Zoetis Inc - Class A (ZTS) — Q1 2023 Earnings Call Transcript

Thank you, operator. Good morning, everyone, and welcome to the Zoetis first quarter 2023 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Wetteny Joseph, our Chief Financial Officer. Before we begin, I will remind you that the slides presented on this call are available on the Investor Relations section of our website and that our remarks today will include forward-looking statements and that actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statements in today’s press release and our SEC filings, including, but not limited to, our Annual Report on Form 10-K and our reports on Form 10-Q. Our remarks today will also include references to certain financial measures, which were not prepared in accordance with Generally Accepted Accounting Principles or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and the company’s 8-K filing dated today, Thursday, May 4, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin.

Thank you, Steve, and welcome everyone to our first quarter earnings call for 2023. Today, we reported solid first quarter results of 4% operational growth in revenue as expected, based on our diverse portfolio and strength in international markets. As we indicated in February, we expected a softer first quarter and a stronger growth for the remainder of the year, and we are reiterating our full year guidance for operational growth of 6% to 8% in revenue and 7% to 9% in adjusted net income, given the underlying strength of the petcare market. In the first quarter, our international segment led the way growing revenue 10% operationally and was partially offset by a 1% decline in the U.S. Our livestock portfolio drove the results with 12% operational growth in revenue, while companion animal product revenues were flat operationally. The performance in livestock was based on double-digit operational growth for cattle, poultry, sheep and fish. In the case of U.S. cattle, this performance was supported by an improvement in the supply of key products. Meanwhile, our companion animal portfolio in the U.S. declined due to distributors destocking and reducing their inventories in the first quarter, as well as higher purchases in the fourth quarter of 2022, which occurred in anticipation of price increases and based on promotional programs. We see strong end market demand in companion animal channels based on data from veterinary clinics, retailers and pet owners. And we view distributor inventories as a short-term impact on our companion animal sales. For example, while our sales into distributors declined in the quarter, as we expected, our product sales from distributors out to veterinary clinics were up approximately 8% and our product sales out of retail channels to pet owners were up about 35%, affirming a healthy petcare market in the U.S. Pet owner demand for product is expected to grow during the second quarter, pulling through more inventory and allowing purchase patterns by distributors to become more aligned with the underlying demand throughout the year. Other dynamics in the U.S. vet clinics also continue to show momentum and trend in a positive direction. Clinic visits increased 2% in the first quarter, showing an increase for the first time since 2021. Meanwhile, clinic revenue and average spend per visit continue to grow even in the face of inflationary pressures. Revenue and average dollars per visit increased 11% and 9%, respectively, in the quarter. The combination of evolving pet owner demographics, innovative medicines and an unbreakable human-animal bond, all continue to support a positive and growing companion animal market where we lead. Despite the Q1 distributor issues in the U.S., our overall growth was driven by strength in international markets, which delivered 10% operational revenue growth in both livestock and companion animal portfolios. This quarter's results are a testament once again to how our diverse portfolio and geographic presence help deliver steady and predictable growth. Turning now to adjusted net income, we saw a decline of 3% operationally in the first quarter, which was in line with our expectations. The first quarter reflected significant investments in our U.S. petcare field force and shifts in the go-to-market model for diagnostics, costs which were not incurred fully in the year ago quarter. We also saw increased investments in R&D, which we have discussed previously. The investments in diagnostics are maturing and gaining traction in the U.S., and we continue to grow and expand outside of the U.S. We expect a return to growth in U.S. diagnostics for the year as we build our Vetscan Imagyst AI platform, refine and grow our reference lab business and bring further innovative offerings to the space. Looking ahead, we see strong demand driving double-digit operational growth for our innovative companion animal portfolio and relatively flat operational growth in our livestock portfolio this year. We will continue to invest in the franchises and capabilities that support our future growth, including large and growing product areas like parasiticides, dermatology, monoclonal antibodies, vaccines and diagnostics. For example, we continue to build out key product franchises through lifecycle innovations and claim extensions in products like Simparica Trio, Cytopoint and Draxxin. We are also expanding our global reach with approvals in additional markets for new livestock vaccines like Protivity, for beef and dairy calves, and Lawsotek for swine. And most recently, we purchased a manufacturing site outside Atlanta, Georgia, which will be used as a new monoclonal antibody, vaccine, and petcare product operation to add capacity for expected growth. As you know, our monoclonal antibody and vaccine platforms are rapidly growing and this new site will substantially expand manufacturing capacity for our biologics portfolio and ensure long-term supply across all global markets when it begins operations in 2026. While the overall economic uncertainty remains a headwind globally in 2023, we have proven to be up to any challenge. We have learned valuable lessons and built new muscles, especially over the last three years, developing more agility, flexibility and resilience in our business and our people. Despite the unusual mix of results in our first quarter, I continue to feel very positive about our full year guidance, and how our diverse portfolio and vision for the future of animal health can drive long-term sustainable growth and create value for our customers and shareholders. We will continue to be disciplined yet adaptable in our approach to the opportunities, potential challenges and economic shifts that could occur throughout the year. We remain committed to delivering strong growth in 2023 based on our market leadership, innovative franchises and diverse portfolio, while continuing to invest for the future. Thank you. Now let me hand this off to Wetteny.

Thank you, Kristin, and good morning, everyone. We had a solid start to the year, with growth driven by our livestock business and strong international market performance. Echoing Kristin’s comment, our Q1 results are in line with our expectations. As we indicated on our Q4 earnings call, we expected the first quarter to be below the low end of our forecasted annual operational growth rate of 6% for 2023. In the first quarter, we generated revenue of $2 billion, growing 1% on a reported basis and 4% on an operational basis. Adjusted net income of $607 million declined 3% on both a reported and an operational basis. Of the 4% operational revenue growth, 5% came from price with a 1% decline in volume. The volume decline is driven primarily by U.S. companion animal distributor destocking in the quarter. Our livestock portfolio led the way in terms of species growth, growing 12% operationally with companion animal revenues flat on an operational basis in the quarter. Livestock growth was broad-based with double-digit operational growth across cattle, poultry, sheep and fish. The growth in cattle was driven by additional supply of key products in the U.S. We saw growth in our poultry portfolio driven by higher sales of vaccines. Our sheep products benefited from favorable market conditions in Australia as well as our acquisition of Jurox in the fourth quarter of 2022. Finally, our fish portfolio continues to perform well with double-digit operational growth driven by strong vaccine performance in Norway. Sales of our companion animal products were flat operationally in the quarter, with growth in our monoclonal antibody products, Cytopoint, Librela and Solensia, offsetting declines in Apoquel, parasiticides and anti-infectives. Our monoclonal antibodies for osteoarthritis pain in dogs and cats, Librela and Solensia, posted $51 million in revenue globally in the quarter, with strong demand for both products. Additionally, Solensia benefited from our U.S. launch in the third quarter last year. As for Librela in the U.S., we still anticipate approval in the first half of this year with the launch later in the second half. Simparica Trio posted global revenue of $151 million in the quarter, representing an operational decline of 7% versus the comparable 2022 period. This was primarily the result of U.S. distributor destocking during the quarter, as well as pre-price increased buy-in and promotional activity during the fourth quarter. This decline was partially offset by growth in our international markets from increased clinic penetration and launches in new markets. Our key dermatology portfolio declined 3% operationally with $290 million in global revenue. This decline is attributed to the impact of pre-price buy-ins in the U.S. in Q4, and in Japan in the comparable period in 2022. Cytopoint partially offset this decline with double-digit growth based on continued veterinary preference for injectables, which keep revenues in the clinic. Cytopoint better reflects underlying market demand due to our direct sales model on our dermatology portfolio and the lack of retail channel impacts. While we do believe conversion from Apoquel to Cytopoint may be accelerating, our overall outlook for our key dermatology portfolio remains unchanged. Our companion animal diagnostics portfolio declined 3% operationally, with declines in the U.S. partially offset by growth internationally. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1 billion in the quarter, declining 1% with companion animal products declining 7% and livestock sales growing 15%. Companion animal performance in the quarter is reflective of the expectations we set in the prior quarter and is a result of distributor inventory and promotional impacts. As Kristin mentioned, demand for the veterinary market, as demonstrated by distributor sales to clinics, is healthy and growing. We continue to see robust sales outgrowth across our companion animal portfolio, including strong growth in parasiticides and our key dermatology products, and our outlook for the full year remains unchanged. U.S. vet practice trends are improving, with clinic visits up 2% in the quarter and clinic revenue growth up 11%. Average revenue per visit is up 9%. These trends are slightly better than we expected and largely reflect the normalization of the COVID impact on vet clinic visits. Total visits in the quarter remain above pre-pandemic levels and clinic revenues have grown on average 10% annually over that period. Spent per visit remains elevated as the standard of care continues to increase. Turning to product performance, the companion animal decline in the U.S. was driven largely by a decrease in sales of our parasiticides portfolio as well as key dermatology products. Simparica Trio posted sales of $127 million in the quarter, declining 13% driven by distributor destocking, partially offset by growth in patient share where we continue to outpace the overall flea, tick, and heartworm market. Our outlook for Trio remains unchanged, as we continue to see strong customer demand and continued conversion from topicals and collars. Key dermatology products sales were $184 million for the quarter, declining 5%. Apoquel sales were negatively impacted by high sales in Q4 ahead of our 2023 price increases and significant retail buy-in in Q1 2022. Cytopoint sales growth partially offset the Apoquel decline due largely to its injectable administration, which is preferred by clinics. The U.S. companion animal decline was partially offset by growth in sales of Solensia, which launched in the third quarter. We continue to see solid clinic penetration growth in Solensia and expect to drive awareness of feline OA through our DTC advertising campaigns. U.S. livestock grew 15% in the quarter, primarily resulting from our cattle business where we have improved several supply outages, which impacted our revenues throughout 2022 and replenished our channel partner inventories. While we will continue to see benefit from improved supply, the replenishment impact is largely isolated to this quarter. We also saw growth in Synovex due to expanded label claims. Our poultry business also contributed to growth driven by expanded sales of vaccines. Moving on to our international segment, where revenue grew 3% on a reported basis and 10% operationally in the quarter with companion animal and livestock revenue both growing 10%. Increased sales of companion animal products resulted from our monoclonal antibodies for alleviation of osteoarthritis pain, small animal parasiticides, as well as the impact of our Jurox acquisition, which was completed in the fourth quarter of last year. We continue to be encouraged by the performance of Librela and Solensia. Librela generated $34 million or 74% operational growth driven by strong underlying demand and the removal of supply allocations that were in place for the first half of 2022. Solensia delivered $9 million in the first quarter sales internationally, driven by stronger demand. Simparica Trio was the top contributor to growth for our international small animal parasiticides with $24 million in revenue, growing 47% operationally due to expanding market share in the flea, tick, and heartworm space. Our international key dermatology portfolio was flat operationally in the quarter. We saw double-digit operational growth across most of our major markets, driven by higher compliance and new patients. However, this growth was offset by large pre-priced buy-ups of Apoquel in Japan in Q1 2022. Our international livestock segment also grew 10% operationally in the quarter with growth in four of our five core species. Growth was driven by our cattle portfolio, which benefited from price increases in certain emerging markets. Our sheep business had an exceptional quarter with high demand in Australia due to favorable market conditions as well as the impact of our Jurox acquisition. Poultry also contributed to growth in the quarter with higher key account penetration in the Middle East and Eastern Europe as well as the benefit of price. And lastly, our fish portfolio continues to perform well, driven by growth in salmon vaccines in Norway. Swine was flat for the quarter with strong sales in China, partially offset by intermittent supply constraints in some markets. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 70.8% declined 80 basis points on a reported basis compared to the prior year, resulting from higher manufacturing costs and unfavorable product mix. This was partially offset by favorable foreign exchange and price increases. Adjusted operating expenses increased 12% operationally with SG&A growth of 11% operationally driven by headcount-related compensation costs as a result of our U.S. small animal field force expansion, which largely began in Q2 of 2022, and higher T&E. R&D grew 19% on an operational basis, driven by higher project spend for our pipeline candidates, advancing projects that include disruptive, novel innovation and lifecycle management. R&D remains our first priority in capital allocation. Other income and deductions in the quarter are reflective of a favorable benefit associated with a settlement in the current period for prior period underpaid royalties related to sales of certain products. The adjusted effective tax rate for the quarter was 20.5%, an increase of 160 basis points driven by lower net discrete tax benefits in the quarter and less favorable jurisdictional mix of earnings, partially offset by higher benefits in the U.S. related to foreign-derived intangible income. And finally, adjusted net income declined 3% operationally and adjusted diluted EPS declined 1% operationally for the quarter. Capital expenditures in the first quarter were $223 million. We are still anticipating a significant increase in capital expenditures for the full year of 2023. We continue to make investments to support our future growth, including manufacturing capacity for monoclonal antibodies as well as oral solid dosage. In the quarter, we repurchased $283 million of Zoetis shares and grew a dividend over 15% versus Q1 2022. Now, moving on to guidance for the full year 2023. As we have mentioned, the first quarter has gone largely as we expected. We are therefore reaffirming our 2023 guidance provided during February's earnings call. Note that guidance reflects foreign exchange rates as of late April. Foreign exchange rates have been volatile over the quarter. We will continue to monitor the impact of this volatility going forward. For the year, we continue to expect revenue between $8.575 billion and $8.725 billion, representing a range of 6% to 8% operational growth. We also continue to expect adjusted net income to be in the range of $2.49 billion to $2.54 billion, representing operational growth of 7% to 9%. And finally, we expect this adjusted diluted EPS to be in the range of $5.34 to $5.44 and reported diluted EPS to be in the range of $5.03 to $5.14, both consistent with our February guidance. Just to summarize before we go to Q&A, we remain confident in our ability to deliver on our full year guidance commitments and expect more normalized growth in subsequent quarters. We continue to see positive trends and solid fundamentals in the underlying demand and are confident that our innovative portfolio will continue to allow us to grow in line with or faster than the market.

Thanks, everyone. I appreciate it. Good morning. I'd like to start with a couple of important questions. First, is the channel in the U.S. now normalized, Kristin? Additionally, if we consider that U.S. companion animal sales were down 7% while we saw an 8% increase, that's a significant difference of around 1500 basis points. If we quantify that, it indicates more than $100 million in sales. Could you help clarify how you arrived at those numbers? I believe there was around $25 million to $30 million in parasiticides last quarter, or perhaps you're working down inventory by a week. Any details you can share would be helpful. Lastly, regarding Librela, you mentioned that approval is still anticipated in the first half of the year. Will the launch be completed in the second half, ideally before the end of the year? And Kristin, how confident are you in your ability to meet demand? We think there are many Solensia users eager to get Librela. Do you foresee any supply issues for U.S. Librela in the first half of 2024? Thank you.

Sure, Jon. I'll address your second question. Yes, we still expect approval of Librela in the first half of the year, followed by a launch in the second half. The exact timing of the full launch will depend on our initial experiences, and it could happen quite late in the year. However, I want to emphasize that Librela is not accounted for in our financial projections for the year, as we do not include a product expected to launch late in the year for obvious reasons. We will conduct early experiences first, as we usually do, and if a full launch occurs, it would be late in the year based on our current outlook. We do not foresee any supply issues for a full launch in 2024, whether it happens late this year or early next year. Regarding your second question about distributors, we will spend some time discussing that today since there are many complexities involved. However, we believe the trends observed in this quarter are not going to persist. Let’s dive into the details, as I know this is one of the primary questions we've been receiving this morning. Wetteny, would you like to go over some specifics?

Sure. Jon, regarding your question about whether we are at normalized levels, yes, we're at those levels in the second quarter. To provide more context, as Kristin mentioned, we entered the year noting increased buy-in during the fourth quarter due to promotions on parasiticides and a recovery of supply. There was notable pre-priced buy-in as we approached 2023, leading us to anticipate some destocking, which we previously indicated would result in the first quarter being below our growth range of 6% to 8%. We observed destocking in the first quarter, aligning with the lower end of our historical normal range. This was somewhat expected given rising interest rates. As we moved into April, we did see slightly more destocking; however, it has since normalized and is reflected in our guidance. We do not expect a return to previous inventory levels, and we assume inventories will remain approximately constant. It's important to note that end market demand remains strong. As highlighted in our earnings release, sales from distributors to clinics increased by 8% in volume for the quarter, and retail sales to pet owners jumped by 35%. For the first time in about a year, vet visits have risen by 2%, particularly for dermatology patients compared to the previous year. Normalization has been observed since then, and internationally, we haven't seen the same level of destocking as in the U.S., with operational growth of 10% across our international markets for both livestock and companion animals. These factors have been considered in our guidance, including when we provided our initial projections back in February.

Great. Thanks. Two questions, one on livestock, one on companion. So, on the livestock side, was there a stocking benefit across livestock in the segment in the quarter? Can you quantify that for us and how much of the strength in U.S. livestock should continue in the coming quarters, given that you expect flat for the year? And you touched on derm a little bit on the companion animal side, but you mentioned Apoquel declined with no competitors in that segment and your direct distribution strategy, what drove the decline, and does that volatility that you're seeing across that retail channel for this product change how you think about leveraging that alternative channel, and are you proactively shifting customers to Cytopoint going ahead of competition? Thanks.

Sure. Thanks, Erin. Again, livestock did grow 12% as you mentioned, which was in line with what we expected, but the growth really was driven by resupply or increased supply of a lot of key products. As we reiterated in our prepared remarks, we continue to expect flattish growth for livestock for the year. If you look at it we saw, if you look at the U.S. business, we think you'll see it's really more of a one-time sort of getting back into supply and some of this. Is it slightly up or slightly down? I think a lot of that is genuinely going to depend on China. If its return to travel and dining out in China will drive growth in a number of our markets around the world in our export markets such as Brazil or Australia, or even the U.S. So we continue to expect and built into our guidance for the year is to have a flattish livestock number, which obviously gets back to Wetteny’s point, which is we're expecting very strong double-digit growth in companion animal. As you look at derm for the quarter, it did decline, but this is largely due to the destocking of the pre-price buy-ins and promotions in the U.S. And as Wetteny mentioned in his remarks, the one-time issue in Japan back to Q1 of 2022, in fact, if you pull that out, international had double-digit growth if you take out Japan. So again, this performance was in line with our expectations, but really importantly it is not indicative of our view of our expectations for the year. We continue to expect double-digit growth for the rest of the year and for the overall year for dermatology. Our sales out remain really strong. We're seeing a lot of uptick right now in Cytopoint, more and more pet owners are really seeing the compliance benefits of it, the efficacy of it, invest, love it because it obviously stays in the clinic. As we continue to see the shift here, it would comply, I think again we'll underscore our growth there. And the other thing I'd mentioned that Wetteny mentioned is derm visits continue to grow in Q1. And we're not really seeing any pushback from customers on the price increases that we did do. So we continue to expect strong growth for derm for the year per our last guidance, double-digit growth for derm.

Yes, I would just add that the first quarter is non-indicative of the year here, Aaron, similar to the overall results. And so to your point around retail channels, etcetera, we don't see us changing that. I think the fact that, Cytopoint we expect to continue to lead the growth for key derm franchise will change the mix between those two. But not changing the overall picture and our expectations for derm remain the same for the rest of the year. And we're off to actually a strong start. In the second quarter for derm both in the U.S. and internationally.

Great. Thanks for taking the question, guys. First, I want to ask about sort of the top-line progression through the rest of the year. I think you'd point to some softness from what you previously and you talked about just now let me on when you saw distributors start the second quarter. But any additional color you could give us as sort of we go through the rest of the year, given that there is a relatively steep ramp implied in numbers right now just to hit your $8.65 billion and 6% to 8% operational growth. So just talk about the step up in Q2, Q1 to Q2 versus Q2 to Q3, 4Q. And then as a follow-on to that, Kristin, you touched on Librela earlier, but I was wondering if you guys could comment on the other product launch expected this year, the competitor to Simparica Trio. We haven't seen that yet. Obviously can come any day, but just curious what you're hearing on that. And if your thoughts on what's going on parasiticides market have changed regarding that in terms of what some of your competitors are doing with stocking, what some of your competitors are doing with promotions of some of their products and sort of how that's impacting your view on Trio through the rest of the year. Thanks.

Hey, Mike. I'll start with progression for the top line for the year and then I'll turn it over to Kristen. And she'll cover Librela launch in sure competition. So with respect to progression for the balance of the year, we expect normalized growth across the year starting with the second quarter, which obviously we're already about halfway into the second quarter. And as I mentioned just a little bit ago, we've got a strong start particularly in derm but across the board to what I'll call more normalized mix and normalized cadence for the balance of the year. One thing I would say is with respect to Q2, and that's normalized operational growth rate I'm referring to. If you take a look at FX, for example, that was about three points of headwind in the first quarter based on where rates are right now, I would expect about two points of headwind on the second quarter. So when you map out operational growth to reported growth, you should take that into consideration. That turns around in the second half again based on where rates are now and it ends up being slightly unfavorable on the year, year-on-year on FX on the top line and slightly favorable at the bottom line. So that's how I would sort of think through the progression. But again, starting with the second quarter, you should expect normalized growth to get to the guidance that we just reiterated at 6% to 8%.

Sure. And let me pick up your second question, which was the other product. We are continuing to expect competition in the second half of the year for Simparica Trio. But I want to underscore that as you look at the first quarter, we actually gained share. So as we said, there's very strong underlying demand for Simparica Trio in the U.S. and even with competition coming, if you look at our performance, it was in line with our expectations. Again, we said it's not indicative of the year and we continue to expect strong growth for the remainder of the year. Even with competition in the second half. So we have been expecting this competition. The good news is it's later than we did expect. As we think about it, we've talked about this before, we're not expecting them to radically change any pricing if they would really I think given they are the leader right now with HEARTGARD NexGard, they would really cannibalize their own business. And I think it's important to keep in mind even if you look at the quarter. They ran very strong promotions ahead of their launch. And even with those promotions, we gained share in that quarter. So we remain very confident in the strength of Simparica Trio. In the strength of our relationships with that in the pet owner satisfaction of it, we do expect competition. We think they'll bring a product, as I said, in the second half of the year, but we remain confident of the strong growth for Simparica Trio as we said before for the year.

Great. Thanks for the questions. Sorry to keep honing in on the destocking dynamics, but could you maybe just talk about how the first quarter U.S. companion animal sales kind of played out month by month? It seems like January and February price saw the bulk of the impact from the pre buy-in and pull forward into the fourth quarter. It sounded like the destocking might have occurred a little bit later in the quarter. I think this is people are looking to get better visibility on the improvement in the second quarter. Could you maybe just comment on how March or April played out just as we think about kind of where the business is heading into the second quarter?

Yes. So look, I'll be happy to answer the question as to destocking. We saw destocking from the start of the quarter just as we anticipated and as we discussed in some of prior calls given the dynamics coming out of Q4. As we mentioned too in the last call, the timing of our supply recovery in terms of last year would have had an impact on the cadence on the year, which is playing out exactly as we thought. I'll give you a little bit more color perhaps that might be helpful if you think about what the end market demand looks like. When we look at our sales out of distribution to clinics, we said it's 8% volume growth on the quarter. If you look at how those played out for March, the end of the quarter, they're actually above that number. So, we haven't seen anything in terms of what the end markets are that would indicate a slowdown. And as I said, we've had a strong start to the second quarter and we're sitting here in the middle of the second quarter, and I'm saying that we would see normalized growth starting in this current quarter for the balance of the year.

Yeah. And I think I want to also reiterate what Wetteny said earlier, which is they are at very low levels, the lower end of their ranges, but our guidance expects that they do not go back up. We believe that given the current interest rate environment, our expectation is that they will stay at this level. So again, our confidence in the guidance we're providing is assuming that they're not going back up; they will stay at the levels that they're at now.

Hi, thanks for taking my questions here. So wanted to ask you, on your upcoming investor event, what will you discuss here? What are some of the key things that you're going to be going over? It's been a while since you've had an investor event. And will you be disclosing more additional pipeline products, longer-term guidance, anything from that front? And then I also wanted to ask you in your diagnostics business, what's the outlook for the remainder of the year on that business? Thank you.

Sure. We are excited for our Investor Day. We spent time talking to a lot of our investors over the last six months as to what they're looking about. Our focus there will be really on building confidence in our medium to long-term growth expectations. We've gotten a lot of questions obviously on our pipeline and R&D. So, you'll see us as we mentioned in our press release, Rob Polzer, our Head of R&D, will be coming to give more detail on our R&D portfolio. And we also look forward to introducing you to other members of our leadership team. So you get to meet them as well. We're excited to share what we view as the short, medium, and long-term growth aspirations and give you some confidence in more detail around all of those. So Wetteny, do you want to take her second question on diagnostics?

Yes, I'm glad to. Regarding diagnostics, we have observed increased productivity from our diagnostics team, especially in the U.S., following the changes we implemented about a year ago in the second quarter. In this first quarter, we experienced strong placements of our instruments, including images. This will contribute to growth in consumables for the remainder of the year, aligning with our guidance. We expect to see improvements in productivity due to the new field force and the changes made last year, which we anticipate will lead to growth in the U.S. in the latter half of this year. We're building on the changes we've made, which we strongly believe will foster long-term growth for the business, alongside the ongoing innovation in diagnostics.

Thank you for taking my question. Regarding the Simparica Trio franchise, I view the parasiticide portfolio as being particularly strong from March to August. Looking at the overall situation, do you believe that the recent distributor destocking will negatively affect the annual sales of the product? In other words, do you think this could impact the timing of missing the flea and tick season? Additionally, concerning inventory in the livestock portfolio, it seems that the dynamics are different since the price increases in livestock were not as significant as those in companion products. Therefore, the distributor dynamics might not be the same. Lastly, I haven't seen the inventory or balance sheet yet, so I wanted to check if inventory levels have gone up or down. Thank you.

Sure. Let me start with Trio and then I'll let Wetteny take the other two. I want to underscore what we said earlier. We have very strong demand in sales out. And so what you saw in Trio in the first quarter was a stocking issue. But as we look at the demand for the product and where it's going, it has no effect on the flea and tick season as needed. We have full supply in. I think what makes it a little complicated and as unusual was the supply issues we had in Q3, Q2 and Q3 of 2022 put us putting a lot more inventory into the channel at the end of Q4. Trying to restock shelves against what we thought as you remember was going to be a launch in Q1 of a competitor. So I think there's obviously some quarter-to-quarter stocking dynamics, but I want to underscore demand for this product remains strong. We gained share in the quarter. We are now at normal inventory levels, so no, we do not see anything if you look at the Q2 to Q3 of the product and which we would agree that is normally Q2 to Q3 is the strongest sales normally in parasiticides. So, we continue to see very strong demand for the product. Obviously, there is some quarter-to-quarter stocking stuff that is relatively unique as you look at the end of 2022 and the beginning of 2023. But we don't think that actually signals through anything and the demand for the product or importantly the strong growth we see for the product for the year. Even as we said assuming competition in the second half.

Yes, look, I think there were a couple of other parts to your question, I'll touch on in terms of livestock. We're not seeing the same dynamics in livestock. Look, I mean if you look at where we ended last year, maybe we're in the middle of the range towards the bottom of the range, might have been a slightly increased in the quarter given the recovery of some supply for certain products as we mentioned in our prepared commentary. But overall, not any meaningful movement there to speak of. And then with respect to our balance sheet on inventory, as you know, we are ramping up certain products, anticipating launch and approval of certain other products that will continue to drive inventories. First, if you look at operating cash flows on the quarter, they're actually favorable to last year because as inventories continue to increase, we saw really strong performance on receivables and other NAP. So overall, operating cash flows look favorable versus a year ago.

Hi, good morning, everyone. Thank you for the questions. I have a couple of my own. Firstly, could you provide an update on the supply chain issues that affected growth in 2022, particularly concerning the vaccine side and Trio? Do you expect any supply chain problems that could impact your key products this year? Secondly, I didn't fully understand the decline in the derm segment. This is not a standalone independent segment. Can you share some numbers related to the derm segment and explain what contributed to the decline? Thank you.

Sure. I'll start with your first question on supply chain and maybe Wetteny can build on my derm answer from before. With regards to the supply chain, as we expected, we have completely normalized the supply chain. We always have some small level of challenges as we mentioned before in the biologics. But the challenges we saw in 2022 have been resolved, as we indicated they would be. We're back into normal supply on these products as you look at whether that's parasiticides or importantly our monoclonal antibodies. As expected, those are at normalized levels. We'll have some small number in bios as we always have that all of our competitors generally have. But supply chain has been normalized and we don't foresee any specific supply chain challenges in 2023 going forward. But maybe Wetteny you can build up my previous comments on the derm segment if you can clarify some of these questions?

Yes, I'd be happy to. So look, the derm story is similar in terms of destocking from pre-price buy-ins that we saw in the U.S. into retail in Q4. As well as a year ago, if you look at Japan and if you look at our reporting last year in Q1, you would have seen a significant growth rate for Japan in the first quarter, driven by those pre-price buy ups in Apoquel. And then you saw that go the other way in the second quarter. So if you were to I would say pro-forma the results for the first quarter taking into account what I just said, you will see double-digit growth for the derm franchise in both the U.S. and international.

Hi. This is Katarina on behalf of Chris. Thank you for taking our questions. First, regarding price increases, have you received any feedback from veterinarians or pet owners about the price increases implemented at the beginning of the year? Are you experiencing any resistance? What are your initial thoughts on how you'll approach price increases in 2024? Secondly, I’d like to ask about diagnostics. What are your insights on the proposed Mars Heska acquisition and its potential impact on the diagnostics market? Will it affect Zoetis’ plans or the investments you are making in that area? Thank you very much.

Thanks for your question. I'll address the second question first and then let Wetteny respond to the first one regarding pricing. The acquisition of Heska really affirms that the veterinary diagnostics market remains a highly attractive area for investment. It reinforces our strategy, especially with the initiatives we've implemented in the U.S., such as developing our reference lab network and continuing to invest in innovation, particularly in our point of care offerings. We have had a strong start to 2023 with our imaging services, virtual lab, and reference lab offerings, which we believe are resonating well with our customers. Our main goal is to lead with advanced medical solutions, and the rollout of our virtual lab is a key differentiator for us. Overall, our focus remains on innovation in areas such as point of care, customer experience, and reference lab services. Thus, we view this acquisition as further confirmation of our strategy, and we plan to enhance our growth by concentrating on innovative diagnostics. Wetteny, would you like to tackle the second group of questions about pricing?

Yes, we have not experienced any pressure in end market demand despite our price increases. We raised prices by 5% this quarter compared to 3% last year. The end market dynamics we've discussed show significant growth from distributors to clinics, and notably, there's also strong growth from retail to pet owners. We're continuing to see increased patient visits, particularly in dermatology. Therefore, we haven't encountered any resistance to the price increases. Additionally, in the international sector, we achieved a 10% growth in the companion animal segment this quarter, driven by price increases, despite some typical pre-price buy-in during the fourth quarter. We have not detected any signs of negative impact. In livestock, the situation only marginally offsets some of the price increases we observed in companion animals. We note some impact on Draxxin, but it isn’t significant, especially compared to previous levels. In fact, we experienced some positive volume offset to help balance the price effect on Draxxin. Overall, we are in a good position regarding market reaction to our pricing. As for what this means for 2024, it's too soon to make any predictions.

Hi, good morning. Thanks for taking the question. The first one is just on guidance. You started off the year pretty strong despite kind of inventory levels creating a little bit of noise here. But if you kind of read through that, you're looking at, I don't know, high single digits, maybe even double digits operational growth to start the year reiterated guide for 6% to 8% operational growth. So the question being basically what would get you to that low end of that operational growth range given the strength you're already seeing in the year if you kind of read through the noise?

So look, if you look at the end market dynamics that we see, we see strength there, so I think that supports certainly the mid to high end of our guidance I would say. If you look at what it means for the rest of the year and I'll reiterate this point, which is we're already halfway through the second quarter. And again, we're seeing a strong start to the quarter and we'll see that normalized growth rate including mix by the way for the balance of the year. And keep in mind, right, our guidance didn't change including what we expect from livestock for the balance of the year. Right? We went from saying livestock could be minus one to plus one. We're saying it's flattish, basically the same thing. So how Q1 has played out exactly as we thought essentially and therefore the rest of the year is the same. And no point in our guidance range is any, I would say, more probable than the other, we feel great about where we are on the year. And how it's starting out for us in the second quarter, particularly despite what you described as the noise in terms of the inventory levels.

Thank you. A couple of questions. First, the new manufacturing facility in Georgia, is the investment based predominantly on increased forecasts for current products or positive late-stage R&D progress for which we at least on the outside currently don't have visibility or is this some combination? And in the prepared remarks, you referred to disruptive novel innovation in the pipeline. Should we expect to get a window on that during the May meeting? And can you tell us if this is likely mainly directed at currently untreated diseases, more species, wider claims within existing species, improved dosing or something else? Thank you.

The new manufacturing facility near Atlanta, Georgia will support our current products and their growth, and we also plan to launch some of our new monoclonal antibodies from this site. It is a large facility that provides us with significant flexibility, which is very exciting as it allows us to utilize it for various purposes and establish a strong presence in the South, where there is a great labor market and good access to the workforce. Our intention is for the facility to serve both functions, and we expect it to be fully operational by 2026. Regarding Investor Day, we plan to review our entire portfolio and provide more details about the pain opportunity and our expectations there. We will also discuss new disease areas we've previously mentioned, sizing those new markets. Additionally, we will provide insights into our pipeline and what we are currently working on, including both species-specific information and key technologies related to monoclonal antibodies, as well as discuss emerging major markets we aim to target with our innovative technologies.

Thank you. So look, just to summarize, we really see a very positive and sustainable demand for our product based on what we've talked about for a long time which is the fundamental drivers of animal health. We are confident that Zoetis has the industry's most diverse and durable global portfolio. And this is really founded on innovative science, as we talk about, and supported by a high-quality supply chain. We'll remain focused this year and going forward on our five key growth catalysts; dermatology, pet parasiticides, pain, diagnostics, and emerging markets. And we're going to continue to invest in the talent, the pipeline, and the capabilities that support this future growth while ensuring that we can adapt to the dynamic environment that we all operate in. And we really look forward to sharing more about this with you. Our vision, our pipeline, our strategies for growth at our Investor Day on May 25th. And there you'll hear more from me, Wetteny, our Head of R&D, Rob Polzer, about the confidence we have in the animal health industry. And importantly, our ability to go faster than that market and the investments that we're making to create that value for our shareholders. So, we announced the event this week, and I hope you can all join us virtually or at the New York Stock Exchange. As always, you can find more details about our Investor Relations information on our website. So thanks so much for joining us today.