Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc..

Louise Chen - Guggenheim Securities LLC Derik de Bruin - Bank of America Merrill Lynch Gregg Gilbert - Deutsche Bank Securities, Inc. Erin Wright - Credit Suisse Securities (USA) LLC Jonathan Block - Stifel, Nicolaus & Co., Inc. Brett W. S. Wong - Piper Jaffray & Co. John C. Kreger - William Blair & Co. LLC Jami Rubin - Goldman Sachs & Co.

Alex Arfaei - BMO Capital Markets (United States) David R. Risinger - Morgan Stanley & Co. LLC Mark J. Schoenebaum - Evercore ISI Christopher Schott - JPMorgan Securities LLC Kathy M. Miner - Cowen & Co. LLC.

Welcome to the fourth quarter and full year 2016 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com.

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

At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin..

Thank you, operator. Good morning and welcome to the Zoetis fourth quarter and full year 2016 earnings call. I am joined today by Juan 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 statements 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, February 16, 2017. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón..

Thank you, Steve. Good morning, everyone. I'm very pleased to say that in 2016, we delivered our fourth consecutive year of operational revenue growth and improved profitability since becoming a public company. We completed a significant initiative to shape our business for greater efficiency and cash generation.

And we continue to make investments that will sustain our future growth, innovation and market leadership. Our growth in 2016 was driven by the successful launch of several new products.

The strength of our diverse portfolio and a deeper commitment to the direct customer relationships, productive R&D and high quality manufacturing that are the foundation of our business model. Let me highlight some of the headlines for 2016.

We delivered on our financial goal for the year despite some challenging market conditions for livestock producers, especially in the U.S. We generated 5% operational growth in revenue for the full year, and 8% growth based on a normalized organic operational view that Glenn will discuss in his remarks.

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

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

We were able to deliver these strong results on innovation while implementing important changes to our business last year. For example, we completed the implementation of our ERP system, which has really given us more efficient tools and better visibility across our operations.

We eliminated approximately 5,000 low revenue, low margin SKUs from our product portfolio. And we have sold or exited six manufacturing sites.

During 2016, we strengthened our industry leadership with more than 200 product approvals including Cytopoint in the U.S., the first monoclonal antibody approved to help dogs suffering from atopic dermatitis; Simparica, our new oral parasiticide and several new wonder vaccines.

We continue to look at this productive R&D engine as critical to our future and we spend more on R&D than any of our peers. We also continue to see the value of investing in external business development opportunities. Last year, we acquired Scandinavian Micro Biodevices in the diagnostic space for approximately $80 million.

And our prior acquisition of PHARMAQ contributed $90 million in revenue in 2016, while achieving rapid adoption of its ALPHA JECT LiVac SRS vaccine for salmon. Fish farmers in Chile have responded very favorably to the interaction of this vaccine.

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

All of the work that we have done in 2016 and in previous years such as building our infrastructure, investing in new systems and becoming more efficient has positioned us for success in 2017 and beyond.

In 2017, we will target operational revenue growth of 5.5% to 7.5% and continue improving our adjusted EBIT margin as we realize the full benefit of our operational efficiency initiative this year.

All the major actions of the operational efficiency program that we announced in 2015, has been implemented and we expect to exceed the initial target of $300 million in savings in 2017. These additional savings will be used to support our short- and long-term growth in several ways.

In 2017, we plan to initiate direct-to-consumer marketing and advertising campaigns in the U.S. for two of our companion animal products. In the case of Apoquel, we want to increase awareness of atopic dermatitis among pet owners, especially those whose dogs maybe suffering from acute conditions.

And in the case of Simparica, we want to illustrate the advantages of our products and increase our share of voice in the highly competitive parasiticide market. These campaigns will include national television ads and digital promotions online. They are targeted to begin in the first half of this year.

We'll also support new product launches like Cytopoint, which was approved in the U.S. last year and Stronghold Plus, which is expected to be launched this year in the European Union.

Stronghold Plus is a topical parasiticide for cats that combines sarolaner, the active ingredient of Simparica with selamectin, the active ingredient in our current Stronghold and Revolution product lines. This is our first combination product for sarolaner.

This is a great example of how we use an R&D focus on lifecycle innovation to expand our platform and maintain a durable and valuable product line for decades. We also will remain focused on improving the way we interact with and support our customers.

Our people and technology are important parts of any customer experience and they remain critical areas of investment. For example, we'll be deploying new tools and capabilities on our ERP system and we have been expanding our field force in markets like Brazil and China where we see significant and sustainable growth opportunities.

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

Our business development team will continue exploring acquisitions, partnerships and alliances that enable us to fill gaps in our portfolio, and expand that further in complementary spaces and geographies.

And we will continue executing our long-term supply network strategy to improve the quality and reliability of key growth platforms in manufacturing. We have become the profitable business and market leader we always envisioned when we launched in 2013, and the outlook for Zoetis in 2017 is very positive.

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

In the case of fish, we expect that PHARMAQ to capitalize on the success of the new ALPHA JECT LiVac SRS vaccine in Chile.

And we recently received a favorable legal ruling in Norway, the world's largest farm salmon market, which will allow us to launch our vaccine for salmon pancreatic disease this year, a great result and opportunity that demonstrates the value we saw for this acquisition.

In closing, we are proud of our ability to deliver better than expected results in 2016, despite the market challenges we faced and the business changes we implemented. I want to thank all our Zoetis colleagues for their commitment and personal contribution to these results. As we look ahead in 2017, we see a brighter future.

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

Glenn?.

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

Operational revenue growth for the year was 5%, but a better indicator of our underlying performance is what we refer to as our normalized organic operational growth, that was 8% for the year. It excludes the negative impact of our operational efficiency initiative and the positive impact of M&A.

You can find the details of these items in the tables on our website. Of this 8% growth, 5 percentage points came from new products, including Apoquel, 3 percentage points came from the in-line portfolio, with 2 points of that from price and 1 point from volume.

This will be the last quarter that we will report our normalized revenue growth metric, as our operational efficiency initiative will have only a small impact on our revenue in 2017.

There will be some continued drag in our revenue growth from product rationalization, especially in the first two quarters of the year, and we will help you understand the magnitude of those items as we go through 2017.

As we said in the past, we take a long-term view of our business, and prefer to assess our financial performance on an annual basis, rather than taking a quarterly focus. During the year, we saw many of the familiar seasonal fluctuations that occur in our industry.

But as we progressed through the year, our expectations for outperformance steadily increased. Our team delivered on those higher expectations, with 17% operational growth in adjusted net income compared to the 6% to 12% we expected at the beginning of the year.

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

Turning to the quarter, we delivered double-digit operational growth in adjusted net income, overcoming the negative impact to revenue of fewer calendar days and business changes related to our operational efficiency initiative. Both reported and operational revenue growth were flat for the quarter.

We saw no impact from foreign exchange to revenue, unlike many of our prior quarters. Our operational efficiency initiative reduced revenue by 3%, and fewer calendar days in the quarter had approximately a 4% impact. M&A activity, primarily PHARMAQ, contributed 2% to our revenue growth.

PHARMAQ was below our revenue projections for the year, but we feel very good about the value we're getting from this acquisition. Our positive views are supported by the strong performance of our SRS vaccine in Chile and a recent legal win in Norway that opens the door to an important category in the aquaculture market.

These two PHARMAQ drivers represent a meaningful portion of the value we saw in this company. While market conditions in Chile were challenging in 2016, the long-term structural drivers of growth that attracted us to the aquaculture market remain intact.

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

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

and other markets. In the U.S., we continued to absorb the decline in surgical fluid products. This was partially offset, however, by additional sales in the quarter as we expanded distributor relationships on other products. The U.S. companion animal grew 7% on a normalized basis. U.S.

livestock grew 3% on a normalized basis, with growth in cattle and poultry offset by declines in swine. Market conditions in cattle continue to be difficult, and results were somewhat lighter than expected in the fourth quarter. However, our U.S.

cattle business delivered low-to-mid single-digit growth on the same normalized basis for the quarter and year, despite very challenging market conditions for our beef and dairy customers. Again, this demonstrates the resiliency of the animal health industry and Zoetis even in challenging market conditions.

International companion animal normalized growth of 16% was supported by new product contributions as well as higher levels of medicalization in emerging markets, a fundamental long-term structural driver of our business.

2% normalized growth for international livestock was supported by growth in China, Mexico and Brazil; offset by lower usage of antibiotics in Western Europe. You can see the full results of our top 11 markets in the table, but let me highlight a few items. Growth in key emerging markets, like Brazil and China, continues to be strong.

Operational revenue growth in Brazil of 8% was driven by price, new companion animal products, and favorable cattle conditions. High demand for beef exports from Brazil more than offset the difficult market conditions in poultry and swine where producers saw higher input prices.

Operational growth in China of 17% was driven by continued strength in the swine market and growth in companion animal vaccine due to increases in routine care. For the year, China grew 24% operationally, our fourth consecutive year of double-digit growth since becoming public.

Our recent field force expansions in Brazil and China have been productive, and we'll continue to deploy selling resources in these and other markets where we see significant and sustainable growth drivers combined with high returns on our investments. Emerging market growth was not limited to Brazil and China.

Our other emerging markets category grew 6% operationally. Now turning to the rest of the P&L, I'll quickly cover a few items of note in the quarter and then move to a review of guidance.

Adjusted gross margin increased 110 basis points in the quarter on a reported basis, primarily due to favorable foreign exchange, which was partially offset by higher inventory charges. Adjusted other income included a $15 million charge for the devaluation of the Egyptian pound that occurred in November, after our most recent guidance update.

The adjusted effective tax rate for the quarter was 25%. This rate included the effects of discrete items and the jurisdictional mix of earnings. This brought our full year adjusted tax rate to 30%, which was two points below our guidance for the year. Adjusted net income grew 13% operationally, despite the fewer selling days in the quarter.

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

Versus our full year guidance, our one-time costs were above the range as we settled the product dispute with poultry customers in Mexico and had higher than expected severance cost associated with our efficiency initiative.

In the quarter, we also incurred a net tax charge as a result of the implementation of certain operational changes, including the revaluation of tax assets associated with the change in our operating model. All-in-all, Q4 was a good quarter wrapping up a great year.

We delivered a normalized organic operational growth of 8%, adjusted gross margin improvement of almost 200 basis points, 23% operational growth in adjusted EBIT and 17% operational growth in adjusted net income. Now, let's talk about guidance for full year 2017.

We are updating our previous guidance for changes in foreign exchange rates, since our last update in November. Our guidance now reflects rates as of late January, which reduced revenue guidance by approximately $50 million and adjusted EPS by $0.03. On an operational basis, our guidance is unchanged.

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

We continue to see companion animal driving much of our growth in 2017. We will have additional penetration of Apoquel including its expansion into more acute and seasonal cases. We will continue the launch of Cytopoint in the U.S.

as we build our dermatology portfolio, and we will see additional market penetration of Simparica, as well as the launch of Stronghold Plus in Europe. All of the necessary actions to deliver our 2017 efficiency goals were largely completed by the end of 2016.

We expect to deliver more than the $300 million in savings we initially targeted, some of which we will be investing back in the business. Despite the lower tax rate in the fourth quarter, our guidance for adjusted ETR is unchanged. We do not expect the favorable discrete items from Q4 to recur. Our guidance for adjusted ETR is based on current U.S.

tax law, and does not take into account any potential changes being discussed in Washington. With more than half of our adjusted pre-tax income in the U.S., a lowering of the U.S. corporate tax rate would have a meaningful benefit to us.

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

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

This will disproportionally affect the first quarter. We are expecting first quarter gross margin to be generally in line with the fourth quarter of 2016 due to the timing of recognition of cost of goods sold.

We are also re-investing a portion of our additional cost savings, in investments in product launches and key brands like Apoquel, Cytopoint and Simparica early in the year. We expect to begin seeing the revenue effect of these investments in the second half of the year.

The result is that we currently see limited adjusted income growth in the first half with significantly stronger growth later in the year. A final point on capital allocation. We have completed our initial share repurchase program and in December, we announced the $1.5 billion authorization.

We view this repurchase plan as multi-year and flexible in nature depending on other capital allocation priorities. We have increased the pace of our repurchase from last year to $125 million per quarter. This pace is related to the improved cash flow we expect in 2017 now that we are beyond the cost of our operational efficiency initiative.

Our guidance for adjusted diluted EPS assumes only that we offset dilution from equity awards. As a general rule, we view 2017 adjusted net income as a good proxy for the operating cash flow we expect to generate. We do expect to maintain CapEx in line with the last two years as we invest in manufacturing to deliver our in-line and new product growth.

So let me wrap up before we go to Q&A. We achieved our 2016 revenue and adjusted EPS guidance. And we affirmed our outlook for 2017 with updates for foreign exchange. We continue to see a path to continued margin expansion, increased cash flow and greater efficiency as we achieve the full benefit of our operational efficiency program.

And we're prioritizing and funding investments in long-term growth in all of our core capabilities. With that, I'll hand things over to the operator to open the lines for your questions.

Operator?.

And the floor is now open for questions. We'll take our first question from Louise Chen with Guggenheim. Please go ahead. Your line is open..

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

Thank you, Louise. And we'll maintain the same capital allocation philosophy that we already shared with you. So, we'll continue investing in the business. We see opportunities this year of reinforcing our presence in the market with DTC campaigns, also expanding field forces in the markets.

We'll continue investing in R&D because we consider that the productivity of R&D is very high and we have been delivering very strong products and we'll continue supporting our growth with this investment. We'll also invest in manufacturing, to ensure that we have the capacity, and the capabilities that we will need to support our future growth.

And we'll also continue assessing external opportunities, business and developmental opportunities that will reinforce our internal growth. And any excess capital we will return to the shareholders through dividends or the program that we already announced for buying shares back..

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

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

Hi, good morning. So can you talk a little bit about the new product launches? I mean, we had some positive feedback on Cytopoint talking to vets at the NAVC Conference.

And just wanted to get your initial thoughts on that product and how we should look at expectations on that? And I guess the other question is, it did look like you tweaked down your core growth guide by about 50 bps. I'm just sort of wondering what was behind that given that 4Q ended up exactly where we generally thought about it? Thanks..

Thank you, Derik. I will answer the first question and then I will ask Glenn to provide an answer to your second question. Cytopoint, definitely the feedback from the market is extremely positive. But also we want to consider not Cytopoint or Apoquel as separate.

We want to consider now our dermatology portfolio, which is now even stronger than last year with Cytopoint, and we expect that the combination of these two products will cover all the needs of veterinarians when treating acute, chronic, or seasonalized atopic dermatitis or any type of skin condition. So we are very excited about our portfolio.

We are considering that Apoquel will continue growing and we're supporting Apoquel this year with additional resources in terms of DTC and some additional activities in the market.

And this also will have an impact in the Cytopoint because, as I said, we'll consider the combined portfolio in dermatology as the way to deliver the value to our customers and to cover the needs in terms of treating itching conditions or atopic dermatitis..

And in terms of the growth rates for 2017 on an operational basis, when we set the guidance back in November, since 2016 actuals were not final, we based the 2017 growth off the midpoint of those ranges. Now that we have final 2016 actuals and we came in towards the high-end of those ranges, the growth rates naturally declined.

I do want to make it clear, the operational numbers themselves have not changed and in the core expectations for the business have not changed, except for the update to foreign exchange that we've reflected..

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

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

Okay, thank you. Well, we have the first news on the products in terms of combining the flea, ticks, and heartworm because now we have topical product, which is a combination of the active ingredient of Simparica, sarolaner with the active ingredient of Revolution/Stronghold that it's selamectin.

And this product has been already approved in Europe and we plan to launch this product every soon in the European market. Definitely, this is only the first step.

We'll continue working internally to combine the same principle of different agents to have broader spectrum of coverage in parasiticides, including internal parasiticides, in this case for dogs.

We have not yet provided the timing of the launch, but definitely our R&D team is working in this combo, but also working in future formulations that can also include injectable formulations and longer duration of protection. When we have more clarity on the timing, we'll provide an update on this information.

And then in terms of the clinic consolidation, so now Banfield that has around 900 clinics in the U.S. will be a consolidated with VCA that has another 800 clinics. So this will represent 1,700 to 1,800 clinics of a total of 30,000 clinics in the U.S. market for companion animals.

We have good collaboration with both companies with Banfield and VCA, and we expect also to continue this collaboration.

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

And our next question is from Erin Wright with Credit Suisse. Please go ahead..

Great. Thanks for taking my questions.

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

Thank you, Erin. So let me start with your question about the distribution strategy. And these are related, as you mentioned, to companion animal. In previous year, we had the exclusivity provisions for few products and with certain distributors.

So in 2016, we extended the collaboration with distributors, adding vaccines, but on a non-exclusive basis, in this case for the vaccines. So this year also, we included as part of the agreement with distributors, our parasiticide products. So Revolution, ProHeart 6, and Simparica. This will be part now of the agreement with distributors.

With these extended partnership with distributors, we are confident that we'll be able to increase our share of voice and also penetration in veterinarian clinics.

Also the changes with distributors, with these changes, we have considered that it's much more attractive model to have that contract with the distributors based on total volume, rather than exclusivity, for a small number of products.

Having said that, also, we remain committed to our commercial model based on direct interactions with customers through highly qualified field force to generate demand for our products. And the result of all these changes is that we expect a positive impact in our business.

And the outlook for generics is also something that maybe some questions in the market will remain unchanged from what we said in the past. So, in summary, we are confident that this new model will be very attractive.

We'll also have better support from distributors, while we'll maintain our presence (38:05) in the market with our direct interaction with the customers. Glenn will talk about what has been the impact in terms of stock and revenues related to the change on the distribution..

Hi, Erin. In terms of the stocking impact for Q4, when you look at that and if you compare that to our total sales for the quarter, it's less than 1%, right. So if you're looking at the companion animal growth, there was a benefit of slightly less than 1% related to that.

The offset to that in evaluating the companion animal growth, particularly in the U.S., is the impact of the surgical fluid business and the decline we saw there, that was slightly greater than the impact of the stocking.

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

I think we'd expect that difference to come closer in 2017, but again, we'd expect companion animal to grow stronger..

Thank you. Our next question is from Jon Block with Stifel. Please go ahead..

Great. Thanks and good morning. Juan Ramón, maybe just qualitatively, if you could talk about how do you feel about U.S. livestock? Back in the summer when conditions did not seem overwhelmingly favorable, you put up a good 3Q number, aided by promotions. This quarter U.S.

livestock, I think you said up low-single digits operationally, although an easier comp, yet conditions seem to be getting better, especially as we enter 2017. So maybe just any color on increasing momentum that you see in U.S. livestock, specifically cattle? And then quantitatively, Glenn, can you just provide Apoquel-specific numbers to the U.S.

and international, and will we be getting that number going forward, or will it sort of be combined under the atopic dermatitis portfolio with Cytopoint? Thanks, guys..

Thank you, Jon. And let me go through the different species in livestock in the U.S., starting with cattle. So we expect, in the cattle business, for the market growth that will be 2% to 3%, and we expect to grow faster than the market in 2017. We expect also a slowdown in terms of herd expansion.

Still, in 2017, we expect the herd will be continue growing. But something that is new is, we expect that in 2018 and 2019 also, this herd expansion will be now stable. Beef prices continue being a challenge in the U.S. market, but still we expect a recovery in the second half of the year.

And the dairy segment, in terms of profitability, is normalizing, which is also positive. So we will see also that the volume in terms of prevention and productivity will continue growing, and maybe will be a slowdown in terms of the use of anti-infective.

As I said, 2% to 3% the market, and we are predicting that we'll be growing faster than the market. In poultry, we expect flat to 1% market growth, and we expect a growth in this segment for Zoetis.

So we'll see continued pressure on antibiotics, but we also have a portfolio that can be alternative to the antibiotics, which are considered as medically important for human, and we can offer alternatives that will generate growth in our portfolio.

And finally, pork, about 1% to 2% growth in the market, and again, we expect also to grow faster than the market, mainly driven by now the entrance of the new PCV2 vaccines in our portfolio that we expect to roll during the year. And we'll continue working on new combinations of vaccines or vaccines that will be adding antigen.

That also will reinforce our position in pork..

And our next question....

And in....

Go ahead..

We have another question that Glenn will talk about..

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

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

and $78 million international. In terms of how we're going to disclose that moving forward, between Apoquel, Cytopoint, or the derm portfolio, we're still early on in that. We want to see how the mix evolves, and then we'll determine what's the best way to disclose the sales are moving forward..

And we'll go next to Brett Wong with Piper Jaffray. Please go ahead..

Great. Thanks, guys. Thanks for taking my question. Wondering if you can please talk to the expected growth in Brazil in 2017. You mentioned that it's going to continue to be strong.

But should we expect the ongoing high-single digit operational growth there? And what will drive double-digit growth in that region? If you can talk to both livestock and companion that would be very helpful..

So thank you. So we stopped providing exactly rate of growth in Brazil. Definitely, we see Brazil market that will continue growing, growing in many different species, including companion animal. And that's why we decided also to expand our field force for companion animal in 2017, and we are also expanding our field force for cattle in 2017.

So we are investing in the market because we see the opportunities that this market will continue growing. And we see that this market will also grow in terms of export. So the projections for Brazil continue being very positive.

Still one of the things that is difficult to predict in exactly how much will be the impact of the different discussions in terms of trade. But we are confident that maybe Brazil can have a benefit on all these trade discussions, including the export, that has been very strong in the past.

In companion animal, definitely we see the opportunity of increasing that medicalization in dogs. They will be also having the benefit of having the entire portfolio of Zoetis now approved in Brazil. We have Apoquel, we have also Simparica is something that definitely will help us to generate even faster growth in companion animal in this market.

Next question..

And we'll go next to John Kreger with William Blair. Please go ahead. Your line is open..

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

Well, the lessons that we learned – and thank you for the questions, John – the lessons that we learned that we understood from the beginning that there were opportunities for being much more efficient. But at the same time, we went through a process of building the infrastructure, implementing ERP.

And we considered that it was too much trying to implement everything at the same time. But when we have full control on our operations, we really focus on improving our efficiency. And the result of this operational efficiency program is that, first, now we learned that managing so many SKUs is not adding any value to our customers.

In the past, we tried to meet all customer needs in terms of not only products, but we remain with significant large number of products, but meeting expectations in terms of dosages, formulations that in many cases were adding only complexity and limiting our ability to be reliable in terms of supply. So this is one of the first lessons.

So it's reducing complexity in terms of SKUs, in terms of market. It's providing to us the opportunity to be much more focused and provide more value to all our customers. The second lesson is that the reaction of Zoetis team in terms of embracing all these opportunities.

And really targeting all these savings, we serve the objective of not only being more efficient but also supporting our future growth in a way that that will be stronger. And I think is the last lesson that we learnt through the process is that definitely there were significant opportunities of eliminating non-added value activities.

And these were related to marketing, it was related to some of the activities that we were doing in terms of meetings and travels that were not adding value to our growth and not adding value to our operations. And we are very pleased what we have achieved.

Definitely, we have now mobile that is (48:37) much more efficient in commercial, also in finance, and in many other parts of the company. But definitely, we learned that it's important to focus on improving profitability, but even more important than just improving profitability is ensuring the future growth of Zoetis.

So then you asked about the plan to optimize manufacturing going forward. Maybe Glenn can cover this question..

Yeah. In terms of the plan to optimize manufacturing going forward, I think there are essentially three major plants that are still set to be transitioned by 2020.

And as we go through that transition and move a lot of those products, we expect to get another 200 basis points improvement in our gross margins, but those are the next major initiatives related to manufacturing. Next question..

And our next question....

Next question..

...is from Jami Rubin with Goldman Sachs. Please go ahead..

Thank you. With this you are marking the end of the SKU rationalization program. Should we assume that the Zoetis story becomes more focused on top line growth versus margin expansion? And Glenn, can you talk about how much more room you see for margins? I think you had guided to 34%, 35% this year, it's up about 1000 basis points since 2012.

How much higher can that go and what are the key drivers of that improvement. Thanks very much..

Thank you, Jami, for the questions. The focus on revenue growth has been always a part of our objective. And what we achieved with this operational efficiency program, it's having more better allocation of resources to generate future growth.

So the fact that now we were able to exceed the $300 million target, it's allowing us to invest in DTC, it's allowing us to expand our field force in certain markets, and also to invest in technology that also will support the interactions with customers.

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

Glenn?.

In terms of continued margin expansion, so we do expect this year of 2017 to be between 34% and 35%, which is a significant improvement over where we've been historically.

We do see further room for improvement, we talked about 200 basis points that we see in gross margin coming by 2020 and we also do expect to be able to grow our expenses slower than our growth in revenue moving forward. That being said, we're not targeting a margin.

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

Next question..

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

Good morning, folks and congratulations on a strong 2016. There has been some concerns about generic erosion in your base companion animal business in the U.S., excluding the new products like Apoquel, Simparica et cetera.

Could you comment on that, because I think you mentioned that the growth in the segment was driven by the newer products, so should we expect the base business to decline? And also just to follow-up on Simparica, what were the sales of Simparica now and what is the potential of this product in combination form? And forgive me if you've mentioned this, when should we expect the approval in the U.S.

for the combination form as well? Thank you..

Thank you, Alex. So we don't see any change in the outlook for generics in 2017 or 2018. So we know that the generics will capture part of the market. We have been managing very well in the past and we don't see anything that is creating a change in terms of generic penetration.

So we are very confident that there is many different aspects that are also supporting our portfolio. We have very strong brand equity. We are promoting many products in our portfolio, which is also allowing us to also to offer volume discounts.

We are a company that is bringing significant innovation, which is also an important part of what is our reputation in the market. And we maintain a significant presence in terms of direct interaction with customers. So all these elements are in my opinion supporting our portfolio and definitely we see that the generic will get part of the market.

But no different what we have been communicated that over time, they can reach 20% to 40%, but definitely not in the first year as we have been demonstrated many times. So it's a very different market than human health, and I don't think things are changing that will increase the penetration of generics significantly.

At least for companies that maintain a significant presence in the market, they promote large portfolio and they have the reputation and the interactions with customers. Simparica combo, I guess, that you referred to the product that has been recently approved in Europe, that it was a topical formulation for cats.

We expect also to introduce this product in the market in the U.S. We don't have yet details or we have not provided the timing. Definitely, once we have more information, we'll provide these details. We file in the U.S., but it's FDA filing and it depend on the U.S. reviews, the timing of the approval and the launch of the product.

The rest of the portfolio, combining the combo products sarolaner with other active ingredients to include internal and external parasiticide for dogs, again, so it's something that we are working and will provide more details when we are progressing in this project..

In terms of sales for Simparica that is something that we haven't disclosed. Performance this year has been in line with our expectations and we do expect peak sales for the product to be over $100 million.

We expect it to be a blockbuster and we're also very focused on the platform that it provides us to have continued lifecycle enhancements related to that product..

And our next question from David Risinger with Morgan Stanley. Please go ahead..

Yes. Thanks very much. Juan Ramón, I was hoping that you could talk about the competitive landscape, some of your large competitors have merged in the past.

My guess is that the disruption at Lilly may be normalizing now and maybe they will be a slightly stronger competitor in the next year or two, but that's just a guess on my part, I'd love to hear your perspective on that. And if you could talk about the other major consolidation, and whether that's good or bad for Zoetis? Thank you..

Well, I will say that, rather than providing a general comment, maybe it's good to see what is the impact by species. First, on the consolidation of Boehringer Ingelheim with Merial. So in companion animal, the majority of the portfolio will be Merial. They will be adding some products, especially in pain, coming from BI.

We don't see a significant change in the competition landscape in terms of companion animal. For cattle is where we see that the combined portfolio will strengthen the position of the new company. In swine, basically portfolio will be the portfolio that BI had in the past, so no changes in the competitive landscape, and the same for the poultry.

Poultry will be mainly the Merial portfolio. So we don't expect significant changes in terms of competition, in terms of species. They will have, definitely, a bigger critical mass.

This critical mass they can help them in terms of investments, and also especially in smaller markets, and definitely will be a stronger competitor than the two companies separated.

At the same time, so the combined company, they will need to manage higher complexity, and I'm sure that they will manage in the future, but they will have to understand how to manage the diversity of this extended portfolio and also, they will be facing the distraction of the integration.

So in 2017, probably we will see challenge and opportunities, not too big changes in terms of competition by species, and it's something that we are confident that we will be managing. You asked about Elanco. Elanco has been reinforced with recent acquisition, but this is something that, it's already part of our competitive landscape.

So we don't see that Elanco in 2017 will have a different type of challenge, in terms of competition, compared to 2016..

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

Hey, guys. Thanks for taking the question.

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

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

Sure. In terms of the price volume growth for the year. So if we start with our normalized organic operational growth, right, of 8% for the year, about 5% of that comes from new products. So we'll classify that as volume, right. Then there is the remaining 3%. The remaining 3%, 2% of that comes from price and 1% volume.

So in total, 2% price and 6% volume for the year, in terms of the impact that we have on a normalized basis. And in terms of the impact of inflation on price, that's something, as we go across geographies, not just in the U.S., inflation is definitely a factor that we consider when setting our price increases.

So it definitely does have an impact on how we set those increases annually..

And our next question is from Chris Schott with JPMorgan. Please go ahead..

Great. Just a couple of quick ones here. Following up on the dermatology assets, can I just get an updated view in terms of peak sales potential when we think about Cytopoint and Apoquel, how large do you think that portfolio can become over time? And the second one was on tax reform.

I think you've clearly articulated the company would benefit from a lower U.S. corporate tax rate, can you just elaborate a little bit more on border adjustment, I don't have (1:01:08) details at this point, but can you just give us a little bit of color in terms of, we think about your U.S. business, how much of that is manufactured in the U.S.

versus ex-U.S., so when we get more details here, how much of the franchise would be affected? Thanks very much..

Thank you, Chris. And I think we are not changing our projection that has been provided in the past for Apoquel, so we think that Apoquel will be generating more than $300 million on peak sales. How much is something that we'll see depending on also the market that will be also captured in Cytopoint.

And we also think that, now that we have Cytopoint with a full license in the U.S., but still no Cytopoint in the rest of the world. I think it's important that we understand that the full potential of Cytopoint, and then we provide guidance on the combined portfolio, when we have this information.

But we see that the Cytopoint will be adding revenues to the more than $300 million that we already communicated for Apoquel..

So, Chris. Specific to your question on border adjustability, when we look at that and we look at our imports and exports, we're essentially net neutral between imports and exports in the U.S. So in terms of the impact on tax reform, it's really going to depend on what the tax rates are on imports and exports to understand the impact of that.

But from an overall number perspective in terms of what we import and what we export, we're essentially net neutral..

And we'll go next to Kathy Miner with Cowen & Co..

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

So, in terms of biologicals, we will continue investing there heavily to develop new vaccines, to develop combination of vaccines. We also intend to reinforce our presence in cattle vaccines in Europe.

We also want to develop a larger portfolio of vaccines in China, and we'll be developing a strategy to be having stronger presence of our teams in China, mainly for swine, but also with opportunities of other species. So all areas of R&D investment, we are now using the platform of sarolaner to develop a new parasiticide.

And we mentioned the approval of sarolaner with selamectin in Europe for cat topical formulation, and we'll continue investing in this platform to ensure that we're covering broader spectrum of parasiticides.

We also with Cytopoint, we have quite significant knowledge in terms of monoclonal antibody, and these monoclonal antibodies also will be targeting all the different indications including pain or including other therapeutic indications.

And we're also targeting in livestock opportunities of improving profitability for productivity, improving productivity in livestock. So we know that there are now products that are helping us with efficiencies. We think that there will be opportunity for adding new products that will support this additional productivity in livestock..

And we will now open the floor for any follow-up questions. That's follow-up questions only, thank you..

And we can take the first follow-up from Erin Wright with Credit Suisse. Please go ahead..

Hi, thanks. It's follow-up on biologics there.

I guess, what and maybe this depends on which indications you're focused on from a monoclonal antibodies standpoint, but will that fall under this FDA or the USDA jurisdiction? And how should we think about kind of the timeline of approval and commercial launch of those products?.

Well, Cytopoint has been under the jurisdiction of USDA. We expect that other monoclonal antibodies will depend. We expect that the indication for pain will be under the jurisdiction of FDA, but this will depend.

And there is a clear definition of who should be responsible for each type of product, and also with discussions with the regulators when we start developing the programs, then we will find which will be the final regulator that will be involved in the approval..

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

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

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