Zoetis Inc.

Welcome to the fourth quarter and four-year 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. It 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. If you would like to ask a question at that time, please press star 1 on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question. When posing your question, please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Good morning, everyone, and welcome to the Zoletus fourth quarter and full year 2018 earnings call. I am joined today by Juan Ramona Lykes, 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 report 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 measure is included in the financial tables that accompany our earnings press release and in the company's eight-day filing, dated today, February 14, 2019. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon- Thank you, Steve.

Good morning, everyone. Our 2018 results once again confirm the strength of our business and our leadership in the animal health industry. We delivered another year of strong performance and executed our investment plan to continue to strengthen our portfolio across the continuum of care. Our successful innovations, the high quality of our manufacturing, our best-in-class field and the diversity of our portfolio has been driving our steady revenue growth over the years. Since we became a public company in 2013, we have consistently grown revenue faster than the market. And this revenue performance has been achieved while significantly improving our profitability. With our adjusted EBIT margin increasing from 24% in 2013 to 35% in 2018. In 2018, we delivered our sixth consecutive year of operational revenue growth, 10% overall, with organic operational growth of 8%, which excludes the revenue related to our abacus acquisition. In terms of organic revenue drivers, we achieved our strongest growth in our dermatology portfolio, vaccines and parasiticides. Meanwhile, our anti-infective and medicated feed additives showed more modest growth. And this was because of regulatory changes around the use of antibiotics in animal production. For the second year in a row, Our broad base of about 300 products and product lines generated operational revenue growth across all our core species and major markets. We expect our 2018 organic growth to once again outperform the market and deliver our value proposition of growing in line with or faster than the animal health market. We also increased profitability faster than revenue growth for the full year, growing adjusted net income by 31% on an operational basis, consistent with our value proposition. This improvement was driven by higher revenue, improved cost structure, and tax reform. In 2018, we achieved other important milestones that will support our future growth and success. Apoquil, our largest product by revenue, achieved $464 million in sales in 2018, an increase of 28% from 2017. We added two new blockbusters to our portfolio in 2018, bringing our total number of products with more than 100 million in the annual sales to 12. Our oral parasitic is Empirica, and our monoclonal antibody for dermatology, Cyzopoint, each exceeded $100 million in sales for the first time, with $158 million and $129 million in annual sales, respectively. We also introduce critical new lifecycle innovations that keep our portfolio updated and competitive and support the durability of our major global franchises. For example, Postera Gold, PCVMH, our latest swine vaccine, was introduced in the U.S. and Canada to provide greater options and flexibility in protecting pigs from diseases. We also built on the sarolaner compound in Sympharica to develop Revolution Plus, a topical parasiticide for cats that was recently approved in the US, Japan, and Canada. It combines two ingredients, sarolaner and salamectin, and it's already marketed in the European Union as Stonehold Plus. All these new products and lifecycle innovations demonstrate the excellent return on our investment in R&D. We also took important steps to expand our manufacturing capacity. In the U.S., we enlarged our production facilities for poultry vaccines in Charles City, Iowa, and our expansion in Kalamazoo, Michigan, is progressing ahead of schedule. with the first commercial batches of oral solid dose medicines expected to be delivered to customers by the middle of 2019. Outside the U.S., we expect to complete the construction of a vaccine manufacturing facility in Suzhou, China, by the end of 2019. And we acquired a facility in Tala, Ireland, to help increase the supply for our market-leading bovine seed sealants that help protect cows from mastitis infections. During the year, we made our largest acquisition to date, purchasing Avaxis for $2 billion in the fast-growing point-of-care diagnostics space. We see diagnostics as an important area to broaden our portfolio, and with tremendous growth opportunity ahead, especially in international markets. We also acquired SmartBow for its sensor technology and monitoring systems, which will be essential to our expansion in precision livestock farming and other digital and data analytic solutions that are emerging in animal health. And we return excess capital to our shareholders. In December, we announced a $2 billion multiyear share repurchase program and the increase of our quarterly dividend by 30%. Looking ahead in 2019, we'll continue investing to generate short- and long-term growth. We support our key dermatology and parasiticide products with direct-to-consumer advertising and promotional campaigns to advance health penetration and launches in new markets. In the U.S., we'll be launching two new products in our companion animal business. Evolution Plus, a topical parasiticide for cats that I mentioned before, has launched this quarter. And pending FDA approval this year, we would expect to launch a new injectable formulation to protect dogs against heartworms for up to 12 months. In terms of R&D, our pipeline remains very strong, and we expect to see more progress in 2019. Potential filings for new products and continuing market expansions offer major products like Cytopoint, Symparica, and Apoquil, which is expected to launch in China this year. will continue our work on new monoclonal antibodies to manage pain in dogs and cats, as well as for dermatology in cats. We are making good progress with our research programs, and we feel very positive about the potential this type of treatment offers for greater compliance, convenience, and efficacy for different species. This remains an area to watch as we invest further internally, and we build on our partnership with Regeneron in this space. As I have mentioned in previous communications, the application for our new three-way combination parasitic site, composed of simparica and two other active ingredients, has been filed in the US and with the European Medicines Agency. And, if approved, we still anticipate incoming to market in 2020. Additionally, we'll be investing more in research for diagnostics, devices, digital and data analytics technologies that can be integrated with our portfolio of medicines and vaccines. Diagnostics for livestock are a promising long-term opportunity, and areas such as sensor technology, monitoring systems, and other digital applications for animal health will be receiving more investment. In terms of our deeper commitment to diagnostics, we look forward to a full year of selling a more robust portfolio of point-of-care diagnostic instruments, consumables, and test kits. We are seeing great progress with integration of the legacy of Axis Field Force in the U.S. Outside the U.S., we are building the infrastructure, sales, and technical teams needed to support our diagnostic portfolio. Moving into market projections for 2019, we expect the overall industry to grow approximately 5%, excluding the impact of foreign currency. The swine market, companion animal market, and poultry are all expected to be somewhat in line with the market growth. The cattle market growth is expected to be more limited based on challenging market conditions for beef and dairy customers. For Swedish, we expect to grow faster on the market for companion animal and swine based on our new products and to grow in line with the poultry and cattle markets. We announced our full year 2019 guidance today. and we are expecting organic operational revenue growth of 4.5 to 6.5 percent, excluding a 3 percentage point contribution from AVAXIS. Operational growth for adjusted net income is expected to be in the range of 8 to 11 percent. In 2019, we are committed to investing profits to generate short and long-term growth while returning excess capital to shareholders. In conclusion, our strong performance in 2018 is based on our diverse portfolio, our leadership innovation, and customer experience across the entire cycle of care. In 2018, We have invested to support the growth of our core business as well as in evolving spaces like diagnostics, devices, digital and data analytics. We expect to build on this strategic approach to our growth in 2019 while delivering on the full year guidance. With that, let me hand things over to Glenn who will provide More details on our 2018 fourth quarter results and full year 2019 guidance.

Thank you, Juan Ramon, and good morning, everyone. As Juan Ramon noted, we had another exceptional year in 2018 with strong performance in both revenue and adjusted net income. Revenue exceeded our guidance, and adjusted net income was in line with the high end of our range. We expect our 2018 organic growth to again outperform the market once industry figures are finalized, delivering on a value proposition of organically growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Revenue for the full year 2018 was $5.8 billion, with both reported and operational revenue growth for the year at 10%. Excluding the impact of the AVAXIS acquisition, operational growth for 2018 was 8%. Of this 8%, 3% comes from price and 5% from volume. Included in the volume growth are contributions from our key dermatology portfolio of 2%, new products, including Semparica, of 2%, and inline products of 1%. Adjusted net income for the full year was $1.5 billion, representing reported growth of 29% and operational growth of 31%, driven by revenue growth, gross margin improvements, and a lower effective tax rate. In 2018, we grew our business operationally across all core species, therapeutic areas, and major markets. Our key dermatology portfolio and Simparica continued to grow and gain additional market share both in the U.S. and internationally. For the full year, we recognized combined revenue of $593 million for Apoquel and CiderPoint. This portfolio continued to grow rapidly in 2018 and is well-positioned for future growth heading into 2019. For livestock, our diverse portfolio of products drove growth across both developed and emerging markets, capitalizing on industry trends of higher protein consumption and improved productivity. Turning to the fourth quarter, reported revenue growth was 7%, which includes a negative 4% impact from foreign exchange. Currency depreciation in Brazil continued to be the largest driver of the unfavorable foreign exchange impact in the quarter. Operational revenue growth in the quarter was 11%. Excluding the impact of the ABAXIS acquisition, operational revenue growth was 7%. Of this 7%, 3% comes from price and 4% from volume. Included in the volume growth are contributions from our key dermatology portfolio of 2%, and new products, including Simparica, of 2%. Q4 represents the first full quarter of Avaxis-related revenue being included in Zoetis results. We recognize $65 million in legacy Avaxis products, contributing 4% growth to overall Zoetis in Q4. These results included de-stocking of wholesaler inventories in the U.S. as we normalized wholesaler inventory levels to be consistent with the rest of our business. New products, including Simparica, Stronghold Plus, and PCV Combo vaccines, were also growth drivers in the quarter. Simparica generated $32 million in global sales this quarter, representing operational growth of 90% over last year. Equine's core EQ innovator, the first and only vaccine to contain all five core equine disease antigens, also launched in 2018, and it helped to drive operational revenue growth of 12% in equine for the quarter. Our key dermatology portfolio, comprised of Apoquil and Cytopoint, also continued strong performance this quarter, with sales of $156 million, a 25% increase over the prior year. Adjusted net income for the quarter grew 21% operationally, driven by revenue growth, discrete other income items, and a lower effective tax rate. Now let's discuss the latest segment revenues for Q4. Beginning with the U.S., revenue grew 14% in the fourth quarter, including 6% growth due to legacy ABAXAS products. Including the impact of the ABAXAS acquisition, companion animal grew 26% while livestock grew 3%. Companion animal sales in the quarter were driven by sales of legacy ABAXAS products, our key dermatology portfolio, and new products, including Simparica. Certain inline product declines due to competitive pressure partially offset these increases. Excluding the impact of the abacus acquisition, companion animal growth was 14 percent. Key U.S. dermatology sales were $110 million for the quarter, with both Apoquil and Cytopoint exhibiting significant growth over the prior year. Subcarica also had another positive quarter, with U.S. sales in the quarter nearly doubling over the last year. Revenue growth continued due to increased clinic penetration and market share resulting from our field-force selling efforts. Partially offsetting growth in our companion animal business were declines in Rimidu and Clavamoc due to anticipated competition. The U.S. livestock business delivered growth across all species in the fourth quarter. As a reminder, this growth calms off a strong fourth quarter in 2017. In the cattle business, we continued to see challenges in both the beef and dairy segments. However, growth was primarily due to higher sales of premium products as well as competitive supply constraints in the quarter. In poultry, the ZOETIS portfolio of alternatives to antibiotics and medicated feed additives continued to be a solid contributor to growth as we saw additional market expansion of no antibiotics ever production. Overall, the U.S. demonstrated another strong quarter with growth across all species. Turning now to our international segment, revenue grew 5% operationally in the fourth quarter, including 1% growth due to Avaxis legacy products. Including the impact of the Avaxis acquisition, companion animal operational growth was 14%, and operational growth in livestock was 2%. As a reminder, International markets faced a headwind of four fewer calendar days this quarter, resulting from the change in our accounting calendar implemented this year. Full-year operational revenue growth of 9% was not impacted by calendar days and provides a more accurate indicator of international performance. Companion Animal product growth was driven by the addition of Legacy of Axis products, new products such as Symparica and Stronghold Plus, our key dermatology products, and increased medicalization rate in key international markets. Livestock growth was driven by poultry, swine, and fish, while cattle was relatively flat in the quarter. The complete quarter and annual results of our top 11 international markets are provided in the table included in our earnings release, but I would like to highlight a few items for the quarter. In Brazil, sales grew 8% operationally, with companion animal growing 22%, and livestock growing 4%. Companion animal revenue in Brazil benefited from growth in vaccines due to improved supply and key products, primarily symparic and apical. Livestock benefited from damp weather conditions, which increased the use of cattle parasiticides, as well as expanded usage claims on vaccines, which helped drive premium pricing. Moving on to China, we had another great quarter, growing revenue 16% operationally, largely due to continued growth of companion animal products, primarily vaccines and parasiticides. Canada grew 10% operationally, with balanced growth between companion animal and livestock. Companion animal growth was driven by the inclusion of Abaxis legacy products, as well as growth in apical. Livestock benefited from sales of new products in swine and strong performance of key brands in cattle. Other emerging markets also performed well in the quarter. Summarizing international performance, the addition of Avaxis legacy products, continued growth of new products, and diversity across our portfolio all contributed to another solid quarter for our international segment, despite the impact of fewer calendar dates. Now moving on to the rest of the PML. Adjusted gross margin of 66.4% decreased approximately 250 basis points in the quarter on a reported basis versus the prior year. The decline this quarter is primarily due to the unfavorable impact of foreign exchange, a full quarter of ABAXAS-related revenue, including our results, and increased inventory charges. The declines are partially offset by strong revenue growth and continued cost improvements and efficiencies in our manufacturing network. The Q4 margin is not indicative of the gross margin we anticipate going forward. Total adjusted operating expenses including the impact of the Abaxis acquisition, grew 15% operationally. The increase is primarily related to the acquisition of Abaxis and additional spend in R&D, including investments in monoclonal antibodies for chronic pain and other pipeline programs. The adjusted effective tax rate for the quarter was 17.3%. This tax rate 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 21% operationally through a combination of strong revenue growth, favorability in other income, and a lower effective tax rate. Adjusted Zulu VPS grew 25% operationally in the quarter versus the same period of 2017. Our income growth and balance sheet discipline have enabled us to continue increasing operating cash flow. Inventory improvements are one area I am particularly pleased with, having decreased months on hand since 2016 by more than two months. The current level of less than nine months on hand is consistent with industry standards and we expect we will continue around this level going forward. The significant improvement in inventory has released approximately $300 million of cash from our balance sheet since 2016. Now moving to guidance for 2019. We are committed to our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Before I get into the specific numbers, please note that you can find our guidance table included in the press release as well as the investor slides. Also note that all foreign exchange impact is based upon exchange rates as of late January. In 2019, We are projecting revenue between $6.175 billion and $6.3 billion, reflecting operational revenue growth of 7.5% to 9.5% over 2018. Foreign exchange is expected to reduce revenue growth by approximately 1.5%. Our organic operational revenue growth, which excludes the impact of the AVAXIS acquisition, is projected to be between 4.5% to 6.5%. In addition to Abaxis legacy products, our key dermatology portfolio and new products will be strong contributors to growth in 2019. From a species perspective, we expect companion animal to grow at a faster rate than livestock, driven by the Abaxis acquisition, continued growth in our key dermatology and parasiticide portfolios, increased medicalization rates in emerging markets, and market dynamics, including growth in per-pet spending. From a geographic perspective, US and international markets will contribute balanced growth. Adjusted cost of sales as a percent of revenue is expected to be in a range of 31% to 32%. The expected improvement over 2018 is driven by price increases and manufacturing cost reductions, partially offset by the impact of the abacus acquisition and currency movement. We expect adjusted SG&A for the year to be between $1.47 billion and $1.52 billion. We anticipate foreign exchange to reduce growth by approximately 1% on a reported basis. Operational growth in SG&A reflects a full-year impact of the ABACDIS acquisition, as well as investments in our diagnostics, international field force, and technical service teams. We'll also continue to fund strategic investments that have demonstrated a strong return including direct-to-consumer advertising for Apple Pro and Symparesis. Moving on to R&D, we expect 2019 expenses to be between $445 million and $465 million. Consistent with 2018, we have committed to an increase over 2018 in R&D spending to ensure we are well-positioned to capture future short, medium, and long-term growth opportunities in critical spaces. These spaces include a new combination parasiticide, monoclonal antibody therapies for pain in cats and dogs, and new vaccines for pulses. We'll also continue to invest in the next wave of diagnostic innovation, building on our existing zoetis and newly acquired diagnostic platforms to ensure we are delivering best-in-class point-of-care diagnostic solutions. The increase in adjusted net interest expense and other income deductions is related to our 2018 debt offering, primarily used to fund the ABAXAS acquisition. Our adjusted effective tax rate for 2019 is expected to be within the range of 20% to 21%. The increase over 2018 is related to the impact of favorable discrete non-recurring items in 2018 and the impact of the GILTI tax, which is effective for us in 2019. We projected adjusted net income in the range of $1.65 billion to $1.7 billion, representing 8% to 11% operational growth. While we do not provide specific guidance on cash flow, we anticipate that in 2019 operating cash flow will decline compared to 2018. As mentioned previously, we have significantly decreased our inventory months on hand to be in line with industry norms which has provided a significant cash flow benefit in the last two years. In 2019, we expect to maintain our current levels of months on hand, and as a result, we will not have the benefit of a working capital release in our cash flow. In 2019, we also expect an incremental increase of approximately $100 million in capital expenditures for information technology and manufacturing to support our recent acquisition improved cost efficiencies, and increased capacity. In terms of our capital allocation priorities, we continue to focus first on internal, commercial, manufacturing, and R&D investments, then business development opportunities, and finally, returning excess capital to shareholders. We recently announced an increased pro-dividend for Q1 2019 of 30%, in line with our 2018 earnings growth, And we also announced the new $2 billion multiyear share repurchase program, resulting from our consistent performance, financial discipline, and the strength of our business model. Finally, we expect adjusted diluted EPS will be in the range of $3.42 to $3.52. Our range for reported diluted EPS of $2.83 to $2.99 includes purchase accounting, abacus acquisition-related costs, and certain significant items. I'd also like to remind you that while we take a long-term view of our business and prefer to focus on annual rather than quarterly results, there are some considerations I want to point out for 2019 within the quarters. The full year impact of the ABACSIS acquisition will have a disproportionate impact on growth across the P&L in the first half of 2019 and partially in Q3. In addition, foreign exchange will negatively impact growth in the first half of the year by approximately 400 basis points in Q1 and 300 basis points in Q2 in revenue. Now to summarize before we move to Q&A. 2018 was another strong year, delivering top-line operational growth of 10% and bottom-line growth of 31%, demonstrating once again that the WED is committed to delivering on its value proposition. We also remain committed to creating shareholder value, returning more than $900 million to shareholders in 2018 through dividends and share repurchases. We expect to continue delivering on our value proposition in 2019, driven by solid growth in our core business and increased contributions from the Legacy of Access portfolio of diagnostic products. Finally, in 2019, we will continue to invest internally and externally to grow profitably in the short, medium, and long term. Now, I'll hand things over to the operator to open the line for your question.

Operator? And at this time, if you'd like to ask a question, please press Star 1 on your touch-tone phone. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question. When posing your question, please pick up your handset to allow optimal sound quality. Thank you. We'll take today's first question from Michael Riskin with Bank of America Merrill Lynch. Please go ahead. Your line's open.

Thanks, guys. Appreciate you taking the call. Congrats on the quarter. A couple quick questions. First one, you talked about 5% market growth for the oil industry in 2019. I just want to go into that a little bit deeper, because in the past, we've seen something more in the five to six range. So I'm wondering what you're seeing there, if you could give a little bit more color on the dairy markets, cattle markets in the U.S., some of the swine issues we're hearing about internationally. And where I'm getting at with this is what should be our expectation for the in-line portfolio in 2019? You know, if you exclude a vaccine, if you exclude the dermatology portfolio, Semperica, what's the base portfolio doing in terms of volume and price? And then I've got a quick follow-up question on the margin expansion for 2019. Okay.

Thank you, Mike. I will try to cover some of the questions also. I will ask Glenn to provide some additional details on how we can see the growth, the line growth in 2019. So I agree that in previous communication I mentioned that we're expecting the market growth of 5 to 6. Since then, we have seen that the cattle market, especially in the U.S., in both beef and dairy, has been showing some weakness. And we expect that rather than 5 to 6, now we are projecting the total market growth of 5%. We still expect that the cattle business worldwide will be showing growth, but definitely a growth that will be below this 5%. The rest of the species, as I mentioned in my comments, companion animal and also swine, and poultry will be growing in line or slightly above the market and the only species that we see some market growth below the market will be cattle. Then moving into the details of the organic growth, as part of our guidance it's 4.5 to 6.5. You know, if Glenn can provide a little bit more details of how much will be price growth and also volume growth and new products. Sure.

So in terms of just the overall breakdown, it's really consistent with our long-term expectations. So price, you know, we expect to generate around 2% price this year. We're particularly strong with price at 3% for 2018 going to 2019, probably more in line with our long-term proposition of around 2%. New products, again, consistent, probably 1% to 2%. And then the remainder comes from the inline portfolio. We do consider Durham part of the inline portfolio as it has matured and has been on the market a number of years at this point. Also, in terms of your question on margin expansion, when you look at where we closed 2018, cost of goods sold as a percent of revenue was a little over 32%. Our guidance for 2019 is 31% to 32%. And we made significant progress in cost of goods in 2018, improving our cost of goods as a percent of revenue by over 100 basis points. So that leaves about another 100 basis points to deliver our commitment of improving cost of goods sold as a percent of revenue by 200 basis points by 2020. You'll probably see that spread between 2019 and 2020 in that attainment.

Thank you. Next question, please. And we'll go next to Kevin Ellis with Craig Hallam. Please go ahead.

Good morning. Thanks for taking the question. So I just wanted to start off on the cost structure. You know, it looks like, you know, some expenses this quarter came a little bit higher than were expected. And then, Glenn, you made comments about, you know, where you think things will line up in 2019 with increased investments in R&D. Can you just talk about some of the moving parts and, you know, given how good the year was for you in 2018, did you pull forward any expenses or, you know, how should we be thinking about that?

So, Kevin, in terms of cost of goods, you know, I'll emphasize again, you know, we had significant improvement this year of 100 basis points in improvement in cost of goods. For Q4, we did see elevated cost of goods, and that was really related to the impact of FX, also back this and higher inventory right up in the quarter. Really, the Q4 should not be viewed as a run rate for 2019. We have good visibility into our cost of goods, and we're confident in the guidance of 31% to 32% for 2019. As we look into 2019 from an expense perspective, consistent with what we've said, we are making investments in R&D. And R&D is growing more in line or closer to revenue, as we do have many projects that we're very excited about in our pipeline that we want to make sure that we fully fund. SG&A, when you look at the operational growth, is growing below revenue, even with the investments that we're making in a basis. Thank you.

Next question, please. We'll go next to Erin Wright with Credit Suisse. Please go ahead.

Erin Wright Great, thanks. Can you speak to the underlying performance at Abacus and how the integration is progressing in the longer-term cross-selling opportunity with the diagnostic portfolio? And then my second question is on Semperica Trio. Do you think there's a possibility that you're first to market there in that category, and how should we think about your competitive positioning there? and do you still feel confident in the 2020 timeline, and do you anticipate one or two review cycles from the FDA? Thanks.

Thank you very much, Irene. I will start with the comments on the abacus integration. Glenn will also provide some details of abacus performance, and then I will also talk about sympatica trio. In terms of ABAXIS integration, things are progressing in line or even in some cases faster than initially planned. In the U.S., both teams, ABAXIS legacy team in the field force and also our teams, are already working together. And as we communicated initially, the ZOETIS team is identifying the opportunities and also helping the other team also to identify customers to complete the sales. They will be also engaged in ensuring that we increase the use of consumables, and this will be an opportunity for future growth. We are working definitely that in the future will be not only the teams that are working together, but also the portfolio will be politicized. And this also is depending in some of the work that we are doing in terms of the SAP implementation for ABAXIS operations. We plan to do it in 2019. In international markets, we are also progressing really well. We have almost completed the hiring process of field force and also technical support. We still have some positions that will be completed in the next coming months, but this team is already working together with the field force team of Zoetis, generating the demand. In most of the markets, the supply to customers will be still done through third party distributors and in 2020 we'll be deciding if we keep distribution or we go direct in some of the markets. But definitely all integration opportunities or integration plans are progressing extremely well. We are also working on continue identifying opportunities in terms of R&D. And this is an area that also we are integrating the teams of cities in Kalamazoo, also in Denmark and Union City, all together are defining the future portfolio of zoetis in both companion animals and livestock. Glenn, do you want to give details of AVAX's performance?

In terms of performance for the quarter for ABAXIS, as we mentioned, we had $65 million in sales for the quarter. I want to remind you that ABAXIS was on a different accounting calendar, but however, if you do normalize the accounting calendars, that would translate to approximately 8% growth. Again, within the quarter, we did have some destocking to bring ABAXIS more in line with our overall levels of inventory with wholesalers. If you adjust for that destocking, the growth for the quarter is double digits. Also for the year, again, if you try to look at it on an apples-to-apples basis, the growth is double digits for the year with and without the destocking.

Thank you, Glenn. And then moving into the triple combo. So let me maybe provide a little bit of context. So when we launched Sympatica as a single agent, we were two or three years behind competitors, NASCAR and Brevetto. Now with the triple combo, we don't know it will be first, second to market, but what we did is significantly reduce this gap of two or three years, and then we expect that if FDA approval is coming in line with our filings and expectation to introduce this policy in 2020. So even if we are second to market, we'll be only second with a few months. different with the competitors, which is a significant improvement compared to the situation that we have with Simparica. And with Simparica, we have been able to continue growing patient share. In 2018, we increased patient share from 13.1 at the beginning of the year to 15.6 at the end of the year. So we are confident that with the efficacy and also the safety profile of Sympatica and the future efficacy and safety profile of People Combo, we have the opportunity to have a significant market share.

Next question, please. And we'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead.

Hi. Thanks for taking my question. So my question here is can you talk more about your pipeline as it pertains to the MAPs livestock diagnostic and aquaculture. When will some of these new products hit the market? Do they have the potential to be blockbusters or an aggregate to be blockbusters? And then just a quick follow-up on the triple combo, is that expected to be a blockbuster product for you as well? Thank you.

Starting with the easiest question, thank you, Louise. It's definitely triple combo. It's expected to be a blockbuster. Definitely Simparica is already a blockbuster, but we expect also that the triple combo will reach this status. In terms of the rest of the pipeline, definitely there are programs for livestock. These programs, there are a lot of programs that maybe in aggregate basis will represent a significant growth opportunity, but I will not describe these programs as probably in livestock as a blockbuster potential. But actually it will help us. First, to protect the current portfolio, and second, to bring innovation in livestock into the market. In terms of monoclonal antibodies for chronic red pain, we expect that this will have the opportunity of being a blockbuster, and we are convinced that the monoclonal antibodies for dogs and cats will represent a significant opportunity treating dogs and cats in a different way than there is today with NSAIDs, especially for cats, that there is nothing especially developed for these animals in terms of pain. But we also are excited about the opportunity of developing a monoclonal antibody for dermatology in cats. Again, it's an opportunity that we expect that will be coming in the next years. And this will be our portfolio also moving to another species with a monoclonal antibody. Next question, please.

John Krieger with William Blair. Please go ahead. Hi, good morning. This is John Kaufman on for John Krieger. So a couple questions on cattle here. You mentioned premium product sales in the U.S. Is that a trend that you foresee continuing in spite of market weakness? And then internationally, where are we in the cycle in some of the key markets? You know, looking out beyond 2019, can international growth more than offset U.S. weakness? And what are your expectations for long-term growth in this market? Thank you.

Well, definitely the U.S. market for cattle has been immediately driven by our premium products. Well, some of our products, they face competition during the year, especially when the situation of the animal was of lower risk profile. But we also have seen that in a risk situation, our premium products are the best products to protect or to treat animals. So we are confident that our products also will remain generating growth in the future. In the U.S., definitely we see the cattle business growing below market and maybe also growing below what we expected some months ago because we also projected daily recovering the second half of 2018. then we think that it will take even longer to see a recovery on the daily business. In the case of beef, I think there will always be cycles, animals moving into the feedlots sooner or later, but we don't see a significant change on beef. We're still predicting that beef will be slightly increased in the number of animals, only by 1%. but we think that beef will be probably in line with what we expected some months ago. We expect that the overall cattle business for Israelis will be growing in 2019, maybe growing faster in international markets than in the U.S., and as we said many times, the diversity of our portfolio in species and geographies. It's helping us to manage these cycles. These are cycles that we have been facing forever, and one of the things that not only our industry but also Zoetis has been very consistent, even in the face of changes, cycles, regulatory situations. very consistently delivering growth in line with the market or even higher in the last six years of Soetis as a public independent company. Next question, please.

We'll go next to John Block with Stifel. Please go ahead.

Great. Thanks, guys. Good morning. Maybe a couple questions, and I'll try to lump it into one long one. So, Glenn, the 150 FX basis point headwind, I thought you messaged maybe 200 to 300 basis points recently at JPMorgan, so I just want to see if I'm correct and what, if anything, has changed there. And then on that same question, does the midpoint of the 19 EPS of 347 imply any sort of a share repo? I think just trying to blow through your numbers, I get towards the lower end of the EPS. if I use the 4Q share count. And then just to pivot over to Abaxis, you know, when you guys bought Abaxis, they had a bunch of new products in their pipeline, a new urine sediment, blood gas, rapid assay. So just any more color you can give us in your control now for four or five months. How has the uptake been on some of these new products within their portfolio? Thanks for your time, guys.

So, John, so I'll address the FX question. So you are correct. When we were at JP Morgan, we did see a bigger impact of foreign exchange based on the rates that were applicable at that time. In terms of the guidance that we have today, we based the guidance based on FX rates as of the end of January. And as I mentioned, based on that, you know, there is 150 basis point impact. to um to revenue however if you look at the last few weeks the dollar has continued to strengthen and based on the rates that we see actually as of yesterday uh revenues would be negatively impacted by about another 50 million dollars and eps by a few pennies so this is currently not reflecting our guidance and something that we'll continue to monitor um the other question we had was in terms of the midpoint and share repo when we set our guidance range we really only assume that we'll offset dilution from compensation in terms of setting our guidance, but nothing additional.

And then on the question, so the focus that we have been in the last month since the acquisition has been to ensure that all the portfolio, existing portfolio, we're really meeting the needs and the quality that is expected from our customers. And one of the efforts that we have been doing significantly is to make sure that our equipment are connected to the practice management system and that really helping veterinarians to have a full integration of information from different equipment in the clinics. We have also been working on defining the priorities in terms of R&D focus. And we are progressing well. In terms of you asking also about new products, well, definitely the Flex4. It's working very well. We also are planning to introduce Flex4 in the international markets, including Canada and some other markets. And we will provide a little bit more details on the future launches as we are making progress in terms of defining all the priorities and all the problems that will be coming in the next coming years. So next question.

We'll go next to David Reisinger with Morgan Stanley. Please go ahead.

Thanks very much. I have, well, first of all, congrats on the performance. I have two high-level questions. The first is with respect to ABAXIS, we spoke with a consultant who suggested that it will be difficult for ABAXIS to displace IDEX at many US customers. Could you speak to that, your ability to knock IDEX out of US customers and drive placements of ABAXIS going forward? And then with respect to the FDA's assessment of heartworm drug efficacy and potential resistance concerns, could you just speak to where the FDA is in that process and whether the heartworm coverage that you're able to demonstrate to the FDA for TRIO will be at the 100% level or whatever level the FDA will require.

Thank you. Thank you, Dave. And, well, starting with the question of heartworm, definitely we have presented to the FDA all the support of 100% efficacy in terms of protection against heartworm. So what is the process of the FDA? It is something that probably we cannot comment. But we are confident that we have submitted all the data to support our efficacy and safety profile. We'll continue working with the FDA. It's a process. It's a process of submitting different information and also responding to questions, we are confident that through the process we will be able to introduce the product in 2020. About the question on can we gain share in the U.S., the answer is yes, and we are convinced now that Zoetis is competing with any competitor in the market on equal or even stronger conditions. In the past, AVAX was limited in terms of access to customers, and I mentioned that maybe they were meeting or visiting their customers once per quarter, compared to the other competitors having even more frequency than once a month. Now we have the opportunity to really be in front of our customers even more than once a month for our customers. And also very important, we have the opportunity also to combine all the diagnostic portfolio with our external portfolio of vaccines, parasites, germs, and so on and so forth, and also create a value proposition to the customers that it was not available at the time of vaccine. So I understand that there may be people that need to be convinced, but I hope and will be working hard to make them wrong in terms of the assessment that we cannot compete against IDEX.

Next question, please. We're going next to Chris Schott with JP Morgan.

Please go ahead. Great. Thanks very much for the questions. I guess first one was on Apoquil. I'm just trying to get a sense of where we are in the growth cycle here. So specifically, how much more growth potential do you see for the product in the US market? And when we think about the ex-U.S. opportunity, can you just give us a little bit more color about how uptick has trended relative to the U.S. and the markets you've launched and what are the biggest ex-U.S. opportunities that you're watching? My second question was on margin expansion over time, so beyond 2019. I know you've highlighted 19 to be an investment year with the BACs coming on board and the R&D investments. But when we look beyond 19, can we think about OpEx growth returning back down to the low single-digit levels? Or should we think about Zoetis in a period of, you know, a kind of multi-year period of OpEx investment as you look at some of these growth drivers? And so, again, this is beyond 19 as we think about the longer-term model. Thanks very much.

Thank you, Chris. Well, on Apple 12, and comments for the U.S. and also comments for international companies, In the U.S., we started the year with a patient share of 59% and we ended 63%. We still think that there are opportunities of growing patient share. Second, we still see opportunities for expanding the market. I will continue expanding the market or helping to expand the market with DTC campaigns. That will be the third year that we are investing to create this market demand. And third, we still see opportunities for pricing. So these three elements are probably supporting the growth in the U.S. for ApoCorp. Definitely lower growth than what we have seen in previous years. So the product has been in the market now for four years. It will be five years in 2019. So we should expect that there will be some reduction on the growth in the U.S. In international markets, well, the situation is slightly different. And I'm not talking about only Epoquel. I'm talking about the full DERMA portfolio, including Cytopoint. Cytopoint has been introduced in the market recently in some of the international markets. We expect growth. in the introduction of Cytopoint, we still expect growth for Apoquel. Definitely in terms of patient share, it's below the patient share that we have achieved in the U.S., and we expect over time reaching a similar level of patient share, although the number of medicalized dogs outside of the U.S. is lower than in the U.S. And finally, we expect in 2019 to introduce the problem in China. And again, China has been a market that has been surprisingly positive in terms of growth in companion animals. Now if I remember well, and then you can correct me if I'm not, so now China in terms of companion animals is the second largest after the U.S. and maybe It's another market, but second, third, it's in-company animals growing very fast, and we expect also that APOCOL will be successfully introduced in this market. Talking about margin expansion, do you want to cover this question?

Of course. So, Chris, there are a number of opportunities for us in terms of margin expansion beyond 2019. Just starting with positive goods and beyond 2020 and delivering on the proposition of delivering the 200 basis point improvement in 2017. As we look past that, you know, we should be able to continue to get improvements in our cost of goods as a percent of revenue. Really with cost of goods efficiency coming from a lot of the capital investments that we're making today, which we expect to pay off in the longer term in terms of improved cost of goods, and we'll continue to also get margin expansion from price. Looking at the OPEX lines, from a G&A perspective, we do expect general administrative expenses to grow more in line with inflation is we already have the infrastructure established in most of our markets. Selling will probably be more between the overall inflation rate and the growth in revenue, depending on the level of revenue growth that we have and new product introductions that we'll need to support. And then from an R&D perspective, that will really depend on the opportunities that we have. But that will probably grow more in line with the revenue than others.

Thank you, Glenn. Adding to the question on a portfolio of DERM, I already mentioned that one day we should be also facing competition. It's an area that Redis has created. It's not the first time that we are creating the market. We did it for Payne and now with DERM. But we are convinced that we have developed a significant portfolio in DERM. portfolio, which is showing a high level of efficacy, excellent safety profile, and will be also adding in the future monoclonal antibody for dermatology issues for cats. So we are confident that we have the opportunity of continuing growing. Always, we need to consider future competition in this space.

Next question, please. And we'll take today's final question from Kathy Minor with Cowan. Please go ahead. Your line is open.

Kathy Minor Great. Thank you for taking the question. One, just a brief follow-up on the dermatology area. And I apologize if I missed it, but did you give an update for your expectations for 2019 for dermatology, particularly as you've met or exceeded the $500 million plus for 2018? And the second question, just on M&A, does your 2019 guidance assume any small bolt-on acquisitions? And given that Abaxis is now on board, what would be the key areas we should watch for that there might be some interest in adding? Thank you.

Thank you, Kathy. And well, in terms of the sales, peak sales for our DEM portfolio, so in 2018, we almost reached $600 million. It was $593 million. We are projecting growth in 2019, but we are not now updating in terms of peak sales. We know that in the future we have competition in this space, so it's a little bit complicated now what is the full potential. We are convinced that we still have opportunities to continue growing. As I mentioned before, We also expect to add new products to our portfolio, monoclonal antibodies for cats, and maybe also working to ensure that we also apply lifecycle innovation to Apocwell to protect this franchise. And this can be in terms of formulations, in terms of expansion to other species, so it's something that we'll continue working on, lifecycle innovation. And you also asked if we are including any acquisitions in 2019 guidance, and the answer is no. So it's just our current portfolio, including AVAXIS portfolio, and what we describe now as organic growth, including AVAXIS. And definitely we will continue assessing opportunities in the market. We are convinced that we have the infrastructure, we have the expertise to integrate, and also we have the research of the customers. And we will continue assessing opportunities available in the market. And if these opportunities are meeting the criteria of strategic value creation and supported by the financials, we think that we have the cash possibility to go and acquire other companies. And I think with that, we conclude this session. So thank you very much for attending this call. Thank you for your questions. And with that, we close this call. Thank you.

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