Zoetis Inc - Class A (ZTS) — Q2 2016 Earnings Call Transcript

Good day, and welcome to the Second Quarter 2016 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-out or dial-in 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. 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. It is now my pleasure to turn the floor over to Juan Ramón Alaix.

Thank you, Steve, and good morning everyone. Our performance this quarter once again demonstrates why we have confidence in the consistency and the predictability of our results and why we are the leader in the animal health industry. True to our diverse business model, we continue generating results from many different sources, both in the U.S. and international markets and across different species and therapeutic areas; and our portfolio helps us deliver steady results over the long-term despite some economic and market challenges that exist. Our R&D investment is maintaining a high level of productivity with new products like SIMPARICA as well as lifecycle innovation and market expansions for key product lines such as DRAXXIN, VANGUARD and VERSICAN Plus. We also combine this internal investment with external partnerships and opportunities with products like SILEO, the new noise aversion medicine we are marketing for dogs in the U.S. In addition to sales and innovation, we are demonstrating our leadership in the animal health industry with the profitability and performance of our operations. We have been executing on the operational efficiency program we announced last year; and we are on track to deliver more than $300 million dollars in savings and an adjusted EBIT margin of 34% by the end of 2017. We believe this achievement in efficiency and profitability is unparalleled in the animal health industry. Looking more closely at our second quarter results, operational revenue was up 6%, excluding the impact of foreign exchange. As you will recall, this year our revenue growth and focus will continue to reflect the impact from changes related to the operational efficiency program we put in place in 2015. Those SKU rationalization and business changes in countries like Venezuela and India continue to partially offset more significant gains in our core business. Excluding these impacts and the impacts of acquisitions, our normalized organic operational growth will be 9%; and on the same basis, our companion animal products grew 15% and our livestock products grew 5%. Paul will provide more details on the bridge from reported to normalized organic operational growth in his remarks. The growth in companion animal was based on the strong performance by APOQUEL, as well as our recently launched vaccines and SIMPARICA. In livestock, we saw growth coming from a recovery of the cattle business in the U.S. In swine, the positive performance from the International segment was offset by a decline in the U.S. And in poultry, we declined globally due to market conditions and pressure from competition. We are improving our cost of sales and gross margin as we refine our manufacturing network, execute our efficiency plan and focus on continuous improvement. On an operational basis, our adjusted operating expenses were flat in the second quarter, even as we grew revenues significantly; thanks to the ownership and mindset of our colleagues and expense management discipline. The growth in revenues, gross margin improvement and discipline on expenses resulted in adjusted net income growth of 22% operationally; once again, supporting our long-term and value proposition to grow adjusted net income faster than revenue. We always emphasize a full-year view of our business to account for some of the seasonal fluctuation and timing patterns in animal health; and we continue to see good progress through that lens. We're increasing our guidance for 2016 based on our strong performance in the first half of the year, the continued strength of our business model and the confidence in our outlook for the rest of the year. Paul will go through updated 2016 guidance in his remarks. Now let me turn to the innovation investments that are fueling our performance this year and positioning us well for future value creation. At the beginning of the year, I said we needed to execute flawlessly on our new product launches; and I'm very pleased with our progress. In the case of APOQUEL, it has become a very positive story. For the first half of 2016, we have exceeded $100 million in revenue; until May, we have been supplying APOQUEL with no restrictions. Recently, we have launched it in additional markets such as Brazil, Japan, Mexico and Russia; and in the coming months, we plan to introduce APOQUEL in the rest of the approved markets such as Colombia, Peru, and Uruguay, as well as Singapore and Hong Kong. SIMPARICA, our new oral parasiticide for dogs is now available to customers in the U.S. and most of the European countries; and we expect it to be further deployed in Canada, Brazil and New Zealand during 2016. We are pleased with the launch of SIMPARICA, despite being the most recent entrant in a very competitive oral flea and tick market for dogs. At launch, SIMPARICA was introduced with extensive published data, showing its rapid onset of action, its sustained persistence of protection against fleas and ticks and other advantages over various oral and topical parasiticides on the market. While new products have been a big lift for us recently, we continue to build on our major established product lines and focus on the lifecycle innovation that will keep our portfolio strong and sustainable. One of the strengths of our R&D organization is the ability to innovate across the phases of care that veterinarians encounter; phases that include prediction, prevention and treatment. Our R&D begins with an understanding of the biology of the diseases, their pathways and how they work. Then, we complement that with customer insights that come from our commercial teams working shoulder to shoulder with veterinarians and producers; and we apply this knowledge across the phases of healthcare. We use innovations in genetics, diagnostics and increasingly digital platforms to help predict risks or detect diseases in species. This means the ability to breed healthier and more productive animals, to detect disease earlier and to develop practices informed by bioinformatics and digital applications that capitalize on the use of big data. In the second quarter, for example, we continue to expand our business diagnostic franchise into new markets with an additional approval in Spain for livestock test kits. These point-of-care test kits deliver accurate, fast and clear results that give the customers timely and informed diagnosis without disrupting their clinical consultation. Our customers are also seeking new solutions to get ahead and help prevent infectious diseases. We have been placing a greater emphasis on our vaccine portfolio, some of which we introduced last year and others that we continue to expand in terms of approvals and geographies. For example, in the second quarter, we expanded our VERSICAN Plus and the VANGUARD vaccine franchises with new approvals in Europe and Canada. VERSICAN Plus, a combination of vaccines that protect dogs against 10 canine diseases was first approved in the European Union in 2014; and this quarter, we received additional approvals in the United Kingdom, Denmark, Sweden and the Netherlands for a smaller combination of the vaccine. Additionally, VERSICAN Plus Rabies achieved approval for a new claim in the European Union for three years duration of immunity. Meanwhile, VANGUARD B Oral and VANGUARD crLyme vaccines were approved in Canada after having just received their U.S. approval in December 2015. And finally, across the phases of healthcare, we develop medicines to treat sick animals. DRAXXIN, one of Zoetis' largest global product lines and was first introduced in 2005; and this quarter, we received approval of a new label claim in Europe for DRAXXIN and DRAXXIN 25, an injectable anti-infective for treating swine respiratory disease. In addition to our internal R&D, we also look for partners that can help broaden and strengthen our product portfolio. For example, in May, Zoetis launched in the U.S. a product called SILEO under an exclusive agreement with Orion Corporation. SILEO is the first and only medication approved by the FDA for the treatment of noise aversion in dogs. And if you were in the U.S. this July 4, you probably read about or heard about this exciting new product that brought hope to many dog owners. In summary, we have continued our positive momentum through the first half of the year based on the strength of our U.S. portfolio and dedicated Zoetis colleagues. We continue to reap the benefits of a productive, world-class R&D organization focused on new products and lifecycle innovation across our approximately 300 product lines. And we are executing on key product launches and our operational efficiency program to ensure our long-term growth and value creation. With that, let me turn things over to Paul.

Thank you, Juan Ramón. Another solid quarter with lots of good things to cover, so let's get to it, starting with a quick walk down the P&L for the quarter. Then, I'll provide some commentary on a number of areas that I believe will be helpful to understanding our quarter, our first half of 2016 and what you might expect for the balance of 2016. Before I start, I want to point out that the SKU rationalization and the changes in business models we made in several international countries continue to impact our revenue in 2016 and growth in revenue for 2016 compared with 2015. First, we're confident that the steps that we took and are taking to improve efficiency will put Zoetis in a position to deliver higher profits and cash flows and to better grow those profits and cash flows from here forward. Second, while we're going through this transition, we believe it's important that we and you have visibility into how the go-forward portion of our business is performing. So we prepared analyses that strictly eliminated SKUs out of our revenue to show the underlying growth of the go-forward business. On our website, you'll see slides and you'll find a table – or tables rather that show our reported revenue growth for the second quarter and for the first half of 2016; and then walk you through the impacts of foreign currency, the operational efficiency changes related to SKUs and other business model changes, recent M&A; and in the case of the year-to-date charts, the extra days in our first quarter relative to the prior year. The objective here is not to divert attention from the reported revenue growth rates; it's to provide perspective on how you might think about our future growth prospect in our to-be state. While we use the phrase operational growth, that means excluding the impact of changes in FX rate versus the same period in the prior year; when we say normalized organic growth for any period compared with the prior year period, that means excluding the impact of FX, the eliminated SKUs, the business changes outside the U.S., the extra days in the first quarter of the year and the impact of recent M&A. So with that lengthy preamble, let's talk about the quarter. Revenue grew 6% on an operational or constant currency basis. We posted an adjusted gross margin of 67.9% in the quarter, resulting in adjusted gross profit growing faster than revenue; up 11% on an operational basis. Adjusted operating expenses were flat on an operational basis, reflecting the great progress we've made on our efficiency initiative. As Juan Ramón said, we're on track to deliver more than the previously announced $300 million in savings associated with the efficiency initiative; and those savings are considered in our guidance for 2017. The combination of 11% operational growth of adjusted gross profit and the flat adjusted operating expenses enabled us to grow adjusted EBIT for the quarter by 25% on an operational basis. Below the operating line, we had higher interest expense and higher effective tax rate on adjusted income, which together reduced the operational growth rate of adjusted net income to 22%. We put adjusted earnings per share of $0.49 on the board for the quarter. And the strong performance in the first half of the year enabled us to increase our guidance for the full year 2016 by 3% – excuse me, $0.03 per share across the range; a solid quarter and a solid first half of the year for sure. So a bit deeper dive on revenue. The star of the quarter geographically was the U.S., up 10%, and by global business it was companion animal, up 13%; and both of those are on an operational basis. Of course, APOQUEL was an important driver of both. APOQUEL sales in the quarter were roughly $60 million. APOQUEL has a lot of revenue growth still ahead. And with SIMPARICA and a number of other recently introduced companion animal products, we expect our companion animal business to drive above market revenue growth through 2017. Our International segment was up 2% operationally, and the global livestock business grew about 1% operationally. Both were disproportionately impacted by our SKU reductions and the changes we made to our operating models in countries, including Venezuela and India. On the flipside, global livestock is benefiting from M&A, mostly PHARMAQ. Now let's talk about the components of our operational revenue growth of 6% in the quarter. APOQUEL accounted for 3% of that growth. New products other than APOQUEL, including our new companion animal vaccines, SIMPARICA, SYNOVEX ONE and SILEO, to name a few, added 2%. In-line products added 4%, with 3% coming from increased prices and 1% for volume; and M&A accounted for another 2%. The impact of the SKU reductions and the changes in business models reduced our growth by around 500 basis points; and that gets you to the 6% operational revenue growth for the quarter. Pretty good, right? Once again, our revenue growth came from a number of sources and reflects the strength of our diverse business model. Let's turn to our two segments, U.S. and International, starting with the U.S. Overall, the U.S. business was up 10% in the quarter. On a normalized organic basis, the U.S. grew 11% in the quarter. U.S. companion animal business was up 17% mainly due to the ramp of APOQUEL, the launch of SIMPARICA and the introduction of other new products. Half of the growth was driven by the ramp of APOQUEL. U.S. livestock grew 2% with a 4% pick up from increased selling prices that were offset in part by volume decreases related to some of the SKU reductions. On a normalized organic basis, the U.S. livestock business delivered growth of 5%, compared to a 9% decline in Q1 of this year. The business rebounded nicely in Q2 and the year-to-date normalized organic growth rate for the U.S. livestock business was negative 3%. After the first quarter, there was some concern out there about the health of our U.S. livestock business. For the avoidance of doubt, after a slow start, we expect our U.S. livestock business to deliver growth for the full year 2016 on a normalized organic basis. Within U.S. livestock, cattle, especially beef cattle, was particularly strong as the herd size and placements in feedlots were increasing and drove higher demand for our high-value injectable anti-infectives, vaccines, parasiticides and the recently launched SYNOVEX ONE implants. U.S. swine products experienced a decline due to competition for Fostera PCV vaccines, new restrictions on the use of some of our products for pork exports to China, a decline of PEDv revenue as the disease is no longer prevalent and some eliminated SKUs. U.S. poultry revenue declined in the quarter with the impact of SKU rationalization more than offsetting growth from the increased use of our health maintenance products and MFAs for antibiotic flea production; products like Zoamix, for example. On to the International segment, revenue from our International segment was up 2% operationally. On a normalized organic basis, the growth rate was 7%. On the same normalized organic basis, the international companion animal business led the way, up 10%, while international livestock was up 5% in the quarter; again, both of those are on a normalized organic basis. It's worth spotlighting a few countries for you. China was up $14 million or 49% operationally. Pork prices in China were relatively high leading to favorable conditions for pork producers and for our swine portfolio, including products like DRAXXIN, EXCEDE and our vaccines. About one-third of the growth in China was driven by products purchased by producers to stock up ahead of label changes for some of our products. Finally, we had a very successful spring promotion that drove increased sales of our REVOLUTION and DECTOMAX products in China. In Brazil, cattle and companion animal sales were strong, but partially offset by a weakness in poultry. The cattle portion of livestock in Brazil enjoyed favorable market conditions, leading to strong performance from our vaccines and parasiticides. We also saw increased adoption of IMPROVAC in the swine business. Across the portfolio, we also benefited from increased selling prices. The poultry business saw high input prices and increased restrictions on exportation to Japan that made for a challenging market for poultry producers and saw us lose a few accounts based on price. For the quarter, Brazil grew 6% operationally. Australia posted a solid 10% operational growth for the quarter, led by the launch of APOQUEL, the success of a promotional campaign for REVOLUTION and sales of anti-infectives for cattle. On the negative side of the growth ledger, in the UK, we saw our sales decline 21% operationally. The biggest factor, nearly half the decline was due to weather. A wet winter to spring delayed the cattle sheep turnout seasons; and that was a factor. The second quarter was also negatively impacted as we were in the process of shifting the acquired Abbott products to our distribution and we saw the channel accelerate purchases into Q1 and work off the inventory in Q2. Year-to-date, the UK business is up 3% operationally. Finally, the grouping in other emerging countries declined 5% operationally with the biggest drags being Venezuela and the SKU reductions. We saw growth across most of the countries in this grouping, including through the addition of PHARMAQ revenue in Chile. So on revenue, high level, the beat goes on. Growth from many sources in a diversified model that enables us to overcome softness in parts of our business with strength in other areas. Now let's shift to the rest of the P&L. We posted a high gross margin, 67.9% in the second quarter. But before we all start high-fiving each other, let's look at the factors that led to the 250 basis point improvement over the prior year quarter. Of the improvement, roughly a third came from price increases; a third from a mix shift toward higher-margin companion animal products; and a third came from other areas, mostly improvements in our supply chain efficiency. These three net positives experienced a bit of a headwind due to unfavorable foreign currency. Our gross margin has been improving, but it's not a one-way ratchet and there are some seasonal elements that we expect to come into play in the second half of 2016. For example, sales of our livestock products are greater as a percentage of total revenue in the second half of the year; and pricing promotions heading into the fall can lessen our net selling prices and thereby reduce gross margins in the period. These factors are expected to result in our reporting lower gross margins in the second half of the year as compared with the first half. And finally, there's, of course, FX. Predicting the timing and magnitude of FX changes on the cost of goods sold and on gross margin in short periods is very difficult. So that's a lot of discussion designed to caution you about assuming that our guidance for adjusted cost of goods sold as a percentage of revenue for 2016 and 2017 are conservative. There's good news here. We fully expect our gross margin to continue to improve over time based on increased selling prices, increased sales from our companion animal products versus livestock and increased efficiency on our supply chain. But the upward journey will not be linear quarter to quarter. Turning to adjusted operating expenses. There is really not a lot to say except that we're on track to take out more than our target of $300 million of operating cost by year-end, so we enter 2017 in our new leaned out state. Total adjusted operating expenses were flat on an operational basis when compared to Q2 of 2015. Note that our operating expense base is not static. We've added costs, selling, marketing and R&D to the base via the PHARMAQ acquisition and to support the launch of SIMPARICA and we may consider investing in promotion of certain key products or incremental R&D. The purpose of the efficiency initiative was to eliminate non-productive expenditures, not to ignore high-value investments we can make in our business. At this stage, our to-be operating expense structure is what you see in our 2017 guidance table. We continue to demonstrate excellent expense discipline through the second quarter, and that combined with the gross margin improvement enabled us to post operational growth of adjusted EBIT of 25% for the quarter. Below the operating line, we had increased interest expense due to the note issuance in Q4 that funded the PHARMAQ acquisition and pre-funded the $400 billion of debt that matured in the first quarter of the year. And our effective tax rate on adjusted income increased by some 100 basis points, mostly due to the change in our tax status in Belgium. Bottom line, our adjusted net income grew operationally 22% and our adjusted earnings per share grew 23% operationally, about 100 basis points faster than adjusted net income, as our fully diluted weighted average shares outstanding in Q2 2016 were almost 1% less than in Q2 of 2015. A couple of additional factors, I think, that you need to think about for the balance of 2016 and into 2017. First, as always, FX. While there has been a bit of volatility in FX rates recently, notably with the British pound and the euro, the FX impact on the balance of our year and into 2017 is little changed from our last guidance update. The overall impact on our future expectations for our International operations, based on FX rates, in late July is negligible. That said, FX rates had a negative impact on our reported revenue and profit rates, decreasing revenue growth in Q2 by some 300 basis points compared with Q2 of 2015 and adjusted net income growth by some 800 basis points. Contrast that with a 700-basis-point drag on reported revenue growth in Q1 and a 1,300-basis-point drag on adjusted net income in Q1. So as we had hoped on the last call, the impact of FX rates on our reported growth is moderating. Regardless, we continue to measure ourselves on a constant currency or operational basis. Next, the SKU reductions, including the changes we made to our business models in places like Venezuela and India. As we communicated on our last call, we expect the SKU reductions and business changes to decrease revenue growth by some 500 basis points for the full year 2016. In Q1, the impact was roughly 400 basis points; in Q2, it was roughly 500 basis points; and year-to-date, it was roughly 500 basis points. I'll point out, there's a little bit of rounding in there. You can see the impact of the SKU reductions in business model changes on the revenue growth in the charts that are on our website that I mentioned earlier; and I call your attention to those. I think they're helpful. On to one-time costs, I won't use this time to walk through the table in the press release, but want to call your attention to a contra expense item from the reversal of a portion of our severance accrual. At the time we recorded the accrual, we based it on the best information available. As it's worked out, we expect to pay out a little bit less in severance than we had thought, mainly due to a greater level of voluntary attrition than expected. From a cash out the door perspective that's a good thing for us. For the avoidance of doubt, the reversal did not increase our adjusted net income, but it did increase our reported GAAP net income in the quarter and was a factor in narrowing the gap between adjusted earnings and Generally Accepted Accounting Principle earnings. Finally, on to guidance. Today, we're updating our guidance for the full year of 2016 for a couple of things. We've increased our revenue guidance range by $25 million to reflect the strength of our business and our improved visibility now that we're through the first half of 2016. And we moved our expectations for adjusted cost of goods sold as a percent of revenue from a range of 33% to 34% to approximately 33%, so the favorable end of the range. Adjusted EBIT projections have improved in a similar fashion, so that's been updated too. We also updated our one-time costs to reflect the lower expectations for the severance point I just talked about. All other categories remain the same and the result is that we've raised our guidance range for 2016 adjusted earnings per share by $0.03 to the range of $1.86 to $1.93 per share. Note that the operational growth rate for adjusted net income implied by our guidance increased by 100 basis points and is now a range of 10% to 14%. The majority of the increase in our guidance is operational, not FX-related. Now, we can all do the math into what our guidance implies for the second half of the year for adjusted net income per share and you may think that that outlook is anomalous, given the second half revenue is expected to exceed revenue in the first half of the year. Here are a couple of observations about the phasing of our business in 2016. First, we do expect second half revenues to exceed the first half, that's a good start. However, as I mentioned earlier, we expect to generate lower gross margins in the second half of the year than seen in the first half due to mix and promotional programs reducing net selling prices and, therefore, gross margins. Next, our major promotional spending and operating expenses in support of our various product franchises are more weighted to the back half of the year. And finally, our R&D spending also skews to the second half of the year. Generally, the benefits of the increased sales expected in the second half of the year compared with the first may be more than offset by reduced gross margins, and the phasing of spending on promotional programs and R&D. So you all know I don't like to talk about quarters, but here are a couple of tips for phasing Q3 and Q4 2016. We expect Q4 to be our highest revenue quarter. We expect gross margins in the second half to be below those in Q1 and Q2. Selling expenses are expected to be heavier in the second half of the year, particularly heavy in Q4; and R&D spending in the second half is expected to be higher than the first half and heaviest in Q4. From an adjusted net income perspective, Q3 may be the low quarter for the year. What's most important is that we raised our full year 2016 guidance at revenue by $25 million and at adjusted earnings per share by $0.03. This is all good stuff. Our guidance for 2017 is unchanged. We expect a more detailed look at 2017 at the time we report our third quarter. That's it from me. Keith, let's go ahead and queue up the Q&A.

Hi. Thanks for taking my question. I was wondering if you could give us more color on why you think livestock sales should continue to improve in the second half of 2016, especially since some of your competitors posted disappointing livestock sales this quarter? Thanks.

Well, livestock is a combination of many species. Let's start with cattle and let's start with cattle in the U.S. Cattle in the U.S. have two different segments, beef and dairy. In beef, we have seen that the number of animals is larger than the previous year by 3%. In the second quarter also we saw that the number of placements in the feedlot increased by 5%. For the total year, we expect that the number of animals will be about 3% higher than in 2015; and also the placements on the feedlot during the second half will be lower than in the second quarter, we expect also to grow by about 3%. With all this, we expect that the cattle business for beef in the U.S. will be positive. We have seen also improvement in Australia because of the weather conditions. We have seen that the fundamentals of Brazil remain very strong with even increasing exportations. So in our opinion, the cattle business for beef will be positive for the year. Dairy prices are having a negative impact on the profitability of farmers around the world. In the U.S., we expect that the business will not be – or revenues coming from dairy will not be a significant driver of growth; although we have seen also that so far farmers are not reducing the number of animals, which is also a good indication that they also expect improvement in pricing in the second half or first half of 2017. Swine, and for us, as we said, in the international business is doing extremely well. We expect this trend to continue in the second half. In the U.S., we are facing some competitive challenge that we also expect to start solving in the fourth quarter of 2016 and the first quarter of 2017. And poultry is the area where we expect probably less positive evolution for our portfolio. But, in general, we expect that livestock at the end of the year will show positive growth.

Hi. Thanks very much. Juan Ramón, can you talk about the longer-term goals that you've got for SIMPARICA and SILEO? How do you think those products over time will end up sizing compared to APOQUEL? Thanks.

Well, we expect SIMPARICA to be a key product in our portfolio. And we think that SIMPARICA and SIMPARICA also as a platform for adding new products into the parasiticide franchise will be an important product. We mentioned that we expect this product to generate more than $100 million. Based on the current trends of the market switching more into oral and moving away from topicals will represent a higher opportunity for SIMPARICA. For SIMPARICA, we also are implementing our approach in lifecycle innovation from the very beginning. So we expect also to increase or improve the label of SIMPARICA very soon with new ticks and also new indications and using SIMPARICA as a platform to combine the active ingredient of SIMPARICA with other active ingredients that will extend the protection of dogs for any type of parasiticide. We will also be working on how to use the SIMPARICA active ingredient to develop products for cats. So, overall, we consider that SIMPARICA as a platform will be a very strong product in our portfolio. SILEO, it's a product that – it's showing that why we are the product of choice in the animal health industry. It's also combining our internal effort with external collaborations. We obtained the license for SILEO from Orion Corporation for the U.S. And SILEO got very good support in terms of communication at the time of the launch. And it will not be a large product in our portfolio, but it's adding solutions to our customers and definitely it's increasing the relevance of Zoetis in terms of providing any type of needs to our customers.

Great, guys. Maybe I can slip in two quick ones. SIMPARICA, you just mentioned the label expansion. What about plans for a DTC similar to what we've seen from some of the competitive offerings? And then if so, on the DTC, Paul, is that embedded into some of that promotion expenses that you mentioned in the back half of the year? And then also, if I can just ask one on APOQUEL. I think you threw out $60 million versus $50 million last quarter. What do you feel like inventory looks like in the channel, people who were sort of trying to hoard or stockpile that in the early days? Thanks, guys.

Let me start with SIMPARICA and then I will ask Paul to answer on the APOQUEL question. So definitely we see SIMPARICA as a strong candidate for DTC promotion. But we also want to make sure that the product has enough penetration in the market to benefit from this type of investment. And we'll consider this opportunity when we have the product well established in the U.S. market, and we expect that to be in 2017. In terms of APOQUEL, I will ask Paul to answer the question on the inventory channel.

Sure. And I'll come back and hit the DTC question as well. With respect to APOQUEL and the channel, I think we saw a much more normalized pull-through of APOQUEL in Q2 than we had in Q1. Anybody that wants APOQUEL can get it now. They can order what they want. And so, we're starting to see a more normalized or a matching between our revenues and the products that are moving out through the various clinics where it's been stocked. You hit it right on the head. I mean, earlier when people were not quite convinced that we've put the supply chain issues behind us, people were hoarding it or holding it in the office to ensure they had supply. But that is, from our perspective, less and now you're seeing normal stocking and pull-through of the product. There may be pockets where it's still there, but much more normalized; and we're excited about prospects for APOQUEL. With respect to DTC, and if you think about DTC for potentially two products, it's APOQUEL and it could be SIMPARICA, I'd just say that within our guidance or within our OpEx guidance for 2016 and 2017, there are dollars allocated for promotional programs, including DTC. I think when I talk about – and during my prepared remarks, not ignoring opportunities to invest and say, we made assumptions about the level of promotional spend against all of our product franchises. And it's currently embedded within our guidance for 2016 and 2017 to the extent that we see great returns from certain promotional activities, we may well increase them in the future. But for now, they're baked in.

All right. Thanks. On your restructuring, SKU rationalization, overall cost structure initiatives, how should we think about the quarterly progression throughout the year? What would you – or would you say you're running ahead of plan? What were you able to accomplish in the quarter and what's left to do on that front? And then my second question is on capital deployment. Can you just sort of outline your near-term and longer-term priorities there, particularly as cash flow builds heading into next year? What is your guidance also assuming in the way of share repurchases? And if I can ask just a really quick housekeeping question – if you haven't broken it out yet, the U.S. sales and International sales of APOQUEL? Thanks.

Okay. So I will answer the first question on – I think it was a question on APOQUEL? But let me – did you ask...

Yeah, I will take capital deployment. I think we continue to look for ways to invest our cash flow back in our business where we could earn the highest returns. Certainly to M&A and as we said pretty consistently, to the extent that there's not a better call on our cash flow within our business for M&A, then when will distribute it back to shareholders in the form of dividends and share repurchases. We are currently purchasing shares at the rate of about $75 million a quarter. We have a program that runs through the balance of 2016; and we're obviously in the process of looking at 2017 and beyond and thinking through what we'll do there. But, Erin, you bring up a great point and it's something we talk about quite a bit. 2016, we don't really demonstrate through our quarter results the real cash-generating properties of our business. 2017 will be the first opportunity for the market to see in our reported results the ability of this company to generate significant free cash flow. And the reasons for that are the obvious ones that we're completing our standup from Pfizer, and that's been expensive and lengthy; we are completing – or generally completing the payments for implementing our efficiency initiative and we hope to put those behind us by the end of 2016. And so, when we enter 2017, you're going to see a much more normalized level of cash generation from this company. And as we generate that cash, we will stick to the model of looking for ways to deploy inside, outside in value-generative M&A. And last and certainly not least, in the form of our dividends and share repurchases.

Sorry. I was just coming off mute there. Thanks very much. I was just hoping for a bit of a higher-level framework for where you are with the restructuring and reorganizing of Zoetis. My sense is that you're about two-thirds of the way done with rationalizing SKUs and rationalizing people and your SG&A, et cetera. But, obviously, it's different for the cost of goods sold line than the SG&A line. So I was hoping that you could just provide a little bit higher-level framework for how far you are along with the rationalization and restructuring by cost line? Thank you.

So thank you, Dave. Let me maybe provide a little bit more details on where I see we are in terms of our progress in terms of restructuring efforts. So I would say that all the efforts in terms of commercial and R&D are mostly completed. What we are still not fully finalized is related to some areas of G&A, mainly finance and IT, because this was also dependent on the implementation of SAP and we wanted to make sure that while we were transitioning to a different model – a more efficient model, we were ensuring the compliance of any type of finance, tax or IT elements. But we have no doubt that by the end of the year, all the programs will be in place and we'll start 2017 with a new base. In terms of SKUs, I said most of the work has been completed. And there are only some SKUs that we'll be eliminating from now until the end of the year; and this will be also with the introduction of new product that also will help us to minimize the negative impact of this last SKU rationalization. The other area that is still work in progress, but also progressing in line with expectations is the manufacturing changes. We exit the seven plants that we targeted. There is one plant that is still in progress, but five have been sold, one has been exited and the other one is in process. So in that area, things are progressing very well. There are some structural changes also in manufacturing that are a work in progress. And, again, so we plan to finalize this work by the end of the year and start 2017 with a fully implemented plan for the operational efficiency program that we announced in 2015.

Okay. Thank you for taking my question. It's Vlad Nikolenko on behalf of Mark Schoenebaum. First of all, congratulations on the quarter's strong performance, EBIT and EPS. It's very nice and that. So the question will be about the guidance and longer-term margins. So back in November 2014, the company issued the long-term guidance for the first time, given target 34% operating margin in 2017. So I'm wondering – and since that day, they just never re-issued the longer-term guidance and did not expand to further years. So wondering if you're planning to provide longer-term guidance in the future or it was more like one-time event in advance of restructuring a month later. And if there is no long-term guidance, how should we think about operating margins going forward? And if you can also specifically and whether there is a limit for operating margin growth and whether you can specifically quantify contribution from the product gross margin growth due to ongoing supply network rationalization initiative? Thank you.

Thank you. Let me make a short comment on the guidance that we provided back in November 2014; and then I will pass to Paul on how we see this margin evolving over time. So the first thing, almost three years ago or two years-and-a-half after we made this projection, we are confirming that in 2017 we'll be improving or reaching that 34% EBIT margin. And moving from at that time 25% that was projected for the end of 2014 to 34%, it's a significant improvement. And I think it's probably the confirmation of the predictability and the sustainability of our business. I think there are not too many companies that after three years can maintain what I consider, of course, an aggressive target of improving our margin by 900 basis points. Now I will turn to Paul to provide some additional comments.

Yeah, sure. And I want to be real clear. One, why did we provide long-term guidance? We provided that because we knew the steps that we were about to embark on would include the SKU rationalization, the change in business models outside the U.S. and a pretty substantial change in our OpEx base. And in light of that, outside parties trying to forecast what we would look like in 2016 and then in 2017, you would have had no chance to really be somewhat accurate. And so, we felt compelled to provide longer-term guidance to let people determine through their own models whether they were in the neighborhood of what we were thinking or they had a difference of opinion. I think that was a one-time event. We, like most other companies, are reverting to having just – we will revert to having just one year’s worth of guidance on the Street. So we'll provide the update, as I mentioned, in my prepared remarks for 2017 later this year and then we'll have 2017 on the board. But I really want to focus on comments, Vlad, that you made around the 34% kind of operating EBIT margin – or excuse me, adjusted EBIT margin target that you referenced. Because I want to be really, really clear. We're not targeting a maximum operating margin. We're seeking to maximize our cash flow and grow it at a fast rate. If that's at a 33% margin, that's okay; if that's at a 36% margin, that's okay too, but it's not focusing solely on what is that margin and let's maximize that margin. We're looking at maximizing earnings as a proxy for cash flow and then growing it as quickly and for as long as we can at an attractive rate. Now, separately I believe you asked about is there an upper limit. One of the advantages of our company is that we have a wonderful global footprint where we have the scale to support that global footprint and generally – not completely, but generally, we have the ability to drive a lot more revenue on the infrastructure that we have deployed around the globe. So the answer is, yeah, we have the ability to continue to leverage our cost structure and thereby improve that operating margin. But what I don't want people to do is to focus on and say, a 33% or a 35% or – and look at that and say, well, gee, that's less than I thought. The goal is not to continue to drive that percentage; it's to maximize profit, cash flow, grow it and grow it fast and grow it for a long time. So I rambled a little bit there, but I hope I covered your question.

Thanks very much. I was just hoping for a bit of a higher-level framework for where you are with the restructuring and reorganizing of Zoetis. My sense is that you're about two-thirds of the way done with rationalizing SKUs and rationalizing people and your SG&A, et cetera. But, obviously, it's different for the cost of goods sold line than the SG&A line. So I was hoping that you could just provide a little bit higher-level framework for how far you are along with the rationalization and restructuring by cost line? Thank you.

Thank you, Dave. Let me provide a little bit more details on where I see we are in terms of our progress in terms of restructuring efforts. So I would say that all the efforts in terms of commercial and R&D are mostly completed. What we are still not fully finalized is related to some areas of G&A, mainly finance and IT, because this was also dependent on the implementation of SAP and we wanted to make sure that while we were transitioning to a different model, a more efficient model, we were ensuring the compliance of any type of finance, tax or IT elements. But we have no doubt that by the end of the year, all the programs will be in place and we'll start 2017 with a new base. In terms of SKUs, I said most of the work has been completed. And there are only some SKUs that we'll be eliminating from now until the end of the year; and this will also be with the introduction of new products that will help us to minimize the negative impact of this last SKU rationalization. The other area that is still work in progress but also progressing in line with expectations is the manufacturing changes. We exit the seven plants that we targeted. There is one plant that is still in progress, but five have been sold, one has been exited and the other one is in process. So in that area, things are progressing very well. There are some structural changes also in manufacturing that are a work in progress. And again, we plan to finalize this work by the end of the year and start 2017 with a fully implemented plan for the operational efficiency program that we announced in 2015.