Zoetis Inc.

Welcome to the third quarter 2019 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. If you would like to ask a question at that time, please press star and 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 Zoleta's third quarter 2019 earnings call. I am joined today by Juan Ramon Alikes, our chief executive officer, Glenn David, our chief financial officer, and also by Kristen Peck, our CEO-elect. Before we begin, I'll remind you that the slides presented on this call are available on the investor relations section of our website, and that our remarks today will include forward-looking statements and that actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statements in today's press release and our SEC filings, including, but not limited to, our annual report on Form 10-K and our reports on Form 10-Q. Our remarks today will also include references to certain financial measures which were not prepared in accordance with generally accepted accounting principles or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and in the company's 8K filing dated today, November 7, 2019. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Thank you, Steve.

Good morning, everyone. Today, you will hear a commentary on the market dynamics and quarterly results from me and Glenn. I am also pleased to have Christine Peck, our next CEO, joining us to share some remarks on her appointment and the future of Zeratis. At the end of the year, let me provide some context around recent market dynamics. The animal health industry in 2019 has been facing a challenging year for swine and cattle, while seeing very good performance in companion animal and poultry. We have seen a growing appetite in the companion animal market for spending on innovation in pet care. And we, once again, expect to grow much faster in the market in companion animals for 2018. Veterinarians are excited by the new products and life cycle innovations, giving them more advanced ways to assist pet owners with the skin conditions and parasites. Dermatology treatment continues to be a critical need. And Zoetis has been rewarded for the innovation we have developed in this space with a continued market penetration and a global expansion of our key dermatology products, Apoquel and CytoPoint. They are on track to achieve more than $700 million in sales for 2019. In recent years, Zoetis has also been strengthening its position in parasitic sites. This year, we added two new products to our parasite design portfolio. Revolution Plus to protect cats against ticks, fleas, and internal parasites, and ProHard 12, a one-year injection to prevent heartworm disease in dogs. Additionally, we are planning to launch Sympathica Trio in European countries and Canada in the first quarter. In the U.S., we expect the FDA to complete the review of Sympatica Trio at the end of the first quarter. If approved, we will launch shortly after. Based on these assumptions, we project to generate incremental global sales of Sympatica Trio in 2020 at around $150 million. In other areas like pain, alternative to existing treatments for dogs and cats represent a significant opportunity. And in the case of our cats, it is largely unmet need today. We are excited by the potential for our research programs with monoclonal antibodies in this area. As I mentioned in the last quarter, we initiated the filing process in the EU and U.S. for a new feline monoclonal antibody candidate to treat osteoarthritis pain in cats. And we recently also initiated the filing process in the EU and US for a canine monoclonal antibody candidate to treat osteoarthritis pain in dogs. If approved, we would anticipate these products coming to market in 2021. African swine fever, trade incentives, and weather conditions affecting mainly U.S. cattle are having a significant negative impact on the livestock market. As a result of this negative impact, we expect the overall animal health market to grow operationally between 3 to 4 percent in 2019, compared to 5.6 percent in 2018. As noted in our guidance, we expect to outpace the market with operational growth in revenue of 6% to 7%, and this excludes the positive impact of ABAXIS. Turning now to our third quarter results. We continue our strong performance with 9% operational revenue growth in the third quarter, driven by sales of our companion animal and poultry products. Our companion animal portfolio continues leading the way with a 23% operational growth based on strong sales of our parasiticides, our key dermatology products, and diagnostic portfolio. Diagnostic revenue from the Avaxis acquisition accounted for 2% of the overall growth. In terms of livestock, we saw an operational decline of 4%. Growth in poultry was 5%, but it was offset by declines in cattle, mainly due to lower feedlot placements in the U.S. and the impact of African swine fever in China. Our third quarter results demonstrate how our diverse portfolio and focus on meaningful innovations are driving our success. These trades remain the foundation of our consistent long-term performance. In the third quarter, we grew our adjusted net income by 10% operationally, and we continue to benefit from increasing revenue, improve growth margins, and moderate growth in operating expenses. We remain confident in our latest innovation, future pipeline, and core business to support future growth and deliver our 2019 guidance, which Glenn will discuss later. As we look ahead, we are making good progress with innovations and investment that will generate our future growth. As I said, we are preparing for the launch of Simparica Trio in European markets and Canada at the beginning of next year, with the product currently in production. Other regulatory reviews remain underway in Australia, Brazil, and Japan, with further submissions expected in China and Mexico. In the U.S., we have been expanding our field force to better support our growing companion animal portfolio, including diagnostic products, and in preparation for the launch of a sympatic atrio next year, once approved. We also continue to enhance our vaccine portfolios for livestock. In October, Zoetis received USDA approval for Pulvac Procepta HVTMD, the company's first vector vaccine for poultry. It will help to protect against both malaria disease and Newcastle disease. highly contagious infection for poultry. The product complements our market leading innovative vaccine delivery system for poultry producers. And it is the first in what is expected to become an important new global vaccine franchise for phloetis over the next several years, especially in international markets. We are also taking important first steps to address African swine fever, having reached a non-exclusive license agreement with the U.S. Department of Agriculture in late September. This agreement gives us access to three patents and materials related to African swine fever vaccine strains that will be incorporated into our research. While it could take several years to complete the development and licensing of a vaccine, a work with the USDA and other partners provides a comprehensive approach to addressing this infectious disease. In addition to new products approval and lifecycle innovations, Zoetis continues to support the future growth through business development activities. we announced the acquisition of Phoenix Lab, a Seattle-based reference laboratory that is highly valued by veterinarians for quality assurance and customer care. This is Zoetis' first entry to the veterinary reference laboratory space, and it is expected to further strengthen our overall diagnostic portfolio, building upon our 2018 approaches of ABAXIS, a leading provider of point-of-care diagnostic instruments. We view reference labs as another important part of our comprehensive diagnostic offering, and we plan to build our presence in reference labs over time through organic expansion and other small acquisitions in this space. Now, I would like to say a few words regarding our leadership transition. As we announced in October, I am retiring at the end of the year. It has been an amazing opportunity to build a company like Zoetis over the last seven years, and I feel very positive about Zoetis' future based on our proven strategy, hard-earned track record of execution, the diverse and innovative portfolio that underlies our success with customers, and the growth investment we are making for the long term. I am confident that our talented colleagues and management team led by our next CEO, Christine Peck, will continue to capitalize on the many growth opportunities ahead of Zoetis and create significant value for our company, customers, and shareholders. has been with the company since the beginning of Zoetis, and currently serves as Zoetis Executive Vice President and Group President of U.S. Operations, Business Development, and Strategy. Having worked with Christine for many years, I know that she's the right leader for Zoetis' next phase of growth and industry leadership. She is a strong advocate for our customer needs, a champion of her Zoetis culture and values, and an inspirational and collaborative leader for our people and industry. Her track record of strong performance through her tenure at Zoetis, as well as her operational experience, innovative strategies, and deep customer knowledge, positioned her well to drive Zoetis' continued growth. She will build on our long-term strategy, which she helped to develop, alongside with the rest of the Zoetis management team, and bring her own vision to leading the next stage of Zoetis' journey. I will remain an advisor to Zoetis during the course of 2020. And Christine and I are already working closely to ensure a smooth transition and maintain the momentum of our business growth. Before Glenn discuss our third quarter results, I have asked Christine to say a few words. Christine?

Thank you, Juan Ramon. I'm honored to be named the next CEO of Zoetis, and I look forward to leading our company into its next phase of industry leadership and value creation. I want to thank Juan Ramon for establishing Zoetis as the world's leading animal health company. I have deep respect for Juan Ramon and his track record of creating value for our customers and for delivering strong returns for our shareholders. His innovative mindset has kept Zoetis at the forefront of the industry. And I echo Juan Ramon's confidence in our company's solid foundation and prospects for continued growth. Sowetis has a diverse and innovative portfolio, deep expertise in animal health, and a winning culture shared by our talented colleagues around the world. We know how to partner with our customers to address their evolving needs across the continuum of care, from prediction and prevention to detection and the treatment of disease. We have a promising pipeline of new products and lifecycle innovations and we are focused on making investments in digital technology, data, and analytics that will fuel our future growth. As CEO, I will continue to drive forward with our successful long-term strategy. I will look for opportunities to accelerate our progress in the most meaningful areas for our veterinary and producer customers. and I'm committed to building on the strategies, diverse portfolio, and financial discipline that have been critical to our success. To that end, I've been working with Juan Ramon, Glenn, and the rest of the Zoetis team, as well as the board, over the last few weeks to ensure a seamless transition. As I look ahead, I continue to view animal health as a very valuable sector for investors. with steady growth prospects as the fundamental macroeconomic drivers of global population growth, urbanization, and a growing middle class in emerging markets will drive growth in both companion animal and livestock. The long-term history of animal health and Zoetis is a testament to the resiliency of our business. The drivers of pet care and animal agriculture are fundamental to the world economy and core to people's connections with animals for both companionship and nutrition. I am excited by the new opportunities for raising the standard of care with innovative new medicines, biologics, and integrations across the continuum of care. As I prepare for my new role, a key priority for me has been directly connecting with our stakeholders around the world to better understand their perspective on how we can build on our company's success. I look forward to engaging with many of you as part of this process and sharing more on our outlook for the market and plans for 2020 early next year. And now Glenn will cover the financials.

Thank you, Kristen, and good morning. Before discussing our Q3 financial results, I'd first like to congratulate Juan Ramon on his upcoming retirement and welcome Kristen as the next CEO of Zoetis. In his role as CEO, Juan Ramon has led our business through a remarkable transformation from a business unit advisor to an independent and publicly traded industry leader in animal health. He achieved revenue and adjusted net income growth well above the market during that period while managing acquisitions and a significant restructuring. And from a personal perspective, he supported me through my own transition to CFO during that time as well. I am very thankful to have worked with him over the past decade and appreciate that we will continue to benefit from his insight and knowledge as he remains an advisor and director on the board. I'm also very excited to work with Kristen as she transitions to her new role, building upon Zoetis' strong foundation and delivering the next phase of growth. Kristen and I have worked together at Zoetis for many years, and we share a commitment to customers, colleagues, and value creation that has driven our company's success. Now let's review the financial results. We delivered another healthy quarter with operational revenue growth of 9% and adjusted net income growth of 10%. These quarterly results, which build upon our strong performance for the first half of the year, give me confidence in delivering on our full-year improved earnings outlook. For the full year, we are narrowing operational revenue growth at the high end of the range, increasing operational growth for adjusted net income, and increasing and narrowing adjusted diluted EPS. Reported revenue growth for the third quarter was 7%, including a negative 2% impact from foreign exchange. Foreign exchange was primarily driven by the strengthening of the dollar against the Euro, Argentinian peso, and the Australian dollar. Operational revenue growth of 9% for the quarter is driven by 1% price and 8% volume. The volume contribution of 8% includes 3% from key dermatology products, 2% from new products, 2% from Legacy of Axis products, and 1% from other inline products. Breaking down our operational revenue growth by species, companion animal group 23%, partially offset by livestock declines of 4%. Compatible animal revenue growth was driven by our Parasiticide portfolio, including new products, Revolution Plus and ProHAR-12, key dermatology products, the impact of the Abaxis acquisition, and growth in emerging markets such as China. Excluding the impact of the Abaxis acquisition, compatible animal products grew 20% operationally. Equine also had strong growth in the quarter, benefiting from the acquisition of Platinum Performance, a nutrition-focused animal health company. Livestock product declines in the quarter were primarily driven by market weakness in U.S. beef and dairy sectors, the ongoing impact of African swine fever, and the revenue recovery of the Brazil truck driver strike that increased revenue in Q3 2018. These headwinds were partially offset by growth in poultry. Our key dermatology portfolio demonstrated continued strength this quarter with sales of $217 million, representing 27% operational growth. This was our first quarter with revenue greater than $200 million. Positive performance in this portfolio was driven by the ongoing expansion of the addressable market, increasing market share, and continued uptake of both Apoquil and Cytopoint into recently launched markets. As Juan Manuel mentioned, we are clearly on pace to exceed a combined $700 million in revenue this year. New products, especially Revolution Plus and Stronghold Plus, as it's known internationally, ProHard 12 and Swine Combination vaccines, contributed 2% to overall growth in the quarter. This growth is a net of cannibalization of the original formulations and highlights the success of our investments in lifecycle innovations. Sales and legacy of Axis products were $68 million in the quarter, representing 10% operational growth over the prior year per former revenue. Other inline products contributed 1% growth in the quarter, including Symparica, with $55 million in revenue and 28% operational growth. This growth was partially offset by declines in U.S. cattle and the ongoing impact of African swine fever. Now, let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 11%, with companion animal growing 26% and livestock declining 9%. Excluding the impact of the Abaxis acquisition, U.S. revenue grew 10%. Strong companion animal performance in the quarter was driven by growth of our parasiticide portfolio, key dermatology products, and the impact of the Abaxis acquisition. Excluding the impact of legacy Abaxis products, companion animal growth was 25%. Our parasiticide portfolio, including inline products such as Symparica and ProHard 6, and new products such as Revolution Plus and ProHard 12, which launched in the quarter, contributed to strong companion animal growth. U.S. dermatology sales were $154 million for the quarter, growing 28%. Growth this quarter was driven by market expansion, increasing market share, returns on direct-to-consumer investments, and price. Positive companion animal performance was partially offset by U.S. livestock declines in the quarter driven by cattle and, to a lesser extent, swine. Sales of our cattle products were negatively impacted by unfavorable market conditions in the beef and dairy sectors. Lower feedlot placements in the quarter impacted sales of our products, as well as pricing pressure driven by competition. While we continue to see good adoption and growth of the Forstera Gold swine vaccine, declines in other product sales led to lower swine revenue this quarter, primarily due to the timing of promotional activities. These challenges in cattle and swine were partially offset by continued growth in poultry, primarily due to sales of our portfolio of alternatives to antibiotics and medicated feed additives. In addition, we were able to capitalize on competitive challenges, including lack of efficacy and supply constraints. To summarize, the U.S. business had a very positive quarter with diversity and innovation driving results, despite challenging market conditions in the cattle sector. Our international segment also contributed to growth this quarter, with operational revenue growth of 5%. Companion Animal operational revenue growth was 16%, while livestock declined 1% operationally. Excluding the impact of the Abaxis acquisition, international revenue grew 4% operationally. Companion Animal product growth was driven by key dermatology products, the addition of legacy Abaxis products, and growth in emerging markets such as China. Excluding the impact of the Vaxxas acquisition, companion animal operational growth was 13%. International livestock declined modestly, primarily due to the impact of African swine fever, as well as an unfavorable comparison to the prior year, which included the revenue recovery from the Brazil truck driver strike. Growth in cattle and poultry partially offset the declines in swine, driven by favorable market conditions in key markets including Mexico, the UK, and Canada, while poultry benefited from increased sales in China, Australia, and Brazil. Now, I would like to review in more detail a few markets in the quarter. Beginning with China, revenue declined 9% operationally, driven by the ongoing impact of African swine fever, which was partially offset by continued double-digit growth in companion animal. Our livestock portfolio declined 40% operationally in China, driven by swine declines that were partially offset by growth in poultry and cattle. As I indicated last quarter, we expect the four-year impact of African swine fever to our revenue to be approximately $50 million. While the outbreak has continued to spread to other markets in Southeast Asia, our four-year estimate remains consistent. In the medium to long term, we continue to anticipate that other regions will increase exports of pork and other proteins. However, we have not seen increases in productions to any significant extent. Our companion animal products continue to grow significantly in China, increasing 43% operationally. Sales from parasiticides, vaccines, and apple oil were the primary drivers of growth, aided by fuel force expansion and effectiveness. Moving on to Brazil, sales grew 1% operationally, driven by companion animal growth of 17%, partially offset by a livestock decline of 5%. Companion animal revenue growth in Brazil was driven by our key dermatology portfolio, including Cytopoint, which launched in the second quarter, as well as growth in Simparic. Livestock declines in Brazil this quarter were driven by an unfavorable comparison to the prior year when sales were recovered due to the resolution of a national truck driver strike that occurred in Q2 of the prior year. In Mexico, sales grew 22% operationally, driven by livestock growth of 15% and companion animal growth of 46%. Livestock benefited from sales of our premium products for cattle while strong companion animal performance was driven by growth in legacy abacus products, parasiticides, and vaccines. Other emerging and developed markets also contributed to international growth this quarter, particularly in companion animal, driven by parasiticides and key dermatology products. Overall, our international segment continued to perform well, demonstrating the importance of our global diversity in helping to offset the impact of African swine fever. Now moving on to the rest of the P&L. Adjusted gross margin of 70.1% increased approximately 140 basis points in the quarter on a reported basis compared to the prior year. The increase is driven by foreign exchange, product mix, and price, partially offset by tariffs on certain products, and the inclusion of the lower margin legacy of ABAXAS portfolio. Total adjusted operating expenses, including the impact of the ABAXAS acquisition, grew 6% operationally. The increase is primarily related to compensation-related expenses and investments to support future growth of the business. The adjusted effective tax rate for the quarter is 20.5%. The increase from the comparable 2018 period is primarily related to the impact of the Global Intangible Low-Tax Income, or GILTI, tax, which is affected for Zoetis in 2019. Adjusted net income for the quarter grew 10% operationally, and adjusted diluted EPS grew 11% operationally, again outpacing revenue growth. The combination of revenue growth, improving gross margins, and disciplined operating expense growth enabled us to deliver strong bottom-line results while still investing strategically for long-term sustainable growth. Now moving on to guidance for the full year. As a result of our strong performance in the first nine months of the year, we are narrowing operational revenue growth at the high end of the range, raising operational growth for adjusted net income, and raising and narrowing the range for adjusted diluted EPS. Please note that guidance reflects foreign exchange rates as of late October. I'll now walk you through each of the individual line items, beginning with revenues. We are now expecting to deliver revenue between $6.2 and $6.25 billion as compared to our previous range of $6.175 to $6.275 billion. The dollar decrease in revenue guidance at the high end of the range is related to unfavorable foreign exchange. Operational revenue growth is now expected to be between 9% and 10% as compared to our previous estimate of 8.5% to 10%. reflecting the continuing momentum of our companion animal portfolio. Our organic operational revenue growth, which excludes the impact of the taxes, is now expected to be between 6% and 7%. We are now projecting adjusted cost of sales as a percentage of revenue to be approximately 30%, compared to our previous range of 30% to 31%. Adjusted SG&A for the year is expected to be between $1.525 billion and $1.55 billion, compared to our previous range of $1.505 to $1.545 billion. The increase in narrowing at the high end of the range reflects our focus on critical investments to support revenue growth, including promotional activity on key companion animal products. Adjusted R&D expense for 2019 is now expected to be between $445 million and $455 million for the year compared to our previous estimate of $450 to $465 million. The decrease is related to the timing of project spend. Our four-year adjusted interest and other income deductions is expected to be approximately $190 million and our four-year adjusted tax rate is expected to be approximately 20%, which are both consistent with previous estimates. Adjusted net income is now expected to be in the range of $1.72 to $1.745 billion, representing an increase of $10 million at the high end of the range. The updated adjusted net income range represents operational growth of 11% to 14%, compared to previous range of 9% to 12%. The improved outlook for adjusted net income is primarily driven by gross margin favorability. We're also increasing our adjusted diluted EPS to a range of $3.57 to $3.62 compared to our previous guidance of $3.53 to $3.60. Our range for reported diluted EPS is increasing and narrowing, now expected to be between $2.99 to $3.08, based upon operational increases. Our previously estimated range is $2.93 to $3.04. We expect approximately $450 to $475 million in capital expenditures this year, with increased investment in information technology and manufacturing to support our BACSIS acquisition, improve cost efficiencies, and increase capacity. We anticipate continuing at an elevated level for the next few years as we invest in manufacturing and infrastructure to support future growth and product launches. We also repurchased approximately $450 million of Zoleta shares in the first nine months of the year. We have $1.9 billion remaining under the multi-year share repurchase plan that was approved last year 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. While we will not provide guidance for 2020 until February, we view next year as a continuation of strategic investment to support recent and future product launches, our recent acquisitions, including Phoenix Lab and Platinum Performance, and other strategic priorities. Now to summarize, before we move to Q&A, we have consistently delivered strong top and bottom line growth in the first nine months of the year, despite market challenges in cattle and swine. We are narrowing our outlook for operational revenue growth at the high end of the range, and we are increasing and narrowing our outlook for adjusted net income and adjusted diluted EPS, reflecting the strong performance year-to-date. And our investments in R&D, diagnostics integration, manufacturing capabilities, and field force expansion will provide a solid platform for continued growth in 2020 and beyond. Now, I'll hand things over to the operator to open the line for your questions. Operator?

And at this time, if you'd like to ask a question, press star 1 on your touchtone 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 re-queue 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 our first question from Kevin Elich with Craig Hallam. Please go ahead.

Good morning, Juan Ramon. It's been great working with you, and I hope you enjoy retirement and get to play a lot of golf. Thank you. Chris, congratulations. We all know you're going to do a terrific job succeeding Juan Ramon. So, yeah, the questions I have. First, I think you guys talked about some paracatrio, saying that your assumption is if it's approved in the U.S. by the end of Q1, revenue would be about $150 million in 2020. Did I get that right?

Yes, the incremental sales that we expect for TRIO over our existing portfolio is $150 million.

And what are the underlying assumptions there, Glenn, in terms of pricing, how much will come from the U.S. versus international, and how much cannibalization?

So in terms of the breakout between U.S. and international, like we've said all along, we expect the majority of the sales for this product to be in the U.S., I don't really want to get into details on price from a competitive perspective at this point, but like we said, we do expect it to be priced at a significant premium to Simparica. And the cannibalization impacts, obviously there'll be some cannibalization to Simparica, but we also expect to take significant share from competition.

We'll take our next question from Louise Chin with Cantor Fitzgerald.

Hi, thanks for taking my question here. So Juan Ramon, we will miss you. And Kristen, congratulations on the new role. My first question is for you, Kristen. As the new CEO of Zoetis, what will you do differently from Juan Ramon? And then also just on 2020, I know you're not giving guidance until February, but how should we think about the pushes and pulls as we look into next year? Thank you.

Sure. Thanks so much, Louise. You know, I'm going to be focused on really continuing the strong path of value creation. If you look at the strategy that we've had over, because we IPO'd actually, it's delivered significant results both for our customers and for our shareholders. It has been a dynamic strategy that has always been predicated on continuous innovation and disruption, which I think is really what has helped us stand out. It's also been characterized by a great diversity of our portfolio. And my goal is to maintain that strong momentum, to stay ahead of competitors, you know i think if i look into 2021 and beyond i'm really going to be focused on innovation making sure we continue to bring to market products that really solve both our customers and animals challenges i will continue the relentless focus on our customer making sure that we're finding ways to make their jobs easier to do and to make them more productive And I'll be looking to better leverage digital and data, both to make us more efficiently internally as well as to drive better productivity and greater growth in some of our data and digital revenue products, both in diagnostics and in precision livestock farming. So that will be my focus as we look into 2020 and some of the sources of where I think you'll see our continued growth.

And in terms of the pushes and pulls for 2020, starting with the revenue line, we continue to see good momentum in our companion animal business, and particularly with the expected launch of some paracatrios subject to approval, we expect to see very strong performance there, as well as the continued growth in some of the new products that we launched this year, such as ProHard 12 and Revolution Plus. So again, also when you take into account the impact of African swine fever that we had this year, we would expect that to stabilize this year and not to be a negative detractor to growth in 2020, so that should benefit us as well. When we look at the expenses, obviously there will be some investments to support our new product launches. We want to make sure that we get those products off to a strong start, and also some investments to support the recent acquisitions that we have in place. So overall, we'd expect revenue to grow faster than the market, again, in 2020, and we'd expect that we'd be able to grow our income faster than revenue.

Thank you. We'll take our next question from Aaron Wright with Credit Suisse. Please go ahead.

Great, thanks. And Kristen, congrats. Juan Ramon as well. It's obviously been very, very nice working with you. I had a quick question on Semperica Trio, $150 million in 2020. It's a little bit higher, I guess, than what we were contemplating on a net basis. I just want to confirm some of the assumptions that you're making. Does it assume that you launch ahead of VMX? And does it assume that you'll be the only player in the U.S.? ? And does it also assume a puppy indication or other label caveats from a safety perspective? And then can you, a separate question here, but can you also speak to the diagnostic strategy in the reference laboratory market? I guess how quickly can you scale up the U.S. lab footprint and what are some of your plans internationally from a reference lab perspective as well? Thanks.

So Christine will answer all these questions, so please, Christine.

Sure. So starting with TRIO, we do not expect to be launching ahead of VMX and Western Vet, but we do expect to be launching ahead of the very important Q2, Q3 parasiticide season. So, you know, we will not be there, but I do think if you look at the $150 million, to your point, we still expect to deliver a very strong year there. We do expect to get a puppy claim. That is one of the assumptions that is in there. It's obviously subject to FDA approval, but that is our going-in assumption as we look at that. So as I move towards reference lab, you know, we continue to believe that diagnostics is an important part of our go-forward portfolio. It is critical to the vet and is a part of their business that will stay there. We think it enhances Zoetis' current value proposition and is a great complement to our existing portfolio. It's a large and very fast-growing market. As the market has been growing at 10% plus, we strongly believe that it can accommodate a third player. We also know that customers have been looking for a third-party alternative. And if you look in different MSAs, shares of third parties have actually been significant. As our acquisition of Phoenix demonstrates, they had an over 50% share in the MSAs they operated in. Our plan in this space is to invest both organically and inorganically over the next few years, and we remain committed to the space.

Next question, please.

We'll take our next question from Christopher Schott with JP Morgan.

Please go ahead. Great. Thanks very much for the question. I guess my first one just was on Apoquil and Cytopoint XUS. Can you just provide any additional color in terms of where penetration rates stand in some of the bigger markets in terms of Europe, Brazil, etc., and where you think those penetration rates can go over the next several years? And my second question, sorry to keep coming back to this $150 number, but I'm still not quite clear. Can you help me understand again how much of that $150 is incremental revenue on top of what your parasiticide business is already doing as compared to erosion from, I guess, legacy simperica and some of your heart products, et cetera? I'm just trying to understand the magnitude of overall growth I should be thinking about for parasiticides next year. Thank you.

Thank you. Glenn will provide some data related to the penetration rates and also details of the 150, how much is cannibalization, how much would be additional revenues.

So when you look at Apoquil and CiderPoint, particularly in the U.S., we see that we have plus 60% share in that market. The data internationally is not as clear in terms of we don't get the same level of data, but we know we're not at that penetration rate. Also, we've launched CiderPoint later international than we do in the U.S., so we do think we have continued uptake there. So we do see significant opportunities international to continue to gain share as we move up to the similar levels that we have internationally. in the U.S. We also see continued opportunity in the U.S. as we continue to expand that market and raise disease awareness of dermatology and atopic dermatitis. So we see continued opportunity in the U.S. as well. In terms of the $150 million in revenues for Simparica Trio, I want to be clear that is incremental sales over what we see for Simparica alone, and that does include the cannibalization effect. So we would expect greater sales of Trio than $150 million as a standalone product.

Next question, please.

We'll go next to Michael Riskin with Bank of America. Please go ahead.

Thanks. And I want to mirror the earlier comments. Congrats, Juan Ramon. It's been great working with you. And, Kristen, I look forward to working with you going forward. Thank you, Mike. Two quick questions for me. One, on some of the moving pieces in the quarter and sort of looking forward, I would say one of the bigger surprises this year has been in the entire market, not just soda specifically, but some of the challenges in U.S. livestock, particularly given the negative tone of ASF internationally. There's an expectation that you would see at least some stabilization in U.S. livestock in the market in cattle and swine, and it's been a little bit slow, probably slower than expected this year, you know, if you look back nine months earlier. How do you see some of these dynamics playing out? You know, we talked about ASF internationally, but if you think about the cattle herd in the U.S., some of the feedlot pressures that we've seen this year in terms of placements, you know, if you could talk thematically sort of over the next six, 12 months. And then a quick follow-up on the seasonality question. You talked about the Simparica Trio approval, you know, likely end of 1Q, early 2Q launch. Could you talk about sort of the timing that you think about the vet purchasing? A lot of the ordering by vets happens relatively early in the year. So how much wiggle room do you have built in and how quickly can you ramp up manufacturing to make sure that you don't miss that flea and tick season, you know, if there's a month or two movement either way there?

Let me answer the question on Simparica Trio and then... Christine will cover the trends and also the challenges that we have seen in the U.S. livestock. And we'll also talk about the African swine fever. So we expect approval in late first quarter from FDA. And then, shortly after, we launch the product in the market. We are taking already the appropriate steps to ensure ample supply of the product as soon as we obtain approval in the U.S. So we don't think that the supply will be a restriction in terms of capturing the opportunities of the high season. that it's mainly in the Q2, followed with Q3. We are confident that with all the effort that we are making now, if the product is approved by the ADA, we'll be able really to generate a significant opportunity for Sympatica Trigger in 2020. So moving into the U.S. livestock, Christine?

Sure. As you saw in our numbers, both dairy and beef in the U.S. continue to be weak. As we've said in previous conversations in previous quarters, we expect this to continue for the rest of the year and into next. From a dairy perspective, we've seen depressed milk prices versus historical trends, which has limited producer profitability some. In the last few months, there has been a small improvement in pricing, but it's not yet sustained enough, we believe, for producers to believe recovery is imminent and to start investing significantly. On the beef side, we're at the end of what's been a very long expansion period. So we are expecting a little bit of contraction or flattening out over the medium term. As you look at beef, there's also been a lack of innovation that has driven significant pricing and competitive pressures. You know, we had a wet spring, which had good pasture this year, which has kept cattle out longer. And as you've seen, there's been a significant increase in some of those feeder prices and live cattle prices, which has encouraged them to wait until their animals were heavier and older to put them in the feedlot. So as we look at U.S. cattle, I think we'll continue to see challenges of theirs as we look into next year. And as we look at ASF, as we've spoken at previously, you know, we believe with China specifically, we see about a $50 million impact across Zoetis, primarily based out of China. As we look into next year, we're hoping for that to stabilize, and we're hoping to see some recovery, moderate, but obviously that remains to be seen based on how that goes. But we do see offsets for the China swine. We are expecting imports from EU, Brazil, and the U.S., both in swine as well as across other proteins to help compensate that. We've seen significant price increases in pork globally. We see Brazil and EU probably best positioned to take some of this, but I think overall we've seen some of the announcements in the U.S. The U.S. will also go after trying to get greater share there. So we remain, you know, quite committed. But I think we believe that the impact of ASF should, you know, flatten out as we look into next year. So hopefully that answers that.

Next question, please.

We'll go next to John Krieger with William Blair.

Please go ahead. Hi, good morning. This is John Kaufman on for Krieger. Juan Ramon, we wish you well. And Kristen, congrats on the new role. You know, one of your competitors has talked a lot recently about the importance of alternative channels. Can you guys talk a little bit about that? You know, how important are the online and the and the mass market retail channels for you today. How has your strategy evolved here over the past year or so? And as you think about the future outlook for the company, how much of the growth do you think will come from these alternative channels? Thank you.

Well, we have seen, John, changes on how pet owners are getting their products from different channels. We have seen that mainly in the U.S., but also in some other markets there are changes that really are having an impact into the veterinary space. But Christina will provide much more color on how things are changing in the U.S., Are these affecting the market, affecting manufacturers, affecting veterinarians? So Christine, do you want to provide these comments, please?

Sure. I would start with, if you look at our portfolio as it contrasts with others, the majority of what we sell requires a prescription. So our goal is to work with vets to make our product available to pet owners in a way that works best for them. What we've seen is in the area such as parasiticides and chronic medications, many pet owners have looked more to buy their products from e-commerce and retail. And as such, we've evolved our own strategy to work more directly with e-commerce and retail. We implemented, as we discussed on previous calls, the minimum advertised price or MAP pricing, which is an agreement with all e-commerce and retailers to ensure that they cannot advertise our product beyond a certain price. This has allowed us to legitimately sell our product, eliminate some of the gray market, and provide veterinarians and pet owners the convenience to fill their prescriptions where and how they want. This, I think, is an evolving thing. Just to give you context, still 50% to 50% of what we sell will have to remain no matter what in the clinic. It's definitely expanding quickly, but still on a relative basis, it's still a small part of our business today. It's something we're monitoring closely, and, you know, we're making sure that we continue to develop and enhance our capabilities to best serve this new channel as we move forward.

Next question, please.

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

Thanks, guys. Good morning, and Maybe just a handful of small questions. Most are actually just clarifications. So first, clarification for companion animal. Did you guys say both canine and feline MABs both targeting U.S. approval in 2021? A clarification for ASF. I was a little mixed up there. Is the thought that the drag for 2020... will be less than the $50 million incremental hit in 19, but you still think there could be additional incremental headwinds for 2020. And then lastly, but not going to 2020 guidance on you, but just when we think about that COGS and sort of hitting that 70% bogey for 2019, which is certainly impressive, I would think you're still going to have a favorable mix shift in 2020 as Companion grows faster than Livestock based on all the commentary, but do some of the investments in manufacturing offset that? Thanks, guys.

Thank you, John. Well, let me confirm that we have a file, both monoclonal antibodies for pain, for cash and doxin. EU and the US, and we expect launch in 2021 of these two products in the US. Moving into the African swine fever, well, the assumption that we are making and the comments that we provided today is with assuming that there will not be a further spreading of African swine fever outside of China. We have seen cases in Southeast Asia, Korea, the Philippines to a lesser extent also in Eastern European markets. But what we expect that customers now are improving biosecurity and they are protecting better against the African swine fever. We are not expecting China to continue growing in terms of cases. Maybe an opportunity to slightly increase in production in China. And definitely we see the opportunity in other markets to compensate the gap that we have in terms of supply of meat into the Chinese population with more importation from Brazil, European Union markets, Spain, Germany, and some other markets, Canada, and the U.S. And this is something that, in our opinion, will help also to generate the growth in livestock in 2020. So moving into the third question in terms of gross profit, Glenn, you want to cover that?

Yeah, so John, your thoughts on gross margin are accurate. When you look into 2020, there should definitely be a favorable mix impact as we would still expect companion animal to grow faster than livestock in 2020. Just one thing to note on that, you know, TRIO being the first year of product launch would not be as favorable to gross margin as the rest of the companion animal portfolio would typically be. Over time, we do expect... you know, that product to have very favorable margin. But with the first year of launch, there's always learnings and efficiencies that will be delivered over time. The other thing to take into account is that FX had a very positive impact in 2019 to our overall gross margin. We would not expect it to be positive in 2019, probably be somewhat of a detractor in 2020. Thank you.

Next question, please.

We'll go next to David Westenberg with Guggenheim Securities. Please go ahead.

Hi, thanks for taking the question, and I echo the congratulations. So just in terms of market sizing, can you help us size the market for the cat opportunity, given that there is no existing market? Just any sort of frameworks that we can think about in terms of maybe population, age, et cetera. And then secondly, a competitor called out the African swine fever vaccine market as a multi-billion dollar market. Can you maybe give us... a framework on the size of that as well. Do you agree with that assessment? What are the puts and takes there? Thank you.

Okay, so let me provide some comments on the market size for CARs in molecular antibodies. So first, there is not any specific product today in the market developed specifically for CARs. We know that the number of CARs It's lower than the number of dogs and even more, the number of medicalized cats is even lower than the number of medicalized dogs in the U.S. and also worldwide. If I compare the market of dogs in terms of managing pain, it's about 400 to 500 million dollars worldwide. So with the comments I made in terms of medicalization rates and the number of cats, we should expect that the market potential for cats in pain is lower than this 400 to 500 million. But the advantage is that we'll be entering into a space that there is not any clear product addressing pain in dogs, and we think that we can generate significant growth opportunities in this area. Then how big is the African swine fever market? I don't know if the question is related of how much has been the impact on the African swine fever or the vaccine. Well, I think it's something that is to be seen because definitely we see a significant opportunity in China developing this vaccine, but also not only in China that we have already the disease, but also the need to protect African swine fever in other markets. We are convinced that this can be one of the top vaccine products worldwide. more than FMD or even more than PCV2. So the opportunity for developing a vaccine in this area is significant. Next question, please.

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

Thanks very much. And let me please add my congrats to you both, Juan Ramon and Kristen. So, my two questions are, first, with respect to U.S. tick, could you help us understand what percentage of the U.S. dog market needs tick coverage? Obviously, there are no ticks in the South. I just don't know what percentage of dogs reside in tick-infested areas in the country. And then, second, could you comment on livestock pipeline launch opportunities in the next year or so. Thank you.

Sure. If you look at U.S. tick coverage, there is significant tick coverage across the United States. There are different ticks. So in the south, you might see more of the Gulf Coast tick, which is actually a very difficult tick to treat, versus the Ixodes tick or the deer tick in the north. So we do believe that most pets in the United States need a comprehensive tick protection. There may be some geography where there's not a lot, but I think there may vary the ticks. But lean tick protection is critical, we believe, across the U.S. As we think about our livestock population opportunities, as you saw in the press release, we are quite focused on driving innovation across livestock. We announced a partnership with Colorado State to look at antibiotic alternatives in the livestock space. We're also really focused on immunotherapies in livestock as alternatives to antibiotics and are excited about some projects there as well. We're also looking at precision livestock farming to make producers more productive and to better predict animals that are going to get sick. We're also excited in the area of genetics, where we can breed healthier animals that are also more productive. And as we've talked about in previous calls, looking through diagnostics to bring more shoot-side, farm-side diagnostics across that. Thank you.

Next question, please.

We'll go next to Navin Jacobs with UBS. Please go ahead.

Hi, this is Prakhar on for Naveen. I have two questions, first on Semperica Trio. One thing we are hoping to get more clarity on is around duration of therapy. So tick-free products are more seasonal, which is not typically the case with heartworm products. So how are you thinking about the duration of therapy for Simparica Trio? Do you expect this to be predominantly used in the tick-free season, or could duration of therapy be more? And secondly, on Abaxis, you've talked about expansion into OES markets as a key opportunity. So could you provide an update on the expansion plan and have you identified target markets or regions that might be ideal? And longer term, could ABAXIS reach similar size in international markets as the U.S. market? Thank you.

Thank you very much for the two questions. Let me answer the duration of therapy. One thing is that what should be the duration of therapy? We believe it should be in many of the markets at home. And what is the actual duration of therapy? That is probably three or less months. So it's a significant opportunity in terms of compliance. And we may see some high season for ticks and fleas, depending on the warmer weather. But the need to protect animals goes across the year. And definitely in the case of a heartworm, it's a 12-month need of protecting against this type of disease. And I'd like Christine to talk about abacus expansion plans, both U.S. and international.

Sure. When we announced the AVAXIS deal, we talked a lot about the fact that we think we can continue to operate the AVAXIS business in the U.S. much better and drive more efficiencies and drive growth, but acknowledge that the competition in the U.S. is a little steeper. As we look into international, we strongly believe in international. There are significant growth opportunities. It's more of a blue ocean with a much more fragmented base. The use of diagnostics also varies dramatically by market. We're very focused on building our own direct demand generation field force, which has really been lacking across most companies that operate at international. We've looked at 2019, as we've talked about, for Abaxis as a platform year to really establish ourselves there. And we plan to move to direct distribution from some of our existing distributors across most markets as we look into 2020. So we do think there's a significant opportunity in Abacus to reach a similar, if not higher, share than we have in the U.S., just given it is a less mature market with much more fragmentation. But it will require a market-by-market approach.

Thank you. Next question, please.

We'll go next to Nathan Rich with Goldman Sachs. Please go ahead.

Thanks for the questions and let me also offer my congratulations. On the triple combo, have you guys gotten feedback from the FDA just on where they are in their review process and kind of what is driving your expectations for maybe a little bit later of an approval than you originally expected? And then can you also talk about the timing for submission and when you would expect approval for the triple combo in China and some of the other geographies that you mentioned like Mexico?

Let me make some comments about the process of approval in the U.S. There is something which is part of the normal process of questions and answers. We get some additional requests for information from APA, not related to safety or efficacy, And we already answered these questions. And now we are waiting for the feedback. And we expect the final decision on Sympathica Trio by late first quarter next year. But that is something that is part of a regulatory discussion with many of the regulatory authorities across the world. We said before that we were expecting approval and launch in the first quarter. We have already obtained approval in Europe and Canada, and we are launching at the beginning of the first quarter in these markets, and we'll be ready for launching shortly after approval in the U.S. As I said, we are already taking the steps to have ample supply to meet market needs in 2020, always based with the assumption that we provided today of these 150 additional revenues in the forsyth barricade field. And then you also ask about approval time in China. This unfortunately is something that at this point is difficult to answer. We are preparing the filing in China. And then after the filing, probably we'll get a little bit more clarity on the timing expected to launch in this market. So first, we need to launch Simparica as a single agent in China. And then also CyclePoints, that is another important product that we plan also to launch in China. And then later we'll be launching Simparica 3.0. Even if it would take maybe some years, we have products coming into the market in China that will generate very positive growth momentum in this market. Next question, please.

Next question is from Kathy Minor with Cowan & Company. Please go ahead.

Thank you. First, again, Juan Ramon and Kristen, our congratulations to you both. Just a couple questions. First, on the canine products, pain mab that you filed, can you tell us if that is the compound that you acquired from Nexvet a couple years ago? Second, I noticed that aqua or the fish sales were down 9% this quarter, and that's somewhat unusual. That's been a growing market. Is that something temporary, or is there a change in the outlook? And last question, just when we look at African swine fever, it I think took everyone by surprise. Are there any other diseases that you're monitoring that could impact your business over the next three to five years? Thank you.

Thank you for the question. So let me start with answering the question about the monoclonal antibody for dogs. So we have multiple programs in our IND activity. The product that we are now planning to launch is an internal program for dogs. The one that we are planning to launch for cats is coming from NextVet. You also asked about the decline in the quarter related to fish. Well, we have been growing very fast in previous years in fish. This year, we had some challenges related to the PDE vaccine. in Norway. We expect that it's a temporary adjustment, and we expect fish to continue growing faster than the overall animal health market. The long-term opportunities in fish is related to adding new vaccines to protect other species different than salmon. Today we have most of our revenues concentrated in salmon in Norway and Chile, but we expect to continue developing new vaccines to protect animals different than salmon and to reduce the use of antibiotics, which is today the only treatment or the only protection against infections for species like pengasus or tilapia or other fish. Definitely, we continue investing in fish, and we are confident that fish will be a growing opportunity in the future. Next question, please.

We'll go next to Greg Gilbert with SunTrust. Please go ahead.

Thank you. Good morning. A couple longer-term ones for Kristen. Clearly, Zoetis is a leader overall in the industry, but is there an area or areas you'd like to see Zoetis be more of a leader than it is today? And secondly, On the companion side, Kristen, do you think pet owners are anywhere close to maxing out on what they can afford or what they choose to afford in caring for their pets? I realize fleets take hardware, and it's not in this category, but thinking three to five years plus down the line, expensive biotech products, et cetera, maybe you could just comment on that longer term. Thank you.

So let me answer the first question, and then, Kristen, we'll cover the second. So when we see that we can improve our market share and becoming a stronger leader or becoming leader. And in this call, we announced that we obtained approval of a new vaccine for palsy, which is related to vector technology. It's an area that we believe that will be a growing opportunity for us. We are starting there with one vaccine, but the objective is to develop a complete set of vector vaccines to cover multiple diseases in public. And this will help us then also to maximize opportunities with our leadership in our JETSA vaccination, which is the machine that is used in hatchery to protect chicken before hatchery. So we are injecting eggs, and we see an area where we are less The second area in where we think that we have been improving significantly since the launch of Simparica followed by the launch of erosion plus ProHAR 12, it's parasitic sites. And we expect also with the launch of Simparica Trio to become a much stronger leader in parasitic sites than today.

Sure. I can go to the pet spending question. You know, we've seen increases over the last few years in the spend per pet. I think a lot of that has to do with the demographic shifts in developed markets where people are having fewer children and spending more time with their pets. Millennials in particular are much more engaged with their pets. As we've spoken about, the increase in pet spending starts when they move from their backyard to your house and then ultimately to your bed. So we don't see any end in this market. It's been a very resilient business. Even in times of economic challenges, people have continued to spend on their pets. So we don't see right now any indicators that that spending per pet would be going down. So I think it remains a strong market as we look to the future. And if you look at the urbanization and the emerging middle class and emerging markets, we see significant growth there as you add more markets that keep more pets and medicalize more pets.

Next question, please.

We'll go next to Kevin Ellis with Craig Hallam. Please go ahead.

Oh, thanks. So one quick one. You know, thinking about African swine fever in a different way, down the road when it's time to repopulate the herd, just wondering how much benefit that could bring to Zoetis, your presence in genomics and genetics?

Sure. If you look at repopulation, I mean, eventually China and some of these other geographies will repopulate. We believe when they do, they'll move more to industrialized production and more away from the small backyard farms. We think that does play to the strength of innovative companies like Zoetis. So we do see the future of African swine fever as it goes down, meeting more technologically-based production, which we think will be an increase for us. And certainly, if we're able to create a vaccine for African swine fever, there'd be even more increase for it.

Next question, please.

And there appears to be no further questions. I'll return the floor to Juan Ramon for closing remarks.

Thank you very much. This will be my last earnings call. I want to thank you, all of you, for the support you have given to me and Zoetis over the last seven years. It has been an amazing journey, and I'm very proud of the value that we have created. I know that you will enjoy the same ongoing commitment to our valuable vision from Christine, Glenn, and the rest of our leadership team. as they take Zoritis into the next phase of growth. In closing, I remain confident in the bright future of Zoritis. This company and its people have the capabilities, experience, and customer focus to continue delivering world-class results for our customers and shareholders. Thank you very much.

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