Zoetis Inc.

Good day and welcome to the fourth quarter and fiscal year 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. 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 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 and zero. It's now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Thank you, Keith. Good morning, everyone, and welcome to the Zoleta's fourth quarter and full year 2019 earnings call. I am joined today by Kristen Peck, 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 statement 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 US GAAP, A reconciliation of these non-GAAP financial measures for 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, February 13th, 2020. We will also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristen.

Thank you, Steve. Good morning, everyone. By now, you've read our press release and financial tables on the Zoetis website, so it'll take just a few minutes to recap the full year, talk about our outlook for 2020, and outline some of the long-term investment plans and growth opportunities we see for Zoetis. Our CFO, Glenn David, will then cover the fourth quarter and I'll throw your guidance for 2020 before we open the lines up for your questions. So let's get started. Zoetis delivered another year of strong growth and market leadership in 2019, thanks to our diverse and durable portfolio and our commitment to continuous innovation. We grew revenue 10% operationally, which includes about 2% of growth from the abacus acquisition. This is once again above the market growth for animal health, which is expected to be about 3% to 4% for 2019, reflecting the negative impact of African swine fever. we grew our adjusted net income faster than revenue at 14% operationally, continuing to achieve our goal of growing profitability faster than revenue over the long term. In terms of other elements of our value proposition, we achieved several new approvals in areas that will strengthen our traditional portfolio of parasiticides and vaccines, and we invested in critical acquisitions and partnerships that will accelerate our growth in areas where we are expanding, such as diagnostics. For example, we received approvals for new parasiticides such as ProArt12 in the U.S. and Semperica Trio in the EU and Canada. We are enhancing our vaccine portfolio with new products like Versacan Plus BB Oral, the first oral vaccine for dogs in Europe, and Polvac Preserta HVTNB, our first vector vaccine for poultry. We also continue to invest in building our overall diagnostics capabilities with acquisitions in the reference lab space, which will give us a more holistic offering to veterinarians. And we've expanded our equine and pet care portfolio into nutritional formulas with the acquisition of Platinum Performance, a premier leader in this market. Finally, in terms of our commitment to returning excess capital to shareholders, we generated a 2019 quarterly dividend of 16 cents per share, an increase of 30% from the 2018 dividend rate, and we completed approximately $625 million in share repurchases. We've built a strong record of delivering on this value proposition for shareholders over the last seven years. And I'm very confident we can continue on this path of long-term growth and value creation based on the capabilities, colleagues, and customer focus we bring to every market opportunity. Looking ahead now to the rest of 2020, animal health remains a steady and reliable market based on people's increasing commitment to their pet's health and based on the steady demand for safe and affordable animal proteins. For 2020, we currently expect the overall industry to return to growth of approximately 4% to 5%, excluding the impact of foreign currency. The market took a dramatic hit in 2019 from African swine fever in China, with at least a 50% reduction in herd size, according to reports. While this disease had a significant impact on our business in China last year, we see early signs of stabilization and the opportunity for the industry in terms of farms consolidating, investments being made in better infrastructure and biosecurity, and the frozen pork supply being reduced. As the global pork market and trade picture sorts out more in 2020, and with increased export opportunities for many markets, we could see the overall animal health market return to slightly better growth rates. In terms of species, the swine market should be below the overall market growth for 2020. The companion animal and poultry markets are expected to be somewhat above the market growth, and cattle is expected to be a little more limited than the market, based on the continuing challenges faced by beef and dairy customers. For zoetis, we expect to grow faster than the markets for companion animal and poultry, and in line with the cattle market. For the swine market, we would expect to be in line or faster than the market, depending on the pace of recovery from African swine fever and its impact on additional markets this year. In terms of our guidance for 2020, Zoetis expects to grow revenue significantly faster than the industry, in a range of 7% to 9.5% operationally. And in terms of adjusted net income, we expect operational growth in the range of 8% to 11%. To meet our goals for 2020, we will continue supporting our latest product launches and lifecycle innovations with direct-to-consumer advertising and the recently expanded pet care field force in the U.S. And in international markets, we're focused on supporting new products with field force expansions in certain markets and differentiating ourselves with a focus on direct field force's effectiveness and technical expertise. We will also continue investing in other accelerated growth areas such as diagnostics, genetics, precision livestock farming, and digital and data analytics. This will be an important year in diagnostics as we complete the integration of our systems and look to accelerate sales growth with more integrated offerings of medicines and diagnostics, an important way we can deliver more value to our customers. And we will continue advancing our pipeline with investments in parasiticides, vaccines, monoclonal antibodies, and other therapeutic areas. The Laudis and Perica Trio, our triple combination parasiticide, is highly anticipated for 2020. And we remain confident in a U.S. approval in the fourth quarter with a launch shortly thereafter. As we have said recently, we completed the technical sessions of the Semperica Trio package for the U.S. and are currently in the administrative review, awaiting a final approval. We have already received approvals for Semperica Trio in the EU and Canada, and we expect the Semperica Trio launch in Europe to begin in certain markets this month, as we take a phased approach to the launch there. Based on these assumptions, we continue to expect to generate incremental global sales of Semperica Trio in 2020 at approximately $150 million. I am energized by the opportunities ahead of us in 2020. We have a vibrant and growing companion animal portfolio driven by internal innovation and more to come with Semperica Trio. We are delivering steady performance across our livestock products, despite the market challenges some of our customers face from economic conditions, emerging infectious diseases, and natural disasters. We're partnering with our customers in innovative ways to help them stay ahead of the curve on evolving technology, new commercial opportunities, and shifts in consumer trends. We are building out our capabilities in digital and data analytics to bring meaningful solutions to the challenges facing their farms and clinics. and we are executing on a strategy for growth with internal and external investments that have us well positioned for long-term growth. I look forward to carrying on the company's successful formula of customer focus, innovation, and execution as we continue to deliver on our long-term value proposition to shareholders. Now, I'll hand things over to Glenn.

Thank you, Kristen, and good morning. As Kristen indicated, we had another exceptional year with revenue of $6.3 billion and adjusted net income of $1.8 billion, with both top and bottom line exceeding the high end of our guidance ranges for the year. Reported revenue growth was 7% for the year, including a 3% unfavorable impact from foreign exchange, which was driven primarily by strengthening of the dollar against the Euro, Brazilian Real, and Argentinian Peso. Operational revenue growth of 10% was driven by a 2% price contribution and an 8% volume contribution. Volume growth included 2% from the addition of legacy of access products, 2% from our key dermatology portfolio, 2% from new products, and 2% from our other inline portfolio. Revenue growth through the year was broad-based, with the U.S. growing 11% and international growing 9% operationally. Companion Animal led the way in terms of species growth, outpacing livestock for the year. Revenue from our key dermatology portfolio, our diverse parasiticide portfolio, with several new launches this year, and legacy of access products, drove Companion Animal operational performance of 23%. Livestock declined 1% operationally for the year, impacted by the outbreak of African swine fever in China, and challenging beef and dairy cattle market conditions in the U.S. Our poultry and fish product portfolios continue to grow, partially offsetting the cattle and swine headwinds. Operational growth and a jump in net income of 14% was driven by strong revenue growth and gross margin favorability. Now moving on to our Q4 financial results. We had solid performance again this quarter with revenue of $1.7 billion, representing an increase of 7% on a reported basis and 9% operationally. Adjusted net income of $440 million increased 15% on a reported basis and 13% operationally. Foreign exchange in the quarter drove an unfavorable 2% impact on revenue, primarily driven by the strengthening of the dollar against the Euro, Brazilian Real, and Argentinian Peso. Operational revenue growth of 9% for the quarter was driven by 1% price and 8% volume. The volume contribution of 8% includes 3% from new products, 3% from other in-line products, and 2% from key dermatology products. Contributions from legacy of access products were not a material driver of growth in the quarter globally since this is the first full quarter lapping the impact of the prior year acquisition. Breaking down our operational revenue growth by species, companion animal grew 19% and livestock grew 2%. Companion Animal revenue growth was driven by continued strength of our key dermatology products and our parasiticide portfolio, including new products, Revolution Plus and ProHeart 12, and the continued adoption of Compatica. Equine also contributed to growth in the quarter, with a full quarter of revenue from the acquisition of Platinum Performance and its nutritional products, as well as continued growth of our CoreEQ Innovator vaccine. Livestock growth in the quarter was primarily driven by strong poultry and fish performance, partially offset by declines in cattle and the impact of African swine fever. Swine increased 1% operationally in the quarter, despite the impact of African swine fever. New products contributed 3% to overall growth in the quarter, driven by Parasiticide's Revolution Plus and Stronghold Plus, as it's known internationally, ProHard 12, and the recently launched Alpha Flux Parasiticide in Chile. Other in-line products contributed 3% to growth in the quarter. This was primarily driven by revenue from recent acquisitions and commercial ingredients, including Platinum Performance, our reference lab acquisitions, the Stable Lab diagnostic tests for equine, and companion animal parasiticides, including Simparica. This growth was partially offset by declines in U.S. cattle and the ongoing impact of African swine fever. Simparica contributed strong growth in the quarter, with revenue of $42 million and 34% operational growth. For the full year, Simparica sales were $214 million, growing 40% operationally. Our key dermatology portfolio continued to grow globally this quarter, contributing 2% growth. Global sales were $200 million in the quarter, representing 29% operational growth. Full-year revenue for this portfolio was $754 million, growing 29% operationally. The positive performance in this portfolio was driven by increasing market share, price, and expanded usage of both Apricol and Cytopoint into recently launched markets. Sales from legacy of Axis products were $68 million in the quarter, representing 5% operational growth over the prior year. Now let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 6%, with companion animal growing 15% and livestock declining 3%. Companion animal growth in the quarter was driven by increased sales of our key dermatology products, the impact of recent acquisitions, our parasiticide portfolio, and a number of other inline products, including Serenia and Remedil. U.S. dermatology sales were $133 million for the quarter, growing 21%. Growth this quarter was driven by price and benefits from the direct-to-consumer advertising, driving increased market share. Our parasiticide portfolio, including new products such as Revolution Plus and Pro Heart 12, and inline products such as Simparica, contributed to strong companion animal growth. Positive companion animal performance was partially offset by U.S. livestock declines in the quarter driven by cattle. Cattle product sales continue to be negatively impacted by unfavorable market conditions, driven by heavier and healthier animals coming in from pasture with a lower risk profile and pricing pressure driven by competition. Partially offsetting challenges in cattle was continued poultry growth, primarily from our portfolio of alternatives to antibiotics and medicated feed additives. We also benefited from new customer adoption and competitors having product efficacy and supply challenges. Swine also had a strong quarter, returning to growth due to increased sales of medicated feed additives and vaccines. To summarize U.S. performance, innovation and returns on our investments drove positive results despite challenging market conditions impacting growth in cattle. Our international segment also contributed strong growth this quarter, with operational revenue growth of 12%. Companion animal operational revenue growth was 26%, and livestock operational growth was 5%. Companion animal growth was driven by key dermatology products, growth in our parasiticide portfolio, including Simparica and our Stronghold franchise, and Legacy of Axis products. International livestock also performed well, driven by growth in cattle, fish, and poultry. This growth was partially offset by modest declines in swine due to the ongoing impact of African swine fever. Growth in cattle was due to favorable pricing, as well as increased feedlot placements in Australia, new customers in other developed and emerging markets, and favorable conditions in key markets such as Mexico. The fish portfolio benefited from the continued uptake of the alpha-flux parasiticide in Chile, while poultry growth was driven by price and increased sales of vaccines. As expected, swine remained challenged this quarter by the ongoing impact of African swine fever. We did see some positive signs, however, partially offsetting these declines, with new markets launching our combination swine vaccines and growth in key accounts in China. Our outlook for 2020 remains neutral to slightly positive for swine in China. In the near term, however, we remain confident that other regions and proteins will increase production to help mitigate the pork shortage and long-term industrialization of pork production in China will be a tailwind. Overall, our international segment continues to be a significant driver of growth, supported by innovation and a diverse portfolio across products and geographies, despite the impact of African swine fever. Now moving on to the rest of the P&L. Adjusted gross margin of 68.5% increased approximately 210 basis points in the quarter on a reported basis compared to the prior year. The increase was driven by foreign exchange, manufacturing cost efficiencies, product mix and price, partially offset by increased inventory charges. Total adjusted operating expenses grew 13% operationally. The increase was primarily related to compensation-related expenses, the impact of recent acquisitions, direct-to-consumer advertising, and investments to support future growth of the business. The adjusted effective tax rate for the quarter was 14.2%. The decrease from the comparable 2018 period is primarily related to non-recurring discrete tax benefits recorded in the fourth quarter of 2019, partially offset by the impact of the global intangible low-tax income, or GILTI tax, which was effective for Zoetis in 2019. Adjustment in income for the quarter grew 13% operationally, driven by strong revenue growth, favorability in gross margin, and a lower effective tax rate. Adjustability at EPS grew 14% operationally compared to the same quarter in the prior year. Now moving on to guidance for 2020. Please note that guidance reflects foreign exchange rates as of late January. In 2020, we are projecting revenue between $6.65 and $6.8 billion, representing 7% to 9.5% operational growth. Foreign exchange is expected to be a headwind again next year of approximately 100 basis points. Innovation will be a key driver of growth next year, particularly in companion animal. Companion animal overall is expected to again outpace livestock, benefiting from a diverse parasiticide portfolio, key dermatology, diagnostics, and strong market dynamics, including continued growth in emerging markets. And as Kristen mentioned, our guidance assumes an incremental $150 million in revenue related to Simparica trio. This estimate represents revenue for roughly three quarters of the year. And in 2020, as Kristen indicated, we anticipate all livestock species returning to global growth. From a geographic perspective, we anticipate balanced growth between our U.S. and international segments. Adjusted cost of sales as a percentage of revenue is expected to be in the range of 30% to 31%, neutral to slightly increasing from 2019 due to unfavorable foreign exchange and mildly dilutive acquisitions, partially offset by price and positive mix. Adjusted SG&A expenses for the year are expected to be between $1.59 and $1.64 billion, with the increase over 2019 focused on critical areas of revenue growth. including recent and future product launches, recent acquisitions and expansion into reference lab diagnostics, as well as the annualization of our U.S. Field Force expansion and direct-to-consumer advertising. Adjusted R&D expenses for 2020 are expected to be between $455 and $475 million, consistent with our commitment to invest in pipeline opportunities, both lifecycle and novel new therapies. Going into 2020, investment will be focused on delivering the next wave of high-value innovation, including monoclonal antibody therapies for osteoarthritis, pain in cats and dogs, and new vaccines for poultry. We're also investing in strategic areas of focus, such as diagnostics, biodevices, and precision livestock farming, and strategies to maximize the value of the continuum of care through integrated offerings. Adjusted interest and other income deductions is expected to be approximately $215 million with the increase over 2019 driven by reduced royalty income as well as lower interest income. Our adjusted effective tax rate for 2020 is expected to be in the range of 20 to 21%. The increase in 2020 is related to the impact of favorable non-recurring discrete items that occurred in 2019. Adjusted net income is expected to be in the range of $1.865 to $1.915 billion, representing operational growth of 8% to 11%. We remain committed to our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. However, as I've highlighted, gross and adjusted net income in 2020 will be negatively impacted by the higher effective tax rate, the limited gross margin expansion, and strategic investments. For context, the higher effective tax rate in 2020 will negatively impact our adjusted net income growth by approximately 300 basis points. Consistent with 2019, we are anticipating elevated capital expenditures in 2020 to support investments in manufacturing focused on capacity increases and facilities to support pipeline opportunities. We're also investing in information technology to support our recent acquisitions, as well as digital capabilities and data analytics. We're also committed to our capital allocation priority of returning excess cash to shareholders that isn't deployed internally or for business development opportunities. To that end, we recently announced a 22% increase in our dividend, and we have approximately $1.7 billion remaining under our multi-year share repurchase program, after repurchasing approximately $625 million in Zoleta shares in 2019. Finally, we expect adjusted Zulu VPS to be in the range of $3.90 to $4, and reported Zulu VPS to be in the range of $3.53 to $3.65. While our guidance represents full-year expectations, we do anticipate Q1 to be slightly weaker in terms of revenue with limited growth in adjusted net income due to the timing of this entire portrayal launch and the investment required to support the launch and recent acquisitions. Now to summarize before we move to Q&A, 2019 was another exceptional year in which we delivered 10% operational revenue growth and 14% operational growth in adjusted net income. Our guidance for 2020 underscores our ability to grow revenue organically, well above the market, and grow adjusted net income faster than revenue. And our focus remains on delivering long-term shareholder value through disciplined internal and external investments and returning excess cash to shareholders. Now, I'll hand things over to the operator to open the line for your questions. Operator?

At this time, if you'd like to ask a question, please press the star 1 on your touchdown phone. In the interest of time, we ask that you limit yourself to one question and 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. Take our first question from Louise Chin with Kenner Fitzgerald. Please go ahead.

Hi, thanks for taking my questions, and congratulations on the quarter-end 2020 guidance. My question for you is, if you could provide more color on the headwinds and tailwinds in the macro outlook for animal health in 2020. Thank you.

Sure. Good morning, Louise. Good to hear from you. As we talked about, the overall market for 2020 in animal health is projected to grow at 45%. Probably faster than that will be companion animal, as we've seen in previous years. As we think about where Zoetis is coming in, we believe we'll grow faster than that market, really driven by our innovation. Obviously, we've given guidance around the excitement around some paracatrio, our params, our germ portfolio. We see poultry growing faster than the market as well, and Zoetis growing faster than the market as well. We have some launches there as well as the portfolio we have in poultry to help raise no antibiotics ever. We see cattle returning to growth in 2020, albeit slower than the overall market. And we see zoetis probably growing in line with the market overall. And swine we see returning to growth as well in 2020. And zoetis growing in line or faster. So as we see some of the headwinds, they'll remain innovation overall, as well as sort of a return to growth for livestock in general. Thanks, Elise.

And we'll take our next question from John Block with Stiefel. Please go ahead.

Great. Thanks, guys. Good morning. I'll ask both up front. You mentioned launching the TRIO in Europe later this month. I guess anything you're willing to share on price of TRIO or positioning in the market? You know, in other words, what you guys can do to try to get an incremental revenue from the top two oral flea and tick products versus call it just partially cannibalizing Simparica? Sure. And then, Glenn, what about for you? You know, when I look at that 2020 guide, it seems like revenue is certainly ahead. The adjusted interest expense was above expectations. I think you alluded to less royalty income. What about just from a cash flow perspective? In other words, in the guide, is there any assumed buyback or paydown of debt in there? Thanks for your time, guys.

Sure. Thanks, John. I'll take the first, and I'll let Glenn take the second question. We are expecting to be launching commercial launch in Europe in a few markets this month. We will do a stage launch. So Italy, Spain, and the U.K. are launching this month in Europe. We are not first in the market, as many of you know, in Europe. There are other products on the market. So to your point, it is a competitive position. We will be pricing, as we've spoken about before, at a premium to Semperica. and really, if you look at the competitive side, it actually varies dramatically in Europe by market with the different competitive products on the market overall. We remain excited for approval in Q1 in the US. and plan to launch shortly thereafter, you know, as this customer, and as we've spoken about in other product launches, probably six to eight weeks after that. And in the U.S., as we've spoken about, we should be first to market. Again, we'll plan to launch at a price premium to Semperica, But at a discount, probably overall, if you look at it from the two products there, we're focused very hard in the U.S. and gaining share. So we haven't gotten specific on overall pricing, but it should be at a significant premium to Semperica today. But we haven't fully launched in the U.S., so our pricing is not public yet in the U.S. So I'll let Glenn take the second question.

Sure. From a revenue perspective, very excited about the expectations for revenue growth this year with growth of 7% to 9.5%. I'm obviously very excited about Semperica for you as well. In terms of the bottom line growth of the 8% to 11%, a little less of a differential from revenue than we would typically expect. A lot of that being driven by the impact of the tax rate change year over year. Accounting for that impact, we have about another 300 basis point impact of growth at the bottom line. And also foreign exchange was negatively impacting us in terms of adjusted net income absolute number. And that was about a 200 basis point negative impact. from foreign exchange. Specifically to your questions, there is no assumed payback or pay down of debt. And in terms of share repurchase, the number of shares that we assume in our EPS are the shares ending as of the end of December, 2019.

We'll take our next question from Michael Riskin with Bank of America, please, Gillian.

Thanks, guys. Just sticking on the trio to round out those set of questions. You've been talking about it for a while, obviously, on the conference calls, and earlier this year at VMX, we saw a pretty significant presence from you on the trio. Have you seen any response from your competitors ahead of the launch in terms of either stuffing the channel or giving any promotions with the Spectra product in Europe or even with a standalone product in the U.S., you know, taking any price actions or any combo or bundling actions in the U.S. to try to get ahead of the March launch as VETS stock up in the first quarter. And then just on the same line, follow-up, what's your expectation for TRIO impact on gross margins? Chris, just following up on your comments on how it's priced, and obviously you have the API component of of two different drugs in there. So, net-net, what's going to be the impact on gross margins in 2020 and even in the out years as volume ramps from the TRIO product?

Sure. Thanks so much, Mike. You know, this is the single biggest category in animal health, the companion animal parasiticides. So it is a highly competitive space, to exactly your point. It's a $4 billion market, and the U.S. alone is $2.5 billion. So we are expecting a significant competitive response. You know, this is a category that a lot of people will defend. You know, we would expect normal tactics. Obviously, you know, trying to set the channels or, you know, fill in and fill up the shelves as best they can. We're certainly expecting some of them to look at pricing programs. But we think there's significant excitement around the opportunity for a triple in the U.S. We've certainly, you know, heard it. We did not, as you saw at DMX, we didn't have approval on this product. So we were not promoting this product at DMX. But there's a definite understanding that a triple is coming from us. I think customers are anticipating that and are very excited to have something new and innovative to share with their customers. So I think we're expecting whatever you normally see in a competitive response. But this is a major category. So our plans for launch, our revenue guidance we provided was anticipating a significant competitive response. in this area overall. So I'll turn it over to Glenn to take the gross margin implications on TRIO.

Yeah, in terms of the impact on gross margin, for 2020, we expect it to be mildly beneficial to our overall gross margin. Obviously, as time goes on and we become more efficient in the production and we're operating in full capacity, we do expect this to be a higher margin product for us, and it will benefit our gross margin over time as we move beyond 2020. Thank you.

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

Great, thanks. Can you give us an update on the diagnostic strategy at this point? Do you expect continued inorganic activity in reference labs both U.S. and globally, or is it more of an organic build at this point? And can you speak to some of the success you're seeing already in the bundling across the portfolio between therapeutics and diagnostics? Separate question on stocking. Were there any stocking dynamics worth noting in the quarter, and should we anticipate distributor stocking in the first or the second quarter for Semperica Trio? I guess I just want to make sure we're thinking about the quarterly progression appropriately there. Thanks.

I'm sure I'll take Trio first. In Europe, we obviously did begin shipping in Europe to customers there. So you will see some stocking in Q1 there. In Q2, it will depend on exact timing. But, you know, there could be some shipments, obviously, in Q1. Until we have an approval, as we said before, we won't be able to get very specific. But we're discussing weeks here, and it just happens to be, you know, the timing in Q1. So it's hard to give you an exact, you know, guidance. If you look at the $150 million guidance we gave you, it's assuming we're selling for three-quarters of the year. So there could be stopping, obviously. But back to the diagnostic strategy overall, we remain very excited at diagnostics. You know, for starters, it's a market growing at around 10% per year, so it's quite attractive. It continues to also drive use of our therapeutics and preventatives. So it's exciting. So as we look into 2020, we're looking for double digit growth overall. And so what is the diagnostics portfolio both in the US and abroad? We've spoken a lot about our point of care strategy. We're really focused there on increasing placements as well as driving consumable use. As you look at the reference lab strategy, we have made a number of VD deals over the last three or four months in the US specifically. These are small deals as you've seen, but we're looking to build a network This will be in the U.S., a lot of organic builds from there, scaling the sites we have today, looking at some spoke sites as well. But I think you will see some BD as we look to grow into international. So this will continue to be a mix of organic and inorganic. But again, very focused on ROI. We don't see these as significant deals right now. We're looking at continuing to grow this over time, but great excitement. If you look at sort of some of our excitement ending 2019 and moving into 2020, we've been leveraging our Freedom Flex program, which combines and offers opportunities across our core portfolio and diagnostics, and are very excited to add in reference lab into that opportunity as we look into 2020.

And, Aaron, just to add to the comments on the quarterly stabilization and progression for TRIO, as I mentioned in the prepared remarks, we would expect significantly more sales in Q2 for TRIO and really that growing throughout the year. So when we look at the overall progression of revenue for the company, we would expect Q1 to be slightly lower in terms of overall growth. And then because of the investments that we're making in Q1 to support the launch of TRIO, as well as some other strategic investments, we expect income to be relatively flat. or to low single digits.

Our next question comes from John Krieger with William Blair. Please go ahead.

Hi, thanks very much. Kristen, can you just give us an update on the monoclonal products that you're talking about in cats and dogs? Where does that stand from a regulatory standpoint, and do you think they could be notable contributors in 21, or is that more of a kind of a late-year launch event? Thank you.

Sure. In our Q2 2019 guidance, we indicated we had filed in both the EU and U.S., and we're expecting approval in 2021. It is obviously too early for us to be terribly specific as these regulatory views, which we could predict with that level of precision. So it's probably a little early to be able to say whether or not we have failed in 21 or 22. But, you know, these would be the first maps reviewed by the FDA. So, you know, we want to make sure we give them adequate time and we have less understanding of exactly how fast that will be. But we continue to be very excited. As we've spoken about before, pain in cats is, you know, really there are no products today that adequately serve that market. So there's a lot of excitement as well as for the canine. So when we have more information, then we're happy to provide it, but we remain excited.

Our next question is from Chris Schott with J.P. Morgan. Please go ahead.

Great. Thanks very much for the questions. Just two here. First on the reference lab and organic build in the U.S. from here, just give us a sense of how long you envision that taking to fully build out your network and portfolio in terms of when this becomes, I guess, a bigger piece of the offering. My second question was just on the gross margin dynamics in 2020. It seems like we have, you know, kind of mixed going in your favor with the growth in companion, yet I think the guidance is suggesting flat to slightly declining gross margins. So a little bit more color of what's happening there. And longer term, is it fair to still think about gross margin improvements as we see that companion pipeline continuing to ramp over time? Thanks very much.

Sure. Thanks, Chris. I'll take the first question, and Glenn can take the second. If you look at reference labs built in the U.S., we think this is multiple years. You know, we look to scale in geographic. As we've talked about, reference lab, given the importance of logistics in reference lab, it is an MSA by MSA market. And we're very focused on doing this and making sure we scale the sites that we open. So we do believe this will take a number of years before we'll have a significant presence in the U.S. I would say the same for international. It'll be a buy and build. So to your point, I don't think this is something you're going to see, you know, really be a significant play within the next 12 months. But we're very excited about the long-term growth and scaling in the markets we've entered and then adding folks there. But I'll turn it over to Glenn to take the growth margin in 2020 and beyond questions.

Yeah, so in terms of gross margins, so stepping back to 2019, right, we benefited significantly from foreign exchange in 2019 to the tune of about 120 basis points. As we move into 2020, that impact of FX turns the other direction. We have approximately about a negative 50 basis point impact from foreign exchange on gross margin in 2020. So that offsets some of the favorability that we're seeing, A, from price, but also from mix from a companion animal perspective. The other thing we need to take into account is some of the acquisitions that we have completed, reference labs in particular, and diagnostics. They do come in at a slower or lower gross margin. So that offsets some of the mixed variability that we see from companion animal. Over time, we do anticipate that we'll continue to see gross margin improvements driven by the completion of our supply network strategy, as well as from continued improvements in price and to the extent that companion animal continues to grow faster than livestock that will benefit our margin.

Thanks, Chris.

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

Thank you. Just one question. Could you comment on your China business a little more specifically? Give us a color for the fourth quarter. And also, how do you see the coronavirus impacting both business and your outlook for Africa and swine fever? Thank you. Sure.

Sure, I'll start on corona, and then I'll let Glenn get more into specifics of performance in 2019 expectations. As everyone's watching, the coronavirus is obviously emerging very quickly in the sense of certainly the news overnight. As we look at our business right now, it's probably too early to tell exactly what the impact will be, but let me talk a little bit about some of the risks that we're watching. First is just an overall economic slowdown. which is already driving some reduced overall consumption in animal protein. As you've seen, some of the hardest hit markets are hospitality and travel. So without that, there's a number of people obviously not eating protein. So it should affect consumption a little bit. How long this lasts will really impact whether or not that's a significant driver or not. There's obviously some commercial risks. Many of our fields are not able to get out to veterinarians, and many pet owners are not currently bringing their pets to veterinarians, giving some of the quarantine. But if quarantine is lifted, or as that emerges, we'll watch that. We're obviously watching our supply chain. We do have a number of MFA, I'm sorry, APIs or active pharmaceutical ingredients that are produced in China for the world. We're very confident with most of them that we have adequate supply multiple months. So even if the ports did shut down, we should be fine unless that was extended. The ports are still open and they are still shipping. So we don't see right now at the moment any impacts or overall supply chain. We'll continue to monitor this. Obviously, last year, the big impact was ASF, which we did see either flattening or returning to growth in China. But obviously, that will be subject to the ability to continue to move both feed around China as well as animal protein. So it's a little earlier to tell, but hopefully that gives you a sense of some of the issues that we're tracking to get a sense. But it remains a significant market. I'll let Glenn sort of talk about performance and expectations for China overall.

Yes, when you look at China overall, I'll start with the full year and then talk a little bit about Q4. But China for full year 2019 was about $200 million in revenue, which was essentially flat for the prior year, which is pretty impressive performance considering the impact of African swine fever, which we estimate to be greater than $50 million in 2019. That was really driven by rapid growth in companion animal. Companion animal now represents more than 50% of the overall revenue in China, and it's growing very rapidly. So the market performed very well, even in the challenges of African swine fever. And I think you saw some of that, particularly in Q4, where we saw 10% growth in China in Q4 in an operational perspective, even with a negative $11 million impact from African swine fever.

The next question is from David Westenberg with Guggenheim Securities. Please go ahead.

Hi, thanks for taking the questions and congrats on a good quarter. So your competitor, one of the largest competitors in diagnostics has historically spent three or four times the amount on R&D versus ABAXAS. In order to close, you know, the competitive gap, do you think it simply requires scaling or do you think that you need to actually close the R&D gap longer term? And then just sticking with diagnostics, with the acquisitions in reference lab, do What kind of safeguards are in place you have to make sure that your sales force remains focused on selling your products with such a wide product bag? Thank you.

Sure. Thanks, David. So with your first question, I'm not sure. I know that there's a number of reports out on R&D versus IDEX versus ZOEDEX. We have significant investments in R&D in our diagnostics portfolio, so I don't think we're looking at any incremental spending to close any perceived innovation or R&D gap. As you remember, part of diagnostics has always been a core part of how we even develop the products we develop today, making sure that we can diagnose the diseases that we create treatments for. So we remain very confident in our R&D spend and the percentage of it dedicated to diagnostics and see significant synergies from an R&D perspective between our core portfolio of medicines, vaccines, et cetera, with diagnostics. So no, we don't see that. As we look at the field force, We actually, again, we like to be solution selling as we've spoken about. So we go in and talk about a wellness visit, which diagnostic is a role. If we need to, if we're looking to place new instruments or sign up somebody on a new reference model offering, we bring in specialists, diagnostic specialists to do that. And then we have diagnostics, technical specialists who come in and maintain that equipment. So we do not believe it's distracting at all. We do believe once you place that equipment that our core representatives and strategic account managers can really help drive consumable use as they talk about a wellness visit and how they can combine looking at vaccines, preventatives, and doing wellness screening and diagnostics. So we think it's actually quite synergistic. And, you know, we have experts that come in to sort of help on focus sales and placement of new equipment as well as in reference labs. So, no, we don't see that as a big challenge.

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

Great. Thank you very much. And congrats, Kristen, to a very nice start to your new role as CEO. I wanted to just get a little bit better understanding of the finalization of the Semperica Trio approval. So what needs to be done at this point? I know that you're highly confident that it's imminent, but what steps need to take place. And then I believe that you mentioned that you'll wait six to eight weeks after the approval to launch. And could you just explain that? I would have expected the launch to come much more quickly after the approval, given that it's highly anticipated.

Thank you.

Sure, I'll let Glenn take some of the specific details here.

Yeah, so in terms of the subparricidary approval, as we said, we're in an administrative review period. All the technical sections are complete, so we're just awaiting final response from the regulators at this point in time. In terms of the timeframe of six to eight weeks from approval to launch, that's pretty typical within the industry. There are a number of things that need to occur. You need a final label. You need to complete packaging of the product. You need to make sure you're building up the appropriate launch quantities. Obviously, we're doing that every day, and we're looking to minimize that time of a six to eight-week period, but that is very typical within the industry in terms of approval to launch based on the activities that need to occur post-approval.

The next question is from Greg Gilbert with SunTrust. Please go ahead.

Thanks. First back to ASF. Kristen, has your thinking changed at all in terms of the overall impact of ASF and when that impact will begin to abate? And then, Glenn, can you talk about how much growth you're factoring in for the DERM portfolio in 2020 and maybe comment bigger picture on what inning you think we're in in terms of realizing global peak sales for that portfolio? Thanks.

Sure. Thanks, Greg. I'll start with ASF. You know, we do think the overall impact, based on what we know today, is leveling out in China. The real question is, you know, how fast will they rebuild the herds in China and how will China overall meet its animal consumption demands? So as we sort of see it, as we've talked a little bit, we do think in China specifically, you know, you'll see flat to low single-digit growth in our pork business there. I think you'll slowly see some of the more innovative, technologically advanced industrialized production starts with very strong biosecurity. You're starting to see some signs of this, but it's in bits and starts, and it's a little hard right now with corona to understand how fast that will really evolve. But I think if you look at the broader impact of African swine fever, they are going to need to feed their people, even if consumption is a little bit down. So I think you're going to see the impact of African swine fever in countries like Brazil, the U.S., and EU as they look to meet that demand. There's been a little volatility, obviously, given corona and pork prices more recently. But overall, they've been trending up. This will encourage producers to raise more pigs, raise heavier pigs. We are seeing significant increases in exports, at least in the U.S. already, and Brazil into China. So I think you'll see that, which is one of the, we believe, the drivers of why, as we said, we think livestock overall across species will return to growth in 2020 because China will either have to feed their population, you know, some will come from internal, but they will need significant imports into China. And that will continue to come from Brazil, the U.S., and the EU, both in pork, but we're also seeing potential opportunities in both poultry and beef. I'll let Glenn take the second question.

Yeah, in terms of DERM growth, just looking back at 2019, a really strong year for the DERM portfolio in 2019. We grew 29% operationally, U.S. growing 25%, and international growing 38%. We'd expect to have continued growth in 2020, not to that level as we're working off of a higher base, but the areas that we expect to see growth. A, international. We expect international to continue to outpace the U.S. in terms of growth, just because currently the mix... The revenue between U.S. and international is about two-thirds U.S., one-third international, although the number of medicalized dogs is pretty much equivalent between the two, so we would expect to gain market share in international as it does get more and more comfortable with the products internationally. And the U.S. has had the advantage of direct consumer advertising, which is not available in all international markets. From the U.S. perspective, we continue to see opportunity in terms of continuing to expand the market, continuing to expand the usage into acute patients. And we still expect to continue to get price in the U.S. as well. So we see 2020 as being another year of growth for the Darm portfolio. But as the portfolio continues to mature, the pace of growth will slow.

The next question is from David Jacob with UBS. Please go ahead.

Hi, this is on behalf of Naveen. So thanks for taking our questions. My first question is on the long-term opportunity for Sympirica TRIO. In the past, it has had space to switch from topicals to orals was quite significant at greater than 70%. So do you think this switch is a good analog for how much share could be switched over from the doublet to the triplet class or are we missing any dynamic? And secondly, on your AlphaFlex vaccine, do you have plans to launch this vaccine in Norway as well? And could you frame the market opportunity for this vaccine? Thank you.

Sure, I'll start with the first one, and I'll let Glenn take the second one. So, if you look at the long-term opportunity for TRIO, it's obviously significant, as we've talked about. It is the single largest category in companion animals, certainly overall. It's a highly competitive category as well. So, we're very excited. We think that we will gain shares. We think about the $150 million incremental for 2020. The assumption in that overall is We do not have competition in the U.S. in that year. It is already, obviously, competitive space in many markets outside the U.S. We think we'll get a movement, obviously, from OTC. We think we'll certainly see some cannibalization we've spoken about from Semperica, but we also think it will take from some of the other orals in the market overall. I'm not sure that the switch from topical to oral is necessarily the best overall proxy. And part of the long-term opportunity for TRIA will also depend on our label versus the label of potential other competitors that come to the market, as well as the distance between our launch and their launch. I know the favorite question is, you know, what are we expecting a competitor? As you know, in our space, there's very little information available. One of those is a private company. The other one does not disclose. So at the moment, we believe we'll be the only product on in the U.S. in 2020, and that is part of the assumption on the 150. But the longer we are, the greater the opportunity to gain share overall. We continue to see this. as a significant innovation for both the pet owner and the vet and a lot of excitement around it. So we'll be investing significantly in that. I'll turn it over to Glenn a little bit on AlphaMax.

Yeah, so in terms of the fish portfolio for Q4, we saw very strong growth at 17%, and AlphaPlus was a key contributor to that growth in the quarter, particularly in Chile. There is already a similar product on the market in Norway, so that would not be an incremental opportunity in terms of launching a new product. As we look into 2020, we continue to see the fish portfolio growing. There may be some limitation in terms of the number of salmon available to treat based on certain regulations, but we still see fish as a rapidly growing species for us in 2020.

We have questions from Elliott Wilbur with Raymond James. Please go ahead.

Thanks. Good morning. First question for Kristin. Just want to ask you about longer-term R&D investment. At the midpoint of the guide for 2020, on a percentage basis, guidance would have you coming in below 7%, and that number has trended down. On a relative basis, the last couple of years, obviously, we've enjoyed strong growth. But as you think about driving or the need to invest to really drive more innovation, is a sub-7% R&D investment ratio sustainable, or should we expect that to change? to increase perhaps as we start to see the top line decelerate a little bit in the next couple of years. Just a quick follow-up for Glenn. You mentioned the lower gross margin profile of the diagnostic businesses, but as we think about modeling segment margins, I would also presume that on an operating income basis, those businesses also have lower margins, but I want to confirm that. Thanks.

Thanks, Elliot. On long-term R&D investment, we look every year at the portfolio of opportunities and innovation that we have ahead of us and invest based on where we see those opportunities. It does fluctuate a little bit year to year. It's been growing, I think, faster than our overall SG&A. not necessarily always at revenue growth. We've, I think, made very strong investments, and if we see opportunities, we're more than happy to increase that R&D investment and have done so certainly quarter to quarter and year to year. But, you know, we are confident that a spend around where we are, again, you should expect fluctuations year to year based on opportunities. Some of these studies can, especially in livestock, when you move them, they can drive significant costs year to year. But we are very confident that we have the right level of spend to drive our value proposition of, you know, significant top line growth at or faster than the market long term in what we've provided overall. I'll see if Glenn wants to add anything to that and if he can take the second question.

So in terms of the question on operating margins for diagnostics, so gross margins will be lower over the long period of time for diagnostics. However, when you look at operating margin, obviously right now we're in the build phase, so it's a little lower than our overall business. But as we progress in over the next number of years, with the ability to leverage our commercial infrastructure, we do see the operating margins for diagnostics coming very close to our core portfolio as well.

Next question is from Balaji Prasad with Barclays. Please go ahead.

Hi, good morning, and thanks for the questions. So a couple of questions on the poultry side. One, Chris, you spoke about your competitors at efficacy and supply challenges in the quarter. What can you throw some more light on what were these challenges and how prolonged do you think this could be? And for 2020, would you still have been able to grow faster than market if these dislocations did not exist? Secondly, could you also throw some light on the market opportunity for Vector vaccines and how should we think about the portfolio and revenue ramp from the segment?

Sure. I'll let Glenn take these.

Yes. So in terms of the poultry outlook, so, A, this year we had a very strong performance in poultry. We grew 10% for the year globally in poultry. And we see 2020 as being another very positive year for poultry growing much faster than the overall market and with our portfolio continuing to outpace the market. In terms of the vector vaccines, you know, 2019, we launched our first vector vaccine. That really set the stage for us from an R&D perspective to continue to develop more and more vaccines over the next number of years for those to become a bigger section of our portfolio. And we do see poultry continuing to be a rapidly growing market, and we'll continue to invest in our R&D for that market.

Next question is from Nathan Rich with Goldman Sachs. Please go ahead.

Thanks for the questions. Just two quick ones on diagnostics. You talked about double-digit revenue growth in 2020. Could you just maybe help us think about, you know, how much of the contribution you expect from the three reference lab deals that you've done and what you're kind of expecting for organic growth kind of exos deals? And then, Glenn, I think you mentioned Reference Lab being a drag on gross margins in 2020. Could you maybe just give us some sense of magnitude and help us kind of get a better picture of what you're expecting for margins for the underlying business? Thank you.

Sure, I'll take the first. Obviously, if you look at diagnostics overall, to be clear, we're expecting double-digit growth in our core point-of-care, the way it's diagnostics. That's not being driven by Reference Lab. Reference Lab would be incremental to that. It's, again, I want to emphasize, still a pretty small part of our overall portfolio in the U.S., but we are expecting double-digit growth in both the U.S. and in international in the point-of-care space. But I'll let Glenn talk a little bit more about gross margin overall in just a second.

From a gross margin perspective, again, overall on diagnostics, as we are expecting rapid growth in that area, it will be a negative driver of our overall gross margin as those products tend to be of a low gross margin profile. When you look at the overall EPS impact, particularly to your question on reference labs, reference labs in 2020 is about a negative 3% to 4% impact on our overall EPS based on the investments we're making to grow that business for the future.

The next question is from Kevin Ellis with ACE Research. Please go ahead.

Good morning. Hey, guys. So a lot of my questions have been asked, but just wanted to see if you could provide a little bit more detail on what you're doing in the digital and data analytics and when we could see some material impact in those initiatives. Thanks.

Sure. Thanks, Kevin. You know, digital and data analytics obviously is an important strategy of the company. It's one of our five priorities as we move into 2020. I would say there's two components to that. One is leveraging digital and data to drive greater sales of our core business. So that's really focused around better targeting our customers, providing more personalized and customized solutions to them, so leveraging the data we have to better understand our how they operate their business, what products would be most attractive, what offers would be most attractive to them. So I think that's already in place, and I think we're doing a very strong job both in the U.S. and international of leveraging some of those capabilities to drive our core business. We also see that opportunity in both pet care and livestock to create new revenue-generating solutions. Some of that on the pet care side will be around overall diagnostics opportunities and linking those opportunities to our core portfolio and providing incremental insights to our customers. In livestock, that remains as well around both our genetics portfolio as well as our precision livestock farming, which we see as a significant growth driver for us in the medium to long term. I think if you look at both consumer preferences and where the industry is moving, it's moving more to individualized animal care. So solutions such as what we have with SmartVote, which is ear tags for dairy cattle and better understanding the health and the productivity aspects of animals, individual animals, and helping producers and veterinarians make better decisions in the short term as an opportunity. And we link that to both our genetics business, which is, you know, you can also predict which animals will be born healthier and will have a better productivity. And then we see in the medium term the opportunity to link that as well to our diagnostics and really, you know, provide both veterinarians, producers, and consumers with better understanding and better health for animals. So we think this will help drive our business. You know, as we see some of those, as you saw, are more short-term opportunities, some are more medium-term. And then to think about the connection between all three genetics, precision livestock, you know, data in our core portfolio and diagnostics, that's probably more in the medium to long-term.

Last question to follow up for Michael Riskin with Bank of America. Please go ahead.

Thanks, guys. Just a quick one that keeps coming up, so I appreciate you squeezing me in. I've had a lot of questions on products coming off IT or potential generic competition or others. You talked a little bit about no expectation for a competitor, Sympirica Trio, for example, but I was wondering if you have any expectations or any thoughts about a competing product in the Durham portfolio in the U.S.? ? And also, you know, products like Draxen have had questions on IP rolling off there for a while. So I'm just curious if you're seeing anything there or sort of what your expectations for that are for 2020.

Sure. As we look, I'll just start with DERM. You know, we obviously have a significant market for dermatology. We have been expecting competition will enter at some point. Based, again, in our industry, there's not great data, so I can't tell you exactly when a competitor will launch. We are obviously planning for a competitor launch in the next one to three years. Exactly when that will be will be difficult for us to fully assess. But we do expect, you know, a potential small or large molecule entrant. you know we don't know exactly when that will be but we have put plans in place to prepare for that overall um it's a key focus for us and for draxen we still have patent protections uh through 2021. um this is a significant market so we again here expect we will see competition when that does hit patent um when it patent exclusivity runs out um you know that's a significant market but as we said what's different about animal health than human health is Even though we'll see obvious competition, you know, we still think, you know, in our business that normally has an impact between 20 and 40% both in sort of market share and price over a number of years. So we do expect, obviously, a challenge in 2021 or 2022 on Drexel.

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

All right, well, thanks very much for, you know, I appreciate all the great questions today. And if you've got any further questions, obviously let us know. Thanks so much.

And this will conclude today's program. Thank you for your participation. You may now disconnect and have a great day.