Welcome to the first quarter 2015 financial results conference call and webcast for Zoetis. Hosting the call today is John O'Connor, 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 2 hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. [Operator Instructions] It's now my pleasure to turn the floor over to John O'Connor. John, you may begin.

Thank you, operator. Good morning, and welcome to the Zoetis First Quarter 2015 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Paul Herendeen, our Chief Financial Officer. Before we begin, I'll remind you that our remarks today will include forward-looking statements and actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statement in today's press release and our SEC filings including, but not limited to, our 2014 annual report on Form 10-K and our reports on Form 10-Q. Our remarks today will also include references to certain financial measures, which were not prepared in accordance with generally accepted accounting principles, or U.S. GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures is included in the financial tables that accompany our earnings press release and in the company's 8-K filing dated today, May 5, 2015. We also cite operational results, which exclude the impact of foreign exchange. We have a significant amount of detail to cover today, including specific details of our financial outlook through 2017. We will be posting both Juan Ramón and Paul's prepared remarks on the Investor section of zoetis.com following the call to help clearly disseminate these details. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix: Thank you, John, and good morning, everyone. In my remarks today, I will briefly comment on our performance for the quarter. And then I will provide details of the operational efficiency program that we announced this morning. Paul will then walk you through our result for the quarter and discuss the financial impact of the operational efficiency program, including an update to guidance…

Thank you, Juan Ramón, and good morning, everyone. We have lots of important things to talk about on this call, as we just revealed our plans to improve the efficiency of our operating model. But before we get to that, I don't want us to lose sight of the terrific quarter that we just put on the board. So let's get started. As you'll remember, our fourth quarter of 2014 featured strong operational growth and we were able to carry that momentum forward into Q1 of 2015 and give us a good start to the year. We delivered on our primary value drivers posting revenue and adjusted net income growth on an operational basis of 6% and 14%, respectively. Pretty good, right? Like other U.S. multinational companies, FX rates had a major impact on our reported results. On a reported basis, FX rates decreased our reported revenue by $58 million, resulting in our reported revenue growth being flat with Q1 of 2014. The impact on our adjusted net income was $16 million and so reduced our growth in adjusted net income from 14% on an operational basis to 8% on a reported basis. So FX impacted our top line by some 600 basis points and adjusted net income by 600 basis points. I said this before and I'll say it again today, we can't control FX rates. We manage our business on an operational basis, and on that basis, we're continuing to deliver strong fundamental growth in revenue and profits. You can read about the regional segment results in the press release and tables, so I won't spend too much time on them here, but I do want to cover a few highlights. The U.S. continued to perform very well, up 9% versus Q1 of '14, with strong livestock performance,…

[Operator Instructions] And we'll take our first question from Louise Chen with Guggenheim.

So my question is on your organic sales growth and also your gross margin once you lap on the headwinds from, I guess, getting rid of some of these lower-margin SKUs. Juan Ramón Alaix: Thank you, Louise. And definitely, our plan is to have our growth in terms of revenues in line or faster than the market. The market is expected to grow about 5% in the medium- and long-term, and we are also targeting it to grow in line with this growth or exceed this growth. In terms of gross margin, we also plan to significantly increase our gross margin. So eliminating these lower-margin SKUs will represent 200 basis points of gross margin improvement and also the price increases and also the discipline on -- or the reduction of expenses also will generate a significant improvement in gross margin. So on top of that, as Paul mentioned, our plan and work strategy that we announced at the time of the Investor Day will also generate another 200 basis points of gross margin improvement.

Yes, Louise, and it's Paul, I'll just follow on that. I'll just point you to the slide on the webcast for the 2015 to '17 guidance, and you can see the impact -- or the expected improvement in our gross margin there, where we're looking out to 2017 after the, as I say, after the dust settles. So we'll get to a margin where we're projecting a range of 32% to 33% and with the opportunity to do better than that as we continue our progress on our supply network strategy.

And we can take that question from Kevin Ellich with Piper Jaffray.

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

Yes, thanks for the question, Kevin. It's Paul. I'll start with talking about the growth rate in 2016. I mean, one of the reasons why we felt compelled to provide a lot of detail around '16 and '17 is, as we go about the, what I'll call, the rationalization of our portfolio, the timing of when those sales go away will certainly have an impact on what you should expect, as what we expect, for 2016. And then we return to what I'll call a rebased model in 2017. So 2 things affecting '16: one, as you correctly point out, is Venezuela hitting the operational rate; and the second is, the timing of the SKUs that we're pruning from the portfolio when we start to see a decrease in sales. You note that we, for the balance of '15, expect -- did not show you a line item reducing our revenue expectations associated with the reduction in the SKUs in the portfolio. That really starts to come into play in 2016 and we should enter '17 clean. Juan Ramón Alaix: So let me answer the question on M&A. So definitely, M&A is part of our strategy, and we are considering any M&A opportunity that will increase the value of this company and will support our objective in terms of generating higher margins in our operations. So where is our interest? Any opportunity which is in the animal health domain. We think that we have all the capabilities, and also now we have, or will have, even much better ratios in terms of cost and in terms of expenses to revenue, so we can really maximize opportunities of any potential acquisition.

And we can take that question from Chris Schott with JPMorgan. Christopher T. Schott - JP Morgan Chase & Co, Research Division: Just wonder if you'd -- try and elaborate a little bit more on the operational efficiency initiative here. I guess in the past, you've talked a lot about your direct selling model being a competitive advantage versus some of your peers. Can you just elaborate a little bit more with the decision today in the smaller markets to move to more of an indirect model? Just what's changed in terms of that view? Is it that these were markets that were never going to get the scale you needed to justify the investments you're making? I'm trying to understand a little bit more the strategic shift that you're making on those. Second question is just with the new kind of plan as you're aligning your approach here. Are there any management incentives that you're putting in place or any changes to management incentive that are going to come about as a result of this operational efficiency plan as we think about the 2015 targets, et cetera? Juan Ramón Alaix: Thank you, Chris. And what we are trying with this initiative is to be much more focused. And we mentioned many times that our diversity, or the breadth of our business, it was a competitive advantage. But we have also identified some areas or some elements of this diversity, which is adding a complexity, which is a barrier to deliver value to our customers and also to create that value to Zoetis. What we are trying is we've now been much more focused on the countries and also the products that will generate the highest value to Zoetis. It's to really move away from our model, which is a model that will be 100% applicable to those markets, and we are now in these small markets in -- where we don't see that the model is efficient in terms of our profitability, and then moving to a model that will be indirect and will be relying more on distributors to support our revenues. So the strategy is not changing. What we are, it's really focused on the market that would generate the highest opportunities for Zoetis and also the product that will integrate the highest revenues to our company and the most profitable growth. In terms of the management incentives, we have in place programs to incentivize our leaders in Zoetis for exceeding the $300 million target that we have in our program. So we have these plans and we are convinced that we'll be working to meet or exceed our objectives.

We'll take that question from Erin Wilson with Bank of America.

Does the new guidance on the top line include contributions in Sarolaner, and could that still provide upside? And do you have cash flow forecast for us? And I think you gave some color here, but does your guidance include share repurchases and plans for deleveraging? Juan Ramón Alaix: So let me answer the first question, and then Paul will answer the second one. Thank you, Erin, for both your questions. So the new products, Sarolaner, IL-31, are not part of our guidance today. So we are in process of discussing with the FDA and USDA and other regulators. So once we have more understanding of the timing of these product launches, we'll incorporate in our guidance.

And it's Paul, I'll speak to the cash flow guidance. We're not providing -- we provided an awful lot of detail on the operating side here through 2017. We're not, at this time, providing a forecast of cash flow and our balance sheet, but suffice it to say that we talked in the past about our desire to improve our asset efficiency. For example, through the implementation of our global ERP system, SAP, we expect that over time, we'll be able to reduce our investment in our inventory and unlock some cash there. Frankly, by paring down our business and pruning our portfolio, with the SKUs, that will unlock some cash -- cash as well. We do have an awful lot of calls on our cash here coming up in the very near term. I mean, if you think about it in the first quarter, we completed the acquisition of the Abbott Animal Health assets. We do continue to use cash to fund the onetime costs associated with our separation from Pfizer, and we've provided an estimate of the remaining amount of that to be somewhere in the range of $180 million to $210 million. We provided you with an estimate of the cost of the efficiency initiative that we announced today and the early stages of our supply network strategy, and those costs are estimated in the range of $300 million or $400 million to $500 million over the next several years. And we have, I'll call it out for you, the $400 million debt maturity coming up next spring. And then we have our regular dividend coming up. So we do have some sizable calls on our cash. We have actually provided you also with some guidance, a little bit of guidance at this stage around our share…

And we can take our next question from Alex Arfaei with BMO Capital Markets.

We appreciate all the details on the efficiency program. EuAfME sales were below expectations. Could you comment on the impact of the new anti-infective legislation in France and whether you think that's going to spread to other developed markets. And Paul, I'm not sure if you addressed this, but how much of your lower OpEx this quarter was driven by FX as opposed to other savings? And then, finally, could you comment on the launch of APOQUEL and whether your prior guidance still stands. Juan Ramón Alaix: Thank you, Alex. So the situation in Europe/Africa/Middle East, revenues were affected by the France performance. So they announced the new legislation related to anti-infective legislation. It's eliminating rebates offered by animal health manufacturers to both wholesalers and veterinarians. And as a result of this elimination of rebates, there was an adjustment in the market in terms of inventory levels. We expect that this will be, in the next quarter, compensated and back to normal situation. And now Paul will answer the comment also in terms of the impact of FX.

Yes, Alex, and there's really 2 ways you and think about this. First is you can see the impact, the impact on the first quarter alone, on SG&A expenses in the quarter was roughly 5% change was due to FX, and in R&D, it was 2%. I think a more helpful way to think about it might be to look at our guidance bridge slide going from our previous guidance in February to our updated guidance today. And you can see the expected impact on the full year relative to that February guidance is roughly $20 million on SG&A expenses and none on R&D. Juan Ramón Alaix: And then the comment on the APOQUEL. So in the first quarter of this year, the revenues of APOQUEL have been still facing limited supply. But from April, we have been able to meet the demands of our customers in U.S., also U.K. and Germany, and we expect that the product will meet our expectations in 2015 of delivering $150 million to $175 million in 2015. And we also are planning now in launching APOQUEL in additional markets that will be also making contribution to meet these expectations for the product.

And we'll take our next question from Mark Schoenebaum with Evercore ISI. [Technical Difficulty] Juan Ramón Alaix: We have some problem there with the line?

So the question is about incremental form of [indiscernible]. So the question about M&A and the Tax Matters Agreement with Pfizer that I believe expires next month. So your new cost reduction plan and Tax Matters Agreement expiration, whether this will change your overall strategy for future acquisitions, M&A, and whether you're still open for targets of various size or -- and think about the ZTS as -- more as a net acquirer, not acquisition target. As well as if you're still open for potentially inversion transaction as an avenue to reduce effective tax rate. Juan Ramón Alaix: So let me mention on the tax agreement that you're right, this tax agreement will end on June 24. We mentioned on previous calls that this is something that will eliminate any restrictions, but we didn't think that it was a significant restriction for any type of transaction related to acquisition or licensing or any other divestment. In terms of the new program, its changing our strategy, we think that our strategy has been always to consider M&A opportunities that will create value to Zoetis and will create more value to our shareholders. Definitely, the new program will generate more cash, and more cash also will help us to consider any kind of opportunity. In terms of inversion, I think again, so we are open to any opportunity that will increase the value to our shareholders and is something that we'll be always open. But we know there are not too many options that we can consider in terms of inversion or acquisition of our company that will facilitate this kind of tax strategy.

I'll just follow on, in that I think that with our leaned-out structure, we will be better positioned to realize value from acquisitions that we might consider. I mean as -- looking backwards, using as a great example, the Abbott Animal Health assets. When you have a better cost structure and you can absorb those and realize the synergies, you can gain better value over assets that you're able to acquire. As Juan Ramón said, I want to buttress that as well. We're always thinking about ways that we can build value here, and one of those ways is through smart business development activity.

We can take that question from Jami Rubin with Goldman Sachs.

Just to follow up on an earlier question, about trying to trim assets [ph]. Clearly what you're doing makes a kind of sense, simplifying a very complex cost structure, it's -- reasons why companies spin off assets and those assets tend to perform much better as separate companies. But I'm actually kind of surprised, Juan, when you said your expectation is that revenue growth -- you sort of reiterated the type of organic growth that you have been anticipating, which is the market growth of 5% to 7%. I would think, with shrinking the revenue base and getting out of slower growth or less profitable businesses, that would give you an opportunity to accelerate top line growth, and wondering if you can just talk about that. Juan Ramón Alaix: Thank you, Jami, and I think you are right in your comment. We are doing that because we think that being much more focused will be an opportunity to accelerate growth in products, markets that will be important to our future profitable growth, and this is something that definitely we will be working to ensure that the programs that will stay in our portfolio will generate maximum opportunities. The other important thing is that we also want to make sure that we increase our supply to our customers on those problems that really matter to them. And we want to have a reliable supply and to eliminate the risk for product supply issues that's always very, very different [ph] to our customers. So with being much more focused we are convinced that we can generate a higher profitable growth.

Our next question comes from John Kreger with William Blair. John Kreger - William Blair & Company L.L.C., Research Division: You talked about a changing approach to R&D. Can you just elaborate a little bit on that? And one specific one. Do you still expect Sarolaner to reach the market by spring of '16? But then more broadly, what are the source of products that you're refocusing the R&D efforts on? Is there any criteria around, let's say, region or animal species? Juan Ramón Alaix: Thank you for the question, John. And in terms of R&D, so we are eliminating 5,000 SKUs. So if we are eliminating about 40% of our total SKUs, you can also assume that we'll be eliminating some of the programs that are a very important part of our investment. And just to remind you, almost 50% or even more of our R&D investment is related to life cycle management. So if we are eliminating 40% of our SKUs, we should be also eliminating programs in life cycle management that are supporting this part of the portfolio. We also think that it's a good opportunity also for us to identify the future problems that will generate the highest potential in the animal health industry. We have been extremely successful in identifying these opportunities, and APOQUEL is a good example, but also our progress on bringing back vaccines to the market like PEDv vaccine and many other vaccines that we have been introducing is a good example of being focused, identifying these opportunities. It's a great opportunity for us like this. We'll remain doing that and we are not changing our approach in R&D, but we are trying to identify those projects that would generate the highest return to our company. In terms of Sarolaner, we are working with the FDA. We are presenting all the information that FDA is requesting, and we expect that the program will be launched in 2016.

Before we ask the next question, it's Paul, and I just want to jump in. R&D is, as I said in my prepared remarks and Juan Ramón referenced as well, that's 1 of our 3 key interconnected capabilities and one where we're not changing substantially here. What we're looking for is ways that we can improve the process by which we select projects to go into the queue and then come out on the other end. And John, the way you phrased your question was almost exactly the way I've talked about this inside, is the alignment of our portfolio around our key brands and around our key regional strategies for growth, and ensuring that this course alignment of our R&D strategy around those key brands and regional strategies. And as I say all the time, any process -- and we've been very productive in R&D. Any process that we have can be improved and that's what we're doing here, call it, continuous improvement.

Our next question comes from Kathy Miner with Cowen and Company.

Just to follow up a little more on the 5,000 SKUs that will be eliminated. Can you give us a little more color on them? Such as how many products this might include and will we see a change in your therapeutic product mix post the elimination of these products? And second, just a quick question on the antibody for atopic dermatitis that you expect conditional approval for, is that still on track for the end of this year? Juan Ramón Alaix: Thank you, Kathy, and definitely, these 5,000 SKUs are not 5,000 products. The number of products is much lower. I don't think we have provided the number of programs that will be affected. It's something that definitely, we plan to provide this information to our customers in the next coming weeks, and we also plan to send a communication to our customers on those programs that will be affecting every market. In terms of the change of the mix, well, the mix will improve in terms of profitability, so these products, as we mentioned, are low margin. So by eliminating these low-margin products, we'll improve our margin and mix and this will have a positive impact in our operations. IL-31 is still on track for conditional approval in 2015. We are working with the USDA and we expect this conditional license approval anytime at the end of the year.

And our next question comes from Liav Abraham with Citi.

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

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

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

I just wanted to ask about the 2 segments of the company, companion and livestock. Could you just characterize the different margins for the 2 business segments? I don't know how much detail you can provide, but I was hoping that you could help to provide a baseline for us in terms of where the operating margins stand for each of the segments? And then looking ahead, which of the 2 is the 1 that will experience greater margin expansion over the next 3 years. Juan Ramón Alaix: Thank you, David. So let me start by mentioning maybe the difference between companion animal and livestock in terms of gross profit. So in terms of gross profit, companion animal, it's generating the highest margins, and you know that we have a margin of -- a gross profit of 65%. The net companion animal is much higher than this 65%. And then livestock, we have a different margin depending on cattle, swine or poultry. Being in poultry, the lowest in terms of our gross profit and, cattle, the highest in terms of our gross profit in livestock. But then you also need to add what is the cost to win these products to the customers. And then in that case, I think the total margins are much more equalized. So companion animal require a significant much more field force and promotional activities because the number of our customers in companion animal it's much higher than in livestock. And then poultry is the most consolidated industry, so it require fewer individuals to reach the customers, while cattle still require a significant number of people to reach these customers. So even gross profit are different across different species. In terms of the total margin, the margins are much more similar. And we think that there are opportunities in both. We have been growing livestock faster than companion animal in the recent years. Now with APOQUEL, with Sarolaner, with Abbott, with IL-31, we expect that companion animal will generate a significant growth in our operations.

[Operator Instructions] And we can take our next question from Kevin Ellich with Piper Jaffray.

Just a quick follow-up here. I guess going back to the SKUs that are going to be eliminated. Paul, did I miss -- did you provide how much revenue those products are going to generate or what the impact would be from the SKU elimination in 2016? And then also in the press release, you talked about the feed additive for the poultry, Zoamix. Just wondering how big that could get. And I guess what's your thought, Juan Ramón, on the scrutiny and some of the restaurant companies eliminating using antibiotics in the chickens, especially -- oh, and also, thoughts on the avian flu.

I'll start. Yes, the first question with respect to the period SKUs. We did not provide a specific amount or impact on our 2016 just to say that, by definition, we included the impact as we provided the detailed guidance for 2016. And then call your attention to 2017 where we call it out and it's really $280 million of top line that we expect, relative to our prior expectations, for 2017. And the way I would think of it is 100 is a curious thing with this $10 million of OpEx that maps the cost of goods sold. So the table, you'll see the $290 million versus $300 million, but with $300 million OpEx, you think like $280 million and $100 million, that's the impact on '17 when it's fully reflected in our re-based revenues and that's how I think about it. Juan Ramón Alaix: And on the majority of this key SKU elimination will take place in 2016. So we should expect that there will be an impact in terms of revenues in 2016 that would be very close to this $280 million that Paul just mentioned. So we have not mentioned the exact revenues of Zoamix in the U.S. But what we mentioned is that this has been compensating the rotation of products that are in the industry. It's using it as a way to protect the animal health in the poultry industry. In terms of -- you also asked about the comments on poultry and antibiotics of a recent company that has been issuing a press release in the U.S. Definitely, we are fully aligned with the FDA objective to reduce the impact of -- or the resistance of antibiotics in animal health. These 2 companies have announced that they will eliminate the use of human health products in poultry. In some cases, like Tyson, we have been already working with Tyson some years ago to eliminate these products. And because we have, in our portfolio, alternative to the products which are important for human health, we think that we'll be able to supply to companies in the poultry in the U.S. that will be eliminating gradually the use of human health products, which are important or antibiotic which are important for human health. With all the alternatives that we have in our portfolio, that we also keep the poultry industry productive and also protecting animals against infections.

Our next question comes from Chris Schott with JPMorgan. Christopher T. Schott - JP Morgan Chase & Co, Research Division: Just was trying to just dig a little bit more into the motivating factor that's leading you to this broad restructuring. I guess my question, are you seeing the market changing? Or is this really that you've gotten out of Pfizer, you've had the chance to review the broader strategy, that you're just having time now to dig into these business units and really try to focus the organization overall? I'm just trying to understand, higher level, what led you down this path to begin with? Juan Ramón Alaix: Okay, this program has been part of our plans since the beginning. So it means we have separated from Pfizer. We had, in our thinking, that we should generate greater efficiencies and also define cost-saving opportunities. We also knew that in the first 2 years as a public company, we needed to focus on standing up our infrastructure. Also making sure that we are meeting our objectives in terms of revenue growth, also our objectives in terms of profit growth. We also needed to have full control of our operations. And when I mean full control of our operations, have a full understanding of our corporate functions, also full understanding of manufacturing and, also very important, control of our IT systems. We also decided early in the process of separating from Pfizer to invest in the new ERP. And now that the ERP has been already implemented in certain markets in Europe and went live in the U.S. at the end of April, we see that we are in the process to finalize all these implementations in the first quarter of 2016. With all these elements, I think we are in the position to identify these opportunities to be more efficient, and not only opportunities to be more efficient, but the opportunity to be much more focused. And I want to seize the complexity that we have in some of our operations. It's a barrier to deliver value to our customers. And this is one of the objectives that we have as part of this program, to ensure that we deliver higher value to our customers by being much more focused on certain problems in certain markets.

And it appears we have no further questions at this time, so I'll turn the floor back over to Juan Ramón for any additional or closing remarks. Juan Ramón Alaix: Well, thank you very much for joining us for today's call. We had the opportunity to share with you a lot of information, and we'll be pleased to have a follow-up conversation with you if you need some additional understanding of all the plans that we are announcing and also all the products that we are making as an independent company. Thank you very much.

This does conclude today's teleconference. A replay of today's call will be available in 2 hours by dialing (800) 723-0389 for U.S. listeners and (402) 220-2647 for international. Please disconnect your lines at this time, and have a wonderful day.