Welcome to the Second Quarter 2022 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. 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 is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin.

Thank you. Good morning, everyone, and welcome to the Zoetis second quarter 2022 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Wetteny Joseph, our Chief Financial Officer. Before we begin, I'll remind you that the slides presented on this call are available on the Investor Relations section of our website and that our remarks today will include forward-looking statements. And that actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking 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, August 4, 2022. 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 second quarter earnings call for 2022. I'm pleased to say Zoetis delivered another strong quarter with 8% operational growth in revenue and 9% operational growth in adjusted net income, driven once again by the strength of our companion animal portfolio. We saw a balanced performance across our segments with similar operational revenue growth for both the U.S. and international, 9% and 8%, respectively. Our diversity and strength across parasiticides, dermatology products, vaccines and monoclonal antibodies for pain continue to demonstrate people's desire for innovative and effective care for their pets. We continue to see positive spending trends across the globe for pet care. And we grew 14% operationally in our companion animal portfolio. As anticipated, our livestock portfolio continued to face challenges, declining 1% operationally in the second quarter, largely due to generic competition primarily in U.S. cattle and declines in swine products in China due to lower pork prices and COVID-related supply constraints. Overall, our business remains strong, thanks to the durability of our global portfolio and a steady pipeline of new products. Even as we face uncertain macroeconomic conditions, continued supply constraints, generic competition and the war in Ukraine, we remain confident in the resilience of our business and colleagues. As we look to the rest of the year, we are updating and narrowing our guidance to reflect our positive outlook for the remainder of 2022 and the negative impact of recent changes to foreign exchange rates. Wetteny will walk you through the details in his remarks. As we look at the second half of the year, we remain confident in our long-term growth drivers and our ability to maintain a steady supply for customers despite inflationary pressures on the global economy and ongoing constraints for certain products. We all…

Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a very strong quarter with growth across a number of our core franchises and the continued resilience of our end markets. Today, I will focus my comments on our second quarter financial performance, the key drivers contributing to our performance and provide an update on our full year 2022 guidance. In the second quarter, we generated revenue of $2.1 billion, growing 5% on a reported basis and 8% on an operational basis. Adjusted net income of $567 million was flat on a reported basis and grew 9% on an operational basis. Of the 8% operational revenue growth, 3% is from price and 5% from volume. Volume growth consisted of 6% from new products, which includes the Simparica Trio and Librela, 2% from key dermatology products, while other in-line products declined 3%. The decline in other inline products was expected and largely the result of the impact of intermittent supply challenges and generic competition for Jackson. Companion animal products continue to be the primary driver of growth, growing 14% operationally with livestock declining 1% on an operational basis in the quarter. Simparica Trio was the largest contributor to growth in the quarter. Trio posted global revenue of $237 million, representing operational growth of 72% versus the comparable 2021 period. We also continue to experience better-than-expected results from our Trio franchise outside the U.S. where we had sales of almost $30 million. We expect to continue to grow the addressable market for flea, tick and heartworm globally and see significant headroom for growth with brands like Simparica and Trio. Meanwhile, our key dermatology products, Apoquel and Cytopoint, had significant global growth again with $315 million of revenue, representing 16% operational growth against a robust prior year in which these products…

[Operator Instructions] We'll take our first question from Michael Riskin Of Bank of America.

I'm going to try to squeeze in two real quick. First, on the -- your comments on the Trio competition, Kristin, certainly something that's been talked about and anticipated for a while. But I'm curious if you have any updated thoughts on how you'll respond? Is there going to be a change to how you price Simparica Trio or any additional promotional or do you see plants you can try to implement in the next 6 months. And I'm wondering if it's too early to give us maybe a ballpark dollar target for next year. Is it great to think that you could hit $1 billion in Trio sales in 2023. And then a quick follow-up, if I can. On margins for the year, when I'm hoping you could -- can you walk us impact to margins, both on gross margin and OpEx. Just wondering how that factors into the updated outlook.

Sure. I'll take the first one, Mike. Thanks for the question. For starters, we were really pleased with performance of Simparica Trio and Simparica franchise in the quarter with 72% growth. And we do expect even with competition to grow the franchise here -- what we're really seeing in the market is a strong shift from topicals and collars to worlds. There's a new standard of care. So we see the category certainly growing. We still believe we've got some number of advantages from being first to market. We've gotten a lot of customers enrolled in auto shift, which is really helping continue to drive growth there. We've got strong relationships with the large corporate. But importantly, on that issue, we still believe we've got significant room to expand in our penetrated clinics as we look at where our penetration within those clinics is. The other thing is, we really don't believe you're going to see tons of switching without significant differentiation, which honestly we're not really expecting. This remains a significant market. And right now, the Simparica franchise is number two in the U.S. and flea tick heartworm. So we are expecting approval of a potential competitor sometime in the back half of this year and then obviously launching likely sometime next year. But we continue to believe that we can grow the franchise. We're going to invest highly in that through direct-to-consumer through our field force. And we believe, given all the issues and opportunities we have, we can continue to grow this franchise.

And Mike, your question on margins and OpEx. If you look at our gross margins on a year-to-date basis, if you take out the impact of FX, we're running about 20 basis points above last year. So in the quarter, you saw gross margins down about 120 basis points, but it's all FX driven. We've effectively maintained OpEx growth range in our guidance, and we're able to raise the bottom line guidance to 11% to 13% versus 10% to 13% that we started the year with. So again, FX is having an impact here but we are executing into our plan, and we'll see an improvement even on the bottom line growth rate.

Our next question comes from Erin Wright of Morgan Stanley.

Could we get an update on Librela, both the U.S. approval and the supply chain constraints for that product in international markets. At this point, do you think you have visibility if supply chain constraints will have any sort of impact on the U.S. launch in terms of timing? And after you do get approval in the U.S., will you be ready to broadly launch that product immediately. And then just in terms of the guidance, how should we be thinking about what's embedded in the guidance for companion animal and livestock growth for the balance of the year? Are there any sort of dynamics from a quarter-to-quarter basis that we should be thinking about?

I'll take the first one, Wetteny can take that second question. We are really pleased so far in the Librela success outside of the U.S., and we'll talk a little bit what I think the implication therefore are within the U.S. Right now, Librela is the number one awaiting product in dogs in the EU already, which we think is outstanding if you look at its success, it's really been embraced and we see very strong reorder rates right now. Really impressively, 40% of dogs are new to the category, and we're seeing a 90% reorder rate. So we're really pleased. This is a product, as you've noted, that does share some components with human COVID vaccines. And we've been managing that very carefully, making sure as we launch that we have adequate supply since this is a chronic medication. Really have been thoughtful about that. We do believe we've got additional capacity coming on in some of our suppliers as we look into the second half of this year and into next year. So as we look at the rest of this year, we -- as we said, we believe this product will be a blockbuster this year, over $100 million. And we're very optimistic, assuming we get the approvals we're expecting an infection this year to be able to move exactly as we did it Solensia next year with an early experience in the first half followed by a full launch. So remain very excited investing heavily behind this and believe we're working really hard in the supply chain unless something changes dramatically, we are confident we will have the supply we need for a successful launch in the U.S. next year.

Yes, Erin, with respect to our guidance and how you should be thinking about companion animal versus livestock. And so far year-to-date, we've delivered 9% operational growth at the top line, losses driven by companion animal. I think you can expect that to continue in the back half of the year when you consider, as Kristin just mentioned, Solensia will be fully launched in the second half in the U.S. here, we'll continue to see growth in Trio and with Librela, which we expect to be a blockbuster in the EU this year, we delivered $21 million in the first quarter, $26 million in the second quarter. So that will continue to ramp. So I think those will contribute towards comparing that will continue to drive. When I think about livestock, we do see easier comps in the back half than we would have had in the first half to recall swine in China, for example, prices start to really decline in the second half of last year. So that becomes a comp when you think about Q3 and Q4. And then for cattle, we did have some price adjustments in the fourth quarter last year on Jackson leading into the start of the year. So those make for a slightly easier comp from a cattle perspective in the fourth quarter. So those are sort of the considerations, but I would expect the second half to look more like the first half in terms of the contribution from companion animal compared to livestock.

Our next question is from Jon Block of Stifel.

I'll try to ask two logos upfront. Key derm, I think it was up 22% operationally in 1H, but I think it slowed from 27% in 1Q to 16% in 2Q, and I got a sort of a similar year ago comp. So can you talk to, Kristin, your thoughts on the topic derm growth call it, just the trajectory going forward? Does the chewable version offer a price premium for you guys? And I think, Kristin, you also talked about just no competition for maybe in the next 10 months, just how you have that line of sight. And then shifting to your second question to livestock. That market just always seems to be evolving. Would love to get your thoughts on normalized growth returning to the industry in 2023, Kris, I think you called it out last quarter. Does that stay intact? And would your growth be representative of market since I think you're going to get soon on the back end of some of the generic headwinds that you've been facing.

I'll take the first question, let me take the second one on livestock. We are very pleased with continued growth of derm. To your point, in the first 6 months of the year, it grew 22% and in the quarter, it was 16%. There always has been some cyclicality, but we really believe we can continue to grow this franchise. We can expand it -- we have been through both branded and unbranded DTC. As you know, we just began this year really an investment in unbranded DTC in Europe, where we're now seeing significant pickup there. We continue to see people home with Passmore and importantly, they are still in the U.S. alone, 6 million dogs who are still issuing who do not get -- have not received the product. So we think we can continue to grow this. To your question on competition and life cycle innovation, we are investing heavily behind life cycle innovation. This is our category, as you saw last year, the franchise is already worth $1 billion. So we will work heavily to defend this, both with chewable and with other products in the pipeline. Chewable is a real advantage for a lot of people who have trouble giving tools to their dogs and getting them to take it. I would say there may be a slight price depending it's very market specific as you look at the pricing there. But to us, it's really building the loyalty to our franchise overall. We don't have on the competition. As you know, it's not a perfect science in our industry. But as you saw, we did on the Simparica Trio sense that we do see competition. Mostly that is through working with chatter in the marketplace as well as with distributors and our large corporates, who start negotiating differently with us when they believe there's going to be competition in a space. So we are not seeing that in the same way that we are just starting to see that now on competition for our Simparica Trio franchise. So we continue to believe we can grow this franchise with new innovation, with the strength of our commercial infrastructure with our investment in DTC. So I'll let Wetteny take the second question on livestock.

Yes. When you look at livestock, historically, we've seen livestock grow around the 4% range. Certainly, you're very familiar with what's happened in the last few years in terms of ASF and for us, with generic competition with Jackson and Zoamix, the year is essentially executing as we expected on livestock. We continue to believe that we can see livestock returning to normalized growth in the 2023-2024 time frame. And long term, when you look at livestock, we continue to see growth in this business long term, given population growth. We see urbanization as well as growing middle class, particularly as you look across emerging markets. And even this year, if you look at this quarter, for example, livestock grew 2% internationally, despite the headwinds in swine as I said, those comps get easier in the back half. And if you Russia-Ukraine, for example, another point there. So we're seeing growth in emerging markets on livestock. We expect those to continue in long term with innovation as well as we continue our swine vaccines that we are launching vector vaccines on the poultry side, immunotherapies [Indiscernible], et cetera, we would expect to continue to drive growth in livestock long term.

Our next question comes from Christine Rains of William Blair.

Just piggybacking off of that last point, can you further review those pipeline highlights in the work for our livestock portfolio. And just related on the comparatively well international growth in livestock this quarter. Can you discuss the factors there that drive the different performance between international and domestic here?

Yes. Sure, I'd be happy to do that. Look, I think as we entered the year, we expected given the second year of generic competition for Jackson, our largest product in cattle and to some extent, in swine as well. We expected that to drag our livestock performance in the U.S. And again, that's essentially executing as we thought. What that is masking somewhat is the innovation that we are launching in swine for example, with vaccines in swine or vector vaccines that we have been launching will continue to drive in livestock as well. But we are seeing growth in emerging markets. You saw 2% growth in the quarter. But again, that was offset partially with Russia-Ukraine impact here given the conflict there, as well as swine, as you know, from the second half of last year, we've seen a decrease in price that has impacted the performance there, although we have seen a lift in price on swine over the last number of weeks or months in China, we expect to continue as we execute through the second half of the year.

Yes, I'll take a little bit more on your question on the pipeline and livestock. To build on what Wetteny saying, we do continue to believe that we're -- that there's significant growth opportunities in vaccines and livestock, that's what our customers are looking for. As Wetteny referenced, we've been launching some vaccines in swine. Certainly, vector vaccines, we just announced approval of the second vector vaccine. In poultry, we'll be launching more vector vaccines, not poultry franchise as well. Really excited, as I mentioned earlier, about fish with 23% growth in the quarter. Apoquel really focusing on [Indiscernible] and other potential vaccines there. And then if you look at that more broadly as we look out a little farther investment immunotherapies as well as in precision livestock farming, continuing to add to our block yard product there to our genetics business there. So we do see a number of key platforms in livestock to drive innovation in the space. As Wetteny said, I think you can get back to the historical growth rates of around 4% as we hopefully lap some of these generic issues around Jackson and Zoamix and poultry and the ASF issue in China. But I think to get above that, which we certainly aspire to do, it's going to take bringing innovation, and we are certainly investing to be the leader in innovation in livestock.

Our next question comes from Nathan Rich of Goldman Sachs.

Kristin, you talked about the capacity and labor constraints that clinics are facing. But I think you noted vaccines and injectable products continue to grow. I guess could you maybe talk to your ability to continue to grow those products the current market backdrop. And I guess, ultimately, the bigger picture question is, if we see these market dynamics, both from a macro standpoint as well as some of the pressures that vet clinics are facing continue into next year. I guess -- how should we think about growth? I guess, should we expect a similar level of companion animal growth as to what you're guiding to in the back half?

Sure. I think what's important to keep in mind is that vet clinics are doing quite well. If you look at growth in vet clinic revenue since 2019, it's up 20%. There's definitely with a 5% increase in the number of pets in the U.S. There are capacity constraints to meeting all the needs. But I think what's important to remember also is we are not leveraged as high as some other businesses to in-clinic visits. A lot of our key products are chronic. So if you look at our derm portfolio, our tariff portfolio, et cetera, we're still seeing tremendous growth. We had a 10% volume increase in the quarter in U.S. products. So I think it's important to think there's more movement to online and other spaces. So we don't see some of these capacity issues as a major issue for us in continuing to grow our business. You're seeing some of the same capacity strength in Europe, and yet you're already seeing us have Librela looking to be a blockbuster product this year. And I think what really differentiates us is innovation. When there's important science and new products that they're excited about, we're still seeing great attention at the vet clinic for that and really driving that through. Although a lot of people are very focused on vet visits given we're not as leveraged to that. We really think the spend per visit is really important. And I think we're leading in that category given innovation.

Our next question comes from Louise Chen of Cantor Fitzgerald.

I'd like to ask you, are there any metrics that you can point due to support price and demand elasticity in the pet health space? And then, do you think about this the same way in livestock?

Well, I think certainly, when we look at price and demand, we've continued to see opportunistic price at or above inflation, and we've demonstrated that over the years, particularly in certain markets. We've also looked at data in terms of pet ownership and demographically, we see the structural improvement, I would say, even compared to a very strong basis to begin with. So if you look at pet ownership with respect to Gen Z and millennials, and they're prioritizing pet health that certainly bodes well. But also, we're seeing more adoption at higher income households if you look at what adoption numbers look like over the last number of years, which again is structurally very positive for the industry. So as we've taken price over the years and we took about 5% price on -- in companion animal this year. Overall for the company, we've been running about 3% net given some of the last slight dynamics of the Jackson generic competition. But we haven't been able to take price. And yet we still continue to see strong volume growth across the business. And to Kristin's point, that's largely driven as well by innovation in the space. So we continue to see elasticity in terms of ability to take price see from an inflationary perspective.

Our next question comes from Elliot Wilbur of Raymond James.

Just a follow-up question for Kristin around parasiticide trends in the quarter. Can you maybe just talk about category growth overall? It seemed like some of the metrics out there suggested that overall category growth had actually been down. And obviously, Trio continues to perform extraordinarily well, particularly in the U.S. But I'm just thinking about the second half of the year and then early next year with a potential entrant, what you're seeing in terms of category growth? And if you could just give us the number in terms of where Simparica is with respect to overall share in the category. And if I could just get a quick follow-up in here on Librela. Obviously, the initial EU experience has been quite positive here. I think you mentioned that 40% of pets were new to therapy. Just wanted to get maybe an update in terms of what you're seeing with respect to persistence some of the pets that started therapy initially and sort of where we what kind of persistence rates you're seeing sort of 6 to 7 months after beginning therapy? And is that 40%, is that sort of a normal number in terms of new pets coming into the market or should the takeaway there be that Librela sort of test really kind of elevated the overall category growth?

I'll start with your Librela and see if maybe Wetteny can add anything on the tariff point. Really good questions there on Librela. If you look at the 40% new to the category, we do think that's extraordinary. This is an established category. This isn't like derm when we started where it wasn't really a category. There have been many products across the globe for dogs, for pain management. But I think it really underscores the challenges with the existing therapies. There's -- the trade-offs and safety and efficacy have been significant. Most of those therapies, you can't stay on for very long. And I think -- so for a lot of people that really didn't want to deal with some of those side effects that they had stayed out of the category. I think was something with the label that we have with a monoclonal antibody, we are clearly bringing new people to the sector, and we're growing that sector significantly. I think we talked about before, the global market for pain for dogs was around $400 million. We believe with the addition of Librela that we can double the size of that market over time and move that to 800, and we think we can do that from a few ways and one of them you referenced. One is people staying on therapy longer. Certainly, with a safe and efficacious product, we believe we can increase days on therapy. I think we can also be demonstrated with 40% increase the number of pets getting it. And third, we think we can grow the market certainly based on price. This is a premium product with significant innovation. So we are really pleased with the 40% growth. It is certainly higher than even we were expecting with the new patients to the category. We are seeing significant -- probably higher than we were expected initially, compliant to the sense of months on therapy. So we remain extremely optimistic about EU and the persistence of this growth. And I'll let Wetteny take your follow-up question on Simparica.

Yes. When we look at the category, we speaking, clearly, Trio grew 72% in the quarter. If you look at our overall Simparica franchise, grew 47%, right? So if you get Simparica, not Trio, but Simparica internationally, it grew 23% in the quarter. So we have the broadest offering into the parasiticides in the industry. And clearly, the only triple combination in the U.S. What we are seeing is, categorically, we're seeing a shift from topicals and collars to all medications. And if you look at triple combination in the U.S. One of the interesting statistics that we've seen is that on Trio, about 30% of the dogs that are coming on Trio are new to the category and not having been prescribed a prescription of parasiticide in the prior 18 months or so. So we do see significant room to continue to expand in this space. And as competitors come into the space, there'll be more DTC that will drive even more patients for the clinic, which is beneficial for us as well given our relationships across corporate accounts and so on will benefit from having more voices out driving more patients into the clinic. So we're not seeing a slowdown in the category. There is a bit of a shift from the topicals and collars into rolls and that benefits us given our premium products.

Our next question comes from Balaji Prasad of Barclays.

Firstly, as we start to lap the impact of generics on Draxxin and Zoamix, would you still count a threat of generalization as a top two or top three challenge over the next two years? And if you could also add some broader comments around the percentage of your portfolio exposed to general completion of this period. Also on diagnostics, operational decline of 9%, it seems to be the first quarter of decline after Q2 2020 and in contrast to your per visits results. So wondering what kind of increased spend per visit did you notice that you've been calling out over the past few months? And any metrics that you can direct to between point of sale or reference labs that helps us understand this performance?

Sure. I'll start with your diagnostics and then I will let Wetteny do the Draxxin livestock question. As you look at -- we're about flat in the first half of the year in diagnostics. And as Wetteny mentioned in his remarks, as you saw the decline, really, there was growth in international. We made a huge investment in creating a stand-alone diagnostics field force and technical team and service team in the U.S. is highly disruptive. As you know, if you watch other companies do this over time. So -- but we do believe in the absolute strength of this business long term, investing in it long term, as you've seen, we've invested in innovation and our images platform, et cetera. to grow this business. So obviously, as that people get into new territories, et cetera, there's obviously some disruption that happens there. This honestly was anticipated. We remain extremely optimistic in the growth of this business and the strength of it. We certainly look at the strength of our international business and how well that's been doing and growing that with customers. We invested in diagnostics for the long term. and really believe we can drive strong growth here. And diagnostics as a sector is -- grows faster than the overall animal health space. And we believe we can bring disruptive innovation to the space to help us drive that. But I'll let Wetteny take the follow-up question on livestock and Draxxin.

Yes, sure. If you look at Draxxin, right, the largest product that we have across our livestock portfolio. Beyond that, there isn't any other product that's even nearly that size and magnitude if you look across our portfolio as well in companion animals, there or products that are anywhere near any sort of LOE. So we would not anticipate after the first two years, that the generic competition element will be the key driver here in the business. As we said, we expect lifestyle to be returning back to sort of normalized growth in the '23-'24 time frame is what we would expect in that regard to a generic standpoint.

Our next question is from Chris Schott of JPMorgan.

This is Ekaterina on from Chris from JPMorgan. And my question is on the macroeconomic environment here, are you seeing any notable differences when it comes to panel demand across geographies -- so Europe appears to be getting hit harder by some of the challenges related to fuel costs to food prices and stuff like that. And I was wondering if you're starting to see any changes in behavior in that market.

Sure. Thanks, Ekaterina. Good to have you on the call today. As you look at the sort of macroeconomics, we continue to see, on a global basis, very strong demand. And I think what's driving that for us is the innovation that we bring to the market, as well as who's adopting some of these dogs, millennial Gen Z who are more willing to spend more on their pets as well as more of the pets being adopted by high-income families. That being said, Ekaterina, as you double-click into individual markets, you are seeing as economies get affected, obviously, overall demand may go down, but not -- we have so far not seen to do our products we are monitoring it carefully. I think the one place where we're starting to see a little more of that might be Latin America, just given some of the real hyperinflationary markets that you're starting to see there. But what we've really been pleased about in companion animal is the continued strength in willingness to spend and investing in innovative disruptive technology. So there are certainly differences as you get into individual markets across the globe overall continued strong demand. And I would double-click for you since you asked the global question in a few places. One in Brazil, where we only printed about 1% growth in Q2 overall. Companion animals still grew 35% in the quarter, and you look at China, where we only had 3% growth companion animal grew 24%. So even in what many people might consider emerging markets, we are still seeing incredibly strong demand for our products and for our innovation.

And this does conclude our question-and-answer session for today. I'd be happy to return the call to our host for any concluding remarks.

Great. Look, thank you, everyone, for your questions and for your continued interest in Zoetis. Just to summarize, we see continued strength across our diverse global portfolio, especially in our companion animal and pet care products. We are continuing to invest in talent and innovation and manufacturing expansions that can support our future growth. And we are updating and narrowing our full year guidance to reflect a positive outlook for the remainder of 2022 and obviously, as many other companies, the negative impact of recent changes to foreign exchange rates. So I look forward to keeping you updated on future calls. Thanks so much. Have a great day.

This does conclude the Zoetis Q2 2022 earnings conference. You may now disconnect your lines, and everyone, have a great day.