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

Jonathan David Block - Stifel, Nicolaus & Co., Inc. Alex Arfaei - BMO Capital Markets (United States) Louise Chen - Cantor Fitzgerald Securities Kevin Ellich - Craig-Hallum Capital Group LLC Erin Wright - Credit Suisse Michael Ryskin - Bank of America Merrill Lynch Jon Kaufman - William Blair & Co. LLC Chris Schott - JPMorgan Securities LLC Kathy M.

Miner - Cowen & Co. LLC David R. Risinger - Morgan Stanley & Co. LLC.

Good day, and welcome to the Third Quarter 2018 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's now my pleasure to turn the floor over to Steve Frank. Steve, you may begin..

Thank you. Good morning, everyone, and welcome to the Zoetis Third Quarter 2018 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, 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, November 1, 2018. 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. In 2018, we have been making significant effort to support future growth with investment in the business. We are allocating more resources to critical R&D projects, updating and expanding many of our manufacturing capabilities and investing in key areas such as diagnostics with the recent acquisition of Abaxis.

We are making good progress integrating Abaxis. Our sales teams have been cross-trained on Zoetis' and Abaxis' product lines in the U.S. and Canada, and they're already collaborating on customer accounts. Outside of the U.S.

we are focused on building a more robust diagnostic team and using the existing Zoetis infrastructure to expand our diagnostics sales. The initial feedback on the acquisition has been very good.

Our field force has been very positive about the potential of this combination and the more comprehensive solutions they can now bring to our veterinary customers. Early customer response has been very encouraging.

Our core business and investment strategy has Zoetis well-positioned for the future with a diverse portfolio addressing needs across the continuum of care and a promising pipeline of new products and lifecycle innovations.

As I mentioned last quarter, we have taken a phased filing approach for a new three-way combination parasiticide, and we continue making that progress.

The product will be known by the trade name Simparica Trio, and it will combine sarolaner and two other active ingredients to focus on ectoparasites such as fleas, ticks and mites as well as internal parasites and the prevention of heartworm disease. Our phased regulatory filings are progressing in the U.S.

The safety, efficacy and chemistry manufacturing and control technical sections are under FDA review. In addition, we have submitted the dossier with the European Medicines Agency and subject to regulatory reviews and approval, we would anticipate Simparica Trio coming to market in 2020.

We are also progressing well with our monoclonal antibodies program, targeting pain treatment for dogs and cats. This will strengthen our leadership position for pain in dogs and allow us to expand into cats. I will provide further updates as we move through the regulatory process.

Our R&D team also continues to enhance our internal portfolio with lifecycle innovations and additional product indication such as the recent expansion of Cytopoint to cover allergic as well as atopic dermatitis in the U.S., also introducing of leading product brands into new geographies and new combinations.

Now turning to a few highlights of our third quarter results. Zoetis continued delivering strong revenue growth with 12% operational growth this quarter. Our diverse portfolio remains the foundation of Zoetis' steady and reliable performance with growth across our major species, markets and therapeutic areas.

Our companion animal products performed very well in the third quarter based on continued growth in our key dermatology brands, new parasiticides and, for the first time, the addition of Abaxis diagnostic portfolio. We see further growth opportunities for our key dermatology products in 2019.

In the U.S., we expect that portfolio to continue growing although at a lower rate than 2018. We expect to continue expanding the addressable market in the U.S. and building awareness of dermatologic conditions through ongoing direct-to-consumer campaigns. Internationally, we expect higher growth than in the U.S.

driven by the expansion of the dermatology market, increasing the patient share and the potential introduction of Apoquel in China, pending final regulatory approval. Meanwhile, in livestock products, our swine, poultry and fish portfolios each delivered double-digit growth, with more modest growth in our cattle business.

We expect all our species categories to show growth for the full year 2018 and also for 2019. For 2019, analysts expect the companion animal and poultry markets to outperform the overall industry growth of approximately 5%, excluding the currency impact.

Swine is expected to be in line with the market growth, and cattle market growth is expected to be more limited. Turning to profitability, in the third quarter we achieved 32% operational growth in adjusted net income, thanks to our increased revenue, improved cost structure, and tax reform.

In closing, in 2018 we are confident in achieving our improved annual guidance, continuing to grow revenue faster than market, and growing adjusted net income faster than revenue. And with that, let me hand things over to Glenn, who will provide more details on our third quarter results and guidance..

Thank you, Juan Ramón, and good morning everyone. Let me start by highlighting our continued strong performance in both revenue and adjusted net income in the third quarter.

As Juan Ramón mentioned, we delivered operational revenue growth of 12%, driven by the performance of our dermatology portfolio, new products and the addition of Abaxis' diagnostics portfolio. Our organic operational revenue growth for the third quarter was 9%, which excludes Abaxis. Operational adjusted net income growth was 32%.

We are confident in delivering our improved financial guidance for 2018 where we are narrowing our revenue guidance at the high end of the range and increasing our adjusted net income and adjusted diluted EPS guidance.

While I will not provide formal guidance on 2019 until early next year, I believe our diverse portfolio, core capabilities and investment strategy will enable us to continue delivering on our value proposition of organically growing revenue in line with or faster than the market and growing adjusted net income faster than revenue.

Now, let's talk about the drivers of our Q3 performance, which continued the momentum from the first half of the year. Reported revenue growth was 10% in the third quarter, which includes a negative 2% impact from foreign exchange. Currency depreciation in Brazil was the largest driver of the unfavourability in the quarter.

We generated 12% operational revenue growth balanced across our segments with the U.S. growing 11% and International growing 12% operationally. Looking at growth by species, Companion Animal grew 19% operationally and Livestock grew 6% operationally. Included in our operational revenue growth of 12% is 3% from Abaxis.

Of the 9% organic operational revenue growth, price contributed 4% and volume contributed 5%. New products drove 2% line, with the remaining 3% driven by our key dermatology portfolio.

Price contributions of 4% in the quarter are higher than usual and relate to the timing of promotional activities in the third quarter compared to the same period in the prior year. Price contributed 2% over the first nine months of the year, which is more consistent with our expectations.

Adjusted net income grew 32% operationally, driven by revenue growth, gross margin improvements and a lower effective tax rate. As I already mentioned, our key dermatology portfolio comprised of Apoquel and Cytopoint continued to be a significant driver of growth this quarter with sales of $172 million, a 39% increase over the prior year.

In the first nine months of the year, we have recognized revenue of $436 million in our key dermatology portfolio with both Apoquel and Cytopoint contributing to the continued success.

Consistent with our expectations for these products, Q2 and Q3 are the peak seasons for dermatitis, so we do anticipate moderated performance in Q4, particularly in the U.S. We continue to expect sales for this portfolio to exceed $500 million in 2018, and as Juan Ramón discussed, we see continued growth as we move into 2019.

New products also continued to drive growth for Zoetis with Simparica as the primary driver. Simparica generated $43 million of sales this quarter, representing operational growth of 80% over the same period last year. We expect some moderation in Q4 as we move out of the flea and tick season in the U.S.

Overall, we continue to be very pleased with the performance of this product in the highly competitive parasiticide market, and we expect continued growth both domestically and internationally. Now before moving into the segment results, I would like to provide more visibility into the Abaxis numbers.

Included in Zoetis' reported results this quarter are sales of $42 million from legacy Abaxis products since our July 31 acquisition. These sales represent two months of sales in the U.S., Canada and Latin America and one month of sales for all other international markets based on our international reporting calendar.

Please note that Q3 revenue for Abaxis also includes a destocking of wholesaler inventories that we expect to continue in Q4 as we normalize wholesaler inventories consistent with Zoetis levels.

With the acquisition of Abaxis, we are adding a new major product category in our financial statements and our 10-Q filings within the revenue by major product category section called Animal Health Diagnostics.

This product category will include the animal health products acquired from Abaxis as well as our legacy diagnostics products previously classified within other non-pharmaceuticals. The human health diagnostic products acquired from Abaxis will be classified within a new category called Contract Manufacturing & Human Health Diagnostics.

Now let's discuss Zoetis' segment revenues for Q3. Beginning with the U.S., revenue grew 11% in the third quarter, including Abaxis which contributed 4%. Including the impact of Abaxis, Companion Animal grew 20% while Livestock grew 1%.

Companion Animal sales in the quarter were driven by our key dermatology portfolio, new products, as well as the addition of Abaxis. Certain in-line product decline due to competitive pressure partially offset these increases. Excluding the impact of Abaxis, Companion Animal growth was 12%. U.S.

dermatology sales were $121 million for the quarter with both Apoquel and Cytopoint exhibiting significant growth over the same quarter in the prior year. Simparica also had another positive quarter with U.S. sales in the quarter growing 53% over the same period last year.

Revenue growth was due to increased in-clinic penetration and market share and returns on our direct-to-consumer investments. Partially offsetting growth in our Companion Animal business were declines in Revolution and Clavamox due to competition. The U.S.

Livestock business continued with strong growth in poultry and swine in the third quarter, partially offset by a decline in cattle. In poultry, the Zoetis portfolio of alternatives to antibiotics and medicated feed additives continues to be the primary driver of growth.

Favorable market conditions in the layer market also contributed to growth in vaccines. Swine also had consistent growth in the third quarter, primarily in EXCEDE related to promotional effort. We also continued to increase market share of Fostera Gold PCV MH which launched in the first quarter this year.

In the cattle business, we saw challenges in both the beef and dairy segments related to competition and unfavorable market dynamics. We do expect the cattle market to recover sometime in 2019, however, the impact of weather, herd movements and producer profitability all play a role in the timing. Overall, the U.S.

continues to be a significant growth driver for Zoetis, particularly due to our product diversity and strategic investments, despite some temporary unfavorable market conditions in the cattle business.

Turning now to our International segment, revenue grew 12% operationally in the third quarter with operational growth in Companion Animal of 18% and operational growth in Livestock of 10%.

Companion Animal product growth was largely driven by our key dermatology products Apoquel and Cytopoint, new products such as Simparica and Stronghold Plus, increased medicalization rates in key international markets and the addition of Abaxis.

Livestock products benefited from favorable market conditions, including increasing demand for animal protein, new products and the impact of our field force. Our fish business also performed very well this quarter, with operational growth of 21%.

This strong growth was driven by increased market share of our pancreatic disease or PD vaccine as well as customer adoption of our SRS vaccine in Chile. Highlighting some key markets for the quarter, in Brazil sales grew 31% operationally with Companion Animal growing 48% and Livestock growing 26%.

Companion Animal revenue in Brazil benefited from strong growth in parasiticides with Simparic as the primary driver and a positive return on the direct to consumer investment. Livestock benefited from the recovery of sales that were delayed at the end of Q2 due to the national truck drivers' strike.

Strong underlying demand, favorable export conditions and local promotional activities also contributed to growth in the quarter. In the UK, sales grew 30% operationally. Both Companion Animal and Livestock contributed to this performance, with new products primarily driving growth on the Companion Animal side and fish driving increases in Livestock.

Key dermatology products and new parasiticides both performed well in the quarter, resulting from field force focus and marketing promotions, which increased pet owner awareness of the brand. In fish, vaccines were the primary driver of growth, due to increased market share in our PD vaccine as well as our multivalent vaccine, ALPHA JECT micro 6.

Moving on to China, we had another great quarter, growing revenue 15% operationally, largely due to the timing of distributor purchases of our swine product. Companion Animal products also continued demonstrating growth, primarily in parasiticides and vaccines. Australia grew 9% operationally, primarily driven by Companion Animal and sheep.

In Companion Animal, Simparica and Apoquel increased sales due to the return on our direct-to-consumer investments, as well as strength of our in-line portfolio and promotional efforts in the quarter. Sheep products also benefited from continued strength in local market conditions.

Other emerging markets, particularly Vietnam, Argentina, Turkey and India, performed well. Vietnam performed well on Livestock, particularly in swine, due to increased market prices for pork. Argentina and Turkey had broad-based growth across Companion Animal and Livestock, while growth in India was largely due to strength in poultry.

Summarizing International performance, we saw new products, favorable market conditions and diversity across our portfolio all contributing to another very strong quarter for our International segment. Now, moving on to the rest of the P&L, I want to cover a few key line items and then discuss guidance for 2018.

Adjusted gross margin of 68.7% increased approximately 80 basis points in the quarter on a reported basis. This improvement reflects favorable pricing and the benefit of continued cost improvements and efficiencies in our manufacturing network, which were partially offset by the impact of Abaxis.

Total adjusted operating expenses including Abaxis grew 11% operationally versus the same period last year. Adjusted SG&A operational growth was 10%, primarily due to the addition of Abaxis and increased compensation-related costs.

Adjusted R&D operational growth of 13% reflects increased investments in areas such as monoclonal antibodies for chronic pain and other pipeline programs, as well as Abaxis. The adjusted effective tax rate for the quarter was 19.2%.

The tax rate in the quarter is significantly lower than the rate from the comparable 2017 period due to the favorable impact of U.S. tax reform and discrete items recognized during the quarter.

Adjusted net income for the quarter grew 32% operationally through a combination of strong revenue growth, improvements in gross margin, and a lower effective tax rate. These increases are partially diluted by the impact of Abaxis, which we expect to become mildly accretive in 2019 on an adjusted basis.

As previously communicated, we are creating strong operating leverage, while investing in strategic areas of future growth for Zoetis including acquisitions such as Abaxis. Adjusted diluted EPS grew 34% operationally in the quarter versus the same period in 2017.

Now, moving to guidance for the full year 2018, our consistent revenue growth, gross margin improvement and returns on strategic investments are allowing us to narrow our revenue guidance towards the high end of the range and raise and narrow our outlook on adjusted diluted EPS.

Starting with revenue, we are narrowing the range of our revenue guidance and expect to deliver between $5.75 billion and $5.8 billion in revenue, representing operational revenue growth of 8% to 9%.

Excluding Abaxis' partial-year revenue which consists of five months of domestic activity and four months of International, the organic operational revenue growth range is 6% to 7%.

Consistent with what I communicated the last quarter, our full year guidance includes headwinds in Q4 that I want to remind you of as you think about the remainder of the year. Our business in Q4 2017 was very strong, so the growth off this higher base will moderate. U.S. livestock is one area where we experienced an exceptionally strong Q4.

In addition, the fourth quarter of this year will also include four fewer international calendar days compared to last year, resulting from the change in our accounting calendar implemented this year.

Please note that from an EPS growth perspective, Q4 will be impacted by the timing of cost of sales which were higher in the first half of 2017 when compared to the second half of 2017 as well as the timing of operating expenses.

For SG&A and R&D, we're narrowing guidance towards the high end of both ranges, consistent with our revenue performance and to support investments for future growth. Our guidance for the adjusted effective tax rate has been lowered to approximately 19% from our previous guidance of approximately 20%.

This is primarily due to the impact of favorable discrete non-recurring items resulting from the implementation of U.S. tax reform. We continue to anticipate our effective tax rate going forward to be higher due to certain provisions of U.S. tax reform which will go into effect in 2019.

For adjusted diluted EPS, we are raising and narrowing the guidance and now expect to deliver between $3.08 and $3.13.

Our range for reported diluted EPS of $2.81 to $2.90 includes preliminary estimates for certain significant items and purchase accounting for the Abaxis acquisition as well as gaining on the sale of our plant health business, which was completed in our international Q4 period.

Finally, we repurchased nearly $550 million of Zoetis shares in the first nine months of the year. We have approximately $450 million remaining under the current multiyear share repurchase plan and remain committed to our capital allocation priorities of internal investment, M&A and returning excess cash to shareholders.

Our guidance for reported and adjusted earnings per share reflects the shares repurchased through the end of Q3. Now, to summarize before we move to Q&A, we have delivered consistent operational top and bottom line growth in the first nine months of the year, with contributions across all core species, therapeutic areas and geographies.

We are narrowing our range of revenue guidance to the high end of the range and increasing and narrowing our guidance for adjusted net income and adjusted diluted EPS.

Our diversity, strategic internal and external investments, and ability to innovate, will continue to provide a platform for revenue growth that is in line with or faster than the market. Now I'll hand things over to the operator to open the line for your questions.

Operator?.

We'll take our first question from Jon Block with Stifel. Please go ahead. Your line is open..

Great. Thanks, guys. Congrats on the quarter. I might try to jam three questions into one. So the first, on the big three therapeutics, I have that up over 40% year-over-year. At a high level, how should we think about the rate of growth from these three blockbusters in 2019 and 2020? I think you said very healthy but maybe at a diminished rate.

So, anything more that you can provide there. Second would be just early feedback from the Abaxis acquisition.

How should we think about sales force retention? And then have you kicked off any bundling in terms of price? And lastly, Glenn, just the price of 4% in the quarter, I just want to be clear there, we should think of that more as onetime due to the year ago comp? Thanks, guys..

Thank you, Jon. Glenn will answer the first question. I will cover the Abaxis question and then Glenn also will provide the comments on the 4% price increase in the quarter..

So, Jon, when you look at the big three, and I assume you're mentioning Apoquel, Cytopoint and Simparica, we've had very strong growth in the quarter and year-to-date. As we look forward into 2019 and 2020, we do still see opportunities for growth for all those products. So, particularly, with our dermatology portfolio we see continued growth in U.S.

albeit at a slower rate as we have significant penetration in terms of patient share there. We're up to 63% already. We do see further opportunity continue to grow the market there as well.

We should also see a very strong opportunity internationally where the penetration isn't quite at that level yet, so we do see continued growth internationally in Apoquel and Cytopoint as well.

In Simparica we continue to see very strong performance, continued adoption, and we think that growth will continue into the 2019 and 2020 as well, but again probably at a slower rate and also the impact of competition and new products that may come into that category may also impact growth going forward..

Okay. Thank you, Glenn. In terms of the Abaxis integration, well, the retention of the field force I think is not – I can describe as 100% retention. And not only it's about retention, it's about the feedback that we are getting from the field force from Abaxis, which is extremely positive.

They are expressing the excitement of the opportunity now to be supported by a larger company, by much more presence in our field. And the combination of the two portfolios is something that can create significant opportunities. I think it's too early to discuss about bundling.

Definitely we see the opportunity of combining the diagnostic portfolio of Abaxis, the diagnostic portfolio of Zoetis, and also the rest of the portfolio of medicines, and it's something that it's a work in progress.

We see that diagnostic medicines, vaccines, are very much integrated in the clinics, so we expect that this will present a significant opportunity in the future..

And, Jon, in terms of the price for the quarter, so like you say, the 4% is more of a onetime impact for the quarter. The year-to-date number of 2% is much more in line with what we typically expect to be able to generate from price..

Next question, please..

And we'll take the next question from Alex Arfaei from BMO Capital Markets. Please go ahead..

Great. Thank you very much for taking the question and congratulations on all the progress. First, just a follow-up on atopic dermatitis, I think one of your competitors reported data with their IL-31 recently. I'm referring to Kindred.

Just wondering if you had any thoughts there whether it's on that product or just, in general how you see the competitive landscape evolving here. I'm sure your success hasn't gone unnoticed. Second, could you please break out Apoquel, Cytopoint, and Simparica by U.S.

and ex-U.S.? And finally, if I may, Juan Ramón, I missed your comments about 2019 expectations for livestock species. Could you please clarify that? And any additional color would be appreciated. Thank you..

Thank you, Alex. Good morning. So, let me discuss about the potential competition of our dermatology portfolio. Definitely this is something that we already communicated in previous calls that over time we expect competitors coming into this attractive market. It's a market that has been basically created by Zoetis.

In the same way that many years ago, we also created the pain market for dogs, and even after many years and many new entrants, still Rimadyl remains the leading brand in terms of pain for dogs.

So, we are expecting competition but we also expect that we have a very strong position with the combination of Apoquel and Cytopoint and products that has been responding extremely well to the needs of veterinarians and also the needs of dogs, and we are very confident that these products will continue growing.

And new competition also will expand the market and we also benefit of this market expansion from a leadership position. Glenn will discuss about the breakdown between dermatology products, Simparica, U.S., International and also I will be covering the expectations for Livestock in 2019..

So, just to break out the numbers. So, for derm for Q3, we had total sales of $172 million. $121 million of that came from the U.S., with $51 coming from International. Breaking out Apoquel, we had total sales of $134 million, the U.S. at $88 million, International at $45 million. You can then do the math for Cytopoint, the difference between the two.

For Simparica, we had total sales of $43 million in the quarter, with the U.S. at $26 million and International at $17 million..

So, the comments I provided for 2019 in terms of livestock were related to the market and not specific to our projection for 2019 Livestock Zoetis. What I said is that the market expect that poultry will be growing faster than this 5% which is expected growth for the overall animal health industry.

Swine will be in line with the market and cattle will be much more modest growth. And this is something that, at this point, we are not yet providing the specifics of our growth in 2019, but we expect that we'll be more or less in line with the market expectations.

Next question?.

The next question comes from Louise Chen with Cantor Fitzgerald. Please go ahead..

Hi. Thanks for taking my questions. So, my first question here was just back onto the cattle here.

Can you just give more specifics as to what is going to actually drive the recovery in cattle in 2019? And then the second question is just on opportunities for growth and operating margin expansion in 2019 and beyond, if you still see anything beyond what you've already said and if so, where these could come from. Thank you..

Thank you, Louise. We expect, as I said, in 2019 modest growth in cattle for the animal health industry. We see that prices for dairy are improving. We expect that this improve to be seen in the second half of 2018. It's taking longer. But now there are indications that these prices are recovering in the U.S. and also recovering in International market.

So, we are more optimistic about dairy in 2019. In 2019, we also expect small growth, very little growth in terms of number of heads in the beef section of cattle. And combining all these elements, we expect some recovery of cattle in 2019. But as I said, cattle is expected to grow at modest growth..

And, Louse, in terms of margin expansion, first I'll just continue to say that we're really not managing to any particular margin, but really we are managing for long-term cash flow growth and value.

But when you look forward in terms of 2019 and 2020, we've previously articulated that we expect to get gross margin expansion of about 200 basis points by 2020 with 2017 being the starting point for that. So, our cost of goods as a percent of sales at that point was about 33%.

We've guided 2018 to be approximately 32%, and we do expect continued improvement in both 2019 and 2020. As we move forward, we also do expect to be able to get some leverage from operating expenses.

But in 2019, in particular, as we continue to integrate Abaxis and build to make sure that we're supporting that business, that expansion may not be as strong as it may be moving forward in 2020 and beyond.

But between the combination of the gross margin expansion and being able to grow expenses at a slower rate than revenue, we do expect to be able to get margin expansion moving forward..

Thank you, Glenn. Next question, please..

Our next question's from Kevin Ellich with Craig-Hallum. Please go ahead..

Good morning. Thanks for taking my questions. I guess could we start off with capital allocation? You guys have – now that you're done with the Abaxis acquisition, wondering what else we should be thinking about in terms of how you plan to use the capital aside from the share repurchases.

And then can you also comment on the pipeline, Juan Ramón? Appreciate the comments on Simparica Trio and when you expect it. What about Europe? Are we going to see it approved in Europe before the U.S.? And then congrats on winning the Deming Cup for Operational Excellence Thanks..

Thank you, Kevin. In terms of our capital allocation, we are not changing the previous capital allocation communication. So, definitely, we see and we continue seeing opportunities in terms of investing internally. We are increasing our allocation to R&D. We communicated that also we are expanding and increasing the capabilities in manufacturing.

And we see opportunities in commercial, and in 2018, 2019, the opportunities there definitely will be in diagnostics and will be an expansion of our presence in International markets. So, we'll continue investing internally.

And the result of this investment has been extremely positive and we'll continue making sure that we have the resources to generate long-term growth. In terms of BD, the second priority in terms of capital allocation, we just completed the acquisition of Abaxis.

We also had some other minor acquisitions, Smartbow, that it also a company that will be providing sensors and also the opportunity for more data analytics, digital in the dairy farms.

And it's an area that we are also very interested ensuring that we are developing the internal capabilities in terms of digital data analytics there to provide this value to our customers. And we'll continue with returning the excess capital to our shareholders. It will be through dividends. It will be through buying shares back.

Nothing has changed, and definitely we still see opportunities of, as I said, continue investing internally, identifying external opportunities and returning this excess capital. In terms of the pipeline, well, Simparica Trio has been filed in both the U.S. and also Europe.

When this will be coming to the market, it's to be seen because it's depending on the regulators. But definitely, we expect that Simparica Trio will be in the market sometime in 2020. Who will be first, it's to be seen. There are some other products that also we'll see even earlier than 2019. For example, we are also expecting that in the U.S.

we'll have lifecycle innovation with Revolution Plus and combining Revolution Plus active ingredient with a combination of other agents that we will expand the protection not only to fleas and ticks but making it stronger for ticks. And this is something that we expect this Revolution Plus coming into the market in 2019.

And we'll continue also bringing in some other products in 2019 in the U.S. and also international markets, especially lifecycle innovation. I also mentioned that we are expecting the approval of Apoquel in China.

Again, it's subject to regulatory approvals, but it can be sometime in 2019 and this will also help us to continue growing Apoquel or the dermatologico for Zoetis. And China now is one of our top markets for companion animal within Zoetis. So, it's probably a good opportunity that we see the introduction of Apoquel in this market.

Next question?.

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

Great. Thanks.

A couple of questions here, you mentioned some de-stocking as it relates to Abaxis, but can you provide any sort of metrics on the integration process there and traction you're seeing in terms of in-customer instrument placement trends or consumables growth, and as we think about modeling out the diagnostics segment that you'll be breaking out, should we consider that a double-digit grower when studying your own diagnostics portfolio? And then the second part of my question is how you think about a potentially kind of evolving supply chain in pet medications and do you think that it is rapidly evolving or evolving to some extent that consumers have more choice and veterinarians have more choice? And what do you think about broader implications, newer concepts such as Vets First Choice and your ability to realize price thereon? Thanks..

Okay. Thank you, Erin. So, in terms of Abaxis performance (42:06) I think it's – well, the integration of the closing of Abaxis has been at the mid of this quarter. I think it's probably a little bit too early to provide the full details of the different elements of the diagnostics implementation in the clinics.

This is something that we'll discuss what will be the level of information that we'll be providing in the future. And maybe we can have this discussion in the fourth quarter when we have the full quarter already reporting and having all the elements that are under control by Zoetis.

Glenn will be talking about the de-stocking question that you raised..

Yes. So, just to give a little more color into the Abaxis numbers. So, we referenced that we had $42 million of sales in Q3. Just a reminder, that includes two months of U.S. and one month International, so it's a partial quarter.

Of that $42 million is also $7 million related to human health diagnostics, so the animal health diagnostics piece of that $42 million was $35 million.

To get to your question on growth for the quarter a little bit, Erin, if you take some of the pro forma information and then put that together with what I just referenced in terms of the $35 million, again it's not 100% audited or accurate because we're piecing together different pieces of information.

But you would get to mid-single digit growth for the quarter for the legacy Abaxis business. Now, that does also include the de-stocking that I referenced which we do expect to continue into Q4.

But if you were to adjust for that de-stocking, we get to double-digit growth in the Abaxis portfolio which we do expect to continue moving forward at double-digit growth rate..

And Erin, what we expect from animal health diagnostics growth trend long-term is that we'll be growing faster than the animal health core business medicines, and I think it has been, in the past, growing at 7%, 8%. We also expect that in the future we'll be growing higher than the 5%.

And where we see significant opportunities for growth is in International markets. And we are now expanding our presence and we are convinced that we have a significant opportunity to penetrate in this market.

You also asked about the U.S., changes in the distribution retail channel, talking about Vets First Choice or internet pharmacy (44:42), well, definitely, it's a lot of changes in this segment, companion animal in the U.S.

We see some of these changes also having the positive impact of expanding the market, having much more access there for pet owners, at the same time the opportunity also to increase compliance.

But at the same time, we are convinced that veterinarians will remain at the center of healthcare decision especially in areas that will require prescription and intervention of veterinarians with injectables or vaccination or acute treatment in the Companion Animal.

And we'll continue supporting the veterinarians really to deliver value to our pet owners.

Next question?.

Our next question is from Michael Ryskin with Bank of America Merrill Lynch. Please go ahead..

Thanks. Congrats on the quarter, guys. I have a couple questions I'm going to roll into one but it's going to be focused on some of the innovation of the portfolio. You talked about the additional indications for Cytopoint, the allergic dermatitis.

Can you give any sense of how much that expands the potential for that product, near-term in both as we go into 2019 and 2020? And then regarding some of the other innovation, the lifecycle extensions in Draxxin and Vanguard, some of the work you mentioned, the focus on the pain monoclonal antibody.

Just to get a sense of how big of a contributor this could be in 2019, 2020 as some of these new products come in. And then along that line, one last one is we saw some news reports that the USDA was potentially granting you a license for an African swine fever vaccine that's in an open comment period.

Can you talk about the potential for that market? Obviously, there's a lot of talk in the swine markets about the disease outbreaks there, so, any sense of timing or potential impact? Thanks..

Thank you, Mike. So, let me cover the question on additional label indications for Cytopoint. So, in allergies there are four main reasons for this condition. So, one is related to fleas, the other one is food, and the third one is the environment. Anything which is not in these three areas is described as atopic.

Now, Cytopoint also have the indication of allergy, not only atopic indication, and this will help us really to promote what all the indications of Cytopoint. We are not expecting significant revenues because of that, but definitely it's an area that in our opinion veterinarians has been using Cytopoint based on their own understanding of the needs.

But the fact that we'll be now promoting a broader label, we will always help, but we don't expect a significant incremental revenue. We expect that the market in the U.S.

still has a potential for expansion and also we expect that our patient share also can increase with the right interactions with the veterinarians and the right communication with the pet owner. And this is applicable to the U.S. and also International.

In terms of pipeline contribution in the near-term – well in the near term, we discussed about near-term 2019, so the pipeline will be mainly related to lifecycle innovation. We'll always be introducing some new vaccines, new product, but we expect significant introduction of new products in 2020.

And we'll have the opportunity to discuss in February the details of our guidance for 2019 and also how we see 2019 in terms of the different sources of growth, our current portfolio, new product introduction and also price. You also asked about the African swine fever and the collaboration with the USDA.

This is something that will take several years to see a vaccine in the market to protect pigs against the African swine fever. But definitely, it's an area that has significant impact and we have seen the impact now in China and also in some other markets. It's affecting the production of pork.

But what I think is even more important that what is the short-term opportunity for developing a vaccine to protect pigs against the African swine fever is the confirmation that Zoetis is the banner of choice with the USDA and many other institutions when we need to bring new vaccines into the market.

And this is, in my opinion, what is important at this moment in the collaboration that we are establishing between us and the USDA.

Next question?.

The next question is from John Kreger with William Blair. Please go ahead..

Hi. Good morning. This is Jon Kaufman on for John Kreger. So, a question on the monoclonal antibody products, is there anything more you can tell us? What stage of the development process are they in and when do you expect them to come to market? Thank you..

Well, I think it's too early to indicate when the product will be in the market. So, what I can tell you is that we are making a very good progress. So, we have several products for both dogs and cats. We are very optimistic about these products reaching the market.

And as I said, I will provide to you more updates as we start the process of filing the dossier into the FDA and also the European agencies. And then when we have that information, then I will be providing more details of when we plan to have the product into the market.

Next question?.

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

Great. Thanks very much for the questions, just one coming back to some of the earlier comments on OpEx going forward and expense growth. You've obviously stepped up spend this year supporting the pipeline and the new launches, sounds like 2019 might be another year of investment with Abaxis.

I guess my question is once we get beyond that spend, should we think about OpEx growth slowing back down to more inflation-type growth that we've seen historically for the company? Or are we in a sustained period here where we should think about OpEx growth kind of above inflation, maybe closer to topline just given the variety of new products that you seem to have targeted for the next few years? My second question was just on the Simparica Trio and maybe just taking a step back.

Maybe just put in context how much larger of an opportunity do you see for that product relative to Simparica today as we just think about that 2020 and beyond opportunity. Thank you..

Thank you, Chris. Well, I would probably share my general comments about OpEx, and then also Glenn will provide more details.

So, we have seen 2018, maybe also 2019 as a years in where we are building some additional capabilities in our commercial infrastructure, has been also two years where we see additional opportunities to invest in R&D, and this is driving that higher growth in terms of operating expenses than in previous years.

In the long-term, I think we'll remain in line with previous communications that operating expenses will be growing in line with inflation. But it's also true that we have seen significant changes in our business, the inclusion or addition of Abaxis. We also included some other areas where we need some additional capabilities.

And there are now new opportunities that we have seen also in digital and also in terms of data analytics. All these it's, well, creating the need of further investment but as I said, it's something that we see as temporary, and then over time, moving into the long-term growth in line with inflation.

Glenn, do you want to add some additional comments here?.

Yeah. The only thing I'd add particularly for 2019 as you look at it, I mean, one of the key drivers of the expense growth for 2019 will be the fact that we'll have a full 12 months of the Abaxis portfolio and expenses supporting that portfolio in 2019 versus only a partial year this year.

And we'll also still be in the build phase for some of the diagnostics field force that we're building in both the U.S. and International.

As Juan Ramón said, once we move forward into 2020, we would expect particularly the G&A line to then trend much more in line with inflation, and selling in particular, we would expect expenses to be slower than revenue growth from a selling perspective as well.

R&D, we'll continue to look at the opportunity and to the extent that there are opportunities to drive future short-, medium- and long-term growth, we'll make the right investments from an R&D perspective..

So, in terms of Simparica Trio and the incremental opportunity compared to Simparica, we are very pleased with the performance of Simparica. So, we are now on the nine month close to $150 million, $144 million (sic) [$125 million].

But still we are significantly underrepresented in the oral parasiticide market and where NexGard or Bravecto are generating much more significant sales. And one of the reasons were that we were several years behind competitors in terms of introducing these products.

We are confident that with the Simparica Trio we'll be bringing a product that would be highly competitive and also we'll have the opportunity to capture part of the revenues which are today on internal parasiticides and also heartworm provided by other products.

So, the opportunity in Simparica Trio, it's to capture higher share in terms of the overall market of oral parasiticides and expanding to internal parasiticides. So, we'll provide in the future when we have probably closer to the launch what can be the expectations of Simparica Trio.

Next question?.

The next question is from Kathy Miner with Cowen and Company. Please go ahead..

Thank you. Good morning. Just two quick questions on Companion Animal. First is, in the past you've estimated the U.S. market penetration of your derm products is around 59%.

Is that good or has that increased? And the second question is also on companion animals, derm and Simparica trends have been very strong, but how should we be thinking about the underlying, the base business? Is that flattish or growing slightly going forward? Thank you..

So, thank you, Kathy. So, you're correct, so the 59% share, it was related to patient share for Apoquel, Cytopoint. This was in previous quarters. Now we have increased to 63% in the U.S., and we are significantly lower in International markets.

And again, so, International markets is where we see the opportunity of first expanding the dermatology market and also increasing our penetration with the market share. You also asked about the base business excluding I guess Apoquel, Cytopoint, Simparica, I guess this is the question. Maybe, Glenn, you can answer that..

Yes. So, when you look at the base business in the U.S., if you exclude the derm products, volume growth is declining. That is partially offset by some positive increase in price.

But overall, volume growth is declining, and that is driven by some competitive pressures that we're seeing on some of our more established products such as Revolution and Clavamox as they face competition, A, from other new products but also from generic competition.

But the impact that we're seeing there is very much in line with what we expect from a long-term perspective once we lose exclusivity in terms of the 20% to 40% over an extended period of time..

Next question, please..

The next question is from David Risinger with Morgan Stanley. Please go ahead..

Yes, thanks very much, and congrats on the performance. I have a couple questions related to the Trio opportunity. The first is have you filed all of the components of the application with the FDA? Second, I believe that, Juan Ramón, you said 2020, which I believe is a delay from the prior comments of second half of 2019 approval and launch.

Could you comment on that? And third, do you have 100% heartworm protection in the product? Thank you..

Thank you, Dave. Let me confirm that Simparica Trio has been filed with all the different sections in the FDA.

And I thought that in previous communications we were saying that we are expecting the Simparica Trio to be in the market in 2020, and we can maybe check if there was any confusion here, but I want to confirm that we expect this product in 2020.

And let me – I think we are very confident that the product, Simparica Trio, will have full protection for heartworm. But let me confirm with our scientists what will be the level of protection in terms of percentage. But we are very confident that the efficacy of the product for internal and external will be excellent.

So, this is one of the reasons why we are confident that the product will have a significant opportunity once it's launched into the U.S. and also in International markets. Let me say that in International markets, maybe the opportunity is lower than the U.S. because heartworm outside of the U.S. is less prevalent.

So, the biggest opportunity for Simparica Trio will be in the U.S.

Next question?.

And it does appear we have no further questions. I'll return the floor to Juan Ramón Alaix for closing comments..

Thank you for your attention. We are very pleased with the results of the third quarter, and as I said, extremely confident in our guidance for total year 2018 that has been growing over time, and now we have provided an increase in terms of adjusted net income for the total year. Thank you for your attention..

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