碩騰 (ZTS) 2017 Q1 法說會逐字稿

Welcome to the First Quarter 2017 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 2 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.

Good morning, and welcome to the Zoetis First Quarter 2017 Earnings Call. I am joined today by Juan Ramón 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 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 U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and in the company's 8-K filing dated today, May 4, 2017. We also cite operational results which exclude the impact of foreign exchange.

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

Thank you, Steve, and good morning, everyone.

Before I discuss our first quarter results, I want to share some overviews on the animal health industry. Our industry continues to showing steady and profitable growth in the mid-single digits with about 5% to 6% growth for 2017, excluding the impact of foreign exchange.

In 2017, companion animal and poultry are expected to grow faster than the industry average of 5% to 6% while cattle and swine will be going below those rates.

Companion animal growth will be driven by the increase of oral parasiticides and specialty care products in areas like dermatology, where our portfolio of Apoquel and Cytopoint is driven category growth.

We should also see increased in [clear] consumption of chicken, driving growth in poultry while expecting slower-growth. Cattle and swine will benefit from positive trends, driven by additional (inaudible) cattle, higher prices of milk and an increase of global pork production especially in China.

As I have mentioned many times in the past, the diversity of the animal health industry in terms of species, specific areas and geographies is an important part in prosperity and the profitable long-term performance.

And in this industry, Zoetis stands as the most diversified animal health company and continue delivering revenue growth above the industry average, thanks to the strength of our portfolio and business model.

We continue investing in our portfolio with a highly productive (inaudible), resulting in new product launches and life cycle innovations. In fact, we have continued to spun our canine dermatology portfolio with internally discover and develop product Cytopoint.

Last week, Cytopoint became the first monoclonal antibody approved in European Union for veterinary use, after having been previously approved in the U.S. in December and in Canada in March. Cytopoint is the first monoclonal antibody therapy approved to help reduce the clinical signs associated with atopic dermatitis such as itching in dogs. We are very excited for the early market adoption of this product in the U.S. and the treatment of choice it offers our veterinarian customers.

In February, we also announced that the European Commission granted us a full license for Stronghold Plus, a topical parasiticide for cat that combine sarolaner, the active ingredient in Simparica with selamectin, the active ingredient in our current Stronghold Plus and Evolution product lines.

We continue to look at the ways we use sarolaner as a plan for or other combinations and in other markets.

We also continue to pursue life cycle innovation that help ensure the availability of our revenue streams from approximately 300 Zoetis product lines.

In the first quarter, we received approval for new indications, formulations and geographic expansion of key livestock brands such as BOVI-SHIELD and Fostera vaccine families and the Excenel RTU and EXCEDE anti-infective.

We continue to strengthen our portfolio in areas like diagnostics with the approvals in the U.S. for our Witness and Serelisa lines, both diagnostic test kits. You can read more about this in our press release.

We also combined our internal investment in R&D with external opportunities in both our core business of medicine and vaccine and the expansion of our portfolio in complementary spaces like diagnostics, genetics and bio devices.

You have heard me speak in the past about acquisitions like PHARMAQ in the fish market and SMB in the diagnostic space.

And just few weeks ago, we announced another investment in our core business for [picking] the pain in companion animals.

We announced an agreement to purchase Nexvet Biopharma, which is a mAb innovator in monoclonal antibody therapies for companion animals.

This acquisition is expected to strengthen our R&D pipeline in this area and help to stay in our category leadership in chronic pain for dogs while expanding the market opportunity in cats.

Innovations like these are being supported by other investment with additional savings from our operational efficiency program. And these have included in our guidance.

For example, field force expansion in key markets like China and Brazil, direct-to-consumer marketing campaigns for Apoquel and Simparica and capital investment in our manufacturing network to ensure we have the technology, capacity and capability to support our long-term revenue growth. All of these elements are working together to make sure we can capitalize on the opportunities ahead of us to continue growing revenues in line with or faster than the market and growing adjusted net income faster than savings.

In the first quarter of 2017, we continue to see positive results from our diverse portfolio, innovative new companion animal products and more a efficient cost structure.

Our revenue grew 6% operationally. And excluding the impact of product rationalization, which will also affect the second quarter results, our growth, which has been 8% in the first quarter.

We believe this growth is, again, faster than the market. The main driver of our revenue growth remained in companion animal products, which grew 12% operationally, driven largely by sales of Simparica, Apoquel and Cytopoint. And our livestock portfolio do 3% operationally, which increases in the swine, cattle and fish being partially offset by declines in poultry products. Glenn will discuss more of the market drivers and details in his remarks.

We posted 10% operational growth in adjusted net income, once again, faster than the revenue growth. We saw a modest 2% operational growth in operating expenses and we made investments in the promotional support of new product launches, which were partially offset by savings from our operational efficiency initiative. We continue to stay focused on ways to simplify our operations and drive efficiency, including through the ongoing implementation of our supply network strategy.

In March, we announced plans to sell our manufacturing site in (inaudible), Brazil. We expect to complete that transaction during the second half of 2017. It will be the eighth site that has been either divested or exited as part of the operational efficiency problem and supply network strategy. We are pleased with a strong start to the year from a revenue and adjusted earnings perspective, and we are affirming our full year 2017 guidance.

With that, let me hand things over to Glenn, who will provide more details on our first quarter results. Glenn?

Thank you, Juan Ramón. We performed well, again, in the first quarter based on our newest companion animal products and strength across many of our international markets, most notably China, Brazil, Australia and other emerging markets.

Total company revenue grew 6% operationally, including a negative 2% impact from product rationalization. We saw no net impact from foreign exchange in the quarter, however, as our financial table show, there were some meaningful changes in some individual currency.

Of that 6% growth, 5% came from companion animal growth in Simparica, Apoquel and Cytopoint. Sales of Simparica were $29 million for the quarter and our total dermatology sales were $77 million.

Additional growth drivers for the quarter were 1% from the introduction of other new products and 2% impact from price increases. These growth drivers were partially offset by a negative 2% impact from product rationalization.

In terms of the bottom line, we delivered 10% operational growth in adjusted net income and 10% operational growth in adjusted diluted EPS. As we realize the benefits of our operational efficiency initiative, we have stayed disciplined on expenses to drive more profitable revenue while making the appropriate investments to grow the value of our business. Juan Ramón spoke about these in terms of commercial and manufacturing investments.

Now let's discuss segment revenues. Our international segment generated operational revenue growth of 9% while the U.S. grew 4%. In the international segment, product rationalization had a negative 4% impact on growth. China had an exceptionally strong quarter, growing 47% operationally. This growth is broad-based with contributions from both swine and companion animal with much of the growth coming from vaccine.

In swine, we continue to see strong market conditions with high pork prices for customers as well as greater adoption of animal health product that can help drive more efficiency safe protein production.

In companion animal in China, our peer force is capitalizing on the growing pet population and increases in medicalization rates for pets.

Brazil is also a strong contributor in the quarter, growing 15% operationally with our price increases driving growth across our portfolio there.

Significant growth in livestock benefited from strong market conditions for beef producers and new companion animal products drove higher sales with Simparic, and it's know in Brazil, getting off to a strong start from its launch in the fourth quarter.

Our growth in both China and Brazil was aided by field force expansions in lead markets, which we have discussed before.

Mexico made a significant contribution this quarter as well with 10% operational growth. And our other emerging markets category grew 14% despite a significant impact from our product rationalization.

Shifting to developed markets. Australia grew 10%, drawing on performance in several key brands in cattle, sheep and companion animals as well as price increases and growth in Simparica and Apoquel.

Italy, Spain and Japan also contributed to growth in the quarter while France declined 15% primarily due to the comparison to a strong Q1 2016. We are expecting France to return to growth in the second quarter.

To summarize. Very strong growth in our international business is coming from a number of sources, including strong market trends, strategic investments and our success in bringing new value-added products to market.

Turning to the U.S. Revenue grew 4%. Companion animal grew 10% in the quarter while being offset by a decline of 2% in livestock. The livestock decline was due to our swine business, where the timing of customer purchases had a negative impact in the quarter, and we continue to see competitive pressure on our vaccine franchise.

In the U.S., we have made some changes to our Fostera, TCV and (inaudible) vaccine and based on a recent launch comparative trial, we believe this products should be well received by customers and make us more competitive in this space.

The decline in our swine business was partially offset by growth in poultry, where we've seen higher sales of antibiotic alternatives such as Zoamix.

Our cattle business in the U.S. was flat for the quarter as an increase in the herd side is contributing to growth in our reproductive franchise. Performance was also supported by growth in ACTOGAIN and our SYNOVEX franchise, which was offset by a higher mix of low-risk cattle moving to (inaudible).

Our medicated feed additive sales, both cattle and swine, were negatively impacted in the first quarter by livestock producers implementation of the veterinarian seat directive. This impacted U.S. livestock growth by about 3% as we continue to work with our customers on the implementations of VFD.

Companion animals sales grew 10% primarily due to the launches of Simparica and Cytopoint as well as growth in Apoquel. This growth is partially offset by initial sales into expanded distributor relationships in the prior year quarter.

We are pleased so far with the performance of Simparica in the first spring buying season that it was fully available in the U.S. We've initiated direct-to-consumer and additional promotional campaigns, which we believe will help build upon the success we've seen so far.

In U.S. dermatology, sales were $57 million for the quarter. Cytopoint has been well received in its full first full quarter with a full USDA license and Apoquel sustaining the base it built through the second half of last year.

As we regain more experience with the full supply of our dermatology portfolio throughout a calendar year, we do believe there will be seasonality to the revenue with the second and third quarter dermatology revenue being higher than the first and fourth quarters.

Overall, we continue to hear very positive feedback from our customers about Apoquel and Cytopoint. With the launch of additional promotional campaigns and BTC advertising, we expect acceleration of sales in the coming quarter.

With a continued strong performance in the U.S. and the prospect for additional growth in international markets, we believe our global dermatology portfolio can grow to between $400 million and $500 million in the next 3 years.

Now turning to the rest of the P&L. Adjusted gross margin of 64.4% declined approximately 300 basis points in the quarter on a reported basis and were sequentially flat with the fourth quarter of 2016.

Coming into 2017, we have made additional cost improvements in our manufacturing network.

In the first quarter of 2017, we recognized higher costs associated with previously produced inventory, which depressed our gross margin. This will also negatively impact Q2.

As we progress into the second half of the year, our results will fully reflect more of the impact of our manufacturing cost improvement.

In addition, Q1 2016 contains some favorable items and Q1 2017 gross margin was negatively impacted by unfavorable foreign exchange versus last year. The first quarter results for adjusted gross margin are in line with our expectation, and we reaffirmed our adjusted cost of sales guidance for the year.

Adjusted SG&A grew by 2% in the quarter with higher promotional expenses to support new product launches and higher penetration of Apoquel, offsetting expense reductions from the operational efficiency initiatives.

Adjusted R&D was flat for the quarter with an increase in project spending, offsetting fixed expense reductions from our operational efficiency initiative.

Adjusted other income included lower foreign exchange losses compared with the prior year and a positive impact of a legal victory in Norway for our PHARMAQ business. This single win will allow us to launch a vaccine for pancreatic disease in the world's largest farmed salmon market this year.

The adjusted effective tax rate for the quarter was approximately 28%. The tax rate in the quarter is significantly improved in the prior year due to the realization of benefits that resulted from operational changes implemented in the third quarter last year. It also reflects the effects of discrete items, including a small benefit from divesting and exercise of employee equity awards.

The year-over-year improvement in our adjusted effective tax rate was a significant driver of adjusted net income growth of 10% operationally.

Of note, our onetime cash costs have come down significantly over time as we are moving on the efforts to stand up our company and execute on our operational efficiency initiative.

Now moving to guidance for full year 2017. The year is off to a good start price, particularly at revenue. We are reaffirming our previous guidance and expect accelerated growth in adjusted net income as we get into the second half of the year primarily due to the cost of sales trends I discussed earlier.

As I said in our fourth quarter call, we expect slower income growth in the first half of the year and our current expectations are consistent with that view.

For the year, we continue to expect to achieve operational revenue growth of 5.5% to 7.5% and adjusted EBIT margin of 34% to 35% and operational growth in adjusted net income of 15% to 20%.

Our guidance for adjusted ETR of approximately 30% is based on current U.S. tax law and does not take into account any potential changes being discussed in Washington.

With more than half of our adjusted pretax income in the U.S, a lowering of the U.S. corporate tax rate will have a meaningful benefit to us.

In the first quarter, we repurchased $125 million in shares and our guidance for reported and adjusted earnings per share reflects the share repurchase completed through Q1.

Just to summarize before we go to Q&A. We're off to a good start to the year with continued momentum in the areas we expected such as new companion animal products in market like China and Brazil. We see a good runway for continued growth that is in line with or faster than the market based on our diverse portfolio and recently launched products. Our operational efficiency program has been fully implemented at this point and is expected to achieve more than $300 million in savings in 2017. We will continue to use some of these savings both internally and externally to support sound investments in our business and return excess capital to shareholders. And we are reaffirming our outlook for 2017 and continue to project the stronger second half to achieve our full year targets.

With that, I'll hand things over to the operator to open the line for your questions. Operator?

(Operator Instructions) And we can take our first question from Kevin Ellich with Craig-Hallum.

First off, could you maybe give us a little bit more detail on the strength that you're seeing in companion animal, specifically the strong growth in China, Brazil? And also, Glenn, you actually gave us some great detail on the dermatology sales. Could you break out what type of growth year-over-year growth did you see in Apoquel versus new sales of Cytopoint?

Thank you, Kevin, for the question. Well, let me take first the strength in companion animal in China and Brazil. We have seen that the adoptions and also the medicalization rates in both the countries are growing. We defined this opportunity, and we invested to capitalize on that, so we expanded our field force in China and companion animal in Brazil. And the results are showing a very strong revenue growth. We also benefit in China with introduction of a new vaccine. And also in Brazil now, we have also -- almost all our portfolio approved and products like Simparica has been extremely well accepted by the market and are generating very positive growth. Glenn?

So Kevin in terms of your questions related to Apoquel and Cytopoint growth. So year-over-year, the dermatology portfolio grew 47%. When you look at -- that's actually the segment grew -- Apoquel grew 47%. The segment grew 66%. So really Cytopoint is -- this is really the first quarter of full availability with full USDA license so it's almost 100% growth in terms of Cytopoint. So just to break that down, again. The derm portfolio, 66% growth for the quarter; Apoquel, 47% growth for the quarter.

And we can take our next question from Gregg Gilbert with Deutsche Bank.

This is Esther Rajavelu for Gregg Gilbert. In livestock, do you anticipate any changes in the vaccines portfolio offsetting negative impact from the feed additives going forward for the rest of the year?

Well, this is probably being effective in terms of vaccines but mostly in swine. And we have been working with our PCV2 in the higher vaccine. We have been developing additional trials and the trials are showing very positive results in terms of efficacy. And we are convinced that now we have a product, which is very competitive. And these products will gain momentum in the U.S. [derm] market. We also introduce now in the international markets the PCB2 in higher vaccine and also these vaccine will generate positive growth in the international markets.

We can take our next question from Derik De Bruin with Bank of America.

Two quick questions. Was there any stocking or an outside orders particularly OUS? And then also just on some of the dynamics from the livestock market. Daz has been showing the herd side is increasing and clearly, your data is reflecting that. Is there any signs at all that there could be potentially some oversupply and that they're thinking about doing some cattle herd call?

Well, let me take the question on livestock and cattle. So we see the cattle business overall showing that very positive trends. We still see that the herds are growing in countries like the U.S. and also in Australia. Prices are also showing positive trend, and was recently on the news that the cattle futures are in 18 months high, which is also a positive. Also in the U.S, the (inaudible) and stock growth are back to profitability. So all of these are indicating that the cattle business are showing positive signs. For the year, we expect for Zoetis that the cattle will be growing mid-single digits, which is positive. And also, the positive element that we have seen that the consumption of beef is also growing, driven in some part because of China consumption. But this also accelerate in the export, which also helping producers to capitalize on the investment that they have been making in the last year. So we see that in the cattle business, will be showing the positive trend. In general for the market and also positive for Zoetis. We understand that in the first quarter, we had some challenge, especially in the U.S. The challenge came from mild winter. It also generated low risk profile for animals and then this affected our premium antibiotics. The other impact that we had there in the first quarter in cattle was related to the implementation of the veterinary seat directive that created some challenge in the cattle, especially in the small customers that they were not having veterinarians associated with this operation. We expect also that this will be corrected in the coming months. But again, saw positive outlook for cattle, both in the U.S. and international. And now Glenn, you will answer the comment on stocking in the quarter?

Yes, in terms of the question of stocking in the quarter, there was no material stocking in the quarter. Perhaps in some market, particularly Vietnam, there was some elevated sales in the quarter that was probably expect to reverse to some degree in Q2. The only other thing I would point out, particularly in the U.S. with Simparica, we had very strong sales of Simparica in the quarter. I wouldn't call that a stocking, it's just more of just a season for parasiticides in the U.S. and how the veterinary typically make their purchases.

We can take our next question from Jon Block with Stifel.

Two questions, I'll ask both. Juan Ramón maybe for you just some high-level commentary on the altered structure view with the distributors on the companion animal side where I think the contracts are more volume-based if you would rather than exclusivity. How has that performance been? Has it been in line with your expectations? And then, Glenn, just maybe on the gross margin cadence. I know you guys don't want to guide for the quarter, but how do we ramp to 67 plus for the year? Should we expect a modest improvement in 2Q and then much more pronounced in 2H?

Thank you, Jon. Let me answer question on distribution and a little bit background on these question. So we launched many new products in companion animal and then with these launches, we decided to review the correlation with our distributors in the U.S. And then as a result of this review in 2016, we decided in agreement with our distributors also to include in their promotional portfolio our vaccines for companion animal. The result of this correlation was very positive for them and also for Zoetis. Then in 2017, we decided to expand this collaboration, not only to vaccines plus some other products that they weren't responsible before. Also to our parasiticide portfolio, revolution for parasitics and Simparica. All indicators are very positive. And now thanks to our direct presence together with the support of distributors, we have been increasing significantly our sales voice. And in market that we know that are highly competitive. And this additional volume that has been generating through all these additional portfolio has been also supporting the rest of the portfolio, products that are affected by generic competition, but thanks to this new strategy, the field is performing in line with expectations. And we have not seen significant change on the strength of (inaudible) but in 2017. So overall, very pleased with the new way that we are correlating with distributors and one with the impact that also we have been very positive has been the evolution of Simparica, but now we have our field force and the field force of distributors supporting Simparica.

In terms of gross margin trending throughout the year. So in Q2, we still have somewhat of a negative drag on margin from the impact of cost of previously produced inventory. But the impact will definitely be smaller than it was in Q1. Then as we get into Q3 and Q4, the margin improved as we really fully recognize the benefits of the improved cost that we were able to deliver as part of the operational efficiency initiative, so that should give you some understanding of the trending throughout the year.

Our next question comes from Jeff Holford with Jefferies.

So looks like you had a pretty strong Q1 in international. Is there anything out there through the rest of the year just issues maybe concerned about the stock issue, at least raising the bottom end of your revenue guidance the full year 2017? And then just secondly on Nexvet. I wonder if you might give us a little bit more color on any timing and size of opportunities within that pipeline that you might want to just highlight first to give us some expectation of when then might start to contribute.

Let me start with a question on Nexvet, and then Glenn will provide the comments on the guidance and also the performance in international. So on Nexvet, we just announced the acquisition but it's an acquisition of a company, which is based in Ireland. And we need to follow their regulations and the requirements of the Irish authorities. So at this point, I think we have a lot of limitations and let's wait until these transaction is concluded and then I will provide all details of what we expect from Nexvet and also timing of the new product introduction.

And in terms of revenue and guidance for the year. So when you look at the performance for Q1, on a global basis, we delivered 6% revenue growth for the quarter. But that's very much in line with our full year guidance of 5.5% to 7.5%, so the performance in the quarter was in line with what we expected the year, which is why we believe the guidance that we have is appropriate from a revenue perspective. International performance was positive in the quarter at 9% revenue growth. But again, definitely in line with our expectations and what we would expect throughout the year.

We'll take our next question from Erin Wright (sic) [Erin Wilson] with Crédit Suisse.

A follow-up to Jon's question on the gross margin. You had a particularly strong quarter in companion animal, typically a higher-margin business for you. Your gross margin was essentially in line with your quarterly guidance that you gave on the last call. What can you speak to aside from the moving parts to the gross margin, and particularly just following the strength in a higher-margin business for you? And I understand you can't speak to Nexvet, but how should we think about the traction you are seeing with Cytopoint and the vision on the prospect for monoclonal antibody in general given now you doubled down in the space with this recent acquisition of Nexvet.

So again, so let me start with the comment on monoclonal antibody and Cytopoint. Definitely, what we see with the acquisition of Nexvet, we don't get into any details of products or timing of launches. So definitely, the innovations that we have seen at the Nexvet in terms of monoclonal antibody combined with the expertise that we have developed with Cytopoint and the manufacturing capabilities that we also developed at the time of Cytopoint, there will be a significant opportunity in combining Nexvet's capabilities with our capabilities. On top of that, we have very strong presence and knowledge on how to commercialize monoclonal antibody, and we see a significant opportunity of bringing to the market new options in terms of pain. Still, pain is unmet need in the companion animal market and definitely we see another opportunity of expanding the market with the interaction of monoclonal antibodies for cats. So we see that it has significant strategic rationale on this acquisition, and we feel also that this will generate significant value to us right this over time.

And Erin, in terms of gross margins, so as you mentioned it is in line with our expectations for the quarter. And in terms of mix, there were some ups and downs. As you mentioned, companion animal performed very well typically some of our higher-margin products. Also though we had a decline in performance in some of our premium antibiotics which are also very high margin and international also had higher growth and international, in general, has lower margin than the U.S. So overall, the mix ended up being neutral for expectation as it still kept us in line with where we thought we would be for the quarter.

Our next question comes from John Kreger with William Blair.

Just wanted to follow up in your comments about Stronghold Plus. When you expect that product and something like it to be approved and launched in the U.S. in cats? And how about for dogs either in the U.S. or Europe?

Well this combination is a topical combination and definitely, it would be focused on cats, but we also discussed that we'll be using sarolaner as a platform to develop other combinations. These other combinations will be oral, and they will be focused on dogs. Your question about when we expect the launch on the U.S. This is not yet defined. We are working with the U.S. regulator on answering and developing all the details for the registration. But at this point, we have not provided any timing of the approval. As we progress on the discussion with the U.S., then we'll provide the details on the timing.

Okay. And then a follow-up on PHARMAQ. Given your legal entry. Can you just talk about where that business can go over the next couple of years. And maybe just even reset your -- the longer term strategy there. Is that a business that can start to be a more material contributor over the next few years?

We are convinced -- thank you, John, for your question. We are convinced that fish is an area of growing opportunity. We know that already the farm fish is exceeding the consumption of wild fish. Still there is a lot of use of antibiotics in this segment. We expect that these antibiotics will be replaced by vaccines. PHARMAQ, it's leader in terms of developing vaccines. We are very pleased with the introduction of a new vaccine in Chile or SRS, which is also helping the reduction of antibiotic use in this country. But then the next opportunity should be China, Vietnam and other countries in where already they are #1 in terms of farmed fish production. And again, so we are working on developing vaccines, that we'll be targeting these countries. Both the results of the legal litigation in Norway is offering to us the opportunity of launching a new vaccine for pancreatic disease, which is very important in Norway. It is also helping us really to support the rest of the portfolio in Norway. We communicated that in 2017, we expect to generate $125 million, that will be a significant growth. In the first quarter also, we show very positive growth for PHARMAQ, and we are expecting for the year to generate more than 30% growth in terms of PHARMAQ. So the prospects are very positive, and I will continue investing, not only in salmon in where we have most of our revenues today, but also in tilapia and other species that will be important in the future.

Our next question comes from David Risinger with Morgan Stanley.

Well, first, I want to congratulate you as well on your results. I just wanted to ask about the outlook on a couple of items. First of all, I think that you had mentioned 12% operational companion animal growth in the first quarter. Just wondering if we should expect that to accelerate or decelerate in coming quarters. Second, with respect to other expenses and the tax rate, which surprised me this quarter, the other expense item was $35 million in the first quarter. Wanted to get your guidance for how we should think about in the second quarter and for the full year. And then the same thing on the tax rate, the tax rate was 27.8%. Wanted to understand what you would suggest for the second quarter sequentially. And then finally, it sounds like the 2% price increase that you've seen historically and you saw this quarter is sustainable. Just wanted to confirm that, that in coming quarters and for the foreseeable future, you continue to expect the 2% benefit from price for your business.

Thank you, Dave. And I will provide the comment on the outlook for companion animal, and then Glenn will go through the details of tax and some other questions that you asked, including the price. So on -- look, what we have is 12% in companion animal. So we expect for the year that companion animal will continue growing at double-digit. And we think that this 12%, it's probably a sign that we will see for the rest of the year. We should also have the benefit of the growth of Apoquel, mainly coming from also the full introduction of international market where now, they are -- some of the market, they're now at the launching phase. We also expect that Apoquel in the U.S. will continue growing. But now more than Apoquel, I think it's important to discuss about the dermatology portfolio, including Apoquel and Cytopoint. But we talked about Apoquel in the U.S. for instance, we are very pleased with the level of penetration in clinics. It's about 94%, which is very good. But we only have 49% market share in terms of patients. So we still see opportunities for continued growing and painting the shares from (inaudible) but this still accounts for 30% of patients. Cytopoint, it's definitely has been very well accepted by the market, but still very low market share in terms of patients, only 5%. But growing also very fast in terms of authorization. So both products will drive growth and very important also Simparica in where we have seen very positive interaction of results. Now we have the benefit of this year of enjoying the full vision, so we have the total there, and we have seen that this are performing extremely well. And one of the things that we've seen that is also helping that is the correlation with distribution, and we expect also that in the next coming months, we'll see the impact also of our DTC campaign. So in summary, we expect that this 12% growth in companion animal will be maintained for the year.

And David, this is Glenn. Just to your other question in terms of how the quarter relates to the full year. I'm not necessarily going to breakdown quarter-by-quarter but just how Q1 relates to the full year. So the 2% price increase that we saw for the quarter, we do expect to be maintained throughout the year and then in general, we expect to generate 2% to 3% price increase, so nothing's changed from that perspective. In terms of the tax rate, the guidance on the adjusted ETR for the year is 30%. We came in at about 28% in Q1, really, driven by: A, some discrete favorable items, and also the recognition of some of the benefits related to employee stock options and restricted stock units and the tax effect of those in the quarter. So those had favorable impact in the quarter versus what the trending will be for the full year. And then related to the other expense, so our other income in the top line was favorable in the quarter really driven by 2 key things. A, we have lower hedging cost than we had in past and also we have the PHARMAQ settlement for the PD vaccine that Juan Ramón spoke about just before.

We can take our next question from Alex Arfaei with BMO Capital Markets.

A couple of clarifying questions for Juan Ramón first. First, confirming that you do expect you U.S. apply to start to return to growth in the second half, just want to make sure we're clear on that. And I didn't catch the Apoquel market share you stated. And a couple for -- Glenn, if I may. As conversion improve this year, are you considering a more aggressive dividend policy to better reflect the sustainability of your business? And what are your thoughts on tax reform and how could it possibly impact Zoetis as you evaluate the various policies that are being discussed?

Thank you, Alex. And the answer to the U.S. livestock, I think we expect growth in the U.S. for our livestock. But maybe it will be important to provide some details on the different species in livestock, starting with swine. We expect mid- to low single digits, and we expect that the PCV2 vaccine will help also to gain momentum in terms of revenues. We also think that the swine business in the U.S., it's also having the benefit of high exports. The exports are growing 18% in the U.S. and this is also helping producers to generate profitable results. And we are now, in our opinion, having the portfolio that will be generating growth in the rest of the year. In the case of poultry -- well, poultry we expect that the market will be showing very little growth. But on the contrary, Zoetis will be generating positive growth and they're growing faster than the market in poultry in the U.S. And finally, in cattle. In cattle, we face some challenge in the first quarter. The challenge of milder winter, lower risk profile that also had an impact in our premium anti-infective. Also as I mentioned implementation of the Veterinary Feed Directive that also have an impact in some of our medicated feed additives. We expect that all these challenge in implementation that affected small producers will be managed in the future. And this will help also to have the full use of products in the coming months. In the case of (inaudible) positive for cattle, that makes us positive about this segment. Prices are increasing and as I mentioned, the future of prices are hitting highest in the stock. Also, the placement of the feedlot increased by 6% and very positive also. The animals are now moved with medium-sized compared to heavy size in the future, which is also increasing the reach profile of these animals. And again, another indicator which is positive in cattle is that (inaudible) and stoker are back to profit. So overall, we think that the cattle market are having positive prospects, and we have the portfolio in our company also to generate positive growth in the rest of the year.

So Alex, in terms of the cash conversion as you indicate, as we get outside of the cost of the operational efficiency initiatives and a lot of the spend of cost the cash conversion is improving significantly. In terms of how we'll prioritize that additional availability, A, we'll continue to look internally for areas of high-growth and investment. We also aggressively look business development as well as an area. In terms of dividend, we'll continue to grow our dividend pretty much at or faster than the growth in adjusted net income and really where it will exhibit flexibility in terms of returning capital to shareholders will be share repurchase. So we recently announced $1.5 billion share repurchase program. We indicated that was flexible in nature. Just for context, in Q1, we repurchased $125 million in share and as we go throughout the year, we'll continue to evaluate the magnitude and pace of share repurchase. And also just in terms of tax reform, as we've said, we do have more than half of our pretax income in the U.S. so a change in the U.S. rate will definitely be favorable to us. Really, the magnitude and our favorability will really depend on the totality of the legislation. We'll understand that more as that becomes more clear.

Our next question comes from Brett Wong with Piper Jaffray.

We're seeing some pressure on the dairy industries in the U.S. due to kerosene couldn't [place] in Canada, putting stress on trade. Granted prices are still up year-over-year, but are you seeing a weakness in market are expected to see softness in demand for your product in that sector?

I lost the beginning of your question, so you were talking about the outlook in the U.S. and what else?

Sorry for that. Just wondering if you can comment around the U.S. dairy market. And we've been seeing some pressures there due to trade impacts, and so more potential trade impacts, so just wondering if you're seeing any weakness yet? Or do you expect to see any softness there? And I know the prices are still elevated year-over-year, which is positive, but you seeing is there any weakness so far?

Well, the dairy producers are maybe they are now generating lower profit than in the past we are still generating profit. So we have not seen any significant change in terms of number of animals, which is defining the animal health of revenues. So I think it is something that's stable. And in other markets, we have seen that they are recovering very well and countries like New Zealand are now back to much more profitable situation compared to the past. So overall, the dairy business for us, it's very positive. We'll have some challenge in Western Europe in importation to Russia has been also limited, the opportunity for revenues for some European dairy producers. But overall, our dairy business is showing positive growth per year.

Our next question comes from Jami Rubin with Goldman Sachs.

This is Divya Harikesh on behalf of Jami Rubin. You described growth for the dermatology portfolio of $400 million to $500 million over the next 3 years. Can you help it to explain well how much of that is coming from Apoquel versus Simparica and Cytopoint and just comment on your long-term expectation for these products. With Apoquel have you already reached a stage where a lot of the growth coming forward is going to be from Simparica and Cytopoint that are in earlier stages of ramp? So it would be clear to better understand that.

Maybe it's important now that when we discuss about Apoquel and Cytopoint, we discuss combining this portfolio. Both the products are targeting the same type of medical conditions. It's true that Apoquel, they have more indications than the Cytopoint, but still, it's something that the market is understanding fully how to use this product, concerning the dogs, concerning pet owners, veterinarians and also the division of the veterinarians. So I think it's important that we are not trying now to identify how much will be coming from Apoquel, how much with Cytopoint. Definitely, something that will be providing this information on actual, but I think the important thing is that we expect to generate $400 million to $500 million revenues in 3 years’ time, which is in my opinion, are increased compared to previous estimations. And this related to the reaction of the market. We still see significant opportunities for growing that in international. And international, we have many countries in where we still are on launching phase. But in the U.S., we see great opportunities. As I mentioned, we take Apoquel and Cytopoint combined, the number of the market share in terms of patients is about 50%, 52%. So still we have a lot of opportunities for continuing growing in this area. We expect also that the growth also will come from increasing awareness of performance through our DTC campaign in the U.S. So we expect that there are still significant growing opportunities for our dermatology portfolio in both international and the U.S.

Our next question comes from Chris Schott with JPMorgan.

Just 2 here. First on the gross margin improvement as we think about the next few years, since you've highlighted 200 basis point improvement by 2020 as you optimize infrastructure. Can you give a little bit more color on how to think about that? Is that going to be a gradual improvement as we think about '18, '19, '20 or more of a step function improvement as you do all that work and then we take more in 2020 and that's a big step up? My second question was coming back to capital deployment. Just like a little bit more about your longer-term leverage targets and where you'd like to see the company over time. I'm just trying to get my hands around a little bit more how much capital you're going to have to work with is you consider the various options for cash deployment going forward.

Chris, so in terms of the 200 basis point improvement that we expect in gross margins through 2020, we do expect to be gradual is not going to be necessarily one step change. There are activities that need to occur over those 3 years -- such those 3 years to generate the 200 basis point improvement primarily in terms of moving products from one location to another for manufacturing, so that will be a gradual improvement. In terms of capital deployment and our debt ratios, we're still targeting a gross debt ratio of 2.5 to 3, and we believe that is appropriate for our company, and that will be what we'll be targeting for the next number of years.

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

Just 2 questions. First, I'm not sure if I heard this before, but last quarter, you had talked about having $50 million in sales still to work through the P&L from the streamlining. Could you tell us how much of that impacted Q1, and will the remainder be in the second quarter? And the second question is on antibodies for -- in companion animals. Given your interest with both the IL-31 and your pending acquisition of Nexvet, have you also looked at antibodies in the oncology areas, specifically anti-PD-1 for use in cats and dogs?

So in terms of the $50 million sales, that was a challenge to growth for 2017. That was really related to the product rationalizations and the fact that we still have $50 million of sales in those earlier in 2016. So really a 1% impact in terms of growth for the year is what we're anticipating for 2017. We expected to see the majority of that impact in the first half of the year, so about a 2% impact from the product rationalizations in the first half of the year, which is what we saw on the first quarter. We expect the similar impact in the second quarter and then minimal to no impact in the second half of the year.

And the question in a monoclonal antibodies. Definitely now with the expertise that we have -- that gained, thanks to Cytopoint, IL-31 and also the acquisition of Nexvet, we see opportunities of using the monoclonal antibody at another platform to develop other products and other indications. Oncology is one of the target but we're also discussing other areas that monoclonal antibodies will be also responding to medical conditions or opportunities for some efficiencies in livestock.

It appears we have no further questions at this time. I will now turn the program back over to Juan Ramón for any final or closing remarks.

Thank you very much for joining us today, and we'll be pleased to have following -- follow-up comments to our Investor Relations group, but we'll be also pleased to interact with you. Thank you.

And this does conclude today's program. Thank you for your participation. You may now disconnect, and have a great day.