John O'Connor - Juan Ramón Alaix - Chief Executive Officer and Director Paul S. Herendeen - Chief Financial Officer and Executive Vice President.

Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division Kevin K. Ellich - Piper Jaffray Companies, Research Division Christopher T. Schott - JP Morgan Chase & Co, Research Division Erin E. Wilson - BofA Merrill Lynch, Research Division Alex Arfaei - BMO Capital Markets Equity Research Mark J.

Schoenebaum - Evercore ISI, Research Division Jami Rubin - Goldman Sachs Group Inc., Research Division John Kreger - William Blair & Company L.L.C., Research Division Kathleen M. Miner - Cowen and Company, LLC, Research Division Liav Abraham - Citigroup Inc, Research Division David Risinger - Morgan Stanley, Research Division.

Welcome to the first quarter 2015 financial results conference call and webcast for Zoetis. Hosting the call today is John O'Connor, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com.

The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 2 hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com.

[Operator Instructions] It's now my pleasure to turn the floor over to John O'Connor. John, you may begin..

Thank you, operator. Good morning, and welcome to the Zoetis First Quarter 2015 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Paul Herendeen, our Chief Financial Officer.

Before we begin, I'll remind you that our remarks today will include forward-looking statements and actual results could differ materially from those projections.

For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statement in today's press release and our SEC filings including, but not limited to, our 2014 annual report on Form 10-K and our reports on Form 10-Q.

Our remarks today will also include references to certain financial measures, which were not prepared in accordance with generally accepted accounting principles, or 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 5, 2015. We also cite operational results, which exclude the impact of foreign exchange. We have a significant amount of detail to cover today, including specific details of our financial outlook through 2017.

We will be posting both Juan Ramón and Paul's prepared remarks on the Investor section of zoetis.com following the call to help clearly disseminate these details. With that, I will turn the call over to Juan Ramón..

We will leverage the efficiency and standardization of our newly implemented ERP system to significantly reduce general and administrative costs in corporate functions. In addition to the ERP benefits, another important efficiency driver will be a reduction of management layers and increased span of control through the organization.

We'll improve our ability to be more dynamic and agile in responding to customer needs by shifting marketing resources closer to the customer and simplifying all areas of noncustomer-facing commercial infrastructure.

And we'll enhance our R&D focus to support a smaller portfolio of products as well as better prioritize the R&D portfolio to invest in projects with the highest returns. In the past, we have demonstrated our commitment to improve our operations and be more efficient.

In 2009, we achieved a successful transformation when we became the world's largest animal health business through several acquisitions. Then in 2013, we became a large, global independent company followed by 2 consecutive years of industry-leading performance.

Through each of these changes we have made ourselves better, improve how we serve customers and create new and greater value to our stakeholders.

I'm confident that the comprehensive plan we have announced today will allow us to transform again, building on our successful business model to deliver high-quality profitable revenue growth and becoming a more competitive company. These are significant initiatives that will drive us to be a more focused and streamlined company.

As a result, we'll see a reduction in the number of positions at Zoetis of approximately 2,000 to 2,500 over the next 12 to 18 months, subject to any consultation with work councils and unions in certain markets.

With the implementation of this initiative, we will better align Zoetis' resources and operating structure with our 3 interconnected capabilities; supply products, more reliable and at a competitive cost; increase capacity to invest in future business drivers; and finally, tailor the product portfolio and improve efficiency of the operating model so we can pursue the next horizon of opportunity as a world leader with a single focus on animal health.

Through this process, we'll be more competitive and better positioned to achieve long-term profitable growth. Before Paul cover the financial details, I would like to thank all our colleagues who have contributed to our success through an environment of intense change.

Our next transformation will be key to supporting our future success, and I know that we have the capabilities and the team to implement these significant changes.

Paul?.

one, face-to-face interaction with our customers to drive revenue; two, investment in product innovation to sustain our revenue base and our growth prospects; and three, the ability to meet our customers' demand with quality products.

These capabilities form the basis of our competitive advantage in the global animal health industry and changes to these areas will fall into the category of continuous improvement, not major changes. The bulk of our future cost savings will not impact these areas.

Our field force, the personnel in the front lines with our customers, will remain largely intact. The scope of our activities in R&D will also remain substantially the same, and we will continue to invest in programs to build and improve our supply chain.

Let me separate the 2015 program into 2 parts as I see them and then add on the previously announced supply network strategy to think about 3 areas of focus.

Part 1 is what I'll call rationalizing our footprint, part 2 is driving improved efficiency in our operating expenses, and part 3 is streamlining and improving the efficiency of our supply chain. Starting with rationalizing our footprint.

This work included a review of the number of SKUs that make up our product portfolio, consideration of moving to indirect sales models in a number of markets where we currently have a direct presence and evaluations of markets where we might choose to reduce our efforts. The headline here is that we will be eliminating nearly 40% of our total SKUs.

These SKUs create significant complexity across multiple functions within our company.

Of course, this will reduce our revenue and gross profits in the near term, but it will enable us to substantially improve the efficiency of our operations, from our supply chain and sales support, to G&A expenses and the product maintenance costs that are part of our R&D.

With a leaner portfolio comprised of our more profitable product assets, we will have better growth prospects. We also intend to move from direct sales models to indirect distributor models in certain countries and reduce our efforts or exit some markets.

When complete, the streamlining of our portfolio and global footprint will reduce our expected 2017 sales by some $280 million and gross profit by about $100 million. For the avoidance of doubt, those numbers are based on current FX rates. The estimated revenue and gross profit impacts are reflected in our revised guidance for 2016 and 2017.

Part 2 of the initiative is driving improved efficiency within our SG&A expenses and our investment in R&D. We're collapsing from 4 regions to 2 as we go forward. We're reorganizing the support for countries, including enabling functions, like finance, IT, HR and legal, but also the noncustomer-facing resources that support our field sales forces.

We're taking steps to improve the focus of our R&D activities, supporting a smaller portfolio of products, identifying greater efficiency in our regulatory practices and better prioritizing our R&D spend.

And yes, our expected spend for customer-facing resources will be less as well, mainly driven by the reduction in the number of markets where we'll have a direct presence, and the deemphasis of certain other markets but also through improvements in efficiency.

In total, by calendar 2017, we expect our total operating expenses, that is the sum of SG&A plus R&D, to be roughly $300 million less than it would have been but for this initiative.

As I said just a moment ago, we are not changing our business model here and that should be reflected in the way you should think about the sources of the $300 million of future savings. Roughly 1/3 is expected to come from reduced G&A and another 1/3 from commercial resources that are not customer-facing.

That's roughly 2/3 of the expected savings coming from areas that should not impact our ability to deliver near-term and long-term revenue growth. Of the remaining cost savings, about 10% is expected to come from improvements in efficiency within our R&D organization.

About 5% is expected to come from the reduction of our field resources tied to our revised global footprint and reduced emphasis in some emerging markets, and the balance of the cost savings here is expected to come from reducing complexity and increasing efficiency in other areas.

The third and final piece of the initiative is the supply network strategy that Kristin Peck outlined at our Investor Day last November. Most of the benefits of that work will be realized after 2017.

So for now let's set the supply network strategy aside and focus on the activities that will impact our results in the period from 2015 to 2017, but keep in mind that the supply network strategy initiative is expected to add some 200 basis points to our gross margin by 2020 on top of the improvements driven by the 2015 initiative.

You've heard me say this many times in the past that when we're looking at our operating efficiency, there are opportunities for us to do better. Today we back those words up, providing you with a framework of our plans to improve the operating performance of Zoetis while preserving the key elements of our value proposition.

In our to be state in calendar 2017, we'll be an even better company than we are today, more profitable on a slightly smaller revenue base, positioned to deliver better growth from a more focused product portfolio and working off of a leaner cost structure that can be leveraged to support revenue and profit growth over the long term.

After completing the change we're announcing today, we'll still be the leader in animal health, and we will continue to be the biggest investor in innovation in animal health. And we will continue to have the largest direct sales network in the industry.

Our improved efficiency will provide us with more flexibility to allocate resources where we can best serve our customers' needs and to further distance ourselves from the competition.

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

This initiative adds roughly $0.28 to our prior estimate of 2017 adjusted net income per share. So the song remains the same, only better.

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

Of course, the improvements in our future financial model don't come free. So I want to take a few minutes to talk about one-time costs generally and to specifically address the costs associated with the efficiency initiative.

First, it's important for you to know that we have a high standard when it comes to costs that we characterize as onetime and, therefore, are excluded from adjusted net income. Our policy limits such adjustments to purchase accounting, acquisition-related costs and certain significant items that we evaluate on an individual basis.

These include direct and incremental costs required to complete the stand-up of the company and those direct costs that we will incur to execute our efficiency plan. Next, we want to be transparent about the amount and nature of these costs, so our intention is to provide disclosure of our onetime costs in 3 buckets.

The bucket for stand-up costs and other onetime costs that you're already familiar with; a new bucket for the efficiency initiative that we announced today; and a third bucket for the cost associated with the longer-term elements of the supply network strategy.

We estimate our remaining pretax stand-up and other onetime costs at $180 million to $210 million with those costs to be recorded primarily in the remainder of 2015 and through 2017. These are primarily all-cash costs.

We estimate the onetime pretax cash costs associated with the efficiency initiative to be in the range of $340 million to $400 million and to be incurred in 2015, 2016 and with some modest portion moving into 2017. We expect actual cash payouts to occur over the next few years. Note that there will also be noncash charges triggered by this initiative.

We are not providing an estimate of these charges as both the amounts and timing could vary widely. As we incur these noncash charges, we'll call them out for you when recognized. Finally, the supply-network strategy.

onetime-pretax cash costs are currently estimated at $60 million to $100 million and are expected to be incurred over the term of the plan.

It's worth noting that we are still in the early phases of architecting the supply network strategy, and the final onetime costs for this activity could be substantially different depending on the final outcome of our ongoing analysis of our supply network and the timing or nature of any specific site exits.

There will also be noncash charges triggered by the supply network strategy, and we will call those out to you when recognized.

Note that the estimates of onetime pretax costs for both the efficiency initiative and the supply network strategy ignore the possible proceeds that we may receive from the sale of certain assets, which could potentially offset some of the onetime cash costs.

We provided a webcast slide that summarizes our current estimates of the onetime pretax cash costs associated with each of the 3 buckets over the period from 2015 to 2017. We will refresh our view of the various buckets of onetime costs as appropriate.

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

However, recent economic developments necessitate an evaluation of our efforts there. While our business in Venezuela is profitable, it has become increasingly difficult to realize those profits in U.S. dollars.

Unless and until that environment changes, sales and profits there will drive low quality earnings, so we're significantly paring back our activities there. To be clear, Venezuela is a solid local market and we will maintain a presence there as we believe that the environment will improve over time.

However, in the interim, we believe it's prudent to reduce our activities and exposure there. The decision to reduce our activities in Venezuela impacts our revenue and profit expectations for 2015, '16 and '17. The impact on 2015 can be seen in the exhibit to our press release that bridges from our prior guidance to our revised guidance.

We've also provided a slide on the webcast that shows the impact of Venezuela on 2017, which decreases our expectations for adjusted net income in 2017 by $0.07 per share.

Now let me provide an update on our guidance for the full year 2015 in light of the changes in FX rates since our last guidance update, the anticipated impacts of the efficiency program and our decision to reduce our efforts in Venezuela.

I also want to update you on our expectation for 2016 and '17 and to provide you with more detail about those years. We felt it was important to say more about 2016 and '17 as there are a lot of moving parts here, and we want you to have a clear picture of our expectations. First, 2015 full year guidance.

In our press release and in a webcast slide, we provided a bridge from our prior guidance to our revised guidance.

The headline is that despite the continued headwinds from changes in FX rates and our decision to reduce our business in Venezuela, we're holding our guidance for adjusted net income per share for 2015 in the range of $1.61 to $1.68 per share. This includes pluses and minuses. FX is a minus again.

The changes in FX rates from late January, underlying our last updated guidance, to late April, decreased our revenue expectation for 2015 by some $75 million or 155 basis points, while the impact on adjusted net income was much less, only about $5 million or 60 basis points.

Then our decision to pare back our efforts in Venezuela reduces our revenue expectations by $50 million, operating expenses by $5 million and decreased our expectations for adjusted net income by $25 million.

Finally, the big plus, and that's the impact of the efficiency initiative, which reduced our expectations for operating expenses by $45 million compared with our prior guidance and increased our expected adjusted net income by $30 million.

So when the dust settles, we expect our reported revenue to be down by $125 million from our prior guidance range and our adjusted net income to be consistent with our prior guidance, $1.61 to $1.68 per share.

It's worth pointing out that we decreased our 2015 guidance for revenue growth on an operational basis by 100 basis points to the range of 5.5% to 7.5%. The reduction in the growth rate is due to the expected reduction in sales in Venezuela.

We translate Venezuela revenues at the fixed official exchange rate of VEF 6.3 to the dollar, so the $50 million expected reduction in revenue shifts the operational growth rate.

And the adjusted net income operational growth rate is estimated to increase 1% as a contribution from our efficiency program should more than offset the impact of Venezuela. Turning to 2016 and '17. We provided a lot of detail for you so that you can recalibrate your expectations for us through 2017.

As you can see how this longer-term guidance compares with your prior expectations, I submit that you must first revise your prior expectations to reflect the changed FX rates.

To help you do that, the change in FX rates from late January to late April should reduce your 2016 and 2017 revenue expectations by roughly 215 -- excuse me, 215, 2-1-5 basis points, cost of goods sold by 260, 2-6-0 basis points and operating expenses, including both SG&A and R&D by 170 basis points, with the result being a roughly 235 basis point decrease in projected adjusted net income driven by the changes in FX rates.

Using that re-based forecast in comparison with our revised guidance for 2016 and '17 will enable you to isolate and evaluate the impacts of the 2015 efficiency initiative together with our decision to reduce our efforts in Venezuela.

In a nutshell, and looking at 2017, when the full benefits of our efficiency initiative are expected to be realized, the efficiency initiative increases our expectations for 2017 pretax income by roughly $200 million. Meanwhile, the Venezuela action reduces our pretax expectations by $55 million.

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

Our guidance does not reflect any future currency devaluation in Venezuela. We expect a slightly higher effective tax rate for the remainder of the year 2015, higher than the 27% that we had in the first quarter of 2015.

The operating expense benefits that we are seeking will begin to be most evident in Q4, and our guidance assumes a constant diluted share count of approximately 502 million shares outstanding.

This includes share repurchases totaling an estimated $100 million in the first half of 2015, which are partially offset by actual and projected dilution relating to employees' equity-based compensation.

We also assumed a comparable level of diluted weighted average shares outstanding for 2016 and '17 as we intend for our share repurchase program to at least offset projected dilution from future employee compensation programs, including the acceleration impacts of our operational efficiency initiative.

All the other details of our guidance are included in the table attached to our press release. Finally, we covered a lot of ground on this call. To assist with clear communications, as John said, we will be posting copies of Juan Ramón's and my scripts to our Investor Relations website following this call.

That concludes my prepared remarks and we'll now open up the line for your questions.

Operator?.

[Operator Instructions] And we'll take our first question from Louise Chen with Guggenheim..

So my question is on your organic sales growth and also your gross margin once you lap on the headwinds from, I guess, getting rid of some of these lower-margin SKUs..

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

In terms of gross margin, we also plan to significantly increase our gross margin. So eliminating these lower-margin SKUs will represent 200 basis points of gross margin improvement and also the price increases and also the discipline on -- or the reduction of expenses also will generate a significant improvement in gross margin.

So on top of that, as Paul mentioned, our plan and work strategy that we announced at the time of the Investor Day will also generate another 200 basis points of gross margin improvement..

Yes, Louise, and it's Paul, I'll just follow on that. I'll just point you to the slide on the webcast for the 2015 to '17 guidance, and you can see the impact -- or the expected improvement in our gross margin there, where we're looking out to 2017 after the, as I say, after the dust settles.

So we'll get to a margin where we're projecting a range of 32% to 33% and with the opportunity to do better than that as we continue our progress on our supply network strategy..

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

So looking at the operational improvement initiative. Paul, you laid out a lot of good information. I guess kind of a combination question. In 2016, operational growth looks a little bit like the negative 1% to plus 2%. Is that really due to getting out of Venezuela? Because it looks like you guys expect some pretty decent growth from that market.

And I guess strategically, have you embedded much in terms of M&A acquisitions? I guess, where do your interests really lie within diagnostics? It looked like a new product launch in diagnostics may have helped drive some of the companion animal growth we saw in U.S.

Just wondering if that's the feline rapid test and wondering if you have other plans in that category..

one, as you correctly point out, is Venezuela hitting the operational rate; and the second is, the timing of the SKUs that we're pruning from the portfolio when we start to see a decrease in sales.

You note that we, for the balance of '15, expect -- did not show you a line item reducing our revenue expectations associated with the reduction in the SKUs in the portfolio. That really starts to come into play in 2016 and we should enter '17 clean..

So let me answer the question on M&A. So definitely, M&A is part of our strategy, and we are considering any M&A opportunity that will increase the value of this company and will support our objective in terms of generating higher margins in our operations. So where is our interest? Any opportunity which is in the animal health domain.

We think that we have all the capabilities, and also now we have, or will have, even much better ratios in terms of cost and in terms of expenses to revenue, so we can really maximize opportunities of any potential acquisition..

And we can take that question from Chris Schott with JPMorgan..

Just wonder if you'd -- try and elaborate a little bit more on the operational efficiency initiative here. I guess in the past, you've talked a lot about your direct selling model being a competitive advantage versus some of your peers.

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

Second question is just with the new kind of plan as you're aligning your approach here.

Are there any management incentives that you're putting in place or any changes to management incentive that are going to come about as a result of this operational efficiency plan as we think about the 2015 targets, et cetera?.

Thank you, Chris. And what we are trying with this initiative is to be much more focused. And we mentioned many times that our diversity, or the breadth of our business, it was a competitive advantage.

But we have also identified some areas or some elements of this diversity, which is adding a complexity, which is a barrier to deliver value to our customers and also to create that value to Zoetis. What we are trying is we've now been much more focused on the countries and also the products that will generate the highest value to Zoetis.

It's to really move away from our model, which is a model that will be 100% applicable to those markets, and we are now in these small markets in -- where we don't see that the model is efficient in terms of our profitability, and then moving to a model that will be indirect and will be relying more on distributors to support our revenues.

So the strategy is not changing. What we are, it's really focused on the market that would generate the highest opportunities for Zoetis and also the product that will integrate the highest revenues to our company and the most profitable growth.

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

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

Does the new guidance on the top line include contributions in Sarolaner, and could that still provide upside? And do you have cash flow forecast for us? And I think you gave some color here, but does your guidance include share repurchases and plans for deleveraging?.

So let me answer the first question, and then Paul will answer the second one. Thank you, Erin, for both your questions. So the new products, Sarolaner, IL-31, are not part of our guidance today. So we are in process of discussing with the FDA and USDA and other regulators.

So once we have more understanding of the timing of these product launches, we'll incorporate in our guidance..

And it's Paul, I'll speak to the cash flow guidance. We're not providing -- we provided an awful lot of detail on the operating side here through 2017. We're not, at this time, providing a forecast of cash flow and our balance sheet, but suffice it to say that we talked in the past about our desire to improve our asset efficiency.

For example, through the implementation of our global ERP system, SAP, we expect that over time, we'll be able to reduce our investment in our inventory and unlock some cash there. Frankly, by paring down our business and pruning our portfolio, with the SKUs, that will unlock some cash -- cash as well.

We do have an awful lot of calls on our cash here coming up in the very near term. I mean, if you think about it in the first quarter, we completed the acquisition of the Abbott Animal Health assets.

We do continue to use cash to fund the onetime costs associated with our separation from Pfizer, and we've provided an estimate of the remaining amount of that to be somewhere in the range of $180 million to $210 million.

We provided you with an estimate of the cost of the efficiency initiative that we announced today and the early stages of our supply network strategy, and those costs are estimated in the range of $300 million or $400 million to $500 million over the next several years.

And we have, I'll call it out for you, the $400 million debt maturity coming up next spring. And then we have our regular dividend coming up. So we do have some sizable calls on our cash. We have actually provided you also with some guidance, a little bit of guidance at this stage around our share repurchases.

We indicated that we expect to purchase, in aggregate, $100 million worth of shares over the first half of 2015 and that we can -- expect to continue acquiring shares in the amount that will at least offset the ongoing dilution from our equity-based compensation plans.

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

Did I cover it all? Sorry, the deleveraging question as well. Yes, we have stated in the past that we have kind of a notional -- when we talk about our capital structure, a notional floor of gross debt to trailing 12-months EBITDA of 2.5x.

So I want to reiterate there's a permanent role for debt in our capital structure, and when you think about that cap structure, we remain committed to be responsible stewards of our shareholders' capital.

And our hierarchy for that capital allocation will be first and foremost inside our business; second for business development activity that is value-generative; and lastly, transactions and shareholders including both the regular dividend and the ongoing share repurchases.

So again, think of that 2.5x as a floor and think of our hierarchy of capital allocation as I outlined it for you. I hope I answered the question..

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

We appreciate all the details on the efficiency program. EuAfME sales were below expectations. Could you comment on the impact of the new anti-infective legislation in France and whether you think that's going to spread to other developed markets.

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

Thank you, Alex. So the situation in Europe/Africa/Middle East, revenues were affected by the France performance. So they announced the new legislation related to anti-infective legislation. It's eliminating rebates offered by animal health manufacturers to both wholesalers and veterinarians.

And as a result of this elimination of rebates, there was an adjustment in the market in terms of inventory levels. We expect that this will be, in the next quarter, compensated and back to normal situation. And now Paul will answer the comment also in terms of the impact of FX..

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

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

And then the comment on the APOQUEL. So in the first quarter of this year, the revenues of APOQUEL have been still facing limited supply. But from April, we have been able to meet the demands of our customers in U.S., also U.K.

and Germany, and we expect that the product will meet our expectations in 2015 of delivering $150 million to $175 million in 2015. And we also are planning now in launching APOQUEL in additional markets that will be also making contribution to meet these expectations for the product..

And we'll take our next question from Mark Schoenebaum with Evercore ISI. [Technical Difficulty].

We have some problem there with the line?.

So the question is about incremental form of [indiscernible]. So the question about M&A and the Tax Matters Agreement with Pfizer that I believe expires next month.

So your new cost reduction plan and Tax Matters Agreement expiration, whether this will change your overall strategy for future acquisitions, M&A, and whether you're still open for targets of various size or -- and think about the ZTS as -- more as a net acquirer, not acquisition target.

As well as if you're still open for potentially inversion transaction as an avenue to reduce effective tax rate..

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

In terms of the new program, its changing our strategy, we think that our strategy has been always to consider M&A opportunities that will create value to Zoetis and will create more value to our shareholders. Definitely, the new program will generate more cash, and more cash also will help us to consider any kind of opportunity.

In terms of inversion, I think again, so we are open to any opportunity that will increase the value to our shareholders and is something that we'll be always open. But we know there are not too many options that we can consider in terms of inversion or acquisition of our company that will facilitate this kind of tax strategy..

I'll just follow on, in that I think that with our leaned-out structure, we will be better positioned to realize value from acquisitions that we might consider. I mean as -- looking backwards, using as a great example, the Abbott Animal Health assets.

When you have a better cost structure and you can absorb those and realize the synergies, you can gain better value over assets that you're able to acquire. As Juan Ramón said, I want to buttress that as well. We're always thinking about ways that we can build value here, and one of those ways is through smart business development activity..

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

Just to follow up on an earlier question, about trying to trim assets [ph]. Clearly what you're doing makes a kind of sense, simplifying a very complex cost structure, it's -- reasons why companies spin off assets and those assets tend to perform much better as separate companies.

But I'm actually kind of surprised, Juan, when you said your expectation is that revenue growth -- you sort of reiterated the type of organic growth that you have been anticipating, which is the market growth of 5% to 7%.

I would think, with shrinking the revenue base and getting out of slower growth or less profitable businesses, that would give you an opportunity to accelerate top line growth, and wondering if you can just talk about that..

Thank you, Jami, and I think you are right in your comment.

We are doing that because we think that being much more focused will be an opportunity to accelerate growth in products, markets that will be important to our future profitable growth, and this is something that definitely we will be working to ensure that the programs that will stay in our portfolio will generate maximum opportunities.

The other important thing is that we also want to make sure that we increase our supply to our customers on those problems that really matter to them. And we want to have a reliable supply and to eliminate the risk for product supply issues that's always very, very different [ph] to our customers.

So with being much more focused we are convinced that we can generate a higher profitable growth..

Our next question comes from John Kreger with William Blair..

You talked about a changing approach to R&D. Can you just elaborate a little bit on that? And one specific one.

Do you still expect Sarolaner to reach the market by spring of '16? But then more broadly, what are the source of products that you're refocusing the R&D efforts on? Is there any criteria around, let's say, region or animal species?.

Thank you for the question, John. And in terms of R&D, so we are eliminating 5,000 SKUs. So if we are eliminating about 40% of our total SKUs, you can also assume that we'll be eliminating some of the programs that are a very important part of our investment.

And just to remind you, almost 50% or even more of our R&D investment is related to life cycle management. So if we are eliminating 40% of our SKUs, we should be also eliminating programs in life cycle management that are supporting this part of the portfolio.

We also think that it's a good opportunity also for us to identify the future problems that will generate the highest potential in the animal health industry.

We have been extremely successful in identifying these opportunities, and APOQUEL is a good example, but also our progress on bringing back vaccines to the market like PEDv vaccine and many other vaccines that we have been introducing is a good example of being focused, identifying these opportunities. It's a great opportunity for us like this.

We'll remain doing that and we are not changing our approach in R&D, but we are trying to identify those projects that would generate the highest return to our company. In terms of Sarolaner, we are working with the FDA. We are presenting all the information that FDA is requesting, and we expect that the program will be launched in 2016..

Before we ask the next question, it's Paul, and I just want to jump in. R&D is, as I said in my prepared remarks and Juan Ramón referenced as well, that's 1 of our 3 key interconnected capabilities and one where we're not changing substantially here.

What we're looking for is ways that we can improve the process by which we select projects to go into the queue and then come out on the other end.

And John, the way you phrased your question was almost exactly the way I've talked about this inside, is the alignment of our portfolio around our key brands and around our key regional strategies for growth, and ensuring that this course alignment of our R&D strategy around those key brands and regional strategies.

And as I say all the time, any process -- and we've been very productive in R&D. Any process that we have can be improved and that's what we're doing here, call it, continuous improvement..

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

Just to follow up a little more on the 5,000 SKUs that will be eliminated.

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

Thank you, Kathy, and definitely, these 5,000 SKUs are not 5,000 products. The number of products is much lower. I don't think we have provided the number of programs that will be affected.

It's something that definitely, we plan to provide this information to our customers in the next coming weeks, and we also plan to send a communication to our customers on those programs that will be affecting every market.

In terms of the change of the mix, well, the mix will improve in terms of profitability, so these products, as we mentioned, are low margin. So by eliminating these low-margin products, we'll improve our margin and mix and this will have a positive impact in our operations. IL-31 is still on track for conditional approval in 2015.

We are working with the USDA and we expect this conditional license approval anytime at the end of the year..

And our next question comes from Liav Abraham with Citi..

Just a quick question on the sales force. If I understood correctly, the reduction in the sales force that you proposed is only from the sales force that's associated with products or regions that you're exiting, and you don't anticipate any curtails in sales force in the regions that will remain ongoing.

Is that correct? I just want to make sure that I understood that correctly..

Thank you for the question, Liav..

I'll take it..

we are also considering being much more efficient in terms of span of control. And this will imply some elimination of layers, also in the field force, but not in the people that have customer-facing interactions..

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

I just wanted to ask about the 2 segments of the company, companion and livestock.

Could you just characterize the different margins for the 2 business segments? I don't know how much detail you can provide, but I was hoping that you could help to provide a baseline for us in terms of where the operating margins stand for each of the segments? And then looking ahead, which of the 2 is the 1 that will experience greater margin expansion over the next 3 years..

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

And then livestock, we have a different margin depending on cattle, swine or poultry. Being in poultry, the lowest in terms of our gross profit and, cattle, the highest in terms of our gross profit in livestock. But then you also need to add what is the cost to win these products to the customers.

And then in that case, I think the total margins are much more equalized. So companion animal require a significant much more field force and promotional activities because the number of our customers in companion animal it's much higher than in livestock.

And then poultry is the most consolidated industry, so it require fewer individuals to reach the customers, while cattle still require a significant number of people to reach these customers. So even gross profit are different across different species. In terms of the total margin, the margins are much more similar.

And we think that there are opportunities in both. We have been growing livestock faster than companion animal in the recent years. Now with APOQUEL, with Sarolaner, with Abbott, with IL-31, we expect that companion animal will generate a significant growth in our operations..

[Operator Instructions] And we can take our next question from Kevin Ellich with Piper Jaffray..

Just a quick follow-up here. I guess going back to the SKUs that are going to be eliminated. Paul, did I miss -- did you provide how much revenue those products are going to generate or what the impact would be from the SKU elimination in 2016? And then also in the press release, you talked about the feed additive for the poultry, Zoamix.

Just wondering how big that could get. And I guess what's your thought, Juan Ramón, on the scrutiny and some of the restaurant companies eliminating using antibiotics in the chickens, especially -- oh, and also, thoughts on the avian flu..

I'll start. Yes, the first question with respect to the period SKUs. We did not provide a specific amount or impact on our 2016 just to say that, by definition, we included the impact as we provided the detailed guidance for 2016.

And then call your attention to 2017 where we call it out and it's really $280 million of top line that we expect, relative to our prior expectations, for 2017. And the way I would think of it is 100 is a curious thing with this $10 million of OpEx that maps the cost of goods sold.

So the table, you'll see the $290 million versus $300 million, but with $300 million OpEx, you think like $280 million and $100 million, that's the impact on '17 when it's fully reflected in our re-based revenues and that's how I think about it..

And on the majority of this key SKU elimination will take place in 2016. So we should expect that there will be an impact in terms of revenues in 2016 that would be very close to this $280 million that Paul just mentioned. So we have not mentioned the exact revenues of Zoamix in the U.S.

But what we mentioned is that this has been compensating the rotation of products that are in the industry. It's using it as a way to protect the animal health in the poultry industry. In terms of -- you also asked about the comments on poultry and antibiotics of a recent company that has been issuing a press release in the U.S.

Definitely, we are fully aligned with the FDA objective to reduce the impact of -- or the resistance of antibiotics in animal health. These 2 companies have announced that they will eliminate the use of human health products in poultry. In some cases, like Tyson, we have been already working with Tyson some years ago to eliminate these products.

And because we have, in our portfolio, alternative to the products which are important for human health, we think that we'll be able to supply to companies in the poultry in the U.S. that will be eliminating gradually the use of human health products, which are important or antibiotic which are important for human health.

With all the alternatives that we have in our portfolio, that we also keep the poultry industry productive and also protecting animals against infections..

Our next question comes from Chris Schott with JPMorgan..

Just was trying to just dig a little bit more into the motivating factor that's leading you to this broad restructuring.

I guess my question, are you seeing the market changing? Or is this really that you've gotten out of Pfizer, you've had the chance to review the broader strategy, that you're just having time now to dig into these business units and really try to focus the organization overall? I'm just trying to understand, higher level, what led you down this path to begin with?.

Okay, this program has been part of our plans since the beginning. So it means we have separated from Pfizer. We had, in our thinking, that we should generate greater efficiencies and also define cost-saving opportunities. We also knew that in the first 2 years as a public company, we needed to focus on standing up our infrastructure.

Also making sure that we are meeting our objectives in terms of revenue growth, also our objectives in terms of profit growth. We also needed to have full control of our operations.

And when I mean full control of our operations, have a full understanding of our corporate functions, also full understanding of manufacturing and, also very important, control of our IT systems. We also decided early in the process of separating from Pfizer to invest in the new ERP.

And now that the ERP has been already implemented in certain markets in Europe and went live in the U.S. at the end of April, we see that we are in the process to finalize all these implementations in the first quarter of 2016.

With all these elements, I think we are in the position to identify these opportunities to be more efficient, and not only opportunities to be more efficient, but the opportunity to be much more focused. And I want to seize the complexity that we have in some of our operations. It's a barrier to deliver value to our customers.

And this is one of the objectives that we have as part of this program, to ensure that we deliver higher value to our customers by being much more focused on certain problems in certain markets..

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

Well, thank you very much for joining us for today's call. We had the opportunity to share with you a lot of information, and we'll be pleased to have a follow-up conversation with you if you need some additional understanding of all the plans that we are announcing and also all the products that we are making as an independent company.

Thank you very much..

This does conclude today's teleconference. A replay of today's call will be available in 2 hours by dialing (800) 723-0389 for U.S. listeners and (402) 220-2647 for international. Please disconnect your lines at this time, and have a wonderful day..