碩騰 (ZTS) 2017 Q2 法說會逐字稿

Welcome to the Second 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 you, Steve Frank. Steve, you may begin.

Thank you, operator. Good morning, and welcome to the Zoetis Second 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, August 8, 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. Good morning, everyone. As in previous quarters, the innovation we bring to the market and the diversity of our portfolio across the geographies, species and the therapeutic areas are all supporting the consistency of our financial results. Our innovations include the recent introduction of new products like Cytopoint, Simparica and Stronghold Plus and lifecycle innovation that are developed across our approximately 300 product lines.

Our diverse portfolio helps us overcome economic cycles and deal with other political situations and weather conditions that can affect market, species or product categories. We are seeing this diversity once again in the second quarter, and along with the excellent execution of our Zoetis team and our single focus on animal health, all these factors helped deliver excellent results.

In the second quarter, our revenue grew 6% operationally, and excluding the impact of product rationalizations that we have discussed before, our operational growth would have been 7%. We expect this will be the last quarter that we see any significant impact from the product rationalizations as those efforts and their comparisons are largely complete.

The main driver of our second quarter revenue growth remains companion animal products, which grew 10% operationally, driven largely by sales of our industry-leading dermatology portfolio consisting of Apoquel and Cytopoint, and our new oral parasiticide, Simparica.

In the U.S., companion animal products grew 7%, and in international markets, they grew 15% operationally. We continue to see order penetration of new products in key countries outside of the U.S., (inaudible) Japan, Brazil and Canada.

We have been supporting growth for Simparica and Apoquel with direct-to-consumer advertising that we started in the second quarter in the U.S. We have made similar efforts in Brazil.

Initial reports on DTC in the U.S. are positive, and we look forward to analyzing more data as we evaluate the full year impact.

Our total dermatology portfolio has shown significant growth, achieving our first ever quarter of more than $100 million in sales. We continue to build disease awareness through our DTC campaign and expect to expand the market. Our latest data shows that 85% of dogs with dermatology problems in the U.S. are treated with Apoquel or Cytopoint, up from 52% in the first quarter.

Cytopoint has gotten good traction in the U.S. this year. And in new countries, we are conducting an early experience program and expect to fully launch in September. We believe the early adoption and favorable reaction in the U.S. is a good indication of the success we can achieve in the European markets.

Although Simparica sales were lower than in the first quarter, we continue to track well, with our expectation for the year in this highly competitive market. In the U.S., we have seen sales from clinic to pet owners growing market share since the beginning of the year. Meanwhile, our livestock portfolio grew 3% operationally, with increases in cattle and poultry products being partially offset by a decline in fish products. Our swine product sales in the quarter were flat.

In the cattle market, we reported 4% operational growth. Export demand for U.S. beef has been increasing due to the lower average retail prices, and we continue to see positive signs in other major beef-producing markets like Brazil, Argentina, Mexico, Australia and Canada.

In the case of poultry products, we grew 4% operationally. We have seen strong growth in the U.S., driven mostly for our broad portfolio and expertise to help customers address a range of consumer and retailer preferences.

Combining our vaccines with product such as Zomig. (inaudible)Cox, we are helping certain producers shift to nonperiodic Aero (inaudible) production.

In swine products, although we have taken actions to represent our vaccine portfolio in the U.S., we are still showing a decline in U.S. sales. In international, however, our swine business is growing very strongly, led by China, the world's largest pork market.

In fish produce in the second quarter, we have seen a decline of 5% operationally, mainly due to a lower uptake of our SRS vaccine in Chile. Nevertheless, we still expect double-digit growth for fish produced this year, and we remain confident in the long-term prospects for this business.

We posted 11% operational growth in adjusted net income. Once again faster than revenue growth of 6% and in line with our value proposition to shareholders to grow adjusted net income faster than revenue, and the full implementation of our efficiency initiative is enabling us to invest in additional promotional activities like DTC, while showing only a modest 1% operational growth in operating expenses.

With our increasing cash flow, we continue to look at other investment we can make to support our future growth. One key area is ensuring reliable, high-quality supply to drive our growth. As part of our supply network strategy, we expect to complete the sales of our Guarulhos plant in Brazil in the fourth quarter. At the same time, we are planning to expand our vaccine plant and invest in manufacturing capacity for other innovative products. We will share more details as plans move further along.

While new products like Simparica and Cytopoint may get well-deserved headline, we also focus on lifecycle innovation to keep established brands, delivering value to customers over decades. For example, Zoetis received approval in May from the NDA for CLAVAMOX CHEWABLE for dogs. This leading anti-infective was first approved in the U.S. in 1994 and it provides a broad spectrum of treatment for various infections in dogs and cats. CLAVAMOX CHEWABLE joined the regional tablet and liquid drop formulations, which we'll continue to market, and our internal innovation is complemented by M&A opportunities.

Last week, we completed the acquisition of Nexvet Biopharma, an innovator in monoclonal antibody therapies for companion animals in management of chronic pain and other therapeutic areas. This attrition demonstrates how we use external innovations in key technologies and therapeutic areas to support future growth. Nexvet strengthens our R&D pipeline in monoclonal antibodies and help us sustain our leadership in chronic pain management for companion animals, an area valued at an estimated $400 million a year and which is poised for innovation with the new monoclonal antibody set therapies. We are moving ahead with the work of integrating Nexvet into our existing research and manufacturing operations in order to advance with their promising product candidate.

With the first half of the year now behind us, we are tracking to our expectations. We are pleased with a strong start to the year, and we are increasing our full year 2017 guidance for revenue and net income based on foreign currency changes and our continued confidence.

With that, let me hand things over to Glenn, who will provide more details on our second quarter results and full year guidance. Glenn?

Thank you, Juan Ramón, and good morning, everyone.

We had another solid quarter based on the strong growth of our dermatology portfolio and other recently launched companion animal products as well as growth in our global livestock portfolio, which was balanced across our U.S. and international business segment.

Total company revenue grew 6% operationally, which exclude the negative 1% impact from foreign exchange. Breaking down that 6% growth, 6% came from dermatology and other new products and 1% came from our in line portfolio, with the product rationalization having a negative 1% impact on operational growth.

As Juan Ramón mentioned, our dermatology portfolio reached a considerable milestone with sales in the quarter of $102 million. As we have said in the past, Q2 and Q3 are the peak seasons for dermatitis in the U.S., with a softer Q1 and Q4. As expected, Simparica sales were lower sequentially at $20 million. This was driven primarily by the U.S. and the timing of distributed purchases in Q1 in anticipation of the flea and tick season.

Internationally, we saw strong growth sequentially in Simparica, with additional penetration in most major markets.

In terms of the bottom line, we delivered 11% operational growth in adjusted net income and 12% operational growth in adjusted diluted EPS. Overall, we had another quarter of solid top line performance, and we again grew our bottom line faster than our sales. We continue to deliver steady, long-term growth in an attractive and stable industry.

Our ability to bring innovative and differentiated products to market, combined with our diverse portfolio and leading commercial capabilities gives us a sustainable foundation for future long-term growth.

Now let's discuss segment revenues. Our international segment generated operational revenue growth of 7% while the U.S. grew 5%. In the international segment, product rationalization has negative 1% impact on growth.

So let me highlight a few markets. China delivered another strong quarter growing 14% operationally, with growth coming from both our livestock and companion animal businesses.

In livestock in China, we benefited from solid market dynamics in swine, including favorable pork prices through the first half of the year. We expect some softening in this trend during the second half of the year. However, the continued modernization of production will drive greater long-term growth based on the use of vaccines and medicines to ensure safe, high-quality food supply.

In companion animal, our recently expanded field force continues to partner with local veterinarian to improve medicalization rates and increased routine care for pets in China.

In Brazil, we grew 8% operationally in the quarter behind the strength of our cattle and companion animal businesses. Investments in field force expansion and favorable market condition contributed to growth in cattle despite recent industry and government headline. And companion animal growth in Brazil was driven by new product introductions, including Simparica and Apoquel.

Japan also made a significant contribution in the quarter, growing 17% operationally over the same quarter last year. Apoquel sales began to normalize with distributors and better reflect the strong underlying demand in the local market.

As a reminder, there was significant distributor stocking in Q3 of 2016 when we initially launched Apoquel.

Key markets in Europe performed well in the quarter as the U.K., Germany, France, Spain and Italy all exhibited operational growth. The U.K. and Germany led the way at 12% and 8% operational growth, respectively. Growth in the U.K. was driven primarily by Apoquel, while Germany's performance was due to strength in both Apoquel and Simparica.

To summarize, very strong growth in our international business 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 5% in the second quarter. Companion animal grew 7% and livestock grew 3%. Companion animal sales in the quarter were driven primarily by our dermatology portfolio, Simparica and a number of other new product launches. U.S. dermatology sales was $74 million for the quarter, with Cytopoint sales reaching $15 million, exhibiting nice sequential growth as clinic penetration and dosing accelerates. As Juan Ramón said, patient share also continues to grow for Apoquel and Cytopoint.

As I mentioned earlier, Simparica sales were lower this quarter than last, but still in line with expectation. Our increased selling and promotional activity will lay the groundwork for continued revenue growth in this highly competitive market. We will continue to evaluate the performance of our direct-to-consumer promotional campaign for Apoquel and Simparica, with earlier indications suggesting that we are on track to meet our business objectives.

Additional contributions to companion animal growth came from new products, including Ditropan, which recently received approval for the treatment of dogs with heart worm. With the introduction of Ditropan, Zoetis now offers veterinarians of full canine heart worm product portfolio, including prevention, detection and treatment.

Moving to U.S. livestock. Sales grew 3% in the quarter, due primarily to our cattle and poultry businesses. Our cattle business returned to growth this quarter due to the success of products such as ACTOGAIN and SYNOVEX, while sales of our premium injectable antibiotics continue to be impacted by healthier animals moving into the feed block.

As certain poultry producers expand the no antibiotic as a label, our portfolio of medicated feed additives for these criteria are doing well and contributed to poultry growth in the U.S. We work closely with our customers to provide the necessary product and technical assistance to help them switch over when they choose.

Our swine business declined again this quarter in the U.S., primarily due to competition for our Fostera PCV and (inaudible) vaccine. Our updated vaccine products is seeing a modest uptick with medium and smaller producers and will continue to work with customers to gain acceptance.

Finally, both our cattle and swine businesses were impacted by the implementation of the Veterinary Feed Directive, or VFD, which negatively impacted our medicated feed additives performance as producers are adjusting to the new regulation and how to adapt their protocols.

Now turning to the rest of the P&L. Adjusted gross margin of 65.6% decreased approximately 230 basis points year-over-year on a reported basis, and on a sequential quarter basis, improved 120 basis points from the first quarter of this year.

As I had mentioned during last quarter's earnings call, in 2017, we have made additional cost improvements in our manufacturing network. As a result, in the first quarter of 2017, we recognized higher costs associated with previously produced inventory, which depressed our gross margin. This change also had a negative impact on our second quarter margin, which we had previously indicated.

The second quarter results for adjusted gross margin, while showing improvement over the first quarter, are slightly below our initial expectations. We have been working to improve our inventory management, including reductions in the level of inventory write-offs we incur. While we still expect to improve in this area for 2017, the magnitude of improvement is less than we had expected and will continue to be an area of focus in the future. Gross margin was also impacted by unfavorable foreign exchange in the quarter.

Adjusted SG&A grew by 1% in the quarter, with higher investment in our DTC advertising campaign offsetting the expense reductions in other areas. Adjusted R&D declined 1% operationally for the quarter due to the timing of project spending and fixed expense reductions from our operational efficiency initiative.

The adjusted effective tax rate for the quarter was approximately 29%. The tax rate in the quarter has significantly improved from the prior year primarily due to the impact of operational changes implemented in the third quarter of last year. Taking all these factors into consideration, we generated 11% operational growth in adjusted net income for the quarter.

Moving to guidance for full year 2017. This year, we continue to perform in line with our expectations with certain upsides and downsides, particularly with tax and cost of goods sold. For the year, we still expect to achieve operational revenue growth of 5.5% to 7.5% and an adjusted EBIT margin of 34% to 35%.

Since our last update in May, changes in FX rates in several markets are favorable to revenue, and we're increasing both the lower end and higher end of the range as a result. We have also narrowed the range for revenue towards the high end of our guidance by $25 million to reflect our performance to date and our confidence in the remainder of the year.

Our guidance for the range of cost of goods sold for the year has moved from 32% to 33% of revenue to approximately 33%. As we progress into the second half of the year, our results will more fully reflect the impact of our manufacturing cost improvement. Our updated view, however, also reflects the higher expense for inventory charges that I discussed earlier as well as unfavorable mix and foreign exchange.

For SG&A, we're increasing the lower end of our range and maintaining the high end, consistent with the change in our revenue guidance.

We have increased both the low end and high end of R&D expense range to reflect additional investments, primarily as a result of the Nexvet acquisition and the impact of foreign exchange.

Our guidance for an adjusted effective tax rate has been lowered to approximately 29% from our previous guidance of 30%. The favorable change is primarily due to jurisdictional mix and certain discrete items that had been realized in the first half of the year and does not take into account any potential tax 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 would have a meaningful benefit to us.

As a result of the aforementioned changes, we have increased the low and high end of the range for adjusted net income for the year. In the second quarter, we also repurchased another $125 million in shares, and our guidance for reported and adjusted earnings per share reflects the share repurchases completed through Q2.

We expect our operating cash flow to grow through the year, allowing us to fund incremental investment in our business, including the $85 million used to purchase Nexvet last week.

Just to summarize before we go to Q&A. We have delivered consistent operational revenue growth of 6% in the first half of the year. We expect positive trends in the uptake of new products and growth in international livestock to continue. Our earnings growth will accelerate meaningfully in the second half of the year, and cash flow generation will continue to improve, giving us greater flexibility to invest in our business.

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 Derik De Bruin with Bank of America Merrill Lynch.

So just a couple of questions. So the first one, could you -- now that you've closed Nexvet, could you give a little bit more timing on the pipeline? How can we think about -- from the product coming through? I believe you've got one canine, one feline drug coming in the market in the research and development line -- pipeline right now. Could you just give us some timing update there? And also on the gross margin, could you sort of back out what the different headwinds were this quarter and sort of what's the underlying growth rate was?

Derik, I will take the first question, and then Glenn will answer the question on gross margin. So Nexvet, we completed the acquisition last week -- on Monday last week. Our team -- R&D team, is now interacting with the R&D team of Nexvet, getting a full understanding of all the problems. Once we have completed this analysis, then we will find when we expect the launch a product for both dogs and cats in both in the U.S. and the European market. It's a little bit too early now. But again -- so one thing that we need to remember is that we are in a market in where our competitors are not providing any detail in terms of R&D progress, and providing too many details, and especially in area that we think that can be also of high interest, will have a negative impact in our programs, and maybe in the opportunity to generate the future revenue growth.

In terms of gross margin or cost of goods sold. So for Q1, our cost of goods sold was about 35.6% of revenue. In Q2, that improved to 34.4%. The key drivers of that were the costing methodology and the fact that we did recognize the disproportionate amounts of the higher costs associated with previous introduced inventory in the first half of the year. When you look at our guidance for the full year of approximately 33%, that definitely implies a significant improvement in second half of the year after or outside the costs associated with that previously produced inventory.

We'll take our next question from John Kreger with William Blair.

Can you talk a bit more about your swine product performance? It seems like the vaccines have been under pressure for the last 2 or 3 quarter. Should we expect that to persist in the second half? Or do you expect that to turn?

Thank you, John. Well, we mentioned that we have been working in our vaccine portfolio in both U.S. and international markets. We have seen good growth in international market. But in the U.S., despite of the -- our portfolio now being much more competitive, we have not yet gain a share as we expected. We remain confident that we have now a very strong portfolio, and very important, we also have products in our pipeline, that will be reaching the market in 2018, that will bring this segment also to growth in the U.S. In the second half, in the U.S., that is also a question that you raised. I think we'll be improving, but probably not improving as fast as we expected initially. On the other hand, in international, we expect that the continual growth and positive evolution of our portfolio in swine.

Our next question comes from John Block with Stifel.

Two questions and I'll try to ask them both upfront. First off, the PHARMAQ number was a bit light, and Juan Ramón, curious if you think its market or market share? And is there a revised figure for the year, which I believe stood at $125 million. And then sort of putting the guidance and just looking forward, Glenn. The gross margin will obviously be better in 2H relative to 1H. So do we take that 2H '17, sort of use it as a run rate for '18? And then finally, I know you don't guide quarterly, but just how do we think about the cadence behind revenue growth? Probably we should think about greater the revenue growth greater in 4Q relative to 3Q just from a comp and days adjustment perspective.

Thank you, John. And -- well the PHARMAQ was the main driver of our line performance in the quarter. Fisheries vaccine that it was a significant growth driver and the vaccine for farmers in Chile, is still showing significant result in terms of efficacy and safety, and is helping fish farmers in Chile, to review the use of antibiotic. In the second quarter, we saw a reduction of the use of the vaccine mainly because of pricing discussions. At the end of the quarter, we reached price agreement with fish customers in Chile, and we have seen already in the first 2 months of the third quarter the vaccine showing very good revenues and very good growth. We remain very confident that this segment will deliver long-term growth. In the quarter, as I mentioned in my comments, we expect double-digit growth, but you mentioned the $125 million will be below this amount. But nevertheless, we expect that in the future years, the corrections will be in line with our expectations.

And, John, in terms of gross margin in the first half, second half, so as indicated with the guidance that we provided, we do expect significant improvement in gross margin in the second half. Regarding the impact of that and how you look at that for 2018, there are a number of factors that will impact the gross margin for 2018, including mix, foreign exchange as well as the goals that we have in place from an inventory reduction perspective, which mainly just make some decisions that will have some impact on our ability to use utilized overhead. While that would be the right impact from a cash flow perspective, it may have some negative impact from a P&L perspective, but there are a number of factors that will impact gross margin for 2018, and we'll provide guidance for 2018 to get better clarity on that. In terms of the guidance for the second half of the year from a revenue perspective, based on the minimal impact in the second half, we do have one more day in Q4. But other than that, there's really nothing that would lead to significant changes in growth between Q3 and Q4. Next question.

Next question comes from Jami Rubin with Goldman Sachs.

Just following up on the question related to gross margins. Are you still comfortable with your 200 basis point improvement after the 2017 initiatives by 2020? Is that still on track? And also with respect to U.S. livestock, can you update us on the impact of meat prices this quarter and your expectations for the rest of the year?

Thank you for the questions. We are still seeing the opportunity of improving by 200 basis points in gross margin by 2020 and plans are moving ahead as expected. In terms of comments on the cattle business in the U.S. While there are some positive factors that are really felt in the cattle business in the U.S., one is the number of cows expected to roll in '17 and '18. We also expect that the number of placements in feedlots will be higher than in '16. And we also saw that the feedlot producers alternating their profits in 2017, and we expect also the same in the second half. The price of the beef is also helping exporters to increase exportation to markets like Japan, markets like Mexico and many other markets in where the beef is in the U.S. is being exported. Also, the prices of milk are positive, is not related to beef, but we have seen an increase on the price of meat. Still below prices that we saw in 2016, but it's also helping us to start stabilize the market. And at the same time, we have seen some headwinds in the U.S. market for cattle. One was the mild weather in the first quarter that reduced the risk profile of animals and also had an impact, negative impact, in our premium antibiotics. The implementation of the Veterinary Feed Directive also had an impact in the first quarter and we expect also having an impact in the remaining of the year. And finally, we have seen in the first half of the year that animals moving to the feedlots were heavier, again with lower risk profile. In the second half, we expect that these animals will be medium-sized that also will increase the opportunity for the cattle business. But, in general, we have seen that the prices in the different parts of the chains of production has been more positive than in 2016. Next question.

The next question comes from Louise Chen with Cantor Fitzgerald.

One question I had was, I was wondering if you could talk a little bit more about some of your near and long-term growth drivers, that being PHARMAQ, the Nexvet acquisition, and also the triple combo product and how should we think about the peak sales potential for these products and when we'll see some sort of meaningful accretion to earnings from these different products? And then the second question I have was just on diagnostics. Do you want a bigger footprint in diagnostics? And will you have to make additional investments to get there?

Well, definitely, we described that in -- we expect '17, companion animal being the main driver of growth and the same for '18. And this will be, well, coming from still growth of Apoquel, growth of Cytopoint and Simparica. For Apoquel, Cytopoint, we mentioned that 400 to 500 is what we expect in terms of peak sales. For Simparica, a single agent, we also generated more than $100 million. And when we introduced these 3 combo products, then we'll update on our expectations. So we have not yet provided details of what we expect for Simparica platform that will include the single agent plus also Stronghold Plus later also REVOLUTION product in the U.S. and also the triple combo. In terms of PHARMAQ, we are convinced that this will continue generating double-digit growth. We expect double-digit growth in 2017. We have not yet provided details for '18. We'll be providing this information in a later date. In Nexvet, it's too early to define what are the projections for Apoquel for managing pain in both dogs and cats. So we know that the pain market for dogs is about $400 million. And we also know that cats is a real unmet need, so we see also opportunities. Giving Apoquel to manage pain for cats. In terms of diagnostics, we acquired SMB that also complements the previous acquisition of Synbiotics. Now we have facilitation of -- future participation in 2 segments. One is the rapid test at point of care and the other one is equipment that will be coming out of the program that has been developed by SMB. We are convinced that SMB has very interesting platforms in different areas, in chemistry, immunology, molecular, also specialty. And we'll be working on developing all these programs to bring products into the market. There will be a phasing of introduction of products and we are confident that by end of '17 or early '18, we'll start introducing new products into the market. Next question.

The next question is from Erin Wright with Credit Suisse.

Can you speak to some of the initiatives you alluded to in your prepared remarks in terms of the manufacturing footprint and also the potential for further rationalization? It sounds like you continue to expect the 200 basis points in gross margin expansion associated with those initiatives, I guess, starting in 2018, but could that process be expedited at all? And then my second question, you mentioned they will be in cash flow, which I think that statement is still absent from the press release disclosure, but can you speak to capital deployment priorities, how is the M&A pipeline shaping up and is Nexvet fully incorporated into your guidance at this point from an expense perspective?

Okay. Thank you. We mentioned in the comments on manufacturing initiatives. So first, we are -- the manufacturing is always a continuous work in design opportunities for being more efficient. Reducing cost is a priority, but it's not the only priority we have here in design in manufacturing. We also want to make sure that we are improving the cost, but at the same time ensuring that we have reliable supply and at the same time that we are also working on reliable supply that will reduce our inventory levels. So it is something that is a target for the company. We identified a target for '17 and we'll continue targeting inventory improvements over time. In terms of the initiatives that we already communicated is the 200 basis points by 2020. And you're asking if we can accelerate that, it's something that we always try to do things as fast as we can. But at this point, what we are really targeting is to ensure that by 2020, we generate these 200 basis points. And we also need to understand that in some cases, these savings are the result of transferring the products from one plant to another plant or recent plants, and it's something that it takes time because it's a complex process to move products from different plants and we need to make sure that when the product is in the final destination, it's really delivery in terms of cost and also in terms of supply to the market. We also expect that because of all the product rationalization, all the manufacturing plant rationalization, also we have a specific impact in terms of volume and improving our allocation of overheads. In terms of cash flow and the priorities for cash, we remain committed to invest internally, investing in commercial. And we had examples this year to invest in DTC campaigns to support new product launches. We also continue -- committed to bring innovation to the market internally with our R&D expertise and capabilities. And we see opportunities also for further expansion of some of the areas in where we think that we can improve our operations in terms of manufacturing. With special attention on ensuring that we have the right capabilities and capacity for vaccines in developed and also in energy markets that also will be equally important. And we also mentioned that we -- as a second priority, its identifiable opportunities that will complement our internal efforts and will support further revenue growth and further profitability. And it is something that we are committed to identify these opportunities and bring these opportunities and these opportunities can bring value to our operation. And finally, you also asked in terms of Nexvet guidance. So at this point, we're not yet providing any guidance in terms of Nexvet. It's too early, so we need first to have full control of all the products that Nexvet has been developed. We have access to these products, but now that our R&D colleagues are really working together with Nexvet R&D colleagues, then we will have full understanding of the opportunities. So Glenn will add some comments.

Aaron, just to sort of clarify on Nexvet. So for 2017, you'll notice that we did raise our R&D guidance and that was to reflect the costs that we see for 2017 for Nexvet. One of the most common things more in terms of long-term guidance for Nexvet. The only thing I just want to comment on was the manufacturing initiatives. There are certain investments that we're contemplating that will lead to some -- increased capital expenses that will keep our capital expense as we move into 2018 probably more aligned with previous years. However, those initiatives, we do believe will shore up supply for some of our newer products, some of our key products as well as key products in key markets. And they'll also have the right return from a financial perspective bringing our costs down on those products as well. Next question.

The next question is from Kevin Ellich with Craig-Hallum.

Juan Ramón, could you maybe give us an update on what you're seeing in the companion animal market? You guys gave some good detail on Simparica. I wanted to see why we saw the sequential decrease in Q2 and what's your outlook is for distributor increases or purchasing in the back half of the year? And are you going to -- do you plan on expanding your relationship with those distributors? And then secondly, on the production animal side, you talked about the premium line of antibiotics like vaccine, did you say you expect the trend to reverse in the second half or kind of the midsized cattle will be in the feedlots and that could lead to increased sales?

Thank you, Kevin, for those 2 questions. So first, on companion animals. So on companion animal, we expect that we'll continue generating very positive growth in the second half, and we expect that the differential between companion animal and livestock will remain in the second half of the year. We have seen in the second quarter growth in the U.S. of companion animal 7% while international markets was 15%. I think it was in line with our expectations. In the U.S., in the second quarter, in companion animal, we had some additional promotional activities that also had an impact, a temporary impact, in terms of prices. But the growth in the different part of companion animal portfolio has been in line with our expectations. Simparica also had additional revenues in the U.S. in the first quarter that had an impact in the second quarter, but we don't see any situation that is different than what we expected vaguely with the performance of new products, Apoquel, Cytopoint, Simparica. All indicators are showing our progression in terms of market share improvement in both for dermatology and also for parasiticides segment. And in the other, in line portfolio, again, so we haven't seen any change in the generic assumptions. So I think it's something that is in line with the trend that we have seen in previous quarters. Maybe a comment on RIMADYL that has been affected by the interaction of Galliprant. Galliprant is another product for treating pain. And we know that in this market, new products, they get significant attention and growth, and this growth is maintained depending on the results that are showing in the mid and long term in terms on efficacy and safety. But we are very pleased with our performance in companion animal. And definitely, it's a significant driver of our growth in the first half and we expect also a significant driver of our growth in the second half. In terms of the trends for the cattle in the U.S., you mentioned that the vaccine impact, I will say that maybe definitely the mild winter and also the heavier animals into the feedlots has an impact in terms of the use of premium antibiotics. The other impact that we have seen was also the implementation of the veterinarian feed that has been affecting our cattle business, especially the medicated feed additive. We saw that this was affecting temporarily to smaller producers in the U.S. and they will be adjusting how to use these products in the future. These adjustments are taking longer and we have incorporated in our guidance a more permanent impact in our revenue. But having said that, we expect more favorable conditions in the second half of the year for cattle. And we also have seen that in the second quarter, premium antibiotics has been performing very well in the years. Next question.

The next question is from David Risinger with Morgan Stanley.

Maybe we can try the next one.

Yes, we'll go next to Kathleen Miner with Cowen and Company.

Just a follow-up on the dermatology sector. Can you give us a little bit more color on Cytopoint and how it -- characterize its use, is it being used in more every 4 weeks or every 8 weeks? And are you seeing it used in more Apoquel-treated dogs or non-Apoquel dogs? And also just on Apoquel, can you talk about whether you're starting to see getting any more traction in the acute and shorter-term settings as opposed to the chronic case?

Thank you, Kathleen, and I would start with Cytopoint. And first, I think -- Cytopoint is the indication of the label in the U.S. It's 6 to -- close to 8 weeks. And we see that it's more used on the mid of these 4 to 8 weeks than 4 weeks. And we have seen also that Cytopoint in pancreas also having a 28% cannibalization to Apoquel. But combining both together, I think they are growing very nicely. And now I think we see the opportunity also to extend this experience to the European market in where we started early experience program, and we expect a full launch in September, in European market. And in the European markets, the label, it will be different. It will be a 1 milligram for 4 weeks compared to 2 milligrams in 4 to 8 weeks in the U.S. But still the products are very consistent in terms of efficacy and also in terms of safety. For Apoquel, we have seen now that Apoquel use has been extended or increased in terms of acute, but also in terms of seasonalized conditions of dogs. And this is a result of now full availability of product in the market. And also, we think -- we believe also the effort that we are making in terms of direct-to-consumer advertising. Current use will remain the main generator of revenues because the use will be very prolonged, but the acute or the seasonalized use of the product also will have significant opportunity. Next question.

We'll go next to Alex Arfaei with BMO Capital Markets.

Juan Ramón, I just want to clarify your comments on RIMADYL. So I guess the pain franchise was lower because of new product competition and not cheaper generics being -- from the distributors. And then a follow-up on Brazil, very good performance given that everything that's going on. My understanding is that the USDA has banned fresh beef imports from Brazil because of safety concerns; obviously, we know there's other concerns there as well in Brazil. So what impact could all of this have longer term on your business? And is there an opportunity for U.S. livestock to do better as a result and gain share?

So for the question on RIMADYL. So we are not saying that generic competition is not gaining share. It's gaining share in line with previous comment. And the -- well, the message I wanted to convey was that we have not seen significant changes in defense of generic penetration. What we saw is that product, which is Galliprant, it's a new product that has been introduced recently, it's a product developed by Aratana and commercialized by Elanco. It has been gaining share in this pain market. We have seen also in the past that new products in this market are having rapid penetration because it's still some level of dissatisfaction in terms of safety and products coming to the market may have some opportunity, and definitely, the opportunity will be maintained if it can really deliver all the expectations in the medium and long term. But we don't think that -- well this is something that we are confident that RIMADYL with so many years in the market with very well established profile in terms of efficacy and also in terms of safety will remain a key player in terms of managing pain for dogs. At the same time, so moving into the acquisition of Nexvet. It's very strategic for us to maintain our leadership in this area. We are convinced that there's still unmet needs in this market in terms of safety and efficacy and this can really fill this gap in terms of providing alternative to current products in the market. And we're convinced that in both in dogs and cats, RIMADYL will play a significant role. In Brazil, definitely, the scandals are not helping, but we have been managing volume quite well our growth in Brazil, despite of these political and scandal situation. And we -- the investment that we made in terms of expanding our sales force are having a very positive payback. We are growing sales in Brazil very rapidly, in Preto, but also in some other areas, areas like companion animal is also driving significant growth. And Brazil, in general, has been a market exporting, in most of the cases processed beef rather than fresh beef to some of the markets. And this is not really changing. And Brazil, they have a temporary challenge when it had the scandal in terms of the meat quality with China, but this has been already managed. And I think the prospects for Brazil are very positive. And definitely, Brazil will continue competing with the U.S. Although today, they are competing with different quality of meat. U.S. is much more focused on quality. While in Brazil, at this point, they are much more focused on process, which has not shown importance in terms of quality. So very positive in terms of future growth in Brazil. And also, we see some additional opportunities in terms of export in the U.S. Next question, please.

And our last question will come from Brett Wong with Piper Jaffray.

I just wanted to see if you could talk a little more on the U.S. livestock, although you already talked about the beef cattle outlook into 2018, expecting expansion. How long are you expecting expansion in other species like chicken? When we see contraction in any of those markets, including cattle, what is the expected impact for the business given the animal health products are a lot less discretionary in nature?

Thank you, Brett. And so we think that the fundamentals of the U.S. livestock are very strong. So in terms of cattle, I described that in our opinion, cattle will continue being an important part of the production of quality meat in the U.S. and also export to many other markets. We expect also that the growth in terms of number of heads in cattle will moderate in 2018, but still growing, which is positive. And we also think that in both in poultry and swine, the production in the U.S. is very efficient. They are very competitive. The consumption of animal proteins worldwide will continue growing and the U.S. will continue playing a significant role in terms of producing the meat that will be reaching customers around the world. The poultry and the swine, they are 2 areas in where they can manage very well the additional volumes. And we expect that in 2018, poultry and swine also will remain positive. If we move -- I was making comment, in general, to the market. If we move to our Simparica business, so we expect both poultry and swine in the U.S. showing positive growth in 2018. So we expect it to bring new products. And also, we have seen that even for producers that are moving to no antibiotic ever, we can offer to these producers a very good portfolio that will meet their demand and at the same time also will generate very positive growth in our company. Next question.

And it appears we have no further questions. I'll return the floor to you, Juan Ramón, for any closing comments.

Thank you very much for joining us today. As we mentioned during the call, we are very pleased with the results. We are also very confident on the guidance for 2017. And as I mentioned, companion animal will continue driving growth, but we see also positive growth in terms of livestock. We expect in the second half also maintaining the differential growth that we have seen with the companion animal and livestock in the first half.

With that, thank you very much for joining, and looking forward for meeting you again in the third quarter earnings call.

And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.