, what maybe this depends on which indications you're focused on, from a monoclonal antibody standpoint, but will that follow under the FDA or USDA jurisdiction? And how should we think about the time line of approval and commercial launch of those products?

Well Cytopoint has been under the jurisdiction of USDA. We expect that all of the monoclonal antibodies we depend. We expect that the indication for pain will be under the jurisdiction of the FDA, but this will depend on the -- there is a clear definition who should be responsible for each type of product. And also with discussions with the regulators, when we start developing the programs, then we find will be there -- we find that the regulator that will be involved in the approval.

And there appears we have no further questions, I'll return the floor to you, Juan Ramon, for any closing remarks.

Thank you very much for joining us today, and we'll continue with providing updates to our business. Thank you very much.

Thank you. This does conclude today's teleconference. A replay of today's call will be available in two hours, by dialing 800-388-6197 for US listeners, and 402-220-1115 for international. You may disconnect your lines at any time, and have a wonderful day.