Zoetis Inc - Class A (ZTS) — Q1 2015 Earnings Call Transcript

Thank you, operator. Good morning, and welcome to the Zoetis First Quarter 2015 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Paul Herendeen, our Chief Financial Officer. Before we begin, I'll remind you that our remarks today will include forward-looking statements and 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 2014 annual report on Form 10-K and our reports on Form 10-Q. Our remarks today will also include references to certain financial measures, which were not prepared in accordance with generally accepted accounting principles, or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and in the company's 8-K filing dated today, May 5, 2015. We also cite operational results, which exclude the impact of foreign exchange. We have a significant amount of detail to cover today, including specific details of our financial outlook through 2017. We will be posting both Juan Ramón and Paul's prepared remarks on the Investor section of zoetis.com following the call to help clearly disseminate these details. With that, I will turn the call over to Juan Ramón.

Thank you, John, and good morning, everyone. Today, I'll provide a brief overview of our quarterly performance and details about the operational efficiency program we announced this morning. Paul will then present our quarterly results and discuss the financial impact of the operational efficiency program along with updates to our guidance for 2015, 2016, and 2017. In the first quarter, we saw operational revenue growth of 6% and a 14% increase in adjusted net income, resulting in adjusted diluted earnings per share of $0.41. Of our operational growth, 3% was attributed to price increases. New products like ACTOGAIN, which we acquired from Abbott Animal Health, contributed 2%, and in-line products added 1% to revenue growth for the quarter. Please note that all the following growth rates discussed are operational. In livestock, we achieved a 7% growth to $715 million, with all species contributing. Cattle revenue rose 7% to $397 million, supported by favorable market conditions in the U.S. and Brazil, while adverse weather and reduced herd sizes caused declines in Australia and New Zealand. Swine revenue increased 13% to $170 million, benefiting from a larger herd size in the U.S. following lower piglet mortality during the winter due to PEDv and positive industry dynamics in the CLAR region. Poultry revenue grew by 1% to $129 million, aided by the U.S. reintroduction of Zoamix, a medicated feed additive, which helped mitigate the negative impacts from the timing of product rotations in several countries. In companion animal health, revenues rose 4% to $377 million, driven by the solid performance of key brands and strong growth in China and Latin America. We purchased Abbott Animal Health assets in early February, contributing to results primarily in the U.S., where we faced additional competition in the pain and sedation markets. These results underscore the robustness of our business model, defined by our three interconnected capabilities: the largest and most competent field force in the industry with direct customer interactions, the highest investment in innovation among competitors, and superior product quality with reliable supply at competitive costs. These capabilities are critical for our long-term success in animal health. Moving forward, we will continue to invest in these areas while seeking to leverage them more strategically to enhance competitiveness and create increased value for our customers and shareholders. Over the past two years since becoming an independent entity, we have met our operational and financial targets, enhanced shareholder value, and fulfilled customer needs while establishing a new global company and infrastructure. We take great pride in our accomplishments. As we move beyond our start-up phase, our focus will shift towards improving efficiency and reducing complexity that hampers productivity. The program we announced today is a comprehensive plan aimed at streamlining operations, enhancing our cost structure, and better allocating resources. We enter this next phase riding on solid business performance and anticipate emerging as a stronger, simpler, and more cost-efficient organization. We expect to achieve cost savings of $300 million in 2017, with our adjusted EBIT margin projected to climb from 25% in 2014 to approximately 34% in 2017 as we simplify operations and increase our focus on key brands and markets. We are committed to achieving these goals and have strategies in place to incentivize our leaders to surpass these targets. These initiatives will enable us to unlock additional value by fully leveraging our scale, allowing for more investments in products, markets, and infrastructure that will foster profitable growth and maintain our leadership in the animal health sector. There are several key reasons driving this program initiation. First, following two years of separation from Pfizer, we now have complete oversight of our operations, manufacturing, and corporate systems and have identified considerable improvement opportunities. Second, although the breadth of our portfolio and global reach are strengths, some elements have introduced complexities that obstruct value delivery to our customers and hinder long-term growth. Third, we are starting to reap the rewards of our newly implemented ERP system. The standardization and simplification potential from this system will enhance our productivity and streamline operations. Lastly, we remain dedicated to increasing revenues and discovering the most effective ways to allocate resources for internal investments and business development. Our operational efficiency initiative is centered around three primary objectives. First, we aim to eliminate complexity that offers no value to our customers or business. Second, we want to streamline our resource allocation and boost efficiency. Third, we will position Zoetis for sustainable, profitable growth. To achieve our first objective of reducing complexity, we will sharpen our focus on the products, markets, and manufacturing facilities most essential to our future. We will phase out around 5,000 lower-revenue and lower-margin product SKUs, down from 13,000, leading to increased attention and more dependable supply of our products and services. We plan to enhance our manufacturing operations and accelerate implementation of our supply network strategy, with plans to sell or close approximately 10 manufacturing sites in the long term. Acknowledging the strategic paramountcy of manufacturing to our business model, Roman Trawicki, President of Global Manufacturing and Supply, will now report directly to me as a member of the executive team. We will adjust our selling approach in about 30 markets by shifting to an indirect sales model or scaling back our presence in certain countries, and we will consolidate regional reporting segments from four to two: the U.S. and International. We anticipate these adjustments will empower greater decision-making authority closer to our customers while utilizing our scale for efficient delivery of marketing and operational support. Kristin Peck will lead the U.S. Region, and Clint Lewis will helm the International Region, both of whom are current members of our executive team and will continue to report to me. To fulfill our second objective of optimizing resource allocation and efficiency, we will take specific actions, including leveraging the effectiveness and standardization enabled by our new ERP system to significantly lower general and administrative costs in corporate functions. Additionally, a notable efficiency driver will be the reduction of management layers and increased control throughout the organization. We will enhance our agility in responding to customer needs by repositioning marketing resources closer to customers and simplifying all non-customer-facing commercial infrastructure areas. Moreover, we will enhance our R&D focus to support a more streamlined product portfolio and prioritize investments in projects that yield the highest returns. In the past, we have proven our commitment to operational improvement. In 2009, we successfully became the world's largest animal health company through various acquisitions, followed by our establishment as a major global independent company in 2013 and maintaining industry-leading performance for two consecutive years. Through these transitions, we have continuously improved our service to customers and created new value for stakeholders. I am confident that the comprehensive plan we are announcing today will again transform us, building on our successful business model to produce quality, profitable revenue growth and enhance our competitiveness. These significant initiatives will lead to a more focused and streamlined organization. Consequently, we expect a reduction of approximately 2,000 to 2,500 positions at Zoetis over the next 12 to 18 months, subject to consultation with work councils and unions in various markets. By executing this initiative, we will align Zoetis' resources and operational framework with our three interconnected capabilities: providing products more reliably at competitive costs, enhancing our capacity to invest in future business drivers, and focusing on refining our product portfolio and improving operational efficiency to pursue the next opportunity horizon as a world leader in animal health. Through this process, we will enhance our competitiveness and position ourselves for enduring profitable growth. Before Paul discusses the financial aspects, I would like to express gratitude to all our colleagues who have contributed to our success during this period of significant change. Our next transformation will be crucial in supporting our future achievements, and I am confident in our capabilities and team to manage these critical changes. Paul?

Thank you, Juan Ramón, and good morning, everyone. We have many important topics to discuss today as we have just outlined our plans to enhance the efficiency of our operating model. However, before diving into that, I want to acknowledge the excellent quarter we've just delivered. Our fourth quarter of 2014 showed impressive operational growth, and we maintained that momentum into the first quarter of 2015, giving us a strong start to the year. We achieved our primary goals with revenue and adjusted net income growth on an operational basis of 6% and 14%, respectively. However, like many U.S. multinational companies, foreign exchange rates significantly affected our reported results. On a reported basis, foreign exchange rates reduced our reported revenue by $58 million, resulting in flat revenue growth compared to the first quarter of 2014. The impact on our adjusted net income was a $16 million reduction, lowering our growth from 14% operationally to 8% reported. Foreign exchange affected our top line and adjusted net income by about 600 basis points each. As I've emphasized before, we cannot control foreign exchange rates; we manage our business operationally, and in that regard, we continue to see solid fundamental growth in revenue and profits. You can find details about the regional performance in the press release, so I won't delve into that here, but I will highlight a few key points. The U.S. continued to perform strongly, up 9% from the first quarter of 2014, driven by a 14% increase in livestock performance. We are gaining market share in the U.S. livestock sector, particularly cattle, due to producers’ confidence in our products. In companion animal, we saw a 3% increase and expect even stronger results moving forward as we now have improved supply for APOQUEL. CLAR's performance remains robust, with revenue growing 13% operationally, mainly due to Brazil and other emerging markets. I will discuss our plans to reduce efforts in Venezuela later, where the business climate is becoming more difficult. In the APAC region, revenue grew 1%, reflecting good performance in emerging markets like China, though drought conditions in developed markets are affecting us. In Europe, Africa, the Middle East, revenue was flat compared to the first quarter of 2014, with strong performance in companion animal brands offset by declines in anti-infectives due to regulatory changes in France. Now, moving to our operational efficiency initiative, this is a natural progression for our company as a standalone entity focused on animal health. Although we currently have a strong position in animal health, our existing product portfolio and organization have evolved somewhat organically. Our product lineup was greatly influenced by human health acquisitions by Pfizer, which included animal health components. While these acquisitions were crucial for building our scale, the animal health assets were not the primary focus. As we've built our own organization and culture, we've also retained some processes and designs that were beneficial when we were part of Pfizer but may not be the most effective for a dedicated animal health company. Our immediate goal over the last few years has been to establish the necessary functions to sustain our business independently. We've created our own supply chain, IT infrastructure, and general and administrative functions like finance, HR, and legal support. During this time, we decided to keep our commercial and R&D organizations relatively unchanged to minimize any disruption to our customers and business. Our revenue and profit growth over the past two years and up to now in 2015 supports that approach. However, as we near the end of our setup activities, it's time to assess our current state and make improvements to our company’s design and efficiency. Importantly, we are not questioning the core elements of our business model, which relies on three interconnected capabilities: direct customer interaction to drive revenue, investment in product innovation for sustained growth, and the ability to meet customer demand with quality products. These capabilities underpin our competitive advantage in the global animal health market, and changes will focus on continuous improvement rather than major overhauls. Most future cost savings will not affect these areas, and our field force will mostly stay intact. Our R&D activities will remain largely the same, and we will continue investing in supply chain enhancements. Let me break down the 2015 initiative into three parts. The first part is rationalizing our footprint, the second is improving operating expense efficiency, and the third involves streamlining our supply chain. Beginning with rationalizing our footprint, we've reviewed our product portfolio and are considering moving to indirect sales models in several markets where we currently sell directly and evaluating markets where we might reduce our efforts. Ultimately, we will be eliminating nearly 40% of our total SKUs, which adds complexity across multiple functions. While this will temporarily decrease our revenue and gross profits, it will significantly enhance our operational efficiency, enabling better growth prospects with a leaner portfolio focused on more profitable products. We also plan to shift from direct sales to indirect distributor models in certain countries and reduce efforts in some markets. Once this streamlining is complete, we expect a reduction in our estimated 2017 sales by approximately $280 million and a decrease in gross profit by around $100 million, based on current foreign exchange rates. These anticipated impacts are included in our updated guidance for 2016 and 2017. The second part of the initiative is enhancing efficiency within our selling, general, and administrative expenses and R&D investments. We're consolidating from four regions to two going forward and reorganizing country support functions, including finance, IT, HR, and legal, as well as resources that support our sales teams. We're refining our R&D focus to support a smaller product portfolio, improve regulatory efficiency, and prioritize our R&D spending. Our spending on customer-facing resources will also decrease, mainly due to reduced direct presence in fewer markets and efficiency improvements. By 2017, we expect our total operating expenses to be roughly $300 million lower than if we hadn't pursued this initiative. As mentioned earlier, we’re not altering our business model; approximately one-third of the savings will come from reduced general and administrative costs, with another third from commercial resources not directly interacting with customers. This means that two-thirds of the savings will not affect our ability to grow revenue in the near or long term. The remaining savings will come from improved efficiencies in R&D, reductions in field resources tied to our global footprint adjustments, and the balance from reducing complexity and increasing efficiency elsewhere. The third and final part of the initiative is our supply network strategy, which Kristin Peck discussed at our Investor Day last November. The benefits from this strategy will primarily be seen after 2017. For now, let's focus on the steps that will affect our results between 2015 and 2017, but remember that this initiative is expected to add around 200 basis points to our gross margin by 2020 on top of the improvements from our 2015 efficiency initiative. As I've mentioned before, we recognize that there are opportunities for us to enhance our operational efficiency. Today, we provide you with a framework for improving Zoetis's operational performance while maintaining the core of our value proposition. By 2017, we aim to be a more profitable company with a slightly smaller revenue base, positioned for stronger growth from a more focused product portfolio and with a leaner cost structure supporting long-term revenue and profit growth. Despite these changes, we will still lead the animal health industry and remain the largest investor in animal health innovation, with the most extensive direct sales network in the industry. Our improved efficiency will allow us greater flexibility to allocate resources where they are most needed and to further distinguish ourselves from the competition. The efficiency initiative is expected to add an estimated $200 million to our pretax earnings in 2017, driven by the $300 million in operating expense savings, offset to some degree by a projected $100 million decrease in gross profit due to the streamlining of our product portfolio. This initiative contributes approximately $0.28 to our previous estimate of adjusted net income per share for 2017. To sum up, we are positioned to grow our rebased revenues in line with or faster than the mid-single-digit growth of our markets while managing our operating expenses to align with inflation rates, thus delivering long-term profit growth greater than our revenue growth. However, achieving improvements in our financial model will come with costs. Therefore, I want to discuss one-time costs in general, particularly related to the efficiency initiative. Our standards for categorizing costs as one-time exclude them from adjusted net income. We limit such adjustments to purchase accounting, acquisition-related costs, and significant items evaluated on a case-by-case basis. These include direct costs necessary for completing our company's transition and those incurred to execute our efficiency plan. To maintain transparency, we will categorize our one-time costs into three buckets: stand-up and other familiar one-time costs, a new bucket for the announced efficiency initiative, and a third bucket for longer-term supply network strategy costs. We anticipate remaining pretax stand-up and one-time costs between $180 million and $210 million, primarily to be incurred mainly in 2015 through 2017, which will primarily be cash costs. For the efficiency initiative, we project one-time pretax cash costs of $340 million to $400 million to be spread across 2015, 2016, with some continuing into 2017. We expect actual cash payouts to occur over the upcoming years. Additionally, noncash charges will arise from this initiative, although we are not currently estimating these amounts, as they could vary widely. We also anticipate one-time pretax cash costs related to the supply network strategy ranging from $60 million to $100 million over the duration of that plan. Given that we are still in the early stages of developing the supply network strategy, the final costs may differ substantially based on our ongoing supply network analysis and any site exits. Noncash charges will also arise from this strategy, which we will disclose when recognized. Note that the estimates for one-time pretax costs for both the efficiency initiative and the supply network strategy do not account for potential proceeds from asset sales, which could offset some onetime cash costs. We provided a web slide summarizing estimates of one-time pretax cash costs for each of the three buckets from 2015 to 2017, and we'll update you on these as necessary. Now, I want to draw attention to an unrelated change in our outlook and our decision to decrease activities in Venezuela. The animal health market there remains strong, and our business has been performing well. However, recent economic changes require us to reassess our efforts in Venezuela. Although the business is profitable, realizing those profits in U.S. dollars has become increasingly challenging. Until the environment improves, our sales and profits there will yield low-quality earnings, prompting us to scale back significantly. We will maintain a presence in Venezuela, believing the market will recover, but in the interim, we think it prudent to reduce our exposure. This decision will affect our revenue and profit forecasts for 2015, 2016, and 2017. The 2015 impact can be seen in our press release, showing the transition from previous guidance to revised guidance. We have included a slide in the webcast detailing the Venezuela impact, which decreases our adjusted net income expectations for 2017 by $0.07 per share. Next, let’s update our full-year 2015 guidance in light of foreign exchange rate changes, the anticipated impact of our efficiency program, and our decision to reduce efforts in Venezuela. It’s essential to provide clarity regarding our 2016 and 2017 expectations as well, given the various factors at play. First, regarding 2015, our press release includes a bridge from our previous guidance to the revised outlook. Despite ongoing challenges from foreign exchange rate changes and our decision to reduce Venezuelan operations, we are maintaining our guidance for adjusted net income per share in the range of $1.61 to $1.68. There are factors contributing to this balance, including a negative effect from foreign exchange rates. The changes in these rates since late January translate to a $75 million revenue reduction for 2015, or about 155 basis points, while the impact on adjusted net income is around $5 million, or roughly 60 basis points. Additionally, our decision to cut back in Venezuela results in a $50 million reduction in revenue, $5 million in operating expenses, and a decrease of approximately $25 million in adjusted net income. A positive offset comes from our efficiency initiative, which lowers expected operating expenses by $45 million and boosts expected adjusted net income by $30 million. In summary, we forecast our reported revenue to decline by $125 million from our prior guidance, maintaining our adjusted net income forecast at $1.61 to $1.68 per share. It's noteworthy that we have lowered our operational revenue growth guidance for 2015 to a range of 5.5% to 7.5%, primarily because of anticipated declines in Venezuelan sales. This shift in our expected revenue in Venezuela is accounted for using the fixed official rate of VEF 6.3 to the dollar; thus, the anticipated reduction in revenue adjusts our operational growth rate. Adjusted net income growth on an operational basis is predicted to rise by 1% due to the contributions from our efficiency program, which more than offsets the impact of Venezuela. Looking ahead to 2016 and 2017, we provided ample detail to help you realign your expectations for these years. It’s crucial first to adjust your prior expectations based on changed foreign exchange rates. The FX changes from late January to late April should decrease your 2016 and 2017 revenue expectations by approximately 215 basis points, cost of goods sold by 260 basis points, and operating expenses—SG&A and R&D—by 170 basis points. This shift results in an estimated 235 basis point decrease in projected adjusted net income due to foreign exchange rate changes. Using this updated forecast will help you assess the effects of our efficiency initiative alongside our decision to scale back in Venezuela when comparing to our revised guidance for the 2016 and 2017 period. In summary looking at 2017, we expect the full benefits of the efficiency initiative to contribute around $200 million to our pretax income, while the actions related to Venezuela reduce expectations by $55 million. In total, we expect to enhance our pretax expectations for 2017 by $145 million, translating to about $100 million in adjusted net income or $0.20 per share. As Juan Ramón mentioned, the initiatives we are taking are expected to improve our EBIT margin by approximately 500 basis points to around 34% in 2017. I would like to highlight a few other considerations: our guidance does not incorporate any future currency devaluation in Venezuela, we expect a slightly higher effective tax rate for the remainder of 2015 compared to the first quarter, the benefits of operational expense reductions will be more apparent in the fourth quarter, and we are assuming a constant diluted share count of approximately 502 million shares. This figure includes estimated share repurchases totaling $100 million in the first half of 2015, partially offset by dilution from employee equity compensation. We anticipate a similar level of diluted weighted average shares for 2016 and 2017 as we plan for our repurchase program to at least counterbalance projected dilution from employee compensation programs, including the impact of our operational efficiency initiatives. All additional guidance details are included in the table attached to our press release. Lastly, we've covered substantial ground today. To ensure clear communication, as John indicated, we will post copies of Juan Ramón's and my scripts on our Investor Relations website after this call. This concludes my prepared remarks, and we are now ready to take your questions.

So my question is on your organic sales growth and also your gross margin once you lap on the headwinds from, I guess, getting rid of some of these lower-margin SKUs.

Thank you, Louise. Our goal is to achieve revenue growth that is in line with or exceeds the market, which is projected to grow around 5% in the medium to long term. We also plan to significantly enhance our gross margin. By eliminating lower-margin SKUs, we expect to see a 200 basis point improvement in gross margin. Additionally, price increases and better expense management will contribute to this improvement. Furthermore, the strategy we announced during our Investor Day is also expected to provide another 200 basis points of gross margin enhancement.

Yes, Louise, it's Paul. I'll follow up on that. Please refer to the slide on the webcast for our guidance from 2015 to 2017, where you can see the projected improvement in our gross margin. We expect to reach a margin of 32% to 33% by 2017, and there's potential for even better results as we continue to enhance our supply network strategy.

So looking at the operational improvement initiative. Paul, you laid out a lot of good information. I guess kind of a combination question. In 2016, operational growth looks a little bit like the negative 1% to plus 2%. Is that really due to getting out of Venezuela? Because it looks like you guys expect some pretty decent growth from that market. And I guess strategically, have you embedded much in terms of M&A acquisitions? I guess, where do your interests really lie within diagnostics? It looked like a new product launch in diagnostics may have helped drive some of the companion animal growth we saw in U.S. Just wondering if that's the feline rapid test and wondering if you have other plans in that category.

Thank you for the question, Kevin. It's Paul. I'll begin by discussing the growth rate for 2016. One reason we felt it was important to provide detailed information about 2016 and 2017 is that as we rationalize our portfolio, the timing of when we phase out certain sales will significantly affect expectations for 2016. After that, we will move to what I refer to as a rebased model in 2017. Two main factors will influence 2016: first, as you mentioned, Venezuela reaching its operational rate; and second, the timing of the SKUs we are removing from our portfolio as we begin to see a decline in sales. You will notice that for the remainder of 2015, we did not indicate a decrease in our revenue targets linked to the SKU reductions. This will start to have an impact in 2016, and we should enter 2017 in a stronger position.

So let me answer the question on M&A. So definitely, M&A is part of our strategy, and we are considering any M&A opportunity that will increase the value of this company and will support our objective in terms of generating higher margins in our operations. So where is our interest? Any opportunity which is in the animal health domain. We think that we have all the capabilities, and also now we have, or will have, even much better ratios in terms of cost and in terms of expenses to revenue, so we can really maximize opportunities of any potential acquisition.

Could you please provide more details on the operational efficiency initiative? In the past, you've emphasized how your direct selling model offers a competitive edge over some competitors. Can you explain the decision to shift to a more indirect model in smaller markets? What has changed in your perspective? Were these markets unlikely to achieve the scale necessary to justify your investments? I'm looking to understand this strategic shift better. Additionally, regarding the new plan and your alignment efforts, will there be any management incentives introduced or adjustments to existing ones as a result of the operational efficiency plan, especially in relation to the 2015 targets?

Thank you, Chris. And what we are trying with this initiative is to be much more focused. And we mentioned many times that our diversity, or the breadth of our business, it was a competitive advantage. But we have also identified some areas or some elements of this diversity, which is adding a complexity, which is a barrier to deliver value to our customers and also to create that value to Zoetis. What we are trying is we've now been much more focused on the countries and also the products that will generate the highest value to Zoetis. It's to really move away from our model, which is a model that will be 100% applicable to those markets, and we are now in these small markets where we don't see that the model is efficient in terms of our profitability and then moving to a model that will be indirect and will be relying more on distributors to support our revenues. So the strategy is not changing. What we are doing is really focusing on the market that would generate the highest opportunities for Zoetis and also the product that will integrate the highest revenues to our company and the most profitable growth. In terms of the management incentives, we have in place programs to incentivize our leaders in Zoetis for exceeding the $300 million target that we have in our program. So we have these plans and we are convinced that we'll be working to meet or exceed our objectives.

Does the new guidance on the top line include contributions in Sarolaner, and could that still provide upside? And do you have cash flow forecast for us? And I think you gave some color here, but does your guidance include share repurchases and plans for deleveraging?

So let me answer the first question, and then Paul will answer the second one. Thank you, Erin, for both your questions. So the new products, Sarolaner, IL-31, are not part of our guidance today. So we are in the process of discussing with the FDA and USDA and other regulators. So once we have more understanding of the timing of these product launches, we'll incorporate in our guidance.

It's Paul, and I'll address the cash flow guidance. We're not providing a cash flow forecast or balance sheet details at this time, but we have talked in the past about our goal to enhance asset efficiency. For instance, with the implementation of our global ERP system, SAP, we believe that we can eventually reduce our inventory investment and free up some cash. Additionally, by refining our business and trimming our portfolio, we can also release some cash. We face significant cash demands in the near term. For example, in the first quarter, we completed the acquisition of the Abbott Animal Health assets. We're still using cash to cover one-time costs related to our separation from Pfizer, which we estimate will be between $180 million and $210 million. We also provided an estimate for the costs of the efficiency initiative that we announced today, along with the early stages of our supply network strategy, which are estimated to be between $300 million and $500 million over the coming years. Furthermore, we have a $400 million debt maturity upcoming next spring and our regular dividend to consider. Thus, we have substantial calls on our cash. We’ve given some guidance regarding share repurchases, indicating that we expect to buy back a total of $100 million worth of shares in the first half of 2015 and that we will continue to acquire shares to offset ongoing dilution from our equity-based compensation plans. I've mentioned before that share repurchases will remain a part of our capital allocation plans, with the activity in 2017 serving as a baseline. As we generate free cash or more debt capacity, we will adjust our plans accordingly. Regarding the deleveraging question, we have previously mentioned that we have a notional floor for our capital structure of gross debt to trailing 12-month EBITDA of 2.5x. I want to emphasize that debt will play a permanent role in our capital structure, and we remain committed to responsibly managing our shareholders' capital. Our capital allocation hierarchy prioritizes first our business, second value-generating business development activities, and lastly, transactions and shareholder returns, including dividends and share repurchases. Therefore, think of that 2.5x as a floor and follow the capital allocation hierarchy I've outlined. I hope I’ve addressed your question.

We appreciate all the details on the efficiency program. EuAfME sales were below expectations. Could you comment on the impact of the new anti-infective legislation in France and whether you think that's going to spread to other developed markets. And Paul, I'm not sure if you addressed this, but how much of your lower OpEx this quarter was driven by FX as opposed to other savings? And then, finally, could you comment on the launch of APOQUEL and whether your prior guidance still stands.

Thank you, Alex. So the situation in Europe/Africa/Middle East, revenues were affected by the France performance. So they announced the new legislation related to anti-infective legislation. It's eliminating rebates offered by animal health manufacturers to both wholesalers and veterinarians. And as a result of this elimination of rebates, there was an adjustment in the market in terms of inventory levels. We expect that this will be, in the next quarter, compensated and back to normal situation. And now Paul will answer the comment also in terms of the impact of FX.

Yes, Alex, and there's really 2 ways you can think about this. First is you can see the impact, the impact on the first quarter alone, on SG&A expenses in the quarter was roughly 5% change was due to FX, and in R&D, it was 2%. I think a more helpful way to think about it might be to look at our guidance bridge slide going from our previous guidance in February to our updated guidance today. And you can see the expected impact on the full year relative to that February guidance is roughly $20 million on SG&A expenses and none on R&D.

And then the comment on the APOQUEL. So in the first quarter of this year, the revenues of APOQUEL have been still facing limited supply. But from April, we have been able to meet the demands of our customers in the U.S., also U.K. and Germany, and we expect that the product will meet our expectations in 2015 of delivering $150 million to $175 million in 2015. And we also are planning now in launching APOQUEL in additional markets that will be also making contribution to meet these expectations for the product.

The inquiry concerns the incremental aspect of future acquisitions, specifically regarding the M&A and the Tax Matters Agreement with Pfizer that is set to expire next month. You are asking if the new cost reduction plan and the expiration of the Tax Matters Agreement will alter our overall strategy for future acquisitions, and whether we remain open to targets of various sizes. Additionally, it’s important to consider ZTS more as a net acquirer rather than as an acquisition target. You also wonder if we are still considering inversion transactions as a method to lower the effective tax rate.

So let me mention on the tax agreement that you're right, this tax agreement will end on June 24. We mentioned on previous calls that this is something that will eliminate any restrictions, but we didn't think that it was a significant restriction for any type of transaction related to acquisition or licensing or any other divestment. In terms of the new program, its changing our strategy, we think that our strategy has been always to consider M&A opportunities that will create value to Zoetis and will create more value to our shareholders. Definitely, the new program will generate more cash, and more cash also will help us to consider any kind of opportunity. In terms of inversion, I think again, so we are open to any opportunity that will increase the value to our shareholders and is something that we'll be always open. But we know there are not too many options that we can consider in terms of inversion or acquisition of our company that will facilitate this kind of tax strategy.

I believe that with our streamlined structure, we will be in a better position to capitalize on potential acquisitions. A great example is the Abbott Animal Health assets. With an improved cost structure, we can absorb those assets and realize synergies, leading to greater value from acquisitions. As Juan Ramón mentioned, we're continually exploring ways to enhance value, and one effective method is through strategic business development initiatives.

I want to follow up on an earlier question regarding asset trimming. What you're doing makes sense by simplifying a complex cost structure, and there are reasons why companies spin off assets, which often perform better as independent entities. However, I was somewhat surprised, Juan, when you mentioned that your expectation for revenue growth is still in the range of 5% to 7%. I would assume that by reducing your revenue base and moving away from slower growth or less profitable businesses, you would have a chance to accelerate top line growth. Could you elaborate on that?

Thank you, Jami, and I think you are right in your comment. We are doing that because we think that being much more focused will be an opportunity to accelerate growth in products, markets that will be important to our future profitable growth, and this is something that definitely we will be working to ensure that the programs that will stay in our portfolio will generate maximum opportunities. The other important thing is that we also want to make sure that we increase our supply to our customers on those problems that really matter to them. And we want to have a reliable supply and to eliminate the risk for product supply issues that's always very, very different to our customers. So with being much more focused we are convinced that we can generate a higher profitable growth.

You talked about a changing approach to R&D. Can you just elaborate a little bit on that? And one specific one. Do you still expect Sarolaner to reach the market by spring of '16? But then more broadly, what are the source of products that you're refocusing the R&D efforts on? Is there any criteria around, let's say, region or animal species?

Thank you for the question, John. And in terms of R&D, so we are eliminating 5,000 SKUs. So if we are eliminating about 40% of our total SKUs, you can also assume that we'll be eliminating some of the programs that are a very important part of our investment. And just to remind you, almost 50% or even more of our R&D investment is related to life cycle management. So if we are eliminating 40% of our SKUs, we should be also eliminating programs in life cycle management that are supporting this part of the portfolio. We also think that it's a good opportunity also for us to identify the future problems that will generate the highest potential in the animal health industry. We have been extremely successful in identifying these opportunities, and APOQUEL is a good example, but also our progress on bringing back vaccines to the market like PEDv vaccine and many other vaccines that we have been introducing is a good example of being focused, identifying these opportunities. It's a great opportunity for us like this. We'll remain doing that and we are not changing our approach in R&D, but we are trying to identify those projects that would generate the highest return to our company. In terms of Sarolaner, we are working with the FDA. We are presenting all the information that FDA is requesting, and we expect that the program will be launched in 2016.

Just to follow up a little more on the 5,000 SKUs that will be eliminated. Can you give us a little more color on them? Such as how many products this might include and will we see a change in your therapeutic product mix post the elimination of these products? And second, just a quick question on the antibody for atopic dermatitis that you expect conditional approval for, is that still on track for the end of this year?

Thank you, Kathy, and definitely, these 5,000 SKUs are not 5,000 products. The number of products is much lower. I don't think we have provided the number of programs that will be affected. It's something that definitely, we plan to provide this information to our customers in the next coming weeks, and we also plan to send a communication to our customers on those programs that will be affecting every market. In terms of the change of the mix, well, the mix will improve in terms of profitability, so these products, as we mentioned, are low-margin. So by eliminating these low-margin products, we'll improve our margin and mix and this will have a positive impact on our operations. IL-31 is still on track for conditional approval in 2015. We are working with the USDA and we expect this conditional license approval anytime at the end of the year.

Just a quick question on the sales force. If I understood correctly, the reduction in the sales force that you proposed is only from the sales force that's associated with products or regions that you're exiting, and you don't anticipate any curtails in sales force in the regions that will remain ongoing. Is that correct? I just want to make sure that I understood that correctly.

Thank you for the question, Liav. No, the reduction on the field force, it's mainly related to those markets that we are planning to change our model, moving from direct to indirect. Also, in some of the markets, we are also adjusting our field force to the real potential of our portfolio. We are not changing our field force in key markets like the U.S. We have some small adjustments in some markets in Europe, which is also the reflect of the market potential of those markets. But basically, we are maintaining our presence in the market. So we are convinced that our direct interaction with the customer represents a significant competitive advantage and we are planning to protect these interactions and continue interacting there with customers on a daily basis. And again, I want to insist that in most of the markets, there is no change in the infrastructure of our field force. What is something that is applicable not only to the field force but to the rest of the organization: we are also considering being much more efficient in terms of span of control. And this will imply some elimination of layers also in the field force, but not in the people that have customer-facing interactions.

I just wanted to ask about the 2 segments of the company, companion and livestock. Could you just characterize the different margins for the 2 business segments? I don't know how much detail you can provide, but I was hoping that you could help to provide a baseline for us in terms of where the operating margins stand for each of the segments? And then looking ahead, which of the 2 is the 1 that will experience greater margin expansion over the next 3 years.

Thank you, David. I would like to start by discussing the differences in gross profit between our companion animal and livestock segments. Companion animals yield the highest margins, generating a gross profit of 65%, with net figures even higher. Livestock margins vary depending on the type—poultry has the lowest gross profit, while cattle has the highest. However, when considering the costs associated with reaching customers, the overall margins become more comparable. Companion animals require a significantly larger field force and promotional efforts due to the higher number of customers compared to livestock. Conversely, the poultry industry is more consolidated, needing fewer representatives to access customers, while cattle still necessitate a considerable workforce. Despite variations in gross profit across species, the total margins tend to be more aligned. We see growth opportunities in both segments, and notably, our livestock segment has been expanding faster than companion animals recently. With products like APOQUEL, Sarolaner, Abbott, and IL-31, we anticipate that the companion animal segment will experience substantial growth in our operations moving forward.

Just a quick follow-up here. I guess going back to the SKUs that are going to be eliminated. Paul, did you provide how much revenue those products are going to generate or what the impact would be from the SKU elimination in 2016? In the press release, you mentioned the feed additive for poultry, Zoamix. I’m curious about its potential growth. Also, what are your thoughts on the scrutiny of restaurant companies eliminating antibiotics in chickens, and what do you think about the avian flu?

I'll start. Yes, the first question with respect to the period SKUs. We did not provide a specific amount or impact on our 2016 just to say that, by definition, we included the impact as we provided the detailed guidance for 2016. And then call your attention to 2017 where we call it out and it's really $280 million of top line that we expect, relative to our prior expectations, for 2017. And the way I would think of it is 100 is a curious thing with this $10 million of OpEx that maps the cost of goods sold. So the table, you'll see the $290 million versus $300 million, but with $300 million OpEx, you think like $280 million and $100 million, that's the impact on '17 when it's fully reflected in our re-based revenues and that's how I think about it.

The majority of the elimination of this key SKU will occur in 2016, so we should anticipate a revenue impact in that year closely aligned with the $280 million Paul mentioned. We have not disclosed the exact revenues for Zoamix in the U.S., but it has been compensating for the rotation of products in the industry, serving as a means to protect animal health in poultry. Regarding the poultry and antibiotics comments from a recent press release, we fully support the FDA's goal to combat antibiotic resistance in animal health. Two companies have announced plans to stop using human health products in poultry. We have already collaborated with Tyson for several years to phase out these products, and since we offer alternatives that are crucial for human health, we believe we can provide solutions to U.S. poultry companies transitioning away from these important antibiotics.

Just was trying to just dig a little bit more into the motivating factor that's leading you to this broad restructuring. I guess my question, are you seeing the market changing? Or is this really that you've gotten out of Pfizer, you've had the chance to review the broader strategy, that you're just having time now to dig into these business units and really try to focus the organization overall? I'm just trying to understand, higher level, what led you down this path to begin with?

Okay, this program has been part of our plans since the beginning. So it means we have separated from Pfizer. We had, in our thinking, that we should generate greater efficiencies and also define cost-saving opportunities. We also knew that in the first 2 years as a public company, we needed to focus on standing up our infrastructure. Also making sure that we are meeting our objectives in terms of revenue growth, also our objectives in terms of profit growth. We also needed to have full control of our operations. And when I mean full control of our operations, have a full understanding of our corporate functions, also full understanding of manufacturing and, also very important, control of our IT systems. We also decided early in the process of separating from Pfizer to invest in the new ERP. And now that the ERP has been already implemented in certain markets in Europe and went live in the U.S. at the end of April, we see that we are in the process to finalize all these implementations in the first quarter of 2016. With all these elements, I think we are in the position to identify these opportunities to be more efficient, and not only opportunities to be more efficient, but the opportunity to be much more focused. And I want to seize the complexity that we have in some of our operations. It's a barrier to deliver value to our customers. And this is one of the objectives that we have as part of this program, to ensure that we deliver higher value to our customers by being much more focused on certain problems in certain markets.

Well, thank you very much for joining us for today's call. We had the opportunity to share with you a lot of information, and we'll be pleased to have a follow-up conversation with you if you need some additional understanding of all the plans that we are announcing and also all the products that we are making as an independent company. Thank you very much.