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ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,015
| 3
|
2015Q3
|
2015Q2
|
2015-08-11
| 4.528
| 4.825
| 6.161
| 6.525
| null | 16.31
| 17.31
|
Executives: Anders Gustafsson - Chief Executive Officer Mike Smiley - Chief Financial Officer Joe Heel - Senior Vice President, Global Sales Dean Lindroth - Vice President, Finance Analysts : Richard Eastman - Robert Baird Keith Housum - Northcoast Tim Mulrooney - William Blair Andrew Spinola - Wells Fargo Paul Coster - JPMorgan Operator : Good morning and welcome to Zebra Technologies Second Quarter 2015 Earnings Release Conference Call. Joining us from Zebra Technologies are Anders Gustafsson, Chief Executive Officer; Mike Smiley, Chief Financial Officer; Joe Heel, Senior Vice President, Global Sales; and Dean Lindroth, Vice President, Finance. All lines will be in a listen-only mode until after today’s presentation. [Operator Instructions] At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time. And at this time, I would now like to introduce Mr. Dean Lindroth of Zebra Technologies. Sir, you may begin. Dean Lindroth : Thank you and good morning. Thank you for joining us today. Today’s call will include prepared remarks from Anders Gustafsson and Mike Smiley. Joe Heel will join for the Q&A portion of the call. A replay of this call will be available on our website approximately 2 hours after the conclusion of the call. Certain statements made on this call will relate to future events or circumstances, and therefore, will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, anticipate and outlook are a few examples of words identifying a forward-looking statement. Forward-looking information is subject to various risks and uncertainties, which could significantly affect expected results. Information about risk factors that could impact our results is noted in the press release we issued this morning and is also described in Zebra’s latest 10-K, which is on file with the SEC. Finally, we will be making references today to both GAAP and non-GAAP measures. You can find reconciliations of our GAAP to non-GAAP results in today’s press release. In addition, year-over-year sales growth references for enterprise and total Zebra will be on an estimated historical basis. I will now turn the call over to Anders. Anders Gustafsson : Thank you, Dean and good morning everyone. This morning, we reported another strong quarter of revenue growth, broad-based demand in mobile computing, scanning and printing and solid execution drove second quarter sales to $894 million, excluding purchase accounting adjustments. This represents 11% year-over-year growth on a constant currency basis. We are seeing the impact of our focus on strengthening the Enterprise business and the benefits of being One Zebra. Non-GAAP earnings per share were $1.05, up 14% from a year ago and adjusted EBITDA was $132 million. While sales were near the top end of our prior guidance range, earnings were at the lower end as a result of two main drivers that impacted gross margin. First, we had approximately 1 percentage point impact related to one-time factors, which Mike will comment on in a moment. Second, our success in winning large deals, particularly in mobile computing, was higher than we anticipated resulting in an adverse impact to gross margin percentage. Importantly, while rapid growth in sales and of customer-facing and in mobility devices has put some near-term pressure on mobile computing margins. We believe this will be mitigated by an increased mix of higher margin run-rate business from cost reductions and continued strong growth in our task-oriented and industrial class devices. I will now share some highlights of the business for the second quarter. Our focus on the customer, execution in the channel and an industry leading portfolio of product portfolio are clearly differentiating Zebra in the marketplace. Enterprise sales increased 2% or 9% in constant currency. Pre-transaction Zebra sales grew 11% or 17% in constant currency. From a regional perspective, we delivered solid growth in our three largest regions. Quarter-over-quarter growth was 7% in North America, 16% in constant currency in EMEA, and 20% in Asia-Pacific. Latin America was essentially flat. In North America, sales in printing and mobile computing were strong, particularly with large retail customers. In the quarter, we were also successful in securing two highly contested retail orders. The first was the multimillion dollar deal in which we will displace incumbent consumer devices and printers as well as provide Zebra OneCare services. The second was one of the largest mobile computing orders in our history, where the runner up was the leading consumer device. These are both strong examples of Zebra’s ability to successfully demonstrate the benefits of our commercial class devices over consumer devices. These include higher durability, lower total cost of ownership, superior device management and security. In healthcare, we saw a strengthening pipeline and solid demand, particularly in printing for patient care and productivity improvements. In EMEA, results in the quarter were driven by an outstanding sales effort and strong execution in the channel. Sales growth in both enterprise and printing was broad-based geographically, with particular strength in large customer accounts in postal, transportation and logistics and retail. This was supported by growth trends in e-commerce, applications around parcel labeling and tracking and personal shopping. In addition, we displaced a major competitor by winning a significant multiyear award with the Royal Mail in the UK. We will provide 76,000 of our new TC75 mobile computers, which feature a unique touch screen display, enhanced battery life and signature capture. Once deployed, this solution for field service and delivery applications will increase staff mobility, operational efficiency and quality of service. In Asia-Pacific, the Enterprise business continued to regain share from pre-transaction levels. By leveraging Zebra’s historically strong relationships, together with a focus on operational execution, we are building a healthier and stronger channel as well as an increased partner confidence. As a result, we are seeing the emergence of valuable cross-selling opportunities in China and across the region. E-commerce and online shopping continue to drive growth in transportation and logistics, which resulted in strong demand, particularly for desktop and tabletop printers. In retail, solid demand in scanning is being driven by e-commerce and mobile payment trends, particularly in China. Our sales growth demonstrates that our innovative product portfolio is enabling us to take full advantage of the trends in cloud computing, mobility and the Internet of Things. For example, the large installed base of aging legacy CE and mobile products and the acceptance of Android is driving demand for mobile devices with more up-to-date operating systems. To address this opportunity, we remain OS agnostic and are investing in both the Android and Windows platforms. By engaging early, we have established a leading position with the broadest Android-based product lineup in the industry. Our objective is to secure as much of the early adopter business as possible. After an increase of over 400% in bookings last year, this year’s bookings through the first half, have exceeded all of 2013 and 2014 combined. While this has been driven primarily by a number of large deals for customer-facing and field mobility devices, it has put some pressure on near-term margin. However, we believe this strategy will help us drive share and lead to higher margin run-rate business for Zebra going forward. Our portfolio also includes a wide array of mobile computers and wearable products that have more task-oriented or industrial-based applications, for which demand was also strong. These products generally carry higher margin and are expected to continue to contribute meaningfully to our overall mix. In addition to Android, we expect continued strong demand from Windows-based products and are investing in those opportunities. As a result, we will be introducing a number of new devices on Windows 8, which will be fully upgradable to Windows 10. These will include 8-inch and 10-inch tablets to address one of the fastest growing segments in mobile computing. Used cases include field sales and service, retail front of store and assisted selling applications. Available with either Windows or Android, our tablets will provide several benefits over consumer devices, including scanning functionality, increased durability and more processing power. Omni-channel also continues to drive demand. In retail and transportation and logistics, customers are seeking solutions for everything from growing online commerce to order fulfillment via traditional brick-and-mortar stores. As a result, growth in mobile printers and 3D scanners is accelerating. In printing, we have established a competitive differentiator with Link-OS, a software platform that makes printers easy to integrate, manage and monitor from any location. This Enterprise asset intelligence solution benefits customers through improved actionable information about their operations and the performance of their assets from any location. Bookings in the second quarter, due to the multimillion dollar order by a national food company for 5,000 printers, supplies the Link-OS platform and Zebra OneCare services. The customer’s objectives were to reduce cost, implement device management and improve efficiency. In wireless LAN, we are investing in a path to grow. This year, we have added internal sales resources, expanded our channel network by over 100 partners and focused heavily on building our pipeline. Recent results include strong demand for our 802.11ac product and an increase in several brand awareness and lead generation metrics. In services, we made solid progress on integrating resources and creating one global service organization. The team is focused on serving our customers and improving performance and repair turnaround time, quality management, call handling and case cycle times. In EMEA and Asia Pacific, we are now delivering at much higher levels of performance, as on-time repairs have stabilized. In North America and Latin America, we have increased service levels as well but have more to do. Operational improvements, along with improved alignment between services, resources and channel teams and the launch of Zebra OneCare have begun to improve attach and renewal rates. In managed services, bookings are trending up, with encouraging levels of orders and pipeline growth for our recently launched asset visibility platform and operational visibility subscription services. The growth that we have delivered in the quarter and since the acquisition of the Enterprise business validates our strategy. It also demonstrates our ability to execute on our continuing commitment for meeting our customers’ needs for asset visibility solutions. I will now turn the call over to Mike, who will provide more details on our financial results and the outlook for the third quarter. I will then return for some closing remarks. Mike Smiley : Thank you, Anders. Total GAAP sales for the company were $890 million. Enterprise sales, excluding the impact of purchase accounting, were $573 million, up 9% on a constant currency basis, primarily due to higher sales of mobile computing and scanning products. Pre-transaction Zebra sales were $321 million, up 17% on a constant currency basis. In addition to solid growth in printing, sales of location solutions were up significantly from a year ago. This reflected growth in the industrial vertical and the continued rollout of our MotionWorks tracking solution for the NFL. Sales of Hart retail inventory solutions were comparable to a year ago and seasonally lower than the first quarter. In North America, sales were up $418 million excluding the impact of purchase accounting, were up 7% year-over-year. Growth in printing, mobile computing and scanning was offset partially by lower sales and services in wireless LAN. In mobile computing, our success with several large retail customers resulted in the sale of a higher proportion of MC40 and TC55 devices than we have seen in recent quarters. EMEA sales were $303 million, up 16% year-over-year on a constant currency basis. This reflects strong demand across the region. From a product perspective, sales increased significantly in printing, scanning and mobile computing. Sales in Asia-Pacific were $117 million, up 20% year-over-year. Sales of Enterprise products grew substantially as we continued to gain traction from improvements in operational efficiencies and channel management compared to a year ago. Sales of printing and supplies were also up significantly. In Latin America, sales were $55 million, roughly flat compared to a year ago. Continuing macroeconomic challenges have pressured sales in Brazil, which we have offset with modest growth across the rest of the region. Gross margin for the quarter was 44.2%. This reflects the impact of purchase accounting and one-time accounting adjustments related to Enterprise that adversely affected results. Additionally, we incurred expenses associated with re-branding of products containing the Motorola marks. Product re-branding activities will continue according to the staggered cutover schedule through the end of next year. However, we expect the majority of this effort and the associated cost to be completed by the end of this year. Excluding these factors, gross margin will be approximately 45.3% and 42.8% for total Zebra and Enterprise, respectively. Gross margin for the pre-transaction Zebra business, which is unaffected by these items, was 49.9%. Enterprise gross margin was also impacted by the mobile computing product mix. While we saw solid growth in our task-oriented industrial products, there was margin pressure associated with high levels of sales of customer-facing and field mobility devices to large retail and postal customers. Fluctuations in mix can be a challenge to predict in the near-term as we address the OS migration opportunity and balance our growth with higher margin run rate business. Finally, in the services business, the results of which are included in our segment results, gross margin improved sequentially due to lower repair costs and was in line with our expectations. Operating expenses for sales and marketing, R&D and G&A were $293 million, including $8 million of stock-based compensation expense. The increase compared to the first quarter of the year is primarily a result of higher marketing expenses and the impact of our annual merit increase. To-date, with our focus on our cost synergy programs and improvements in operating leverage, we have captured approximately $60 million of savings and remain on track to achieve our target of $150 million of run rate savings by the end of 2016. In addition, we believe that there is potential to achieve further operating leverage beyond the 2-year timeframe. Other operating expenses in the quarter included amortization of intangible assets of $63.7 million and acquisition and integration and exit and restructuring costs of $49.1 million. In the quarter, we recorded $11.3 million foreign exchange gain. Recently, we added Enterprise business activity to our balance sheet program – hedging program, which is expected to reduce the volatility of foreign exchange movements on net monetary assets. We also plan to incorporate Enterprise into our cash flow hedging program during the third quarter. Interest expense is $49.3 million, including $5.1 million for amortization of debt issuance costs. The GAAP net loss per share was $1.50 and includes income tax charges associated with our ongoing legal entity rationalization strategy. On a non-GAAP basis, earnings per share were $1.05 compared to $0.92 in the second quarter of last year. Adjusted EBITDA was $132 million or 48% of sales. While we remain committed to achieving the 18% to 20% long-term EBITDA margin target we established when we announced the deal, second quarter EBITDA margin of nearly 19% – second quarter EBITDA margin was nearly 19% on a constant currency basis. Turning now to cash, we ended the quarter with $205 million in cash, including $156 million held outside the U.S. During the quarter, we made total loan repayments of $80 million, bringing the total repayment so far this year to $130 million. Next, I will provide some perspectives on the second half and our guidance for the third quarter of 2015. As you look ahead for the balance of the year, we expect sales momentum to continue. However, growth rates in both enterprise and printing will moderate compared to the first half, given the strong results in the third and fourth quarters of a year ago. From a margin perspective, we expect a continuation of large deal activities as we drive the OS transition and additional expenses associated with the Enterprise product re-branding activity. We also will begin to see the impact of price increases in certain international markets, including Europe and cost synergy benefits. This is expected to result gross margins generally consistent with the second quarter, excluding one-time adjustments. For the third quarter, we expect total sales in the range of $900 million to $930 million, flat to up 2.5% year-over-year and up 4% to 7% on a constant currency basis. We expect non-GAAP earnings in the range of $1.10 to $1.35 and adjusted EBITDA in the range of $135 million to $150 million. Gross margin is expected to be in the range of 44.8% to 45.8%. Operating expenses for sales, marketing, R&D and G&A are expected to be in the range of $293 million to $298 million, including stock-based compensation expense of $8 million. On a sequential basis, the increase is primarily related to investments in mobile computing. We anticipate cash interest expense of $45 million and assume an annualized non-GAAP tax rate in the range of 22% to 24%. I will now turn the call back to Anders for his closing remarks. Anders Gustafsson : Thank you, Mike. On our last call, I talked about the priorities that we believe will drive the continued success of the business and shareholder value. They are growth, execution and cultural and business transformation. I would like to provide you with a brief update on each. Beginning with growth, we are engaging more deeply with strategic accounts, developing cross-selling opportunities, enabling the OS transition and strengthening our services and wireless LAN businesses. Better together is also showing results. In addition to North America – to the North America retail deal I mentioned earlier, there have been a number of other important wins. These include the retail award in Asia-Pacific that incorporated mobile computers and mobile printers and a customer in EMEA, who purchased an asset tracking solution involving mobile computers, scanners and printers. All of these wins further underscore the strength of our end-to-end solutions. In addition, we are capitalizing on several market trends. These include the need for customers to upgrade technology, including updated operating systems as well as a deeper penetration of technology into the enterprise. There is also significant opportunity in Enterprise Asset Intelligence applications that are currently in the early stages of adoption. Used cases include inventory monitoring to enhance security and availability, order fulfillment to improve customer delivery times, improve manufacturing process controls and finishing the mobility and workflow. With this momentum, combined with an industry leading portfolio, I am confident in our ability to continue to grow this business. From an execution perspective, we are focused on improving operational efficiency and effectively managing our investments for future growth. Our services and channel improvements are two examples as well as the early termination of several transition service agreements with Motorola Solutions. To improve efficiency and reduce costs, we have exited 14 sites so far this year. We will be exiting or consolidating others as we continue our integration activities. This includes the consolidation of our North American distribution centers, which should be completed before the end of next year. From an investment perspective, our priorities continue to be top line growth, product innovation, strengthening the team and extending our leadership position. Finally, significant business and cultural transformation is taking place within the company. For example, since we acquired Enterprise, we have had three specific objectives in our sales organization. First, quickly unify the teams and present one face to the customer. Second, be partner-centric in our go-to-market strategy, which includes improving our effectiveness in the channel, expanding our partner network to enhance our reach and implementing a best-in-class partner program. And third, begin to transform to a more solutions-based sales organization. As you are aware, two sales teams were unified into one global team almost immediately following the acquisition. More recently, we migrated the team on to a single customer relationship management system, which will result in a meaningful improvement in efficiency. We are also well underway with our second objective. More partners have come on board since the start of the year and we will launch a unified channel program early next year. As for transformation, we continue to build on the foundation of strong partner relationships and a broad portfolio. Recently, we launched the steel building initiative focused on further strengthening our salesforce’s knowledge of the full Zebra portfolio and enhancing our solution and selling capabilities. Collectively, achieving these three objectives will enable us to continue to move up the value chain and deliver differentiated solutions to our customers. Finally, we believe that culture is an enabler and we are being very thoughtful about how we shape the culture and organization design to support our long-term strategy. I am very pleased with the progress that we have made. In closing, we believe that with the commitment and dedication of our team, together with the trends in mobility, the cloud and Internet of Things, we are well-positioned to deliver on Enterprise Asset Intelligence and meet the needs of our partners and customers. Thank you for your continued support of Zebra. I also want to thank our employees for their considerable efforts to realize our One Zebra mission and hard work to satisfy our customers every day. And now, I would like to turn the call back to Dean for Q&A. Dean Lindroth : Thank you, Anders. Before we open the call to your questions, let me ask that you limit yourself to one question and one follow-up. Operator, can you provide our callers with instructions on how to ask a question? Operator : Thank you. [Operator Instructions] And our first question comes from Richard Eastman from Robert Baird. Richard Eastman : Yes, good morning. Just the first question, could you kind of speak to now with a couple of quarters of Enterprise consolidated here, could you maybe speak to the orders in the quarter for Enterprise and potentially what the book-to-bill look like and how comfortable you feel now with the visibility that you are gaining on the Enterprise business as more of a backlog-driven business? Anders Gustafsson : Yes. So, we feel good about the progress we have seen in the business so far. Generally, we only enter a quarter with about 20% booked before at the beginning of the quarter. So, we really have to win the business in the quarter, but we put a lot of emphasis on pipeline management and being very disciplined in how we build up our forecast, our pipelines, and the opportunities that we go after. And we feel quite good that we have a much better visibility into the outlook. And we manage it on a weekly basis basically to ensure that we stay very close to it. And I will ask Joe Heel also to give some extra color on that. Joe Heel : Yes, sure. Hi, Joe Heel here. In terms of the pipeline management, as Anders said, we have added – lifted our sights a little bit in terms of the duration that we look out ahead and we now plan our pipeline one or even two quarters ahead. That’s given us a lot better visibility. We have worked – also worked very hard on what we call the run-rate, which is the business that goes through distribution that’s not in large deal and increasing that in the Enterprise business is our focus and has been quite successful for us since we have made the acquisition. Richard Eastman : Okay. And then the second question maybe for Mike, could you address the free cash flow year-to-date date and maybe there is a couple of big tax payments made in each of the quarters if that continues, but how does – can you give us any sense of what the free cash flow should look like for the full year? Mike Smiley : Yes. I guess the big thing I would say is that we certainly have big tax payments that go out in the second quarter. So, that affected our cash flow. The other thing is if we can get you to come visit us here in Lincolnshire, we moved into a new consolidated business, which drove some leasehold improvements, which is more or less a lot of it behind us, which drove some of the CapEx numbers. So, generally and as we go forward I would say we will continue to invest in integrating the company that’s primarily from an IT standpoint. So, I would expect though the first half had a meaningful part of leasehold improvement, in the second half, we will continue on with ERP integration activities. So, again, I don’t expect the tax payments to be as meaningful as it was in the second half. I would expect the CapEx to be somewhat maybe a little bit lower in the second half than the first half because of the building leasehold improvements we made in the first half. Richard Eastman : Is there any range or forecast on free cash flow for the full year you would be willing to offer? Mike Smiley : No. Yes, we don’t do that. But I would say that you saw that we repaid another $80 million of debt in the second quarter bringing the total to $130 million. We continue to see good cash flow in the second half and I think we are on track for our goal of three times debt to EBITDA at the end of 3 years. So I am feeling really good about the management of our cash flow and getting us to the targets we have committed to at the time of the acquisition. Richard Eastman : Okay, thank you. Anders Gustafsson : Yes. Next question please. Operator : Our next question is from Keith Housum from Northcoast. Keith Housum : Good morning gentlemen. Let me ask a question, I think this is probably a pressure point for you guys you today and it’s is going to be on your guidance for the third quarter, most particularly the gross margins, Mike can you give a little more color on how you guys are looking now, I think you guys said 45.3% without the one-time costs, but give us a little more idea about what the rebranding costs would be in the third and fourth quarter and is there any more color you can give us on exactly the impact that the large deals have and the gross margin compared to your run rate business? Mike Smiley : Yes. So I guess on the – first of all, just to start out, the margin obviously is at the lower end of sort of what we were expecting we gave guidance. I will say that I am pleased with the success of the deals that we have because it put our sales at the top end. And I think Anders at some point will talk about fact that Android has been extremely well received. We won some very large deals. So generally, those large deals have I think for the business demonstrated that we are successful against consumer-grade devices and there is also the strong pickup of Android. Be that as it may, roughly 1% of our gross margin hit in the quarter was associated with what I would call unusual items. A piece of that is rebranding. So with the Motorola transaction, we have the ability to use the Motorola brand for a certain period of time and that’s staggered. So we would expect $2 million to $4 million per quarter through the rest of this year, sort of trailing off next year, affecting our gross margin and we have incorporated that into our guidance for the third quarter. We also have – we also had a number of units that we sold through MSI consistent based on our purchase agreement with very, very favorably pricing, which affected our margin, that stops this quarter. We also – I would say, we had a – as you go to the grocery store and you buy milk real cheap, so you buy all the other stuff for a while, we had some sales went through in the second quarter, which was sort of low margin profitability, which will benefit us as we go forward. So there is a number of things sort of on the unusual one-time items that will go forward. So as you look at it in the second half, I would say the reason we have the guidance that we do is that we have an expectation for continuing to be successful in some large deals, which is going to dampen some of our margin reflected in our guidance. We still have the rebranding efforts going forward, which again is $2 million to $4 million as we guess it right now. That’s offset by the price increases that we talked about in Europe. I think that as the year goes on, those price increases will continue to have some modest benefit for us. And then we also have some cost synergy benefits which are generally on track with what we said from our synergy capture assumptions. So with that, we are expecting second half, again, because – primarily because of large deal activity, to be in line with our Q2, excluding one-time items. Keith Housum : So it sounds like the fourth quarter should be much better than from a gross margin perspective than the third quarter, is that a good take on that? Mike Smiley : No. The good thing is we – Anders will talk more about this but this OS migration provides a huge opportunity for customers to reconsider what solutions they want going forward. I would call this a huge jump ball where it provides an opportunity to grab more market share than perhaps we have been able to do over the last several years. As a result of that, there are large deals coming, very attractive large deals that as we are successful with again with our Android portfolio and such that we should be able to capture those deals. And so that’s where we would say in the second half, we expect to continue to be successful with that – with the large deals. I don’t know Anders, if you want to give some more color? Anders Gustafsson : Yes. I think we believe that it's very important for us now to take advantage of this discontinuity we can call it in the marketplace and really focus on extending our leadership and pursue these large deals very aggressively. This OS migration is something that happens probably once every decade or something. And we have a product portfolio that’s now very well positioned for this and our customers are –we are also very well positioned with customers to do this. So we want to make sure we get this – many of these orders as we can. But we also can recognize and our history has shown that once we get these deals, we will start working the cost side of these things. We will start cross-selling other opportunities into them. We would expand our footprints within those accounts. And margins will improve based on that, they would be very attractive business over the longer term. Mike Smiley : And just to follow-up real quick, I also think as we win these large deals and gain market share, it will later on build our run rate business, which comes with a higher – which naturally comes with a higher margin for us. So I think winning this jump ball right now is important for our future building that run rate higher margin business. Keith Housum : Okay. So, it sounds like for this year, the EBITDA margins of 18% to 20% is not likely by you are finding on being able to reach that goal next year? Mike Smiley : We have talked about our goal was more at the end of roughly 2 or 3 years. So, given – I mean, the one thing I would highlight is that gives me some comfort is that we did a constant currency adjustment for our EBITDA margin. We would effectively be at the target we had hoped for 3 years ago – that we hope for in a couple of years. So I think we are operating the business in a good way. We obviously have more foreign exchange headwinds than when we close the deal. Even with those headwinds though, we still think in 2 years, 3 years – 2 years or 3 years from the time the transaction closed, we will hit the 18%, 19%, 20% EBITDA margin that we had told investors. So I think that’s pretty good considering the fact that we have the FX challenge. Keith Housum : Okay. Inside asking the questions, but I guess the last one for the current quarter, what impact did FX have on your EPS line? Mike Smiley : From our guidance, really virtually nothing, if you look at it from a year-over-year standpoint, our gross margin would have been three points higher than we reflected. So again, that’s a huge impact to our profitability year-over-year. Keith Housum : Alright, I will jump back in the queue. Thank you. Anders Gustafsson : Next question please. Operator : Our next question is from Tim Mulrooney from William Blair. Tim Mulrooney : Good morning. Anders Gustafsson : Good morning. Tim Mulrooney : You guys announced the Royal Mail win in the UK in June, can you give us any sense for the amount of revenue associated with that deal and are you selling any other product or services as part of that deal other than the TC75? Anders Gustafsson : Yes, we – unfortunately, we can’t talk about revenues for this. We have got to have permission from our customers by what we share. But we are – we have shared that the TC75 is by far the largest product in that contract, but it also includes some wearable computers, some ring scanners and also a number of services. So, it’s a much broader portfolio and we can already see that having beat the asset or brought in a asset customer. We are positioned to be able to pursue all sorts of other opportunities that are coming along, Joe any further...? Joe Heel : Perhaps the other thing that’s important than a trend that we see is that together with our partner, which is British Telecom in this case and our ISP partner Packet Mobile this was sold as a managed service to Royal Mail which is I think way that our customers are increasingly interested in consuming these solutions. Tim Mulrooney : Okay. I know Honeywell won the U.S. Post Office PDA business in 2014, I assume they competed for the Royal Mail business as well, are there any key differentiators in your product or service offering that you can point to that you think really helped you win this Royal Mail business? Joe Heel : Yes. Joe Heel again, in this case we know that the selection process had several levels, and we know that Honeywell didn’t kind of proceed based on the product portfolio. So the product portfolio in this case, our breadth of Android capabilities was very instrumental in our ability to secure the business. Tim Mulrooney : Got it. Stepping away from the large deals, I am wondering if you can talk about how the run-rate business performed in the second quarter? Anders Gustafsson : The run-rate business is actually very strong. It grew quite nicely. It didn’t grow quite as fast as the large deals, but the run-rate business grew very well with our printer business, our data capture business and a good chunk of our mobile computer business really is run-rate business and that performed very well across the board, across all geographies. Tim Mulrooney : Was it up year-over-year? Anders Gustafsson : Yes, it was up healthily. Tim Mulrooney : Okay, got it. Thank you. And then the last one, this one is probably for Mike. I am wondering if Mike you gave us an understanding of what we should expect for the cost-cutting targets for 2016, where do you expect to be at on a run-rate basis by the end of 2015? Thank you. Mike Smiley : I think, if you look at our guidance for the third quarter that would give you an indication, although I think the synergies will continue to improve even in the fourth quarter. The challenge is – so lot of the selling synergies have already been captured in our expense and reflected in our forecast. The procurement benefits that we have talked about are primarily going to rollout more in the fourth quarter as we go forward. So, the guidance I think we gave for the third quarter is it gives you an idea about where we expect margins to be generally towards the back half of the year. Anders Gustafsson : We will take our next question please. Operator : Our next question is from Andrew Spinola from Wells Fargo. Andrew Spinola : Thanks. I wanted to ask just more high level on the OS transition that you have been mentioning during the call. We have been sort of trying to figure out what’s driving the strong growth that you’ve shown for the last six quarters and guided to here in Q3. And I know part of it’s been the OS transition but it sounds to me while listening to you that maybe we’re a little bit earlier in this OS transition than I thought. Can you maybe give us a sense of in what inning we are and what sort of growth you can see in ‘16 and beyond from the OS transition? Anders Gustafsson : Yes. First, I’d say the growth that we’ve seen has come from basically all our product lines. Printers which is not really tied to any OS upgrade, has grown very nicely. Data capture portfolio has been growing very nicely. The OS migration is really exclusively an issue for our mobile computer business. But even there, we’ve seen a lot of growth that are not tied to that. So the growth drivers that we have seen has been very substantial and I will just go through a couple of other growth drivers before I’ll touch on the OS migration. But I think the whole Better Together for Zebra is paying results. We are seeing many more cross-selling opportunities. We are selling, say, if you have an installed accounts, installed base account, with one product, we now have much better success of selling one or two more products into that account. We are seeing our channel partners being much more eager to sell the entire portfolio of products. So we see very good overall performance of growth and how we have executed on this strategy that we set out. Now, the OS migration is somewhat unique. It’s driven by some of the older existing OS today widely deployed that are going to be taken out of service for – in some years. This means that basically, a lot of our customers will need to find an upgrade path between now and the next several years. And we are – our approach to this is to make sure that we are OS agnostic. We want to work with our customers to figure out what is the best upgrade path for them, for all intents and purposes, they have two upgrade paths. They can go to Windows 10 or they can go to Android. We now have a strong lead with Android and we try to capitalize on that but we’re also working very hard to make sure we have the full portfolio products to engage with our customers. And I’d also ask Joe to fill in a few more bits here. Joe Heel : Yes, perhaps on the growth driver around mobile computing and the OS migration that’s occurring there. The book end of the time line is really the end of service that has been announced for Windows CE and Windows Mobile, which 90% - over 90% of the install base today is on operating system. That’s in 2020. Based on that, we’re sort of seeing, to use our baseball analogy, maybe we’re in the third inning. There are clearly some early adopters that have already made the migration that Anders described. But the bulk of the migration we believe is still ahead of us. In total, we think there is over 15 million, of these mobile computers out there that are installed. And perhaps 10% of them have migrated so far. So that gives you a little bit of an idea of the timing. Andrew Spinola : Thanks. That’s helpful. Then one question for Mike Smiley, you mentioned earlier in the call that on a constant currency basis, the business would’ve done a 19% EBITDA in the quarter and I know there’s a lot of adjustments that occur throughout the end markets and the supply chain when FX changes. But longer term, with the price increases and other things on the cost side, how much of the FX impact can you reverse? So is 19% a relevant number because you can get back to that in time or does the FX impact remain as long as the dollar stays here? Thanks. Mike Smiley : So, just as a reference point, so we announced the deal, the Euro was basically 1.33 and were basic roughly 1.10, 1.08. So as you can imagine, it has a big impact on our top line and our profitability. That said, we still expect at the end of three years, which is when we said and we announced the deal that we would get to the 18% to 20%. So, my point would be is even with that FX, we feel confident with the synergies that we are doing, with leverage on the business. In other words, our OpEx is going to grow at a slower rate than our revenue and that’s because of a lot of integration efforts are going on. We still feel comfortable with the 18% to 20% that we quoted when we announced the deal even with the FX. Anders Gustafsson : Yes, one point to add maybe here. Most of our competitors are dollar-denominated companies. And I would say pretty much everybody’s supply chain is predominantly dollar-denominated. So, there is nobody who really gets a windfall by having a lot more cost in Europe, say. There is certainly some who have more costs in Europe, but it’s on the margin side. So I think that everybody is more or less in the same boat. Joe Heel : And to that point, as again we mentioned a quarter or so ago that we increased the prices in Europe, nice thing is our business continues to grow very strongly even with those price increases. So I think that’s another positive thing for our ability to drive towards the 18% to 20% EBITDA margin. Next question please. Operator : Our next question is from Holden Lewis from Oppenheimer. Holden Lewis : Maybe switching over to the SG&A line, I think at the end of Q1, you said you are at a $50 million run rate in terms of the synergies. That equates to basically $12.5 million sort of down per quarter. In Q2, you’re kind of at the same revenue stream, same revenue level as Q1. The costs were actually up a little bit. So I guess I’m trying to get a sense of where did all those savings go? How come I can’t see them a little bit more than model? Mike Smiley : Well, I think a couple of things. Number one is in the first quarter and the second quarter we had a fair amount of cost that didn’t come over. So, for example, we didn’t have a full complement of finance people. So, when you look at our expense, even though some of these areas will increase as the year progressed that had relative to what the baseline was when we acquired the business, it’s still below what that baseline was, that pro forma number. The other piece is our top line continues to grow at a rate much faster than our OpEx, so that by definition, gives us our – helps us drive our margin improvement. I think one thing we’re trying to be clear on is that we’re driving towards net synergy improvement. So if you really look at it gross, we are doing very well on things we’ve identified but we need to make sure that after the increases that we’re still net $150 million of savings in Year two. So that’s why you’re sort of seeing not the savings in absolute dollars from the first quarter because some of those costs really didn’t come over when we acquired the business. Holden Lewis : Okay. And I guess you touched on my second question, obviously, you are spending on various elements of the business. You’ve been open about that. But when you talk about that $150 million, you are referring to that as being a net number to the bottom line, right? You’re not talking about that being a gross number and then you plan on spending some of the windfall, if you will, so if the net number is more like $75 million or $100 million. I just want to make sure I am clear on exactly how you plan to utilize that $150 million? Anders Gustafsson : So, the net number is what we expect to pull out of the business. And the target I would suggest you focus on is the EBITDA margin of 18% to 20%. So, the point would be is as we drive and are more successful in some of these synergies, we really want to invest it in the business. So, for example, we are continuing to invest in our mobile computer business to expand Android, to be able to provide good Windows solutions. So, it’s not like everything comes down necessarily to the bottom line in terms of dollars, but when we get the EBITDA margin of 18% to 20%, that’s sort of the hard target, I think as an investor you should focus on. Holden Lewis : Okay, thank you. Anders Gustafsson : Next question please. Operator : It’s from Paul Coster from JPMorgan. Paul Coster : Yes, thanks. Mike, perhaps you could just give us some sense of where you stand from a debt to EBITDA ratio level now and some investors are sort of looking to see whether you might perhaps start to allocate some capital to buybacks again. Under what circumstances, would you do that? Mike Smiley : Our debt-to-EBITDA has improved modestly for obviously when we did the deal. It’s – again, we have paid down $130 million. We see the second half that will continue to generate strong cash flows to further pay down our debt. But as far as buying back shares, I think we are, I don’t want to say I think, we are absolutely committed to reducing our leverage to three times debt to EBITDA over the next three years. So, I don’t think anybody should expect us to be buying back stock for the near term. Paul Coster : Okay. I think, Anders, you mentioned that you went head-to-head in some smartphones for some contracts and of course we are pleased that you won. But of course, it also raises the question of how close was that? What is it that separates your mobile computing solutions from the smartphone off-the-shelf solutions? Anders Gustafsson : So, there is a lot of things that separate us. One of the accounts we talked about was actually win back from that already installed, a very prominent smartphone and we were able to win them back to our platform. So, there was not any incumbent Zebra account. And the reason they did that was that they recognized that our total cost of ownership turns out to be much better. Our devices are much more designed for the used cases that these customers have particularly within the enterprise. So, a greater control of the operating system environment, a much greater security, control of the applications they use, the ruggedness of the device, you have battery life that lasts the entire shift. Many of these customers are also heavy scanner, use the device for scanning and our scan capability has much improved compared to any consumer device. So, we have probably 10 different features or functions that really distinguish us compared to our smartphone competitors. Joe Heel : I would add two more, especially as for those customers who consider Android, remember there are two choices, Windows 10 and Android. On the – for those customers the consider Android, we have invested heavily in extensions to Android that ensure the security and the longevity of the platform. And those are key factors when people make decisions that they don’t find to the same degree on consumer devices. Paul Coster : Okay. My last question is I know that you still have a number of transfer service agreements that I think I might recall, with Motorola and you are keen to get itself off any dependencies where from an operational perspective, what is the status now? Anders Gustafsson : We are making good – making very good progress. I think one thing that we just recently completed was implementing a single CRM program that’s supporting the sales group. It gives Joe and his team visibility to the pipeline. So, as Joe was talking about visibility, I think one thing is we have integrated tool. That was his plan. I think generally, everything is on plan. We realize that this is a big task, but we have the right people working on it. So, I think we are generally on task for what we are looking to accomplish. Paul Coster : Okay, thank you. Operator : [Operator Instructions] We have a question from Keith Housum from Northcoast. Keith Housum : Hey, guys. I appreciate the opportunity for follow-up. Mike just a little bit more clarification on the guidance and the revenue line,, I think on an organic basis, constant currency, you are talking revenue growth of 4% to 7%. In the quarter, we saw enterprise up 9% and printers up 11%. And I think you guys, easier comp in Asia and you have at least part of the World Mail deal going into the third quarter. I guess, help me understand why the revenue guidance is a little bit higher in the third quarter? Mike Smiley : As a percentage of growth, obviously, the third quarter last year was much stronger. So, as we mentioned, the second half as far as year-over-year growth is going to be a little bit more difficult than the first half as we go forward. And I think we give a range because we know that some of these large deals are very binary. You either win them or you lose them. I think in the second quarter, we ended up winning a deal, which by the way, the customer requested or at least demanded, but they strongly requested that we deliver in the quarter, which was different than our forecasts. So, a lot of the stuff is very, very lumpy. I don’t know if Joe or Anders if they have more color on the back half? Anders Gustafsson : I think we believe that we started off with a very strong backlog. We had good backlog going into Q3 and bookings trends certainly support the guidance we have given, but also got to remember that Q3, particularly Q3 last year from an enterprise perspective, was a big bounce up from Q2. So, the comps are a little harder, but we still feel that we have very good sales momentum. The pipeline is very good for Q3 and for Q4 and beyond. So, we feel good about where we are from a revenue perspective. And if you go back to when we first combined the businesses, I think that was one of the big concerns that could we get growth out of the business. And I feel good about what we have been able to achieve so far in the trajectory we are on that we are growing healthily, we have been able to compete against the consumer devices and create a very solid, very profitable business. Keith Housum : Okay. One follow-up, Anders, I think you said before that traditionally, your pipeline was like you saw 20% of your pipeline going into the quarter, is that number greater in the third quarter I guess what could you say that is? Anders Gustafsson : It was a little stronger than what we would normally see, but we still have to win the majority of the business in the quarter. It’s not like its orders of magnitude a bit different. Keith Housum : Okay, alright. Thank you. Operator : And we have no further questions and I will now turn the call back over to Dean Lindroth for closing comments. Dean Lindroth : Thank you. This concludes our call for today. Thank you for joining us. Operator : Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,015
| 4
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2015Q4
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2015Q3
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2015-11-10
| 4.893
| 4.887
| 6.465
| 6.365
| null | 15.5
| 13.26
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Executives: Dean Lindroth - VP-Finance & Investor Relations Contact Anders Gustafsson - Chief Executive Officer & Director Michael C. Smiley - Chief Financial Officer Joachim Heel - Senior Vice President-Global Sales Analysts : Keith M. Housum - Northcoast Research Partners LLC Holden Lewis - Oppenheimer & Co., Inc. (Broker) Andrew C. Spinola - Wells Fargo Securities LLC Brian P. Drab - William Blair & Co. LLC James E. Faucette - Morgan Stanley & Co. LLC Paul J. Chung - JPMorgan Securities LLC Matthew Gall - Barrington Research Associates, Inc. Jason A. Rodgers - Great Lakes Review Operator : Good morning, and welcome to Zebra Technologies Third Quarter 2015 Earnings Release Conference Call. Joining us from Zebra Technologies are, Anders Gustafsson, Chief Executive Officer; Mike Smiley, Chief Financial Officer; Joe Heel, Senior Vice President, Global Sales; and Dean Lindroth, Vice President, Finance. All lines will be in a listen-only mode until after today's presentation. Instructions will be given at that time in order to ask a question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time. At this time, I would like to introduce Mr. Dean Lindroth of Zebra Technologies. Sir, you may begin. Dean Lindroth - VP-Finance & Investor Relations Contact : Thank you, and good morning, for joining us today. Today's call will include prepared remarks from Anders Gustafsson and Mike Smiley. Joe Heel will join us for the Q&A portion of the call. A replay of this call will be available on our website approximately two hours after the conclusion of the call. Certain statements made on this call will relate to future events or circumstances and therefore, will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, anticipate and outlook are a few examples of words identifying a forward-looking statement. Forward-looking information is subject to various risks and uncertainties, which could significantly affect expected results. Information about risk factors that could impact our results is noted in the press release we issued this morning and is also described in Zebra's latest 10-K, which is on file with the SEC. Finally, we will make references today to both GAAP and non-GAAP measures. You can find reconciliations of our GAAP to non-GAAP results in today's press release. In addition, year-over-year sales growth references for Enterprise and total Zebra will be on an estimated historical basis. Now, I'll turn over the call to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Dean, and good morning, everyone. We recently celebrated the one year anniversary of Zebra's acquisition of Motorola Solutions' Enterprise business. I have long believed that these two businesses would be better together and today, I'm more convinced than ever. Before I discuss our results for the third quarter, I would like to review the strategic priorities that we set last year and our progress to date. These priorities are the foundation for Zebra's transformation and delivery of our value proposition. Our priorities include; first, growing the business particularly in Enterprise through renewed focus, leveraging complementary strength, capitalizing on cross-selling opportunities and increasing our strategic importance to customers; second, expanding our market opportunity by creating solutions to enable Enterprise Asset Intelligence; third, improving execution, particularly in the channel, service delivery and customer experiences; fourth, realizing cost synergies; and finally, differentiating ourselves with our leadership in technology, channel relationships, partner ecosystem and brand. Executing on these priorities will enable us to capitalize on the opportunities being created by the secular trends in mobility, the cloud, and the Internet of Things. The proliferation of the connected devices, the explosion in mobile apps and e-commerce as well as the expanding mobile workforce are all generating exciting growth opportunities for Zebra and our partners. Other key growth drivers are technology advances including the operating system migration in mobile computing and the data capture transition from 1D scanning to 2D imaging. One year into the merger, I'm very pleased with our progress. We have returned to Enterprise to growth with sales through September, up 6% year-over-year in constant currency. Part of this achievement is the result of increasing our win rate against consumer devices in retail to nearly 80%, compared to 50% last year. Win rates in transportation and logistics and manufacturing are also higher. This was accomplished with an expanded portfolio of differentiated enterprise grade devices that deliver a superior value proposition in our target market segments and use cases. We have improved Enterprise execution in the channel, particularly in China where we have begun to regain ground and have increased sales year-to-date by 60%, compared to last year. With an early investment in Android, we have demonstrated a high level of success in the operating system of migration in mobile computing by growing Android sales through September by 170%, compared to last year. In the original Zebra business, we have grown sales year-to-date by 12% in constant currency, with double-digit increases in printing, supplies and location solutions. Finally, our growth is also attributable to a stronger, more recognizable Zebra brand, and an unrivalled partner network. With these achievements, we have delivered a nine-month adjusted EBITDA margin of 16.3%. On a constant currency basis, this is nearly 20%, compared to a 2013 pre-merger estimate of 15.6%. We have more work to do in areas that include launching our new channel program, growing services, expanding gross margin and cross-selling. That said, our results underscore the potential of the strategies we are pursuing and the value of bringing together Zebra and the Enterprise business. They also demonstrate that we have accelerated Zebra's transformation into a globally diversified industry leader that is well positioned for the opportunities ahead and to achieve our long-term financial targets. And now turning to our results for the third quarter. Sales were $919 million, excluding purchase accounting adjustments. In constant currency, this represents 6% year-over-year growth, including Enterprise growth of 5% and pre-transaction Zebra growth of 8%. Non-GAAP earnings per share were $1.39, up 71% from a year ago. From a sales perspective, we continue to grow in our three largest regions. Year-over-year growth in the quarter was 8% in North America, 3% in constant currency in EMEA, and 23% in Asia-Pacific. Demand remains strongest in retail and transportation and logistics. Momentum in healthcare also continues to grow. Top growth drivers, again, included e-commerce, mobility, the OS transition and the continuing refresh cycle in printing. In North America, mobile computing sales reflected strong demand for our Android product line, particularly in retail. From a new order perspective, wins in retail and manufacturing included several mid-to-small sized accounts, which came through the channel. In data capture, growth was particularly strong in our OEM vertical, and we continue to see increasing momentum in the transition to 2D imaging. Printing growth was led by increases in sales of tabletop and desktop product lines. In EMEA, as we anticipated, growth in constant currency moderated from first half levels. This included a more typical summer slowdown in Europe in contrast to the unusually strong summer last year. Momentum in mobile computing remained solid in Europe, particularly in the UK and Germany, where orders included new wins in manufacturing, retail, and government. Sales in Africa and the Middle East slowed due to the low price of oil impacting industrial customers. Sales in Russia and Turkey declined due to current geopolitical challenges. With respect to the April price increase in – on euro-priced products, demand does not appear to have been negatively impacted. In the third quarter, the price increase gained traction, particularly in printing. Compared to the third quarter, we expect a sequentially higher benefit in the fourth quarter resulting in an annualized benefit of $25 million to $30 million. In Asia-Pacific, we continued to see solid growth across the region, particularly China, India, and Southeast Asia. While manufacturing remains challenged, retail upgrades and e-commerce are driving strong growth in both mobile computing and scanning. Solid printer growth, particularly in desktop continued in transportation and logistics and healthcare. Aftermarket sales were also up significantly as a result of our ongoing effort to address an underserved market. Sales in Latin America – in the Latin America region declined 16% as a result of a difficult macroeconomic environment. Currency devaluations and the decline in purchasing power have led to postponement or cancellation of opportunities across the region. To position ourselves for a return to growth when the regional economies improve, we are using this opportunity to strengthen our go-to-market strategies. One of the contributors to our sales growth this year is the operating system migration in mobile computing. We believe that there are approximately 15 million units in the field with legacy operating systems. We expect that the majority will be replaced by the end of 2020 with devices featuring a modern operating system. Typically, with technology transitions, the largest customers lead the way, winning this early adopters is critical to establishing a beachhead and paving the path for future growth and profitability. These large accounts are strategic, profitable and drive significant levels of business. Some due to their scale yield a lower than average initial gross margin. Over time, margins in these accounts improve as we reduce product cost and cross-sell other higher-margin products and services. Most importantly, these accounts provide key reference points in the marketplace, which are necessary for broad-based technology acceptance. This in turn, expands partner support and fosters adoption by mid-sized and run rate channel customers, which generally yield a higher than average margin. In our mature Windows device business, for example, our highest margins come from mid-sized deals and run rate business, which represents over 80% of Windows-based sales. Currently in Android, large customers are leading the OS transition. Sales from mid-sized customers and run rate business represents only 40% of Android sales. As we grow our Android business and shift the sales mix toward the Windows sales mix we expect the gross margin across our Android portfolio to improve. Other margin improvement plans include product redesign and supplier cost reductions. In addition, our synergy program will have a more meaningful impact on product costs next year, including further reductions in material, freight, and overhead costs. I'm pleased with our results in the quarter and year-to-date. We are executing on our strategies and capitalizing on the opportunities in the marketplace. We remain confident that we will achieve further success through consistent execution and satisfying our partners and customers with technology to enable this smart connected enterprise. I will now turn the call over to Mike to provide more details on our financial results, and the outlook for the fourth quarter. Michael C. Smiley - Chief Financial Officer : Thank you, Anders. Total GAAP sales for the company were $916 million, Enterprise sales, which exclude the impact of purchase accounting, were $605 million, up 5% on a constant currency basis, primarily due to strong growth in mobile computing and data capture products. Sales of wireless LAN and services declined from a year ago. Pre-transaction Zebra sales were up $314 million, up 8% in constant currency with solid growth in printing, supplies, and location solutions. GAAP margins for the quarter were 45.2%. Excluding the impact of purchase accounting, gross margin was 45.5%, up slightly from our adjusted second quarter gross margin of 45.3%, and consistent with our guidance. Enterprise gross margin was 42.5% compared to the second quarter adjusted margin of 42.8%. Sequentially, margins reflected product costs, and warranty expense reductions, some of which were one-time in nature, and our European price increase. This was offset by increased excess and obsolescence reserves on various product and service parts inventory, primarily also one-time in nature. Pre-transaction Zebra gross margin was 51.2%, compared to 50% in the third quarter of last year. Compared to a year ago, the impact of currency has been offset by lower product costs in hardware and supplies, the price increase in Europe, and the benefits of our hedging program. Margins were also up sequentially due to higher pricing in Europe and lower product costs. Operating expenses for sales and marketing, R&D and G&A were $288 million, including approximately $8 million of stock-based compensation expense. Expenses declined from the second quarter due to the timing of expenses from market development programs, and non-integration-related IT projects. G&A costs declined due to lower than anticipated employee-related benefits costs. Other operating expenses included acquisition and integration, and exit, restructuring costs of $43 million, and amortization of intangible assets of $58 million. In the quarter, the net loss per share on a GAAP basis was $0.57. Non-GAAP earnings per share were $1.39 compared to $0.81 in the third quarter of last year. Adjusted EBITDA was $159 million, or 17.3% of sales, up from 14.7% in the second quarter. Turning now to cash. Free cash flow in the quarter was $58 million and we ended the quarter with $258 million in cash. This includes $170 million outside the U.S. Subsequent to the end of the quarter, we made $65 million in scheduled interest payments and a $20 million principal payment in our term loan. This brings the total principal payments this year to $150 million. Our current net-debt-to-adjusted EBITDA ratio is 4.8 times. Through nine months, cash flow has been impacted by significant expenditures associated with the Enterprise transaction. This includes non-recurring expenditures of $51 million in working capital settlement payments to Motorola Solutions, and $32 million in real estate expenditures, primarily related to the building out of a leased facility to accommodate our Illinois-based employees. With these expenditures behind us, growth in the business and working capital management, we expect a significant increase in cash flow generation next year. With this improvement, we anticipate additional debt reduction next year of $300 million or more. Before moving onto guidance, I want to provide an update on our synergy program and overall cost structure. We targeted a synergy opportunity of $150 million associated with the integration of the two businesses with the ultimate objective of achieving an adjusted EBITDA margin of 18% to 20% by the end of 2017. We have pursued this synergy opportunity while we restructure and staff the organization and grow the business. Compared to the pre-merger 2013 baseline we established, we'll realize this year approximately, $120 million of operating expense synergy benefit from actions implemented in 2014 and 2015 and costs not transferred from Motorola Solutions. This includes $60 million in sales and marketing and $25 million in engineering, primarily a result of staff reduction. We'll also incur this year, approximately $30 million of incremental operating expenses, associated with the transaction. These include resource and efficiencies of operating in two separate IT systems, filling critical positions not transferred from MSI that are necessary to support the business and support and advisory costs, particularly in finance. Finally, the business continues to grow, requiring the appropriate level of reinvestment as well as compensation related cost increases such as merit and incentive pay totaling $60 million, compared to the baseline in 2013. In aggregate, we expect an absolute reduction operating expenses this year of approximately $30 million or 3%, compared to 2013 levels. Constant currency sales growth over the same period is approximately 10%. Measured as a percent of sales operating expenses will decline this year to 32%, compared to a currency-adjusted 36% in our baseline year, a 400 basis point improvement in our cost structure. Finally, on a run rate basis, the operating expense synergies I've mentioned combined with $50 million of targeted cost of goods sold reductions, resulted in approximately $200 million of total gross run rate synergy benefits by the end of next year, compared to our goal of $150 million. Looking ahead with some potential or further operating cost savings prior to completing our IT integration, balanced with investment to grow the business we plan to tightly manage net growth in our operating expenses. This is expected to result in further operating expense leverage in the range of 200 basis points to 250 basis points over the next two years. With respect to our fourth quarter outlook, our guidance reflects the recent further reduction in the U.S. dollar against the euro. We expect continued growth in the business resulting in sales of $945 million to $975 million. This represents year-over-year growth of 3.6% to 6.9% on a constant currency basis. Non-GAAP earnings per share are expected to be in the range of $1.38 to $1.63 and adjusted EBITDA in the range of $155 million to $170 million. We expect gross margin in the range of 44.5% to 45.5% – 44.5%. On a sequential basis, we anticipate increased benefits from European price increase and cost reduction offset by the impact of a large mobile computing deal. Operating expenses for sales, marketing, R&D and G&A are expected to be in the range of $293 million to $298 million including stock-based compensation expense of $8 million. The increase in the third quarter is primarily related to typically higher fourth-quarter expenses from marketing programs, sales commissions, and employee benefit costs. IT cost will also be higher as we begin to implement and support parallel business applications in preparation for certain TSA exits. We expect interest expense of $48 million to $50 million, and a non-GAAP tax rate in the range of 22% to 24%. Compared to the third quarter currency environment, the impact of the recent strengthening of the U.S. dollar against the euro has reduced the high and low end of these ranges by approximately $6 million on sales and $5 million on adjusted EBITDA, 30 basis points on gross margin percentage and $0.05 per share on non-GAAP EPS. I will now turn the time back to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. In addition to satisfying customers, introducing new products, and pursuing new opportunities, we have been hard at work integrating the company. Since the closing in October of last year, the integration program has progressed well with accomplishments in organizational design, and culture development, real estate consolidation, implementation of tools for our sales team, engineering system migrations, and a global brand to transition. This works includes the elimination of over 250 Enterprise IT applications, closure of over 200 Motorola transition service agreement items and exits of over 20 real-estate sites. The team has accomplished a lot in the past year, but we have more to do. Future integration efforts will primarily focus on implementing – on the implementation of the IT infrastructure and business systems and enable us to conclude all remaining support services from Motorola Solutions. In doing so, we will modernize and right-size our business processes and ecosystem by transitioning Enterprise on to new or upgraded Zebra systems. The result will be a more efficient and cost effective IT architecture and ecosystem of applications, lower operating costs, and lower ongoing capital expenditure requirements. Further progress in our efforts will be marked by several milestones next year. In the first quarter, we will complete several additional engineering system consolidations, the phased implementation of the systems for our services business, and our integrated ERP will start in the second quarter. Systems supporting our new channel program, will also begin to rollout in the second quarter. In the third quarter, we will launch our distribution center consolidation initiative with the outsourcing of our North America printing operation to a third party logistics provider. We expect to complete the systems migration and be entirely off Motorola supported IT systems before the end of 2017. The remaining costs to complete the overall integration program, including capital expenditures are expected to be approximately $180 million to $200 million through 2017. Looking ahead, our strategies remain anchored in capturing growth, improving execution, and differentiating ourselves. Our top-line results demonstrate that customers are increasingly turning to our technology to gain a competitive advantage, reduce costs, and improve productivity in an expanding array of applications, including e-commerce, omni-channel, workforce mobility, and workflow, and delivery of real-time actionable data. Solid execution is improving customer experiences, and performance in the channel. We are differentiating ourselves with innovative products, deep-channel relationships, and a global ecosystem of more than 10,000 partners, and a highly trusted brand. Our progress this year, along with secular growth drivers and Zebra's differentiators, underpin our confidence in achieving long-term sales growth of at least 4% to 5% over a cycle. With the strength of our mobile computing portfolio, we believe that we can exceed that range if the pace of the operating system migration in mobile computing accelerates. As we grow the business, we continue to expect adjusted EBITDA margin expansion to 18% to 20% by the end of 2017, assuming a currency environment consistent with the third quarter. Over the next two years, we expect to achieve our adjusted EBITDA margin target with gross margin improvement in the range of 50 basis points to 100 basis points as we introduce more innovative products, reduce product costs, and services cost, and grow our Android mobile computing sales, particularly through the channel. In addition, we expect further cash operating expense leverage in the range of 200 basis points to 250 basis points as we manage our cost structure, and realize the efficiency benefits of our IT migration. The increased cash flow generation from margin expansion and other actions will enable us to further reduce debt by at least $650 million and reach net-debt-to-adjusted EBITDA ratio of less than 3 times by the end of 2017. In closing, Zebra has a history of consistent execution and we intend to extend that track record by capitalizing on the opportunities ahead and delivering on the targets that we have set. Thank you for your continued support of Zebra. Now, I would like to turn the call back to Dean for Q&A. Dean Lindroth - VP-Finance & Investor Relations Contact : Thank you, Anders. Before we open the call to your questions, let me ask that you limit yourself to one question and one follow-up. Operator, can you provide our callers with instructions on how to ask a question? Operator : Thank you. And our first question comes from Keith Housum from Northcoast Research, please go ahead. Keith M. Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Thanks for taking my question. A question for you guys on the gross margins, if I can just hone in on the Enterprise margins. If I understood that correctly, the Enterprise margins were 42.5% versus 42.8% last quarter. I guess, Anders and Mike, how does that compare to, I guess, historical averages for Enterprise margins? And then if you could just drill down more on the one-time items, like the obsolescence write-off that you guys took, and how that may have impacted it this quarter? Michael C. Smiley - Chief Financial Officer : Yeah, Keith, this is Mike. So, I think a couple of things on the one-time items. I think, first of all, the excess and obsolescence was – the higher level of that – a lot of that was related to services, wasn't so much on mobile computing. We had within the mobile computing a number of sort of beneficial things – one-time things going both ways, so net-net it really didn't have a big impact on our gross margin. So, some of the E&O was related to enterprise mobile computers offset by – as we've talked about before working with our suppliers and vendors to reduce some of our product costs one-off. So, when you look at it there wasn't a big net-net benefit or change in our gross margin for the enterprise mobile computers. Keith M. Housum - Northcoast Research Partners LLC : And how does this compare to, like, historical cycle that you guys are in, when you guys are launching new products, is it historically average, or is it a little below average? Michael C. Smiley - Chief Financial Officer : Actually, as you look at this, I think the – obviously, the Android is the new product area you're focused on. And as we look at the large deals that we're getting for Android products that are very similar to the large deals we'd win in Windows, so we're really encouraged that to build that market share, we're doing it at very consistent margins that we had had before. However, as the business grows in the Android, as Anders mentioned, we will expect to see more channel run rate business, which will come at a higher margin going forward. Also encouraging is the fact that as we continue to develop those products with – at a lower cost point, we would expect margins to be – continue to be favorable. Keith M. Housum - Northcoast Research Partners LLC : So the 42.5% that you guys compare to like historically, three years or four years or five years ago, is that historically average, or how does that compare to historical numbers? Anders Gustafsson - Chief Executive Officer & Director: I think we'd – if you normalize that for FX, we would expect that to be very similar to what we've seen before. Keith M. Housum - Northcoast Research Partners LLC : Okay. Anders Gustafsson - Chief Executive Officer & Director: And maybe, if I was to reiterate at one point Mike said, which I think may have been misunderstood by the markets maybe is that if you look at the margins we get on our large Windows based deals, it is very consistent with the margins we get on our large Android deals. So there is no difference really in the price points and margins on large deals either Android or Microsoft. Michael C. Smiley - Chief Financial Officer : Yeah, the other thing, just to go back to FX, I mean if you look at our EBITDA margin, we would have been, FX adjusted, we would have been 20% EBITDA margin for the quarter. So FX has a very meaningful impact on our profitability. Keith M. Housum - Northcoast Research Partners LLC : Okay. I appreciate that. If I may ask one more, Mike, you went through the synergies really quick. But I guess in a nutshell, should we think of synergies, you guys had actually increased your guidance from operating synergies from $150 million to $200 million? Michael C. Smiley - Chief Financial Officer : Over a three-year period, yes. And I think a couple of things that happens, sources of that are, as we talked about some of the dis-synergies associated with the transaction that we're incurring we expect that to moderate substantially, we expect the IT systems to allow us to be more efficient as we go forward. So there's a number of things that we would expect over a three-year period to help us to go from $120 million we've already realized eventually to $200 million over the next several years. Dean Lindroth - VP-Finance & Investor Relations Contact : So take our next question, please. Operator : And our next question comes from Holden Lewis from Oppenheimer. Please go ahead. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Great. Thank you. Good afternoon – or good morning. On that synergy question, I guess, the $120 million that you're talking about, I mean, what are you expecting to actually sort of realize in 2015? And what's sort of the incremental that you expect to realize in 2016? How does this sort of the incremental realized dollars playing out at this point going forward? Michael C. Smiley - Chief Financial Officer : So I think one of the neat things about our business is the topline is growing. So effectively on a constant currency basis, our revenue is grown by 10% from the last since 2013, yet our operating expenses net have gone down by 3%. So basically that's 13%, what I would call operating leverage. When you try to determine or as far as how that net-net happens, we have $120 million of realized synergy in our P&L in 2015 for the full year, which is big buckets again are R&D and sales and marketing. And then we have cost increases of roughly $30 million, which is associated with, again the inefficiencies of putting the two businesses together, ERP that related stuff, offset by what you would expect is normal OpEx growth as the business grows by 10% on a constant currency basis. So net-net we're $30 million lower in OpEx 2015 to 2013. So again, with the plans we have going forward, we still expect to hit the 18% to 20% EBITDA margin reflecting exchange rates we saw in the third quarter. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. And then with respect to – it looks like the core Zebra business is somewhat slower. I know that your revenues were in line sort of with the guide. So the first time or couple quarters that you didn't come in at the high end. I guess, but does that reflect a little bit of weakening in the market? And if it does, can you talk about what triggers you may have to pull related to the acquisition and integration, where if the macro does slow you could perhaps mitigate it with some specific initiatives that could offset? How do I think about your ability to perform at the top line, in maybe a weakening macro environment? Anders Gustafsson - Chief Executive Officer & Director: First, we had, I think, signaled all along that the very strong growth rates we had on the printing side in the first half would start to moderate a bit based on kind of lapping ourselves, having very strong growth rates in the second half of 2014. So I think the growth rates are actually very solid I thought in Q3. The only one that kind of stood out in that case quarter-over-quarter would be the European one. But Europe tends to have, historically has had, a slight decline in Q3 as good chunk of Europe goes on vacation. Last year we did not see that. We actually had a very strong quarter; we had growth in that piece. So we feel good about where we are, we have been able to gain quite a lot of market share over the last couple of years and with our portfolio, with our sales team and the support of our channel partners, we do believe that we should be able to continue to gain share and grow faster in the market. And I'll let Joe Heel, he'll also make some comments. Joachim Heel - Senior Vice President- Global Sales : This is Joe. I'll add specifically to your question about initiatives and levers that we have to continue to drive growth. On top of what Anders said, I would point specifically to the operating systems migration. This is an area where we do have targeted initiatives underway. The installed base is an area that we are very actively and very systematically pursuing. And the second one is the transition from 1D to 2D in scanning also an area where we are very actively taking the opportunity to systematically go through installed base and take share. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. Thank you. Dean Lindroth - VP-Finance & Investor Relations Contact : Next question, please. Operator : And our next question comes from Andrew Spinola from Wells Fargo. Please go ahead. Andrew C. Spinola - Wells Fargo Securities LLC : Just looking at your operating expense commentary, off the base of 2015 instead of 2013, did I hear it correctly that, Mike, you think that expenses will grow, but at a slower pace essentially than revenue in 2016 and 2017? Is that the right way to think about it? Michael C. Smiley - Chief Financial Officer : Absolutely. What we're looking to do is manage our operating leverage. We expect to see some nice improvement as our top-line grows and our OpEx will grow substantially lower. And so, when you net it out, we see a 200 basis point to 250 basis point improvement between now and end of 2017 to get us to the 18% to 20% EBITDA margin. Andrew C. Spinola - Wells Fargo Securities LLC : Understood. And just a clarification. I think, Anders, you made the comment, that there's another $180 million to $200 million of integration and acquisition spend between now and 2017, did I catch that correctly? Anders Gustafsson - Chief Executive Officer & Director: That's correct. That includes then, all the IT spend, including CapEx also. And we also said that that would help yield substantial efficiencies past the 2017 date. So as we get into 2018 and so we expect to drive further operating leverage based on those investments. Andrew C. Spinola - Wells Fargo Securities LLC : Understood. Just stepping back from my perspective, it does seem like – I'm a little surprised the acquisition and integration spend was the highest this year in the third quarter. I guess, I would have thought it would be stepping down. And then, the fact that there's another $180 million to $200 million sounds like a good bit more than I was looking for. And so, I'm just wondering, did it turn out that there's more opportunities for things that you could optimize? Or maybe on the flip side, it turned out that Motorola needed more investment than was initially expected? Anders Gustafsson - Chief Executive Officer & Director: But first we're very pleased with the efforts to date on integration. We feel that the integration has gone very, very well for us. If you look at the things like the – how we designed and integrated a new sales organization, I think that was done very, very well. There we had a basically a blank sheet of paper that we started with and we didn't really merge the organizations, but that was pretty stressful as we went through it, but looking back, I think we very quickly got the right team, knowing their roles and be out focusing on selling. We've done a lot of work around culture, we feel that culture is one thing that can derail an acquisition like this, so we've had 250 of our most senior people come together in various workshops to work on how to create a common culture across the entire organizations, and I'd say, the organization has responded really, really well to all of those things. But on the negative side, I'd say the complexity of the IT systems has been greater than we had expected, Motorola had a bit of a patchwork of systems. A lot of customization, they didn't necessarily all talk to each other. So as we pull this together, we're looking to see how we can create the platform that's across all of Zebra to drive the right level of efficiencies to then continue to generate great operating leverage benefits after we done with it. Michael C. Smiley - Chief Financial Officer : And as far as the third quarter, up until the third quarter, a lot of the energy on the IT integration stuff was really on planning. And so, we're starting to put a lot more resources and actually executing on those plans, so that's I think a little bit of impact on the timing of the cash flows for that work. Andrew C. Spinola - Wells Fargo Securities LLC : All right. All makes sense. I was just curious. Thank you very much. Anders Gustafsson - Chief Executive Officer & Director: You're welcome. Dean Lindroth - VP-Finance & Investor Relations Contact : Next question, please. Operator : And our next question comes from Brian Drab from William Blair. Please go ahead. Brian P. Drab - William Blair & Co. LLC: Hi. Good morning. Congratulations on the solid results. Anders Gustafsson - Chief Executive Officer & Director: Thank you. Brian P. Drab - William Blair & Co. LLC: First question, I just want to make sure that I have this clear. Is the expected restructuring savings amount now $200 million by the end of 2018? Anders Gustafsson - Chief Executive Officer & Director: 2017? Just yeah. Brian P. Drab - William Blair & Co. LLC: By the end of 2017? Anders Gustafsson - Chief Executive Officer & Director: Yeah. So, the run rate, as we exit 2017, will be that. So, you should realize it in 2018. Brian P. Drab - William Blair & Co. LLC: Got it. Okay. Thanks. And then the $30 million in expenses, the incremental expenses, that's an offset to that $200 million? Or is that $200 million number a net figure? Michael C. Smiley - Chief Financial Officer : (40:17 – 40:27). Brian P. Drab - William Blair & Co. LLC: I don't know if it's just me, but it's very hard to hear, Mike, if that's Mike. Michael C. Smiley - Chief Financial Officer : Sorry about that. So, the $30 million is in relation to 2013 versus 2015. So, again, we've had $120 million, we realized in 2015 in our P&L. We've had a $30 million in 2015, with cost increases associated with the transaction and additional normal expense growth of $60 million. That $30 million we would expect to decline over the next year or so, because obviously, some of the work associated with the integration will go away. So, for example, some tax stuff, consulting and such, so the $30 million will go down, which is in part one of the reasons why we have some of the synergies we expect to achieve as we go forward. Brian P. Drab - William Blair & Co. LLC: Okay. Okay. Thanks. So some of the $30 million stays, some – but a significant portion of that will go away? Michael C. Smiley - Chief Financial Officer : Yes. Over time. Brian P. Drab - William Blair & Co. LLC: Okay. And then, can you just break down your sales? I don't know if you can just do this roughly maybe, but in a couple different ways. First I'm curious about the percentage of sales in the third quarter that was associated with large deals? And also, if you could give us any sense percentage of large deals that have been Android versus Windows in the third quarter? Anders Gustafsson - Chief Executive Officer & Director: I'll start, and I'll hand over to Joe, but generally we can't really share with you all that detail. But, large deal is not a new phenomenon for us, we've had large deals forever. As I mentioned before, the margins on large Windows based deals is very much in line with the margins on large Android based deals. So, the pipeline for large deals is healthy and growing. We certainly hope to have some more things to announce in the next couple of months. But we're also spending a lot of effort trying to make that we get Android into the channel, and we get the channel business to really pickup as much as possible so we can get the run-rate of high margin deals there. Brian P. Drab - William Blair & Co. LLC: Okay. Joachim Heel - Senior Vice President- Global Sales : And perhaps the only thing I would add just to emphasize what Anders said. Large deals with larger customers are nothing new and different. What's happening here is, discontinuity of operating systems is creating an opportunity for us to take share. And I think that's what we've been very successful at in the last year, and we see an opportunity to continue to do that as this migration cycle continues, and the large deals will be the most prominent ones where this manifests itself. Operator : And our next question comes from James Faucette from Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. I had a couple of follow-up questions. First, in terms of the European performance in the quarter, you indicated that it was kind of a difficult comparison, or at least last year you saw growth, whereas this year you looked at there was more normal seasonality. I'm just wondering, if you have any sense for how much price changes in that market may have impacted – may have impacted the demand there, and getting a sense for your view of price elasticity there? And then also, in a similar vein is if the currency remains weak there, or to weaken further, do you think that you'd be moved to make additional pricing adjustments? And at what point are you able, or will you be unable to make continued pricing adjustments there based on competitors? And then my last question, was kind of a follow-up to the question – the previous question, just on large deals. Did – at the time the large deals were announced last quarter, you talked about follow-on sales and the like, and I would imagine those probably take time. But I'm just wondering if we're getting any incremental indications of follow-on deals, either of people trying to emulate solutions that were put in place, or did those customers themselves are preparing to come back and buy? Thank you very much. Anders Gustafsson - Chief Executive Officer & Director: Just quickly, what was the first one again. To make sure I answer the right ones in the right order. James E. Faucette - Morgan Stanley & Co. LLC: Sorry. Yes, yes. Sorry. Just asking if the pricing changes in Europe exacerbated any seasonality in that market? Anders Gustafsson - Chief Executive Officer & Director: So, yeah, to the best of our analysis, we don't believe that the price increase has had any negative impact on volume. We don't think that we lost business because of that. If there was one possible thing, there will be that some of our partners stacked up a bit more in Q2 and it took them a little longer to burn off that inventory – bought stuff before the price increase, basically, and it took long to burned that off, but now we started to see good improvement in margin based on this. And we said it, from Q4 now, where we think we are basically gone through all the possible changes from Q2. We expect to see an annualized margin benefit of $25 million to $30 million based on that price increase. Now, you also asked, I think, the next question about so what happens if foreign exchange continues to deteriorate? And it's obviously hard to answer that in an abstract, because we raised our prices in May or April by 12%, but that was also done in conjuncture with many of our competitors. So, many other technology companies did something similar. I think it's hard for us to by ourselves go out and do something like this, but we obviously keep all our tools available for us and we have the ability to raise prices more, we also have the ability to be more restrictive with price concessions and other things to make sure that the price points are higher. A lot of our large deals are going to go through the channels, so they are bid on an individual basis, and when we bid them we always look at the gross margin and the profitability of that overall deal. So, there, we have a very immediate impact or ability to impact margins even in a deteriorating FX environment. And maybe, Joe, do you have any more comments on that? Joachim Heel - Senior Vice President- Global Sales : (47:21 – 47:41). James E. Faucette - Morgan Stanley & Co. LLC: Sorry, I think once again, somebody's mic is off. Joachim Heel - Senior Vice President- Global Sales : Yes. I'm sorry. That was mine. So, I was on the third point. The question was whether the large deals are beginning to lead to follow on sales in the medium and small categories, if I understood it correctly. And indeed, we are beginning to see this on the Android side in particular. If I look back to the beginning of this year, we can say that the vast majority of the deals if not all of them were ones where our direct sales force was driving, and leading the sale, they were all large in nature. As we now come towards the end of this year, we're seeing a much more significant portion of deals come without much of our intervention from the channel and the mix is including now a large proportion of these medium and small-sized deals, which we think is healthy and beneficial the way that such migrations typically evolve. Anders Gustafsson - Chief Executive Officer & Director: Maybe one example of one large deal that we won for mobile computing some other products and services that we have been able to sell to them now include wearable devices, which are very high margin, a lot more services, which we also have a very sticky and – or with us for a long time. We also now understand that they have started to offer some of their customers Zebra printers, which they didn't do before. And we're in talking to them about other more longer range newer type of solutions. So, clearly we now have gone from being somebody who was kind of on the outside, to have a chance maybe to bid on a RFQ at times to somebody they think of as a trusted advisor, a technology partner and come to us to seek our thoughts and opinions about how we can best help them develop their technology portfolio? James E. Faucette - Morgan Stanley & Co. LLC: Great. Thanks. Dean Lindroth - VP-Finance & Investor Relations Contact : Next question, please. Operator : And our next question comes from Paul Coster from JPMorgan. Please go ahead. Paul J. Chung - JPMorgan Securities LLC : Thanks. This is Paul Chung on for Paul Coster. Thanks for taking my question. For the 80% win rate in retail, can you elaborate on the drivers behind these wins, besides the migration of the operating systems? Anders Gustafsson - Chief Executive Officer & Director: Yes. These were specific to wins against consumer devices. Now in the prior calls we've had some concern by investors that the consumer devices are going to encroach on our space. And I think is fair to say that back in 2011, 2012 or so when consumer devices first appeared on our radar screen, we were caught maybe a little flat-footed; we didn't really have any devices that could compete with them. Now, we have a very compelling portfolio of new devices that are – have all touchscreens, they're ruggedized, but they have modern operating systems. So they feel much more like the traditional phones, and our customers' users are able to much more quickly get comfortable and use those, but they are purpose built for the use cases of our customers. So with those devices, we now have something where we can compete, and we're winning probably more than our fair share of those devices, but is really driven by new innovative products that we've been able to launch. Joachim Heel - Senior Vice President- Global Sales : I would add, Joe Heel speaking again, that over the last roughly three years there have been many customers who have tried and experimented with consumer devices in the application in the Enterprise. And as they have made their experiences, we have been able to now win a lot of these deals based on the Enterprise-grade features of our devices, in addition to the adaptation of the form factor that Anders mentioned and the functionality. So things like battery life, stability of operating system, ruggedness, some are key factors that are helping us to win these deals. Paul J. Chung - JPMorgan Securities LLC : Okay. Thanks. And what kind of visibility do you have with large deals in the pipeline in the next 6 to 12 months? Joachim Heel - Senior Vice President- Global Sales : Joe Heel, again. We are very confident about our ability to continue to drive large deals. And also to supplement them with the medium and small-sized deals to really build out a pipeline that is very balanced. But we feel strong about the large deals. Paul J. Chung - JPMorgan Securities LLC : And then, I don't know if you mentioned it or, what was your 2015 CapEx guidance and are you giving guidance for 2016 and 2017? Michael C. Smiley - Chief Financial Officer : Yeah. We're not giving guidance for 2016, at this point. The CapEx for 2015, I would expect the fourth quarter to be a little bit softer than the third quarter, but not dramatically different. Paul J. Chung - JPMorgan Securities LLC : Okay. Thanks, guys. Operator : And our next question comes from Matthew Gall from Barrington Research. Please go ahead. Matthew Gall - Barrington Research Associates, Inc.: Good morning. Thank you for taking my questions. A lot of the topics that have been asked, to review as far as OpEx synergies and things like that on follow-up. But maybe just from a broader scale, there's been some new product launch announcements recently, and you're expressing some larger mobile computing deals that are in the pipeline. But if you could just touch on maybe some of the new product launches like the ET50, ET55 tablets, where you're seeing some success there? And then as we look out, kind of a cadence of new product launches, both within mobile computing, and then maybe along some of the other data capture or printing lines as well for hardware? Anders Gustafsson - Chief Executive Officer & Director: Yeah. So I'll start on the tablet side here. We won't talk about new products that we haven't launched yet, because we want to do that kind of properly in the markets. But on the tablet side, we see a lot of our customers use tablets in different form factors and we felt that there was an opportunity for us to have a presence, a bigger presence than we had before. And it's one where we feel that having that broader portfolio will also position us better to be able to win the entire fleet of products that they have. Early indications from the launch, which is only about a month back now I think, has been very positive. I'm not sure we have any big announcements to make quite yet, but we feel good about where we are after a month. And Joe has some further comments here. Matthew Gall - Barrington Research Associates, Inc.: Okay. Joachim Heel - Senior Vice President- Global Sales : Yeah. We have some very nice deals that are coming together on our new ET50 and ET55 tablets. We're excited about this product from two perspectives. On the one hand, this is the one area where consumer products had made some inroads and we didn't have a product to properly counter them, which we now have. And our customers have been very eager to have a product that meets those same enterprise grade specifications that we have in our handheld devices that we can now bring to the tablet market. So we feel that both from an offensive and defensive perspective, this is really a terrific product for us to have in the market, and we have some early successes that we're quite proud of. Matthew Gall - Barrington Research Associates, Inc.: Great. Thanks for providing more color on that. And then, I know you may be touched it on the opening remarks, but as far as the rebranding efforts, where are you on that and is it moving as expected? And then, as far as any of the costs associated with that, is there a guideline of maybe when that should flow through the P&L and we should see the rebranding costs be removed from the P&L? Anders Gustafsson - Chief Executive Officer & Director: So, at the end of this year, we expect that the majority of the rebranding should be done. There is a long tail though, so they will continue to stay with us for 2016, but from an intensity of the effort,. 2015 is really where most of these things happen. So, for Q4 I think we have a slightly, that we have a bit more rebranding expense in our forecast than we had in Q3. So that's one kind of miscellaneous item that's hitting the Q4 gross margin that we saw last time in Q3? Michael C. Smiley - Chief Financial Officer : Yes, but to Anders' point, it's not a huge number for the fourth quarter, but it is a little bit of a headwind. Matthew Gall - Barrington Research Associates, Inc.: Okay. Thank you very much, guys. Dean Lindroth - VP-Finance & Investor Relations Contact : Take a next question, please. Operator : And our next question comes from Jason Rodgers from Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Good morning. Anders Gustafsson - Chief Executive Officer & Director: Good morning. Jason A. Rodgers - Great Lakes Review : Just to follow up on the large mobile deals, I wondered if you're seeing any change in competition – when you compete against those deals, if you're seeing other companies introduce more Android-based devices? As well as if the pricing on these large deals has changed, if you've actually walked away from any, just because the pricing didn't make sense? Thanks. Anders Gustafsson - Chief Executive Officer & Director: Yeah. First the competition for this large deal is by-and-large the same as for mid-sized deals, the competition is probably more determined based on the vertical. So, if you're competing in retail versus manufacturing, you probably have some more differences there, but we tend to see our traditional competitors, but we also see some consumer grade competitors as well, and some lower price or lower quality competitors from Asia, China and Korea particularly. So, it is a largely the same group of people. I think we have a pretty good understanding of their offerings and how to compete against them. We feel we are certainly holding our own and I would say this year, we've been gaining share in the new wins, both on the larger deals and the more normal run rate business. The pricing environment seems to be consistent with what we've seen historically. So, as we mentioned on the call, the margins we see on our large – on large deals for Windows based devices is actually the similar or the same as the margin we see on large deals for Android devices also. So, I don't think that we see a big difference in that area. Joe, any further comments? Joachim Heel - Senior Vice President- Global Sales : No. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : And we do have a follow-up question from Holden Lewis from Oppenheimer, please go ahead. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Thank you. On the pricing, just so I understand, you said that the impact of pricing could be $25 million to $30 million. Is that the sales impact, is that a profit impact? What number is that? Anders Gustafsson - Chief Executive Officer & Director: So that – say if we raised the prices by $25 million to $30 million annualized, there is no cost associated with that. So, basically you get the revenue, but it flows straight through to the bottom line. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. And then, if that is an annualized full-year number, can you tell me how much you're realizing in Q3 and for full year 2015, so we have a sense of what the incremental impact will be next year? Anders Gustafsson - Chief Executive Officer & Director: Yeah. I think we expect that we will be – basically in the run rate now for this in Q4, so you can take basically a quarter of that for the fourth quarter. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. So you don't think that you realized much of that in Q3 at all? Anders Gustafsson - Chief Executive Officer & Director: We did realize some of that in Q3, not the full run rate, but we realized some of that. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. So $7 million give or take in Q4, and some smaller number than that in Q3, and then the rest will be realized incrementally next year? Anders Gustafsson - Chief Executive Officer & Director: That's correct. That's how we think about it. Holden Lewis - Oppenheimer & Co., Inc. (Broker): Okay. Great. Thank you. Anders Gustafsson - Chief Executive Officer & Director: Thank you. Operator : And we have no further questions. I will now turn the call back over to Dean Lindroth for closing comments. Dean Lindroth - VP-Finance & Investor Relations Contact : Okay. Thank you. Thank you, everyone, for joining us today. That concludes our call. Operator : Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,016
| 1
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2016Q1
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2015Q4
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2016-02-25
| 5.082
| 5.3
| 6.325
| 6.26
| null | 11.95
| 11.21
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Executives: Mike Steele - Vice President, Investor Relations Anders Gustafsson - Chief Executive Officer & Director Michael C. Smiley - Chief Financial Officer Joachim Heel - Senior Vice President-Global Sales Analysts : Richard Eastman - Robert W. Baird & Co., Inc. (Broker) Saliq Jamil Khan - Imperial Capital LLC Jason A. Rodgers - Great Lakes Review James E. Faucette - Morgan Stanley & Co. LLC Keith Housum - Northcoast Research Partners LLC Josh Berman - William Blair & Co. LLC Paul J. Chung - JPMorgan Securities LLC Operator : Good morning, and welcome to the Zebra Technologies Fourth Quarter and Full Year 2015 Results Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, VP, Investor Relations. Please go ahead. Mike Steele - Vice President, Investor Relations : Good morning and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Mike Smiley, our Chief Financial Officer. Anders will begin by discussing our 2015 accomplishments. Mike will then provide more detail on the financials and introduced our 2016 outlook. Anders will conclude with an overview of our strategic priorities in 2016 and elaborate on our outlook. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures, as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release. In addition, year-over-year sales growth references for Enterprise, which was acquired in October 2014 and for total Zebra, will be on an estimated historical basis. Now, I'll turn over the call to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike, and we're excited to have you on the team. Good morning, everyone, and thank you for joining us. I am pleased to report fourth quarter sales and non-GAAP EPS in line with our guidance. For the quarter, we reported sales of $956 million adjusted for purchase accounting, reflecting 4% year-over-year constant currency growth, and non-GAAP EPS of $1.51. After completing our first full year with the acquired Enterprise business, we delivered 2015 sales growth of 8% on a constant currency basis and adjusted EBITDA margin of 16.6%. This transformative combination has positioned Zebra as the global leader in Enterprise Asset Intelligence. This means delivering visibility solutions to help companies improve productivity and deliver better experiences for their customers. Our solutions enable our customers to sense, analyze and act. With sensing, we enable real-time operational visibility into people and things, such as : packages moving through the supply chain; merchandise in a store; workflows in a medical facility; analyzing this operational data, which can include status, condition, and location, results in actionable insights. This gives our customers the ability to make smarter decisions and act on those insights anytime and anywhere. Zebra's deep expertise and portfolio of innovative solutions have enabled us to be a strategic and trusted advisor to leading Enterprise customers and partners. Our breadth and depth of products, services and technologies is unmatched in the industry. In short, as One Zebra we are well positioned for success. On slide five, you will see the solid progress we made last year against our four strategic priorities. We have delivered profitable growth, our first strategic priority, by capitalizing on secular growth trends through innovative solutions, solid execution, and cross-selling opportunities. As I mentioned, we finished a very successful year with total company sales growing 8% on a comparable constant currency basis. This includes 13% legacy Zebra growth and 5% growth for Enterprise. Sales of mobile computers, printers and scanners were particularly strong as we extended our global market leadership in these product categories. With Enterprise now part of Zebra, 2015 was the first year in which organic Enterprise sales have grown since 2011. In services and wireless LAN, sales were lower than a year ago. We are focused on improving execution, launching new products, and developing our sales pipelines. In our overall business, solid growth in North America, EMEA and Asia-Pacific, more than offset weakness in Latin America, especially Brazil. From a vertical markets perspective, we saw strong sales growth in retail, transportation and logistics, and healthcare. Our customers continue to invest in technology to improve efficiencies and in turn profitability, a trend that benefits Zebra in both good times and bad. For example, we improved our win rate against consumer mobile devices in 2015 as customers realized the inherent advantages of our devices that can be tailored to specific work environments. We saw 150% growth in Android-powered devices as our broad offering resonated with customers' needs. We have also made great progress on our second strategic priority of realizing cost synergies. We realized approximately $130 million in the full-year 2015 and remain on track to achieve $200 million of annualized cost synergies from the Enterprise acquisition by the end of 2016. We saw most of this benefit in operating expenses as we integrated and rationalized our sales, marketing and engineering teams. Our third strategic priority has been to delever our balance sheet. We are pleased to report the pay down of $165 million of debt associated with the acquisition in 2015. We are on track to decrease our financial leverage to less than three times net debt to adjusted EBITDA by the end of 2017. And finally, our fourth priority has been to operate effectively as One Zebra. Today, our customers consider us a more strategic partner. Our ability to provide solutions to meet our customers' long-term business objectives will further enable us to deliver the full value of the combined business. As an example, we won the business of a leading national food and beverage company through our Better Together value proposition, displacing a major competitor. We were able to leverage the strength of our printer solutions to subsequently secure their mobile computing business with our TC70 Android device and provide services to help them transition their legacy applications. Regarding our integration work, we are pleased with the progress we have made. However, we still have more work to do. To-date, we have unified our organizational structure and have begun to establish a strong common Zebra culture. We have migrated and consolidated engineering systems, implemented sales tools, rebranded the company and reduced a number of real estate sites. Turning now to the fourth quarter highlights on slide six. As I mentioned, sales of $956 million for the quarter translated to 4% growth in constant currency; continued strength in North America and Asia Pacific more than offset softness in EMEA and a decline in Latin America. The underperformance of EMEA was primarily driven by macro factors, with particular weakness in Russia, Turkey, France and the Middle East. However, we saw solid demand in Germany and the UK. Asia Pacific growth continued to be propelled by the business in China. From a product perspective, sales were higher in mobile computing. Larger companies continued to be early adopters of Android. This is laying the foundation for our run rate business, as smaller customers who have traditionally been served by our channel partners determine how they will transition to next-generation operating systems. Both data capture and printing performed well in the fourth quarter. The strength within our data capture business was broad-based and continued to be bolstered by 2D imaging. The printing business continued to be a strong performer in all product categories with notable growth in mobile printing and the Link-OS software platform for device management. We had a strong fourth quarter adjusted EBITDA margin of 17.3%. We continue to balance investments for growth with prudent expense control, while realizing acquisition cost synergies. With this continued focus, we are confident in our ability to further expand margins over time. With that, I'll turn the call over to our CFO, Mike Smiley to review our financial results in more detail, our integration progress, and to introduce our 2016 outlook. Michael C. Smiley - Chief Financial Officer : Thanks, Anders. Before I discuss fourth quarter results shown on slide seven, I would like to remind you that we completed our acquisition of Motorola's Enterprise business on October 27, 2014. As a result with the exception of certain sales growth references, 2014 information reflects the financial results for the Enterprise business for the last two months of the year. Total GAAP sales for the fourth quarter were $953 million. Excluding the impact of purchase accounting, total sales for the fourth quarter were $956 million. Enterprise sales excluding purchase accounting adjustments were $636 million, up 2% year-over-year on a constant currency basis, inclusive of estimated 2014 Enterprise sales. Data capture and mobile computing sales grew and sales of wireless LAN and services declined. Pre-transaction Zebra sales were $321 million, up 7% in constant currency. Demand remains strongest in retail and transportation logistics verticals. Momentum in healthcare also continues to grow. Top growth drivers again include e-commerce, mobility, share gains associated with the OS migration in mobile computing, the transition from scanning to 2D imaging in data capture and the continuing refresh cycle in printing. From a regional perspective, on a comparable basis, sales in North America grew 7%. We experienced the strongest growth in the data capture business. Mobile computing continued to be driven by strong growth in our Android portfolio. Printing, tabletop and mobile computers were out performers. EMEA continued to experience softness and was up 1% from a year ago on a constant currency basis. Scanning and printing sales grew, offset by lower mobile computing sales. Sales in Asia-Pacific grew 9%. The region continued to be led by strong performance in China. Growth in mobile computers were driven by retail and transportation logistics both supported by trends in e-commerce. The printing business also performed well with mobile printers posting very strong growth. In Latin America, sales declined 12% as a result of a difficult macroeconomic environment. The region experienced growth in printing but currency devaluations continued to drive local currency prices higher, adversely impacting the overall demand environment. The region is stabilizing and we remain focused on pursuing selective opportunities and improving demand generation. GAAP gross margin for the quarter was 44.9%. Excluding the impact of purchase accounting, gross margin was 45.1%, consistent with our guidance. Normalized for currency, gross margin was comparable to third quarter 2015 gross margin of 45.5%. Enterprise gross margin of 42.3% was down slightly compared to the third quarter. Improved services margin resulting from operational efficiencies was offset by the impact of a large mobile computing deal and currency changes. Pre-transaction Zebra gross margin was 50.7% compared to 49.7% in the fourth quarter of 2014. The impact of currency has been offset by lower product sales in hardware and supplies, the price increase in Europe and the benefits of our hedging program. Operating expenses for sales and marketing, R&D and G&A, were $291 million, including $6 million of stock-based compensation expense. Operating expenses were favorable to our prior outlook, due to good expense control and lower stock-based compensation expense. Other operating expenses include acquisition and integration and exit and restructuring costs of $54 million and amortization of intangible assets of $61 million. In the quarter, the net loss per share on a GAAP basis was $0.13. Non-GAAP earnings per diluted share were $1.51 compared to $1.22 in the fourth quarter of 2014. Adjusted EBITDA increased 14% year-over-year to $165 million, or 17.3% of sales. Turning now to the balance sheet and cash flow highlights on slide eight. We ended the year with $192 million in cash, which includes $166 million held outside the United States. In the full year 2015, cash was negatively impacted by significant integration costs associated with the Enterprise acquisition. This includes $51 million of working capital settlement payments to Motorola Solutions associated with the acquisition and $34 million of real estate capital expenditures primarily related to the build out of a leased facility to accommodate our Illinois-based employees. As of year-end, we had $3 billion of long-term debt consisting of $1 billion of senior notes due in 2022 and a$2 billion term loan maturing in 2021. The debt was used to finance the October 2014 Enterprise acquisition and we've been paying it down aggressively. With $165 million in total principal payments in 2015, yearend net debt-to-adjusted EBITDA ratio was approximately 4.7 times. Subsequent to the end of the year, we made an additional $80 million in debt payments. For the full-year 2015, we generated $103 million of cash flow from operations and made capital expenditures of $114 million. In 2016, we expect a significant improvement in free cash flow primarily driven by sales growth and EBITDA expansion, approximately $90 million to $100 million less integration and restructuring costs, at least $75 million improvement in working capital as well as approximately $30 million lower non-integration-related capital expenditures. We also expect to reduce our minimum target operating cash level by approximately $50 million. As a result, we are confident in our ability to reduce debt by at least $300 million this year. Roughly one-quarter of our total company sales are denominated in euros. Given continuing elevated levels of currency fluctuations, we have been evaluating the options to cost effectively mitigate earnings and cash flow volatility associated with foreign exchange rates. As a result of that review in January, we implemented a hedge of approximately 80% of Zebra's net euro cash flow exposure for the entire year effectively locking in $1.09 euro rate. Finally, in light of the external focus over uncertainties on the macroeconomic environment, I'd like to point out that our liquidity levels are solid. We have no near-term debt maturities and an untapped $250 million revolving credit facility with no financial covenants triggered on our long-term debt unless we draw down more than $50 million. Before moving on to our guidance, I want to review our acquisition synergy program on slide nine. As we discussed last quarter, we have a stated goal to achieve $200 million of cost synergies on a run rate basis by the end of 2016. In 2015, we recognized significant synergy benefits and improved our operating leverage from a combination of organizational realignment, real estate consolidations, and other cost reductions. We realized approximately $130 million in cost synergies in 2015. We expect our P&L to benefit from realizing an incremental $50 million in cost synergies during 2016, $30 million of which will improve our gross margin and $20 million to reduce operating expenses. Finally, for 2017, we anticipate realizing an incremental $20 million of gross margin synergy benefits after reaching full run rate benefit as of the end of 2016. We are very pleased with the integration efforts thus far. As we said in the past, given the size and scope of the transaction, the integration of the IT systems is very complex. Modernizing, simplifying and integrating these systems into Zebra's IT network will increase efficiency and meet the demands of our growing business. It will also enable us to conclude our transition service agreements with Motorola Solutions. Consistent with our prior outlook, the rationalization and modernization of Zebra's IT platform and ecosystem will result in a remaining $130 million to $150 million of integration-related costs over the next two years, of which approximately 20% will be in the form of capital expenditures. We expect the vast majority, or roughly 80% of the remaining, total integration cost to be incurred this year. The expense portion of these costs are one-time in nature and will be excluded from our non-GAAP P&L results. These efforts are expected to drive additional operating expense efficiencies and reduce our ongoing capital expenditures once completed. I will now review our 2016 outlook, and in a few minutes, Anders will provide further perspective. Given the quarter to quarter volatility of our business, in addition to the quarterly outlook, we are providing an annual outlook to provide a longer-term view of our business. On slide 11, you will see that for the first quarter we expect net sales excluding purchase accounting adjustments to be flat to down 3% from the comparable net sales of $899 million in the first quarter of 2015. This expectation reflects a range of a negative 1% decline to positive 2% growth on a constant currency basis. First quarter 2016 adjusted EBITDA margin, expect to be in the range of 16% to 17%. Non-GAAP earnings are expected to be in the range of $1.19 to $1.34 per share. Compared to the first quarter 2015, this outlook reflects growth in Asia Pacific and EMEA, offset by a decline in North America. While North America remained strong in the fourth quarter, we did experience some softening in December, as a typical benefit we receive from the year-end budget flush was not as significant as in past years. This softening was driven by a cautious tone around capital spending, resulting in a lower backlog as we entered the first quarter. In addition, we had an exceptionally strong first quarter of last year with North America sales growth of 13% year-over-year, resulting in a challenging comparison for the first quarter of 2016. Our outlook also reflects a lower gross margin as compared to the first quarter of 2015 primarily due to a negative FX impact and changes in product mix. However, the gross margin should be higher than the fourth quarter. Operating expenses are expected to be flat to slightly lower than the prior year period. For the full-year, the company expects net sales excluding purchase accounting adjustments to grow 1% to 4% from the comparable net sales of $3.7 billion for the full-year 2015. This reflects an expectation of year-over-year growth of 2% to 5% on a constant currency basis. Adjusted EBITDA margin is expected to be in the range of 17% to 18% for the full-year 2016 driven primarily by a higher gross margin and improved operating expense leverage compared to 2015. For the full-year 2016, we have also assumed the following shown on slide 12 (sic) [slide 11]. We expect capital expenditures of $70 million to $75 million including $15 million to $20 million related to acquisition and integration; depreciation and amortization expense of $310 million to $315 million; interest expense of $195 million to $200 million including amortization of debt issuance cost of $18 million to $20 million; share-based compensation expense of $33 million to $35 million, and non-GAAP tax rate of approximately 22% to 24%, and cash taxes of approximately $50 million to $60 million. I'll now turn the call back to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. As we kick off 2016, we remain focused on extending our leadership within Enterprise Asset Intelligence by executing on our four strategic priorities shown here on slide 12. I am confident that we can continue to deliver profitable growth for the full-year 2016, as we capitalize on secular growth trends and prudently manage our cost structure. This confidence is supported by customers in all verticals, recognizing the importance of technology in achieving their long-term strategic goals. We believe this focus will continue to be critical for customers, whether they are investing for growth or looking to streamline their operations and improve efficiencies. As we drive solutions-based selling, you can leverage our expertise and expand our share in key verticals such as healthcare as investments by customers within this vertical continue to accelerate. The dynamics of the retail industry, our largest vertical historically, are evolving as e-commerce and omni-channel are now top priorities. These initiatives require retailers to meet shoppers' growing expectations and provide product when, where, and how customers want it. This in turn requires further investments in technology to receive accurate and timely data on inventory availability. As e-commerce plays an increasingly more vital role in their businesses, Zebra is a trusted partner helping them with the tools to drive productivity and efficiencies. As a related benefit to the evolution of retail, we are in a position to benefit from the extension of this trend in T&L, as the increased number of packages from retailers to consumers drives the need for additional investments in technology by package delivery companies. We feel very optimistic about the opportunities today and in the future within retail and T&L. We are excited about our healthy pipeline of innovative products and solutions. For example, we launched our new mobile computer, the TC8000, which enables users to be 14% more productive through improved ergonomics and versatile capabilities. In addition, our new cartridge-based tabletop printer, the ZD420, has an ultra-compact design and provides Zebra an annuity revenue stream of aftermarket supplies. These high-margin high-volume products demonstrate our ability to build on well-established staples within our portfolio and reinvent them to meet the changing needs of our customers. Both products contributed to very strong customer engagement and heavy booth traffic at the National Retail Federation tradeshow last month. In 2016, we are also investing in Windows 10 solutions, as legacy Windows Mobile operating systems are expected to go end-of-life by 2020. In our services business, we strengthened the leadership team and made changes that will make us more competitive and support meaningful improvements in 2016. For example, we are starting to benefit from increased attached and renewal rates on our product support plans. As we move forward and maintain our focus on increasing efficiencies, cost reductions and pricing, we expect to drive margin expansion in services. While we continue to invest in R&D to further extend our leadership position, we will also maintain prudent management of our cost structure, as we further improve operating expense leverage. As Mike discussed in detail earlier, we expect to realize $50 million of incremental cost synergies in 2016, the majority of which will positively impact gross margin. Another top priority for us is to improve free cash flow in 2016 and 2017 and delever the balance sheet. Lastly, we will continue to make meaningful progress on our transition to One Zebra as we execute the remaining steps of our integration and leverage the Zebra brand. Our teams are performing extensive IT systems integration work including the start of our ERP system transition next quarter. We have the appropriate expertise and resources to execute well through the 2017 integration timeline. In addition, a key customer facing initiative is the implementation of our new channel partner program. This program is scheduled for a second quarter launch, which will simplify program administration for our partners, align our goals with theirs and ultimately enable growth for Zebra and our partners. And now, I would like to offer an additional perspective on our 2016 sales and EBITDA outlook. For the full year 2016, we are expecting sales growth of 2% to 5% on a constant currency basis. While our annual guidance does assume some continued headwinds from a macro perspective, we are not anticipating a meaningful change in the environment. As we have indicated for the first quarter, we are expecting approximately flat sales year-over-year on a constant currency basis due to lower sales in North America. However, we had a healthy global pipeline in our core markets and consistent expectation of growth from across our reseller network. In North America, we expect growth beginning in the second quarter and through the end of 2016. We expect the strongest growth this year in Asia-Pacific, driven by ongoing momentum in China and India, particularly in retail and T&L. In EMEA, we expect continued solid growth in Germany and the UK, while Russia, Turkey and the Middle East will likely remain soft. Latin America is stabilizing and we could see some modest growth in the region. As a result for the full year, we feel confident in our expectation to continue to grow the business. With expanding margins, managing our overall cost structure and increasing working capital efficiencies, we will generate increased free cash flow and reduce leverage. In conclusion, our business is performing well. We are positioned for long-term success and are reiterating our long-term financial goals as shown on slide 13. We continue to see sales growth of at least 4% to 5% over a cycle, which is faster than the market rate of growth. We also expect to achieve adjusted EBITDA margin of 18% to 20% by the end of 2017 driven by growth, gross margin expansion, and operating margin leverage. This also assumes no material change to this recent global currency exchange environment. Finally, we expect to achieve net debt to adjusted EBITDA of less than three times by the end of 2017. This will be driven by a total of at least $650 million of debt pay-down over 2016 and 2017. And with that, I'll hand the call back to Mike Steele. Mike Steele - Vice President, Investor Relations : Thanks, Anders. We've reserved the balance of the call for Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator, please let our callers know how to ask a question. Operator : We will now begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. The first question comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Anders, as we look out to 2016 against your constant currency growth forecast of, what, 2% to 5%. Could you just speak to the product lines and where you'd expect that continued growth to come from, from mobile computing, printer, just kind of line them up relative to that LC growth rate? And then I have one follow-up. Anders Gustafsson - Chief Executive Officer & Director: Yes. First, we feel confident about the full year growth expectations that we have. We had a very strong 2015, and we built a lot of momentum across the business there. Our portfolio did very well in 2015. We gained share in most of our product lines globally. Three of our four regions had solid growth. We launched some new products in the beginning of 2016 that we are very excited about. The TC8000 is a great example of new – one of our highest running products that we reinvented in a new fashion. We got great feedback on that product at the NRF and since. We also launched a new tabletop printer. That's the highest volume of our printer portfolio, which has also a cartridge-based model, so you can make it very easy for customers to load ribbons and that drives an annuity-based revenue stream for us. And as the year goes on, we have a number of other attractive new product releases. But our pipeline is very healthy. We have a very detailed approach to build up the pipeline. It's both based on individual customer accounts but also looking at product and so far we feel that we have a very solid outlook for the year. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Okay. And then just one last question as a follow-up. There has been a number of additions here to the marketing team, to the global marketing team. And all of which are right in front of the channel program adjustments that you are going to put in place in the second quarter. Could you just, kind of, walk through the structure there? And maybe what the additions are intended to accomplish? Anders Gustafsson - Chief Executive Officer & Director: Yes. We announced, I think it was early this week, right, that Jeff Schmitz would become our new Senior Vice President and Chief Marketing Officer. So he will lead the overall marketing organization. So he joined us on Monday officially. He also visited with us at one of our sales kickoff meetings to get a good view of what the entire business looks like. We are very excited to have Jeff on board. We think he will be a great addition to our team. Under Jeff he has a number of different functions. One of those is a channel operations team. So that channel operations team is the one that really own, developing the channel program and make sure we work with the regions to launch it effectively into each of the regions. So Jeff has the team that owns the development and implementation of the new channel program, but clearly they also work very closely with the regional sales teams to make sure that the region is ready to engage with the partners and be off to a good start. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Okay. Thank you very much. Anders Gustafsson - Chief Executive Officer & Director: Yes. Operator : The next question comes from Saliq Khan of Imperial Capital. Please go ahead. Saliq Jamil Khan - Imperial Capital LLC : Thank you, all. Hi, Anders. Hi, Mike. Anders Gustafsson - Chief Executive Officer & Director: Hey. Michael C. Smiley - Chief Financial Officer : Hey. Saliq Jamil Khan - Imperial Capital LLC : Hi, guys. As I take a look at the overall product portfolio and the changes that you've made to it, you certainly brought a lot of sleekness and changed the ergonomics to altogether bring about a lot more ease to the end customer. However, if I take a look at what your competitors are doing and I take a look at your product portfolio, are you merely trying to keep up with them or are you trying to find a way to go ahead and become a lot more competitive, take customers away from them and increase theoretically your market share? Anders Gustafsson - Chief Executive Officer & Director: Well, so if you look at our performance in 2015, we gained market share in most of our large product lines. We believe that we have a more competitive product lineup. We take great pride of the strength of our products and the innovation of our products. As we look into 2016, there is a lot of new, very attractive, you can say, extensions of existing products, but also some new product concepts that we are very excited about. So we are very dependent on having a vibrant product portfolio in order to demonstrate value to our customers and we feel that the portfolio we have should enable us to continue to gain market share and extend our leadership position in the industry. Saliq Jamil Khan - Imperial Capital LLC : As my follow-up, what you just noted is including with the fact that the business operations, the integration and the rebranding initiatives that you've been working on throughout 2015 and it was very evident at the NRF conference as well, how does this improve your overall sales cycle and how does it help you go ahead and have a more deeper and more of an integrated conversation with your end customer? Anders Gustafsson - Chief Executive Officer & Director: Yes, I'll start and then I'll let Joe Heel also add to this. So I'd say when we talk to our customers, we hear two themes quite regularly : one, they feel that the combined business, the combined Zebra and Enterprise business is more strategic to our customers. They see that the lineup we have now, the capability and competencies we have now and the vision we have make us a more strategic partner to them and they tend to invite us in to be part of their more long-ranging plans to make sure that we can develop the right solutions for their needs. The other thing they have been saying goes more to your point about rebranding that from their perspective the integration has been quite seamless. They haven't seen a lot of challenges from the integrational missteps in the integration. They feel that we have actually been handling this quite well. So both of those things, I think, are making us a much stronger partner with our customers and have access to more of their longer-term thinking. And, maybe, Joe, you have some more thoughts. Joachim Heel - Senior Vice President- Global Sales : Yes. From a sales perspective, we see the benefits in many areas, but three that I would perhaps call out : the first is the confidence that the new brand and the new presence gives our customers is really essential to driving changes like our largest single opportunity around operating system migration. That's what customers need. They need that confidence to interact with us and we're projecting that now and we're seeing that with our customers. They have that confidence, as Anders was saying, to elect us to be a strategic partner for them. The second is that the customers are feeling the Better Together that we're bringing to them. The fact that we can bring the full portfolio of our capabilities to them, Anders was mentioning one of our large package goods customers that elected to go with us for precisely that reason and we're seeing more-and-more of those opportunities. And the third one, and I am particularly excited about this, is our ability to bring solutions to the market, and customers are really believing that and seeing that now in some of the things that we're doing where we're solving their business problems and they have confidence that we can do that. Saliq Jamil Khan - Imperial Capital LLC : Thank you, guys. I look forward to speaking with you later on. Anders Gustafsson - Chief Executive Officer & Director: Thank you. Operator : The next question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Good morning. Anders Gustafsson - Chief Executive Officer & Director: Good morning. Michael C. Smiley - Chief Financial Officer : Good morning. Jason A. Rodgers - Great Lakes Review : Wondered if you could talk a little bit more about the ERP consolidation, if that's going as anticipated and if you expect to remain on track as far as ? Anders Gustafsson - Chief Executive Officer & Director: Yes. The ERP integration is going as per plan. We feel it is going well. We have a strong team of people who've been working on this for quite some time now and we have a robust product plan or project plan with lots and lots of detail behind it. So we track it on kind of hourly basis or daily basis as far as what progress and what deliverables we have. We are looking to implement the first phase of the ERP conversion in Q2 in Asia and then go live with the full global entity middle of 2017, so we get a chance to road test it and then add some additional functionality for the full-year roll out. So we get great benefits from this. We get a much more rationalized modern IT platform. What we've had so far has been a lot of disparate IT systems, which drives a lot of inefficiencies. So if you have to enter data on two systems or sometimes three systems and they don't transfer data between them very well, so this provides a much more robust and streamlined IT platform for us and that will drive also great cost benefits as we go into the future. Jason A. Rodgers - Great Lakes Review : And the follow-up, did any large mobile computing deals have an impact on the fourth quarter and what is the expectation for Q1? Anders Gustafsson - Chief Executive Officer & Director: So every quarter we have large deals. It would be bad if we didn't have large deals every quarter. So we had large deals in fourth quarter. I wouldn't say that they were different from any other quarter particularly. Michael C. Smiley - Chief Financial Officer : Yes, this is Mike Smiley. I think one thing is actually our fourth quarter results are very comparable to the third quarter, excluding FX. So it was really in line with our guidance. The euro was basically Q3 about $1.11 versus $1.09 in the fourth quarter. Our service business had margin improvements offset by some of the large deals that Anders talked about and our legacy Zebra printing margins were flat sequentially. So, generally, the fourth quarter margins were really what we expected. Jason A. Rodgers - Great Lakes Review : Okay. Operator : Mr. Rodgers, do you have anything else? Jason A. Rodgers - Great Lakes Review : No. I'm just following up with that. So Q1 there is no major mobile deals out there that are larger than normal that might impact margins? Anders Gustafsson - Chief Executive Officer & Director: No. I think the outlook for Q1 is also for normal rate or normal volume of larger projects. There is nothing that sticks out that's particularly bigger than normal. But we have a good pipeline for large deals for the full year. Jason A. Rodgers - Great Lakes Review : Got it. Thank you. Operator : The next question comes from James Faucette of Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. Just a couple of questions for me. First, the strength in Motorola, I think, you've kind of mentioned this, but I wanted to make sure, is that from new products and are we expected to gain steam as we head into 2016? And then talking about specific geographies, obviously, we had a big pickup in results this quarter with a bit of a downtick in North America. And you kind of spoke to some of the dynamics there, but I'm wondering how much of that may be attributable to a couple of big customers or is there something I guess more broad-based and widespread? Thanks. Anders Gustafsson - Chief Executive Officer & Director: So the first question was around the strength of the Enterprise business and the second about the softness at the end of Q4. Is that right? James E. Faucette - Morgan Stanley & Co. LLC: Yes. That's right. Yes. Anders Gustafsson - Chief Executive Officer & Director: Yes. So the strength of the Enterprise business, I think, is it's multifaceted. We have worked hard on making sure we have a very competitive product lineup. Android has been a strong growth driver for us so far. We have by far the broadest portfolio of Android products of anybody in the industry and our win rate in Android is very high, higher than the overall win rate, say, it is for us across all operating systems. But I'd say it is more than product. I think the integration, the combination of our two companies have helped both sides. I think the Better Together story is very much resonating with customers. We have seen many examples where we mentioned one in the script here where printing led the way and got into new account first, but then we were able to pull in mobile computing afterwards. But we have many examples of where we've done the other way. So part of the growth is the Better Together and I'd say also we have executed well. We have improved on our services performance, which was a bit of a drag before and I would say the culture of the combined company is good. I don't hear much talk about say us versus them and things like that. It's very much we're all in this to try to make the company as successful as we can. I'll let Joe expand a little bit also. Joachim Heel - Senior Vice President- Global Sales : Well, I might support what Anders is saying in terms of the strength of the Enterprise business with two specific points : one, I already touched earlier on the subject of the OS migration, which is really where we have a leadership position and where we've been successful in 2015 and we see that continuing here in the first quarter as we are driving that migration from legacy Windows operating systems to Android and to a certain extent also on to Windows; and the second one, as we saw really a broad strength in our scanning business as well. Our scanning business as you probably know is undergoing a transition in technology from 1D to 2D, and we've assumed a leadership position in that transition as well. And what's fundamental about that is that the Android transition is largely driven by large deals, whereas the scanning transition is also broad-based in the channel. So we're really seeing that strength on the Enterprise business in two dimensions. Anders Gustafsson - Chief Executive Officer & Director: Yes, maybe just to expand one more point on this. I think most of these comments were kind of North America centric, but if you look at the Enterprise business performance in 2015, the international markets were very strong. Asia was particularly strong and we had several large wins for mobile computing in Europe. So this is very much a diversified business like Zebra's legacy business where we have a broad portfolio of products, selling to a diversified set of vertical markets and geographically also very diversified. Joachim Heel - Senior Vice President- Global Sales : That scanning growth I was talking about. Anders Gustafsson - Chief Executive Officer & Director: Yes. Joachim Heel - Senior Vice President- Global Sales : Our biggest contribution came from China, for example. Anders Gustafsson - Chief Executive Officer & Director: Yes. Joachim Heel - Senior Vice President- Global Sales : So it is broad-based. Anders Gustafsson - Chief Executive Officer & Director: Broad-based, yes. James E. Faucette - Morgan Stanley & Co. LLC: And then as far as looking at North America and any weakness there, was that related to specific customers or was that more broad-based? Anders Gustafsson - Chief Executive Officer & Director: It was more broad-based. We talk about, say, budget flush that tends to be from many customers. Yes, there was more of, I think, a general cautiousness among our customers and they were I suspect looking at what was going on with their share prices and wondering what that was meaning for 2016 and being a little bit more cautious on capital spend. But it wasn't anything specific to any one customer or any large customer. James E. Faucette - Morgan Stanley & Co. LLC: And have you seen that persist early in the year? Anders Gustafsson - Chief Executive Officer & Director: I think the start of January is always a bit weak, and I think it was commensurate with normal seasonality. As we look at the guidance we gave for the full year also, we expect basically normal seasonal increases quarter-over-quarter for the year. So we aren't assuming that there will be some form of heroic recovery. This is just based on looking at the last five to seven years of how much of our revenues come in Q1 versus Q2, Q3, Q4 and looking at how that should play out. James E. Faucette - Morgan Stanley & Co. LLC: Thanks. Operator : The next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Guys, I was hoping to spend a little bit of time talking about the supplies and services. As I look at, perhaps, what we're expecting what you guys have done in quarters past, it looks like both of those have lagged a little bit here in the fourth quarter. What's your expectations for, I guess, your thoughts going into FY 2016? Anders Gustafsson - Chief Executive Officer & Director: So services is an area that we have spent a lot of effort to strengthen. We believe services should be a good growth driver for the business. We brought in some extra leadership, some new leadership in the business to augment the team we had and so we could have more focus on both driving the sales side but also driving the operational side. We made I think great improvements in our execution. The customer-facing performance of break, fix, repair, return statistics are much better than they were when we first assumed the business. We've reduced the cost basis for most of these services and we've seen an increase in attach rates for new services. So we feel quite good about where we are and we feel confident that we should see good growth in 2016 from services. And I'd like Joe to add on that too. Joachim Heel - Senior Vice President- Global Sales : Yeah. From a sales perspective, of course you know that services is one of those that benefits from bookings that then deliver revenues over a longer period of time. And so what we've been very focused on and I think successful with in 2015 is on the support side increasing our attach and renewal rates, those will deliver increasing revenues this year. On the managed and professional services, increasing our bookings and we actually had an exceptional year in terms of increasing our bookings last year in managed and professional services, that continues here in Q1. And we've also been focused on migrating our managed and professional services to more higher value types of managed and professional services, ones where we have some unusual IP or unusual value added and that's been the focus of that, which will help us with the margins that we can deliver from those services in addition to the cost reductions that we're taking. I also wanted to make sure I heard you talk about services and supplies. Did I hear that correctly? Keith Housum - Northcoast Research Partners LLC : Yeah, absolutely. Supplies were down 8% in the quarter year-over-year? Anders Gustafsson - Chief Executive Officer & Director: So I think supplies now, for the year supplies was up, I think it was 8% in constant currency. In Q4, I don't know, I don't have that data off the top of my head here, but constant currency was a lot better, so supplies is more – has a higher proportion of supplies in Europe than we have for our normal products. So Europe is a very large part of our overall supplies business. Let me see if I can find the number here. Keith Housum - Northcoast Research Partners LLC : I can follow-up that offline. Anders Gustafsson - Chief Executive Officer & Director: Yes, we can follow-up offline. Joachim Heel - Senior Vice President- Global Sales : Yes, I didn't want to lump that in with services. Anders Gustafsson - Chief Executive Officer & Director: Yes. Keith Housum - Northcoast Research Partners LLC : Yeah. Anders Gustafsson - Chief Executive Officer & Director: Yeah, supplies.... Keith Housum - Northcoast Research Partners LLC : Yeah, I'll follow-up offline, that's fine. Michael C. Smiley - Chief Financial Officer : Supplies for the full-year by the way was up 1.2%... Joachim Heel - Senior Vice President- Global Sales : In nominal. Michael C. Smiley - Chief Financial Officer : ....nominal currency. Now by the way I would also argue that in – we have been seeing very strong growth in supplies. I think that in 2015 we recognize the benefit of wristband products that I think makes the 2015 to 2014 comp a little bit more difficult. Anders Gustafsson - Chief Executive Officer & Director: And profitability of supplies has gone up because we have in-sourced some more of our wristband manufacturing, so that we have seen a great improvement in margins. Keith Housum - Northcoast Research Partners LLC : Thank you. If I can just follow-up, I guess, on the previous question regarding some of the cautious commentary as you exited fourth quarter. As you look at the demand going into FY 2016, your expectations, I guess, that you're hearing from the customers regarding your large project, is there a hesitancy of people moving forward, or are anybody talking about deferring projects out in response to the macro demand? Anders Gustafsson - Chief Executive Officer & Director: So, at the high level, I'd say, we aren't expecting any material changes to the macro environment, to how our customers kind of behave. We get very good feedback, very encouraging feedback from our reseller communities. They certainly believe that 2016 should be a good year with good growth. I think the issues we saw in the end of Q4, beginning of Q1 were more isolated and we believe temporary in that it was more, I think, driven by people looking at the stock market and getting cautious about what that meant for the business and didn't want to lean in to the same extent, so budgets gets pushed out a bit. It takes a little longer for companies to hand out the operating budgets to – but once that happens, things go back to more normal we believe. And we have seen from end of last year some deals got pushed from Q4 into all of 2016. And some customers may have looked at some larger deals and instead of giving us one PO, they gave us one PO for P1 (sic) [Q1] and Q2 and so forth. But you should remember also that our value proposition is one that really works in good times and bad times. In good times, our customers are working with us to expand into new retail stores, new factories. In tougher times, they use our equipments to trade OpEx for CapEx. We have very short and well defined return on investment calculations. So, normally, our products are proven to have an ROI of less than, let's say, one year to upwards of maybe two years. And even in tougher times, companies tend to be comfortable with those types of paybacks. Joachim Heel - Senior Vice President- Global Sales : And one other thing that – or maybe two other things that give us a perspective on this cautiousness that we may have seen at the end of Q4 is number one, our pipelines for Q2 and the rest of the year are very strong. So that gives us a lot of good confidence. And also as we speak with our reseller partners, they reflect a lot of confidence to us in terms of the growth prospects that they see for the year. So that puts in perspective I think what we have seen. Keith Housum - Northcoast Research Partners LLC : Great. Thank you. Operator : The next question comes from Josh Berman of William Blair. Please go ahead. Josh Berman - William Blair & Co. LLC: Hi. Good morning. Joachim Heel - Senior Vice President- Global Sales : Good morning. Anders Gustafsson - Chief Executive Officer & Director: Good morning. Josh Berman - William Blair & Co. LLC: Just two quick ones, one, I know you gave some of the components that go into free cash flow, but I was wondering if there's a certain dollar amount you're targeting for 2016? Michael C. Smiley - Chief Financial Officer : You know, I think what we – again our goal is to pay down $300 million of debt. We're confident in our ability to do that. Again, we expect some improvement from our EBITDA margin expansion and just regular business growth. We also know that we have improvements in our working capital, which should drive at least $75 million of additional cash flow from what we had last year. We will have $90 million to $100 million less integration spend from 2015. We also have our CapEx that's not related to integration down by about $30 million. I think Anders mentioned the fact that we had some Illinois – some spending in Illinois to bring the facilities together for the two companies. We also expect to reduce our cash levels by about $50 million. So when you put it all together, we're very confident in reducing our debt by $300 million in 2016 and $350 million in 2017, again, to get our leverage below 3 times debt-to-EBITDA. Josh Berman - William Blair & Co. LLC: All right. And then switching topics, I was wondering if you could dive a little bit more into the Windows 10 opportunity? Maybe how big is that, especially relative to the Android transition? Anders Gustafsson - Chief Executive Officer & Director: So, first, there are no Windows 10 mobile products on the market at the moment. But I'll put it in context, maybe of what's more going on from an OS migration perspective. So, today, let's say, virtually all our customers, certainly most our customers are well aware of the need to migrate to newer, more modern operating systems. Android has been the primary beneficiary of this so far. And we were early investing in Android and so that is a great opportunity for us. Microsoft is planning on coming out with Windows 10 later on this year, and there will be some customers who believe – that are very loyal to Microsoft and would like us to have Microsoft 10. We have some Microsoft 8 products today, but which we will upgrade to 10 and then come up with some more products later on in the year, and we want to be basically operating system agnostic when we talk to our customers. We don't want them to feel that we are only supporting one operating system. We want to be able to go in and have a conversation with them about their unique situations and be able to offer the right type of solutions for them. Maybe, Joe, you have some? Joachim Heel - Senior Vice President- Global Sales : Well, what I would say is, first, we should recognize that still the majority of our revenues today come from Windows-based operating systems. And the transition to Android is happening very fast as Windows 10 Mobile, right, the mobile version of Windows 10 haven't been released for a very long time. With that now happening, we do see some customers, and it's very specific to the needs of individual customers. Logistics is a vertical where we see a bit more of it than others express the need and a desire in fact to be on a Windows 10 Mobile platform. And as such, we're developing those devices, and we'll see that they'll occupy a significant portion of the market. Josh Berman - William Blair & Co. LLC: Great. Thank you. Operator : The next question comes from Paul Coster of JPMorgan. Please go ahead. Anders Gustafsson - Chief Executive Officer & Director: Hey, Paul. Paul J. Chung - JPMorgan Securities LLC : Hi. This is Paul Chung on for Paul Coster. Thanks for taking my question. So a question on the core printing business. It's grown nicely really ever since 4Q 2013. You mentioned upgrade cycles have been a strong contributor. How much of that growth has been from existing customers, how much from market share gains from new business? And, finally, can you confirm how cross-selling initiatives with the Enterprise business have been going? Has it been a material contributor? Thanks. Anders Gustafsson - Chief Executive Officer & Director: Yeah. I think the strength of the printing business is really driven, I think, by a number of different factors. Ultimately, I'd say, bring us back to – I think we've just executed well on our overall printing strategy over many years. So we've gained a lot of shares. So there's upgrades or refresh cycles, but we also gained a lot of share. I think according to VDC, we've gained about 1% of market share per year for the last several years. And I would attribute that to us having a very compelling and competitive product lineup. Some of the new things we talked about like Link-OS is one that unifies the look and feel and the user interfaces and how you interact with the printer across our entire portfolio. Something that's very difficult to replicate for smaller suppliers. I think the way we engage with the channel also gives us some benefits with the scale that we have there and how we can provide very compelling value propositions to our channels and our end users. So I'd say it's not really one thing that's driving the strength in the printing business. It's really a number of different things. Joe might have some more comments? Joachim Heel - Senior Vice President- Global Sales : Yeah. I'd say, we have seen a market share expansion in the printing business and I would attribute at least a part of that, a significant part of that to the Better Together, to the ability to operate and cross-sell between them. I'll give you a generic example of that. The strongest vertical for the Enterprise business was and is retail, right, in which we have mobile computers and scanners, which we deploy and there are applications such as when you change the pricing at the retail level where you would like to not only scan and understand the pricing on a item in the store as it is, but change the label immediately. This plays right into our technology of mobile printing which goes very well with that scanning capability that we already have on the retail floor. So we've seen an expansion of solutions like this where we're able to put the two technologies together to a solution to solve a problem like price markdowns and changes. Paul J. Chung - JPMorgan Securities LLC : Great. Thanks. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mike Steele for closing remarks. Mike Steele - Vice President, Investor Relations : Thank you all for your questions. Have a great day. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,016
| 2
|
2016Q2
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2016Q1
|
2016-05-10
| 5.399
| 5.465
| 6.325
| 6.23
| null | 9.99
| 10.53
|
Executives: Mike Steele - Vice President, Investor Relations Anders Gustafsson - Chief Executive Officer & Director Michael C. Smiley - Chief Financial Officer Joachim Heel - Senior Vice President-Global Sales Analysts : Paul Coster - JPMorgan Securities LLC Brian P. Drab - William Blair & Co. LLC Keith Housum - Northcoast Research Partners LLC James E. Faucette - Morgan Stanley & Co. LLC Richard Eastman - Robert W. Baird & Co., Inc. (Broker) Jeffrey Ted Kessler - Imperial Capital LLC Andrew C. Spinola - Wells Fargo Securities LLC Operator : Good morning, everyone and welcome to the Q1 2016 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note that today's event is being recorded. At this time, I'd like to turn the conference call over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele - Vice President, Investor Relations : Good morning and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Mike Smiley, our Chief Financial Officer. Anders will begin by discussing our first quarter highlights and key drivers of the results. Mike will then provide more detail on the financials and discuss our 2016 outlook. Anders will conclude with an overview of our strategic priorities in 2016 and a brief update on our integration of the Enterprise business. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures, as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release. Now, I'll turn the call over to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. Good morning, everyone, and thank you for joining us. It was clearly a challenging quarter as the softening demand we began to see in late 2015, particularly in North America, unexpectedly persisted through the end of the first quarter. As a result, adjusted sales declined 3% year-on-year on a constant currency basis, short of our expectation for approximately flat sales. In addition, given the flow-through impact of lower sales, non-GAAP earnings per share were $1.01 also below our expectations and lower than the prior year. Typically, our quarterly sales volume is backend loaded, particularly in the first quarter, through February we had been encouraged by a healthy pipeline of direct business, as well as the expectation for a pickup in growth across our reseller network. However, as we progressed through March, continued economic uncertainty combined with the slow IT purchasing environment led customers to push out decisions and commitments. This impacted our late quarter close rates and resulted in lower than expected sales. Also, our distribution partners reduced inventories as they navigated through softer than expected end-user demand. As a reminder, we faced a challenging comparison to exceptionally strong first quarter sales growth last year of 13% in North America, and 11% in constant currency for the total company. Turning to our regions, while we anticipated a decline in North America. The decrease was more pronounced than expected, driven largely by the macroeconomic uncertainty I discussed earlier. In EMEA, we saw a modest constant currency growth driven by strength in the UK, Germany and Eastern Europe. We saw some weakness in Southern Europe and the Middle East and the run-rate business was softer. Our Latin America region continued to see sharp sales declines through the first quarter after a weak 2015. That said, we had limited growth in Mexico, our largest contributor to sales volume in the region. This was overshadowed by ongoing weakness in Brazil where we have yet to see stabilization in the political and economic environment. There were some bright spots in the first quarter. First mobile computing sales were up slightly on a constant currency basis, including solid growth in Android. Second, on a constant currency basis, we achieved double-digit growth in Asia-Pacific, led by strong performance in China, and our supplies business returned to growth after a brief pause in the fourth quarter. In the U.S. and Europe, sales-out of our distribution partners outpaced sales-in, which indicates stronger end-user demand than our results indicate. Looking at our verticals, we saw the strongest growth in transportation and logistics, which benefits from parcel delivery and e-commerce growth. Healthcare continued to gain momentum and remains a strong vertical for us. However, retail, our largest vertical, declined due to slower purchasing decisions and fewer large transactions. While a number of environmental factors put pressure on our first quarter sales results, our team executed well within the areas of the business we were able to control. For example, despite lower than expected sales, we delivered Q1 gross margin at the high end of our expectations, as the result of our efforts to capture synergies and execute on our improvement plan for services margins. Given the lower than expected first quarter results and the continued headwinds, we are introducing a tempered outlook for the second quarter and have lowered our full year sales forecast. I'll now turn the call over to our CFO Mike Smiley, to review our financial results in greater detail and discuss our 2016 outlook. Afterwards, I will return to discuss our progress on strategic priorities, as well as key areas we are focused on to position the business for improved performance. Michael C. Smiley - Chief Financial Officer : Thanks Anders. As you can see on slide five, adjusted net sales for the first quarter were $850 million, a 3% decline year-over-year on a constant currency basis. Enterprise adjusted sales were $537 million, down 4% year-over-year on a constant currency basis. Data capture and services declined while mobile computing sales increased slightly. We saw the steepest decline in data capture due to a difficult comparison, as we realized especially strong demand in Q1 2015. Wireless LAN sales, which represents approximately 3% of total Zebra, also were lower than last year. Legacy Zebra sales were $313 million, down 3% on a constant currency basis, against 19% growth in Q1 2015. This is largely driven by a decline in location solution sales related to last year's NFL contract. Our supplies business resumed growth in Q1 while printer sales declined slightly. As Anders mentioned, sales in North America declined 7%, with the sharpest decline in data capture offset by modest growth in mobile computing. EMEA generated modest growth, up 1% from a year ago on a constant currency basis. Slight growth in mobile computing, data capture and supplies were partially offset by lower printer sales. Sales in Asia-Pacific grew 10% in constant currency, led by strong performance in China. We saw growth in all major product categories. The growing middle class is creating healthy momentum in e-commerce and healthcare and driving growth in China and India. In Latin America, sales declined 15% as the result of a continued difficult macroeconomic environment, particularly in Brazil. Sales grew slightly in Mexico, where we are seeing signs of stabilization and have an improving pipeline of opportunities. Adjusted gross margin was 46.2%, at the high-end of our expectations and in line with the prior period. The benefits from integration synergies, including lower service costs, were partially offset by the flow-through impact from lower sales volumes, as well as the impact from unfavorable foreign exchange movements of approximately 60 basis points. Operating expenses for sales and marketing, R&D and G&A were $288 million, including $9 million of stock-based compensation expense. This reflects an increase of $4 million compared to the prior year, due to increased litigation expenses and the settlement of a legal matter. In the first quarter, we recorded expense associated with an under-accrual of 2015 commissions. This is mostly offset by lower year-on-year expenses related to the company's short-term incentive compensation plan. Other operating expenses included acquisition and integration and exit and restructuring cost of $43 million, which was $6 million higher than the prior year, and amortization of intangible assets of $59 million, which declined by $9 million compared to the prior year. In the quarter, non-GAAP EPS was $1.01, compared to $1.41 in the first quarter of last year. First quarter 2016 adjusted EBITDA margin was 15.5%, a decline of 140 basis points to the prior period, primarily due to the flow-through impact from lower sales, and an estimated 100 basis point unfavorable impact from foreign currency. As a side note, Q1 EBITDA margins would have been approximately 400 basis points higher using the exchange rate as of the close of the acquisition in October 2014. Turning now to the balance sheet and cash flow highlights on slide six. We ended the first quarter with $194 million in cash, which includes $143 million held outside the United States. We are at a seasonally high level of cash at the end of Q1 prior to a semi-annual interest payment on our senior notes in the second quarter. At the end of Q1, we had approximately $2.9 billion of long term debt on the balance sheet, consisting of $1 billion of senior notes due in 2022 and a $1.9 billion term loan maturing in 2021. The debt was used to finance the October 2014 Enterprise acquisition and we've been paying it down aggressively. With $80 million in total principal payments in the first quarter of 2016, net debt to adjusted EBITDA ratio is approximately 4.8 times. Our liquidity levels are solid. We have no near term debt maturities and an untapped $250 million revolving credit facilities with no financial covenants unless we have more than $50 million drawn at the end of any quarter. In the first quarter of 2016, we generated $95 million of cash flow from operations, which compared to $36 million in the first quarter of 2015. Capital expenditures were $19 million compared to $26 million in the first quarter of 2015. Our goal is to reduce debt by $300 million this year. In 2016, we expect improvement in cash flow as compared to the prior year driven by EBITDA margin expansion, approximately $90 million to $100 million less integration restructuring costs, and approximately $30 million lower non-integration related capital expenditures. We're also targeting greater than $30 million (sic) [$100 million] from various working capital initiatives, which we have already seen good progress in accounts payable and receivables management through the first quarter. Additionally, we also expect to reduce our minimum target operating cash level by approximately $50 million from the end of last year. Roughly one quarter of our total company sales are denominated in euros, and the vast majority of our cost in the eurozone are in U.S. dollars. In order to minimize volatility in our financial results, earlier this year we hedged approximately 80% of Zebra's net euro cash flow exposure for the entire year, effectively locking in $1.09 euro rate. This hedge rate is below current rates as the euro has recovered in recent months. Slide seven shows our path to financial deleveraging, our top priority for free cash flow over the next couple of years is to pay down the acquisition debt to achieve a more optimal capital structure. We are still committed to achieving net leverage ratio of less than three times by the end of 2017. Given the current headwinds we are facing, the potential impact on conversion rates and timing within our sales pipeline, we've moderated our growth expectations for the second quarter and full year. On slide eight, you'll see that for the second quarter, we expect adjusted net sales to be flat to down 3% from the comparable net sales of $894 million in the second quarter of 2015. This expectation reflects a range of a 2% decline to 1% growth on a constant currency basis. Second quarter 2016 adjusted EBITDA margin is expected to be in the range of 15% to 16%. Non-GAAP EPS are expected to be in the range of the $1.0 to $1.20. Our outlook also reflects a higher gross margin compared to the prior period, but lower than Q1 due to seasonal factors. Also in Q2 operating expenses are expected to be slightly lower than prior year period as we tightly control costs. For the full year, adjusted net sales growth is expected to be in the range of a 3% decline to 1% growth from the comparable net sales of $3.7 billion for the full year 2015. This reflects an expected range of a 2% decline to a 2% growth on a constant currency basis. We expect sequential growth in quarterly sales volumes throughout 2016 and also expect positive year-over-year sales growth by the fourth quarter. Due to the downward revision of our sales guidance, our adjusted EBITDA margin is now expected to be approximately 17% for the full year 2016, which is at the low-end of our previous expected range. The improvement over the prior year is driven primarily by higher gross margin. We expect slightly lower operating expenses than the prior year. Also note that we are assuming a 50 basis point drag to EBITDA margin year-on-year, based on foreign currency changes. For the full year, we have the following assumptions shown on slide eight. We expect capital expenditures of $70 million to $75 million, including $15 million to $20 million related to acquisition integration. Depreciation and amortization expense of $310 million to $315 million. Interest expense of $195 million to $200 million, including amortization of debt issuance costs of $18 million to $20 million. Share based compensation expense of $27 million to $29 million, a non-GAAP tax rate of approximately 22% to 24% and cash taxes of approximately $50 million to $60 million. As previously stated, relative to 2015, we expect to realize an incremental $50 million in acquisition cost synergies, during the full year 2016, approximately $30 million of which will improve our gross profit and roughly $20 million to reduce operating expenses. Consistent with our prior outlook, the rationalization and modernization of Zebra's IT platform and ecosystem will result in $130 million to $150 million of integration related costs over 2016 and 2017, of which approximately 20% will be in the form of capital expenditures. Also we expect the vast majority or roughly 80% of this cost to be incurred in 2016. The expense portion of these costs are one-time in nature and will be – and are excluded from our non-GAAP P&L results. These efforts are expected to drive additional operating expense efficiencies and reduce our ongoing capital expenditures once completed. I will now turn the call back to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. As shown on slide nine, we are executing within the framework of our four strategic priorities to address our near-term challenges and to meet our financial objectives. First, we are focused on delivering profitable growth as we capitalize on secular trends, prudently manage our cost structure and take immediate actions to improve sales. These include refining our go-to-market sales strategies, more frequent and intensive reviews of the opportunities in our sales pipeline, targeted programs to drive increased lead generation activity for our direct sales teams and distribution channel partners, and the rollout of new products and solutions. Additionally, in early April, we launched our PartnerConnect program, which better aligns partners' incentive with our own to drive growth. We believe PartnerConnect will also help us recruit more partners to expand our global network. Second, we continue to expect to realize $50 million of incremental cost synergies in 2016. In addition, we are tightly managing our overall cost structure, through investment prioritization and stringent controls on discretionary spending. Third, a top priority for Zebra is to improve free cash flow and de-lever their balance sheet through margin improvement, declining integration costs, lower capital spending and working capital efficiencies. Lastly, we will continue to make meaningful progress on our transition to One Zebra as we execute the remaining steps of our integration and leverage the Zebra brand. As I mentioned earlier, the recent key milestone in our transition to One Zebra was the launch of PartnerConnect, our new channel partner program. We've incorporated the strengths of the two prior programs and we have added a number of new design features. The launch is the result of an intense year of planning and engaging with channel partners to develop a best-in-class program. As part of the rollout, we got off to a great start last month with four regional summits held around the globe. We received very positive feedback on the new program and on our vision for Enterprise Asset Intelligence. Slide 10 provides some perspective on our progress in integrating the October 2014 enterprise acquisition. From the beginning, we've had a very structured process to ensure a successful integration. We established an internal Business Transformation Office or BTO to oversee the execution of the integration. The BTO has executive management and board oversight, as well as external resources to ensure that we implement best practices. The tremendous amount of advanced planning was done starting immediately after the transaction was announced. This included laying the foundation for our global integrated ERP. The first phase of our ERP successfully went live this month in our Asia-Pacific region and the remainder of our global operations will be transitioned over the next year. Other selected key initiatives shown on the slide have either been completed or are in advanced stages of completion. Despite near term challenges, I remain optimistic about the business, our value proposition to customers and our growth potential. We have made tremendous progress with integration and we remain highly focused on extending our leadership position in Enterprise Asset Intelligence. Our robust solutions extend our relevance well beyond hardware products into services and software. Later this month, we are launching our new brand campaign named Visibility That's Visionary, which highlights our smart innovative products, software and services, that help businesses gather insight into every aspect of their enterprise. Our Enterprise Asset Intelligence solutions enable our customers to sense, analyze, and act. With sensing, we enable real-time operational visibility into people and things, such as packages moving through the supply chain, luggage on an airport tarmac, and work flows in a medical facility. We can provide instantaneous connectivity between our customers' physical and digital worlds. We can then analyze this operational data, which can include status, condition, and location to provide actionable insights for our customers. Zebra's deep expertise has enabled us to be a strategic and trusted advisor to leading enterprise customers and partners throughout the world. Through Enterprise Asset Intelligence, we help enterprises improve productivity and deliver better experiences for their customers. Let me provide a few examples of emerging areas, where we have developed Enterprise Asset Intelligence solutions for our customers. First, we are working with a global transportation company on what we call Zebra Trailer Load Analytics, which collects real-time data on key load metrics, analysis the information and displays the results on a dashboard. The industry average load efficiency is about 70%, just 1% improvement in trailer space utilization, can represent millions of dollars in savings to transport carrier. This patented solution provides the visibility to quickly survey the status of the loads and make real-time adjustments to optimize capacity utilization. The result is improved margins through productivity gains and a reduced carbon footprint. Second, a solution piloted in Danish hospital allows staff to identify and track beds, wheelchairs, medical equipment and other assets on their mobile device. In general, more than one-third of nurses spend at least an hour locating equipment during an average hospital shift. By leveraging this Zebra RFID technology, users are able to optimize workflows, increase accuracy and asset utilization and improve patient care. And third, we are currently working with Bosch to create visibility across the food supply chain. The Food Safety Modernization Act requires greater transparency through the entire supply chain and requires electronic records of temperature to be kept from farm to fork. This regulation is driving increased interest in solutions that can sense and monitor temperature and other environmental conditions as goods are transported through the supply chain. Using Zebra's easy to deploy cloud-based temperature monitoring solution that uses wireless sensors, mesh networking, mobile computers and our cloud service. Providers are able to meet increasingly stringent regulatory demands, while offering consumers enhanced protection. All of these solutions demonstrate how our two legacy organizations are better together. We have a healthy pipeline of other innovative products and solutions to differentiate ourselves from our competition and drive leadership in Enterprise Asset Intelligence. One example of a recently launched product line is our 3600 Series scanners, which are 23% more durable than any other scanner in its class. These scanners are ideal for use in demanding industrial environments, such as warehouses, distribution centers, manufacturing shop floors and do-it-yourself retail stores. They also provide another proof point of Zebra's innovation in the core markets that we serve. We continue to be very well positioned. Our enterprise customers value our innovative products and solutions more than ever to meet their demands to increase productivity and improve customer service. Zebra facilitates retail commerce through all its channels. We benefit from the continued growth of e-commerce as those e-tailers expand their business. For traditional brick-and-mortar retailers, we are a key strategic partner as they work to improve their omni-channel capabilities and customer service levels, which require a more advanced level of inventory tracking technology than they have historically been able to deploy. For these reasons, independent research forecasts that retail will be our fastest growing opportunity in mobile computing in coming years. In our other key verticals, particularly transportation and logistics, healthcare and manufacturing, customers turn to our technology to gain a competitive advantage, reduce costs and increase efficiency in a wide array of applications, including workforce mobility and workflow and patient safety. Momentum behind secular trends including mobility, cloud computing and the Internet of Things continues to build with the proliferation of connected devices and mobile applications. Furthermore, the ongoing Windows operating system migration in mobile computing and the transition from 1D scanning to 2D imaging in data capture point to the depth and breadth of the growth opportunities ahead for Zebra. For these reasons, we firmly believe in the outlook for the company and are reiterating our long term financial goals, as shown on slide 12. We plan to continue to balance investments for growth with prudent expense control while realizing acquisition cost synergies. With this continued focus, we are confident in our ability to grow the business, further expand margins and reduce leverage. And with that, I'll hand the call back to Mike Steele. Mike Steele - Vice President, Investor Relations : Thanks, Anders. We've reserved the balance of the hour for Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Jamie, please let our callers know how to ask a question. Operator : Michael C. Smiley - Chief Financial Officer : Before we start, just real quick, I wanted to clarify something that I – in my prepared remarks, I mentioned that in our – achieving our goal of $300 million of debt repayment, I said that our working capital would provide $30 million of cash. Well, that number should be $100 million. I just want to make sure that's correct for everyone. Thank you. Operator : And our first question comes from Paul Coster from JPMorgan. Please go ahead with your question. Paul Coster - JPMorgan Securities LLC : Yeah. Thanks. Two questions. The first one really is to do with sales-out versus sales-in, in the United States. Can you just sort of clarify which products we are talking about? And what is this telling us about the sort of confidence of the distributors versus the end customers? And then I have a follow up. Anders Gustafsson - Chief Executive Officer & Director: Yeah. We saw the same trend in North America, Europe and Latin America, where the end markets were a little weaker than what the distribution partners had expected at the beginning of the period. So, when their expectations are tempered a little bit, tempered down a bit, they tend to reduce their inventory positions, in order to maintain the same level of days on hand. But for us that means that basically sales-out continues at a reasonable clip, but they can then satisfy that with inventory in hand for some time. So for us, our revenue recorded becomes less, while the sales-out, which is a better indication of the health of the end markets, continues at the better pace. Paul Coster - JPMorgan Securities LLC : Okay. And then the follow-up question Anders is that, I think people will be forgiving if this is an air pocket that's cyclical in nature. I think the concern is that there is competition, there's commoditization, substitution by smartphones of some of the MSI business, and that some of the secular growth isn't as strong as perhaps depicted. So, can you just sort of give us some sense of whether there's an – what your view of the competitive landscape and the commoditization risk currently is and whether that's also impacting you in addition to the cyclical slowdown here? Anders Gustafsson - Chief Executive Officer & Director: Yeah. Our industry is clearly competitive. We always said it's a competitive industry, but it is also fairly fragmented. Zebra is the clear market leader, and if you go back to 2015, we gained share across all our main product lines globally, and early indications are that we held or gained share in the first quarter here also. So, I think the cost for the difficulty we're seeing is much more macro in nature. I think we certainly feel that we are very well positioned to continue to expand our leadership position in the industry. And our customers view us now much more as being strategic to them, our solutions are well respected and needed by our customers and I think we're very well aligned – our solution is very well aligned with our customers priorities. Paul Coster - JPMorgan Securities LLC : Okay. Thank you. Operator : Our next question comes from Brian Drab from William Blair. Please go ahead with your question. Brian P. Drab - William Blair & Co. LLC: Good morning. Thanks for taking my questions. First one is just on OpEx is up slightly year-over-year and the expectation was for it to be flat to slightly down. Mike you mentioned the litigation expense, I guess that's related to the lawsuit around the NFL technology, I'm just wondering if you could comment further on why OpEx was up slightly year-over-year versus your expectation for flat to down? And are those litigation costs something that – is that a headwind we should be expecting to be around through the balance of 2016, do you have any idea? Michael C. Smiley - Chief Financial Officer : Yeah. The majority of that increase is related to a settlement, so fortunately settlements don't incur additional costs, so that shouldn't be ongoing. It's related to an IP matter, and it's not the – it's not related to the NFL. I think that one thing we would want people to take away is that, we have been aggressively managing our cost. And I think as we put out our forecast for Q2, we're seeing slightly lower year-over-year OpEx as we go into the second quarter, so OpEx is getting a lot of focus from management at this point. Brian P. Drab - William Blair & Co. LLC: Is that settlement – does that settlement account for the discrepancy between what you are expecting for OpEx versus the actual result? Michael C. Smiley - Chief Financial Officer : Most of it. There's a little bit also of healthcare. Healthcare is a difficult item to forecast. And so, depending upon the actual employee health issues it goes up and goes down. So the biggest – the biggest one is the litigation related to the IP. I'd say the next one is healthcare. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks. And then can I just ask too, is there any way you could quantify what we were talking about in the last caller's question related to the sell-through for the channel. Anders you mentioned that the channel is seeing growth, what sort of growth are they seeing, how big is the discrepancy between your sales versus what the channel is seeing? Anders Gustafsson - Chief Executive Officer & Director: Yeah. I don't think we can quantify it in real dollar terms, but the channel sales were slightly negative for us in North America, but they were on the sales-in basis, but they are positive on the sales-out basis. So there was a difference, but I wouldn't say that that would be – that's not the sole reason for why we missed our numbers. Brian P. Drab - William Blair & Co. LLC: Understood. Do you have any sense for the inventory level going into the second quarter in the channel? Anders Gustafsson - Chief Executive Officer & Director: Yeah. We believe that the inventory level going into the channel is appropriate. And we are forecasting basically a neutral sales in and sales out for the second quarter. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks very much. Anders Gustafsson - Chief Executive Officer & Director: Yeah. Operator : Our next question comes from Keith Housum from Northcoast Research. Please go ahead with your question. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Anders Gustafsson - Chief Executive Officer & Director: Good morning. Keith Housum - Northcoast Research Partners LLC : Good morning, guys. If I could just follow-up on the performance of the legacy Zebra business during the quarter, I just want to clarify, how the business performed excluding the Location Solutions Group? Michael C. Smiley - Chief Financial Officer : Effectively, it was fairly flat except for Location Solutions. Location Solutions was the major change from year-to-year. Keith Housum - Northcoast Research Partners LLC : Okay, great. And as we look at the first quarter guidance and the second quarter guidance, obviously, compared to full year, you guys are expecting significant growth, I think even in second half of the year, what gives you guys the confidence in that? Is it the larger deals, is it your pipeline as you guys are exiting the quarter? Anders Gustafsson - Chief Executive Officer & Director: Yeah. So, we have confidence in our 2016 outlook as we've outlined here now. We certainly had persistent macro headwinds in the first quarter. It's a big drive. And when we look at the markets going forward, we don't believe that they are getting worse. If anything that feels like Q2 is getting a bit better, but we want to have a cautious tone I guess to this, and we've also taken a more cautious assessment of some of the assumptions that we used to build up our forecast. So, I think on the last call, we talked about our close rates for the deals we have in the pipeline, they ended up being lower than what we had expected, lower than what we had seen in the last five years, based on both the budgets being pushed out, but also more C-level people changes where they kind of came in and put a freeze on some projects until they could figure out what the new IT strategy and IT projects priorities should be. And we're also assuming some longer sales cycle based on what we've seen here in the quarter. But we do expect stabilization in the second quarter, and we would expect to have sequential growth, but we're forecasting basically sequential growth in line with historical trends when we look at what the business has done quarter-over-quarter over the last five years. It gives us a sense of what's normal, so we don't want to – we're not pushing beyond that particularly. And as I said earlier, sales-out versus sales-in we're forecasting to be neutral. Our partner community they were very bullish beginning of the year at the end of last year, beginning of this year, and they continue to remain very optimistic. So that gives us some confidence. We launched our new partner program, PartnerConnect in April, that we believe will help us drive some enthusiasm around our brand and recruit some more partners and win more business, and we have a good pipeline, we do have a very strong pipeline for the business. Keith Housum - Northcoast Research Partners LLC : Great. So you said that they are – they are just being pushed out and not being cancelled, but deals are in the pipeline? Correct. Anders Gustafsson - Chief Executive Officer & Director: Yeah. The vast-vast majority of them are just being pushed out some to Q2, some further out. We don't expect that trend will totally stop. I suspect that we will see some continued push out from Q2 to Q3, but it will diminish as the year goes by. And our – we have not lost anymore deals than we would normally do, so this is not about we losing deals. This is deals getting pushed out. Keith Housum - Northcoast Research Partners LLC : Okay. Thank you. Operator : Our next question comes from James Faucette from Morgan Stanley. Please go ahead with your question. James E. Faucette - Morgan Stanley & Co. LLC: Thanks very much. I guess I have two questions. First, gross margins seems to have rebounded in the first quarter. And I'm wondering kind of, if you can give a little color what drove that, was that mix or were there build material changes, et cetera? And then I have kind of a longer-term question or specifically related to 2017, is that if we look, you're continuing to talk about getting below three times debt-to-EBITDA type ratios, but – and it seems like they're indicating that part of that will come through the commitment to pay down the $350 million in debt, but at the same time I think at least what we're seeing today is that, the earnings outlook for 2017 probably looks a little dimmer today. And then also it seems like you're also reducing a little bit your synergies benefits expectations, so I'm just wondering if you can help us bridge a little more directly what you think you may have to do or how you can get those ratios? ?Thank you. Michael C. Smiley - Chief Financial Officer : Yeah. This is Mike. And so, there is a couple of questions in there and I'll start with the gross margin. I think, first of all, we were very pleased with the results in the first quarter from a gross margin standpoint. One of the nice things that we saw there was our services margin improved meaningfully in the first quarter, which helped, obviously the synergy work we've been doing on the procurement side has helped us. We see as the year goes on that we'll continue to benefit from further work that's been done on the procurement side. Volume will also improve. So, from what I think was a very solid first quarter, we see that continuing to improve through the end of the year. So, when you look at the cash flow available for re-payment of our debt, part of it's going to come from the stronger margins to offset some of the top-line dampening that we've been sharing. As far as the ability to reach our three times net debt to EBITDA, there is a couple of things that I want to highlight is that when we set the $350 million for 2017, we weren't assuming that all of our cash for 2017 would be necessary to get down to that three times debt to EBITDA, so there is – so as a result, if we achieve what our expectations are in 2017 even with what we had prior to our current change, we could have done more than $350 million and we still see an easy path getting to the $350 million. As far as the $300 million for this year, again just to reiterate, we said that we expect our EBITDA margin to improve from last year. And as I tried to clarify earlier, working capital improvements should be $100 million better than last year. I think if you look at our cash flow, you can see we had $96 million of operating cash flow, a lot of that came from working capital. So, it was a huge improvement from the prior year. We also have $90 million to $100 million lower integration spend year-over-year. CapEx will be lowered by $30 million, a big chunk that relates to the savings for the spending we had last year to get everybody in the same place. And then, we also see the ability to – this doesn't necessarily go to three times as far as paying down our debt. We see the ability to repatriate $50 million in the year from foreign locations that will help us reduce our debt. Anders Gustafsson - Chief Executive Officer & Director: Maybe just to add a couple of things. You mentioned also, you thought our synergy target had gone down and it hasn't. We have not changed our synergy target, that's the same as it was before. And in 2017, our integration cost will further come down and actually go away altogether, so it could generate a lot of additional free cash flow. James E. Faucette - Morgan Stanley & Co. LLC: That's great. Thank you. Operator : Our next question comes from Richard Eastman from Robert W. Baird. Please go ahead with your question. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Yes. Thank you. Anders, could you just speak a little bit. I just want to dig down into this dynamic around the push-out of the deals. We continue to pick up, obviously the omni-channel spend is still pretty healthy. We do have this Android/Microsoft operating language conversion on the mobile computing side. I'm just curious, what is the genesis of the push-outs? I mean, the spending in the omni-channel, and you commented earlier that your retail business was down. But that spending in the omni-channel seems to be somewhat independent of the health of the retailers, given that they're supporting their online spending infrastructure, or their online shipment infrastructure. So maybe you could just help us understand the context of these push-outs and maybe the timing of that? Anders Gustafsson - Chief Executive Officer & Director: Yeah. I'll start a little broad, a little high, and then I'll kind of narrow myself down to more the omni-channel activities, but first I'd say the corrections we saw in the stock market in late 2015, early 2016, that happened as people were starting to put together their 2016 operating budgets. So I think that caused people to wonder, should I lean into 2016 or should I lean out of it. So, I think people took a little longer to finalize their budgets, they took a little longer to hand down those budgets to their operating units. So it took longer for basically the businesses to get back to business again. And also in retail specifically I think the Christmas season was kind of uneven between the different retailers. And the omni-channel activities for retailers, it's a big strategic shift for retail generally. You have traditional brick and mortar retailers and then you've had more the pure play e-commerce guys fulfilling through a distribution center. So, there has been more change I guess in the executive suite to be able to deal with this and when you have a new, say an IT team come in, they tend to want to pause a little bit of what they're doing, assess what they're doing, figure out what the new priorities, new strategies should be, but then, in order for them to execute on their omni-channel strategy. Now, we are very well positioned to help them with their omni-channel strategy. We are an essential part of helping them drive greater visibility into all the merchandise they have in store, which is essential to having an effective omni-channel strategy. But I'd also like to, again, maybe point to, there are more new use cases that drives demand for our products in retail and in, say the online e-commerce piece. So if you just go back and think about how historically a retailer would get a pallet of goods delivered at the back of the store, you would take the boxes out and scan them in, put them in the back of the store, then you would put them in the front of the store and the consumer will pick it up and take it to the point of sale, where they will be scanned. So the touch points for our products was there, but not as dense as it is today. If you now look at, for a brick-and-mortar retailer, say, you have click-and-collect. So you order from home, you have somebody in the store pick up all the merchandise for you and check you out; that requires a lot more mobile computing, scanning, printing. You have mobile point-of-sale as part of that. You have pick up at the curb. You have to identify the consumer. We use lockers to do this. And if you go into a fulfillment center, you see lots and lots of touch points where you have to scan every item in, it's not just pallets, you are scanning every item that comes, and equally you have to scan it out. And it drives lots of printing, lots of mobile computing, and eventually also you get the benefit of transportation logistics, that each package has to deliver to somebody's home. So the backdrop for us in retail, we see as being very positive as these new modalities of how consumers want to interact with the retailers tends to be very favorable and require more of our product. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Let me just ask one follow-up question; in terms of rolling out the PartnerConnect program, do you feel that – I mean it's fairly well telegraphed. And I don't exactly know how commission structures have changed or any of that, but at the same time, was there any impact from the second quarter roll out of the PartnerConnect program on your sell-in to the distributors? Anders Gustafsson - Chief Executive Officer & Director: I think if there was, we believe it is very small. We don't believe that that had a big impact on the first quarter. We purposefully were not sharing too much about the new program until we got into the first days of Q2 to specifically ensure that we didn't distort Q1 or Q2. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Okay. All right. Thank you. Operator : Our next question comes from Jeff Kessler from Imperial Capital. Please go ahead with your question. Jeffrey Ted Kessler - Imperial Capital LLC : I'd like to drill down on the – sorry, on your pipeline a little bit. Could you describe the nature of what's in the pipeline from a – let's just say from a functional or perhaps from a vertical market point of view, and what gives you that confidence that that pipeline is going to have a good gross margin in it? Anders Gustafsson - Chief Executive Officer & Director: Yeah. So, I'll start and then I'll hand over to Joe Heel here also. But we've driven a lot of discipline around how we manage our pipelines, making sure all the deals get put into the pipeline. So, we have as good a visibility into all the opportunities that we work on to make a quarter. We categorize all the opportunities based on, if it's something that's high likelihood, medium likelihood or less likelihood and then we have our run rate business too in there. So, there's a number of different components that we look at historical, statistical conversation rates to add up to our forecast, and that's worked very well for us for many years. The conversion rates were lower in Q1 than they've been before and that we had not anticipated that. We think that's because of the uncertainty in the economy and budgets getting pushed out later and so forth, not something that is systematic. Thinking more episodic. I think Joe can probably give you a little bit more color around exactly how we use the pipelines? Joachim Heel - Senior Vice President- Global Sales : Yeah. So, what we're seeing in the pipelines is very much a product of what Anders described happened in the first quarter in terms of some of the deals in particular in retail pushing out. Those deals are in our pipeline going forward and the ones that we see there are the more significant investment decisions in particular things related to for example the operating system migrations. Those are big decisions that the retailers need to make and they were affected by this hesitation that they perhaps sensed in the first quarter. But we see those in our pipeline where the customers are planning to do those operating system migrations. The other things that we see in the pipeline are the new products. We've released a significant number of new products as you've seen over the last one to two quarters and those are beginning to take hold in our pipeline as are some of the new technologies that we have developed in some cases with customers. So that's a good summary of what we're seeing. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Also, on the incremental $30 million that you have – or $50 million, assuming that you expect to save in synergies this year. You mentioned that a portion of that is going to go to, I believe, $30 million or $20 million will go to gross margin and the rest is going to go into operating expense. Is this a – is this in effect an incremental improvement over improving the margin than you saw in the first round of expense – of synergies? Michael C. Smiley - Chief Financial Officer : Yeah, this is Mike. So yes it's $50 million, $30 million of it is cost to goods sold, $20 million is OpEx. Again this is improvements from 2015 and for the OpEx, a portion of it is just actions that happened in last year will have a full year effect in 2016. The cost of goods sold is primarily procurement related items where you have to sort of burn through old inventory at higher prices before you can process through your P&L, the lower cost items that you negotiated previously. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. So interpreting that last sense, you are saying that essentially by doing that. The margin on cost of goods should continue to be helped by what you're doing right there on that $30 million? Michael C. Smiley - Chief Financial Officer : Yeah, so we talked about the gross margin. As we go through the year, we see – obviously we're affected year-over-year by FX headwinds, right. So that is a negative impact for us on our gross margins. We saw actually in the first quarter of 60 basis points. That's offset by the synergy benefits that we saw, services improvements in margins that we talked about in the first quarter, we expect it continues through the full year. And then as we forecast it, our revenue is going to increase, our volume is going to increase as the year progresses, and that will also help us. So as we've talked about gross margins, though we've done – considering the headwinds of FX, we had very strong Q1 and we expect that to continue through the end of the year. Jeffrey Ted Kessler - Imperial Capital LLC : Okay, great. Thank you very much. Michael C. Smiley - Chief Financial Officer : Yes. Operator : Our next question comes from Andrew Spinola from Wells Fargo. Please go ahead with your question. Andrew C. Spinola - Wells Fargo Securities LLC : Anders, I wanted to ask you about the long-term EBITDA guidance of 18% to 20%. When you've talked about that in the past, you've sort of referred to it as not just a range that you hope to be in just for a moment and then back below it, but a range you hope to operate in on a consistent basis. As you can imagine after this quarter and the lower guidance, it's starting to look fairly far out into the future, and even the low end of that range is looking more difficult to achieve. So it would seem to me there's going to need to be an inflection here in the expenses or the gross margin to reach that range by the end of 2017. So I'm wondering two things. One, do you still feel like that range is the range you will be in as opposed to just a peak range? And at what point in 2016 and 2017 will we start to see this inflection that you can get to that? Anders Gustafsson - Chief Executive Officer & Director: So, first, we are confident that that's still a very appropriate range for us and we expect to be within that range more consistently. I think the original target was for that to happen as a run rate as we exit 2017. So, I think that what we saw here in the first quarter is much more driven by short-term economic issues that seems like many other companies have been hit by too, not a structural issue to us or our industry. We feel we have good growth opportunities. We have good opportunity to expand our gross margin, expand our EBITDA margin as well. So, I feel that's a very appropriate and doable target for us. Michael C. Smiley - Chief Financial Officer : Yeah. Just to follow-on Andrew, just not to belabor the point, but if we had – the exchange rate – the goals that you talked about were set and we did the acquisition. And at that point, the exchange rate for the euro was a about a $1.33. So, if we were still in that environment today, our EBITDA margin would be 19.8% for the first quarter. So, I think from a management standpoint, as Anders is saying for us to still hold onto this 18% to 20% EBITDA margin. I'm hoping people will realize that we are managing in a very, very challenging environment. That said, as I mentioned on the previous question, we still see in the year, we had very strong Q1 gross margin. We see that improving through the year. We have – we're managing our OpEx carefully and I would say that within our current OpEx, there are certain integration, or two-system dis-synergies, which is in the middle of 2017 should reduce pretty dramatically – meaningfully I don't want to say all of a sudden OpEx falls off the table, but that will help us further drive towards the EBITDA margin that we're still holding on to and are confident we'll achieve. Anders Gustafsson - Chief Executive Officer & Director: It's a very important goal for us. We have set a lot of internal targets around that also to align the entire organization towards these things. So, we clearly see this as one of our absolute top priorities, and one that we feel very good about our ability to meet. Andrew C. Spinola - Wells Fargo Securities LLC : Thanks. And I also wanted to ask you about this recent sort of interesting product introduction by Cognex. Just wondering if you have any thoughts on that product instruction in terms of sort of philosophically does it change your view at all on the effectiveness of smartphone products for some in this space, or make you think anything differently about how to approach the market for some of these products? Anders Gustafsson - Chief Executive Officer & Director: No. As I said earlier, we have a competitive market. It's a very fragmented market. There's lots of competitors coming in and out of our market. We are the clear market leader and we gain share in 2015, we certainly expect to continue to gain share in 2016. So, we're not focused on anyone particular competitor. We're looking at how do we make sure that we can execute our plans. There're obviously a number of players with different sleds out there. So it's not something radically new for the industry, so I feel comfortable with our competitive position and our ability to continue to grow and expand our market share. Andrew C. Spinola - Wells Fargo Securities LLC : Thanks, Anders. Operator : And ladies and gentlemen, at this time we've reached the end of today's question-and-answer session. I'd like to turn the conference call back over to Mike Steele for any closing remarks. Mike Steele - Vice President, Investor Relations : We appreciate all your questions today and have a great rest of your day. Operator : Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.
|
ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,016
| 3
|
2016Q3
|
2016Q2
|
2016-08-09
| 5.4
| 5.285
| 6.006
| 5.75
| null | 9.96
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Executives: Michael A. Steele - Vice President-Investor Relations Anders Gustafsson - Chief Executive Officer & Director Michael C. Smiley - Chief Financial Officer Joachim Heel - Senior Vice President-Global Sales Analysts : Richard Eastman - Robert W. Baird & Co., Inc. (Broker) Paul Coster - JPMorgan Securities LLC Jason A. Rodgers - Great Lakes Review Keith Housum - Northcoast Research Partners LLC James E. Faucette - Morgan Stanley & Co. LLC Matthew Cabral - Goldman Sachs & Co. Jeremie Capron - CLSA Americas LLC Brian P. Drab - William Blair & Co. LLC Andrew C. Spinola - Wells Fargo Securities LLC Operator : Good day, and welcome to the Q2 2016 Zebra Technologies Earning Release Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael A. Steele - Vice President- Investor Relations : Good morning and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Mike Smiley, our Chief Financial Officer. Anders will begin by discussing our second quarter highlights and key drivers of the results. Mike will then provide more detail on the financials and discuss our 2016 outlook. Anders will conclude with an update on Zebra's 2016 strategic priorities and an overview of our vertical go-to-market strategy. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release. Now, I'll turn the call over to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. Good morning, everyone, and thank you for joining us. We are pleased with our overall performance in the second quarter, which reflected sales in line with our expectations as well as strong gross margin expansion, lower operating expenses, and improved profitability. We achieved $144 million of adjusted EBITDA, a 10% increase over the prior year, and adjusted EPS of $1.34, which exceeded our guidance range. We continue to make solid progress on the integration of the Enterprise business. I am particularly pleased with our progress on the improvement plan for services margins and realizing meaningful product cost reductions, both of which were key contributors to our gross margin outperformance. From a sales perspective, as expected, macroeconomic uncertainty combined with a slow IT spending environment has continued to elongate the sales cycle. It is important to note, while some customers have delayed projects into future quarters we have not experienced any increase in order cancellations. Conversely, Zebra's strength, scale, and robust solutions have enabled us to further extend our market leadership during the past quarter. Of note, mobile computing and scanning were particularly strong from a sales and margin perspective. A key driver is our leading portfolio of Android-powered devices and solutions, which now represents more than one-third of our mobile computing sales volume, as customers upgrade from legacy operating systems. Turning to our regions. North America was flat on a year-over-year basis, which was an improvement in trend from the first quarter as the compares were slightly less challenging for that region. We saw lower sales in our EMEA region from the same quarter a year ago as we cycled over double-digit growth last year. Good growth in Northern Europe was offset by softer sales in Eastern and Southern Europe and the Middle East. Our Asia Pacific region generated record sales and approximately 10% growth year-over-year. China, our largest market in the region, continued to grow double digits, aided by new business from the largest online retailer in the country. Japan also recorded strong double-digit growth. In Latin America, revenue declines have moderated as we continue to navigate a challenging market. We have also begun to see the benefits of organizational improvements, as well as proactive sales generation activities we have implemented. From a vertical perspective, we experienced the strongest growth in transportation and logistics or T&L, which has benefited from our innovative visibility solutions, as well as increased parcel delivery driven by e-commerce growth. Retail, our largest vertical, declined largely due to the slower IT spending environment we discussed, and sales to manufacturers were also lower. In healthcare, we once again saw double-digit growth as we capitalized on attractive opportunities within this sector. Our vertical expertise and focus remains a key differentiator for Zebra. I will provide some more detail on how we will drive growth in each of our primary verticals a bit later on this call. Looking forward, we are reiterating our full year 2016 outlook, which assumes no material change in the current operating environment. As we look at the bigger picture, while we expect near term sales performance to be impacted by customers pausing decisions in an uncertain environment, we continue to have a healthy pipeline and believe we have a commanding position in the global marketplace. Organizations around the world are recognizing the opportunity to adopt visibility solution like Zebra's to drive growth, improve productivity, and reach higher levels of customer service. I will now turn the call over to our CFO, Mike Smiley, to review our financial results in greater detail and discuss our 2016 outlook. Michael C. Smiley - Chief Financial Officer : Thanks, Anders. As you can see on slide 5, adjusted net sales for the second quarter were $882 million, approximately flat year-over-year on a constant currency basis. Enterprise sales were $577 million, up approximately 1% year-over-year on a constant currency basis. Sales increased in mobile computing and data capture, whereas services and wireless LAN sales were lower than last year. In Q2, we booked revenue from our first Trailer Load Analytics order, an innovative solution we discussed last quarter. Pre-transaction Zebra sales were $305 million, down approximately 3% on a constant currency basis against 17% growth in Q2 2015. Performance within our Printer business was solid and the sales decline was due to an especially large order from a retail customer last year. Supply sales increased while location services decreased versus the prior year. Sales in North America were flat, with growth in the Enterprise segment offsetting a decline in the pre-transaction Zebra business. EMEA declined approximately 4% from a year ago on a constant currency basis as we cycled strong sales performance in Q2 of last year. Sales in Asia Pacific grew 10% in constant currency, led by growth in all major product categories, as well as strong performance in China and Japan. In Latin America, sales declined about 4% as a result of a continued difficult macroeconomic environment. We drove further growth in Mexico, our largest market in the region and have positioned ourselves well for promising opportunities there. Our adjusted gross margin of 46.4% exceeded our forecast and was 190 basis points higher than in the prior period. We benefited from a strong mix, continued improvement in services margins and delivering on our cost reduction programs. Additionally, keep in mind that in second quarter of last year, we incurred product rebranding and various other costs in the Enterprise segment. Operating expenses for sales and marketing, R&D and G&A were $285 million including $3 million of stock-based compensation expense. This reflects a decrease of $10 million compared to the prior year primarily due to lower stock-based comp expense and reduced sales and marketing and R&D costs. Favorability was partially offset by increased G&A cost including tax advisory fees and $4 million of litigation expenses. Other operating expenses were $10 million lower than the prior year. This included both acquisition and integration and exit and restructuring costs of $39 million as we made progress on our IT integration and restructuring efforts related to the October 2014 Enterprise acquisition. Amortization of intangible assets were $60 million. The ERP and broader IT implementation is going well and has been on budget and on schedule through the first half of the year. Our Phase 1 Asia Pacific deployment has gone well and we continue to assess and monitor the implementation as we plan a roll out to the remainder of our global operations next year. In other areas of the integration, we invested approximately $20 million more integration expense during the first half of 2016 to meet the requirements for certain key business and function-specific activities. These included changing and integrating the Enterprise business flows into the Zebra model, legal and restructuring, and integration of the new channel partner program. The scope and cost changes were executed to ensure smooth transition and deliver the desired operating results. In Q2, we successfully launched PartnerConnect, the industry's premier channel program. And as you saw in our Q2 results, we have a consolidated operating structure that is delivering a lower tax rate than was possible utilizing the legacy Enterprise operating model. The investment for these projects is behind us now, and despite additional costs, remain on track to achieve our $300 million debt pay-down for this year. As a reminder, in late Q2, we successfully repriced our term loan, reducing the rate by 75 basis points. This action reduces our interest expense going forward, but negatively impacted interest expense in the second quarter of 2016 by nearly $2 million on a net basis due to one-time impacts of accelerated amortization and transaction fees. In the quarter, non-GAAP EPS increased to $1.34 compared to $1.03 in the second quarter of last year. A lower tax rate, impacted by cash adjustments and estimated changes to related profitability mix by jurisdiction, positively impacted the second quarter of 2016 non-GAAP EPS by approximately $0.14. Second quarter 2016 adjusted EBITDA margin was 16.3%, an increase of 170 basis points in prior-year period, primarily due to higher gross margins. There was a negligible impact to EBITDA margin on a year-over-year constant currency basis, but I think it's worth noting that Q2 EBITDA margins would have been approximately 300 basis points higher using the exchange rates as of the close of the acquisition in October 2014. Turning now to the balance sheet and cash flow highlights on slide 6. We ended the second quarter with $141 million in cash and cash equivalents, which includes $116 million held outside the U.S. At the end of Q2, we had approximately $2.9 billion of long-term debt on the balance sheet. The debt was used to finance the October 2014 Enterprise acquisition, and we've been paying it down aggressively. Year-to-date, we have made $145 million in total principal payments and our net-debt-to-adjusted EBITDA ratio has decreased to approximately 4.5 times. Zebra has a strong liquidity profile. There are no near-term debt maturities, and we have an undrawn $250 million revolving credit facility with no financial covenants unless we have more than $50 million drawn at the end of any quarter. In the first half of 2016, we generated $122 million of cash flow from operations which significantly exceeded the $20 million in the first half of 2015. Total capital expenditures were $35 million compared to $49 million in the first half of 2015. In the first half of the year, we drove improvement in cash flow primarily from initiatives from reduced working capital and expect to drive well over $100 million of benefit for the full year as compared to 2015. With respect to foreign exchange, approximately one quarter of our total company sales are denominated in euros and the vast majority of the product costs are in U.S. dollars, which exposes us to currency transaction risk from both the sales and earnings perspective. In order to minimize volatility in financial results, early this year, we hedged approximately 80% of Zebra's net euro cash flow exposure for the entire year, effectively locking in a $1.09 euro rate. Going forward, we are adopting a rolling four-quarter hedging program and therefore already begun to implement a layer of hedges for 2017. Although the British pound has sharply devalued since the Brexit vote in late June, it has not materially impacted our results. Our UK business represents only a mid-single digit percentage of Zebra's overall sales and has performed well on a year-over-year basis helped by some significant wins. Slide 7 shows our path of financial deleveraging. Our top priority for free cash flow and excess cash balance is to pay down the acquisition debt to achieve an improved capital structure. We remain committed to pay down $300 million of debt this year and $350 million in 2017. Despite this debt repayment schedule, absent a material change in the macroeconomic landscape, we are unlikely to achieve our initial net debt to adjusted EBITDA leverage target ratio of less than 3 times by the end of next year. As a result of currency pressures and a challenging global sales environment, our original goal became very aggressive within that timeframe. That said, we will continue to aggressively manage our expenses and cash flow with our ultimate objective, continuing to be net leverage target of between 2 times and 3 times adjusted EBITDA. We continue to make steady progress towards this target with our EBITDA growth and commitment to pay down debt. We continue to be on track with the outlook provided last quarter. On slide 8, you'll see that for the third quarter we expect adjusted net sales to be flat to down 3% from a comparable net sales of $919 million in the third quarter of 2015. This expectation reflects a range of a 2% decline to 1% growth on a constant currency basis. Third quarter 2016 adjust EBITDA margin is expected to be approximately 17%. Non-GAAP EPS is expected to be in the range of $1.30 to $1.50. Our outlook also reflects a higher gross margin compared to the prior year period, but sequentially lower than Q2. Also, in Q3, operating expenses are expected to be approximately flat to slightly higher than the prior year period and assume a couple million dollars of increased litigation expense. For the full year 2016, we continue to expect adjusted net sales growth to be in the range of a 3% decline to a 1% growth from the full year 2015. This reflects an expected range of a 2% decline to 2% growth in a constant currency basis and positive year-over-year sales growth by the fourth quarter. We also continue to expect adjusted EBITDA margin of approximately 17% for the full year 2016. The improvement over the prior year is expected to be driven primarily by a higher gross margin. We expect approximately flat operating expenses compared to the prior year. Note that our forecast includes the assumption of $8 million to $10 million in higher litigation expenses for the year with the majority coming in the second half. Also note that this reflects a 40-basis-point negative impact to EBITDA margin for the full year 2016 based on year-over-year foreign currency changes. For the full year 2016, other assumptions shown on the slide 8 remain largely the same as outlined during Q1. However, we expect interest expense to be $5 million lower than our previous outlook, which reflects the benefit of a lower interest rate partially offset by fees and other costs related to the June repricing. Also, the full year adjusted effective tax rate has been adjusted lower to approximately 20%. I will now turn the call back to Anders. Anders Gustafsson - Chief Executive Officer & Director: Thank you, Mike. As shown on slide 9, we continue to execute on our four strategic priorities to drive near and long-term growth and profitability. First, we are focused on delivering profitable growth and extending our leadership. As we capitalize on secular trends, drive sales, and prudently manage our cost structure. Although 2016 has been a challenging year from a sales growth perspective, we believe these pressures are temporary. We continue to launch innovative solutions and we are working closely with our customers to meet their demands, to be more productive and provide better service for their customers. Also, our margins continue to improve as we execute on our integration and improvement of the Enterprise business. Second, we are tightly managing our overall cost structure through investment prioritization and maintaining stringent controls on spending. We continue to expect to realize approximately $50 million of additional cost synergies in 2016. Our ongoing efforts around this initiative were a key contributor to our gross margin outperformance during the second quarter. Third, the top priority for Zebra is to improve free cash flow, optimize operating cash levels, and delever the balance sheet through working capital efficiencies, declining integration and restructuring costs, margin improvement, and lower capital spending. Lastly, we will continue to make meaningful progress on our transition to One Zebra as we complete the remaining steps of our integration plan, leverage the Zebra brand, and enhance the culture of the new Zebra. I would like to update you on several key integration milestones. As I mentioned last quarter, we launched our new channel partner program, PartnerConnect, in early Q2, which was the most comprehensive change to our channel strategy in company history. The goals of this new program are centered on three key elements : simplicity, cross-selling and partner profitability. Some of the most partner-requested enhancements within this new framework include expanded deal registration across our entire portfolio to encourage partners to invest in the development of business opportunities, a comprehensive integration and simplification of our pricing categories, making it much easier to configure, price and quote our solutions, a clear differentiation in financial incentives among partners based on performance and commitment in the program, and additional incentives for certification and specialized capabilities. We believe PartnerConnect is the best channel partner program in the market and will be a differentiator for Zebra and its partners. Early feedback has been very positive from our existing base of partners, and it has attracted many new partners. We are also pleased that the first phase of our ERP integration, which went live in May in our Asia Pacific region, is doing well. This adds to our list of successful implementations, which include our unified CRM system, various engineering systems and tools, IT infrastructure build-out and global rebranding. As I discussed last quarter, we launched a new brand campaign, Visibility That's Visionary, which highlights our smart, innovative products, software and services that help businesses gather insight into every aspect of their enterprise so they can make better decisions. Enterprise Asset Intelligence, or EAI, provides enhanced operational visibility, which empowers customers to analyze and act upon real-time data to optimize their performance. This new campaign showcases our leadership position in the EAI category and our ability to further enhance our strategic relationships with customers by leveraging our deep vertical expertise. Our proven solutions are more relevant than ever due to the convergence of some key digital trends, including the Internet of Things, cloud computing, and mobility. On slide 11, we lay out the four key verticals in our go-to- market strategy : T&L, retail, healthcare and manufacturing. Our specialized resources and strategic relationships with industry partners enhances our credibility with customers and helps us engage as a strategic advisor higher up within their organizations. In T&L, we are providing visibility into truck capacity and delivery optimization that translates into fuel savings and other productivity benefits for our customers. This real-time data provides enterprises a vantage point into every area of transport operations, including the ability to maintain and monitor fleets and track drivers and shipments instantaneously. An exciting and new innovative offering in T&L is the recently launched Trailer Load Analytics solution Mike referenced, of which a leading global transportation company is our first customer. The solution utilizes Zebra's sensors and analytics to aggregate data across thousands of dock doors and indicates the next best action in loading operations in real time. We also recently launched an innovative line of Total Wearable Solutions, which is the world's only dedicated suite of enterprise wearable devices built on the Android operating system. These lighter and more durable wearables free up warehouse workers' hands and eyes, allowing Zebra's solution to improve productivity and accuracy. With regard to our retail vertical, our solutions do more than connect every aspect of an enterprise. They also connect an enterprise to its customers. This type of visibility helps to develop consistent messaging, pricing and service across in-store, online and mobile touch points, resulting in a seamless customer-centric experience. For example, one of our high-end department store customers needed to display thousands of shoe styles and colors to appeal to its customers. The wide variety of shoes meant a complete inventory assessment could only be performed weekly, which translated into lost sales and missing display samples. To ensure real-time display accuracy, the customer selected a Zebra RFID solution that captures full information on each shoe style. As a result, this customer achieved quicker fulfillment, reduced out-of-stocks, improved customer service and increased revenues. Our end-to-end healthcare intelligence solutions enhance operational efficiency, staff productivity and patient safety. Zebra provides the kind of visibility that lets healthcare facilities see into every aspect of the patient journey, from admittance to discharge. A University Medical Center in the Netherlands recently teamed with Zebra to create a system which provides time tracking, evaluation and feedback when treating heart attacks, the world's number one cause of death. This solution measures the crucial time between when the patient enters the hospital and when the appropriate procedure is initiated. It wirelessly transmits real-time information from a Bluetooth-enabled patient ID band, providing immediate visibility into the time it takes to restore blood flow in each patient, ultimately improving patient outcomes. In this Enterprise Asset Intelligence offering, we have connected smarter supplies, patient identification, and location-enabled wristbands with our Zatar cloud platform to aggregate and analyze collected data. This is the first step in enabling our printer supplies to become more intelligent. As we unlock further value with Enterprise Asset Intelligence, we are identifying additional opportunities to make our supplies and media more connected and intelligent. In our fourth key vertical, manufacturing, seeing the big picture means having visibility into every moving part of the customer's operation. With increased visibility, manufacturers can streamline processes, exceed production targets, and deliver flawless fulfillment. For the largest processor of dairy ingredients in the world, the limited scanning range of its solution was making it difficult to capture barcodes on its shipping containers and pallet stacks from varying distances. This customer upgraded to Zebra's recently released rugged extended range scanner that can read 1D and 2D barcodes from up close to up to 70 feet away. Zebra scanners were an ideal fit to streamline processes and increase reliability, particularly within the demands of a tough industrial environment. In another case, a global provider of water, hygiene, and energy services found it increasingly difficult to meet its service level agreements for tracking its customers' processes around the clock. By partnering with Zebra, they were able to aggregate data from multiple sensors, which can be analyzed and promptly make improvements and keep their processes operating efficiently. The Zebra solution has also enabled more accurate reporting and reduced inventory levels. These are just a few examples of how our unique solutions are increasing visibility, improving processes, and ultimately generating significant efficiencies across enterprises in the T&L, retail, healthcare, and manufacturing sectors. In conclusion, we remain confident in our long-term growth and profitability outlook for the company. Over time, we expect our focus on smart investments for growth coupled with our disciplined cost structure to unlock meaningful value for Zebra's key stakeholders. As shown on slide 12, we continue to expect annualized sales growth of 4% to 5% over a cycle and adjusted EBITDA margins of 18% to 20% by the end of 2017. Further, our commitment to pay down $300 million in debt in 2016 and $350 million in 2017 drives us closer towards our target net debt to adjusted EBITDA range between of 2 times and 3 times. In closing, we have an opportunity to transform how organizations operate and we have a dedicated, engaged and global One Zebra team that is motivated and excited to make it happen. With that, I'll hand the call back to Mike Steele. Michael A. Steele - Vice President- Investor Relations : Thanks, Anders. We've reserved the balance of the hour for Q&A. And we ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator, please instruct our callers how to ask a question. Operator : Thank you. We will now begin the question-and-answer session. [Operator Instruction] Our first question comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Yes. Good morning. Anders Gustafsson - Chief Executive Officer & Director: Good morning. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Could you speak for a minute or two just to, how the channel looks versus how your direct sales look? If I look at maybe the sales upside in the quarter, at least to our expectations, it came out of Enterprise, and I'm curious if that upside at Enterprise came from direct sales on the mobile computing side or maybe health of the channel, sell in, sell out, that type of color. Anders Gustafsson - Chief Executive Officer & Director: I would say the – I'll start and I'll ask Joe Heel to help out here also. I'd say our revenues were very balanced between channel and direct high-touch business. We had a large – a healthy number of larger deals, but we also had a very strong performance in our channel across the world, and we were particularly pleased with that as obviously introducing a new channel program with as much change as to one we did, and not see a hiccup in any of the performances was a great performance. So, we think that's a great win for us. Joe? Joachim Heel - Senior Vice President- Global Sales : Yeah. I would add, the channel constitutes 83% of our revenue. And such, the introduction of the new channel program was particularly important for us, and as Anders said, we're very pleased that we saw strength in the channel revenues while we were introducing that new program. So really, the channel very nicely complemented the strength of the large deals that we did see in Q2. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Was that strength kind of back end quarter loaded? I mean... Anders Gustafsson - Chief Executive Officer & Director: No. I think we would say the business in the quarter was pretty evenly spread. We had good momentum as we entered Q2 and it continued to just be I think, from our perspective, a solid quarter. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Okay. And this is just a follow-up question for Mike Smiley. In the $50 million of cost saved that we had forecasted for the year, I think $30 million of that was in – was targeted for the COGS line. When we look at the gross margin on the quarter, was that $30 million largely achieved on a run rate basis in the quarter? Michael C. Smiley - Chief Financial Officer : I would say over the first half of the year a lot of it was achieved. There's still some to be realized in the second half. Richard Eastman - Robert W. Baird & Co., Inc. (Broker): Okay. Thank you. Operator : Our next question comes from Paul Coster of JPMorgan. Please go ahead. Paul Coster - JPMorgan Securities LLC : Yeah. Thanks for taking my questions. First of all, Anders, you've – you obviously look to return to growth as soon as this fourth quarter but also over the long haul. There's many dimensions to growth. Is this from first-time adoption of a new generation of applications? Is it from market share gain? Is it from increasing the software content and raising the ASPs? If you could kind of give us some flavor of what you think the main vectors of growth are over the long haul; that would be helpful. Thank you. Anders Gustafsson - Chief Executive Officer & Director: Yeah. We see a lot of, I guess, first, strong secular growth trends that we're trying to capitalize on, starting from a vertical perspective, in healthcare. Healthcare has been a strong growth vertical for us for several years, and really, the catalyst has been the electronic health records, and we expect that there's still plenty of untapped potential within that vertical, particularly in the U.S. in the short term. But over time, we expect that to become more global. Transportation logistics has been a good vertical for us also over time. I think e-commerce continues to be a good driver, and we are for T&L also developing a lot of new and exciting solutions that are uniquely suited for T&L and to help drive more value for them. On the retail side, there's a – every retailer that we talk to has a big program around how to drive omni-channel or enable omni-channel. And in our view, omni-channel will be at least a neutral driver for us over time. But it might be a little more choppy in the short term as some retailers have more opportunities to invest than others. But we're seeing a lot of good opportunities or a lot of growth already from retailers that are adopting omni-channel type of strategies. So, if you think of, if you do Click & Collect or something like that in a store, it drives a totally different level of technology intensity around our products. And... Paul Coster - JPMorgan Securities LLC : I'm sorry. Anders Gustafsson - Chief Executive Officer & Director: And I'd say, maybe from a geographic perspective, Asia Pac continues to do very well for us. We think it's a, we have good opportunities to continue to do well there. We believe we're very well-positioned in Europe and the U.S. also, and we are programmed to reinvigorate growth in Latin America. It feels like it's also starting to pay off. And as a backdrop, I'd say, we are very excited about the new types of solutions we are developing around Enterprise Asset Intelligence to really help our customers get greater visibility into their operations to drive productivity improvements and enhancements to their service levels. Joachim Heel - Senior Vice President- Global Sales : This is Joe Heel. I'd like to add one more dimension to the sources of growth, and that is that we continue to be in the middle of and, in fact, driving technology transitions in three major areas. The first one is the transition in mobile computing from legacy operating systems that requires migration of operating systems. There's over 50 (35:32) million mobile computers that need to migrate off Windows CE and Windows Mobile platforms by the end of 2020. And as you know, we're leading that transition, we had a very strong market share position in that transition in the first half and even in the last year. The second is in scanning, where the transition from 1D to 2D scanning is one that we are now leading, and the third is in printing where the transition from – where the expansion into mobile printing is providing lots of new growth opportunities for us. Paul Coster - JPMorgan Securities LLC : I got more than I anticipated it. Separately, the – Anders, you talked to that, projects being delayed rather than being cancelled. In which verticals are they being delayed? And how are the customers – but why are they being delayed and how are the customers justifying it? I mean, assuming that they've got a three-year to five-year payback on these investments, delaying doesn't seem to make an awful lot of sense, but explain it to us, please? Anders Gustafsson - Chief Executive Officer & Director: Yeah. I think, it's a few different reasons for that. I'd say, Q1, it was a lot to do with budgets hadn't been fully allocated out to the business units. So, they weren't necessarily in a position to go forward with some of those projects. In Q2, I'd say, it was more that many of our customers were saying there were a lot of things going on and they needed to pull back and be more focused. So, they didn't want to take on more projects than they felt they could realistically execute on. So, they were being more, I guess, diligent about which ones they picked and focused on. And, I said, that was probably more from a retail perspective where there's a lot of things going on within retail around omni-channel activities. So, those would be the – probably the top priority thoughts around that. Joachim Heel - Senior Vice President- Global Sales : If I could correlate it with you. If you looked at the holiday season, which is of course, the key season for retailers, last year, it really was a very mixed season with some clear winners and some clear losers as you can say retailers that struggled to keep up. And as a result, as they entered into Q1, some of these retailers then went into introspection and reconsidered their plans for the coming year. That's not unusual, but because the Christmas season was so split in performance, I think it led to the reconsideration of some of the spending plans in Q1 in particular. Some of it spilling over into Q2 and the rest of the year. Paul Coster - JPMorgan Securities LLC : Thank you. Operator : Our next question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. Just a follow-up on the retail discussion. Would you say that the environment overall for spending in retail improved in 2Q versus Q1 or did it pretty much remain about the same? Anders Gustafsson - Chief Executive Officer & Director: No. It was definitely stronger. We saw good improvements, sequential improvement particularly in North America and it was both around traditional brick and mortar retailers, as well as e-commerce. And we certainly see e-commerce as a category to become more and more prominent within our overall retail category. Jason A. Rodgers - Great Lakes Review : And, can you give us an update on what was saved thus far with the ES integration and the expected savings for the second half of the year? Michael C. Smiley - Chief Financial Officer : Yeah. So, the full integration is expected to be completed in the middle of next year. I would say that we talked about the fact at the beginning of the year we saw $50 million of synergies coming through, of which $30 million was going to be cost of goods sold and $20 million was operating expense. Operating expense is primarily a full year impact of the things that were done last year. The cost of goods sold, as we said, a good chunk of it was realized in the first half, and we'll still realize some in the last half. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : Our next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, guys. Thanks for the question. Hey, Mike. What was the gross margin split between enterprise businesses and printing businesses this year – this quarter, I'm sorry? Michael C. Smiley - Chief Financial Officer : Obviously, our gross margin in our printing business is always – has been traditionally higher than it has been in the enterprise business. If you look at it, what we do is we do – you will see the Q, the operating income will come in that area going forward. I think one thing we want to make sure you realize is that we're very pleased with the gross margins in those trends. We're realizing the benefits of the cost reduction initiatives, associated procurement, design to value, service margin improvements, more favorable sales mix. We also have – gross margins within mobile computing were particularly strong. These are a result of, obviously, multiple quarter efforts. And we expect the trend to trend positively. I will say that we did see sequential improvement in the gross margin on the enterprise business, which I think was favorable. Keith Housum - Northcoast Research Partners LLC : Okay. We saw that the tax rate is changing for the year. Is there any change to your long-term guidance for that tax rate? I think you were previously between 22% and 24%. Michael C. Smiley - Chief Financial Officer : Yeah. I think it's going to be probably closer to 25%-ish long term, but it's not changed dramatically. Keith Housum - Northcoast Research Partners LLC : 20% this year and any thoughts to how it – I guess you scale up to 25% over the long term? Michael C. Smiley - Chief Financial Officer : Yeah. Keith Housum - Northcoast Research Partners LLC : I'm sorry. You got 20% this year, long term 25%. Is it going to go up sequentially every year for several years? How do you think we get to that 25%? Michael C. Smiley - Chief Financial Officer : Yeah, it'll go up sequentially every year. Keith Housum - Northcoast Research Partners LLC : Thanks. Operator : Our next question comes from James Faucette of Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. Just a couple of questions for me. First, I think you've talked about cost improvement being an important driver of gross margin. But I just want to make sure that – we were a little surprised with printing being weak that gross margins came in above target. Was that all related to the cost reduction efforts, or were there other mix or other items that really benefited that we should be aware of? Anders Gustafsson - Chief Executive Officer & Director: The – yes. Printing was slightly weaker from revenue year-over-year but it was due to a really tough comp last year. There was one particular deal that we couldn't replicate. If we had been able to replicate that we would have seen growth. But the margin profile across the business, though, is quite steady, and the improvements we see there is really, goes back to all the efforts we put into driving improvements in gross margin or reductions in cost of goods sold. So, we've had a very deliberate initiative around procurement and design to value also for printing, but also for our enterprise product since we closed on the transaction. And we're now starting to see those programs or initiatives starting to bear fruit. Service is another area that we put a lot of emphasis on improving margins, which is also nice to see that that's now coming through. James E. Faucette - Morgan Stanley & Co. LLC: Got it. And then when you look at – one of the key objectives, going back to the Motorola Enterprise acquisition, was looking for opportunities to sell multiple product lines into customers. Can you give us an updated idea of how successful you've been thus far and what your customer base looks like, that may be buying products, multiple product lines now that weren't before? Anders Gustafsson - Chief Executive Officer & Director: Yeah. I'll start and I'll ask Joe to help out also here. I'd say we have seen lots of good opportunities for our better-together story resonating. You can go – from a high level I look at healthcare. That has been a focused area for Zebra for a long time but not so much for Motorola. We have made healthcare a focused vertical for the entire business and we're seeing great growth for both mobile computing and scanning in there. And I'd say similar in retail, we are seeing new wins for printing in retail where we didn't have before. So, that's how – the strength we have on – from one part of the company across other verticals are helping to pull through business. I'd say also the examples that I went through in my prepared remarks, each of those examples are utilizing a number of different products, and all including both Enterprise and the pre-transaction Zebra printer products. Joachim Heel - Senior Vice President- Global Sales : Joe Heel speaking. I would add, we put a lot of emphasis early on in cross-training the sales force in order to be able to sell the entire portfolio and to implement initiatives and incentives that would indeed incentivize the cross-selling. I think it's fair to report that we are seeing good traction on that, not only in the examples that Anders included in the prepared remarks, but throughout our business, we regularly see deals where both printing and our Enterprise products are included. We are moving, in fact, I would say beyond that now to where we have – to where we are implementing solutions in our customers where we integrate those combinations of products into more of a solution. Indeed, some of the things that Anders described are examples of that. One other thought on the cross-selling, of course, I mentioned earlier that 83% of our sales goes through partners. So, in order for us to be successful with the cross-selling, it isn't enough that our own sales force does this, but also that our partners do this. And the new PartnerConnect program is in fact helping us to do this. If you look at the elements of the program, it provides incentives for cross-selling. It provides certifications for partners to acquire capabilities across our entire portfolio. And of course, we only launched it in April, but we're quite confident that it will help us in that ability to cross-sell. Anders Gustafsson - Chief Executive Officer & Director: Yeah. We're doing a lot of things to integrate the product families to work better together. So, initially, you can say there was almost like two separate products that were sold together as a bundle. But now, we've done things around how to make it easier to pair products. But also, we're now integrating our printer products into the OVS, our cloud-based services platform, to make sure that we can manage all products, irrespective of kind of the history of them, from one platform. James E. Faucette - Morgan Stanley & Co. LLC: Got it. Thank you very much. Operator : Our next question comes from Matt Cabral of Goldman Sachs. Please go ahead. Matthew Cabral - Goldman Sachs & Co.: Thank you. In your prepared remarks, Anders, you mentioned how Android is over a third of the mobile computing portfolio now. Can you just give us a sense for how customer interest has evolved around the transition, both with your larger customers, as well as the more run rate business? And when do you think we'll get to the tipping point where Android is more than 50% of that mobile computing portfolio? And then, also, just thinking about it from a gross margin perspective, any sense of how Android stacks up versus the wider enterprise average would be helpful as well. Anders Gustafsson - Chief Executive Officer & Director: Yeah. So, the – we're very pleased with the progress on expanding our Android business. We have the industry's most comprehensive lineup of products for that and we are getting a lot of recognition for that – for product superiority in that area also. I'd say, the largest most sophisticated customers are the ones that are leading the charge. They have their own IT department to understand what is going on with Android and Microsoft and other operating systems and can make their own decisions about what's really in their best interest over the longer term. And so, we see – I'd say, we almost exclusively see larger tenders be for Android devices. Further down, if you look into kind of more the smaller deals run rate type of business. There I think it's a bit more inertia that people know the products they have. They have written applications around those that they don't necessarily have the resources in-house to migrate those off a legacy operating system to an Android, say. So, we expect there to be a lag before that happens. But we do – we are seeing Androids having more and more traction deeper down in the pyramid, say. So, it is working and we are having a number of plans for how to engage with both directly with end-users, as well as with – through our distribution and reseller partners to educate and train both resellers and end-users on these things. And then lastly on the margins, if you look at – if you compare a large deal, say, for Android versus a large deal for a legacy operating system, the margins tend to be very similar. If you compare a run rate type of deal for Android versus a legacy operating system, they again would be very similar. So, the difference we've seen in margin profile between Android and legacy operating system has been much more driven by the proponent (50:31) or the portion of the total revenue that comes from large deals versus run-rate. Matthew Cabral - Goldman Sachs & Co.: Thank you. And then I wanted to follow up on the earlier question about deal push out. Could you just give us a sense for how many of the push out deals that you talked about last quarter's call were actually closed in the second quarter versus the percentage that are still outstanding. And is your sense of either just timing around some volatility with your customers' businesses or are these push outs more a function of a wider re-scoping of projects where they're going back to the drawing board a little bit, and then maybe a couple or a few quarters before those actually convert into deals for you? Joachim Heel - Senior Vice President- Global Sales : So, this is Joe Heel. I'll answer that one. We were very pleased with the fact that the deals that pushed out from Q1, we were able to close a majority of those. I don't have an exact percentage for you, but we were able to close a large number of those deals. That said, we do continue to see the caution that Anders mentioned, in particular in the retail sector and we've talked about it in some of the earlier questions. We do see some of that caution persisting. So, some deals in Q2, we saw push out to Q3. And so, we see some of that caution continuing. But we're quite confident, to your point, that it is a matter of timing and that it isn't that people are fundamentally reconsidering their architecture and their approach. I think they're weighing the projects in the context of an altered economic environment for themselves and an altered budgeting cycle that they perhaps find themselves in. Matthew Cabral - Goldman Sachs & Co.: Thank you. Operator : Our next question comes from Jeremie Capron of CLSA. Please go ahead. Jeremie Capron - CLSA Americas LLC : Thanks. And good morning, everyone. Michael C. Smiley - Chief Financial Officer : Good morning. Anders Gustafsson - Chief Executive Officer & Director: Hi, Jeremie. Jeremie Capron - CLSA Americas LLC : Question on the integration of the Enterprise business. Clearly, some good progress being made here between the new partner program and the cost synergies that are flowing through here. But I couldn't help but notice that you removed your guidance for one time integration charges in 2016, 2017. I think you had $130 million to $150 million planned. Is that still the case? And correct me if I'm wrong, but I think I heard you say that you spent more than initially anticipated during the quarter. So, some color around the trajectory of one time integration charges over the next couple of years would be welcome. Thanks. Michael C. Smiley - Chief Financial Officer : Yeah. This is Mike. A couple things to your point. We've achieved a number of significant milestones thus far. Again, the Asia Pac go-live went successfully as well as the PartnerConnect. Keep in mind that as we went through those within the region, we had a 10% growth. So, I think that speaks to the fact we had good execution. We've also rolled out aspects of our services program. So, all of those have been executed well. We look at sort of the integration spend in two buckets. One is IT-related, which is hooking up the systems to run the business. The other is non-IT or integration costs. The IT piece is on track and on budget at this point, and the non-IT expense was running about $20 million higher than the first half of 2016. We wanted to make sure that there was smooth execution. I think we've demonstrated that in the results that we have. Want to make sure that these things include the operating model by which we run the company, the legal entity structures. Again, this was a carve-out, very, very complex, structuring the PartnerConnect program to accomplish the things that are important for both us and our partners. We also had corporate rebranding as we move from a Motorola name to a Zebra name consolidated. Those types of things. I think it's important to note these additional costs that are non-IT are behind us. The integration expenses have peaked. We expect a step-down going forward, and we remain committed to a debt pay-down goals of $300 million in 2016 and $350 million in 2017. Jeremie Capron - CLSA Americas LLC : Great. Thanks for that. And in terms of the new Chinese e-commerce customer that you mentioned and there's, it sounds like it's an interesting win that you scored here. Can you comment around the opportunity for Zebra in China? How much runway do you see for growth and how much of that could be imminent given what's happening in that e-commerce sector in China? Thanks. Anders Gustafsson - Chief Executive Officer & Director: So, China has been a fast-growing market for us for a long time, and we have a very strong team I think in China. So, we're putting a lot of emphasis, a lot of effort into making sure that we have the right strategies for the long-term including making sure we have the products to support the Chinese customers. So, we are very excited about what China can do for us and how we can continue to grow in China. We've definitely seen our footprint expand over time, so when we first entered China, it was very much based on really Western manufacturing companies but over time we moved into a lot of the local manufacturing. But over the last few years we have seen a lot more retail particularly e-commerce as well as T&L, of course all those e-commerce packages need to be delivered somewhere. We've also seen actually quite strong healthcare growth. So, the portfolio of products we sell in China is now much broader, it starts to be much more similar to what we see in the U.S. and Europe as examples. Maybe... Joachim Heel - Senior Vice President- Global Sales : Yeah. I'd add two other opportunities for growth that we're pursuing and have been pursuing in China. It's been really a growth story that's extended over many quarters for us now. The two others are – is cross-selling. We talked about that a bit earlier. We have strength in different sectors between the pre-transaction Zebra and the Enterprise business. Enterprise, as Anders was saying, having charged into the retail segments, the e-commerce segments, fast-growing areas where the printing was very strong traditionally in manufacturing. We now have the ability and are in fact cross-selling between those two. So, that's one very nice source of growth. And then the other one is, we have the opportunity to expand geographically within China, right? So, you have multiple tiers of cities, we're quite present already in the larger cities like Shanghai and Guangzhou and Beijing. But the second and third tier cities are ones we are in the process of penetrating and staffing. And so, we have lots of growth in that dimension as well. Jeremie Capron - CLSA Americas LLC : Thanks very much. Operator : Our next question comes from Brian Drab of William Blair. Please go ahead. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks for letting me sneak in the question here. On Android, one-third of your mobile computing sales is a really impressive result going from essentially zero a couple of years ago. Given you've introduced these new products so recently, I'm wondering if there's an opportunity to improve your margins on those products going forward, just given the nature of when a new product is introduced, there's typically design work than can be done to take costs out of the product and improve your margins there. So, any comments on that opportunity? Anders Gustafsson - Chief Executive Officer & Director: Yeah. Absolutely. This goes into the broader initiative we have around gross margin improvements. So, both – we're working on both regular procurement activities. So, working very closely with our contract manufacturers or JDM Partners to make sure that we get the lowest product cost we can from that perspective. But we also, having a number of this, what we call, design to value initiatives going on. This is where we take an existing product and look at ways to how we can redesign it, to design cost out of the product to reduce the product cost and improve margins. Both of these initiatives were meaningful drivers for the gross margin over performance that we had in Q2 here, and that included also on Android devices. So, we see clearly working very hard to make sure that we are very thoughtful and focused on improving margins in our Android portfolio. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks. And then for Mike Smiley maybe, the selling and marketing expense has averaged $121 million over the previous five quarters. You're at $112 million in the second quarter. Where should we model going forward, closer to the $112 million or the $121 million? Michael C. Smiley - Chief Financial Officer : Yeah. I think that as you look at that, we tend to look at – we obviously have a bottoms-up detail and we'll end up with – for example, adjustments to stock-based comp and stuff like that it sort of goes up and goes down. So, we tend to look at the – as we look for reasonableness, we tend to look at it for a total OpEx trend. I think in Q3, we're seeing things that are driving our total OpEx going up a little bit is we have some duplicative IT costs that are going through G&A, where, for example, you have two systems that have to work at the same time until you get off the old one. We have higher litigation expense, we also have some higher healthcare costs. Absent these costs, our total OpEx would be lower year-over-year. I don't know that sort of giving you definition of OpEx for sales and marketing and all those other things would necessarily be helpful at this point. Brian P. Drab - William Blair & Co. LLC: Okay. That litigation expense is ongoing? Michael C. Smiley - Chief Financial Officer : Probably through this year. Brian P. Drab - William Blair & Co. LLC: Okay. All right. I'll follow up more later. Thanks. Operator : And our last question will be from Andrew Spinola of Wells Fargo. Please go ahead. Andrew C. Spinola - Wells Fargo Securities LLC : Mike, can you just tell us what that litigation expense is associated with and how big it is in the second half? Michael C. Smiley - Chief Financial Officer : It's just related to some of the litigation associated with the acquisition of – as we did the acquisition, we ended up with – assuming some of the responsibilities for some of those items. And it's just – it's not huge, but it's several million dollars quarterly. Andrew C. Spinola - Wells Fargo Securities LLC : Got it. And then just back on the question of the integration spend, the guidance would imply a pretty material step-down in the second half here. Can we still expect that? Michael C. Smiley - Chief Financial Officer : Yeah. Again, we had said I think around $130 million to $150 million for the full year. Our integration expenses have peaked. We said that our expenses for the year are about $20 million associated with the non-IT related spend. Again, to your point, we expect a big step-down going forward, and we certainly remain committed to the $300 million debt pay-down 2016. Andrew C. Spinola - Wells Fargo Securities LLC : Okay. Thank you very much. Operator : And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steel for any closing remarks. Michael A. Steele - Vice President- Investor Relations : Thank you, all, for participating. Have a great day. Operator : The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,016
| 4
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2016Q4
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2016Q3
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2016-11-15
| 5.342
| 5.423
| 5.916
| 6.083
| null | 9.85
| 10.71
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Executives: Mike Steele - Vice President, Investor Relations Anders Gustafsson - Chief Executive Officer Michael Smiley - Chief Financial Officer Joachim Heel - Senior Vice President, Global Sales Analysts : Richard Eastman - Robert W. Baird & Co. Matthew Cabral - Goldman Sachs & Co. Jeff Kessler - Imperial Capital, LLC Brian Drab - William Blair & Company Keith Housum - Northcoast Research Operator : Good day, everyone, and welcome to the Q3 2016 Zebra Technologies earnings release conference call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please also note that today’s event is being recorded. At this time, I’ll turn the conference call over to Mike Steele, Vice President of Investor Relations. Sir, please go ahead. Mike Steele : Good morning. And thank you for joining us. Today, conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Michael Smiley, our Chief Financial Officer. Anders will begin by discussing our third quarter highlights and key drivers of the results. Mike will then provide more details on the financials and discuss our outlook for the remainder of the year. Anders will conclude with an update on Zebra’s 2016 strategic priorities and progress on our vision of Enterprise Asset Intelligence. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company’s current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company’s filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You will find reconciliations of our GAAP to non-GAAP results in today’s earnings press release. Also, unless otherwise indicated, all year-over-year and sequential sales movements will be referred to on a constant currency basis. Now, I’ll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. We delivered another quarter of solid results. Our teams are executing well during a period of rapid change and transformation at Zebra. Sales were in line with our expectations. We delivered higher gross margins and we managed operating expenses well. We achieved an 18.7% adjusted EBITDA, representing a 140-basis-point improvement over the prior year and adjusted EPS of $1.43, which was above the midpoint of our expectations. Stronger profitability and effective balance sheet management enabled us to pay down $90 million of debt during the quarter and we feel confident about achieving our $300 million debt paydown objective for the year. As we have been discussing this year, our results have been impacted by an uncertain macroeconomic environment combined with slower IT spending, which has affected customer purchasing behaviors. However, we are encouraged by the sequential improvement in the overall business, and particularly the strong reception to our new products and solutions. Zebra’s unmatched positioning with customers and partners has enabled us to further extend our market leadership this year. Although we have seen pockets of increased promotional activity in the market, we have remained disciplined, yet flexible, in our approach. We are very comfortable with our channel inventory levels, which are within our normal historical bands. I’d like to touch on some of the bright spots of the quarter. We saw increased momentum in our transportation and logistics vertical, fueled by our new and innovative solutions and e-commerce expansion. Our services business has returned to growth after several years of contraction and we are continuing to see improving margins. We have experienced strong traction with PartnerConnect, our new channel program. Our partners are seeing the benefits of this program, which focuses on simplicity, cross-selling and partner profitability. We have added more than 2,000 partners since its launch and increased revenue through registered partners. Turning to our regions, North America performed in line with our expectations, with sales declining year-over-year, but increasing sequentially. During the quarter, we saw strength in retail on the back of e-commerce growth. Channel revenues for Android are gaining momentum as we had anticipated. We completed the third quarter with a solid backlog and expect further improvements through the end of this year. In the EMEA region, we reported higher sales than we did in the prior-year quarter. Pockets of softness in Southern Europe and the Middle East were offset by strength in Northern Europe. Asia-Pacific third quarter sales were down slightly compared to the prior year due to one-time concessions made to accommodate our distribution partners due to the impact of new duties imposed on printers imported into China. Mike will provide more detail about this shortly. In Latin America, revenue declines have moderated as our team has executed well in a challenging environment. We showed growth in printers, driven by targeted programs we implemented earlier this year. I'm pleased to report that, on October 28, we completed the sale of our wireless LAN business to Extreme Networks. Although it was a small part of our business, the divestiture allows for increased focus on our core business and enhances our growth profile. In fact, the wireless LAN business had a nearly 2% negative impact to total Zebra year-over-year sales growth for 2015 and a nearly 1% negative impact to 2016 sales growth for the first nine months of this year. Overall, we executed well during the quarter. While the operating environment remains challenging, our business trends have stabilized and Zebra is positioned well to further extend its leadership within Enterprise Asset Intelligence. This morning, we also announced the appointment of Olivier Leonetti, Chief Financial Officer. Olivier brings more than 25 years of experience in financial and executive leadership roles. Most recently, he served as Chief Financial Officer at Western Digital where he was responsible for all finance functions and played a critical role in the successful completion and integration of Western Digital's $16 billion acquisition of SanDisk. We are excited to welcome him to the team. At the same time, we want to thank Mike Smiley for his many contributions over the last eight years. During Mike’s tenure, Zebra has grown profitably and extended our industry leadership. He has also been instrumental in our efforts to improve cash flow and strengthen the balance sheet. I hope you will join me in wishing Mike well in all of his future endeavors. With that, let me turn the call over to Mike to review our financial results in greater detail and discuss our fourth quarter outlook. Michael Smiley : Thanks, Anders, for the kind words. It’s been an honor to serve as CFO at Zebra and I'm confident the company is well positioned for long-term success with Olivier as CFO. We have a strong finance team and look forward to working with him to help ensure an orderly transition. With that, as you saw in our announcement yesterday, we completed our financial restatement for the fourth quarter and full year 2015 and the first and second quarters of 2016, which corrected the cumulative impact of fiscal 2015 errors, primarily associated with the Enterprise acquisition. We previously disclosed approximately $11 million of these errors on our first and second quarter filings, which had increased 2016 expenses. As a result of the restatements, for 2015, when combined with corrections to income tax expense, the 2015 after-tax loss increased by $21 million. For the first six months of 2016, the after-tax loss decreased by $7 million. Note that the tax rate for non-GAAP purposes for the first six months of 2016 has been recast to align with our most recent full year 2016 estimated non-GAAP tax rate of approximately 26%. We have presented the non-GAAP impacts on the schedule posted to our investor relations website. Now, turning to our results, as you can see slide five, adjusted net sales for the third quarter were $906 million, approximately flat year-over-year price. Enterprise segment sales grew 1% to $605 million. Sales increased in data capture and services, while mobile computing sales were flat and wireless LAN sales were lower than last year. Pre-transaction Zebra sales were $301 million, down approximately 3%. Sales were lower in our locations solutions business and we provided a $7 million price concession to accommodate our distribution partners to minimize the impact of duties imposed this year on printers imported into China. The ongoing impact is expected to be up to $2 million on a quarterly basis. As Anders discussed, sales in North America declined approximately 2%. EMEA increased approximately 4% from a year ago, led by strength in mobile computing. Sales for Asia-Pacific declined 1%. As mentioned, the price concessions to distributors for printers negatively impacted growth by 6 percentage points. Approximately $5 million of the concession is one time in nature. As a result, we believe the region will grow in Q4 as the go-forward impact of any concession should be modest. A bright spot in this region was continued strong double-digit growth in Japan. In Latin America, sales declined about 3%, which is the largest decline in Brazil as a result of a continued difficult macroeconomic environment. Mexico has been doing well, delivering double-digit growth. Printer sales increased in Latin America due to improvements in our go-to-market strategy. Our adjusted gross margin of 45.9% was 50 basis points higher than the prior-year period, despite the negative impact of previously mentioned price concessions. We benefited from execution on our cost reduction programs and continued improvement in service margins. We're pleased with our operating expense management in Q3. The third quarter operating expenses include a $62 million non-cash write-down of goodwill and intangible assets triggered by the sale of our wireless LAN business. Excluding this one-time expense, operating expenses decreased $13 million as compared to the year-ago period. Specifically, sales and marketing and research and development expenses declined by a total of $12 million compared to the prior-year. General and administrative expenses were $7 million higher, primarily due to increased professional fees, IT and legal expenses. Professional fees have been elevated as we work on improving our tax and accounting processes and controls. Acquisition and integration costs related to the 2014 enterprise acquisition have been decline sequentially this year after peaking in Q4 2015. We expensed $28 million in Q3. We continue to expect a decline in spending through the completion of the integration process. We continue to make good progress with the integration and transformation of our business, which we plan to have completed midyear 2017. In the quarter, non-GAAP EPS increased to $1.43 compared to $1.39 in the third quarter of last year. The tax rate was higher than we forecasted, primarily impacted by changes related to profitability mix by legal entity as we integrate and restructure the business. Third quarter 2016 adjusted EBITDA margin was 18.7%, an increase of 140 basis points from 17.3% in the prior-year period, primarily due to higher gross margins and operating expense management. As a side note, Q3 EBITDA margins would've been approximately 3 percentage points higher using exchange rates as of the close of the Enterprise acquisition in October 2014. Turning now to the balance sheet and cash flow highlights on slide six. We ended the quarter with $163 million in cash, which includes $104 million held outside the US. At the end of Q3, we had approximately $2.8 billion of long-term debt in the balance sheet. Back in June, we successfully re-priced our $1.8 billion term loan, which is our largest tranche of debt, reducing the rate by 75 basis points. As a reminder, all of our debt is a result of financing the October 2014 Enterprise acquisition and we’ve been paying it down aggressively. Year-to-date Q3, we have made $235 million in total principal payments and our net debt to adjusted EBITDA ratio has decreased to approximately 4.4 times, which is down from 5.1 times as of the close of the transaction. Zebra has a strong liquidity profile. There are no near-term debt maturities and we have zero borrowings on our $250 million revolving credit facility. We drove significant improvement in cash flow. During the first nine months of 2016, we generated $245 million of cash flow from operations, more than double the $116 million in the first nine months of 2015. Additionally, our initiatives to repatriate foreign cash balances in a tax efficient manner have helped with our debt paydown objectives. Total capital expenditures were $49 million in the first nine months of 2016, a significant reduction from $87 million in the prior-year period. With respect to foreign exchange, approximately one quarter of our total company sales are denominated in euros and the vast majority of our costs are in US dollars, which exposes us to currency transaction risk from both a sales and earnings perspective. At the beginning of the year, we hedged approximately 80% of Zebra’s net euro cash flow exposure for the entire year, effectively locking in a €1.09 rate in order to minimize volatility in our financial results. Earlier this year, we implemented a rolling four-quarter hedging program, hedging into 2017. The British pound has sharply devalued since the Brexit vote in late June, but has not materially impacted our profitability due to a natural hedge of local expenses in that country. Our UK business represents only a mid-single-digit percentage of Zebra’s overall sales and performed well in Q3. Slide seven shows our path to financial deleveraging. Our top priority for cash flow and excess cash balance is to paydown the acquisition debt to achieve an improved capital structure and drive increased shareholder value. Excluding the impact of the October sale of our wireless LAN business, we expect to paydown $200 million of debt in 2016 and $650 million of debt over the 2016 and 2017 two-year period. We have an ultimate objective of a net leverage target between two and three times net debt to adjusted EBITDA. We continue to make steady progress towards this target, with our EBITDA growth and commitment to pay down debt. With respect to the wireless LAN transaction, we expect to net more than half of the $55 million gross sales proceeds after working capital price adjustments, severance fees, and taxes from the sale. We’re on track with the trajectory of the business we've been expecting since we last spoke on the second quarter results. On slide eight, you'll see, for the fourth quarter, we expect adjusted net sales to be down between 1% and 4% on a nominal basis from the net sales of $954 million in the fourth quarter of 2015. This expectation reflects a range of flat to down 3% on a constant currency basis. This outlook includes a negative impact of approximately 3 percentage points from the October divestiture of our wireless LAN business. We believe we can achieve sales growth on an organic basis. Fourth quarter 2016 adjusted EBITDA margin is expected to be in the range of 19% to 20%. Non-GAAP EPS is expected to be in the range of $1.65 to $1.85. Our outlook also reflects a higher gross margin compared to the prior-year period and in line with the third quarter. We also expect lower operating expenses due to strong expense management and the divestiture of the wireless LAN business. From a full-year perspective, our expectations for the business are largely unchanged. Sales are tracking close to what we had been expecting. Full-year adjusted EBITDA margins are expected to exceed 17%, up from 16.6% last year despite lower sales and an expected 40 basis point negative impact to EBITDA margin based on the year-on-year foreign currency changes. Interest expense and stock-based compensation expense remain in line with our prior outlook. We now expect capital expenditures be between $65 million and $70 million, which is tracking lower than we had expected. Depreciation and amortization expense is expected to be between $305 million and $310 million, which is slightly lower than our prior forecast due to the write-down of intangible assets associated with the sale of the wireless LAN business. We now expect the full-year adjusted effective tax rate of approximately 26%, which is higher than we previously forecast due to estimate changes related to profitability mix by tax jurisdiction as we integrate and restructure the business. Cash taxes are expected to be $70 million to $75 million this year, of which we have paid $70 million through Q3. With that, I now turn the call back to Anders. Anders Gustafsson : Thank you, Mike. We have made tremendous progress with integration to date and we have implemented several new programs focused on enhancing the combined business. As a result, I feel confident about the opportunities that lie ahead of us. As shown on slide nine, we continue to execute on our four strategic priorities to drive near and long-term growth and profitability. First, we remain focused on delivering profitable growth and extending our leadership as we capitalize on secular trends, drive sales and prudently manage our cost structure. In the last several months, we announced new offerings that better position Zebra as the leader in Enterprise Asset Intelligence. For example, we recently launched the TC51, our next generation handheld mobile computing device. As a mid-tier offering with an attractive price point, the all-new TC51 is proving to be another example of our leadership in the Android – in the transition to the TC51 operating system in our core use cases and verticals. It has a great form factor, including a large touchscreen, greater durability, better battery life, built-in enterprise grade scanning, and overall improved functionality. Zebra continues to enable Android for the enterprise environment with our software suite that simplifies device provisioning, lifecycle management, security, and operational visibility through our cloud-based platform. We are highly encouraged by the early interest we've received so far. Many customers are considering our enterprise-grade TC51 device to displace existing consumer mobile devices, which lack many of the key operational capabilities we offer. We also saw a return to growth in our services business with sales growth from increased service plan attach rates as well as gross margin expansion, stemming from our operational improvement strategies. Our services business had been underperforming since prior to the Enterprise acquisition two years ago. And new leadership in that business is driving strong execution and helping to improve our operational and financial performance. Second, we are prudently managing our overall cost structure through investment prioritization and maintaining tight controls on spending. Excluding the non-cash impairment charge we recorded during the quarter, we drove lower year-over-year operating expenses. Additionally, we’ve been driving savings from initiatives to reduce material, freight and overhead costs. Third, we continue to make strong progress on improving cash flow, optimizing operating cash levels and de-levering the balance sheet through working capital efficiencies, reducing integration and restructuring costs, improving margins, and reducing capital spending. Lastly, we recently celebrated the two-year anniversary of the acquisition of the Enterprise business. We're making meaningful progress on our transition to One Zebra as we complete the remaining steps of our integration plan – leverage the Zebra brand and establish the culture of the new Zebra. We've exited more than 75% of the transition service agreements with Motorola Solutions as we further integrate the Enterprise business and march towards the expected completion in the middle of 2017. As Mike mentioned, we’ve been making good progress and continue to ramp down integration spending. Moving to slide ten, Enterprise Asset Intelligence is giving a digital voice to our customers’ entire operation. Over the last six months, we have discussed Visibility that's Visionary, which enables our customers to see what is happening in their operations more clearly and make better decisions. Last quarter, we discussed how our vertical expertise, combined with our innovative solutions, is creating better opportunities for us to serve our customers across verticals. We have made excellent progress on fostering a culture of innovation that leverages our unique capabilities, which allows customers to increase their visibility throughout their operations. To that end, we recently announced the appointment of Tom Bianculli, the Chief Technology Officer of Zebra. This new role was a strategic move to align with our customers and address the increasing demand for our visibility solutions across the industries we serve. For many years, Tom has helped us successfully bring our innovative solutions to market. He is a proven leader and I'm certain his team will help ensure Zebra continues to drive the EAI category. At Zebra, we are enabling customers to make better real-time decisions to drive growth, enhance productivity, increase safety, and achieve a high level of customer service. We have a rich portfolio of sensing technologies, which puts us in an enviable position to offer our customers the optimal solution for their needs. Data is at the core of EAI value propositions. Tom and his team will help enhance our efforts to capitalize on the company-wide investments we're making in EAI to develop a common Zebra platform, data-driven applications, and advanced data science capabilities. Our Mobility DNA solution is a good example. Workforce mobility has been a megatrend at the epicenter of visibility for many of our customers. Mobility DNA transforms our devices into an enterprise-grade solution that increases productivity, simplifies management and eases integration with customer's IT systems. It is a more advanced enterprise mobility solution that enhances visibility into operations, which leverages an entire software ecosystem, formulated for our customers’ workforce. Sensing data, analyzing it for insights, and then mobilizing it to the right person to drive specific actions is fundamental to EAI and the core of our Sense-Analyze-Act framework. Many of our innovative solutions were borne out of relationships with our strategic customers such as our trailer load analytics solution, which increases load efficiencies in the T&L space. We are looking to replicate these unique offerings across other key verticals we serve. In retail, we partner with both brick-and-mortar retailers and e-commerce players. While we are serving brick-and-mortar retailers for their traditional technology needs, these customers are increasingly looking to Zebra for solutions that will enable them to execute on omni-channel fulfillment. This proposition is attractive for Zebra, not just at the store and warehouse, but in the last mile delivery of goods. To advance retailers’ capabilities, we are working with them to develop solutions to dramatically improve inventory accuracy levels, which is frequently a barrier to a successful omni-channel strategy. Zebra’s mobile solutions, such as the TC8000 handheld and our wearable product family are essential for our retail customers looking to implement complex omni-channel strategies. The Click & Collect process, for example, has additional layers of intricacies for retailers. While our solutions enable automation, human interaction is still critical at many points in the fulfillment chain and we are helping retailers with real-time visibility of inventory, efficient picking, staging and delivery to customers. e-commerce continues to grow at a fast pace and we are a key partner of the largest players. Our understanding of the complexities of slotting and picking items is imperative to provide the right solution to fit our customers’ needs. I'm more excited than ever about Zebra’s positioning in the market and our ability to take share and develop new and innovative solutions for our customers. In conclusion, we remain well-positioned for long-term success. As shown on slide 11, we continue to expect annualized sales growth of 4% to 5% over a cycle and to improve adjusted EBITDA margin to 18% to 20% on an annual basis by the end of 2017. As Mike mentioned, we believe we can return to organic constant currency sales growth in Q4 and gain momentum in 2017. We continue to expect gross margin improvement with the actions we've taken in 2016. Additionally, as we work through our operating plan for 2017, we will continue to ensure that our cost structure is lean and that our R&D investments yield an attractive return. Further, our top priority is to pay down debt and we continue to make good progress towards our target net debt to adjusted EBITDA range of between two and three times. And with that, I’ll hand the call back to Mike Steele. Michael Smiley : Before we go back to Mike, just a quick point, I mentioned that our full-year EBITDA margins are expected to exceed 17% for 2016. And that is actually up from 16.2% after the restatement from last year. So, it's an 80-basis-point improvement from 2015. Mike? Mike Steele : Thanks, Mike. And we’ll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator, please instruct our callers how to ask a question. Operator : [Operator Instructions] Our first question today comes from Richard Eastman from Robert W. Baird. Please go ahead with your question. Richard Eastman : Yes. Anders, could you please expand a little bit on your commentary around the verticals. You did mention, I think, some strength in retail, but could you just kind of touch on T&L, industrial and retail? Anders Gustafsson : Yeah. So, we saw, in Q3, particular strength in retail and T&L. Both of those were driven by e-commerce. There’s an underlying secular growth trend. T&L, we also saw great growth from some of our new solutions that we had introduced earlier this year. And both retail and T&L are very strong, I’d say, globally, but particularly North America, Europe and in Asia-Pac. Manufacturing, we've seen as a more flattish or slightly down in North America vertical this quarter, but we have a lot of new initiatives to help drive growth in manufacturing. As an example, we're looking to announce a relationship with Rockwell Automation where we are designing our products into their factory automation ecosystem much more closely, which will help both of us offer better solutions. Richard Eastman : Okay. And then healthcare probably grew, but small? Anders Gustafsson : Healthcare grew, but smaller this year. We had strong performance in printing, but we’re going through some product transitions on the EVM side, which held back growth a little bit. Richard Eastman : And then, just as a follow-up, I’m just a little bit curious, Mike Smiley, you had mentioned, again, this discount on imports into China. Just a couple of things. I presume that that $7 million falls directly to the gross profit margin line. And then also, don’t we produce all of our printers in China? Michael Smiley : Yes, good questions. So, the $7 million is really a – again, the $7 million is a duty that our partners are paying as they import printers into China. And so, what we’re doing is giving a price concession to offset that 8% charge that they receive. Now, as we mentioned, so when you look at how that falls in the P&L, you’d end up with – for whatever you sold, there would be – we sold $7 million less because of the price discount. And, obviously, that would affect our margin. We expect sort of – as you looked at the China duty, there was a one-year clawback that we had to pay. So, of that $7 million, roughly $5 million or so is related to the prior year. We really expect basically $2 million a quarter ongoing. And, again, the $5 million was a one-time in Q3. I don’t know Anders if you want to add any more color. Anders Gustafsson : Yeah. We felt it was in our best interest of our customers to make the end users be neutral to this, so we wanted to basically mitigate the impact of the duties that our distribution partners pay. We are now working on ways to minimize the impact of these duties. So, on a going-forward basis, we expect them to be up to $2 million, but, hopefully, we can get them to be a little bit lower than that and we have a number of ways of doing that, including how we structure our own manufacturing in China. Michael Smiley : So, Rick, to your question, we do manufacture in China, but it’s in a duty-free free trade zone. So, as a result, it’s effectively as if we were manufacturing outside of China from a duty standpoint. Richard Eastman : I see. Okay. All right, very good. Well, thank you and nice quarter. Anders Gustafsson : Thank you. Michael Smiley : Thanks. Operator : Our next question comes from Matt Cabral from Goldman Sachs. Please go ahead with your questions. Matthew Cabral : Yeah, thank you. Anders, I think I heard in your prepared remarks that channel momentum for Android is going well. Just curious if you could expand on that comment a little and give us an update for how Android is doing both within the channel as well as for larger deals. And I think in the past, you had given the split of how the Android business breaks down between the two. It would be helpful if you could provide that again. Anders Gustafsson : Yeah. So, our market share, overall, for mobile computing, has increased a few percentage points this year and our market share for Android specifically is substantially higher and it's been stable at those levels. We see the majority of large deals today in mobile computing to be for Android-based devices – or Android-powered devices. What we have started to see now in the last couple of quarters is a nice improvement in what we think of as the run rate in the channel. So, these are smaller deals where our channel partners are primarily driving the – identifying those opportunities and closing those opportunities. So, the trend that we had talked about sometime back of – that, over time, Android becoming a bigger part of our channel revenue stream is starting to happen. Matthew Cabral : Got it. And then you guys had talked earlier in the year about some deal push-outs that you were seeing, just wondering how those projects are developing. And maybe more broadly, curious how the environment was for large deals, both in the third quarter and what you see ahead in the fourth quarter. Anders Gustafsson : I think we had a healthy pipeline of large deals. I wouldn’t say there was a heavy type of environment, but it was certainly much more normal than what we saw in the first half. And as we look into Q4 and the pipeline into 2017, I think we are – the pipeline of opportunities for larger deals continues to be healthy. And maybe, Joe Heel, you want to comment also? Joachim Heel : Yes. This is Joe Heel speaking. So, we did see some push-outs of deals as you were mentioning in the earlier quarters. In this quarter, that activity of push-outs has moderated a bit. We still see it, consistent with what we talked about earlier in terms of our expectations, but it has moderated. And it's also positive for us that the ones that have pushed out in previous quarters have all closed. So, we do see it as a delay, not a loss or decline. Matthew Cabral : Thank you. Operator : Our next question comes from Jeff Kessler from Imperial Capital. Please go ahead with your question. Jeff Kessler : Thank you. Referring to your chart on page ten, can you tell us how far into the Enterprise Asset Intelligence – the vision that you have is relative to how far you've gone? You’ve got another year to go to or, let’s say, another nine months to complete the integration. How are the two measuring up, so that you’re going to speak with one voice and provide multiple products and multiple services to your end user clients? Anders Gustafsson : Yes. I would probably separate the integration from the Enterprise Asset Intelligence vision and strategy. From an integration perspective, we are working on integrating our back-office IT systems. That's really primarily what is left of our integration activities. They have very little impact on our Enterprise Asset Intelligence vision. So, when it comes to EAI, I feel we're making very good progress. I think we have developed a compelling vision for it. It certainly resonates very well with our customers. I feel very confident in our EAI strategy overall. And as I say, we are clearly the leader in that space with an unmatched portfolio of products and solutions. We continue to drive a lot of value-adding innovation that is resonating very well with our customers. We are bundling product, software and services into solutions much more now than what we had done before. And our focus is very much on how we can leverage our Sense-Analyze-Act framework to help our customers transform how they operate, transform their workflows, improve their productivity, and drive much greater levels of service. And I’d say, at this stage, I don't think any other competitors can really offer that value proposition. Joachim Heel : I’d like to add one thing. From an integration perspective, you probably have noticed that we integrated the customer-facing aspects of our business very rapidly. We integrated the sales force in January of the very first year. We integrated our partner program in April of this year. So, from a selling and customer-facing perspective, we have been in front of our customers with the Enterprise Asset Intelligence strategy very visibly. The remaining pieces of the integration are, as Anders said, back-office and our IT systems, which don’t impede us from realizing the strategy in the marketplace. Jeff Kessler : Related to the integration, how are you coming along? And, I guess, this is perhaps on some of them on the services side being able to take the information that you are gaining from your customers, analyze it, providing them with more feedback on their own needs and their own operations, so that you get this virtuous circle of, if you might call it, value proposition, so you can become – get more profits out of your customers. Anders Gustafsson : We’ve done a lot of things to help get both more efficient in the execution of our services business as well as getting a more easy way of gaining insight into the data streams that we have. In Q2, we integrated the Asia-Pac services business on to one common systems, so we got off the Motorola system and we have been working there now for, I guess, about six months on a single platform. We've also more recently exited the Motorola platform for Latin America. And middle of next year, we expect to do the same for the rest of the world. So, we are now having the IT infrastructure around IT to enable us to take advantage of all the data that we have. We are looking at the number of other data streams or information in order to help be proactive in our sales activities and identify opportunities for upsell or when somebody's contract is about to expire. And I’ll ask Joe Heel to add some comments also. Joachim Heel : Yeah. I think this is an excellent example of where we use some of the assets that we have to realize the Enterprise Asset Intelligence strategy early on. We have a platform that we've been building out aggressively since the early days of the integration, which was called our Assets Visibility Platform. And this platform is cloud connected to all of our devices, at least to the extent that our customers turn that on. They do have the option of doing that. And it allows us to gather data in real-time from all of those devices and use it both for the purposes of service; it also allows us to offer to our customers visibility, instant real-time visibility to all of their assets, which, as you can imagine, is quite valuable to them and is at the core of a strategy around offering managed services both on our part as well as on the part of our partners, who are, of course, in the business of supporting the customers’ estates. Our vision is that this platform of asset visibility can be used beyond just the provisioning of service to our own devices. You can imagine many other uses that it could serve in a customer’s data management strategy. So, this is a very central part and a key differentiator that we, in fact, have in Enterprise Asset Intelligence through services. Anders Gustafsson : Yeah, that’s helpful. Jeff Kessler : Thank you. And have you just – obviously, you’ve just started on this. Do you have any definitive traction in this yet? Joachim Heel : Yes, indeed. We do. So, we offer two types of services, which customers are actively buying today. We have many contracts on these today. One is called Asset Visibility Services and the other one is called Operational Visibility Services. And the way you can imagine it is Asset Visibility Services is a relatively light cloud-based dashboard that we can make available almost instantly to a customer if they buy our devices, and that goes for printers and mobile computers, by the way, that they can instantly get visibility on a simple dashboard. Whereas OVS is a more heavy service offering, in which we then can manage certain aspects of a customer's estate. For example, give them visibility to when batteries need to be replaced or print heads on a printer require renewal. That more intensive service-driven offering is called OVS. Both are in the market, being sold today to customers. Jeff Kessler : Okay, great. Thank you very much. Appreciate it. Thank you for taking my questions. Anders Gustafsson : Sure. Operator : Our next question comes from Brian Drab from William Blair. Please go ahead with your question. Brian Drab : Hi, thanks. First, just going back to the Android question. I might have missed it. But did you say what percent of revenue – in the third quarter, what percent of your mobile computing sales were Android? Anders Gustafsson : We have not broken that out historically and I think it’s just – we said that it's been a growing part of our portfolio and it is – I guess, directionally, you can say it's getting towards being half of our revenues. Brian Drab : Okay, thanks. Am I incorrect in my notes here, on the last call, we said it was about a third of revenue in the second quarter, though. Anders Gustafsson : I think that's probably correct. Brian Drab : Okay, thanks. And then I just wanted to see if we could get, from a high level, an update on this upgrade cycle that you’ve discussed extensively in the past. Going through 2020, I think, the feeling was that you have 15 million or so devices globally in the field that need to be upgraded. Is that, at this point, being pushed out a little bit or how are we progressing toward that type of a target? Anders Gustafsson : I think the overall upgrade cycle that we talked about is progressing pretty much in line with our expectation. We started about a year-and-a-half ago to see more of the larger deals. Today, I think pretty much all our larger deals tend to be Android-based. But we also started to see now this trickle down into the run rate business that our channel is conducting. Will there be a tail that goes beyond 2020? I am sure there will be some customers that will not see the need to upgrade and they are just going to run those devices for as long as they possibly can. No upgrades to them, I think. But I would expect that that will be a very small subset. Most larger organizations, I think, will feel, they want to be on supported software platforms, so they can get both security patches and other upgrades to their environments. And so, broadly, I would say that the Android migration is progressing pretty much in line with how we expected it. Joachim Heel : Yes. And Joe Heel speaking. I think the Android migration or operating system migration more broadly is a little bit unusual from other technology transitions because it's driven by an end-of-life of an existing predominant technology, right, Windows CE, Windows Mobile in 2020. Therefore, it doesn’t only depend on customer's perception of the new technology, it depends also on their expectation for how long they can continue with the existing technologies. So, as Anders said, it’s led to a massive wave of early adopters that you have seen and there is a second wave of adoption, which is the broader market, the market that has served predominantly to channels that is occurring right now. And we do see that pretty much as we had expected happening, as we speak, and it will continue over the course of these next three years. Brian Drab : Okay, got it. Thank you. And then, can I just ask, on RFID, for an update there in terms of roughly what kind of revenue that is today, how that is evolving, how the pricing has come down there and made it more economical for more applications? Anders Gustafsson : Yeah. So, RFID continues to be a small, but healthily growing product set for us, solution set for us. Retail is the primary vertical to adopt RFID today. And the use case is primarily around in-store inventory visibility. So, retailers putting RFID inlays and chips on the merchandise. We are not really in that business much. That’s others to serve. But the price curve has been very aggressively coming down. And today, in volume, you can get a chip like that for between $0.05 and $0.07. We are focused on encoding those RFID chips with the right data as well as reading the data off those chips through either mobile or fixed infrastructure. And that's healthily growing, but it’s still a small part of our business. Brian Drab : Okay, thank you. Operator : Again, our next question comes from Keith Housum from Northcoast Research. Please go ahead with your question. Keith Housum : Good morning, guys. And first off, Mike, good luck to you. I wish you the best of luck in your next endeavors. Michael Smiley : Thank you. Keith Housum : Following up on the previous question regarding Android, I’m starting to see the Windows 10 mobile computers hitting the market. What’s the though in terms [indiscernible] evaluate the Android or how you think about Windows sequentially [indiscernible] with the market. Anders Gustafsson : So, so far, I think Windows 10 has been primarily on the desktop, not so much on the mobile. There’s been some changes, I think, on the architecture that's been harder to – for customers to adopt a Windows 10 platform. But from our perspective, we want to have the right solution for our customers. So, we would also expect to have Windows 10 devices available when that makes sense, when the Windows technologies are ready. So, we see it as likely going to be one predominant, but a second technology or operating system available for enterprise customers and we want to serve both. Keith Housum : Okay. Go ahead, I’m sorry. Joachim Heel : Well, I just wanted to mention if you look at our product lineup, you'll see that on the very high end of our mobile computing, on PC75, we now have a Windows 10 or Windows IoT, it’s also called, version now, and the same is expected on the tablet. So, you'll see that, in relevant parts of our portfolio, we will have Windows 10 for those customers who want it. Keith Housum : Got it. As a follow-up, Anders, you mentioned a promotional environment. Clearly, in one of your competitors, we saw more than that – than yourselves. Can you talk about where you saw the promotional environment and what part of the business and did you see that throughout the quarter or was it stronger at the beginning of the quarter versus end? Anders Gustafsson : I think it was more steady. I don't think we saw it being particularly strong in any point in the quarter. So, it's more of a – something that's going on in – almost in the background. It’s part of the environment. And we are trying to take a very disciplined approach to how we respond to it, but we also want to be flexible to make sure that we do respond appropriately to win deals, but do it at the appropriate margins for us. Keith Housum : Was it heavier in the enterprise business versus printing? Anders Gustafsson : Maybe a little bit. Keith Housum : Okay. Thank you. Appreciate it. Operator : And, ladies and gentlemen, at this time, we’ve reached the end of today’s question-and-answer session. I would like to turn the conference call back over to Mr. Steele for any closing remarks. Mike Steele : Thank you all for joining us today. Have a great day. Operator : Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,017
| 1
|
2017Q1
|
2016Q4
|
2017-02-23
| 5.45
| 5.45
| 6.197
| 6.35
| null | 11.48
| 13.31
|
Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: James E. Faucette - Morgan Stanley & Co. LLC Richard Eastman - Robert W. Baird & Co., Inc. Jason A. Rodgers - Great Lakes Review Saliq Jamil Khan - Imperial Capital LLC Brian P. Drab - William Blair & Co. LLC Matthew Cabral - Goldman Sachs & Co. Keith Housum - Northcoast Research Partners LLC Paul Coster - JPMorgan Securities LLC Michael Morosi - Avondale Partners LLC Operator : Good day and welcome to the Fourth Quarter 2016 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our fourth quarter highlights and key drivers of the results and progress made in 2016. Olivier will then provide more detail on the financials and discuss our outlook for 2017. Anders will conclude with discussion of Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation. Also, our financial results include the divested wireless LAN business through October 2016. In this presentation, our references to organic sales growth for the consolidated company, the Enterprise segment, our services business and all regions are in a constant currency basis and exclude the sales results from the wireless LAN business in both 2016 and the prior year. Now, I'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. As you see on slide 4, we delivered solid results in the fourth quarter, thanks to strong execution by our team and disciplined cost management. For the quarter, we reported net sales of $944 million at the high-end of our guidance range, with organic growth of 3.5%. We drove gross margin expansion and reduced operating expenses. And we achieved a 19% adjusted EBITDA margin, reflecting a 310 basis point improvement over the prior year, resulting in non-GAAP EPS of $1.93, a 48% increase from the prior year period. A few additional highlights during the quarter include solid growth in our largest region, North America, led by strength in retail; a record quarter in our mobile computing, led by the strongest product launch in our history with our new TC51 Mobile Computer; a return to growth in our printing business; and sales growth in our Latin America region in a very challenging macroeconomic environment. For the full-year, we paid down $382 million in debt, significantly exceeding our goal of $300 million. This was driven by increased earnings, excellent working capital management and proceeds from the sale of our non-core wireless LAN business. As a result, we are well on our way to exceeding our two-year goal of $650 million in debt pay-down. We have seen steady improvement over the past year. We returned to organic sales growth in the fourth quarter after a challenging start to 2016, while also driving improved profitability and cash flow. At the same time, we have been extending our leadership position by continuing to deliver innovative solutions that create value for our customers. As shown on slide 5, our improved performance was a direct result of the successful execution of our strategic priorities in 2016. First, we gained market share and grew margin and profits in an improving global environment, while also prudently managing our cost structure. While we have seen pockets of elevated promotional activity, we have remained disciplined yet flexible in our approach. In our services business, we delivered solid gross margin expansion and low single-digit organic sales growth by successfully executing on our operational plan. Zebra's positioning with customers and partners remains unmatched. We announced a number of new offerings that further differentiated us as the leader in Enterprise Asset Intelligence or EAI. Key introductions throughout the year include refreshed and strengthened mobile computing and data capture devices for warehouse, storefront and field mobility use cases. These devices have enhanced capabilities and applications that enterprises require to optimally run their operations. Our mobile devices are supported by Zebra's Mobility DNA suite, which layers enterprise-rich features on top of the standard Android platform. As a result of our early strategic investments in Android, we are ahead of the competition and have the broadest portfolio in the industry. Today, nearly half of our mobile computing shipments are Android-based devices. With more than 14 million legacy Windows-enabled mobile computers in the market today, Zebra has a significant opportunity to gain additional share over the next several years, as Microsoft phases out support of its legacy mobile operating system. In 2016, we launched Asset Visibility Services or AVS as an extension to our OneCare managed service portfolio. Designed to increase mobile computer and printer performance, AVS offers insight into device health, utilization and availability, resulting in increased productivity and operational efficiency. We also introduced Trailer Load Analytics, which enables our customers in the transportation and logistics space to monitor and optimize load efficiency. Second, we continue to successfully manage our overall cost structure through tight controls on spending. With regard to our investment in the business to drive growth, we have employed a disciplined R&D process focused on identifying opportunities with the highest potential to strengthen our core portfolio and EAI solutions. Third, we made excellent progress on improving free cash flow, lowering operating cash levels and retiring debt balances. Finally, we are harnessing the strength of the Zebra brand to further extend our leadership position in EAI, and we are delivering on our financial objectives. Upon execution of our global ERP implementation, which is scheduled for mid-year, our transition to One Zebra will be complete. With that, let me now turn the call over to Olivier to review our financial results in greater detail and provide our 2017 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. It is a privilege to be part of the Zebra team and its long successful history. I am excited about the opportunities in front of us. As a reminder, all references to organic sales growth for the consolidated company, the Enterprise segment and all regions are on a constant currency basis and exclude the sales results from the wireless LAN business in both 2016 and the prior year. Let us begin with a walk through the P&L. As you can see on slide 6, adjusted net sales in the fourth quarter were $944 million, up 3.5% on an organic basis. Solid fourth quarter sales performance was driven by our innovative portfolio resulting in strength across most regions. Enterprise segment sales of $617 million increased approximately 4% on an organic basis. Sales on mobile computers increased due to strength in retail and demand for our new devices. Pre-transaction Zebra sales were $327 million, up approximately 3% on a constant currency basis. As Anders highlighted, we returned to growth in printing in Q4, led by solid growth in mobile printing. Sales of supplies were higher, while sales in our location solutions business were lower. Turning to our regions, organic sales growth in North America was 6%, driven by strength in mobile computing, mobile printing and services. We saw particular strength in retail. EMEA sales decreased 2% from a year ago on an organic basis. While underlying trends were solid, we cycled a significant sale in the prior year period to a large customer in the UK. Sales in Asia Pacific were up 5% on an organic basis, including the adverse impact of the previously communicated printer price concessions of nearly $2 million. We also continued to see strong growth trends in China. As Anders highlighted, Latin America sales increased 12% on an organic basis, which was a sharp reversal from the steep year-on-year decline during the first three quarters of the year. This was driven by strong growth in Mexico, resulting from our team's efforts to stimulate growth in a very challenging environment. Adjusted gross margin of 46.1% was 90 basis point higher than the prior year period. We benefited from our continued focus on cost reduction and additional improvement in services margin. Adjusted operating expenses declined by $24 million, primarily due to the benefit of our productivity initiatives and expense controls, as well as the sale of our non-core wireless LAN business. Fourth quarter 2016 adjusted EBITDA margin was 19%, a 310 basis point increase from 15.9% in the prior year period. This was driven by higher gross margins and disciplined operating expense management, partially offset by approximately 10 basis points due to foreign currency impacts. Finally, it is worth highlighting that our full-year 2016 EBITDA margins will have been approximately 3 percentage points higher using currency rates as of the Enterprise acquisition in 2014. Non-GAAP earnings per diluted share increased to $1.93 in the fourth quarter compared to $1.30 in the prior year period. A lower tax rate impacted by tax adjustments and changes in profitability mix by jurisdictions positively impacted fourth quarter 2016 non-GAAP EPS by approximately $0.16. Acquisition and integration cost related to the Enterprise acquisition declined throughout 2016. We expensed $27 million in Q4 and expect continued sequential declines in spending through the first half of 2017 as we complete the integration. For the second half of 2017, we expect integration expenses to be minimal. Turning now to the balance sheet and cash flow highlights on slide 7, we ended the fourth quarter with $156 million in cash, which includes $98 million held outside the U.S. Zebra has strong liquidity and no borrowings on our $250 million revolving credit facility. At year-end, we had $2.6 billion of long-term debt on the balance sheet, which is 65% fixed rate, including nearly $700 million of floating to fixed LIBOR swaps against our term loan. In December, we successfully completed our second repricing of the year on our $1.7 billion term loan, reducing the spread by an additional 75 basis point and saving approximately $13 million of annualized interest expense. Strong cash flow, repatriation of international cash and net cash proceeds from the sale of the wireless LAN business enabled $382 million in principal payments on our term loan during 2016. Our net-debt-to-adjusted-EBITDA ratio decreased to 4 times as of year-end, down from 5.1 times as of the close of the Enterprise acquisition. Capital expenditures were $77 million for the full-year 2016, down from $122 million in 2015, primarily due to lower spending on integration and real estate. We generated $295 million of free cash flow in 2016, which was a significant improvement from the prior year. The key drivers of this improvement were working capital optimization, reduced integration and restructuring cost, improved margins and lower capital spending. With respect to the wireless LAN transaction, we netted $29 million of cash proceeds in the fourth quarter after transaction fees, escrow, taxes and other adjustments. With respect to foreign exchange, for 2017, we implemented a rolling four quarter program to hedge the euro in order to mitigate the impact of exchange rate volatility. As a reminder, approximately one-quarter of our total company sales are denominated in euros, and it is the only currency where we have material exposure to sales, profitability and cash flow. Slide 8 shows our path to financial deleveraging. We expect to exceed our original goal of $650 million of debt pay-down for the 2016 and 2017 two-year period. Our top priority for cash flow and excess cash balances is to aggressively pay down the acquisition debt to achieve an investment grade credit rating. We entered the first quarter of 2017 with a solid sales backlog and healthy pipeline of opportunities. These facts, along with the assumption of the continuation of a gradually improving macro environment, give us cautious optimism for our outlook. On slide 9, you will see that for the first quarter of 2017, we expect the change in adjusted net sales to be between negative 2% and positive 1% on a nominal basis. Organic sales growth is expected to be between 3% and 6%, which excludes the adverse impact of 4 percentage points from wireless LAN, as well as the adverse impact of 1 percentage point from changes in foreign currency rates. We expect organic sales growth to moderate through the balance of 2017, considering the year-over-year comparisons to our improving results through 2016. First quarter 2017 adjusted EBITDA margin is expected to be approximately 17%, which assumes flat to higher gross margin and lower operating expenses relative to the fourth quarter of 2016. Non-GAAP diluted EPS is expected to be in the range of $1.20 to $1.40. For the full-year 2017, we expect low single-digit organic sales growth. This outlook exclude the adverse impact of 3 percentage points from wireless LAN, as well as the adverse impact of 1 percentage point from changes in foreign currency rates. Full-year 2017 adjusted EBITDA margins are expected to be in the range of 18% to 19%, including an 80 basis point adverse impact from year-on-year foreign currency changes. Our full-year outlook assumes slightly higher gross margin rate compared to the prior year period due to continued productivity improvements, offset by impacts of foreign currency changes. We also expect lower operating expenses due to cost efficiencies, as we complete the integration of the company, as well as from the sale of the wireless LAN business. For 2017, we expect debt pay-down to exceed free cash flow and to be back-end loaded in the year. Our goal is to pay-down at least $300 million of debt, which is supported by higher EBITDA, lower integration expenses, lower interest cost and reduced cash balances required to operate the business. Our teams made great progress in 2016 to optimize cash conversion metrics. However, we do not expect working capital to be a source of cash this year. Please reference additional full-year 2017 modeling assumptions on slide 9. With that, I would turn the call back to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. In 2016, we successfully completed our planned integration milestones, executed in a challenging global environment, extended our market leadership, and ended the year in a position of strength. We are staying ahead of an evolving technology landscape through focused investment and close collaboration with our customers and partners. Building on this strong foundation, we are focused on several areas to further solidify our leading positions globally and to drive growth. First, we are leveraging our scale, innovation and relationships with customers and partners to extend our leadership with the most innovative portfolio of Enterprise solutions and sensing technologies in the market. Second, we are advancing our Enterprise Asset Intelligence vision by capitalizing on key technology trends and leveraging Zebra's deep knowledge of the markets we serve. Third, we are executing on the final phase of the Enterprise integration, which includes harmonizing and streamlining back-office systems and processes. And fourth, we are enhancing Zebra's financial strength by increasing profitability, improving cash flow and optimizing our capital structure. Now, turning to slide 11, connecting the physical and digital worlds to increase visibility into business operations and workflows is the essence of the Intelligent Enterprise. We are uniquely positioned to capitalize on this opportunity by leveraging our deep market expertise and key megatrends such as mobility, cloud computing and the proliferation of smart devices. According to industry experts, within three years, 30% of hospitals will be running on real-time healthcare systems that will leverage location, identification and mobility for clinicians, patients and assets; 15% of global retail sales will occur online, requiring new fulfillment solutions, such as our industry-leading wearable computing and picking solutions; more than 40% of the global manufacturing workforce will be comprised of mobile workers that need access to real-time data to run their operations; and 15% of shipments within T&L will be instant delivery, requiring new levels of visibility throughout their transportation networks. Our solutions directly address these trends and will provide a significant source of growth for us. Slide 12 highlights the key industries we serve. In 2016, we launched a number of solutions that transformed the way our customers do business to enable a more Intelligent Enterprise. Our software, services, analytics and hardware are used to connect customers' assets, systems and people, giving their entire operation a digital voice. As a result, we have increased strategic engagement with customers, which is translating into new growth opportunities for Zebra. For example, in retail and e-commerce, we are seeing transformation driven by several trends including mobility, inventory visibility and multi-channel fulfillment. These trends have the common thread of delivering on increased customer expectations. Both online and brick-and-mortar retailers realize the vital need to invest in technology that provides the improved levels of visibility and functionality necessary to thrive in an evolving environment. A recent Zebra survey highlighted the increasing demands of the retail shopper. We found that nearly two-thirds of shoppers are willing to make purchases from stores that provide better customer services and more than 40% of shoppers agree that they have a better experience in stores where sales associates use the latest technology to assist customers. This means retailers need to delight their customers and equip their associates with the tools necessary to provide better in-store experiences, including real-time inventory visibility. Our solutions are doing just that. At the National Retail Federation Trade Show in January, we launched a revolutionary new EAI solution for the retail sector called SmartSense. This solution leverages multi-technology sensors, a data analytics engine and applications to identify and track the journey and location of merchandise, as well as associates and shoppers. SmartSense enables our retail customers to increase sales, deliver a superior omni-channel experience, and reduce, shrink, theft and operational costs. Outside of retail, Zebra's recent Warehouse Vision Study found that more than 40% of respondents cited the need to reduce delivery times as a top driver of investment in their supply chain. This could include a wide variety of Zebra solutions. In healthcare, patient identification and timely treatment are critical success factors. Smart, non-invasive technology that provide hospitals real-time tracking, evaluation and feedback is crucial to enable better patient outcomes. In closing, our 2016 performance underscores our ability to extend our leadership in the market in any macroeconomic environment. The real-time visibility that Zebra solutions provide is a key competitive differentiator for us. They enable our customers to improve their operating efficiency, comply with regulations and deliver a superior level of customer service. We are well positioned to meet our objectives in 2017 and beyond. We are excited by the opportunities ahead to drive value to our customers and for our shareholders. Finally, I would like to conclude by thanking our employees for their strong commitment and many contributions to help us realize our One Zebra vision. And with that, I'll hand the call back to Mike Steele. Michael A. Steele - Zebra Technologies Corp.: Thanks Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator, please instruct our callers on how to ask a question. Operator : Thank you. We will now begin the question-and-answer session. Our first question comes from Jeremie Capron of CLSA. Please go ahead. Jeremie, your line is now open. Our next question comes from James Faucette of Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. I just had a couple of questions. First, it seems like the business is accelerating pretty nicely or at least showing good on December quarter-end and initial outlook for both the hardware and printing businesses on the back of new products and initiatives. Can you talk about how you're thinking about the evolution of that growth and prospects as we go through 2017? I'm just trying to understand what's built into your guidance and formulation of it. And then, the second question is, longer term, how are you thinking about the need – or if there is a need for you to increase your investment in the software and services to better deliver more complete solutions to your customers? Thanks. Anders Gustafsson - Zebra Technologies Corp.: Sure, I'll start here. So, first on the outlook, we ended 2016 on a position of strength. We saw great momentum build throughout 2016. We obviously had a tough start, but momentum continued to grow and 2016 ended strongly, right. And that momentum, I think, has been continuing into the first part of 2017. All four regions did perform very well in Q4, and our products – also all our product families performed well. And I think we are well positioned to continue to drive growth here. So, I think we entered 2017 with the strongest product portfolio we've had in a very long time, and I feel very good about the competitiveness of our solutions. And we're getting very good feedback from our customers and partners on both the line-up of solutions that we have, as well as the progress on the integration, as we're working our way through that. As we entered 2017, we also had a higher backlog than we had last year. So, that gives us an extra confidence, and a robust pipeline of new opportunities. So, based on all of that, I feel that our 2017 outlook is prudent as we see things today. And as you look through the year, maybe the comps get a little tougher, but we feel that this is a prudent and good outlook. But we also see that we have a very strong foundation from which we can grow and continue to extend our leadership. And do you want to... Joachim Heel - Zebra Technologies Corp.: Well, this is Joe Heel speaking. Your second question was around the software and services? Anders Gustafsson - Zebra Technologies Corp.: Yeah. What I was going to say on that one was – we certainly recognize that software will become a more prominent part of our portfolio. So far, we have created a software organization and a software BU within the company. It's a smaller organization today, but we're looking to make some smart investments to both – gain some greater knowledge and put some investments behind some very compelling opportunities. We are certainly looking – if you think of our mobile computing platform around Mobility DNA as an example also, we have – we are doing a lot things around software to make sure that our devices are as smart and connected as they can be, so we can use them to both generate data to fuel other type of applications and use cases. And on the printing side, I'd say one of our biggest differentiator is Link-OS, which is our real-time operating system, which makes the printer a smart and intelligent network device or network citizen. So, we are working on developing more use cases and more applications that we can satisfy by – that are closely related to our devices. Joachim Heel - Zebra Technologies Corp.: And perhaps to add and point out some of the things that were mentioned earlier, that our proof points of the importance of software and services as we evolve towards solutions around Enterprise Asset Intelligence, we mentioned the launch of OVS and AVS, which are services that we are now providing to give visibility to the status of our devices, which enables our customers to manage them in a much more effective way. We also mentioned the SmartSensing (34:10) solution, which was launched at NRF, which is a combination of hardware, software and services needed in order to provide retailers with visibility. And another example was the TLA solution that we're providing to logistics customers, again, one that includes hardware, software and services needed to optimize doctor (34:33) operations. So, those are some examples of how we think that software and services are central to our long-term targets for growth. James E. Faucette - Morgan Stanley & Co. LLC: All right, thanks. Operator : Our next question comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman - Robert W. Baird & Co., Inc.: Hi, first question just is around EMEA. Could you just kind of speak to maybe where we ended up in local currency or constant currency for the full-year in EMEA? And then just kind of maybe speak to the tone of business, tone of demand there. The macro picture seems to be continuing to improve. And I'm just curious, as you move into 2017, what your expectations might be for that region. Anders Gustafsson - Zebra Technologies Corp.: So, I'll start first with maybe more like setting the context around EMEA, and then Olivier will follow-up with the specific numbers for you. But the underlying trends in EMEA has been very positive. We had a rich mix of wins with existing and new customers in Q4. Retail was strong. T&L was also strong. The TC51 Mobile Computer launch went very well in Europe, and we had some big wins with important customers there. So, as we look at 2017, we do expect to continue to see positive trends as we go out the year and continue to drive growth from Europe. Olivier Leonetti - Zebra Technologies Corp.: And in terms of performance for EMEA in local currency, it would have been a decline, a slight decline, maybe in the range of zero to 1%. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. And then, when we look into 2017, I'm curious the local currency with all adjustments with the wireless LAN business, the thought is a low single-digit revenue growth for 2017 is maybe what the thought process is now. Anders, if you were to maybe identify two upsides to that, what might those be? For instance, would that be U.S. retail spending or how could we see some upside to that low single-digit kind of adjusted outlook, revenue outlook? Anders Gustafsson - Zebra Technologies Corp.: Let me start by giving you a sense of a little bit more broadly maybe on the outlook here. So, we ended 2016 strong and we see that momentum coming in. Well, we are well positioned for growth across our regions and with our products. The business is quite diversified, and we have a number of different avenues or levers to pull to achieve growth. There are areas of the business that I consider to be somewhat under-penetrated, I would call, supplies, services and healthcare to be some of those. And I would say also our Enterprise Asset Intelligence vision, that's something that is compelling to customers and generates a lot of interest, and we have a number of new attractive offerings in that area. So, when we go back and look at our 2017 outlook, I think it is prudent based on everything we know today. There's obviously some level of upside or downside, however you look at it, that can happen. But as we see things today, we think that this is a prudent outlook. Richard Eastman - Robert W. Baird & Co., Inc.: Okay, okay. All right, thank you. Operator : Our next question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. A question on the organic growth forecast for the first quarter. It seems like you're looking for a little bit of acceleration from the fourth quarter, and I wonder if you could talk about where you're seeing that. Is it anywhere in particular or just across the board? Anders Gustafsson - Zebra Technologies Corp.: Our Q1 outlook is strong for all regions and I'd say all product families. So, I think the strong momentum we had in Q4 is carrying into the first quarter here also. And the strengthening on, say, a percentage year-over-year growth also has to do a little bit with we had a weaker compare in Q1 of last year. Jason A. Rodgers - Great Lakes Review : And wonder if you can comment on your distributor inventory levels and the progress you're making with the new channel program. Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, first PartnerConnect, we launched PartnerConnect, our new channel program, in Q2 of last year. It's now been basically working for nine months or so. We're very pleased with how it's gone. I think it's been well received as a good structure, a good program. We were able to gain share of wallet with our channel partners through 2016. And like I say, I'm quite pleased with that, because going through all the complexities of our integration and be able to gain share at the same time, I think is quite an achievement. And so, yeah, so the channel program I think is working very well. The second part – I forgot the second part of the question. Jason A. Rodgers - Great Lakes Review : The inventory levels. Joachim Heel - Zebra Technologies Corp.: The inventory levels. Anders Gustafsson - Zebra Technologies Corp.: Inventory levels, yeah. So, we target about 50, 55 days of inventory with our channel partners. And we've stayed close to those targets for the year, and we've entered 2017 with an appropriate inventory position with our distribution partners across the world. So, we feel that's healthy. It's good. Jason A. Rodgers - Great Lakes Review : And then, just looking at the synergies realized, $50 million, in 2016 from ES, is $20 million still the target for 2017 and is there anything additional that you can realize in 2018? Olivier Leonetti - Zebra Technologies Corp.: So, that's correct. $20 million, mainly in COGS, is what we believe we will realize. We have a fair amount of line of sight of that number. And in addition, as we implement our new ERP system and we'll do that in the middle of this year, we believe we will have further opportunities to increase operational leverage in the company. Jason A. Rodgers - Great Lakes Review : And then, if I could just squeeze one more in, you mentioned during the prepared remarks about pockets of elevated promotional activity. Is that something new that you've seen from past quarters, and maybe if you could say where you're seeing that and what you're doing to address it? Thank you very much. Anders Gustafsson - Zebra Technologies Corp.: So, our markets have always been competitive, right, so that's not new. And I think we've mentioned we've had the same concept of some pockets of elevated promotional activities in earlier calls also. And our approach continues to be one where we're trying to respond in a very disciplined way. We want to have flexibility to go after deals that we think are worth winning and that we need to win, but we do it with a strong focus on driving profitable share gains. That's our – we gained share in the past year, but our – the one metric, say, that we're trying to really maximize is to drive profitable growth and maximize the value of the Enterprise over the long-term. So, we want to make sure that we are prudent in how we pursue those things and disciplined in our approach. Jason A. Rodgers - Great Lakes Review : Thanks very much. Operator : Our next question comes from Saliq Khan of Imperial Capital. Please go ahead. Saliq Jamil Khan - Imperial Capital LLC : Hi. Good morning, Anders. Anders Gustafsson - Zebra Technologies Corp.: Good morning. Saliq Jamil Khan - Imperial Capital LLC : Anders, when you were at NRF, what gave you confidence that the retailers are willing to open up the wallets and invest in these new retail technologies over the next 12 months to 18 months? Anders Gustafsson - Zebra Technologies Corp.: Yeah. Retail has always been a strong vertical for Zebra, and I think we're very well positioned to capitalize on the transformation that's currently going on, driven by e-commerce and omni-channel. Our traditional, say, brick-and-mortar customers are recognizing the need for them to invest more in our type of technologies to drive improvements and enable them to compete against e-commerce. So, investments to drive greater customer experiences, enable different delivery modalities such as buying online and pick up in-store, but also to drive just greater efficiencies to enable them to compete on price with others. And we also see – and we have had several, I think, large retailers in the U.S. publicly talk about their strategy of stepping up investments in technology to do just that. We also see traditional e-commerce players investing meaningfully in our type of solutions to enable them to scale efficiently and also to be able to offer new customer offerings. So, I think that bodes well for us. And our portfolio to address retail, both brick-and-mortar and e-commerce, is very strong. The TC51 Mobile Computer that we launched in Q4, that was the fastest ramping product in the history of the company. It really was a great success for us. And at NRF, we also showed a couple of other products that you might have seen, so like MP7000 (44:26), it's a flatbed scanner that's very competitive, that's coming out this year, and the SmartSense solution that Joe also referred to here. And also, I'd say we feel good about being able to add additional customers through the year. So, in 2016, we added a lot of new customer names, both traditional brick-and-mortar customers as well as e-commerce customers. And I guess this all gives us confidence that momentum will continue into 2017. Saliq Jamil Khan - Imperial Capital LLC : And then, Anders, as you kind of walk around the booth at NRF, one of the things that you saw over the last couple of years was there are payment solution providers, asset tracking solution providers or scanners and printers solution providers that were out there. So, where do you believe the Zebra technology ranks in the purchasing priority for the retailers? And wherever you believe it ranks, how do you actually improve that ranking as well, so they're more likely – the retailers are more likely to go ahead and adopt the Zebra technology as opposed to the payment solution technology that's out there? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I think I will say that we have – we are essential for retailers. If retailers want to implement an omni-channel type of strategy, I think that getting that increased visibility into what their – the in-store visibility, being able to effectively guide people to do the pick-up and the self-checkout and so forth in the store are capabilities that are essential for them to have. And we do offer that. Now, many things that retailers do are broader projects, and we are not the only thing that's in it. So, there are certainly other solutions that goes into that too. But I do believe that we are considered to be a strategic partner to many of our largest retail customers, because they see the value and the essence of what we do. Maybe, Joe, you can add something. Joachim Heel - Zebra Technologies Corp.: Yeah. Also, bear in mind that our go-to-market strategy inherently is one of partnering. So, you will find us, in many cases, partnering with many of those solution providers that either provide checkout solutions or payment solutions. And indeed, if you look at many of the most prominent solutions that were showcased at NRF, you'll see that there's either a Zebra inside or there's a Zebra partnership involved there. So, that's deliberately part of our strategy. Saliq Jamil Khan - Imperial Capital LLC : Okay. And just one last question on my end. To get to the organic growth outlook of 3% to 6%, could you kind of break-down what the outlook looks like for the different geographies? Anders Gustafsson - Zebra Technologies Corp.: No, for Q1, I think we tend to give you an outlook for the company, and we give you some color for each of the regions. I think we've gone through some of the regions here already this morning and for the products. But we don't really break it down by all its components. Saliq Jamil Khan - Imperial Capital LLC : Great. Thank you. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : Our next question comes from Brian Drab of William Blair. Please go ahead. Brian P. Drab - William Blair & Co. LLC: Hi, good morning and thanks for taking my questions. Just wanted to... Anders Gustafsson - Zebra Technologies Corp.: Good morning. Brian P. Drab - William Blair & Co. LLC: Good morning. Just wanted to start with just a quick question on OpEx for 2017. I guess we should be modeling OpEx in terms of dollars to be down in 2017. Just wondering if you could give us a better sense for how much those dollars should be down and how it breaks down in terms of benefits from restructuring and productivity versus how much OpEx was associated with the wireless LAN business. Olivier Leonetti - Zebra Technologies Corp.: Good morning, Brian. We gave you two numbers on purpose, one which is a gross margin number. We believe that this gross margin number will slightly increase in 2017. And we also gave you an EBITDA number of 18% to 19%. So, you can deduct what the OpEx is. And we did it this way for a reason. We want to adjust the OpEx of the Enterprise based upon the trajectory of the business. That's why we model it this way. However, the integration effort is actually well on its way. We believe that we're going to hit our various commitments. And in addition, the implementation of our new ERP system mid-year will give us the opportunity to deliver additional operational leverage. Brian P. Drab - William Blair & Co. LLC: Okay, great. Okay, that's helpful. Thanks. And then, I guess this is just sort of theoretical, I guess, at this point, but there's a lot of discussion around tax policy changes, of course. And I was wondering if you could just give us an update in terms of how much of your manufacturing is done overseas. I know the Legacy Zebra business manufacturing went to Jabil, and how much of the Motorola Enterprise business is done overseas and just the total – if you look at your total manufacturing footprint, what percent of that is overseas? Olivier Leonetti - Zebra Technologies Corp.: Let me answer indirectly to your question, Brian. So, we don't know for sure what a new tax reform will include. So, we have spent actually a fair amount of time with our teams internally, with our business partners, with our various advisors, and we believe that we have the ability to mitigate the impact of a new tax reform. Looking at the way the supply chain is structured is one lever. That's not the only lever. Brian P. Drab - William Blair & Co. LLC: Yeah. So, I understand it's not the only lever. I'm just wondering, could you help us at all – if we did focus on this one lever for a second, what – how much of the manufacturing is done overseas? I guess – I understand that the Legacy Zebra, most of it is done at Jabil. But do you reveal how much of the Motorola business – I'm just not as familiar with that side of the business in terms of the manufacturing footprint. Olivier Leonetti - Zebra Technologies Corp.: So, we haven't disclosed how exactly on purpose. It's obviously competitive information. And we could restructure the supply chain in order to achieve our goals, which is to make tax reform neutral. So, there are few things we can do. We don't want to be definitive for obvious reasons. We don't know really what the tax law is going to be. But we have various scenarios, and all of them, we believe, would be – will lead to a neutral impact for the new tax reform. Brian P. Drab - William Blair & Co. LLC: Got it. Anders Gustafsson - Zebra Technologies Corp.: But to give you a little bit more color maybe as to – our supply chain is probably very similar, I suspect, to most electronics supply chains. So, we have a significant footprint of manufacturing and also assembly in Asia, but we also have it in Mexico. And we have all our converting and a lot of our services activities in the U.S. But that only – that gives you kind of the current footprint. There are certainly things that we can do to mitigate any impacts of any border-adjustment taxes, but we still don't know what they look like or anything. But we are working on how would we respond to various scenarios. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks very much and congrats on the solid quarter. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : Our next question comes from Matt Cabral of Goldman Sachs. Please go ahead. Matthew Cabral - Goldman Sachs & Co.: Yeah, thank you. So, it sounds like the TC51 is off to a pretty good start. Can you just talk a little bit about where you've seen the biggest traction so far and if you think there was any meaningful amount of pent-up demand that you had heading into the launch of that product? Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, the TC51 is a – we think of it as a mid-range Android all-touch device. It certainly met an unmet – or satisfied an unmet need in the market, because otherwise we wouldn't have had that kind of launch or that kind of ramp, right. So, I think we got it right from a form factor, from a functionality perspective. We got kind of the latest and greatest operating system drop (53:04), chipsets and so forth in there. So, it was a very compelling product when it came out, and we're seeing – still seeing very good feedback from customers about it. We were down at the HIMSS this past week also, which is the healthcare show, and had a great interest from healthcare providers in that product. And we're coming out with a special healthcare version of the TC51. But the Q4 launch was primarily aimed at retailers, so mostly say brick-and-mortar retailers who are working on omni-channel type of solutions, and also to help them to have a more compelling customer experience by arming their sales associates with better tools to engage with their customers. Joachim Heel - Zebra Technologies Corp.: Yeah. I would add two things in terms of the pent-up demand opportunity that I think TC51 squarely hit. On the one hand, retail and the need to compete with e-commerce that this device enables in a number of different directions. On the other hand, bear in mind this transition of operating systems, which is still ongoing. And many of our customers, whether they're in retail, healthcare or other verticals, are looking to make that transition and are waiting for or have been waiting for the compelling opportunity to do that. And TC51, I think, struck that nerve and hit that opportunity squarely, which is why it's been such a successful launch. Anders Gustafsson - Zebra Technologies Corp.: Yeah. Maybe one more point to say also there's been a lot of conversations or concern over the years around consumer encroachment, and the TC51 certainly – I think the first customer we had was a very large consumer device user, where we were able to basically win them to switch over to our devices. So, I think we – this is a great way for us to compete against the consumer devices also. Matthew Cabral - Goldman Sachs & Co.: Great. And then, as my follow-up, I hate to ask a question on tax rate. But I guess just given the magnitude of the difference, can you give us a little bit more detail on what drove the benefit in the fourth quarter and just the right level that we should be thinking about just on an ongoing basis as we go throughout 2017? Olivier Leonetti - Zebra Technologies Corp.: Absolutely. So, at the end of Q3, we were planning a tax rate for the year 26%. So, that was an estimate that was based upon the forecast, assuming a mix of profit by legal entities or tax jurisdictions. So, when we closed the year, based upon the mix of the profit, based upon additional work we did as part of the year-end process, the tax rate for the year moved from 26% to 23%. And we had to book the full impact in the Q4 quarter, which was about $0.16. Now, to answer to your second question in terms of tax rate for 2017, we believe that low to mid-20s will be a good planning assumption. Matthew Cabral - Goldman Sachs & Co.: Thank you. Operator : Our next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Thanks for taking my question, and congratulations on the execution during the year. Anders, can you revisit your long-term growth rate of 4% to 5%? Obviously, printers came off of an incredible stretch here in 2015, with double-digit growth for several years. But since then, it looks like the growth rate has been much lower. Do you still think the 4% to 5% long-term growth rate over the cycle is the right way to think about it? Anders Gustafsson - Zebra Technologies Corp.: Yeah. We still think 4% to 5% growth rate or the target is an appropriate target for us over the cycle. If you look at our performance over the last two years, we have actually hit that level. It didn't kind of come exactly the way we had expected. So, we had almost 10% in constant currency growth in 2015, and we were just a tad of growth in 2016. So, our business is a bit more cyclical than we might enjoy, but it tends to drive it towards a good number over time. But again, we feel we have a good diversified business with many avenues and levers to pull in order to achieve our growth. And generating the kind of growth we did in the last two years, while we were going through a very complex integration, I think is a testament to our execution. And we still feel that that's an appropriate target for us and that's what we're going for. Keith Housum - Northcoast Research Partners LLC : Great, thanks. And then if I can follow-up, I think you guys have addressed this a little bit in the previous question regarding TC51. But the mobile – the Microsoft operating systems now, the Internet of Things operating system's out there. You still have the legacy system, which is to be end of lifed in 2020. But obviously, you guys have a huge advantage with the Android portfolio. Are you seeing a shift now where the retailers and the other companies that were hesitant to move toward Android, are they now making the evaluation and starting to make the move or can you speak to the operating system environment for mobile computers? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'll start and then Joe can help out here also, who talks to customers even more frequently. I'd say the momentum around the Android migration is continuing strongly or strengthening. If you remember, two years back, when we first merged our businesses, at that point, there was the largest, most-advanced customers that were doing it. I think now we see – depending on the vertical, but retail, I'd say, all large deals in retail tend to be Android today. Healthcare is very much moving in that direction. So, we're seeing greater traction in our channel with Android, but we always talked about how the largest, most-advanced customers will be leading the charge and that smaller customers won't have necessarily the resources or the know-how to switch as quickly, and that's still the case. If you go down into smaller companies, they're probably more likely to continue to buy what they already have. But we are putting together a different type of both educational material and other offers to make it as easy as possible for customers to switch. If you go back to the TC8000 device that we launched for kind of warehouse applications in the beginning of 2016, that was the first generation of Android device in that environment. That means that our customers have to rewrite and (1:00:10) some of their applications to run on that device. So, the barrier to early adoption is a bit higher. But once you start having – move your applications over, now it's much, much easier to just continue to expand and use a broader part of our portfolio in those areas. Joachim Heel - Zebra Technologies Corp.: So, another viewpoint on the opportunity is, if you go back two years ago, we said there's about 15 million mobile computers out there that need to make the transition from legacy operating systems to either Android or an alternative. And you can do the math of what's been sold in the meantime, but our synthesis would be that the majority of that opportunity is still out there. And we think that there are at least two, but probably two critical things needed to unlock that opportunity, one of which we think we have hit with products like the TC51. You need a compelling offering and value proposition, right, that gets customers over that hurdle. And things like TC51, which is surrounded with the types of software and services that people expected from those legacy operating systems, those are now in the market and present and giving customers the confidence to move that way. The other one, though, that's important and that is the focus of, I think, our growth opportunity this year is that channel partners, which are the majority of the way that we sell, they need to embrace this solution as well and they need to either take their customers along and, in some cases, take their applications. Many of the applications that customers run come from those channel partners, and they need to move those over to Android. That is a focus for us this year, and we see a lot of growth opportunity ahead of us from that. Keith Housum - Northcoast Research Partners LLC : Great. Thank you. Operator : Our next question comes from Paul Coster of JPMorgan. Please go ahead. Paul Coster - JPMorgan Securities LLC : Yeah. Just one question, Olivier, when you are One Zebra and what will actually happen in terms of the TSAs and should there be a kind of step-function reduction in OpEx in the second half once you cross that threshold? Olivier Leonetti - Zebra Technologies Corp.: I'm not too sure we will speak about step-function. But clearly, the implementation of one ERP will allow us now to be really focused on optimizing the P&L further. If you look at the kind of synergies we have generated to-date, they were the obvious ones, duplication in product roadmap, supply chains. But we believe as a management team that we could go to another level in the second half of the year gradually and then forward. Paul Coster - JPMorgan Securities LLC : Okay. And will all of the TSAs be eliminated by the second half of the year? Olivier Leonetti - Zebra Technologies Corp.: The vast majority will be, correct, yes. Paul Coster - JPMorgan Securities LLC : Okay, thank you. Operator : Our final question comes from Michael Morosi of Avondale Partners. Please go ahead. Michael Morosi - Avondale Partners LLC : Hi, guys. Thanks for taking the questions. First, with respect to leverage, it looks like this year, you're targeting maybe another half-turn or so in terms of net-debt-to-EBITDA. Longer term, you've talked about being investment grade. But I wondered if you could just give a little bit more color in terms of those leverage targets. And once you're there, how does that change your cash allocation thought process? Olivier Leonetti - Zebra Technologies Corp.: So, you're right, we believe we should be going down by half a turn between the end of 2016 and the end of 2017. Our target is to reach investment grade rating as soon possible. We believe that we will achieve that rating once we have a ratio of – debt-to-EBITDA ratio of about 3 times. Once we achieve that level, we want to look at the best options to maximize return for our shareholders, and that can take various forms, repaying more debt or allocating excess cash to shareholders in other ways. So, we want to keep options open based upon what will be best for our shareholders. Michael Morosi - Avondale Partners LLC : Very good. And then, a little bit longer term, we're looking at the automation of supply chains and distribution centers and having an impact on head count longer term. How do you view that as both a challenge and an opportunity and how does Zebra's EAI fit into that broader automation trend? And longer term, how would that impact your mix of hardware and software analytics sales? Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, we see that as an opportunity for Zebra today in – some conversations around retail, where they've been trying to do certain things and automate certain things. And when that has happened, it's invariably led to more use of our type of technology in order to enable that kind of automation. So, we see that we are in the central part of enabling a warehouse or a factory, whatever that is, to be much more automated. Some of the things that we're working on for release later this year or in 2018 are specifically aimed at making people much more effective and efficient in how they do their jobs in those types of environments. Michael Morosi - Avondale Partners LLC : That's very good. Thank you. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steele for any closing remarks. Michael A. Steele - Zebra Technologies Corp.: Thank you all for participating on our call today. We look forward to speaking with you again soon. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,017
| 2
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2017Q2
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2017Q1
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2017-05-09
| 5.591
| 5.8
| 6.432
| 6.573
| null | 13.36
| 13.83
|
Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: Jim Ricchiuti - Needham & Co. LLC James E. Faucette - Morgan Stanley & Co. LLC Richard Eastman - Robert W. Baird & Co. Matthew Cabral - Goldman Sachs & Co. Keith Housum - Northcoast Research Partners LLC Jason A. Rodgers - Great Lakes Review Jeffrey Ted Kessler - Imperial Capital LLC Paul J. Chung - JPMorgan Securities LLC Operator : Good day and welcome to the Q1 2017 Zebra Technologies Earnings Release Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our first quarter highlights and key drivers of the results. Olivier will then provide more detail on the financials and discuss our outlook for 2017. Anders will conclude with discussion of recent progress made on Zebra's strategic priorities. Following the prepared remarks, we will take your questions. Joe Heel, our Senior Vice President of Global Sales, is traveling internationally and has joined us by phone. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. Also, as a reminder, our reported financial results include the divested wireless LAN business through October 2016. In this presentation, our references to year-over-year growth are on a constant currency basis and exclude wireless LAN sales from the first quarter 2016 results. Now I'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. As you see on slide four, we are off to a solid start in 2017. Our team executed well and delivered strong first quarter results, including adjusted net sales of $866 million with organic growth of 7% that exceeded our guidance range; gross margin expansion of 20 basis points; adjusted EBITDA margin of 17.2%, reflecting an 80-basis-point improvement over the prior year; non-GAAP EPS of $1.37, a 29% increase over Q1 of last year; and more than $100 million of free cash flow driven by improved profitability and prudent cash management. We achieved solid sales results with double-digit growth in EMEA and Latin America and 5% growth in North America, driven by strong demand across our retail and e-commerce customer base. Growth was diversified across our major lines of business with especially strong results in mobile computing and data capture. This was led by our industry-leading portfolio of solutions and the strong reception from large enterprises for our newest offerings. In the quarter, we extended our market leadership and delivered innovation to our customers. Our solutions are essential to our customers to execute on their strategies. We've also witnessed an improved environment compared to the very challenging first quarter 2016. Our stronger-than-expected Q1 provides us the confidence to increase our full-year sales outlook. With that, let me now turn the call over to Olivier to review our financial results in greater detail and discuss our 2017 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. Before we get started, I would like to remind you that all references to year-over-year sales growth are on a constant currency basis and exclude wireless LAN sales from the first quarter 2016 results. Let us begin with a walk-through the P&L. As you can see on slide five, adjusted net sales for the first quarter were $866 million, up 7%. Our first quarter sales performance was driven by strength across our product portfolio, especially, mobile computing and data capture, resulting in growth across all regions. Enterprise segment sales of $544 million increased approximately 9%. Pre-transaction Zebra sales were $322 million, up approximately 3%. Printing and supplies were higher, as were sales in our location solutions business. Sales of services increased slightly from last year. Turning to our regions. Sales growth in North America was up 5%, driven by strength in mobile computing and data capture. We continue to perform well in retail and e-commerce, as the industry continues to transform to meet evolving consumer purchasing preferences. As Anders highlighted, EMEA sales increased 11% from a year ago, driven by double-digit growth in data capture, printing and mobile computing. We saw strength across most of the continent in an improving macroenvironment. Latin America sales increased 16%, as we cycled weak first quarter 2016 sales. We saw especially strong sales in printing and supplies across the region. Sales in Asia Pacific were up 1%, as we are cycling strong results in the first half of 2016. Consolidated adjusted gross margin of 46.4% was 20 basis points higher than the prior-year period, primarily due to our product cost reduction initiatives, partially offset by slightly lower services margin. Adjusted operating expenses in Q1 were flat compared to last year. The impact of the sale of the wireless LAN business was primarily offset by higher incentive compensation expense associated with our improved operating performance. First quarter 2017 adjusted EBITDA margin was 17.2%, an 80-basis-point increase from the prior-year period. This was driven by higher sales and improved gross margin. Q1 EBITDA margin was negatively impacted by approximately 30 basis points due to foreign currency impacts. Non-GAAP earnings per diluted share increased to $1.37 in the first quarter, an increase of $0.31, or 29%, from the prior-year period. Integration expenses of $27 million in Q1 declined by $9 million from the prior-year period. With the successful launch of our fully integrated ERP, we expect spending to be sequentially lower in the second quarter. We expect minimum integration expense in the second half of 2017, as we complete the first steps to exiting all remaining Motorola Solutions transition service agreements. Turning now to the balance sheet and cash flow highlights on slide six. We ended the first quarter with $180 million in cash, which includes $99 million held outside the U.S. Zebra has strong liquidity and no borrowings on our $250 million revolving credit facility. As of the end of the first quarter, we had $2.6 billion of long-term debt on the balance sheet, of which approximately two-thirds is fixed rate, including nearly $700 million of floating to fixed LIBOR swaps against our term loan. Strong Q1 cash flow of $104 million enabled us to pay down $80 million of principal on our term loan in the quarter. Free cash flow increased by $27 million, or 35%, compared to the first quarter of last year, primarily due to increased profitability, solid working capital management and lower capital expenditures. With respect to foreign exchange, as a reminder, we have a rolling four-quarter hedging program in place to mitigate the impact of euro to U.S. dollar exchange rate volatility. Approximately one-quarter of total company sales are denominated in euros and it is the only currency where we have much exposure to cash flow and profitability. Slide seven shows our path to financial deleveraging. Our top priority for cash flow and excess cash balances is to aggressively pay down acquisition debt. We expect to exceed our original goal of $650 million of debt paid down for the 2016 and 2017 two-year period. Our net debt to adjusted EBITDA ratio dropped below four times as of the end of the first quarter, which is down from more than 5 times as of the close of the Enterprise acquisition in late 2014. Our ultimate goal is a leverage ratio of approximately 3 times. On slide eight, you will see that for the second quarter of 2017, we expect the change in adjusted net sales to be between negative 2% and positive 1% on a nominal basis. Organic sales growth is expected to be between 3% and 6%, which excludes the adverse impact of 4 percentage points from wireless LAN as well as the adverse impact of 1 percentage point from changes in foreign currency rates. We expect organic sales growth to moderate through the balance of 2017, considering the more challenging year-over-year comparisons and the lumpy nature of our business. Second quarter 2017 adjusted EBITDA margin is expected to improve from last year and to be in the range of 17% to 18%. This rate assumes flat to slightly higher gross margin as compared to the prior-year period. We expect to drive adjusted operating expenses as a percentage of sales, lower than both Q1 and the prior-year period. Non-GAAP diluted EPS is expected to be in the range of $1.35 to $1.55. Given our strong first quarter sales and backlog entering our second quarter, we are raising our full-year sales growth outlook. We now expect low to mid-single-digit organic sales growth. This outlook excludes the adverse impact of 3 percentage points from wireless LAN as well as the adverse impact of 1 percentage point from changes in foreign currency rates. Full-year 2017 adjusted EBITDA margin is expected to be in the range of 18% to 19%, which is higher than 2016 and assume a 40-basis-point adverse impact from foreign currency changes. Our full-year outlook assumes slightly higher gross margin rates compared to the prior-year period due to cost reductions and productivity improvements. We also expect to drive lower adjusted operating expenses due to productivity improvements as we complete the integration of the company. For 2017, we expect debt paydown to exceed free cash flow. Our goal is to pay down at least $300 million of debt, which is supported by higher EBITDA, lower integration expenses, lower interest cost and reduced cash on hand required to operate the business. Other full-year 2017 modeling assumptions shown on slide eight include : interest expense of approximately $165 million to $170 million, which includes non-cash amortization of approximately $20 million to $22 million; stock-based compensation expense of $30 million to $35 million; non-GAAP tax rate in the low to mid-20% range; capital expenditure of approximately 2% of revenue; and depreciation and amortization expenses of $260 million to $265 million. With that, I will turn the call back to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. We are focused on several areas to build upon our leading positions globally and to drive profitable growth and cash flow. First, we are leveraging our scale, innovation and relationships with customers and partners to extend our leadership with the most innovative portfolio of enterprise solutions and sensing technologies in the market. It is the one-year anniversary of our redesigned channel partner program, which was the most comprehensive change to our channel strategy in company history. In April, we began hosting our annual meetings with partners around the globe and feedback has been extremely positive. The new program has added thousands of value-added resellers and has successfully provided better incentives for partners to expand and grow their business with Zebra. Second, we're advancing our vision of Enterprise Asset Intelligence, or EAI, by leveraging Zebra's deep knowledge of the markets we serve and capitalizing on key technology trends. I will elaborate on our progress in this important strategic area in a moment. Third, we are executing on the final phase of the Enterprise integration. Last week, we went live with our global ERP and IT ecosystem. The final key milestone of our integration is to have exited all remaining third-party service agreements by the end of the third quarter. As we wrap up the integration, we have the opportunity to further increase productivity across the enterprise and improve the experience for our partners and customers. Our fourth area of focus is to further enhance Zebra's financial strength by increasing profitability, improving cash flow and optimizing our capital structure. As we continue to drive profitable sales growth and improve productivity, we will enhance cash flow generation to aggressively pay down debt to achieve our target capital structure. Now turning to slide 10. Zebra's resources and deep market expertise make us uniquely positioned to capitalize on key mega trends in mobility, cloud computing and the proliferation of smart devices. To address the opportunities these trends create, we have developed an operational framework that enables more intelligent enterprises. It starts with solutions that sense information from all Enterprise assets such as inventory in a warehouse, medical equipment in a hospital, and customers in a retail store. Data from these assets including status, location, utilization or preferences is then analyzed to provide actionable insights in real-time. This EAI framework includes Zebra's hardware, software, services and analytics, which connect customers' physical assets, systems and people. This provides a digital view of the entire Enterprise, which enables visibility into their business operations and workflows, resulting in smarter business decisions. Our offerings resonate with our customers as we collaborate and innovate with them on a daily basis. Slide 11 highlights how we serve our key industry verticals. Major trends in each vertical are driving opportunities for Zebra. Examples include a higher proportion of retail sales executed online or through multiple channels, increased shipping demands for transportation providers, more hospitals running on real-time healthcare systems and increased mobility in the manufacturing environment. Zebra's solutions assist Enterprise customers across multiple industries to gain critical insights into their operations, comply with increasing regulations, enhance the customer experience and empower their mobile work force with actionable information. At the ProMat trade show in April, we announced new offerings in the transportation and logistics and manufacturing sector that further differentiate us as the leader in Enterprise Asset Intelligence. We featured our SmartPack Trailer software analytics solutions, which enables fleet managers to maximize capacity utilization. We also featured our Network Connect solution for manufacturing, which seamlessly connects printers and scanners on the plant floor to the enterprise network without the complexity, failure points and workarounds common in today's environment. Zebra is a clear beneficiary of the transformation taking place in the retail sector. Both traditional brick-and-mortar and e-commerce retailers are committed to investing in their capabilities to enhance the customer experience. E-commerce fulfillment and omni-channel offerings are operationally intensive and we provide retailers the insight they need to meet increasing customer expectations. Our understanding of the complexity of these workflows makes our solutions essential to our customers' operations. We are winning in retail with our compelling offerings. As an example, we recently won a large competitive bid to provide a fully managed mobile computing solution for a leading pharmacy chain. The solution includes our new TC51 mobile computers and ET50 tablets, as well as providing support and managed services. Our mobile devices layer enterprise-rich features on top of the Android platform. We are uniquely positioned to provide security updates and patches for the full lifecycle of the devices, reducing the total cost of ownership below other competing mobile device offerings. Additionally, we will deploy our Asset Visibility Services offering, which provides the customers with insight into device health, utilization and availability, resulting in increased productivity and operational efficiency. In the healthcare sector, Zebra is capitalizing on opportunities to help enterprises advance the quality of care. Patient identification and timely treatment are critical success factors. Providers require smart, non-invasive technology that tracks the patient journey, including positive patient ID, laboratory specimen tracking and medication administration. Additionally, mobile communication with voice and secure texting, along with patient alert, will contribute to improved levels of care. In closing, we've had a strong start to the year, thanks to excellent execution by the Zebra team and their tremendous support of our partners and customers. Our strategy is working and our new products and solutions are being well received in the marketplace. Overall, we are confident with our positioning in the market, and we are energized by the opportunities ahead to drive value for our customers, partners and shareholders. With that, I'll hand the call over to Mike. Michael A. Steele - Zebra Technologies Corp.: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : Thank you. We will now begin the question-and-answer session. The first question will come from Jim Ricchiuti with Needham & Company. Please go ahead. Jim Ricchiuti - Needham & Co. LLC: Hi. Thank you. Good morning. Thanks for the color on the retail market. Just in light of what we're seeing, at least, in the U.S. market, with the brick and mortar retailers, can you characterize that environment? Just it seems like the market is holding up pretty well. And then, just a follow-up question. If you can just go into a little bit more detail on some of the other key verticals, healthcare and the logistics market, what you're seeing in those markets? Thank you. Anders Gustafsson - Zebra Technologies Corp.: Yes. Thanks, Jim. Retail has been a strong vertical for Zebra for a long time, right? And it clearly came off very well in the first quarter. We are capitalizing on some of the shifts that are going on in the retail today, but with movements from traditional, say, brick and mortar towards e-commerce and omni-channel spending. And I'd say all our brick and mortar customers and e-tailers, too, they are investing in our type of technologies today. So while they might be investing less in new stores or closing stores, they are prioritizing more IT type of capabilities in their CapEx budgets. We have also been very fortunate here now of being able to develop a very strong product portfolio that is resonating with our retail customers. Android has been well accepted by retail, and it's going very well there. And our Enterprise Asset Intelligence vision is also resonating very well, as we are coming up with more and more new types of solutions that help to drive greater visibility into their operations, such as with SmartLens. Then, moving on to some of your follow-on verticals here, so in healthcare, that's been our fastest growing vertical over the past several years. We see strong growth drivers for continued good performance around both the ability to help improve the quality of care, but also the efficiency of care or the cost of care. The electronic medical health records is really the catalyst for this to happen. But we also are starting to see better growth in healthcare from outside of the U.S. It started off really being a – say, a North America vertical, but now it's becoming more prevalent, more spending in Europe, Middle East and Asia also. And we have some new products coming out here in Q2, like the TC51 for healthcare that we expect to drive greater growth also. And lastly, I think you asked about our transportation/logistics vertical. Again, it's been a strong vertical for us. It's been benefiting from some good secular trends, particularly, the shift to e-commerce. So you have so many more packages that needs to be delivered to enterprises and to people's homes. And we've gained a good amount of share in the T&L space over the last couple of years. And again, we have expanded our type of solutions to the ones I had mentioned on the prepared remarks, like the SmartPack at the ProMat show. Also, we have the Preload Smart Scan solutions, but both of those are great Enterprise Asset Intelligence solutions, that's been resonating very well with our customers. Jim Ricchiuti - Needham & Co. LLC: Thanks very much. Operator : Our next question will come from James Faucette with Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Great. Thank you very much. Wanted to look a little bit forward in terms of with the integration of Motorola and Zebra finally wrapping up, what have you done internally to further cross-sell? Has this become part of compensation, et cetera? And then, I just had a clarifying question. It sounds like you're basically done with the ERP system transition. So should we expect that expenses associated with that ERP transition should continue to fall in the second half of the year? Thanks. Anders Gustafsson - Zebra Technologies Corp.: Yeah. So I'll start with first – on the cross-selling side, I'll ask Joe Heel to also then participate in that and give some further details on what's going on. But, yeah, we've put a lot of emphasis around the One Zebra across not just sales, but across the entire company on making sure that we get aligned and we can prioritize the right things across the company. From a go-to-market perspective, we have invested a lot in cross-training our salespeople and the systems engineers to ensure that they are as comfortable and as well-versed in all of our different types of solutions. We also have overlays that can provide specific more deeper expertise in parts of our portfolio, because it's always hard for any one person to be an expert in the breadth of portfolio that we have. And I say that's been working very well. We've seen a lot of great wins that has been really a result of the One Zebra where we've either been able to pull in printers into an account, which was strong – had a strong position for our Enterprise business or vice versa. So that's been working well, but it's a work-in-progress. We will continue to work hard on making sure that we get the entire sales team as well-trained and focused on the entire portfolio. And that also goes to our partners. Joe, do you want to add a little bit to that? Joachim Heel - Zebra Technologies Corp.: Yes. You touched on all the high points. We'd integrated the sales force relatively quickly as you might remember already at the end of 2014. And we intensively trained the sales forces in cross-selling the full portfolio of products. We also at the beginning of 2015 already introduced a compensation plan, which to this day, rewards the salespeople for cross-selling. And that has shown results in our big deals as well as in our revenue overall. We've also had an initiative underway across the company to integrate on a cultural level that a large percentage of our employees have already participated in to bring the cultures of Motorola and Zebra together to a One Zebra culture. And the other piece I would highlight in the cross-selling is that our – as we transition towards more and more solutions such as the SmartLens offering that we mentioned, our professional services will play an increasingly important role in bringing solutions that span really across the portfolio and layer value-added on top of the product that we brought together and the acquisition to market through professional services that bring those solutions to life. So a broad array really of cross-selling activity. James E. Faucette - Morgan Stanley & Co. LLC: Thanks. Operator : Our next question comes from Richard Eastman with Robert W. Baird. Richard Eastman - Robert W. Baird & Co.: Yes. Good morning. Anders, could you maybe speak to the Zebra legacy business, the printing business? And maybe some thoughts around the growth rate and the growth expectations there. It sounds like, at least in this quarter, very good quarter for printing in Latin America. But how about the rest of the world outside of Latin America and U.S. What are the expectations as you go forward on the printing side of the business? And can we accelerate any growth in that side of the business? Anders Gustafsson - Zebra Technologies Corp.: Yeah. Our printing business has performed very, very well for many years, I'd say. We had a good quarter in Q1 for both printing and our supplies business. The One Zebra message we had around how to leverage the full complement of all our solutions to pull in more printing has been working well. It's been a success for us, I'd say. And I feel very good about the long-term outlook for our printing business. We have a very strong product road map that has some new products coming out later this year that I would expect to have a meaningful impact in the market. We do see significant opportunities to expand our supplies business, which we think of as somewhat unpenetrated vertical for us, or product space. And we are also including Enterprise Asset Intelligence capabilities into our printers. So Link-OS is a great differentiator for us. It enables our printers to be good network citizens in our customers' networks. Profile Manager is a capability we have which is unique to Zebra and very well-valued. And we talked about on the prepared remarks the Network Connect solution, which enables us to connect into Rockwell Automation's IT systems very easily and makes it a lot easier for our customers to expand and reconfigure their businesses. So we feel very good about where the printing business is. And I think we expect to see good growth as we go through the year. Richard Eastman - Robert W. Baird & Co.: And then, just as a follow-up for Olivier. Just two questions. One is what would be an estimated range of integration and restructuring expense for the full year? And then, the second question would be around the deferred revenue is up meaningfully. Is that a function of services, professional services sales, the deferred revenue growth? Olivier Leonetti - Zebra Technologies Corp.: So let me take your first question about restructuring. So we expect restructuring charges to decline significantly in Q2 and to be de minimis in the second half of the year. As we are finalizing the implementation of our ERP, we believe that cost would be significantly managed down. In terms of your second question for deferred revenue, we are today, as Anders indicated, entering more and more into the Enterprise Asset Intelligence space, meaning that our revenue has multiple elements in it, services, managed services and the deferred revenue was associated with those multiple elements, as I said, with our sales. Richard Eastman - Robert W. Baird & Co.: Okay. All right. Great. Thank you. Olivier Leonetti - Zebra Technologies Corp.: Welcome. Operator : Our next question will come from Matt Cabral with Goldman Sachs. Please go ahead. Matthew Cabral - Goldman Sachs & Co.: Yeah, thank you. So on Android, I'm just wondering if you could update us on where that stands relative to the overall mobile computing mix and just what the growth rate was in the quarter. And just more broadly, I'm curious about the traction that you've seen from the channel on Android and the prospects for smaller more run rate deals starting to catch up within the mix. Anders Gustafsson - Zebra Technologies Corp.: Yeah, so first I'd say our mobile computing business had a very strong quarter, especially, in North America and Europe and driven in no small part to large wins, more large project-based wins. We got a lot of interest in our new Android solutions like the TC51 mobile computer and the tablets. So the Android migration generally is continuing to gain momentum for us. It's becoming a bigger part of our overall business. It's now about half of our total mobile computing sales and our market share is over 50% in Android compared to – which is higher than what we have overall. We have a very close working relationship with Google, which enables us to work more on early insights into what's coming in future releases and influence a little bit of what the roadmap will look like. And we have by far the broadest Android product portfolio with about 15 products in there. And in Q1 here, we launched a new service that we call LifeGuard, which basically enables us to extend security patches and security upgrades for all devices through the life cycle of those devices. And that's something that I think we are uniquely well-positioned to be able to do as we have such a big install base. But we should also say that Windows continues to be a very prominent operating system. And we think of ourselves as being agnostic in the war of operating systems. We want to provide the right device and the right operating system for our customers. And there's still a lot of Microsoft devices being shipped and the total legacy install base of Microsoft operating systems continues to be very large so the future opportunity to upgrade that and refresh that is substantial. And then on the channel side, Android has – initially took off from – based on our larger deals into our direct customers, but as time has gone by, we do see more and more channel business for Android. And the characteristics of those is very similar to the characteristics of similar deals for Microsoft. So I would say today the migration or the growth of Android in the channel is developing along the lines of how we expected it to. So we're pleased with that also. Matthew Cabral - Goldman Sachs & Co.: Got it. And then, a quick follow-up for Olivier on gross margin. I was just wondering if you could talk a little bit more about what drove the expansion year-over-year and just how that splits across the Enterprise business versus legacy Zebra. Olivier Leonetti - Zebra Technologies Corp.: So we are indeed pleased with our gross margin performance. It has been increasing by about 40 basis points year-on-year. It is due to multiple factors. One, the strength of the product portfolio. As Anders indicated, we are now selling more and more solutions on the back of our Enterprise Asset Intelligence strategy. So strength of the portfolio would be first. Second is also the focus of the Enterprise on maximizing productivity. We have – the DNA of the company is to improve cost management quarter after quarter and you see that happening in the P&L. And, third, we pay special attention to run rate margin. Joe and his team are very careful about how we price our portfolio, and you see that also happening, materializing in the gross margin performance. Matthew Cabral - Goldman Sachs & Co.: Thank you. Operator : The next question will come from Keith Housum with Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Thanks for taking my question. And great quarter, by the way. I think – I've been covering Motorola for a lot of years and Enterprise probably did the best in a long time, so congratulations there. I just want to talk a little bit about the pace of sales during the quarter. I know the ordering window was closed at the end of April for a time and you guys were encouraging people to order early. Would you say that there was any pull-forward in business from the second quarter to the first quarter that occurred? Anders Gustafsson - Zebra Technologies Corp.: Yes, as part of preparing for the ERP cutover which happened at the end of April, we worked with our distribution partners to ensure that they were appropriately stocked before that outage. And that basically translated into us working with them to make sure that they raised orders on us earlier, but not shipping. We designed these programs very carefully to have no impact or minimal impact on Q1. So we entered Q2 with more backlog in order so we could ship early in the second quarter to cover the period of ten days or so where we were – when the ERP system was down. But the intent was clearly to make sure that we minimized any impact on the first quarter. And if you look at the outlook for the second quarter, I think, it seems like we feel we have been able to achieve that objective without distorting Q2 based on any of this. Keith Housum - Northcoast Research Partners LLC : Okay. Thanks. And then, Olivier, a question for you. Interest expense fell in the quarter sequentially by a good amount and if you annualize the $41 million, obviously, it's less than what you guys are guiding to. Was there anything unusual or interesting in the first quarter for interest expense that we should be aware of? Olivier Leonetti - Zebra Technologies Corp.: Nothing specific. I'm going to state the obvious, but as Anders indicated, our priority number one is to reduce our debt burden. We want to overachieve our objective of repaying $300 million of debt this year, we are on track for that. Managing for cash is a focus across the enterprise, we have a cross-functional team working on all the elements of cash flow management and you see that happening at the moment. Keith Housum - Northcoast Research Partners LLC : Right. But the $41 million, if I annualize that, that's $164 million, and you will be paying down debt during the year. So I guess, are we going to see a higher interest expense for the following quarters than what we saw in the first quarter? Olivier Leonetti - Zebra Technologies Corp.: I would say lower. So you should expect interest charge to decrease as we go through the year, as we reduce our debt burden. Keith Housum - Northcoast Research Partners LLC : Okay. Thank you. Operator : The next question will come from Jason Rodgers of Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. I wondered if you could talk about the performance of the manufacturing vertical in the quarter, and if you're seeing any signs of pickup there? Anders Gustafsson - Zebra Technologies Corp.: Yes. So manufacturing is a vertical we've been participating in for a long time, and it was one of the real strengths for the original Zebra business. We are seeing visibility in mobility solutions being a driver for manufacturing. Some of the things we've been doing here to provide new innovative solutions, it would be around this Network Connect solution that we demonstrated at ProMat to get – facilitate or make it as easy as possible for customers or enterprises to incorporate printing and scanning into their work flows and into their IT ecosystems. And we're also working hard to expand the route delivery business. That's a big part of our manufacturing – of actually working with manufacturers to get their products delivered to – it could be restaurants or distribution centers and other things. So we see manufacturing to continue to be a good vertical for us. Not as high growth maybe as healthcare, but it's still a good growth business for us. Jason A. Rodgers - Great Lakes Review : And you talked about some expectations for a moderation of organic growth in the second half of the year. Is that just due to the prior-year comparisons? Or are you seeing any reduction of larger projects in the pipeline? Anders Gustafsson - Zebra Technologies Corp.: So the first quarter, I think, we had a particularly strong pipeline of large deals, to some degree, fueled by some of our newer products like the TC51, so we wouldn't expect to be able to maintain that high level of – or that cadence for kind of large project business. And then, second half also has tougher compares. So we would expect that the growth rate in the second half will moderate a bit from the first half. Jason A. Rodgers - Great Lakes Review : And then, finally, I think you mentioned the expectations are for the gross margin to be – I think you said flat to slightly down year-over-year in the second quarter. Wondered why you're expecting that you'd not see a gross margin expansion year-over-year in the second quarter. Olivier Leonetti - Zebra Technologies Corp.: Yeah, we believe that the margin for Q2 is expected to be flat to slightly higher. Yeah. And again, a few reasons for that. One is we're working on productivity initiatives, as I mentioned earlier; and, two, we have a very strong portfolio of products and solutions and that allows us to compete on viable, which is different than price. Jason A. Rodgers - Great Lakes Review : Thank you. Olivier Leonetti - Zebra Technologies Corp.: Welcome. Operator : The next question is from Jeff Kessler of Imperial Capital. Please go ahead. Jeffrey Ted Kessler - Imperial Capital LLC : Thank you for taking my question. With regard to the focus that you're putting on retailers and the purchasing priority that you have for retailers, within your solutions that you're offering them, what – I realize you're working with different retailers with different priorities, but within your solutions, what sub-solutions, what products are you focusing on getting them to take on initially? And then, what others are you having them work into as you try to either get them for multi-strategy, or for actually moving them toward e-commerce? Anders Gustafsson - Zebra Technologies Corp.: Yeah, so I'll start and then I'll ask Joe Heel to add some comments at the end also. But, yeah, retail we have a very strong portfolio of products for retail overall. We are very much focused on driving our One Zebra into retail too, and so it is not like we're looking to really just lead with one product, we want to make sure that we have our mobile computers, our scanners, our printers customers. And I think our ability to cross-sell and up-sell has been improved over the last few years here. But some of the newer things that are having – resonating or driving a lot of larger deals tends to be the mobile computers, so like the TC51 that we launched in Q4 of last year. That's used in multiple different use cases, but omni-channel enablement is certainly one. If you think of what has to happen within a retail facility in order for them to execute on an omni-channel strategy, they have to have much greater use of technology to be able to do those tasks. So that would be one of the newer solutions that are having a lot of traction. But if you look into the future, I would highlight SmartLens, or SmartSense as we called it earlier, but we renamed it to SmartLens, as one that we think has great opportunity and certainly is resonating very well with our customers. We have a great pipeline of interested retailers, who want to do pilots for that. But that's a solution that really helps to drive much greater visibility into inventory, tracking, assets in a retail facility of people, both customers and sales associates. So it can drive a great ROI. So that would be, I guess, my two cents. And, Joe, you can add a little bit to that. Joachim Heel - Zebra Technologies Corp.: Well, building on what you said, I think, there's three areas in retail where both the business processes and the technology innovation are coming together. One is the front of the store where we're enabling empowerment for the associates to interact more with customers. The second is the warehouse, where we're driving a lot of improved productivity. And the third is really the drive towards omni-channel fulfillment that we see in retail. And in all of those you can see what Anders was talking about, the mobile computers and scanners and printers, the more traditional products, are enabling each of those three processes. And that's where also a lot of that Android migration we talked a lot about. That's where a lot of that is happening today. And then in the future, all of the retailers are looking forward to deploying some of our new technologies, the RFID technology, which includes SmartLens is one of the future technologies. In the warehouse it would be technologies like augmented reality that we're working on and bringing to market. So that would be, I think, a good way to overview where we're making an impact in retail. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Great. One other question. One of the ancillary effects of the integration of the combination of the companies was that the conversations you were going to have with management was supposed to rise up, in other words getting up to more C-level conversations around larger projects. In which areas have you been more successful in being able to talk at a full enterprise, C-level responsibility and what areas are you still talking with if you want to call it the – either the security or the logistics person or somebody who's more down in operations and you want to move that one up? Anders Gustafsson - Zebra Technologies Corp.: Yeah, I'll start and I'll have Joe add some comments also. But I'd say across all our verticals we are seeing our ability to engage with the executive conversations about the longer-term vision of where we're going and how our new types of solutions can help our customers address some specific problem areas or business opportunities for them. Retail is a great example where we regularly meet with a number of CIOs, and the executive leadership teams of retailers to brainstorm together about what their biggest business issues are, and how we can help apply technology to solve some of those. But these conversations are meant to be additive, so by no means, are we looking to in any way diminish or de-emphasize the conversations we've had over time with people who are in the operations areas, or IT areas, or whatever there might be within our customers' business, but we just want to make sure we can cover the entire organization better and make sure that we can be better aligned on the business issues that are top priority for our customers and make sure we can align our road maps to that. Joe? Joachim Heel - Zebra Technologies Corp.: Yeah. I would say the area in which we continue to do a business at maybe the conventional levels of the organization are a large run-rate business, which is quite healthy, continues to operate smoothly with all of the relationships that we've had in place traditionally. Where we have leveled our relationships significantly I would say is particularly around two areas. One is some of these large deals, in particular, as customers make a transition to Android, those deals are large enough that they – and transformational enough for many of the customers that they bring us to the attention of a senior level of management. And we have those conversations there and build relationships out of that. And then, the second one is where we talk about solutions like SmartLens, we are always talking about business cases. We're talking about ROI, and we're having conversations with business level decision makers at a senior level. Those are the two cases. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Great. Thank you very much. I appreciate it. Operator : And our last question this morning will come from Paul Coster of JPMorgan. Please go ahead. Paul J. Chung - JPMorgan Securities LLC : Hi. This is Paul Chung on for Coster. Thanks for taking my question. So now with ERP online, TSA agreements sorted out by 3Q, and as your new channel program expands, do you see any additional structural benefits from the integration that could provide some cushion for upward revisions to both long-term gross margins and EBITDA margin targets, and if you could remind us, where your long-term margins target stands. Thank you. Olivier Leonetti - Zebra Technologies Corp.: So the implementation of the ERP is now creating the conditions for us to drive productivity further. Now as I said earlier, that's not new at Zebra. We have a culture of improving efficiencies. We did that before the acquisition. We would do that as the acquisition is finalized. And we have the opportunity to improve the various ratios of the P&L. So gross margin but also OpEx. For that reason, we feel confident about the EBITDA margin range we gave for the year of about 18% to 19% despite currency headwinds. Paul J. Chung - JPMorgan Securities LLC : Thank you. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steele for any closing remarks. Michael A. Steele - Zebra Technologies Corp.: Thank you all for joining the call today. Have a great day. Operator : And thank you, sir. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,017
| 3
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2017Q3
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2017Q2
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2017-08-08
| 5.91
| 6.04
| 6.674
| 6.805
| null | 14.26
| 15.14
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Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: Paul Coster - JPMorgan Securities LLC Matthew Cabral - Goldman Sachs & Co. LLC Jason A. Rodgers - Great Lakes Review James Ricchiuti - Needham & Co. LLC Richard Eastman - Robert W. Baird & Co., Inc. Keith Housum - Northcoast Research Partners LLC James E. Faucette - Morgan Stanley & Co. LLC Jeffrey Ted Kessler - Imperial Capital LLC Jeremie Capron - ROBO Global Operator : Good day, and welcome to the Second Quarter 2017 Zebra Technologies Earnings Release Conference Call. All participants will be in listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning, and thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our second quarter highlights and key drivers of the results. Olivier will then provide more detail on the financials and discuss our third quarter and full year outlook. Anders will conclude with discussion of recent progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. Also, as a reminder, our reported financial results include the divested wireless LAN business through October 2016. In this presentation, our references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN sales from 2016 results. Now, I'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. We had another successful quarter executing on our strategy. As you see on slide 4, our team delivered solid second quarter results, including adjusted net sales of $897 million, with organic growth of greater than 6%, which exceeded our guidance range. Adjusted EBITDA margin of 17.7%, reflecting a 140 basis point improvement over the prior year. Non-GAAP EPS of $1.51, a 29% increase over Q2 of last year and $160 million of debt pay down, driven by strong free cash flow and prudent cash management. We accomplished all of this while successfully implementing the last major milestone of the Enterprise integration by going live with our global ERP system. This represents the culmination of 2.5 years of dedication and focus by the entire team and completes our transition to One Zebra. Now turning to the quarterly results; we achieved growth across all regions, led by double-digit growth in Latin America, and 9% growth in North America, driven by high demand for our Android enterprise mobile computing portfolio. In the quarter, we continued to extend our market leadership and delivered innovative solutions to our customers that provide them increased visibility into their operations. We enjoyed significant wins including many large orders for a wide range of our mobile computers and saw, especially, strong demand from our retail and transportation and logistics customers. Delivering strong results for the past two quarters gives us the confidence to narrow the range of our full year sales outlook to the top-end of our prior guidance. In addition, our recently announced comprehensive debt restructuring, lowers interest rates, and drives profitability improvement. With that, I will now turn the call over to Olivier, to review our financial results in greater detail and to discuss our debt restructuring and 2017 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. Before we get started, I would like to remind you that references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN from 2016 sales results. Let us begin with a walk through the P&L. As you can see on slide 5, adjusted net sales for the second quarter were $897 million, up 6.4%. Our second quarter sales performance was driven by solid results in each of our reporting segments and growth across all of our regions. Enterprise segment sales of $584 million increased 7.9%, driven by double-digit growth in mobile computing. Pre-transaction, Zebra sales were $313 million, up 3.7%. Printing and supplies sales were higher, as were sales in our Location Solutions business. Sales of services were approximately flat. Turning to our regions; sales growth in North America was up 9%, driven by strength in mobile computing. We add another strong quarter in retail and e-commerce as the industry continues to transform to meet evolving consumer purchasing preferences. EMEA sales increased 4% from a year ago. We are seeing broad-based traction and solid demand for our offerings across the region. Latin America sales increased 11%. We saw exceptionally strong sales in data capture, printing and supplies across the region. Sales in Asia Pacific were up 2%, where we were cycling strong results in the first half of 2016. Current year sales were positively impacted by 3 percentage points related to the release of a reserve for price concessions related to duties previously imposed on printers in China. Most of the region grew with particular strength in Australia. China was the exception, where we are experiencing softness in the data capture and printing markets. China accounts for less than one-half of Asia Pacific region sales, and we continue to view it as a long-term growth driver of our business. Our team has a comprehensive go-to-market improvement plan to strengthen results, including enhanced product offerings. Consolidated adjusted gross margin of 46% was 40 basis points lower than the prior-year period, primarily due to changes in business mix, driven by the exceptionally strong quarter in mobile computing. Gross profit increased $4 million from the prior-year period due to higher sales volumes. Adjusted operating expenses in Q2 were $274 million, down from $282 million last year. These results primarily reflect the company's continued focus on improving operating efficiency, controlling expenses, and the divestiture of the wireless LAN business. Second quarter 2017 adjusted EBITDA margin was 17.7%, a 140 basis point increase from the prior-year period. This was driven by higher gross profit and lower operating expense. Non-GAAP earnings per diluted share increased to $1.51 in the second quarter, an increase of 29% from the prior-year period. Lower interest cost and a lower tax rate also contributed to the sharp increase in EPS. Integration expenses were $19 million in Q2, a $15 million decrease from the prior-year period. As Anders mentioned, we exited all remaining transition service agreements with Motorola Solutions in early Q3. We expect minimal integration expense in the second half of 2017. Turning now to the balance sheet and cash flow highlights on slide 6. We ended the second quarter with $95 million in cash. Our transition to a single global ERP system has enabled us to pull operating cash more efficiently and significantly lower our cash balances. As of the end of the second quarter, we added $2.4 billion of long-term debt on the balance sheet. We paid down $160 million of principal under Term Loan B in the quarter, driven by strong free cash flow and reduced cash balances. Free cash flow of $77 million, increased by $65 million, compared to the second quarter of last year, primarily due to increased profitability, improved working capital management, and lower capital expenditures. Slide 7 shows our path to financial deleveraging. The top priority for cash flow and excess cash balances is to aggressively pay down acquisition debt. Our net debt-to-adjusted EBITDA ratio decreased to approximately 3.6 times as of the end of the second quarter, which is down for more than five times as of the close of the Enterprise acquisition in late 2014. Our profitable growth and strong free cash flow profile continue to provide us confidence in achieving a debt leverage ratio of less than three times by mid-2018. Turning to slide 8 On July 26, we announced a comprehensive debt restructuring. We're taking advantage of a favorable credit market to reduce our average interest rate by approximately 2 percentage points and drive more than $45 million of annual interest savings. We closed on a senior secured credit facility maturing in 2021, initially priced at LIBOR plus 2% with the opportunity for reduced pricing as we approach our debt leverage target next year. This facility includes a $688 million Term Loan A and a $500 million revolving credit facility. Yesterday, proceeds from the new facility were used to redeem $750 million of our 7.25% senior notes, maturing October 2022. We plan to redeem the remaining $300 million of the senior notes in the fourth quarter through lower-cost financing arrangements, including an accounts receivable securitization facility. We also amended $1.3 billion Term Loan B facility, maturing October 2021, reducing the interest rate by 50 basis point to LIBOR plus 2%. As a result of the debt restructuring plan, we expect to pay a total of $72 million of redemption costs and transaction fees in the second half of the year, of which we expect to pay $55 million in the third quarter. We also expect to incur approximately $18 million of non-cash accelerated amortization of debt issuance costs and discounts in the second half of the year, of which we expect to record $13 million in the third quarter. On slide 9, you will see that for the third quarter of 2017, we expect the change in adjusted net sales to be between negative 1% and positive 2% on a nominal basis. We expect organic net sales growth between 2% and 5%, with growth in all major product lines. This growth expectation excludes the adverse impact of 4 percentage points from wireless LAN and a 1 percentage point positive impact from foreign currency translation. Given the recent weakening of the U.S. dollar, foreign currency impacts are expected to be accretive to us in the second half of the year. We expect sales growth to moderate through the balance of 2017, considering the more challenging year-over-year comparisons and the lumpy nature of our business. Third quarter 2017 adjusted EBITDA margin is expected to be in the range of 18% to 19%, an increase from the prior-year period. This rate assumes higher gross margin as compared to the prior-year period. Additionally, we expect adjusted operating expenses to be approximately in line with the prior-year period as a percentage of sales. Non-GAAP diluted EPS is expected to be in the range of $1.65 to $1.85. Given our strong first-half sales performance and backlog entering our third quarter, we are narrowing the range of our full year sales growth outlook to the top-end of our prior-year outlook. We now expect approximately 3% to 6% organic sales growth. This outlook excludes the adverse impact of three percentage points from wireless LAN and assumes minimal foreign currency impact. Full year 2017, adjusted EBITDA margin is expected to be in the range of 18% to 19%, which is higher than 2016. Our full year outlook assumes a slightly higher gross margin rate compared to last year and lower adjusted operating expenses as a percentage of sales, due to productivity improvements. For the full year 2017, we continue to expect debt pay-down to exceed free cash flow. Our goal is to pay down at least $300 million of debt, which is supported by higher EBITDA, lower integration expenses, solid working capital management, as well as reduced cash on hand required to operate the business. We are reiterating this debt pay-down goal despite our expectation of paying $72 million of redemption and transaction fees related to our debt restructuring plan. You can see other full year 2017 modeling assumptions on slide 9. Note that we have revised our interest expense assumption due to the impacts of the debt restructuring. Interest expense is now expected to be approximately $235 million to $240 million. This includes redemption cost, transaction fees, and non-cash amortization. With that, I will turn the call back to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. Overall, we are pleased with the progress made on our strategy in the second quarter and our momentum as we enter the back half of 2017. As you see on slide 10, we are focused on several areas to build upon our leading positions globally and to drive profitable growth. First, we are leveraging our scale, innovation and relationships with customers and partners to extend our leadership with an innovative portfolio of Enterprise Visibility Solutions; second, we are advancing our vision of Enterprise Asset Intelligence, or EAI, by leveraging Zebra's deep knowledge of the markets we serve and capitalizing on key technology trends. I will update you on our progress in a moment. Third, we have achieved the final milestones of the Enterprise integration. In May, we went live with our global ERP and IT ecosystem. Since that time, we have been stabilizing the combined platform, and we have recently exited all remaining transition service agreements with Motorola Solutions. We now have the opportunity to further increase productivity across the Enterprise and improve the experience for our partners and customers. Our fourth area of focus is to further enhance Zebra's financial strength by increasing profitability, improving cash flow, and optimizing our capital structure. We are driving profitable sales growth, and our cash flow profile continues to improve. Our recently announced debt restructuring significantly lowers our interest costs and provides the flexibility to de-lever our business to achieve optimal levels. Now turning to slide 11; Zebra is uniquely positioned to capitalize on key megatrends in mobility, cloud computing, and the proliferation of smart devices through our technology, which senses information from all Enterprise assets. Data from these assets, including status, location, utilization and preferences is then analyzed to provide actionable insights in real time. This EAI framework provides a digital view of the entire Enterprise, which enables visibility for our customers into their business operations and workflows, resulting in smarter business decisions. Zebra brings this vision to our customers through our broad innovative portfolio of solutions, including enterprise-grade mobile computers, printers, scanners as well as intelligent infrastructures, software and services. We are also committed to empower our global partner community so that they can deliver our new EAI data-driven offerings as well as their own to the market. We will continue to provide the resources and tools necessary to help them succeed in delivering innovative EAI solutions to the end user. Slide 12 highlights how we serve our key vertical markets. The trends our customers are seeing in the marketplace are driving opportunities for growth at Zebra. Consumers now expect retailers to provide them goods when and how they want it delivered. Transportation companies to deliver in hours rather than days and health care providers to administer a higher-quality of care at a lower cost. Additionally, manufacturers are focused on shortening production cycles and reducing waste with a more mobile workforce. Zebra has a deep and intimate understanding of the operational workflows in the key industries that we serve. Our expertise enables us to help our customers navigate the changes in their business. In retail for instance, we continue to play a leading role in helping companies execute their e-commerce strategies through our broad range of solutions. We are seeing strong demand from the largest e-commerce players in the world for our warehouse-grade mobile computers, hands-free ring scanners and mobile printers. They utilize our solutions to enhance their speed and efficiency. Additionally, e-commerce workflows are tracking-intensive and accuracy is paramount to successful execution. Our solutions reduce errors and minimize returns, which are costly to service and a hassle for customers. We are also driving innovation in the front of the store with our personal shopper mobile computers. Recently, a leading European grocery chain implemented this solution to revolutionize their store experience by allowing shoppers to scan their own items as they shop. This allows their customers to control the store experience as well as check out faster. This solution also provides real-time visibility into their shopping trip, which allows the grocer to send relevant promotions and suggestions for complementary items directly to the mobile computer, increasing basket size and loyalty. Store staff utilized the same device for store audits, price checks and inventory management, which further improves productivity. In the transportation and logistics space, we recently expanded our relationship with a global food service distributor as part of their warehouse delivery and modernization effort, this customer has been implementing our solutions for a variety of workflows and processes. These include forklift-mounted and handheld mobile computers, ring scanners, and mobile printers used for restocking and picking items in the warehouse, including in the freezer. This customer is also upgrading to our recently launched Android mobile computers for thousands of delivery trucks and to execute on their new proof-of-delivery process. This relationship highlights the power of One Zebra and our comprehensive set of Enterprise devices and services. In the manufacturing and industrial space, we recently rolled out our next-generation industrial thermal printers, which are both intelligent and engineered to withstand the years of continuous operation in harsh production environments. This cloud-accessible Link-OS operating system enables user-friendly remote routing, configuration, and firmware updates. These printers also have a flexible design for hardware upgrades in the field, including the ability to print RFID labels. In our health care vertical, we're excited to announce our collaboration with GE Healthcare on a solution that enables hospitals to accurately manage inventory, reduce total cost of ownership, and achieve improved capital allocation. Health care providers are able to locate mobile assets in real-time, so that they can spend less time searching for critical equipment and more time focused on quality patient care. Historically, it had been expensive and time-consuming to implement a hardwired solution. Our new innovative solution is flexible, built upon commercial Bluetooth technology and leverages the hospital's existing Wi-Fi network. This solution only takes days to implement and is accessible to any staff member with a mobile device. With Zebra's expertise, asset and operational activities can be analyzed so that the right decisions can be made in real-time. Finally, across all our verticals, we continue to see traction in our Visibility Services that provide insight into the status, location, usage, health and overall activity of the Zebra fleet of deployed mobile computers and printers. This device visibility is becoming increasingly important to our customers as they seek to further optimize their workforce for activity. In closing, we will continue to work with our customers and partners to drive digital transformation forward, equipping companies of all sizes with data-driven intelligence to improve their operations. I would like to thank the entire Zebra team for their dedication and focus on our priorities. We have successfully executed on a comprehensive acquisition integration program, and we continue to meet our growth and profitability objectives. With that, I'll hand the call back to Mike. Michael A. Steele - Zebra Technologies Corp.: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many view as possible. Operator : We will now begin the question-and-answer session. The first question comes from Paul Coster with JPMorgan. Please go ahead. Paul Coster - JPMorgan Securities LLC : Yes, thanks for taking my question, and congratulations on getting off of those TSAs. With which, maybe Olivier, can you talk about synergies? Are they completely played out now, or even more to come now that you got the ERP here and presumably still kind of road-testing it? Olivier Leonetti - Zebra Technologies Corp.: Good morning, Paul. We believe that after the successful implementation of our ERP that we have the opportunity to drive synergies further. It's to a large extent, actually, reflected in our EBITDA margin, Paul. Paul Coster - JPMorgan Securities LLC : Okay. That's the outlook, right? And are the synergies going to be played out completely by year-end? Or do you see this as a process that extends into 2018? Olivier Leonetti - Zebra Technologies Corp.: We think that this is going to be an ongoing process. You will start to see the benefit of those productivity initiatives in the second half of this calendar year. And more will come next year as well. Paul Coster - JPMorgan Securities LLC : Thank you very much. Anders, I know that you don't have that much visibility, but can you comment on pipeline, backlog and bookings momentum going into 3Q? Anders Gustafsson - Zebra Technologies Corp.: Yes. We are confident in our outlook for the third quarter. We entered the quarter with good backlog and solid momentum. I think we're very well-positioned for growth across the business. We have a very strong portfolio of solutions today. And we also have our Enterprise Asset Intelligence, a new type of solution side. And that's providing great thought leadership for us in the market. So for Q3, we expect growth across all our product lines. Paul Coster - JPMorgan Securities LLC : And to wrap, do you feel like things have changed at all as the macro environment getting incrementally better, or is the understanding of your technology improving? Is your portfolio now hitting sweet spots so that it previously wasn't? Anything that kind of gives us a sense of what's changing here if anything? Anders Gustafsson - Zebra Technologies Corp.: There are a lot of things. I think we are benefiting from, I think, an improved macroeconomic environment. But also, we have, I would say that, maybe two things to highlight here for Q2 and looking at Q3. One will be, we believe our product portfolio is as competitive today as it's probably been ever across the board. While mobile computing win with our Android all-touch devices. We have a refreshed data capture portfolio, and we have a lot of new printer products that came out, particularly the high end here recently. So, I think we have a strong competitive position with our products. And we've seen particularly strong larger deal activity from our retail and e-commerce customers where we are helping them capitalize on the shift from e-commerce – from, say, traditional retail to e-commerce and omni-channel. We're moving from having been viewed more as a tactical productivity tool to more of a strategic enabler. Somebody who can help them execute on their strategies and some of our new solutions like SmartLens, clearly demonstrates how we can do some of those things and positions us to be a real thought leader in the industry. Olivier Leonetti - Zebra Technologies Corp.: Paul, an additional comment. We have been able to compete very well up to now despite having to manage successfully a very complex integration. So a big change now is going to be – that we're going to be fully dedicated to externally and fully dedicated to compete in the market, Paul. Paul Coster - JPMorgan Securities LLC : Thank you. Operator : The next question comes from Matt Cabral with Goldman Sachs. Please go ahead. Matthew Cabral - Goldman Sachs & Co. LLC: Yeah, thank you. You've talked a lot about the strength in retail over the past few quarters. So I've two questions around that, and I guess I'll just ask both at the same time. The first is related to little bit to your last answer, Anders. But it feels like we've heard about the benefits of omni-channel for several years now, but why is it do you think that customers are now finally starting to make those investments? What's been the major catalyst that you've seen? And then the second question I have is just around the competitive environment that you're facing in, if the landscape really changes at all, these retailers are starting to make transformational in next-generation investments? Anders Gustafsson - Zebra Technologies Corp.: So first, your question was around why our retailers getting on with omni-channel today. Yes, it's fair to say that this is not necessarily a new concept. But I think that there's a few things that have changed, say, in the background to enable this to happen. One is that it requires substantial investments across other things like the ERP systems and other things that need to be put in place to be able to execute on that in the first place. So our technology is not the only technology required for this, but it is an essential part of what's required. And I think retailers have been positioning themselves for this – to be able to execute on omni-channel for some time. And today, I think there's, by and large, omni-channel would be one of the top two, three priorities for most of our brick-and-mortar customers. So it is something that is top of mind for them. So, that would be your first question. On the competitive landscape, I'd say we've always been operating in very attractive markets, strong growth markets that have strong secular growth trends behind them. Our EAI strategy, I think, resonates very well with our customers and expands, say, our footprint. Our team is executing very well on that and expanding our leadership position. All the while, we've been also completing the very complex integration. So from a Zebra perspective, we are very much focused on driving profitable share gains. We want to leverage our unmatched portfolio of new products and our vertical expertise to deliver these new innovative solutions, both devices and solutions like SmartLens, which drives some very substantial market opportunities. We also look at our global channel partner program as a competitive advantage for us. But our environment continues to be a very competitive environment. And there's some – as we talked about earlier, some pockets of promotional activity. But we have a very disciplined yet, I would say, flexible approach to how to deal with that. Joachim Heel - Zebra Technologies Corp.: This is Joe Heel. One thing I would add is, the transition in retail, it was at the core of your first question, is also coming at the very time that the technology that we are offering and that the retailers are deploying is changing to Android-based environments, which both offers the retailers new functionalities, but it also is a compelling reason for them to transition at this particular time to embrace that new operating system environment. Matthew Cabral - Goldman Sachs & Co. LLC: Got it. Thank you. Operator : The next question comes from Jason Rodgers with Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. I was wondering, if you could provide some more detail around the retail vertical performance in the quarter. Just looking at the online versus brick-and-mortar? Anders Gustafsson - Zebra Technologies Corp.: Yes. I touched on that on the prior questions here. So it was a very strong performance for us retail in both traditional brick-and-mortar and e-commerce was a strong vertical for us in Q2. We've seen our new, particularly Android-based all-touch devices have great traction in that market. Our market share in retail for Android devices is very high. Overall, in total, I'd say, our Android all-touch devices have over 50% share of the market. And that would be – I would say also here the retail or omni-channel type and e-commerce type of opportunities started off as being primarily in North America and maybe Western Europe. We're started those to become much – to see those opportunities go global. So this past quarter, we had great opportunities in Australia, even in China. So it's becoming much more of a global opportunity for us. Joachim Heel - Zebra Technologies Corp.: Maybe two other characterizations I would add is that the retailers tend to have a purchasing behavior where large refreshes are done at one time. And certainly in the second quarter, several of these very large refreshes have occurred and have driven a large part of the retail business. The second thing I think we were undoubtedly seeing is that we are moving our position with the retailers from being a productivity tool to being more of a strategic enabler. If you look at the agendas that they are pursuing, the offerings that we have are central to some of the transformations that they are trying to accomplish, for example, around omni-channel. And one example that I would give you is the offering which we released at NRF, called SmartLens, which we think is a true demonstration of industry leadership of how workflows and operations in retail can transform with the help of the technology we're offering. Jason A. Rodgers - Great Lakes Review : Wonder if you could just talk a little bit more about the softness in China, if that was due to the competitive factors, and some detail on your plans to improve results there? Anders Gustafsson - Zebra Technologies Corp.: Yes. China has always been a competitive market. It's a very important market for Zebra, where we have a strong position. So we have been working on developing some comprehensive go-to-market plans to strengthen our position there. And we're also – we will also be introducing some new enhanced product offerings over the next several quarters to help grow our business further. And I'd say the early signs of our go-to-market plans, the implementation of our go-to-market plans have been very encouraging. Joachim Heel - Zebra Technologies Corp.: Yes. I think the other thing to note is as we're looking at China in particular, we are cycling a prior year that was extremely strong, right? We had double-digit growth in the first half of the last year in China. And this year, we have that compare to deal with. That said, as Anders mentioned, we have some aggressive plans underway to build on that further, and we're quite confident that we're on the right path with that. Jason A. Rodgers - Great Lakes Review : And then finally, why was services flat for the quarter? And just looking at your Zebra OneCare offering, how many mobile devices do you currently have under management? Anders Gustafsson - Zebra Technologies Corp.: So, we don't have – I can't give you the exact number of devices we have under management. But let me talk more generally about services. We actually have a strong momentum in services around our Managed Services, and in particular, the Visibility Services that we offer. And we are continuing to invest in that space. We think this service is a great add-on to our portfolio. And it supports our Enterprise Asset Intelligence vision. The other thing that's important to us about services is that we have been able to continuously improve our margins. And we expect that to continue also. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : The next question comes from Jim Ricchiuti with Needham & Company. Please go ahead. James Ricchiuti - Needham & Co. LLC: Hi, thank you, good morning. And this is maybe related in part to the last question. But I'm just looking at the – wondering how we should think about that services and software line looking out over the next one to two quarters. And there may be some moving parts here. But I'm just curious about the year-over-year decline in the first half of the year. Anders Gustafsson - Zebra Technologies Corp.: The services and software line, I think go back to what Joe said; we certainly have strong momentum around our Professional Services, our Managed Services. So that's around our what we call OVS and AVS, where that's been – those types of visibility service have been very much liked by our customers and we see great demand for those. We could say also we had less devices to repair in the second quarter, which put a damper on the revenue side, but that's kind of good news/bad news. One thing to remember though maybe will be that when we sell a large new mobile computer contract, usually what happens is that that customer had an existing fleet of devices that were under – not under warranty but that we were servicing that under service contract. But in the first year after a refresh, that fleet is now under warranty. So we don't get any service revenue for that. James Ricchiuti - Needham & Co. LLC: Got it. Are you guys satisfied with the level of activity you're seeing with respect to the software initiatives? Anders Gustafsson - Zebra Technologies Corp.: You can always do better. But we feel that we've been making good progress on software. If you look at say OVS-as-a-software type of service for us. That's been well ahead of our internal plans. And we have a number of other software initiatives that we're working on. So I think we're making good progress there. James Ricchiuti - Needham & Co. LLC: Yeah. Joachim Heel - Zebra Technologies Corp.: Software is essential to our Enterprise Asset Intelligence strategy, right? But, yet, we're being quite strategic with where we invest and then deploy in software because we also have a large partner ecosystem. And our software and the developments we're doing is designed to enhance that partner ecosystem and really support our partners in offering their own capabilities alongside ours. OVS, as Anders mentioned, is a great example of a cloud-deployed software environment that we invested in, that our partners can then build their offerings around. So we're actually quite pleased with how those are being accepted in the marketplace. Olivier Leonetti - Zebra Technologies Corp.: And finally, Jim, to conclude, we believe that the service and software lines would grow faster than the company average. James Ricchiuti - Needham & Co. LLC: That's helpful. Got it. And final question just on gross margins, product gross margins. Mainly it looks being impacted by mix in terms of the new mobile computing device. How should we think about product gross margins looking out to the second half of the year? Will we continue to see these trends? Olivier Leonetti - Zebra Technologies Corp.: So, the answer is yes. And your characterization of the first quarter, Jim, is correct. So based upon the stronger big mix than expected we had in our quarter, our margin was lower. But overall, we ended up with a margin, which is in line with what we would have expected. Our run rate gross margin, which is something we look at very closely, has been strong for a period of time and was strong in the quarter. And as well we have a very strong pricing governance process in the company. And that delivers – that allows us to deliver a balanced margin profile. And to answer to your second question, we expect the gross margin in second half, the gross margin rate to be indeed stronger. James Ricchiuti - Needham & Co. LLC: Thank you. Operator : The next question comes from Richard Eastman with Robert W. Baird. Please go ahead. Richard Eastman - Robert W. Baird & Co., Inc.: Yes, good morning. Anders or maybe Joe, I'll just try to direct the question myself. But at the end of the day, could you just kind of speak to growth in the channel versus the direct business on the mobile computing side? If I look at, your legacy Zebra business and the core growth rate there, just 3.5%, 3.7%. Is that indicative of how maybe the channel is performing, and upside to that is on the direct sales at Enterprise? Is that a fair way to look at the business? Or... Anders Gustafsson - Zebra Technologies Corp.: I'd characterize it kind of in the following way, I think. The run rate business for us is kind of the base on which we work. Then larger deals, we can add on that on top as cream on the cake. So for us, it's absolutely essential that the run rate business performs very strongly. And specifically for mobile computing here, the run rate business were strong. It was actually quite strong and we're seeing good signs that the Android part of the portfolio is picking up steam in the channel. That's part of the run rate. We have enough volume in the market that the broader ecosystem of partners is picking that up and starting to service those accounts also. We were actually quite pleased with the performance of the channel for our mobile computers in Q2. Yeah. Joachim Heel - Zebra Technologies Corp.: In particular, we have – of course, the regions are quite different, right? In terms of how we deal with the channels in each of the regions. But to give you one example in North America, we had a very strong share in the distribution for our mobile computers and across our portfolio. So we're quite pleased with how the run rate has developed in North American distribution to give you one example. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. And then just a follow-up question on the other end-markets, logistics you mentioned was especially strong. Maybe is that a mobile computing-driven end market? And then also, could you just touch on industrial and health care, just how they performed up or down, and any momentum there? Anders Gustafsson - Zebra Technologies Corp.: Yes, transportation and logistics, which was started with, I think, was a good quarter for us before that, it continues to be very strong vertical for us. We had some very strong secular growth trends that's going to fueling that growth, not least has been part of the shift to e-commerce and much more parcel delivery that's going out. So for us, T&L would last several quarters, have seen good growth. And we expect it to continue to demonstrate good growth also. We have introduced several new products in the last two, three quarters that are fit very well into the T&L vertical, so both our TC70, TC75 as well as the TC51 and TC56 are well-suited for that vertical and have been well adopted there also. So T&L is an early adopter and a strong driver of our Android growth also. Within T&L, we do have some of our newer EAI type solutions like SmartPack that is both demonstrating some good industry leadership for us, but also have been generating good growth over the last several quarters for us. If you look at health care, that's been our fastest growing vertical over the last several years. The catalyst for that growth has really been focused on the electronic medical health records. So then you'll have, you can say, an electronic database where you can attach other digital information. Our value proposition in health care is strong. It talks both about how we improve patient care, but also how we lower cost and efficiencies. And for health care, again, we've seen growth started to happen outside of the U.S. Health care started off as very much a U.S. led activity. But in the recent quarters, we've seen good wins in Middle East and other parts of Asia. In the past quarter, we also announced our new relationship with GE Healthcare for more flexible and affordable asset tracking solutions in hospitals. That's based on our beacon technologies. We also, in the last quarter, introduced some new health care versions of existing products. So we have a TC51 Health Care and a DS8100 Scanner for Health Care. So, the portfolio is getting to be fuller for more specialized devices for health care. And then lastly, manufacturing, I think the driver in manufacturing is going to continue to be greater visibility in mobility solutions. And in Q2, we featured our Network Connect solution at the ProMat Trade Show. That's the solution we developed with Rockwell to get our printers and scanners, primarily, designed into their ecosystem. I think that's a great offering and very helpful to their customers. And we've seen the pipeline grow for that, quite nicely. Maybe lastly in that vertical, I'd highlight our new top-end, tabletop printers, the ZT600 and ZT500 that we have recently introduced. We expect those to be good drivers for us also in that market. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. I understand. And can I also just ask for one clarification. Olivier, you had mentioned that in the third quarter, you were talking to the third quarter and you mentioned higher gross margin versus the prior period and also operating expenses in line with the prior period. Is prior the second quarter, or is prior the third quarter of 2016? Olivier Leonetti - Zebra Technologies Corp.: The Q3 of last year, Rich. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. Perfect. Thank you. Operator : The next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, guys and congratulations on a great quarter. If I know just give a bit more color, I think on the comment you made, Olivier, regarding the reserve reversal, I think 3% in China. Could you provide a little more color on that, and does that drop straight down to gross margins? Olivier Leonetti - Zebra Technologies Corp.: It would impact gross margins on the one-to-one basis. And you will have some dilution on Op Inc as we will increase incentive compensation because of that amount. It would mainly, Keith, flow to the bottom line. Keith Housum - Northcoast Research Partners LLC : Okay. So the increase – the EBITDA guidance you have for increasing gross margins year-over-year, sequentially is going to be an impressive increase in gross margins, correct? Will you take that out of consideration? Or is there any reserve reversal anticipating in the third quarter? Olivier Leonetti - Zebra Technologies Corp.: So the impact of the reversal had an impact on the margin and on the operating income, but the rest of the portfolio was also strong. Even if you strip that out, you would see that the performance in the quarter from a margin standpoint or EBITDA standpoint was also strong. Keith Housum - Northcoast Research Partners LLC : Okay. Got it. And as I look at your guidance, if you look at the tax guidance you guys providing, is there any change in that compared to the guidance you gave in the prior quarter? Are you thinking of a tax rate for the year might be a little lower than previous? Olivier Leonetti - Zebra Technologies Corp.: We haven't changed our tax guidance. We believe that we should guide in the low to mid-20% range. And I would advise you to take that as a planning and modeling assumption, Keith. Keith Housum - Northcoast Research Partners LLC : Okay, great. And if I can just sneak-in one, quick one in here. Mobile computers it looks like another impressive quarter for you guys. It's been following the last quarter's impressive performance. Is there any sense that you've got a refresh cycle starting in anticipation of the January 2020 end-of-life of the Microsoft operating system? Anders Gustafsson - Zebra Technologies Corp.: I think we would characterize it today as we've seen certain verticals being early adopters of Android. And I would say the two to highlight would be, retail, the postal parts certainly within transportation and logistics but even beyond postal, health care certainly also on but it's a smaller volume, say, than that. But there are some other areas that are not quite as early adopters. And we would expect them to start to deploy more Android-based devices as we go forward here. I'm not sure we want to characterize those verticals or people who haven't yet switched to Android as having a huge upgrade cycle before 2020. Although, we do expect that the vast majority of these, our estimate that 30 million (sic) [13 million] Windows devices that are out there in the market will become – will be upgraded to Android before 2020. Joachim Heel - Zebra Technologies Corp.: One addition perhaps. I think we've said this in prior calls is in retail in particular but also more broadly in the market, you have large customers who adopt the technology and lead to individual large purchases. But you also have the channel-based business. And what we've seen is that the large customers have been the early adopters. And so many of the deals that we've seen in particular in Q2, have been of that variety and have benefited us. We still expect that the channel-based business, smaller transactions will catch up and will have an equally high share of Android come into play in the quarters to come. And that will then provide – drive our business going forward. Keith Housum - Northcoast Research Partners LLC : Great. Thank you. Operator : The next question comes from James Faucette with Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. I just had a couple of follow-up questions to some of the comments that we've already touched on. I guess the first is when you look at your mobile computing and the strength that you're beginning to see there, how much of this is coming from either new customers or customers with whom you've haven't had much of an engagement versus our follow-up to the data capture deals as you talked a lot about last year? And then, just looking for a little more color on the uptake of software products, I can appreciate how you need to work within and continue to support your borrowers and other partners. But where – what kinds of products are you seeing the most strength? And how should we expect the capabilities of those to evolve? Thank you. Anders Gustafsson - Zebra Technologies Corp.: So, I'll start and, say, maybe Joe can help out here also. So first on mobile computing and the strength we're seeing there, I think your question was about, are we attracting a lot of new customers into our portfolio or into our business versus just refreshing with existing ones? And we have a healthy mix of both. But I can say we have a number of large customers that we – had not been – who had not been using our mobile computers before. So, we've definitely seen us being able to expand our share position on the back of our Android portfolio. Our mobile computing market share position today is as strong as it's been in many, many years. And particularly based on the Android performance we have. So very good news, I think, across all aspects of how it's helping us drive more business. And as part of that also, we have many examples of how the One Zebra plays out, that we can get the good win with new customer for, say, mobile computing. But on the back of that, we were able to position mobile printing and come in with scanners and so forth. We can position the entire portfolio on the back of that. On the software side, I wasn't quite as clear on exactly what the question was, but I'll start and I'll ask Joe to help out here also. But first, as we said, we want to be very careful with software in that we work very closely with our valued reseller partners. And we don't want to compete with them. We want them to think of us as good partners. We're also partnering with a lot of ISVs, Independent Software Vendors, to ensure that we can include all of their applications into our portfolio of solutions that we can offer. It provides great value for them and getting a greater reach, but also enables us to help solve more customer problems. But we have a number of software initiatives going on. I would say the one that probably is the most prominent, maybe here will be around our services, OVS and AVS. So there we have a common Zebra platform. Part of that would be our – set our platform that we talked about some years back that we have used as the core for that. But we also look at things like our Hart Systems solutions or Zebra Retail solutions. That's a great device-as-a-service or another service offering but it's based on software applications that we've written to be able to take advantage of that opportunity and deliver that service. So, that our software solution tend to be more vertically oriented, specifically focused on how to revolutionize how customers are deploying to some of their use cases and workflows. Similarly with Location Solutions, that is largely a software business, which addresses workflows for a lot of our different customers. So, I don't know Joe, if you have any... Joachim Heel - Zebra Technologies Corp.: Yes. I mean, perhaps one thing that's helpful in thinking about our software business, that's creating some interest out there, is to think about four different levels at which we are bringing the software to market. The first one that's been out there for some time is where we're augmenting our devices. Those would be things like we write software that makes them easier to deploy into customer environment. We write software that allows you to do a voice communication on a device like our Workforce Connect client. A second level is within building platforms that provide functionality over and above the device but using information from the device. What Anders mentioned, our OVS is a cloud-based platform that provides customers visibility into those devices in real-time, at any given point in time and at any place. And also provides a great platform for our partners to write applications too so that they can offer their own capabilities. The third level, which is the one we're carefully moving into is the level of applications. So on these platforms, you can now write applications that provide entirely new functionalities. Take for example the SmartLens platform that allows a retailer to have visibility to all of their inventory and activity in their store. You can imagine applications of many varieties, loss prevention or inventory management, omni-channel fulfillment. We are creating some of those to feed the market. But we're also working closely with partners to have them build a lot of these applications. And then the fourth level, as Anders mentioned, are what we would call solutions like our Location Solutions offering where the software is an embedded part of the total offering. The customer doesn't really buy the software, the hardware, the service, but they buy a total outcome that is enabled by the software. Those will be the four that might characterize the business. James E. Faucette - Morgan Stanley & Co. LLC: Excellent. Operator : The next question comes from Jeff Kessler with Imperial Capital. Please go ahead. Jeffrey Ted Kessler - Imperial Capital LLC : Thank you. Can you talk a little bit about improving your customer experience so that your – if you want to call it, your length, your life with the customer, and the dependence of that customer on you as a consultative partner becomes greater and greater so that essentially, there is very little reason and very little choice for them to move away from you? And I'm thinking certainly about things like the One Zebra programs. Things that you were doing to combine both product but also your software and services that you've alluded to already to keep that customer much more sticky? Anders Gustafsson - Zebra Technologies Corp.: Yes. So that's a big topic. That's kind of everything we do to some degree. But it's a good topic for us now also. From an internal perspective, we have worked really hard for two and a half years to go through the integration of the Enterprise business and to get off the Motorola's ERP system and get off all the TSAs. So now we're done with that, I think we're taking a step back to make sure that we are now also offering the right customer experience. It's very important to us that our customers and partners see that we are the best partner for them to work with across a variety of different ways. So we're mapping out a little bit of the customer journey. Now different touch points we have with customers, and how can we make that all better. But some of the bigger ones that we have I would say is around our channel program. That's something that's going to be foundational to how we engage with our partners and ultimately with our end users. And that's been well received by the market. But it's a live document. We always keep looking at how we can make it even better. We have our services engagements, which is a very important part of it also. And we always work on making sure that we can deliver services that meet or exceed the service level agreements we have with our customers across the board. And also, no small part is the portfolio of products we have, right? We have the right solution to address our customers' needs and software and services are certainly part of that. So this is a very broad thing for us and one something we're taking very seriously. We do look at our Net Promoter Scores and try to drive those up every year to make sure that we are delivering the kind of experience that our customers should be expecting from us. Jeffrey Ted Kessler - Imperial Capital LLC : That's kind of what I was driving at. While the Net Promoter Score is just a number, it's more than a number when you compare it against your peers. Anders Gustafsson - Zebra Technologies Corp.: Yes. And to us, it is a number. But it helps us dig into various aspects of other questions there to identify where we might have some weak spots and try to make sure we come up with kind of a closed loop engagement where we go back to those customers or partners and explore what it is they are less satisfied with and make sure we have a good response and we can then modify if it is a program issue or some other performance issue or whatever it is we're doing that isn't fully meeting the mark. Joachim Heel - Zebra Technologies Corp.: We actually have a very disciplined and broad-reaching program around NPS in the company that the sales forces are engaged in. It covers both customers and partners. And we use it as a tool to then dig into where do we have opportunities to improve, on an ongoing basis. So NPS for us is a core metric. Jeffrey Ted Kessler - Imperial Capital LLC : And is Android education, Android spending on customers a part, a big part of getting them used to a new system that they might not normally consider to be in their best interest at the beginning where it could be in your interest, to keep them on longer once they get used to it? Anders Gustafsson - Zebra Technologies Corp.: I'm not sure if I fully understand the question. Jeffrey Ted Kessler - Imperial Capital LLC : I'm trying to think the amount of time you're spending on adapting the customers and getting them to adopt Android. So that something that is not maybe a little bit aliening to them at the beginning become something that is more sticky to them in the end? Anders Gustafsson - Zebra Technologies Corp.: Yes. To that point, we do have a significant training, educational material. So we go out and engage with our through, say, first our distribution partners to help train a lot of our resellers to get made them comfortable and understanding the value proposition of Android versus Microsoft or other operating systems, and understanding our portfolio and how that – where it makes sense to position it. And similarly, we do that with end-user customers, too. We have a number of partner advisory councils and end-user councils where we also discuss how can we best do those things. But we see it as the market leader as part of our job is to educate the market on the direction we see and how it's developing. Joachim Heel - Zebra Technologies Corp.: But I would see the dynamic around Android in regards to stickiness is a little bit different than you described, right? So we are working hard and moving aggressively to get customers onto the Android platform for the well-known reasons around that. Now when the customer decides to go to the Android platform, currently, we do have an advantage in doing that. We have a broader portfolio. We have very well performing products. We have a great set of tools and capabilities around those. But we have to be also aware of the fact that Android is not exclusive to us, right? Android is open in the market, and therefore, once a customer moves to Android, then also other Android competitors can go and pursue that. That means for us, we have to stay ahead and it's our strategy to stay ahead through the value-added that we've been talking about, right? Superior Android environment, better security, better operating environment, software capabilities and services that's around that. That's the way that we can then keep the customer sticky to our solution once they make the Android transition. Anders Gustafsson - Zebra Technologies Corp.: To that point, we introduced at LifeGuard. I think it was in the beginning of Q2. That is an enhanced service for our Android devices where we can provide security patches and other bug patches for the life of the device. So otherwise, if you think of more into consumer world, that tends to be you support the current and then maybe one or two older versions of the operating system. We are supporting much further back because we know that our customers are expecting to use those products for much longer. This is not a throwaway product that can be in the market for five years. And we want to make sure that we can provide the similar level of service for them throughout the use of those devices. And that's a differentiated offering that makes it very sticky. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Great. Thank you very much. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : The next question comes from Jeremie Capron with ROBO Global. Please go ahead. Jeremie Capron - ROBO Global : Good morning. Thanks very much for squeezing me in here. I would like to ask about pricing trends. To what extent is pricing a positive factor on your margin trajectory today? And is this something that you see as sustainable, particularly in the context of the strong cycle of new products that you just come through? Anders Gustafsson - Zebra Technologies Corp.: Yes. Pricing, so as I said earlier, we are in a competitive market. We have to be thoughtful about how we price. We certainly always try to make sure we have a disciplined, yet, very flexible approach to that. We don't want to lose deals on price but we certainly don't also want to win deals on price. We are always striving to have a premium for our products. We think that we have the best portfolio in the industry. And as such, we should have a premium to other competing solutions. It is our understanding and belief based on the market research we do that we tend to have a premium. It's not infinite. But there was a premium. And we worked very hard to make sure that we are very thoughtful about how we price and how we make sure that we offer our customers a fair and attractive offer, but also one that allows us to continue to invest in the business and generate a return for our shareholders. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steele, for any closing remarks. Michael A. Steele - Zebra Technologies Corp.: Thank you, all, for joining the call. Have a great day. Operator : This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,017
| 4
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2017Q4
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2017Q3
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2017-11-07
| 6.208
| 6.403
| 7.069
| 7.405
| null | 14.66
| 14.07
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Executives: Michael Steele - VP, IR Anders Gustafsson - CEO Olivier Leonetti - CFO Joachim Heel - SVP, Global Sales Analysts : Jim Ricchiuti - Needham & Company Jason Rodgers - Great Lakes Review Brian Drab - William Blair Meta Marshall - Morgan Stanley Paul Coster - JPMorgan Keith Housum - Northcoast Research Matthew Cabral - Goldman Sachs Andrew Spinola - Wells Fargo & Company Jeremie Capron - ROBO Global Richard Eastman - Robert W. Baird Operator : Good day, and welcome to the Third Quarter 2017 Zebra Technologies Earnings Release Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning and thank you for joining us. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our third quarter highlights and key drivers of the results. Olivier will then provide more detail on the financials and discuss our fourth quarter outlook. Anders will conclude with discussion of recent progress made on Zebra's strategic priorities and an update on our positioning in the retail and e-commerce sector. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. As a reminder, our reported financial results include the divested wireless LAN business through October 2016. Through this presentation, our references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN's sales from 2016 results. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least one year. Now I will turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning everyone, and thank you for joining us. As you see on slide five, our team delivered solid third quarter results, including adjusted net sales of $936 million with organic growth of nearly 6%, an adjusted EBITDA margin of 19.2%, which was a 110 basis point year-on-year improvement, and non-GAAP EPS of $1.87, a 31% increase from last year. Each of these metrics exceeded our guidance range. In the quarter, we continued to extend our market leadership and delivered innovative solutions to our customers that provide them increased visibility into their operations. We achieved growth across all regions led by EMEA and Latin America. We also saw strength across all product lines with data capture, mobile computing and printing, each growing above the company average. The broad-based strength in the quarter reflected growth in the channel. In addition, we continued to build our pipeline of larger opportunities, resulting in a strong backlog position as we entered the fourth quarter. We accomplished this while exiting all remaining transition service agreements related to the Enterprise acquisition as well as executing on our debt restructuring plan. With that, I will now turn the call over to Olivier to review our financial results in greater detail and to discuss our fourth quarter outlook. Olivier Leonetti : Thank you, Anders. Let us begin with a walk through the P&L. As you can see on slide seven, sales grew 5.9% in the third quarter, driven by solid results in each of our reporting segments and growth across all four regions. Enterprise segment sales increased 5.5%. Investments to refresh our data capture portfolio, including the expansion of our tiered offerings, are translating into solid growth. Mobile computing continues its momentum with our industry-leading Android-powered portfolio. Pre-transaction Zebra segment sales increased 6.6% with growth in printing and supplies. Sales of services were slightly higher with strength in our visibility services applications, location solutions, and Zebra retail solutions. Turning to our regions, sales growth in North America was 5%, driven by strength in mobile computing and printing products. EMEA sales increased 8%. We saw broad-based traction across mobile computing, data capture, and printing products. Sales in Asia-Pacific were up 2%. As a reminder, prior-year sales were negatively impacted by $7 million of price concessions related to duties previously imposed on printers imported into China. We grew sales in the quarter throughout most of the region with particular strength in Australia. China was the exception where, as we discussed last quarter, we are experiencing softness in our printing and data capture businesses. We consider China a long term growth driver of our business and our team is making good progress on a go-to-market improvement plan and tailored product offering. Latin America sales increased 9%. We saw exceptionally strong sales in mobile computing and data capture products in the quarter. Consolidated adjusted gross margin increased 10 basis point from the prior-year period. This was mainly due to the previously mentioned price concession to distributors of printer products imported into China last year and favorable changes in business mix. These factors were partially offset by temporarily higher supply chain costs due to the regional consolidation of distribution centers as well as higher support services cost associated with the in-sourcing of North American repair operations. Adjusted operating expenses declined $3 million from the prior-year period, a 130 basis point improvement as a percentage of sales. The reduction reflects lower healthcare, legal and professional fees, partially offset by higher incentive compensation expense due to improved business performance. Third quarter 2017 adjusted EBITDA margin was 19.2%, a 110 basis point increase from the prior-year period. This was driven by higher gross profit and lower operating expenses. Non-GAAP earnings per diluted share increased to $1.87 in the third quarter, an increase of 31% from the prior-year period. Lower interest costs also contributed to the sharp increase in non-GAAP EPS. Integration expenses were $4 million in Q3, down from $28 million in the prior-year period. As Anders mentioned, we exited all remaining transition service agreements with Motorola Solutions in late July. Turning to slide eight, as a reminder, in July, we announced a comprehensive debt restructuring plan, which will reduce our average interest rate by approximately 2 percentage points and drive more than $45 million of annual interest savings. In August, we redeemed $750 million of our 7.25% senior notes. We plan to redeem the remaining $300 million of the senior notes on December 4th through lower cost financing arrangements, including an accounts receivable securitization facility. Turning now to the balance sheet and cash flow highlights on slide nine, as of the end of the third quarter, we had $2.5 billion of debt on the balance sheet. We have paid down $187 million of debt principal year-to-date on a net basis, essentially in line with our expectations. In Q3, we were a net borrower of $53 million due to one-time debt restructuring cost and temporary high working capital needs. Free cash flow was $174 million year-to-date, which was $29 million less than the prior-year period. This decrease was primarily due to a significant and temporary inventory build through the end of the third quarter. This mainly related to a backlog build in anticipation of a strong Q4, much of which shipped in October. Slide 10 shows our path to financial deleveraging. Our top priority for cash flow and excess cash balances is to pay down debt. Our net debt to adjusted EBITDA ratio was 3.6 times as of the end of the third quarter, which is down from more than 5 times as of the close of the Enterprise acquisition in late 2014. Our profitable growth and strong free cash flow profile continue to provide us confidence in achieving a debt leverage ratio of less than 3 times by mid-2018. Let's turn to our outlook on slide 11. For the fourth quarter of 2017, we expect the growth in adjusted net sales to be between 3% and 6%. We expect organic net sales growth between 2% and 5%. This growth expectation excludes a 2 percentage point positive impact from foreign currency translation and approximately 1 percentage point adverse impact from wireless LAN. Fourth quarter 2017 adjusted EBITDA margin is expected to be in the range of 19% to 20%, an increase from the prior-year period. This rate assumes flat to slightly lower gross margin due to an anticipated higher mix of large orders. Additionally, we expect adjusted operating expenses to be favorable to the prior-year period as a percentage of sales. Non-GAAP diluted EPS is expected to be in the range of $2 and $2.20. For the full year 2017, we continue to expect to pay down at least $300 million of debt, which is supported by higher EBITDA, lower integration expenses, lower capital expenditures as well as reduced cash on hand. Following a significant inventory increase through the third quarter, the trend is reversing and working capital is expected to be a significant source of cash in the fourth quarter. You can see other full year 2017 modeling assumptions on slide 11 with modest adjustment to interest and stock-based compensation expenses. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson : Thank you, Olivier. Overall, we are pleased with the progress made in the third quarter and our outlook for the fourth quarter. As you see on slide 13, we are focused on several areas to build upon our industry leadership and drive shareholder value. First, we are extending our leadership in enterprise visibility solutions through our scale, innovation and relationships with customers and partners. Second, we are advancing our vision of enterprise asset intelligence or EAI by leveraging Zebra's deep knowledge of workflows and capitalizing on key technology trends and our cloud platform. I will update you on our progress in a moment. Third, we have achieved the final milestones of the Enterprise integration, thanks to the dedication and focus by the entire Zebra team. With that accomplished, we are laser-focused on further extending our lead in the markets we serve. Our fourth area of focus is to further enhance Zebra's financial strength by increasing profitability, improving cash flow and optimizing our capital structure. We are driving profitable sales growth and our cash flow profile will continue to improve as integration and debt restructuring costs subside. Lower run rate interest costs combined with a flexible capital structure should enable us to achieve a target debt leverage ratio of less than 3 times by mid-2018. Now turning to slide 14, Zebra is capitalizing on key trends in mobility, cloud computing, and the proliferation of smart devices. Our devices and smart infrastructures sends information about assets, products and processes. This information, including status and location, is then analyzed to provide actionable insights to front-line employees in real-time to reduce friction in workflows, improved productivity and enable unprecedented insight into business operations. This EAI framework provides a digital view of the entire enterprise. Our strategy not only focuses on sensors and analytics, but also on actions and outcomes that can be optimized by knowing and analyzing what's happening in the physical world on a real-time basis. Zebra brings this vision to our customers through our broad, innovative portfolio of solutions, including enterprise grade mobile computing, data capture offerings, intelligent infrastructures, and specialty printers as well as softer analytics and visibility services. Savanna, our enterprise asset intelligence platform, is a critical component of our overall offering. It interconnects data from sensors, devices and smart infrastructures with workflow applications. Savanna powers the provisioning, analytics and visualization behind our cloud-based, data-driven solutions. These include our visibility services applications and new solutions such as SmartPack Trailer among others. As a reminder, SmartPack Trailer is our software analytics solution, which has been installed on thousands of dock doors, empowering operations managers to maximize cargo capacity utilization. We are now empowering an ecosystem of partners to leverage the Savanna platform by developing secure data-driven applications that integrate into other platforms and traditional ERP systems. In Q3, we selected the first five independent software developers to have access to our Savanna platform to bring additional applications to market. This initiative makes EAI more broadly accessible in the marketplace and uniquely positions us as the partner of choice in providing real-time data solutions for enterprise customers. Slide 15 highlights how we serve our key vertical markets. Increased consumer demands in the marketplace are driving opportunities for growth at Zebra. Retail shoppers want more convenience and flexibility in how they purchase goods, including expedited delivery. Hospital patients demand a higher quality of care at a lower cost, and manufacturers are increasing efficiencies across their value chain. We are uniquely positioned to help our enterprise customers address these challenges because we are experts in the operational workflows in each vertical market we serve. Now turning to slide 16, I would like to provide an update on the retail sector. Retail and e-commerce is currently the largest vertical market we serve and where we've had strong sales growth over the past year. For many years, we have played a leading role in helping retailers enhance their visibility and efficiency through a broad range of solutions. We recently commissioned a study with the IHL Group, a leading retail IT consultancy, to perform a deep dive into the transformational trends of the retail sector and the anticipated impact on Zebra for the five-year period 2016 through 2021. The scope of this study was comprehensive with discussions and input from more than 1,000 public and privately held retailers in North America and Europe. The key findings support important themes driving Zebra's growth. First, the retail sector has been evolving from a brick and mortar-only model to a more dynamic multi-channel model. As it transforms, the sector continues to grow both sales volume and net store count with expansion in most sub-sectors. The e-commerce channel is growing the most quickly. And second, the growing shift to more e-commerce and Omni channel benefits Zebra, our customers and our market leaders who are investing in their business. The Zebra value proposition allows retailers and e-tailers to navigate this transformation successfully. Our core business sales are expected to grow as we provide relevant technologies to the industry. Newer solutions outside of our core provide further upside. Additionally, e-commerce channel sales provide a net incremental benefit to Zebra due to the increased real-time tracking intensity necessary to execute those workflows successfully. You'll see on slide 17 that trends in most retail sub-sectors are expected to continue to have a net positive impact to Zebra's core business sales. These include the three sub-sectors, where we have the largest presence and which account for approximately two-thirds of our retail vertical sales; mass merchants, grocery and e-tailers. Only three of the nine sub-sectors we serve have declining trends in our business and these receive the most coverage in the media because it is where large-scale store closings have been taking place. For instance, five retailers in these three sub-sectors represents nearly 30% of all retail store closings during the past year. Key drivers of success for the majority of retailers include growth in multi-channel retailing, including direct e-commerce delivery, and click-and-collect at a store, in-store investments in various technologies, including tools for efficiency, inventory accuracy, and mobile computers to empower a more connected store associate, and investment increased fulfillment capabilities, which can enable same-day delivery. Technology has become the basis of competition in retail and is an enabler of key transformational initiatives from e-commerce to in-store experiences to multi-channel fulfillment. Adoption of the most effective technologies is what separates the winners from the losers in global retail, and our success demonstrates that we are providing the right technologies needed to optimize operations and delight shoppers. Overall, shoppers are raising the bar for in-store experience, fulfillment options and speed of delivery. The study demonstrates that Zebra is doing the right things to serve retailers who strive to meet that raised bar. The trend we see for retailers as they strive to meet the growing needs of their customers is not unique. We are seeing the same demands in other sectors, including transportation and logistics and healthcare. We will continue to provide solutions to help all these -- all of these customers succeed in a fast-changing environment. In closing, I want to thank the Zebra team for executing well and delivering another successful quarter. We are on track to deliver a solid Q4 and a strong finish to the year. With that, I'll hand the call back to Mike. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jim Ricchiuti with Needham & Company. Please go ahead. Jim Ricchiuti : Hi, thank you. Good morning. You may have given some of this information, but I was wondering if you could provide some additional color on the major verticals in the quarter. And my follow-up question is, it sounds like you're anticipating or have made some large shipments in Q4 presumably that's in the retail vertical, and I wonder if you could perhaps elaborate on that and what's driving that. Thank you. Anders Gustafsson : Yeah. Thank you. Firstly on the verticals, we had -- we had a lot of strong secular growth drivers across all our verticals and we believe we have a very competitive set of products and solutions that are helping to fuel growth across all of them. If I give you some more color on the specific verticals, I'll start with retail. Retail has been a strong vertical for Zebra for several years for a long time. We had solid growth over the past year and the recent study we talked about on -- at the script, I think, validates the growth opportunity that we believe is there for us. The retail vertical is going through a substantial transformation, but it is growing and we started trying to take -- to capitalize on this shift from brick and mortar to e-commerce and Omni channel. Brick and mortar and e-tailers are all embracing our type of technology to be able to execute on their growth strategies. So we are much more essential to their -- executing on their strategies today than we were historically. And we have a number of new attractive product launches and also aided by the overall Android transition in the market, we are seeing good traction. We have some newer solutions like RFID SmartLens, a personal shopper, and the MP7000 bioptic scanners that are very -- have very strong value propositions for Omni channel retailers and helps to drive more towards a frictionless checkout. And we do see some substantial refreshes, but as you know, in retail, that tends to also be a little more lumpy. I can go through a couple of the other ones. Also you asked, I think for all the verticals. So in healthcare, that's our fastest growing vertical. The key driver for growth in healthcare has been the adoption of electronic medical records. Our value proposition historically in our spaces have been primarily focused around efficiency, but in healthcare, we can augment that with also improving the quality of care and the safety of care for patients. So it makes it that much more compelling, I think. We launched some new healthcare specific products earlier this year, the TC51 and DS8100 scanner, and we're seeing good momentum building from those product introductions. We also, I think last quarter, introduced a new collaboration we have with GE Healthcare for flexible and affordable asset tracking in hospitals, which we see is ramping nicely for us. And maybe lastly here, healthcare has been a predominantly US vertical historically, but it's now starting to show more signs of growing outside of the US, also becoming more of a global market. And lastly, I'll do the transportation logistics also. We're seeing solid growth in T&L, certainly benefiting from strong secular trends around e-commerce and much more parcel delivery to people's homes. We launched some new attractive products at the end of last year, beginning of this year, the TC75x and the TC56 and both are having a meaningful impact and helping to drive the Android transition in T&L. We have new solutions in T&L also like SmartPack and trailer location compliance, which demonstrates our industry leadership and provides some upside to the business also. Jim Ricchiuti : Thanks. And just on that Q4, the strength you're seeing, you alluded to some large shipments. Is that in retail and if there is any color on that? Anders Gustafsson : I think that was more broad based than that. So we started the quarter with good backlog position and we wanted to be able to satisfy that demand early. So we built up some extra inventory to be able to do that, but it was not just retail. Certainly some retail customers in that also, but that was more broad-based. Jim Ricchiuti : Thank you. Operator : The next question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason Rodgers : Yes, good morning. I wanted to ask about the strength in legacy Zebra in the quarter that was very strong organic growth. Wonder if you could provide more detail on what drove that and how sustainable you think that is in the coming quarters. Anders Gustafsson : Yeah, we had very good performance. Our printing and supplies business was up mid-single digits. We have a strong product portfolio today and we have more new products coming. I think the printer products have probably been the biggest beneficiary of us going kind of to the one Zebra of trying to cross-sell all the different products into existing customers. We have some, I think, unique differentiators in our products; one is our Link-OS differentiator, which enables us to have a software environment, which makes the printers a smart network citizen. We can now run applications on the printers and it can communicate a lot more things about itself of what's going on. Another differentiator for us is the Network Connect application we have. This is -- enables us to have a direct interconnect into Rockwell Automation's ecosystem. We're developing now good relationships with all of their distributors to be able to be the partner of choice for them. We've launched some new attractive printers in -- at the end of Q2, beginning of Q3, both the new ZT600 and the ZT500. Those are new tabletop printers or top of the line printers for us and they have been very well received in the markets. And our supplies business continues to do well also. It's -- we still consider that an under-penetrated market for us with lots more upside. Jason Rodgers : And then if I could ask a question on China, if you could just expand on what you said earlier about taking steps to improve results there and what should we be expecting for the fourth quarter in China? Anders Gustafsson : Yeah. So first, overall, we had very strong performance in Asia outside of China, led by Australia, Japan and India. We had strong performance of -- in printing in Asia also, but it was certainly helped by a lower -- an easier comp as we had a duty impact in 3Q of '16. China was down this quarter, but it was -- is mitigating, the trend is improving. We did see some softness in data capture and printing. But remember, China is less than half of our Asia-Pac sales, but we do feel good about the progress we're making on our comprehensive go-to-market improvement plan and we're coming out with some products that are specifically tailored for the Chinese market. So we believe we are on an improving trend and we do continue to expect that China will be a long-term growth driver for us. Jason Rodgers : Thank you. Operator : The next question comes from Brian Drab of William Blair. Please go ahead. Brian Drab : Hey, good morning. Good morning, Anders. Thanks for taking my question. Anders Gustafsson : Good morning. Brian Drab : I kind of sense on the call here that I think some people including me are trying to figure out what the longer-term growth rate should be. As you look back at 2016 and organic revenue growth was about flat, and then this year, we've had a series of three great quarters in a row. And then thinking about in the context of that study that you cited, those trends that you cited in the study, I think, we talked about throughout '15 and '16 as positive for you. So could you maybe just try to put a finer point on what in 2017 has changed in your favor? I know you are talking about a lot of new products, but or -- are those trends that you cited in the study actually accelerating? Was 2017 an inflection year in your view? Olivier Leonetti : So Brian, I'm going to take this question. So first of all, about the long-term growth of the company, as we have indicated before and we are still behind this claim, we believe that we can grow the company over cycle at the rate of 4% to 5%. This is a growth that we have been achieving over the last few years. Certainly, we're going to beat that number this year. And that's due to a few reasons. First, strong market trends and also our ability to compete in this market due to our set of product and solutions, which is allowing us to compete better and better every quarter. Regarding 2018, which is a question you alluded to, we're not going to provide a guide today, but we feel optimistic about next year. We believe we're going to be able to deliver a solid growth. The levers of growth are going to be a bit different. I am not going to go into the details of those today, but we believe we have various avenues to grow the company either in our core market or in our close adjacent markets. And last, regarding 2017, a few things explained the strong performance of the company this year. First, a strong end market, and two, an increased ability of the company to compete as the integration of Motorola Enterprise is now behind us. We believe we have the best set of products and solutions we have had as a company and that is translating into either top line or also bottom line improvements. Anders Gustafsson : I'll add a couple of words to it also. I think you asked kind of what -- if retail generally is looking to grow at 3% in their revenues, or retail revenues growing 3%, how can we expect to grow 4% to 5%. And our sense is that technology is much more of an essential enabler for retailers to grow today. They are having to invest much more disproportionately in technology to enable them to execute on their growth strategies like Omni channel and e-commerce. And we are also then benefited -- benefiting disproportionately by that as we have such a broad and relevant portfolio of product and solutions to help them do this. An example would just be how, you look at the device count per store and how that's going up as retailers wants their store associates to be much more connected and be able to engage much more constructively and timely with their customers. So -- and you combine that with our expectation that we will continue to grow some share, I think we feel comfortable that this should help us drive a 4% to 5% revenue growth overall across all industries and through cycles. Brian Drab : Okay, that's all really helpful. Thanks both of you. And maybe one more question for Olivier just on the margins. You've essentially reached the margin target that you set a couple of years ago, and I'm wondering, two things. Can this be a company that consistently generates above 20% EBITDA margin down the road? And secondly, what impact is FX having on margins now? I'm not sure if you mentioned, what the impact was in the third quarter. I know over the last few years, it's been a headwind. Is that now transitioning to a tailwind? Thanks. Olivier Leonetti : So let me answer to your first question. So we are not updating our long-term EBITDA margin target of 18% to 20%. Having said that, we believe we have the ability to improve the operating leverage in the company through either a gross margin rate lever, we have a strong set of products and solutions, which would help us to increase margin, gross margin rate, and also we believe we have also we believe we have also an OpEx lever. As the integration is now behind us, we have the ability to enhance productivity across the company. So no commitment to be over the range, but the vectors are positive. Regarding FX, it's obviously a positive trend. If you look at my prepared remarks, FX is driving a 2 percentage point growth -- goodness in the quarter. Now we are hedging. As you know, about 80% of the currency exposure is hedged as we enter into a quarter. So you don't have the full benefit of that to the bottom line, but some of it, but the margin strength in the quarter was mainly due to operational efficiencies and quality of our pricing, Brian. Brian Drab : Okay. Thanks very much, Olivier and Anders. Thank you. Operator : The next question comes from James Faucette of Morgan Stanley. Please go ahead. Meta Marshall : Hi, this is Meta Marshall for James. Just to dig in a little bit deeper on the gross margins, maybe the gross margin -- or implied kind of gross margin guide in Q4 was just a little bit weaker than expected. And so is that still a carryover of China effects or how should we think about -- and I know you guys have mentioned kind of levers to improve those in 2018, but just how should we think about kind of gross margins being maybe a little bit less than expected in Q4? Thanks. Olivier Leonetti : So we are looking at the margin -- gross margin in term of dollars. So if you look at the margin dollar in Q4, it's increasing relative to last year. If you look at the rate, it's indeed lower than what we have had. It's actually due to a larger mix of bids which will impact the margin rate, but we are pleased with the margin profile of the company, and I wouldn't read too much into rate in a particular quarter. Meta Marshall : Got it. And then just to follow up on the hedging point, is there -- now that the dollar is weakening a little bit, is there any plan to kind of change your hedging strategy going forward, or I know those were put into place when the leverage was much higher. Is there any kind of change to strategy going forward? Thanks. Olivier Leonetti : The net answer is no. We have a very boilerplate hedging plan. We believe that the best lever to improve the growth and profitability of the company is actually to maximize the way we compete rather than having complicated hedge programs. So no change being contemplated in term of FX programs. Meta Marshall : Okay. Great. Thanks. I'll pass it on. Operator : The next question comes from Paul Coster of JPMorgan. Please go ahead. Paul Coster : Yes. Thanks for taking my questions. So the first one, Anders, is can you talk us through Savanna a little bit and what the business model attached to it is? Because it doesn't look to me like it's really going to be driving software revenue services, but maybe I've got something wrong there. Is it all about the tied hardware? Anders Gustafsson : It's a bit of both. I guess, first, we have had a large number of products at the edge of the network and these are products that are obviously connecting the physical world to the digital world and generating large amounts of data. And we have been using a lot of that data in some of our applications like OVS, LS, MotionWorks and so forth and we're now making this data available to other partners as well, but leveraging this, the Savanna platform for doing this. So it's a way for us to combine our deep understanding of the vertical workflows and with insights that we get from all the data at the edge to provide more actionable insights and enable for more frictionless workflows. Joachim Heel : Perhaps -- this is Joe Heel. I'll add a comment. In terms of the business models that you could envision, on the one hand, we expect a large number of partners to use this platform. We've just, as we said in the remarks, introduced the first five partners and we expect to more broadly make this platform available to all of our partners in the spring. And that will -- those data services that will be available to those partners can drive a revenue stream for us in the future. The other one is that it's a platform on which applications can reside, right, and entering into the space of those applications could also be a business model. Paul Coster : But it's an open standard right? So from a hardware perspective, anyone's product will fit into this platform? Anders Gustafsson : Yeah. We can connect -- we make it easier to connect any and all type of sensors into Savanna at the -- on the south bound interface, but also into any and all type of applications on the north side. So we want to make sure that Savanna can be a, we could say, a standard, de-facto standard in our space for when you want to connect data generating devices at the edge of the network to be able to drive real actionable insights into various applications. Paul Coster : Okay. My follow-up question is really unrelated to that, but it's about the Internet of Things inside industrial space. So it looks to me like something like a collision happening here between sensors that are embedded inside production lines and your more mobile sensors and readers. Can you talk to us about whether your intention is to move into sort of the in-line IoT space or not? Anders Gustafsson : I'll start a little bit higher level maybe and say we think of ourselves as an IoT company that's developing solutions that leverages data to reduce friction in workflows for front-line employees. So that's kind of the essence that we're trying to do. So we see EAI for us as a very differentiated and defensible strategy. It is not -- we haven't found other people who are able to do what we can do here. We see it as something that can deliver real outcomes, revenue growth or greater efficiency, improved services. But the way we're doing it is by really connect -- helping to connect the physical world to the digital world, capturing that data at the edge. And it's very hard to get access to that data. Most companies that are talking about IoT, they tend to be analytics companies or companies from the data center, they don't really have access to the data at the edge. And then when you combine that with our deep understanding of the specific workflows in various verticals, we can combine that -- we can gain a lot of insight from that data from the edge that we have access to, to help improve workflows in those vertical markets and help the front-line employees in those markets to be able to perform their tasks more efficiently or better. Joachim Heel : One other addition perhaps is to reference two things you've heard earlier us talk about. I think we understand that there are large ecosystems of IoT sensors out there that can complement ours and it's been a long tradition of Zebra, excuse me, to partner with other firms, as we have done, for example, we mentioned this earlier, with Rockwell, right, that has access to a lot of the IoT sensors used in fixed manufacturing infrastructures, or if you take healthcare, for example, we mentioned GE that has access to those types of infrastructures there. And partnering with those firms, I think, complements very well the types of mobile capabilities that we can bring in. So I think it will be a mix. Anders Gustafsson : Yeah. Paul Coster : Okay. Thank you. Operator : The next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum : Great, thanks. Good afternoon or good morning gentlemen. As we look at the printer segment, it's actually performed very well for you guys this quarter, I think the best third quarter ever, and it's certainly better than what we expected. Was there specific drivers that helped drive some of that printer growth when you compare to last year? Was the introduction of some of the new industrial printers from last year, or any color you can give around the printer strength. Anders Gustafsson : I'll start and then Joe can provide some additional color here. I think there was no one thing that drove the strength of the printer business this quarter. I think we have a very strong portfolio of products. We continue to refresh it and we had the -- our new tabletop printers come out, which added to the revenues, but they are still new products, but we saw a resurgence generally in our high-end tabletop printing business based on those, that helped to catalyze that. And I think also the differentiators that we have around Link-OS and the Network Connect into Rockwell's ecosystem are things that we can do, as we have unique capabilities to enable those. And I think customers who are looking for using printers more intelligently in their networking applications see those as great value adders for us. So -- but otherwise, the performance for us was very broad-based across all four regions and supplies is another area that we think of as a good growth engine for us and one where we are underrepresented today. Joachim Heel : Yeah. Keith, if I could add, there are some, I think, perhaps also mundane drivers that we have paid a lot of attention to. On the one hand, I think economic growth in particular manufacturing resurgence in some regions has benefited us and we've seen some positive there, but also in terms of execution, we have paid a lot of attention over the course of the last year to things like pricing of printers. Especially we fine-tuned our pricing after we introduced the PartnerConnect program and we think we have a very good handle now on where we need to be to compete. We have spent a lot of money on training. For example, all of our people have been -- all of our sales people, I wanted to say, have been trained now on printing, and in particular, all of our sales engineers have gone through a certification program to ensure that printer knowledge is really broadly resident and deep in our sales teams. And we have made changes in our go-to-market in terms of our covered structures and the number of people that we're investing with specific printing capabilities. Those have all been areas of focus to drive growth in printing for us. Keith Housum : Got you. Thanks. And then changing gears, I guess, slightly here, as we look at the gross margin on services, you guys noted supply chain issues and then the in-sourcing of the servicing. What was the impact that had on gross margins for the quarter and how long can we expect that to, I guess, be a headwind for our servicing gross margins? Olivier Leonetti : So services margin is expected to increase over time. We believe we are -- this is actually one of the lever to increase the bottom line of the company. The phenomena we had in Q3 are exceptional in nature and short-term orientated. They are due to mainly the transition from an outsource model to an in-source model for North America, but as I said, Keith, this is a temporary trend and you should expect services margin to increase going forward. Anders Gustafsson : I think we had in-sourced about 30% of the repair volume in North America by the end of the third quarter. We expect it to be about 50% at the end of the year. And when you -- once you get into Q2, you'll have kind of a longer tail of smaller things that we will do till probably Q3 where we -- when we would expect to be done. Keith Housum : Great. Thank you. Operator : The next question comes from Matt Cabral of Goldman Sachs. Please go ahead. Matthew Cabral : Yeah. Thank you. I wanted to dig a little bit more into the working capital trends that you saw in the quarter. Olivier, I appreciate the additional detail around why inventory ticked up in the quarter, but this is the third quarter in a row where it's been a pretty meaningful use of cash. So I guess the bigger picture question is, just if something changed in how strategically you are looking at managing inventory. I guess, has there been a change in the underlying visibility to business? Just curious why it's been such a big use of cash year-to-date. And then just quickly, a second one. DSOs stepped up sequentially. Just wondering what drove that, and if linearity in the third quarter was anymore back half weighted than it typically is. Olivier Leonetti : Right. So let me start by reaffirming, this is not part of your question, but we are confirming that we'd pay at least 200 million of debt for the year, which is a key objective for the company, as you know, Matt. In term of use of cash, what is happening today for inventory is actually the consequence of a high-class problem. The business is strong, we had at the end of the third quarter a strong backlog of orders, and we wanted to bill for this in -- and be ready to ship at the start of Q4, which is what happened, as I indicated in my opening remarks. And we would expect then working capital to be much better in Q4 because, first of all, this inventory will be shipped, but also to your point, linearity including impact on the DSO would be enhanced. But I wouldn't read too much into what happened in the quarter from a working capital standpoint. We are targeting the company in aggregate over time to be top quartile in term of working capital performance and you see today some short-term impacts due to short-term business dynamics. Matthew Cabral : All right. That's all from me. Thank you. Operator : The next question comes from Andrew Spinola of Wells Fargo. Please go ahead. Andrew Spinola : Thanks. I wanted to ask, the organic growth trends at ScanSource in the relevant segment have been more flattish compared to your mid-single digit type growth. And I was just wondering if that says anything. I know it's just one data point, but if that says anything about potential share gains that you're having against the competition, or maybe if the percentage of your sales that are going direct now that you're selling as an integrated company has gone up. Anders Gustafsson : I -- we obviously got to be careful about how much we can comment on ScanSource business, but I think we can say that our revenues through the channel overall and with ScanSource performed very well in Q3. So we -- ScanSource has been a good partners for us for a long time and we continue to do a lot of business with them and our business with ScanSource in Q3 was up. Andrew Spinola : I guess, sort of where I was going with that question, Anders, was just trying to understand if -- as you sell as an integrated company, if your percentage of revenue that goes direct starts to go up. And I wonder if that has any impact on your long-term gross margin. Joachim Heel : So this is Joe Heel. Our percentage of direct revenue has been about 17% last year and we believe that it has not gone up. It is not our strategy for it to go up. Our strategy is to continuously increase the amount of business that we do through our partners. I think we can confirm the other hypothesis that at least in North American distribution, we believe that our share has increased. That's what the data -- the market data would indicate. Anders Gustafsson : Yeah. We don't do -- we don't take deals direct, say, if -- on a whim to improve margin or something. We try to be very loyal to our partners and have -- if the partners worked on a deal, we will support them at those prices and rather lose the deal than take it right because it tends to have a very negative impact on the relationships with the channel community. Joachim Heel : Exactly. Andrew Spinola : Got it. Thank you very much. Operator : The next question comes from Jeremie Capron of ROBO Global. Please go ahead. Jeremie Capron : Good morning. Thanks for taking my question. You've had strong sales momentum in the past year, pretty much across the entire portfolio, printers, supplies due to mobile computing, and you called out the level of innovation and agility of your portfolio of products and solutions with many new introductions in the past year. I wonder if you could talk about how you expect that to evolve over the next year or two in terms of the rate of refresh and new product introduction. Anders Gustafsson : Yeah. I -- we have to be maybe a little bit more circumspect because we don't -- we tend not to announce new products on our earnings call, but the philosophy behind it, I think, we can talk about, right? We see product innovation as a key part of kind of the life blood of Zebra. We are a tech company and we need to have a fresh and compelling set of solutions that offers new value to our customers. So we will always make sure that we have new compelling solutions that we can talk to our customers about. I think I said today, we feel our core portfolio is very, very strong. There are still some products in the core portfolio that will need to be refreshed here in the next -- within next month -- or next year, sorry, but there is also some more adjacent, more EAI like type solutions that we would like to bring to market and accelerate growth from also. So we certainly see innovation to continue to be a key part of our value proposition and how we differentiate ourselves in the market. Jeremie Capron : Thank you very much. Operator : The last question today will come from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman : Yes. Good morning. Just a very quick question. On Zebra legacy, the gross profit margin there at 47.4 was maybe a little bit light of what we're thinking. And the question maybe is not why, but is there a channel sales issue there? Obviously more product through channel would bring the gross margin down. Could you just kind of explain that and what you see the -- for the run rate to be in the gross margin for the legacy Zebra business? Olivier Leonetti : So let me take this one, Rich. So we look -- if you look at the dollars, dollars have increased actually year-on-year even if you normalize for the China duty that I mentioned in my opening remarks. So really we are managing the line of business and the portfolio on a dollar basis. The rate that you're alluding to could be influenced in a particular quarter based upon mix within the product line or mix of orders between large orders and smaller orders. So that influenced the printer or legacy Zebra margin in the quarter. And in addition, you had also some of the effects we talked about in other answers around services cost being slightly higher because of transition from outsource to in-source, also distribution center consolidation. I would note also that the supply revenue and margin also was positive trend. So I wouldn't read too much into the margin in this particular quarter for legacy Zebra. We think we -- all the products should deliver enhanced margin dollars and margin rate over time. Richard Eastman : Well, most of your printer sales -- is the vast majority of your printer sales, do they go through the channel or they go direct? Anders Gustafsson : The vast majority of our printer sales go direct. We have less of these larger deals, but there are some very large customers where we deal with them overall direct. Sorry, sorry. Joachim Heel : So the vast majority of our printer sales goes through the channel. Anders Gustafsson : Yeah, sorry. My mistake. Joachim Heel : Yeah. Through the channel. Relatively little, less than our average goes direct in printer. Anders Gustafsson : Thank you. Richard Eastman : Okay. And is there anything -- again, just in that gross margin, I'm just trying to understand, is there anything from a channel program standpoint in the quarter that maybe played to that inventory build number or to the gross margin here? Anders Gustafsson : I would say no. There are no changes to the channel program that we've made recently that affect printing particularly or the printing gross margin. I think as Olivier said, it's simply a matter of the mix and some of the operational factors. Joachim Heel : Some air freight -- or freight were a little higher to get the inventory and that would be one thing that was maybe a little higher than normal. Richard Eastman : Okay, okay. And then just can I -- just one question on the inventory here and the cash flow impact that it had, the inventory build. Was that in any particular product line, for instance, on the MC side -- mobile computing side or scanner side or printer side? Just staging that inventory ahead of the strong fourth quarter, any particular area that made that somewhat of an anomaly? Olivier Leonetti : No, it's a broad-based strength in the portfolio of products. So not one line of business being impacted more than another. Richard Eastman : Okay. All right. Thank you very much. Anders Gustafsson : Thank you. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steele for any closing remarks. Michael Steele : Thank you all for joining us. Have a great day. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,018
| 1
|
2018Q1
|
2017Q4
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2018-02-22
| 6.628
| 6.87
| 7.593
| 7.79
| null | 14.13
| 13.61
|
Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: Jim Ricchiuti - Needham & Company, LLC Jason A. Rodgers - Great Lakes Review Saliq Jamil Khan - Imperial Capital LLC Brian P. Drab - William Blair & Co. LLC Paul Coster - JPMorgan Richard Eastman - Robert W. Baird & Co., Inc. Keith Housum - Northcoast Research Partners LLC James E. Faucette - Morgan Stanley & Co. LLC Operator : Good day and welcome to the Q4 2017 Zebra Technologies Earnings Release Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning and thank you for joining us. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our fourth quarter highlights and full-year 2017 accomplishments. Olivier will then provide more detail on the financials and discuss our first quarter and full-year 2018 outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Please note that we recently changed the names of our two operating segments. The legacy Zebra segment has been renamed Asset Intelligence and Tracking or AIT, and the Enterprise segment is now Enterprise Visibility and Mobility or EVM. Also as a reminder, our reported financial results include the divested wireless LAN business through October of 2016. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN sales from 2016 results. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. Broad-based strength and excellent execution drove our fourth-quarter results. As you can see on slide 4, for the quarter we reported record sales of more than $1 billion for the first time in our history. Adjusted net sales growth of nearly 9%, with organic growth of more than 7%, an adjusted EBITDA margin of 19.9%, which was a 90 basis point year-over-year improvement. Non-GAAP diluted EPS of $2.33, a 21% increase from the prior year and $268 million of cash flow from operations. We achieved growth across all regions with particularly strong performance in Latin America, EMEA and North America. We also saw strength across all product lines with mobile computing growing above the company average, amplified by robust year-end demand. We also implemented the final steps of our debt restructuring plan. In summary Q4 was a very positive finish to the year. Overall, 2017 was a year of strong operating performance and progress on our strategy. On slide 5 we highlight four key areas of success. We completed the integration of the Enterprise business, including a global ERP system consolidation. It represented more than two-and-half years of dedication and focus by the entire Zebra team and concludes our transition to One Zebra. In 2017 we continued to extend our market leadership and deliver innovative solutions that have resonated with our partners and customers, providing them increased visibility into their operations so they can achieve higher levels of growth activity and service. Enhancements to our broad portfolio of products and solutions include additions and refreshes to the industry's broadest and most mature offering of enterprise grade Android powered mobile computing devices, expanding our leading portfolio of next-generation 2D data capture devices, being first in the industry to offer a full portfolio of smart connected printers with unrivaled manageability through our Link-OS operating system, and new innovative solutions such as SmartLens for Retail and SmartPack Trailer that further our vision and aspire to transform workflows in key vertical markets we serve. All of these solutions are backed by Zebra's data intelligence platform, Savanna, which was launched in 2017. On the capital structure side, we completed a comprehensive debt restructuring that has reduced our average interest rate by approximately 2 percentage points, generating more than $45 million of annualized interest savings. I'm also proud of our team for successfully driving strong profitable growth and cash flow. For the full year, we grew net sales 6.5%, increasing adjusted EBITDA margin by 110 basis points to 18.6%. This profitable growth, combined with disciplined working capital management generated the cash necessary to pay down $454 million of debt principal, exceeding our 2017 debt reduction goal by more than 50%. With that, I will now turn the call over to Olivier to review our financial results in greater detail and to discuss our 2018 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank, you Anders. Let us begin with a walk through the P&L. As you can see on slide 7, sales grew 7.3% in the fourth quarter driven by solid results in each of our reporting segments and growth across all four regions. EVM segment sales increased 8.5% led by mobile computing and our robust Android powered portfolio. AIT segment sales increased 5% with growth in both printing and supplies. Sales of services were slightly higher with continued strength in our Visibility Services Applications, Zebra Retail Solutions, and Location Solutions. Turning to our regions, sales growth in North America was 7% driven by strength in mobile computing and printing products. EMEA sales increased 10%. Mobile computing led our broad-based growth across all major product categories. Sales in Asia-Pacific were up 1%. We grew sales in the quarter throughout most of the region with the exception of China. Our team has been making good progress on our previously mentioned, tailored product offering and go-to-market improvement plan. As a result, we continue to see positive momentum in end user demand and are optimistic that we'll return to growth in China later this year. Latin America sales increased 11% with exceptionally strong sales in mobile computing and data capture products. Consolidated gross profit increased $35 million from the prior period on higher sales volume. Adjusted gross margin decreased 30 basis points, primarily driven by a business mix shift to mobile computing, which included a higher volume of large orders as many customers transition to Android-powered mobile computers. Margin rate was also impacted by higher support services cost associated with the transition to insource our North American repair operations. Adjusted operating expenses increased $12 million from the prior year period, reflecting growth in the business and higher incentive compensation expense due to improved business performance. Fourth quarter 2017 adjusted EBITDA margin was 19.9%, a 90 basis point increase from the prior year period. This was driven by operating expense leverage on higher sales. In addition to EBITDA margin expansion, lower interest cost, and decreased tax drove non-GAAP earnings per diluted share to $2.33, a 21% year-over-year increase. Turning now to the balance sheet and cash flow highlights on slide 8. As a reminder, in December we completed our debt restructuring plan by redeeming the remaining $300 million of our senior notes and establishing the $180 million accounts receivable financing facility. At year-end, we add $2.2 billion of viable rate debt on the balance sheet, of which more than $500 million is hedged with interest rate swaps for 2018. In late 2017, we locked in an incremental $800 million of floating to fixed rate swaps that will become effective in December 2018 for an overall notional swap value of $1.3 billion. For the full year, we paid down $454 million of debt principal on a net basis, helped by strong operating cash flow in Q4. We shipped a significant amount of products in early Q4, resulting in a high level of cash collections within the quarter. Free cash flow was $428 million in 2017, which was $125 million more than the prior year period. This increase was primarily due to higher adjusted EBITDA, lower acquisition integration cost, lower interest payments and lower capital expenditures. We are pleased that free cash flow conversion, defined as free cash flow divided by non-GAAP net income was 113% for 2017, which exceeded our ongoing target of 100%. Slide 9 shows our path to financial de-leveraging. We have made excellent progress on debt reduction over the past three years, paying down $1 billion of debt principal and significantly reducing our net debt to adjusted EBITDA ratio to 3.2 times as of the end of 2017. We are targeting a range of 2 times and 2.5 times, which we believe we can achieve in the second half of 2018. Let us turn to our outlook on slide 10. We had a strong order backlog entering the year and we expect first quarter 2018 net sales growth to be between 7% and 10%, which assumes an approximately 260 basis point favorable impact from foreign currency translation. First quarter 2018 adjusted EBITDA margin is expected to be between 18.5% and 19%, an increase from the prior period due to solid operating expense leverage. The gross margin rate is expected to be approximately flat to slightly lower, primarily driven by an anticipated higher mix of mobile computing sales, including a higher volume of large orders and higher support services cost due to the insourcing transition that I mentioned earlier. Non-GAAP diluted EPS is expected to be in the range of $1.95 to $2.15. For the full year, we expect net sales growth to be between 4% and 7%. This includes an anticipated 2 percentage point favorable impact from foreign currency translation. Full year 2018 adjusted EBITDA margin is expected to be between 19% and 20%, an increase from the prior year period, primarily driven by operating expense leverage. For the full year 2018, we expect to generate at least $475 million of free cash flow. Although we aim to improve our cash conversion cycle, we're assuming that working capital will be a use of cash as we grow the business. Additionally, we expect Q1 to generate the lowest level of quarterly cash flow this year due to seasonality in the business, including the timing of incentive compensation payments. We expect the combination of the recent U.S. tax reform and our tax planning to reduce our non-GAAP tax rate to approximately 16% to 17% for 2018. This is a significant reduction from our 2017 rate of 22%. You can see other full year 2018 modeling assumptions on slide 10. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. We are pleased with the progress made in 2017 and have good momentum into 2018. As you see on slide 12, we remain focused on our key priorities to build upon our industry leadership and drive shareholder value. First, we are extending our leadership in the core business through our unmatched scale, innovation and relationships with customers and partners. These factors are competitive differentiators in the traditional markets and fostering them is crucial to our ongoing success. Second, we are committing our focus and resources to drive growth in attractive adjacent markets that leverage strength in our core. We continually evaluate the opportunities in near adjacencies where we are underpenetrated as well as in emerging areas. Third, we are advancing our Enterprise Asset Intelligence or EAI vision by leveraging Zebra's deep knowledge of workflows and capitalizing on key technology trends. EAI is integral to our strategic focus at Zebra and makes our solutions unique in the marketplace. I will elaborate more on this in a moment. Our fourth area of focus is to further enhance Zebra's financial strength by increasing cash flow and optimizing our capital structure. Now turning to slide 13. Zebra is capitalizing on key trends : mobility, cloud computing and the proliferation of smart tools. Our devices and intelligent infrastructures sense information about assets, products, and processes. This information, including status and location is then analyzed to provide actionable insights to frontline employees in real-time to reduce friction in workflows, improve productivity, and enable greater insight into business operations. This EAI vision provides a digital view of the entire enterprise. Our strategy focuses on actions and outcomes that can be optimized by knowing and analyzing what's happening on a real-time basis, adding a performance edge to frontline employees. Savanna, our data intelligence platform, is an essential component of our overall offering. Savanna powers the analytics behind our cloud-based data-driven solutions by interconnecting data from sensors, devices, and intelligent infrastructures with workflow applications. Slide 14 highlights the key vertical markets that we serve. Increased demands in the marketplace are driving opportunities for growth at Zebra. Retail shoppers want more convenience and flexibility in how they purchase goods. Transportation companies need to deliver in hours rather than days, patients demand a higher quality of care at a lower cost, and manufacturers are increasing efficiencies across their value chain. Zebra has an intimate understanding of operational workflows in the key industries that we serve. Our expertise enables us to help our customers operate more efficiently and successfully navigate the changes in their business. Last month, at the National Retail Federation Expo, we showcased several solutions that help retailers meet omni-channel demands and strengthen store operations. Target Corporation had a prominent presence at our booth, demonstrating how they have leveraged our TC51 Android mobile computer for multiple applications, to enhance the in-store shopping experience for their guests. By using this solution, both in stores and distribution centers, Target is elevating their team member experience to improve productivity and guest satisfaction. We have also received large orders for the TC51 from a number of other market leaders who are investing in their businesses, making it the fastest ramping product in Zebra's history. Technology has become the basis of competition in retail and is an enabler of key transformational initiatives, from e-commerce to in-store experiences to multichannel fulfillment. Adoption of the most effective technologies is a key attribute of the winners in global retail and our success in this sector demonstrates that we are providing the right solutions. In the transportation and logistics sector, today's consumers expect shorter delivery times in an on-demand world, as the number of shipments is increasing exponentially. Our mobile devices and EAI solutions are enabling warehouses to deliver on the promise of more efficient on-time fulfillment. The manufacturing environment, values solutions that maximize the efficiency of their processes and provide traceability for safety and compliance with regulations like the FDA's Food Safety Modernization Act and the Drug Quality and Security Act. Healthcare facilities need to reduce operating costs and improve the quality of patient care delivery. Our clinical mobility solutions help achieve this objective by streamlining complex workflows, eliminating caregiver to patient operational barriers and reducing preventable medical errors. This is accomplished through automating manual work tasks and activities, unifying disparate patient health information sources and enhancing staff communication, collaboration and clinical integration with real-time location applications and operational intelligence. The adoption rate of healthcare workflow digitization is accelerating throughout the world and Zebra is a leading enabler and solutions provider. Our recently published Hospital Vision Study highlights that by the year 2022, over 95% of all nurses and physicians will be using mobile solutions to administer patient care, an increase of more than 30 points from today. There is clearly an increasing need for Zebra solutions in all the key vertical markets that we serve. In closing, I want to thank the Zebra team for continued discipline and excellence and for a strong finish to the year. We are well-positioned to succeed in 2018. With that, I'll hand the call back to Mike. Michael A. Steele - Zebra Technologies Corp.: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow up so that we can get to as many of you as possible. Operator : Thank you. We will now begin the question-and-answer session. And the first question comes from Jim Ricchiuti from Needham & Company. Jim Ricchiuti - Needham & Company, LLC: Hi. Good morning. Thank you. First question is just in the EVM market. You clearly had a good – a strong year. And I'm just wondering what you think the overall market growth is? Are we seeing an acceleration? It also appears that you're taking share. I'm just wondering what do you think the underlying growth rate is for that market right now? Anders Gustafsson - Zebra Technologies Corp.: First, we are driving growth across all our product lines at the moment. And I think that's driven largely by the level of innovation that we have introduced and the breadth of our products and solutions. And I also think that the depth of our understanding of our customers' workflow, so the vertical workflows is a big driver for us. Now, specifically for mobile computing, we had a very strong quarter in Latin America, EMEA and North America. And I'd highlight three points to describe why I believe we have such strength today. I think first the depth and breadth of our portfolio is a true differentiator. We have tiered our portfolio now. So, we have new value tier products with the TC20 and TC25 and we go all the way up to our most premium, most ruggedized devices, the TC70 and the MC9000. A second key advantage would be around all the software innovations we are doing on top of the device. We are now – we've launched the LifeGuard service which is an extended security patching service, where we will provide security patching for the life of the device. So, most of our customers use their devices for much longer than, say, a consumer device and we can then make sure that they are safe for the duration of the use. Other things will be around the manageability of the device. So, our OVS services and generally the usability and how we provide or turn the control of the device back to the Enterprise versus the user with our Mobility DNA services. And the third point will be the Android transition, which I think you alluded to also here. We were the first company to launch Android products for the Enterprise and that certainly benefited us very well. We have well over 50% market share of Android devices for the Enterprise today and the majority of our mobile computing sales are now also Android, and we're seeing strong momentum and that's also to some degree supported by Microsoft, making public their intent of not launching a new Windows 10 operating system for mobile. And we believe there's continued strong demand for Android devices going forward. We think that there are about 12 million legacy Windows devices in the market that would need to be refreshed over the next several years. Jim Ricchiuti - Needham & Company, LLC: That's helpful. If I look at your full-year guidance, it appears to assume some moderation in the growth rate over the balance of the year. Is that just a function of tougher comparisons in the back half of the year or are you seeing anything in the markets that would account for the deceleration from the growth rate that you're starting the year at? Olivier Leonetti - Zebra Technologies Corp.: So, let me – before I answer specifically to your question, a bit of an overall theme. We believe that the company has a very strong competitive position and we also believe that we are facing a very solid global macroeconomic environment. Specifically, for you question, we're going to grow 2018 at 4% to 7% on a nominal basis. That's a respectable growth rate. Two reasons for this, reason number one, tougher compare to your point, but also a prudent approach to planning. We have today a relatively strong visibility for the first half of the year. You can see that in the strong guide for Q1, but our visibility is less strong in the second half. However, we are confident about the growth profile of the company. We have said in our opening remarks that we have many avenues to grow the company, either through core or adjacent markets. And we are prepared to be nimble to face higher demand as this higher demand was to come. Jim Ricchiuti - Needham & Company, LLC: Okay. Thank you. Congratulations on the year by the way. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Jim. Operator : Thank you. And the next question comes from Jason Rodgers of Great Lakes Review. Jason A. Rodgers - Great Lakes Review : Yes. I just wanted to ask about the mobile space. Wondering if you're seeing now an acceleration of these large deals given the Microsoft change? And I wondered also if you could talk about your progress in penetrating smaller customers in the EVM segment? Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, in 2017, we saw a lot of larger enterprises make the transition to our Android All-touch devices. So, it was a high proportion of large deals, particularly in retail for us in 2017. We expect that there will continue to be a good number of large deals, but there is also a finite amount of very large customers. So, we put a lot of effort into driving Android into the channel, and we've seen good progress in that. Our distribution partners are seeing very strong growth for Android in their businesses, too. And we're doing a lot of things to help educate the market and create – help create the end market demand for that. I'll also let Joe Heel here provide some more details. Joachim Heel - Zebra Technologies Corp.: Yes. If you look at this Android migration that has been going on and has been quite strong. We've seen adoption by many retailers with these large deals that certainly put a big mark on 2017. But we also know that there's still a substantial amount of transition that needs to occur. Anders mentioned the number of about 12 million mobile computers which we think are still out there. And we see that a lot of those customers are in segments like warehousing and manufacturing where there are certain structural reasons why the adoption process takes a little bit longer. And many of those customers are also reached by our channel partners. And so, we see that there's a lot of potential for our channel partners this year and in the following years to penetrate those segments, manufacturing and warehouse in particular and drive continued growth from Android conversion for us. Jason A. Rodgers - Great Lakes Review : And also, I wonder if you could talk about performance by vertical in the quarter and if you're seeing any acceleration in raw material cost? Thank you. Anders Gustafsson - Zebra Technologies Corp.: Yes. So, on the verticals, I'd say, first, we have become now much more of an enabler of our customers' top priorities and business strategies. So, we're much more closer to them and much more of a partner to our customers today. And we are driving growth across all our verticals by increasing workflow efficiencies or how we call it, reducing friction in workflows. We're also providing real-time guidance to frontline employees to ensure that they can take better – make better decisions, be more effective in their jobs. And we are helping our customers enhance their customer or in healthcare situation, their patients' experience. So we're doing a lot of things across our verticals to position ourselves to help address their biggest business drivers. If I go through the verticals here, I'd say, first, starting with retail and e-commerce. That's been a strong vertical for us for a long time and we saw very solid growth in 2017 and a very strong finish to the year, too. I think in the last earnings call, we talked a bit about our Retail Vision Study. And I think the growth we are seeing is validating the outcome, so the conclusions we had in that study. Most people are fully aware that retail is now transforming, but it's also growing. And we are both capitalizing and helping our retail customers pursue the shift from traditional, say, brick-and-mortar retail to e-commerce and omni-channel. And as I – virtually all our brick-and-mortar retailers are embracing our technologies to help them execute their growth strategies. And our solutions and the Android transitions are central to many of those growth strategies, but we're also seeing some newer solutions like RFID, SmartLens, our Personal Shoppers, which are essential to omni-channel and frictionless checkout to gain momentum continue to do very well for us. Moving on to healthcare, that's been the fastest growing vertical for us for some time and we would expect that to continue. That's really being driven or the catalyst for that has been the introduction of electronic health records. But when you couple that with the value propositions we have in healthcare which is, to both improve the patient care, as well as drive greater efficiencies, we're able to build quite a strong momentum for our solutions and we've seen a great ramp for some of our newer solutions that we introduced in 2017, like the healthcare versions of both the TC51 mobile computer and our DS8100 scanner. And we – also on the EAI side we're making progress. We had a nice win recently for an RFID asset tracking solution at a large Northeastern healthcare provider. And lastly, I'll touch on the transportation logistics also. There we've seen solid growth and it's really supported by strong secular growth trends driven by the shift to ecommerce. So, both the delivery and the number of packages going through the systems are much greater. Our newer products like the TC75x and TC56 have had great impact. And it's certainly driven our – helped drive our growth in that segment but we're also seeing some of our newer solutions like SmartPack and trailer load analytics or trailer load compliance demonstrate our leadership, our thought leadership in the industry. And we have a number of growing pilots and proof of concepts with many leading customers in that area. Olivier Leonetti - Zebra Technologies Corp.: And let me answer to your second question on raw materials. Your question was do we see an increase? We see an increase today on some categories, on some categories only. And we have been working also for a few quarters now on COGS improvement plan and we believe that those actions will materialize in the P&L in the second half of this year and we should see a margin uptick because of those. Anders Gustafsson - Zebra Technologies Corp.: Yeah. We have had a strong culture of working on gross margin improvement plans. We had our value – design to value programs that we ran hard a couple of years ago. And now, we see some, memories particularly, see some increases there, but we are looking to then transition to new platforms on many of our products. By late this year that we start, introduce different type of memory technologies that would be lower priced. But we've always had the ability to drive sufficient overall cost reductions to offset any material increases or price erosion to make sure that we can maintain stable to improving gross margins and that's clearly our intent. Jason A. Rodgers - Great Lakes Review : That's a great summary. Thank you. Olivier Leonetti - Zebra Technologies Corp.: Thank you. Operator : Thank you. And the next question comes from Saliq Khan with Imperial Capital. Saliq Jamil Khan - Imperial Capital LLC : Hi. Good morning, everyone. Anders Gustafsson - Zebra Technologies Corp.: Good morning. Michael A. Steele - Zebra Technologies Corp.: Good morning. Saliq Jamil Khan - Imperial Capital LLC : Just a few questions, certainly a very good quarter for you. Can you give us a little bit of highlight on what it is that you had heard at the recent NRF Conference that is giving you confidence that the retailers now are willing to go ahead and open up their wallets and invest in some of the retail technologies that you spoke about and have been looking at for the last couple of years? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'd go back to some of the comments I made earlier. First, the NRF was – we thought NRF was a great show for us. We had more traffic in our booth. We had more executive meetings. We had more closed door meetings there where we showed some newer things, that weren't quite on the floor. So, we had lots of good feedback from the show and felt that was a good start to the year for us. The themes that we've seen over the last year I think is continuing. We have gone from having been maybe viewed as more of a tactical productivity tool historically, to now being a much more strategic enabler of our retail customers' business plans. So, they are much more interested in figuring out how to work with us and how to incorporate our technologies to execute on their omni-channel or ecommerce strategies. So, when you look at then also our newer solutions ranging from mobile printers to scanners and mobile computers, as well as the more futuristic, say SmartX-type solutions. We feel we're well positioned to be able to address a number of those growing needs that our customers have. So, we feel good about what's going on in retail for us. Joe, maybe some more comments from you? Joachim Heel - Zebra Technologies Corp.: Yeah. I'll add maybe a few things specifically that we observed. I think for us a big highlight was that one of our customers, Target, was present very visibly in our booth. That, I think was – is not very common at the shows and was for us a great honor, but also a great opportunity to showcase one of the key trends that you observed at the show which was a trend toward mobile point of sale. Our TC56, coupled with mobile payment solutions, was the heart of what we showed there. Another highlight undoubtedly was Personal Shopping. A trend which started in Europe but we're seeing increasingly opportunities in other regions as well, where an Enterprise-based device is in the hands of a customer and they are scanning as they go through a store. We did see strong interest – continued strong interest in automated solutions such as SmartLens, right, where we give continuous real-time visibility to all of the inventory in a store or department of the store and are able to greatly automate and improve productivity in the store. So, those are three examples of highlights from the show, perhaps. Saliq Jamil Khan - Imperial Capital LLC : If I think about the strong growth that you've spoken about earlier and then again highlighted during NRF, the RFID, the analytics, all these things that were not happening before, we're finally to a point that it is happening. So, if you think about from a priority perspective, retailers have been inundated with all these technologies from a backlog perspective that they wanted to do. And then you take a look at cyber security and some of the other solutions that are out there. Where do you believe the Zebra technology ranks in that purchasing priority for the retailers? Anders Gustafsson - Zebra Technologies Corp.: It's a little hard to tell you kind of how exactly how we rank because it does depend on the retailer and say there are certainly competing priorities. So, we're not the only priority. Now if somebody needs to have a – in order to have an ecommerce or omni-channel strategy, they got to have a website that can take orders. That will be a high priority, too. But clearly, we are much more – a much higher priority and viewed as an essential part to this. So, we feel good about how we are positioned with our solutions to be able to address many of the bigger pain points or priorities that our retail customers have. Joachim Heel - Zebra Technologies Corp.: I might add, I can only echo that, right. If you think about the challenges that the retail customers are reflecting to us in our conversations with them, they would say, on the one hand, they need to compete in an omni-channel environment and they want to make their store more productive and a better experience. And we enabled both of those priorities for the retailers. And as such, I think we rank relatively highly in their desire to make those priorities a reality. Saliq Jamil Khan - Imperial Capital LLC : Just last one last question on my end. Everyone has been talking about IoT and OT. Could you kind of highlight briefly what Zebra is doing to be able to converge the IT with the OT to bring about better efficiency? Anders Gustafsson - Zebra Technologies Corp.: Yes. So, we kind of branded our IoT strategy, Enterprise Asset Intelligence, and we talked quite a bit about that in our prepared remarks. But, first, we're very excited about what we're doing within Enterprise Asset Intelligence and it's been resonating very well with our customers, our employees, our partners and it is very integral to everything we do across all our product lines. But the essence of it is this framework we have of sense, analyze, and act. So, we look at how do we enable our customers to sense what's happening in the physical world, in the real world, and then analyze that information and draw actionable insights in real time that help our customers reduce friction in workflows as an example. Some examples of how that's embedded in all our products will be, Link-OS as an example, for printing. We make our printers the most – best connected and networked, best managed devices in the industry. We have OVS that provides visibility into mobile printing or mobile computer fleets. And then, we have more like Smart infrastructure, like SmartLens, SmartPack and others, which provides lots of insights about what's going on in a store or in a warehouse. And we see good progress across all of these areas with the number of pilots and some rollouts. So, yeah, we're very excited about what's going on with EAI, and maybe Joe can help some – give some more specifics. Joachim Heel - Zebra Technologies Corp.: 2017 I think for us in the area of IoT or as we term it EAI, was a year in which we had some really tangible progress. We introduced two of the dedicated EAI solutions, the SmartLens solution that I mentioned earlier for retail and then the SmartPack solution for logistics and T&L at trade shows in the first half of the year. And as a result of that, we have launched and have underway a series of pilots with large customers, where they are evaluating not only the technology, but the business cases that those technologies enable for them. And in the second half, we launched, as you will recall from our last conference call here, the Savanna platform, which is really a force multiplier for our IoT strategy, in that it gives our partners access to all the data coming off our devices, sensors and infrastructures, so that their applications can enable additional use cases for those customers. So, we're very pleased with the tangible progress that we've been able to make in this area of our strategy. Saliq Jamil Khan - Imperial Capital LLC : Great. Thank you, both. Operator : Thank you. And the next question comes from Brian Drab with William Blair. Brian P. Drab - William Blair & Co. LLC: Hi. Good morning. Congrats on the great year and quarter. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Brian P. Drab - William Blair & Co. LLC: Just a couple questions. So, I'm wondering if you could talk a little bit more first on what's happening in China. Is that still primarily a channel issue? And just a little more depth in terms of what corrective actions you're taking to drive growth there? Anders Gustafsson - Zebra Technologies Corp.: Yes. So globally, we had a very strong quarter with crossing the $1 billion mark first time in our history. Specific to Asia-Pacific, I'd say, Asia-Pac had a very strong performance outside of China. So, most of our sub regions within Asia-Pac had very good growth, led by Australia, which had an outstanding performance. You should remember though, China is less than half of our Asia-Pac sales and Asia-Pac is about 15% of our total. So, China was still down year-over-year but we are gaining good momentum and we are seeing good proof points that our – the improvement plans we put in are having effect and we are fully expecting to see growth resume later this year in China. We've seen great progress on our go-to-market improvement plan as well as the new tailored product offerings that we've introduced. So, we introduced several value tier products designed to be able to compete better in China and other emerging markets. And longer term, we certainly expect Asia-Pacific including China to be a strong profitable growth driver for us. Brian P. Drab - William Blair & Co. LLC: Great thank you. And then I was wondering if you could give us your perspective on the competitive landscape if there are any. How do you perceive what appears to be a rather aggressive new product introduction year for Honeywell and Android and are you seeing them more bidding for big projects or has that competitive landscape kind of changed or is it changing? Anders Gustafsson - Zebra Technologies Corp.: I'd say first that we are operating in some very attractive growth markets with strong secular trends supporting that growth and we are continuing to drive profitable share gains like we have for quite a few years now and are starting to feel like we have a bit of track record in being able to do that. I do believe that we have some strong competitive advantages that's making our position very defensible. We have the broadest portfolio of products and as I said there's the virtual cycle between that and our partners, that the broader our portfolio is, the more partners we can attract. And the more partners we have the more revenue we get, which enables us to reinvest in products and expand the portfolio and recruit more partners. So that's I think, a moat that's very difficult for competitors to replicate. It certainly will take a lot of time and money. And if you have one or two products, it will be difficult to compete against the full portfolio that we have. But we also introduced a lot of new innovation into our portfolio and got a lot of momentum and strong market share positions now which are all helping us I think. And I'd say, we have a – one of the differentiators is our team. We clearly have the best team in the industry and we've been executing very well on a number of complex tasks. I'll say we're quite pleased with how we completed the complex integration of the Enterprise business, while also growing market share at the same time. So – and I think also EAI is something that resonates with our customers and provides some thought leadership. And all that being said, we've always competed in competitive environments. We used to have to compete for our daily bread and I don't expect it to be anything different going forward. Brian P. Drab - William Blair & Co. LLC: Got it. Thanks, Anders. Operator : Thank you. And the next question comes from Paul Coster with JPMorgan. Paul Coster - JPMorgan: Yeah. Thanks for taking the question. It looks like the second half of this year will be down to the target leverage ratio at which point as we look into 2019, approximately $0.5 billion of free cash flow comes available. Can you talk a little bit about what the capital allocation strategy is likely to be? Are we going to see a return to old school Zebra, where you do lots of share buybacks? Olivier Leonetti - Zebra Technologies Corp.: So, your calculations are correct and as we reach the end of this year, we'll look at, again, what we do with this cash. We believe that below a leverage ratio of 2 times, accumulation of cash in the balance sheet would not be appropriate return for our shareholders. So, we look at all options when we come to this. One of them could be share buyback, but that could be one. Paul Coster - JPMorgan: Okay. Got it. And then, Anders, can you talk a little bit about the product cadence and investment strategy in R&D? It sounds like proportionately more is going into software development. But I'm just wondering is there any chance that you'll start to explore some adjacencies with new product categories in 2018, 2019? Anders Gustafsson - Zebra Technologies Corp.: Yeah. We are – as a technology company, we are dependent on having a fresh and vibrant portfolio to – that can deliver true value to our customers. So, we certainly want to continue to drive innovation across the portfolio. And I think we've done a nice job of that over the last couple of years. The – we have talked about some of the adjacencies. I would highlight things like support – sorry, services and supplies as two key ones. We think there is great opportunities for us to expand there. We can leverage the strength we have in our core business to build a stronger presence there. And those markets are quite fragmented, so we feel that's a good position for us – or good markets for us to enter or expand in I should say, we're already in them. Joachim Heel - Zebra Technologies Corp.: But perhaps one other thought, as you think about adjacencies, don't just think about product terms, like software or services or hardware, but also think about solutions, the solutions that we've been talking about like SmartLens and SmartPack are a combination of hardware, software and services, and we're definitely investing in building those kinds of capabilities on top of the data platform, Savanna that we introduced. We think those will drive positive business cases for our customers in across our verticals and will enable us to grow the breadth of the portfolio that we really have. Paul Coster - JPMorgan: Okay. Makes sense. Thank you very much. Operator : Thank you. And the next question comes from Richard Eastman with Baird. Richard Eastman - Robert W. Baird & Co., Inc.: Yes. Good morning. Just, Anders, could you maybe speak to, as we've kind of pivoted towards growth with the debt reduction here and our leverage ratio coming down, we kind of pivot towards growth. Should we expect that maybe this software and services category to start to reflect some of these initiatives on the R&D side, some of the solutions approach. But should we start to expect with this kind of growth focus that the software and solutions category, roughly $500 million of revs would start to accelerate as a reflection of those investments? Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, first, I'd say when we – we've been making significant investment in software. But software is something that is permeating our entire portfolio. So, today, well over half of our engineers are software engineers, but many of our – we often monetize that software as part of a device. So, it's not always broken out as software, right? Richard Eastman - Robert W. Baird & Co., Inc.: Yeah. Anders Gustafsson - Zebra Technologies Corp.: But we do expect our services business to start showing more attractive growth as we move through 2018 here. And that's both going to be driven by say the traditional services business, but also from some of these new types of solutions. But you've got to remember just it's a modest base today. But we expect faster growth and the sales cycle is a bit longer but we certainly feel that we are well positioned to continue to drive growth for our software and services from these new attractive solutions. Richard Eastman - Robert W. Baird & Co., Inc.: Is some of that going to be dependent on being pulled through some of the service offerings being pulled through the channel? Anders Gustafsson - Zebra Technologies Corp.: Our – the sequencing of this is that new types of solutions and these tend also to be a bit more complicated. We, as the manufacturer or the OEM, generally have to prove it in the market, get some reference accounts. And once we have that, we can recruit partners to start selling that and ramping around that. I think we have good examples of that in some of our more complex solutions where we've started to bring in partners very purposefully. The Savanna accelerated program that we talked about last time is a great example of that. And we have, in Q2 we will start having our Channel Partner Summits around the world. And at that point, we will have a lot of discussions around how we can enable our partners to participate in that growth. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. And then just a quick question for Olivier. When you speak to 2018 and your EBITDA expectation of 19% to 20%, can I ask you what currency assumption accretion goes into that 19% to 20%? Is it a point or? Olivier Leonetti - Zebra Technologies Corp.: So, we haven't been specific about this. Just a bit of color about FX, so, it's obviously a favorable trend now. But I would like to say that we have one-fourth of our business which is exposed to FX trends, it's the euro. And we have a hedging program which hedge our exposure 50% 12-month out and 80% as we enter into a particular quarter. So, we don't have the full impact of FX when the FX is for or against us. And going back at EBITDA, we have – it's obviously an important metric for us, EBITDA rate. As I alluded to earlier, we have various levers to achieve this rate. But ultimately our goal is to drive EBITDA and EPS dollars. And we feel optimistic about how we are positioned today as a company to achieve an attractive return there. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. And maybe just the other thought I just had is with the ETR that you're kind of forecasting for the first quarter, I presume, that that's a pretty good estimate for the full year. Do you have a sense of – in your free cash flow guidance, do you have a sense of how much that lower ETR would contribute to your free cash flow? I mean, my math says maybe $40 million or $45 million might be in that $475 million estimate? Olivier Leonetti - Zebra Technologies Corp.: Right. Let me answer differently to your question. So the $475 million of free cash flow and our free cash flow conversion which we want to be at 100% of non-GAAP net income, that is contemplating the impact of the new tax rate for the company. Richard Eastman - Robert W. Baird & Co., Inc.: Okay. All right. That's helpful. I can derive it. Okay. Thank you. Olivier Leonetti - Zebra Technologies Corp.: Thank you. Operator : Thank you. And the next question comes from Keith Housum with Northcoast Research. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen, and congratulations on a good quarter. If I can follow up on his question there, if I look at the FX tailwind you guys have now and the headwinds you had just three years ago and the impact it had on adjusted EBITDA, would you guys allow the adjusted EBITDA margins to go above your 18% to 20% range just purely because of the benefit from the FX tailwinds? Olivier Leonetti - Zebra Technologies Corp.: The answer is yes. We're not going to stop obviously at the range, and as I said, Keith, we have many levers to achieve these goals. But clearly FX is going to be a favorable trend for the company, not only on the top line but also profitability and we're driving our teams excluding impact of FX. That's why we were able to navigate through an unfavorable FX environment in the past and that's why we want to maximize the impact of FX going forward. We track our performance excluding this, Keith. Anders Gustafsson - Zebra Technologies Corp.: Yeah, I don't think you need to think of the 20% as some form of barrier that we will purposefully not try to break through. We would like to break through that and stay above that too for that matter. Keith Housum - Northcoast Research Partners LLC : Great. Thank you. And then if I could follow up on the questions before regarding China. Understanding some of the challenges you have there. Are the challenges in the different verticals that you guys have between the mobile computers, the printers, and data scanners or is it more centralized in one product category or another? Anders Gustafsson - Zebra Technologies Corp.: I'll start and I'll let Joe also respond to this one, but it included all the main product lines but I'll say printing has made more progress getting on it. We had year-over-year growth in printing in Q4. We saw a great uptick in acceptance of our new industrial printers, the tabletop printers that we launched in the second half of last year for – in China. They are going to all the big contract manufacturers, but the – we saw a good sequential revenue uptick for our mobile computers and scanners also. So, we feel that it is progressing very nicely and we have expanded our partners into – and expanded geographically into new areas in China. So, there's a number of things that we're doing to position us for better growth, but also making sure we have a portfolio of products that are suitable for China. Keith Housum - Northcoast Research Partners LLC : Great. And if I could squeeze one more in here. The benefit from tax reform, are you guys reinvesting that back into the business at all? Or is most of that going to fall just to the bottom line? Olivier Leonetti - Zebra Technologies Corp.: So, we are going to do both. First of all, we want to invest in the business, in R&D, in sales and also in our talent. But also, we want our shareholders to benefit from the reform. And let me give you a bit of pointers, our tax rate non-GAAP was 22%. The tax reform will allow us to go to a rate of about 18% and then the 18% to 16% is due to a tax restructuring plan we have in place. This plan is now going to allow us to fully optimize the tax structure of the company and the tax reform has been a really a vector of acceleration of the implementation of this plan. But the very attractive tax rate is due to two factors. James – yeah. Keith Housum - Northcoast Research Partners LLC : Great. Thank you. Operator : Thank you. And the last question today comes from James Faucette with Morgan Stanley. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. You've answered most of my questions but I had a couple of follow ups. I guess my first is when you look at FX and the changes there, I appreciate you're hedging at least part of that. But is that having any impact on customer behavior? Is it helping them close projects and deals faster or upsize those, et cetera? And then my second question is you kind of highlighted some of the strengths of the different verticals that you're in and they all seem to be doing quite well. But I'm wondering if we should expect a meaningful change in the relative contributions of those verticals over the next several years? Are you seeing any one of them grow meaningfully faster or start to grow meaningfully faster with better prospects than another, et cetera? Thank you. Olivier Leonetti - Zebra Technologies Corp.: So first, I think you asked if tax reform is a driver for demand. Anders Gustafsson - Zebra Technologies Corp.: FX. Michael A. Steele - Zebra Technologies Corp.: FX. James E. Faucette - Morgan Stanley & Co. LLC: No, sorry. FX. Olivier Leonetti - Zebra Technologies Corp.: FX, yeah. So, FX is really has effect for Europe where we sell in euros and the difference in – when the euro go up or down a percent say, we don't necessarily adjust pricing. So it does not have a big impact on demand. We try to make sure that we mask that as much as we can. Obviously, when we see a very substantial longer term change in FX, we will adjust our price list, like we did back in 2015, I think it was. So, but I wouldn't think of FX as a growth driver. It's probably more an improvement of our margins, if anything. And the second part of your question was I think about the relative growth of the various verticals that we have. I'm not sure I want to be overly specific about how – what growth rate we expect from each vertical by year but we do see great growth potential for each of our vertical markets. There are strong secular trends that support growth in all of them. Go back to retail and ecommerce the whole shift towards e-commerce and omni-channel is a big transformation for the retail industry and to execute on that you need to deploy more technology. Either in the hands of your sales associates or in more smarter infrastructures like a SmartLens product. Healthcare, with the debate in the U.S. around how to get healthcare costs to be lower. What can be better than improving the quality of care because there was also talk about pay for outcomes? But also, we do drive a lot of efficiencies there and it's a market that we talked about from our healthcare study here, that's substantially underpenetrated we believe and should see much greater adoption of technology, particularly in the hands of caregivers. And transportation logistics, again ecommerce is a big driver for them. The volume of packages is increasing exponentially. The number of deliveries they're having to do is increasing very substantially. So, how can we help them drive more efficiencies, improve their service level agreements and so forth? I think that's a strong driver for us. And in manufacturing, there's a strong push across manufacturing to improve the value of tiers or across their processes and we see good opportunities for us to participate there. And also, as Joe mentioned earlier, this is the vertical that it has progressed the least, when it comes to Android conversion. Joachim Heel - Zebra Technologies Corp.: Yeah. Yeah. I was going to emphasize that. I think we have a lot of potential ahead of us in sectors where warehousing is prevalent. So, transportation, logistics and manufacturing are ones where there's an Android-driven growth that we do expect. And one other addition on your – it's more of a secondary effect on your FX question. We obviously sell in a number of countries in U.S. dollars, that don't have the U.S. dollar as their currency. The weakness of the U.S. dollar has helped us in some of those countries, Mexico would be a good example, right, where that does help us. James E. Faucette - Morgan Stanley & Co. LLC: Great. Thank you. Operator : Thank you. And as that was the last question. The conference has now concluded and this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson - Zebra Technologies Corp.: So in 2017, we extended our lead in the markets we serve and exceeded our financial targets. So, we are very encouraged about our momentum into 2018 and are well-positioned for success. I appreciate all the hard work and dedication of our employees and the support of our partners and customers. And with that, have a great day, everyone. Operator : Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,018
| 2
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2018Q2
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2018Q1
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2018-05-08
| 7.067
| 7.597
| 8.109
| 9.373
| null | 15.14
| 15.66
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Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: James Ricchiuti - Needham & Company, LLC Paul J. Chung - JPMorgan Securities LLC Brian P. Drab - William Blair & Co. LLC Jason A. Rodgers - Great Lakes Review Richard Eastman - Robert W. Baird & Co., Inc. James E. Faucette - Morgan Stanley & Co. LLC Jeffrey Ted Kessler - Imperial Capital LLC Operator : Good morning, everyone, and welcome to the Q1 2018 Zebra Technologies Earnings Release Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Mike Steele, Vice President of Investor Relations Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning and thank you for joining us. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our first quarter 2018 highlights. Olivier will then provide more detail on the financials and discuss our second quarter and full-year 2018 outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year and on a constant currency basis. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, we'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. Our first quarter results were driven by strong performance across the business. As you can see on slide 4, for the quarter, we reported net sales growth of 13% or 10% on a constant currency basis, an adjusted EBITDA margin of 20.9%, a 370 basis point year-over-year improvement, non-GAAP diluted EPS of $2.56, an 87% increase from the prior year and $116 million of cash flow from operations. Q1 was a great start to the year. Our team executed well in a solid global macroeconomic environment. Our industry leadership is driving robust broad-based market demand for our solutions. We achieved growth across all regions, with particularly strong performance in EMEA and North America. We also saw exceptional growth in mobile computing, led by our Android-powered devices and solid performance across our printing portfolio, which we have continued to enhance with smarter software and security features. Our operational discipline and focus on a lean cost structure enabled us to significantly expand profit margins and achieve a record earnings per share. Our strong Q1 results and solid order backlog gives us the confidence to raise our full-year outlook for sales, margin and free cash flow. With that, I'll now turn the call over to Olivier to review our financial results and to provide the details of our revised 2018 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. Let us begin with the walk through the P&L. As you can see on slide 6, sales grew 9.8% in the first quarter, driven by solid results in each of our reporting segments and growth across all four regions. Enterprise Visibility & Mobility segment sales increased 11.1%, led by robust demand in mobile computing. Asset Intelligence & Tracking segment sales increased 6.4%, driven by strong growth in printing. Sales of services were higher, with continued strength in our Visibility Services applications and Zebra Retail Solutions. Turning to our regions, sales growth in North America was 9%, driven by demand for our mobile computing devices, due to the ongoing conversion to Android, particularly in the retail sector, as well as solid printer sales to the channel. EMEA sales increased 13%, with broad-based strength and exceptionally strong mobile computing sales. Sales in Asia-Pacific were up 5%, driven by strength in the manufacturing sector and solid growth in printing products. Sales grew throughout most of the region. Our business in China has been recovering nicely and we are seeing increased end market demand for our tailored product offering. Latin America sales increased 7%, attributable to exceptionally strong sales in mobile computing and data capture products. Consolidated gross profit increased $64 million or 16% from the prior period on higher sales volume. Adjusted gross margin increased 130 basis point, primarily driven by improved go-to-market execution, favorable business mix shift in both operating segments and the appreciation of the euro over the past year. Adjusted operating expenses increased $10 million from the prior period, primarily reflecting growth in the business and higher incentive compensation expense due to improved business performance. First quarter 2018 adjusted EBITDA margin was 20.9%, a 370 basis point increase from the prior period. This was driven by higher gross margin and operating expense leverage on higher sales due to our disciplined approach to profitable growth. In addition to EBITDA margin expansion, lower interest cost and the decreased tax rate drove non-GAAP earnings per diluted share to $2.56, or 87% increase year-over-year. Turning now to the balance sheet and cash flow highlight on slide 7. At quarter end, we had $2.1 billion of variable rate debt on the balance sheet, of which more than $500 million is hedged with interest rate swaps for 2018. As a reminder, in late 2017, we locked in an incremental $800 million of floating to fixed rate swaps that would become effective in December 2018, for an overall notional swap value of $1.3 billion. Due to the favorable timing of this transaction, we realized a $12 million non-cash gain in Q1, which we have excluded from our non-GAAP results. In Q1, we paid down $95 million of debt principal supported by strong free cash flow of $98 million. Slide 8 shows our path to financial deleveraging. Continued debt pay down and strong EBITDA growth enabled us to achieve a 2.8 times net debt-to-adjusted EBITDA ratio as of the end of the first quarter. We're targeting a range of between 2 and 2.5 times, which we expect to achieve by the third quarter. Let us turn to our outlook on slide 9. We had another strong backlog entering the second quarter and we expect second quarter 2018 net sales growth to be between 9% and 12%, which assumes an approximately 3 percentage point favorable impact from foreign currency translation. Second quarter 2018 adjusted EBITDA margin is expected to be between 18.5% and 19%, an increase from the prior period, primarily due to slightly higher gross margin and operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $2.10 to $2.30. For the full year, we are raising our outlook and now expect net sales growth to be between 6% and 9%. This includes an anticipated 2-percentage point favorable impact from foreign currency translation. Full-year 2018 adjusted EBITDA margin is now expected to be approximately 20% and assumes higher gross margin and operating expense leverage as compared to the prior year. For the full-year 2018, we now expect to exceed $500 million of free cash flow. This increase is primarily due to higher expected EBITDA. Additionally, although we aim to improve our cash conversion cycle, we're assuming that working capital will be a use of cash as we grow the business. You can see other full-year 2018 modeling assumptions on slide 9. Note that we have made modest adjustments to our assumptions for interest and stock-based compensation expense. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. We are pleased with the progress made in the first quarter of 2018 and our improved outlook for the year. As you see on slide 11, we remain focused on our key priorities to build upon our industry leadership and drive shareholder value. First, we are extending our leadership in the core business through our innovation, unmatched scale and strong relationships with customers and partners. Our product offerings are resonating well in the market and have enabled us to expand our relationships with our Enterprise customers, both direct and in the channel. Several devices that have recently been driving solid growth across our core include our TC51 and TC70 families of Android mobile computers, our Ultra-Rugged scanners and our mobile and RFID printers, which are now equipped with our latest software applications and utilities and the industry's most advanced data security tools. Second, we are focused on driving growth in attractive markets that leverage Zebra's strength in our core. We continually evaluate opportunities in near adjacencies where we are underpenetrated including specialty supplies, as well as emerging areas such as our Visibility Services. Third, we are advancing our Enterprise Asset Intelligence or EAI vision by leveraging Zebra's deep knowledge of workflows and capitalizing on key technology trends. EAI is integral to our vision and makes our solutions unique in the marketplace. Our aspiration is to enable every asset and frontline worker to be visible, connected and optimally utilized. Additionally, we continue to enhance Zebra's financial strength and flexibility by increasing cash flow and optimizing our capital structure. As Olivia mentioned, we have made tremendous progress in this area and we expect to soon achieve our net debt leverage target. I would like to spend a few moments on slide 12 to highlight why more customers are choosing Zebra. We offer a unique value proposition to the enterprise market and we deliver a performance edge to those on the frontline of business. Zebra's global reach and scale allows us to dedicate the resources needed to create the industry-leading solutions our customers are demanding. The size and scope of our operations, including our investment in product development, the breadth of our portfolio, strategic customer relationships and ability to serve our customers globally are key competitive advantages. We have a track record of innovation and it is embedded in our culture. We create products and solutions with purpose-driven design that are tailor-made for frontline users in their particular workflows. Our leading portfolio of products and solutions are rugged and reliable, intuitive to use and easily integrated with other Zebra products to create a scalable platform. They also have enterprise-grade security and are fully supported by Zebra through their lifecycle. We are experts in the vertical markets we serve. We understand the business landscape in these markets and provide the solutions necessary to enable our customers to do their best work. I'll elaborate more on this in a minute. Lastly, our global partner ecosystem consists of more than 10,000 specialized partners, distributors, integrators, independent software vendors and various service providers who all play a critical role in implementing our solutions. This ecosystem is stronger than ever and augments our own capabilities, enabling us to serve more end users and drive sales growth through the channel. We have seen sharp increases in partners selling our entire product portfolio. Over the past year, the number of partners selling more than one Zebra core technology has increased by 40% and 1,600 new resellers have signed on to our partner program. Ultimately, we enable our Enterprise customers to perform better, improve customer service, enhance productivity, comply with regulations and even save lives. This summer, we will introduce our new brand positioning, which will further highlight Zebra's differentiation in the marketplace and why we are chosen most often to help our customers gain a performance edge. Slide 13 highlights the primary vertical markets that we serve, which currently account for the vast majority of our sales volume. Zebra has an intimate understanding of operational workflows in each of these verticals. Our expertise enables us to help our customers operate more efficiently and successfully navigate the challenges in their business. The pace of change is accelerating and businesses that intend to stay ahead of the curve need to invest in the type of solutions that Zebra provides. Through our research, we estimate that 64% of manufacturers expect fully connected factories by 2022, an increase of more than 20 points. 97% of nurses and physicians will use mobile devices at the bedside by 2022, an increase of more than 30 points. 72% of retailers are planning to reinvent their supply chain through automation, sensors and analytics over the next three years. And 70% of Transportation & Logistics field operations are increasing their IT budgets for Mobility through 2020. Let me further expand on Transportation & Logistics. In April, at the MODEX tradeshow in Atlanta, we showcased solutions for the warehouse and field mobility. Our solutions have resonated very well with our customers and partners. We understand that complex consumer needs and progress towards an on-demand economy are driving dramatic changes in the industry. Because of this, our customers are looking to maximize their operational efficiency, achieve a connected supply chain and deliver flawlessly. In order to execute successfully on these criteria, our customers must have superior visibility of assets, people, workflows and inventory throughout their supply chain to make smarter, more informed decisions and actions. For example, a leading European express delivery specialist has made a significant investment in optimizing their last-mile delivery process. They recently purchased our TC56 Android-powered mobile computers to arm their drivers with tools to improve the end user experience. A customized suite of applications has been loaded on the device to improve navigation, parcel delivery and connectivity to the company's centralized information system, among other benefits. There are many similar success stories in each of the vertical markets that we serve and it is translating into strong sales results. In closing, I want to thank the Zebra team for driving a strong quarter and enabling us to erase our outlook for the full year. And with that, I'll hand the call back to Mike. Michael A. Steele - Zebra Technologies Corp.: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and follow-up so that we can get to as many of you as possible. Operator : Ladies and gentlemen, at this time, we will begin the question-and-answer session. And our first quarter today comes from Jim Ricchiuti from Needham & Company. Please go ahead with your question. James Ricchiuti - Needham & Company, LLC: Thank you, good morning. So, you've shown several consecutive quarters of very strong results in mobile computing. And this appears to be more than just an upgrade cycle. But I wonder if you could just give us a little bit of color in terms of where we might be in the upgrade cycle. But clearly, there's some other demand drivers that appears that are fueling this business. Thanks. Anders Gustafsson - Zebra Technologies Corp.: First, I'd just like to put it in context, all the product categories that we have. We drove nice growth across all the lines of business that we had. And I think we did that largely through the innovation that we've introduced into the portfolio and making sure we have a very deep understanding of our customers' workflows and be able to take the data from that and reapply it into those workflows to reduce friction in those workflows. So, I think, we have a very strong value proposition and a strong portfolio across the board. Specifically to mobile computing, that was obviously the standout performance in the quarter. We had a great revenue quarter, particularly driven by Latin America, EMEA and North America. We started to see now strong strength in the channel. If you remember a few years back, it was mostly our large direct deals. Now, we've expanded this into the rest of the channel portfolio. So, we're seeing more mid-sized and smaller run-rate deals. The depth and breadth of our portfolio I think is a great differentiator. We have by far the largest or broadest portfolio of anybody in the industry, particularly around Android devices. And we're also putting a lot of emphasis on innovating, say, on top of the device. So a lot of software innovations like security with our LifeGuard service, manageability with OBS or a number of different types of applications and services through our Mobility DNA suite. But Android is the key to the growth at the moment. We have well over 50% market share for Android. So we've executed very well there. I think we feel good about the continued momentum in the Android migration. Our estimate is that there's at least another 10 million legacy Windows devices out there that needs to be upgraded. And if you look a little bit further out, I think we have some new growth drivers in that the – in North America specifically, the 3G cellular service is going to be turned down in 2021. And so all devices, Zebra or other suppliers, all our 3G devices will need to be upgraded to LTE or maybe 5G at that point also, which will be a new growth driver for us. James Ricchiuti - Needham & Company, LLC: Anders, is there any color you could give on the verticals? Did any one area stand out either geographically or just globally in terms of retail, e-commerce, logistics, industrial? Anders Gustafsson - Zebra Technologies Corp.: Yeah again, we had a strong performance across our four main verticals. Our solutions have become much more foundational and strategic to our customers executing on their business strategies. So we tended to be perceived maybe historically as a bit more of a tactical productivity tool. I think today, many of our customers think of us as an integral part of being able to execute on their strategies if that's omni-channel or e-commerce or what that might be. We can really drive – help them drive much greater visibility into their workflows and translate the data we get there into real actions that drive sales performance, efficiencies, customer service improvements and really provide a performance edge to frontline employees. Retail was a very strong market for us in Q1 here also. Retail is our largest vertical as you know. I think a couple of quarters ago, we talked about a retail study that we had done and I think that continues to validate the growth opportunity that we see. But retail is transforming and growing, particularly on the kind of the brick-and-mortar part of retailers. They're capitalizing on the shift to having to build those types of capabilities and I think they see us as a critical part of doing that. So, I think we've been executing very well on working with them to ensure we have the right solutions for our retail customers. But we are also seeing some new solutions that are starting to take – get – show traction in retail. So RFID will be one, SmartLens, our Personal Shopper, our flatbed scenic (25:13) scanners, the bioptic scanners and I think those are all essential parts to building out an omni-channel strategy also. James Ricchiuti - Needham & Company, LLC: Thank you. Operator : Our next question comes from Paul Coster from JPMorgan. Please go ahead with your question. Paul J. Chung - JPMorgan Securities LLC : Great. Thanks. Hi. This is Paul Chung on for Coster. Thanks for talking my question. So first question is on gross margins. You had some scale this quarter, FX benefits and margins looked like they're kind of moving in the pre-MSI range. So question is, are they sustainable at these levels on a structural change and how should we think about them long term here? Olivier Leonetti - Zebra Technologies Corp.: So you're right. We had a very good, strong gross margin rate in Q1. The G&A of the company is based upon multiple variables, margin is one of them. We have been focusing on gross margin, particularly over the last two quarters. Our level of intensity behind this initiative has been doubling and that paid out. A few factors maybe I would highlight, so operational discipline. We played well with our mix from a product channel, vertical standpoint. Also, our Zebra Retail Solution business was very strong in the quarter and explained about 50 basis point of the margin rate improvement we had quarter-on-quarter. We saw also improvement in our sevices margin. And last, we had also some benefits from FX. I would also mention to be complete, initiatives in the COGS area playing out. So you see from my answer a series of levers, not one in particular. Now to answer to your question on sustainability, we believe that we have the ability to improve margin year-over-year. Our guide is implying this. However, we want to remain prudent and balanced and hence the guide we provided. But we see that we have, again, I repeat it, margin improvement leverage in the P&L. Paul J. Chung - JPMorgan Securities LLC : Great. Thanks. And then, my second question is on the fiscal year 2018 guidance. So, is it safe to assume, kind of, a sequential bump in 3Q similar to previous years and then possibly a weaker 4Q given the tough comp? Thank you. Olivier Leonetti - Zebra Technologies Corp.: So, we are planning indeed for the year to grow at 6% to 9% on a nominal basis. We have increased our guide for the year by about 2 percentage point. This is going to translate for the second half into a growth profile, although low-single-digit growth. This is a balanced view, a prudent view based upon the visibility we have of the business. We're not, at this point – and I mention at this point, we're not relying on as many large orders as last year. We're investing in the run rate generation. Now, we will be nimble if needed and able to adapt to higher demand if this higher demand was to happen, yeah. Paul J. Chung - JPMorgan Securities LLC : Great. Thanks. Great quarter. Olivier Leonetti - Zebra Technologies Corp.: Thank you. Anders Gustafsson - Zebra Technologies Corp.: Thanks. Operator : Our next question comes from Brian Drab from William Blair. Please go ahead with your question. Brian P. Drab - William Blair & Co. LLC: Hi. Thanks for taking the questions. Congratulations on a great start to the year. I guess I wanted – Olivier, if you can just elaborate on the guidance for the – the implied guidance for the second half of the year. It really looks like you'd have to maybe even take a sequential step down from the second quarter to the third quarter, that would be unusual. Is that – do you have that much visibility to where we would expect a sequential step-down? Olivier Leonetti - Zebra Technologies Corp.: That's a fair point. We have today good visibility into Q2. And the visibility is decreasing as we go into the second half of the year. And as indicated, this is a balanced view to guide at this stage. Run rate is going to be what we're going to push for now. And if large deals were to materialize, we'd be prepared to compete and fulfill those. But we think it's the most appropriate way to guide at this stage with the visibility we have. Anders Gustafsson - Zebra Technologies Corp.: If you look at historically, our Q3 numbers tends to be flat or at times slightly down compared to Q2. Europe usually has a bit of a step back as there's more vacation time in Europe. But it's modestly changing from Q2. Olivier Leonetti - Zebra Technologies Corp.: Let me put another color. There was nothing fundamentally different either in the end market or macroeconomic events as well in the – reflected in the guide. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks. I don't know if I'm – we're talking about different time periods but I'm looking at the third quarter last couple of years, up 3% in 2016, up 4% in 2017. I guess over a longer – over longer time period, I guess, I understand why there could be weakness in the third quarter. And can I just ask my second question though? I want to understand a little bit better on the EBITDA margin guidance just – outstanding 20.9% result in the first quarter and the guidance for the second quarter is down 200 to 250 basis points sequentially. Can you just talk a little bit more about the margin dynamics that we should expect in the second quarter for the balance of the year? Olivier Leonetti - Zebra Technologies Corp.: Of course. So if you look at the guide for EBITDA margin, it's good to be an improvement year-on-year directionally by about a point and we will expect gross margin to be up year-on-year and OpEx to be up year-on-year. If you look at the full year, the guide at about 20% EBITDA margin would translate into about a point of a gain. Now, we have said that in other calls, we're not going to stop that, but at this stage, we believe it's a balanced way to manage the company and the P&L. We're looking at short-term performance, but also as on long-term performance. We want to invest in the business and to generate a good return and you see that this is paying out in the Q1 performance. So that's the way we want to approach the management of the P&L. Brian P. Drab - William Blair & Co. LLC: Do you have lower margin work in the backlog for the second quarter though and it's a big step down sequentially, which I'm sorry, but I didn't really – I'm not sure you addressed that, that's a big step down sequentially. Olivier Leonetti - Zebra Technologies Corp.: It is a step down sequentially. You have two elements on this. One, I will look at the year-on-year, point number one. And point number two, sequentially Zebra Retail Solution, which is a seasonal business, is – generated about 50 basis point of margin in Q1 and that will not obviously be present in Q2. So that would be part of the bridge. Brian P. Drab - William Blair & Co. LLC: Okay. I appreciate it. I'll follow-up more later. Thank you. Olivier Leonetti - Zebra Technologies Corp.: Thank you. Operator : Our next question comes from Jason Rodgers from Great Lakes Review. Please go ahead with your question. Jason A. Rodgers - Great Lakes Review : Yes. The 10 million devices still out there that you mentioned, is it possible to estimate how much of those devices belong to large versus medium and small – smaller customers? Anders Gustafsson - Zebra Technologies Corp.: I'll start and I'll see if Joe might have some insights here also. I think it's hard to – for us to have a real detailed view of the mix of where those are. You could certainly see that the largest companies are the ones that have been generally the earliest to adopt Android. But that being said, we have some very large, frankly (34:27) T&L companies that are still working on Windows devices and I would expect that they would be upgraded in the next couple of years. So, I think it's a mix between them, but you'd certainly get more into the smaller accounts as you dig into that pile. Joachim Heel - Zebra Technologies Corp.: Yeah. I would echo that. I think the majority of the remaining devices are likely to be in smaller end user customers and one indicator that we have for this is that the channel part of the conversion was slower to start in the early days of Android adoption, but now, we're seeing strong adoption in the channel and our channel partners driving Android conversion with their customers who tend to be smaller. So that's one indicator of it. The other indicator that we have is if we look by vertical, the vertical that still has the highest penetration of legacy Windows devices is in manufacturing, and many of the smaller manufacturers, again, have not yet made the conversion to Android, and that's where we expect a big portion of those additional 10 million – or remaining 10 million, I should say, to come from. Jason A. Rodgers - Great Lakes Review : And margin profile on the smaller deals is higher for Zebra than the larger, correct? Anders Gustafsson - Zebra Technologies Corp.: Yeah. It tends to be that when we deal with our largest direct customers, there's very sophisticated buyers and obviously they have a lot of power in the negotiations when they talk about such large deals. Our more run rate-oriented business tends to be executed much more around our list pricing. Jason A. Rodgers - Great Lakes Review : And then finally, just if I could squeeze one more in. Just wondering if you're seeing anything material on the way of higher raw material costs? Anders Gustafsson - Zebra Technologies Corp.: So, that's something we have seen for probably nine months or something now. It started mid last year with memory and batteries. So, we've been working very closely with our suppliers to make sure we have the right forecast in because lead times have also extended. And that's part of why we have put so much more emphasis on gross margin improvement plans that Olivier talked about to make sure we can offset any potential price increase that we would see from the supply chain. But this is, I think, a fairly broad-based experience now by people in the technology industries. But we feel we are in a good place and that we have secured supplies for – certainly for the next quarter or quarters and we're working closely with our partners to make sure we have adequate supply going forward and obviously negotiating hard to make sure we get the right pricing and qualify new vendors when we need to, to make sure we get the best possible price. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : Our next question comes from Richard Eastman from Baird. Please go ahead with your question. Richard Eastman - Robert W. Baird & Co., Inc.: Yes. Good morning. Anders, I take from your comments earlier that your best-performing vertical was retail. Could you just provide a little bit of color around the products that go into that market, I mean, if you're leading there with mobile computing or other? And then also, what is the composition of your retail business? Is it slanting towards more in-store with things like SmartLens or are you still basically kind of the back warehouse and fulfillment piece of retail? Maybe just talk to where – directionally, where the business has grown faster? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'll start with that. And then I think Joe can provide some further color here also, but – yeah, historically, we started off in, kind of, the back of the store doing more inventory-type applications and we've migrated now to be much more in the store. So lot of sales associates now in many large retailers are carrying our devices as one of their work tools that they use all the time to make sure they can engage with customers, to answer questions and be helpful to them, even if somebody goes out and can't find a piece of merchandise they're looking for, that the sales associates can then engage with them, understand what they're looking for, see if the neighboring store has it and have them ring up the sale and ship it from the other store. So that will be a great example of how our customers now are using our devices in the store. But they also do other things in the store around price checking and inventory checking and so forth. So I would say our products are prevalent across the warehouse, the back of the retail store and the front of the retail store. Our Android mobile devices, the TC51 and TC70, are probably the mainstay on the mobile computing side now. But if you get to the warehouse side, you'll see lot more wearables and other products, the MC9000 Series products come out there. We have a lot of printing in retail, both in the back of the store and in the front of stores for price markdowns. If you do e-commerce and you buy online, pick up in store, you got to label all those bags in some ways to associate the bag with the actual consumer. So that's new applications for our printers. And also for scanners of course, we have our new flatbed scanners which are doing very well in some of the largest accounts. And we think – see that as a great growth driver for us also. So retail really does utilize the vast majority of our products. And if you look forward, I guess the last comment, we've looked forward, there are some newer technologies that are also developed for retail. So like SmartLens, that would be one example that we can take you all the way up to kind of frictionless checkout technologies. Joachim Heel - Zebra Technologies Corp.: Okay. Maybe two – one additional thought. As you think about front of store and back of store, the other part that we're excited about is, as Anders mentioned earlier, retail is transforming and the omni-channel experience and the blurring of e-commerce and brick and mortar is a hotbed of where our products are being used in new and innovative ways. For example, as retailers introduce click and collect type of schemes, you'll find our products being used to both gather the products in the store as well as then deliver them into the trunk of a car or at a special counter. Our PSS products are being used to start a shopping experience online, prepare a shopping list and then, in the store, retrieve that shopping list, interact with customers while they're on their shopping journey and then check out. So, those are examples of where the technologies and products are used in innovative ways to blur the lines between the front and the back of the store and we're really excited about those. Richard Eastman - Robert W. Baird & Co., Inc.: Understood. And then also, a quick question for Olivier. If you just look at the consolidated gross margin improvement, could you just, in basis points, just break out what FX, how FX benefited you? So, of the 130 basis points improvement in gross margin, adjusted gross margin, I'm just curious, just segmenting FX, was it – how many basis points did FX benefit that line? Olivier Leonetti - Zebra Technologies Corp.: So, the margin improvement year-on-year was due to a series of factors. I wouldn't single out one in particular. Operational discipline was a driver. Service improvement margin was a driver and FX was one. But I wouldn't single one in particular. I think its broad-based improvement. Richard Eastman - Robert W. Baird & Co., Inc.: Just from the standpoint of what does or does not reoccur, I was trying to just segment out FX. I mean, the others seem much more sustainable. I just want to – that was the thought behind the question. But I can follow-up as well. Thank you. Operator : Our next question comes from James Faucette from Morgan Stanley. Please go ahead with your question. James E. Faucette - Morgan Stanley & Co. LLC: Great. Thank you very much. Had a couple of follow-up questions to those that have been asked. I guess my first is, can you talk a little bit about what's happening in Europe? It looks like that number was like 13% organic growth or thereabouts, if my math is correct. And I mean, is – do you think there's any forward stocking that was going on while the dollar was weak or other things that can make that a bit more of anomalous or – yeah, just a little color on what you see happening in Europe? Anders Gustafsson - Zebra Technologies Corp.: Yeah. Europe was very strong, right. But we saw great broad-based strength across virtually all the sub-regions. Mobile computing led the charge, but retail and T&L were strong. From a – so why is Europe growing so much faster today? I would put a lot of that down to execution. I think we have gotten our channel programs to be in very good shape and we're recruiting a lot of new partners into our program. We executed very well on the larger deals in the region also. And if there's any kind of anomaly to it, I would say maybe Europe had underinvested in our technologies a couple of years when they were going through some more difficult economic issues. And so, there could be some catch-up in that case, but we haven't really seen any evidence of that. So, it feels just like there's been good confidence in the business community in Europe and they have approved budgets and investments and I think they feel – Europe kind of feels that they're coming back and they want to compete. James E. Faucette - Morgan Stanley & Co. LLC: Great. And then just on capital and balance sheet, as your debt levels come down, et cetera, how should we think about the uses of cash – should we still anticipate primarily more debt pay down or does it make sense for you to start to look more at acquisitions, particularly those that could continue to enhance the product portfolio? Just trying to get a sense for how we should think about uses of cashes as you hit kind of targeted debt levels. Olivier Leonetti - Zebra Technologies Corp.: Right. So, we have been focusing on free cash flow generation and debt pay-down now for a period of time and the team has executed very well. We believe we're going to be within our range of leverage ratio mid-year this year. After that, we're going to look at options to deploy this capital. We believe that nevertheless, we have many opportunities to invest in the business to deliver attractive return for our shareholders. We're very excited by our end markets and by our ability to compete on those. So investing in the business would be an element where we will focus on. James E. Faucette - Morgan Stanley & Co. LLC: Great. Thank you very much. Operator : And our final question today comes from Jeff Kessler from Imperial Capital. Please go ahead with your question. Jeffrey Ted Kessler - Imperial Capital LLC : Thank you. Can you describe what improvements integrate – what improvements the new platform that you'd set up a year, a year and a half ago such as Savanna began – how they began to affect your ability to gain better margin? Anders Gustafsson - Zebra Technologies Corp.: So, first, if you talk about kind of the broader picture about EAI, I think... Jeffrey Ted Kessler - Imperial Capital LLC : Yeah. Anders Gustafsson - Zebra Technologies Corp.: ...for us, EAI is something that we are very excited about and that's really enabling our devices and other intelligent infrastructures to be able to sense the data, information about assets, products and processes, what it is, where it is, how it is and this information is then analyzed to provide actionable insights to frontline employees in real time to help them reduce friction in workflows and improve productivity and enable greater insights overall to the business operations. Savanna is a critical part of this. It is a data platform that helps to easily integrate data from all these devices, mobile devices or fixed infrastructure that now is generating more insights and do some analytics of that and enable some actionable insights to be drawn, but also to work with northbound applications so that we can hand off some form of analyzed data stream to other applications that can do further analysis and draw additional insights from that. So this is a way for us to – so Savanna, you can say is the way for us to provide kind of the glue across the portfolio. We use Savanna internally as a foundational building block in OVS or in SmartLens and other things to help analyze the data, to manage the data. But we also expose this to our partners. So this is a great way for us to engage our partners to be part of our EAI strategy and offer them growth opportunities in this. And we had a partner conference in Europe, a couple of weeks back, and we had some of our more advanced partners show up on the big stage, show what they had done with Savanna and I think that went a long ways to help our other partners to understand what Savanna our data – and our services strategy is and how they can compete in it. It made EAI much less abstract, I think, further (49:05) much more real. Jeffrey Ted Kessler - Imperial Capital LLC : So what you're saying is for your larger partners, there is a level of confidence in their use already of the platform. Anders Gustafsson - Zebra Technologies Corp.: Yeah. We – you might remember in the fall, we started something we call the Savanna incubation... Olivier Leonetti - Zebra Technologies Corp.: Early adopter... Anders Gustafsson - Zebra Technologies Corp.: ...early adopter program where we brought in five or six partners to work with us on kind of highlighting certain use cases where they would take data from our devices and analyze that and then kind of give it back to our customers in a way which could be more value-add. I think that's gone very well. We're now looking to expand that with a second phase of another 5, 10 partners before we can open it up and say we now have hardened Savanna enough that we can have any and all of our partners write applications to it. Joachim Heel - Zebra Technologies Corp.: Maybe one connection I'll draw for you to your question about margins right. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Joachim Heel - Zebra Technologies Corp.: If you look at the solutions that we have been developing and are piloting with customers and some of which are already commercially rolled out like Location Solutions, the SmartLens and SmartPack Solutions, they have the added feature relative to our products that they are directly linked to a business problem that a customer is trying to solve. And as such, we price these types of solutions in such a way that they deliver a great ROI for the customer. But in the process of doing that, they also deliver great margins, typically higher than our average to us as a company. So, when we do that, we can accelerate our margins by selling these solutions. The platform, Savanna, is a common platform on which we then base all of these different solutions so they give us a way to accelerate these solutions coming to market and they broaden our reach because now our partners have access to these same solutions on a faster and more accessible platform. So it has sort of a double benefit, right? On the one hand, as a platform-based development, it lowers the cost to develop; and then it acts as an accelerant to get it into the market faster for both our partners and for us. Anders Gustafsson - Zebra Technologies Corp.: Maybe one last point will be the data we have is something that's very hard to get access to. So if you are say an IoT company sitting in a data center, you don't have data about what's happening at the frontline of business. That's the data we can capture with our mobile computers and printers and scanners and other – some of our fixed infrastructure. And then, the combination of us, also then knowing the vertical workflows of our customers very well, I think we're uniquely well positioned to be able to take that data to improve efficiency, other things for our customers' workflows, really we call it (52:05) reduced friction in those workflows. So that's something that really is resonating very well with our customers. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. One quick follow-up question. You've talked about the pipeline a bit in generalities and you talked about your, obviously, the leading vertical markets you have. Can you describe what is in the pipeline right now? I mean, not – obviously not product by product, but can you describe the nature of where that pipeline is going as you see it over the course of 2018, that may have been a little bit different from the fourth quarter moving on into the first quarter? Joachim Heel - Zebra Technologies Corp.: So, this is Joe Heel speaking. I can maybe talk a little bit about the nature of what we're seeing. Just to reiterate, the success that we've had in the past is also mirrored in our pipeline going forward in that it is broad-based across all of our lines of business and we see the pipeline strong across all the different business units, mobile computing, scanning, printing and including our services business as well. So, we have a broad-based strength there. What we do see is that if you were to compare to last year, we do not have visibility to as many large deals in the second half as we had last year, but we see a very strong presence in the pipeline of what we would say are more mid-sized deals. And this is related to the question earlier about how we see the Android adoption and the technology conversion there occurring, right, where the – many of the large customers have done their adoption, and now many of the mid-sized and channel customers are following. So that may give you a little bit of color on the movement in the pipeline. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Great. Thank you very much. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : Ladies and gentlemen, that will conclude our question-and-answer session. At this time, I'd like to turn the conference call over to Anders Gustafsson for any closing remarks. Anders Gustafsson - Zebra Technologies Corp.: Yeah. Thank you. Just as we wrap up, I just wanted to mention that I am very grateful to have the best team in the industry and a highly supportive partner community to help serve our valued customers. We could not have delivered these results without their help. Have a great day, everyone. Operator : Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,018
| 3
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2018Q3
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2018Q2
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2018-08-07
| 8.008
| 8.48
| 9.764
| 10.26
| null | 15.5
| 15.4
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Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: Jim Ricchiuti - Needham & Company, LLC Keith Housum - Northcoast Research Partners LLC Jason A. Rodgers - Great Lakes Review Joe Aiken - William Blair Richard C. Eastman - Robert W. Baird & Co., Inc. James E. Faucette - Morgan Stanley & Co. LLC Paul Coster - JPMorgan Securities LLC Operator : Good day and welcome to the Second Quarter 2018 Zebra Technologies' Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning and thank you for joining us. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our second quarter 2018 highlights. Olivier will then provide more detail on the financials and discuss our third quarter and full-year 2018 outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year and on a constant currency basis. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I will turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered excellent second quarter results. We executed well, driving strong profitable growth and further extending industry leadership. As you can see on slide 4, we reported net sales growth of 13%, nearly 11% on a constant currency basis; an adjusted EBITDA margin of 19.7%, a 200 basis point year-over-year improvement; non-GAAP diluted EPS of $2.48, a 64% increase from the prior year; and $150 million of cash flow from operations. We achieved double-digit sales growth in EMEA and North America. We also saw solid growth across all of our major product and service categories, including data capture, mobile computing, our specialty printing portfolio, supplies and support services. The investments we have been making in our best-in-class products and solutions are paying off. Our broad suite of purpose-driven products, enhanced with the smartest software and security features, is resonating well with enterprise customers. Our operational discipline and lean cost structure enabled us to significantly expand profit margins and drive improved operating cash flow. Our strong results and robust order backlog gives us confidence to significantly increase our full year outlook for sales and free cash flow. With that, I will now turn the call over to Olivier to review our financial results and to provide the details of our revised 2018 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. Let us begin with the walk through the P&L. As you can see on slide 6, sales grew 10.6% in the second quarter, driven by solid results in each of our reporting segments and across all major categories. Enterprise Visibility & Mobility segment sales increased 10.9%, led by strong demand in data capture solutions and mobile computing. Asset Intelligence & Tracking segment sales increased 9.9%, driven by strong growth in printing solutions. Turning to our regions, sales growth in North America was 11%, driven by outperformance in our data capture, printing and supplies categories. We saw particular strength in our transportation and logistics and manufacturing verticals. EMEA sales increased 14% with broad-based strength across all geographies and all major product categories. We saw especially strong demand in the transportation and logistics space as well as in retail as investments are made to improve omni-channel capabilities. Sales in our Asia Pacific region were up 8%, driven by broad-based strength across Asia, including China. As a reminder, Asia Pacific sales in the prior-year quarter were positively impacted by 3 percentage points related to the release of a reserve for price concessions related to previously imposed duties on printers in China. We had solid Q2 sales growth in China, despite this challenging comparison. Latin America sales decreased 1%, primarily due to temporary softness in Mexico. Adjusted gross profit increased $60 million or 15% (sic) [14.5%] (06:15) from the prior-year period on higher sales volume. Adjusted gross margin increased 70 basis points, primarily driven by improved go-to-market execution, favorable business mix shift and the appreciation of the euro over the past year. Adjusted operating expenses increased $20 million from the prior-year period, primarily reflecting growth in the business, higher incentive compensation expense due to improved business performance and investment in growth initiatives. Second quarter 2018 adjusted EBITDA margin was 19.7%, a 200-basis-point increase from the prior-year period. This was driven by higher gross margin and operating expense leverage on higher sales. In addition to EBITDA margin expansion, lower interest cost and a decreased tax rate drove non-GAAP earnings per diluted share to $2.48, a 64% year-over-year increase. Turning now to the balance sheet and cash flow highlights on slide 7, in the first half of this year, we paid down $235 million of debt principal, supported by strong free cash flow of $233 million. This $52 million increase in free cash flow as compared to the first half of 2017 was primarily driven by increased operating profitability and the absence of integration cost in the first half of this year. At quarter-end, we had $2 billion of viable rate debt on the balance sheet, of which more than $500 million is hedged with interest rate swaps for 2018. As a reminder, in late 2017, we locked in an incremental $800 million of floating-to-fixed rate swaps that will become effective in December 2018 for an overall notional swap value of $1.3 billion. Due to the favorable timing of this transaction, we have realized $18 million of non-cash gains in the first half of the year, which we have excluded from our non-GAAP results. Slide 8 shows our path to financial deleveraging. Continued debt paydown and strong EBITDA growth enabled us to achieve a 2.5 times net-debt-to-adjusted-EBITDA ratio as of the end of Q2, which is the top-end of our targeted range of between 2 times and 2.5 times. In the second quarter, we completed additional actions to restructure our debt, which have resulted in an annualized interest expense savings of approximately $4 million to $5 million. These actions followed a comprehensive debt restructuring we completed during the second half of 2017, which drove more than $45 million of annualized interest savings. Let us turn to our outlook on slide 9. We had a strong backlog entering the third quarter and we expect third quarter 2018 net sales growth to be between 12% and 15%, which assumes an approximately 1 percentage point favorable impact from foreign currency translation. Third quarter 2018 adjusted EBITDA margin is expected to be between 19% and 20%, assuming gross margin in line with the prior year and increased operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $2.50 to $2.70. For the full year, we are raising our outlook and now expect net sales growth to be between 10% and 12%. This includes an anticipated 2 percentage point favorable impact from foreign currency translation. Full-year 2018 adjusted EBITDA margin is expected to be approximately 20%, assuming higher year-over-year gross margin and operating expense leverage. For the full-year 2018, we now expect to exceed $525 million of free cash flow. This increased outlook is primarily due to higher expected EBITDA. You can see other full-year 2018 modeling assumptions on slide 9. Note that we have made modest adjustments to our assumptions on capital expenditures, interest expense, stock-based compensation and tax rate. Note that our 2018 outlook does not include any projected results from the acquisition of Xplore Technologies, a transaction we expect to complete this quarter. Anders will discuss the acquisition in a few moments. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. We are pleased with the progress we made in the second quarter and the opportunity to raise our full-year outlook. As you see on slide 11, we remain focused on our key priorities to build upon our industry leadership in 2018 and beyond. First, we continue to extend our leadership through our innovation, unmatched scale and strong relationships with customers and partners. We saw strong demand for our products and solutions, both the direct and through the channel. Several areas that have recently been driving solid growth include our families of Android mobile computers, our best-in-class wearables, our tabletop and mobile printers, our next-generation bioptic grocery scanner and our Personal Shopper Solution. Second, we are focused on driving growth in attractive markets where we can leverage our competitive advantages. We continually evaluate organic and inorganic opportunities to strengthen or augment our position in the adjacencies as well as attractive businesses that advance us as a solutions provider. As a proof point, in July, we launched a tender offer to acquire Xplore Technologies, which will enhance our product lineup and provide a complete enterprise tablet portfolio. Xplore's offerings will serve existing vertical markets for Zebra as well as provide an inroad into new markets, including oil and gas, utility, government and public safety. The addition of Xplore will provide access to a great team and outstanding products in an attractive market that should enable us to grow our tablet sales double digits. Third, we are advancing our Enterprise Asset Intelligence or EAI vision by leveraging Zebra's deep knowledge of workflows and capitalizing on key technology trends, including the Internet of Things, cloud computing and mobility. Our aspiration is to enable every frontline worker and asset to be visible, connected and optimally utilized. Lastly, we have enhanced Zebra's financial strength and flexibility by increasing cash flow and optimizing our capital structure. As Olivier mentioned, we have achieved the top-end of our targeted leverage range after several years of EBITDA improvement and aggressive debt paydown. Last week, we were excited to introduce a new brand positioning that highlights our EAI vision and how we enable our customers to succeed. On slide 12, you see our brand essentials, which convey how Zebra delivers a performance edge to the frontline of business. First, Zebra innovates products and solutions with purpose-driven designs that are tailor-made for the frontline and its work flows. Our products are ultra-rugged and reliable, intuitive to use and easily integrated with other Zebra products to create a scalable platform. They also have enterprise-grade security and are fully supported by Zebra through their lifecycle. Second, our smart products and infrastructures capture timely and relevant information creating data-powered environments, supported by Savanna, our data services platform. Third, we enhance collaboration and workflows for frontline workers through mobile connectivity. With our tools and software applications, teams can communicate seamlessly and utilize location information to dispatch instructions to the appropriate employee. And, lastly, we can analyze the operational data we collect through automated methods to provide real-time guidance to the frontline worker. Together with our growing global ecosystem of partners, Zebra's solutions are used to intelligently connect company assets, data and people in collaborative mobile workflows. In summary, these brand essentials highlight Zebra's differentiation in the marketplace and how we enable our enterprise customers to enhance productivity, improve customer service, ensure patient safety and comply with regulations. Across all of the vertical markets we serve, five mega trends have been transforming the needs of our customers. These include the proliferation of connected devices, mobility within the enterprise, cloud computing, the transition from task worker to knowledge worker and an increasingly on-demand economy. We are helping companies across many industries digitize their operations and improve their performance to stay relevant and compete in today's marketplace. Slide 13 highlights the primary vertical markets that we serve, retail and e-commerce, healthcare, transportation and logistics and manufacturing. Our intimate knowledge of operational workflows in each of these verticals is a key reason for our success. We see the pace of change accelerating and the use cases are evolving to address increasing demands. For example, in retail, our solutions have been traditionally used for inventory management, which remains a critical application for omni-channel and e-commerce fulfillment. More recently, we have been driving increased demand for our products and solutions in the front of the store as customers require a higher level of customer service, including more pick-up and delivery options. With our technology, a store associate can immediately check inventory and complete a transaction without ever leaving the shopper's side. In the transportation and logistics space, we are well-known for track and trace and proof-of-delivery use cases. We are now providing real-time visibility of parcels and equipment at every stage of the supply chain, including innovative solutions that maximize the load density of a trailer. In healthcare, we enable patient identification through wristbands and a variety of sensing technologies and we are expanding use cases by driving increased clinical collaboration. Our solutions now allow care providers to monitor patient conditions while being mobile. Additionally, enabling immediate communication among various care team members is vital for timely patient care and the best possible outcomes. In summary, enterprise customers are working with us to solve their evolving business challenges. We see ample opportunity for increased application of our solutions in our existing and new verticals. With that, I'll hand the call back to Mike. Michael A. Steele - Zebra Technologies Corp.: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session. And our first question comes from Jim Ricchiuti of Needham & Co. Please go ahead. Jim Ricchiuti - Needham & Company, LLC: Thank you. Good morning. I was wondering – I have a question on the transportation and logistics and manufacturing markets. What I'm wondering is whether the strength you're seeing in these markets is the result of new capacity additions or increased investments going into existing infrastructure and facilities. And you may not have that clear a pipeline into that, but I'm just wondering if that's what you might be seeing in those markets that's driving the strength. Anders Gustafsson - Zebra Technologies Corp.: Yeah. Thank you. I'd say, first, our solutions are foundational to our customers executing on their strategies and digitizing their businesses across all our verticals. Across all the markets we serve, we help them increase workflow efficiency, provide real-time guidance to frontline employees and enhance customer or patient experiences. And we deliver all of this through our specialized partner ecosystem. So, specifically, for the transportation and logistics and manufacturing markets, I'd say, first, with T&L, there's some strong secular growth trends that are in play there. E-commerce and the on-demand economy are driving a lot of investments by T&L companies. Historically, they've delivered many – say, many boxes to a few corporate enterprise customers. Today, it tends to be much more – a few boxes to many consumers. So, it puts a lot of strain on their supply chain and that's translating into additional investments and business for us. So, our Android portfolio, our wearables, our printing, particularly mobile printing, are all seeing accelerated growth rates from the T&L space. And we see some of our newer solutions, like SmartPack and Location Solutions, demonstrate the thought leadership within the T&L industry. So, it helps also provide a bigger umbrella from how we can operate with those customers. And in manufacturing, it's a strong growth vertical, particularly for printing, and we have released a number of new printers over the last several quarters, new tabletop printers and desktop printers, some new mobile printers too for that matter. And they have been very well received in manufacturing. We also see manufacturing as being the highest Windows conversion opportunity, so Windows to Android. They've been so far, I think, the slowest to adopt Android, but we are having a lot of programs and solutions in place to help make that transition as easy for them and help accelerate that. Manufacturing is also the primary vertical for our Location Solutions business. Jim Ricchiuti - Needham & Company, LLC: Got it. My follow-up question, Anders, is on M&A. Just with the successful integration of the Enterprise business and now this announcement with respect to Xplore, I'm wondering if this signals that the company is going to be more active on the acquisition front. And along those lines, what's the deal pipeline look like and maybe some criteria for doing M&A going forward. Thank you. And congratulations on the quarter. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Yeah. Well, we now been – spent last three years aggressively paying down debt and that's giving us a lot of financial flexibility. So, we're now, as we said in our prepared remarks, at the high-end of our targeted net-debt-to-EBITDA range of 2 times to 2.5 times. We are seeing number of good opportunities for us to invest in our business both organically and inorganically. And these opportunities would deliver attractive ROI for our shareholders. I think Xplore is a great example of this. It's the first acquisition we made since 2014. So, it's basically four years. All our investment opportunities, organic or inorganic, have to drive attractive ROI and attractive growth rates for us, both on the top and bottom lines. We always start by looking at the highest risk-adjusted returns for shareholders. So, we consider all options when it comes to our capital allocation priorities and investment opportunities that we will be particularly excited about would be things that would help advance us as a solutions provider that would bolster our sense, analyze, and act value propositions, also opportunities to strengthen or augment our position in near adjacencies, which will be – Xplore will be a casing point. So, for us, M&A is a vector of growth, but we will always start with looking at the highest risk-adjusted return for our investors. Jim Ricchiuti - Needham & Company, LLC: Thanks very much. Operator : Our next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, gentlemen. Congratulations on a good quarter. Anders, last quarter, I think you guys offered a little bit commentary that the pipeline into large deals for the rest of the year just wasn't that great. Not that we weren't there, but you just didn't have a great pipeline to it. Did things change over the quarter that the large deal pipeline just seems to grow or you (25:49) have more visibility there? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'll start and then, I'll have Joe Heel help out here also. But, yeah, when we started the year, I think we had limited visibility to larger deals and larger pipelines. That has – we put a lot of emphasis on both driving our run rate business, which has also been growing very nicely over the year here, as well as making sure that we paid attention to larger customers and that we could win new refreshes or new deployments with them. And I'd say over the last three, four months, we've seen a meaningful improvement, the strengthening of the large deal pipeline also. And that's reflected in our Q3 guidance. Joe? Joachim Heel - Zebra Technologies Corp.: Not much to add. I think we have been pleasantly surprised by the ongoing momentum in terms of the conversion of Windows to Android, not only in retail, but as we mentioned earlier also in other segments like T&L. And we have seen an ongoing trend by our customers to make those transitions and the visibility we've gotten into those transitions has given us both very good results in Q2 and the confidence for some of our outlook that we've shared. Keith Housum - Northcoast Research Partners LLC : Great. I appreciate the color. I guess a brief follow-up if I can. R&D went up by about $10 million this quarter. I guess Olivier or Anders, can you just talk about the strategy for R&D going forward? And what does the growth that you are having now, what does that give you the ability to invest in it perhaps you weren't able to invest in before? Olivier Leonetti - Zebra Technologies Corp.: So, let me answer to the OpEx trend in general rather than only R&D, Keith. So, first of all, you're right, we have increased the OpEx year-on-year by about $20 million. We're investing in organic investments and also in high incentive compensation based upon the performance of the business. And when we deploy capital in OpEx specifically, we have three key principles in mind. First, we want to scale OpEx as a proportion of revenue. And as you saw in Q2, we have increased OpEx as a proportion of revenue by 140 basis point year-on-year. We had the same kind of scaling last year. So, principle number one. Principle number two, we want to be prudent in the way we invest and we want to generate, obviously, profitable growth and we have been able to do that nicely over the last two years, Q2 being not an exception. And we also invest in a viable cost, we want to be able to nimble. And maybe, Anders, you have other points to add. Anders Gustafsson - Zebra Technologies Corp.: Yeah. Just briefly, I'd say we have lots of very attractive investment opportunities across all our product portfolios. And we have a productivity program going on to help make sure that we free up as much investment capacity as we can to put that money to use in a most productive way. So, product development and sales and marketing are the three areas that tend to get the most of that, but also some of that we let flow through to shareholders to make sure we have a good balance. But we have lots of good opportunities for investment that will drive growth for 2019 and beyond. Keith Housum - Northcoast Research Partners LLC : Great. Thank you very much. Operator : Our next question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. Just wanted to talk a little bit about the AIT segment. You had very strong organic growth there versus what you've done in previous quarters. You mentioned the benefits from new products, but I was wondering if there are any especially large deals that contributed to that growth and how sustainable that growth may be in the second half. Anders Gustafsson - Zebra Technologies Corp.: Yeah. First, we're driving growth across all our business segments now or product segments now and I'd say our innovative and broad portfolio product solutions is a major differentiator and strong driver for us. Also our deep understanding of the vertical workflows within our customers' operations is helping us be much more of a partner to our customers. And we're excited about all our products here this quarter. We had strong performance across all major product categories. On the printing side, we saw – AIT had particularly strong performance in North America and in Europe. The new portfolio – the new products we have come out with have performed very well and we have a very strong and fresh and differentiated portfolio of solutions today. Things like Link-OS provides an unrivaled manageability of our printers that is very difficult for others to emulate. You can now scrape off data from labels and use that as intelligence – or to drive intelligence, you could say. Our desktop and mobile printers did very well in Q2. We also launched a new card printer in the second quarter, one of our entry-level models, which was performing very well and got very good feedback from customers. Supplies we think of as a very attractive business, but it is an underpenetrated market from Zebra's perspective and we believe we have good opportunities to continue to grow there also. And overall, I'd say our printing and supplies business were the biggest beneficiaries of One Zebra of the combination of the traditional printing business with the enterprise business. And let's see if Joe has anything to add. Joachim Heel - Zebra Technologies Corp.: Well, perhaps only on your specific question around large deals, I would say there isn't a single large deal or a grouping of large deals that has influenced our results in Q2 that we share disproportionately. We did have a number of areas that had very nice growth. For example, the manufacturing in Asia, which is one of our big customers, as Anders mentioned, healthcare where we do have a strong presence with printers and supplies, all have contributed very nicely with growth, but not in any one concentrated deal or group of deals. Jason A. Rodgers - Great Lakes Review : And then, as a follow-up, with debt no longer the priority for cash flow, just looking specifically at share repurchase, should we expect that to at least offset the future dilution? And also, I wanted to get your thoughts on initiating a dividend. Olivier Leonetti - Zebra Technologies Corp.: So, as Anders indicated, we are very excited by the end-markets we are serving and by the competitive position of the company. And our first order of priority is going to be to invest in our business organically or inorganically. And we think that is the best way today to deliver good return for our shareholders. Now, buyback and dividends are not off the table. We will evaluate all our options. But first order of priority is going to be organic and inorganic investment opportunities. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : Our next question comes from Brian Drab of William Blair. Please go ahead. Joe Aiken - William Blair : Thanks. This is actually Joe Aiken on for Brian this morning. I was wondering if you could talk a little bit about the winding down of 3G and how large an impact that could have on the business looking ahead to 2020 or 2021 and beyond and more specifically with the transition away from Windows taking place, won't most devices already be compatible with 4G or LTE by that time? Anders Gustafsson - Zebra Technologies Corp.: Yes. The first, the transition from the Windows to Android, that continues to be a key driver of growth for us. We are approaching 50% market share overall for our mobile computing platform or portfolio and our market share for Android is substantially higher than that. So, that's a driver for our market share increases. We see continued good potential for continued growth in Android. There's still, we estimate, at least 10 million legacy Windows devices out there that remains to be updated or refreshed to Android. And we now see continued expansion of the vertical markets or the use cases where Android is being used. So, started off in retail, transportation logistics is clearly helping now. Healthcare is doing well. And we see Android having a somewhat shorter lifecycle than Microsoft devices. So, that will also be a help. Specifically, for 3G, so for those who aren't as familiar maybe with 3G, that's – as the service providers in North America will start rolling out 5G, they will have to do some frequency reharvesting and the 3G service will be turned down over the next, I can't remember, I think it's 2021 is the end date for when 3G service will disappear. And we have and the industry has a number of 3G-only devices, Wide Area Net devices in service today and those obviously will not work on the 4G network. So, we think there's probably about maybe 3 million devices or so in the market from us and others that would need to be refreshed as part of that upgrade also. Joe Aiken - William Blair : Great. Thank you. And then just a follow-up, can you give any more granularity around the software and service segment, specifically what percent of sale the software account for in that and what was the growth of each during the quarter, if you can? Olivier Leonetti - Zebra Technologies Corp.: Of course. So, services and software represent about 10%, a bit more of the company revenue. And the growth has been in the mid-single digits. We are pleased with the performance of this particular segment. It has been an area of focus for us. The first order of priority was over the last few quarters to raise customer satisfaction and as a result, we in-sourced North America operations. We in-sourced that in the U.S. and we have seen, as a result, as indicated, sales benefiting from that transition. So, we are pleased with the result and we think that this is actually the start of a new trend for us. Anders Gustafsson - Zebra Technologies Corp.: Maybe two things I would add is the segment that you referred to also includes professional services and software. And we see those as critical to the EAI solutions that we're bringing to market and they are enabling those very nicely. Joe Aiken - William Blair : Great. Thanks for the color there. I appreciate you taking my questions. Operator : Our next question comes from Richard Eastman of Baird. Please go ahead. Richard C. Eastman - Robert W. Baird & Co., Inc.: Yes. Good morning. Perhaps, Anders, could you just kind of speak to the second half sales outlook, whether it'd be the third quarter and certainly the implied fourth quarter and full year? I'm curious we're now talking about full-year core growth of 8% to 10%, I think, is how the math works out. Could you just zero us in a little bit on where that increased confidence is driven either by end-market, is there – again, we talked a little bit about large deals in the retail segment, but I'm curious, is there any cyclical uptick – you mentioned manufacturing, but maybe just zero us in a little bit on where the increased confidence is over the second half either by end market or perhaps by geography? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I think, firstly, we are forecasting now 8% to 10% organic growth. We think that's a prudent forecast based on the visibility that we have today. And I'd say the growth we are seeing now is very broad-based. Right? You see in Q2, three out of four regions had solid growth, all our product categories had good growth. So, we expect to see continued growth from our channel and we had good visibility now also into a large deal pipeline that we'll convert, we believe, in the second half of 2018. I would say the drivers for this are similar to what we talked about before on the vertical side – within each vertical market. So, in retail, you have the shift to e-commerce and omni-channel. That's a big investment that I would say pretty much every brick-and-mortar retailer and e-commerce provider is embracing and they are adopting our type of technology to be able to execute on those strategies. We also are seeing some of the newer technologies around RFID or smart infrastructures like SmartLens to help drive growth there. And similarly in healthcare, the continued efforts to digitize healthcare, so going from having a manila folder with hand-scribbled notes to electronic medical records, where you can now type patient data directly in real-time, say, to – from reading something about a customer, client or that – into those records. And the value proposition in healthcare is very compelling for us around stronger care, better care, but also more – better efficiencies which is our normal value proposition. We talked earlier about transportation and logistics with some strong secular trends supporting growth around e-commerce and on-demand economy. And manufacturing similarly is a big opportunity for us as they've been the slowest so far to convert into Android. So, we see growth across all the verticals, all the products and, graphically, we continue to see all regions expecting to grow in the second half. Asia Pac, we talked quite a bit about in the prior year. We put a lot of emphasis on Asia Pac and Asia Pac is now delivering very strong growth and I would expect Asia to be the fastest-growing market for us for the foreseeable future. Richard C. Eastman - Robert W. Baird & Co., Inc.: Okay. Joachim Heel - Zebra Technologies Corp.: Let me give you two other data points underpinning our confidence for the second half. One is we look very carefully at a business that we transact in small sizes, what we call run rate business, and we have seen a good and steady growth of that run rate business in Q2 and we see that continuing. That's quite predictable into the second half. So, that underpins our confidence. And the second is we've talked about visibility to large deals. And we were, of course, particularly prudent about our second half, because, as you remember, last year in the second half, we did have a good number of such large deals and we wanted to make sure that we can repeat that. And we do have good visibility to large deals in the second half. So, those two data points, in particular, would underpin our confidence. Richard C. Eastman - Robert W. Baird & Co., Inc.: Great. And then, just as a follow-up question, Anders, should we be concerned or thinking about any tariff-related issues on Zebra, whether it'd be on the cost side or just on the demand side? Anything to think about there? Anders Gustafsson - Zebra Technologies Corp.: I'll let Olivier start. Olivier Leonetti - Zebra Technologies Corp.: Yeah. So, this is a dynamic environment and we don't know what would be ultimately enacted and it would be premature to speculate on the call. The tariffs, which have been enacted to-date, the minimal impact on the company, they're included in our guide. And, going forward, we are looking at all options today and our objective will be to minimize the impact of those tariffs on the P&L of the company. And we have a flexible supply chain, which will allow us to achieve that over time. Maybe, Anders, you have additional comments? Anders Gustafsson - Zebra Technologies Corp.: Yeah. Maybe a couple of comments on the demand side there. So, we certainly haven't seen or heard it from customers today that they are concerned about tariff from the demand side. The one mitigating factor for us will be also that we tend to be a smaller part of a large network or a large rollout. So, even if there were to be some impact, modest impact on our solutions, it would not necessarily put the ROI at risk for our customers in a bigger rollout. Richard C. Eastman - Robert W. Baird & Co., Inc.: Okay. Okay. Very good. Well, thank you. Thank you for your time. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : Our next question comes from James Faucette of Morgan Stanley. Please go ahead. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. I wanted to ask just in terms of your investment, et cetera, should we expect that the impact will be entirely to OpEx as you continue to invest in the business or should we expect that there may be some gross margin impact either as you secure footprint with new big customers or as you introduce new products? Anders Gustafsson - Zebra Technologies Corp.: Do you want? Olivier Leonetti - Zebra Technologies Corp.: Yeah. We have outsourced our supply chain. So, most of the investments we made would be in the OpEx category. But again, we expect, as we have demonstrated, to be able to scale OpEx as a proportion of revenue, James, and the company as the team has done a good job on that particular dimension. So, mainly in OpEx. Anders Gustafsson - Zebra Technologies Corp.: But when we look at where we're making the investments and some of the investments start to show up in OpEx, but we are investing in building capabilities and other ways of reducing the cost of goods sold in our products to make sure that our gross margin can hold up or increase over time. James E. Faucette - Morgan Stanley & Co. LLC: Got it. And then, my other question just related – was related to debt. Obviously, you've done a lot of refinancing there. But given the changing interest rate environment and just what your debt levels are coming down to, is there any incremental that can be done on debt refinancing to further bring down interest rate expense? Thanks. Olivier Leonetti - Zebra Technologies Corp.: We are looking at all opportunities and we are surprised ourselves to keep finding opportunities. We believe we have some additional levers indeed to reduce the debt and would probably deploy those initial odd (45:37) ideas in the coming two to three quarters. But we think we still have opportunities, James. James E. Faucette - Morgan Stanley & Co. LLC: Thank you very much. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Operator : And our next question comes from Paul Coster of JPMorgan. Please go ahead. Paul Coster - JPMorgan Securities LLC : Yeah. Thanks for taking my questions. First up, Anders, I'm wondering if you can hazard a guess of what you think the long-term growth rate is through the cycle now. I mean, what of this is cyclical versus secular? Anders Gustafsson - Zebra Technologies Corp.: Yeah. We are always challenging ourselves to think about how can we maximize profitable growth and the 4% to 5% growth target that we've talked about historically, we think is still – is not aspirational and that does not include any acquisitions. So, that will be only on organic growth. And, hopefully, by now, we've proven to everyone that we can execute and that we have over achieved this target since we concluded the acquisition of the Enterprise business back in 2014. And at this stage, I think we have a very strong competitive position. It's a very diversified business and we have many levers that we can pull to achieve sustainable growth, both in top line and bottom line. We see our core as still having great growth opportunities or near adjacencies and also some of the newer solutions that we have around our Enterprise Asset Intelligence vision. And we are making solid organic investments to drive profitable growth for the business both for 2019 and beyond. So, we feel good about where we are. Paul Coster - JPMorgan Securities LLC : So, Anders, the only thing I'd like to ask about is if you look at the slide 13 of your presentation, enabling enterprise visibility and the strategic objectives here in the four verticals, in every picture there's a human being or a human hand. But as you know, some of the fastest growth we're seeing where the highest multiples being awarded are in machine vision, robotics, where there's no human being involved necessarily. Can you talk to us about those adjacencies? Is that something that you may pursue or whether you are ultimately tied to the human hand essentially here as part of your strategy? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'll start giving you a little bit of a sense of our EAI strategy and then how that plays into automation. But, first, we continue to be very excited about our EAI vision and where we think that can take us and the growth opportunities we can see there. It resonates very well today with our customers and our employees and it's very much integral to everything we do in the company. Our sense, analyze, and act framework is a great way for us to think about this that helps drive real-time guidance at the edge of the enterprise for our customers. We help our customers digitize their businesses through a variety of way or such (48:47) – Link-OS on the printing side, Location Solutions, our various Smartx type of solutions. And it also helps us – helps position Zebra as a thought leader. We had a great win last week actually with an important customer, competitive takeaway, where I think the thought-leader status that we had was a big part of why we won that business. They thought of us as somebody who could help them beyond just the RFQ that was out, but more deliver innovative solutions to them over the next several years. So, overall, with EAI, we're very pleased with progress and it gives us a number of attractive horizons for growth. If you then move into more the automation or intelligent automation as we call it, we think of that as a big net opportunity for Zebra. It's kind of a natural extension to our EAI strategy. We leverage the same kind of critical capabilities for automation as we do for EAI. And when we look at the – we see opportunities to help automate basically each of the steps, the sense, analyze, and act steps, that we have, right? And when people hear automation first, I think many people's minds go to robotics. I think that's one way of delivering that automation, but a lot of it is around how to automate the data capture, the analytics and how to dispatch that action to the right person and that might be a person or a robot of some sort, right? So, what we do is we help solve our customers' problems and we do that by leveraging how to make humans more efficient and effective. We leverage robots where appropriately and we have smart infrastructures that provide even higher level of, say, automation. So, I think of automation again as a continuum. You can possibly think of a specific use case like inventory or replenishment in a retail store. Historically, it started with a human going out and counting whatever was on the shelves and having a clipboard to write down what was there. Then, with barcodes, you could start automating and making those humans more productive by scanning that barcode. Then, you can see with introducing robotics that you can have a robot that can go up and down the aisle and be able to read the labels on the shelf and see also how many units of something is on the shelf. They can see if there's any gaps and they can take action on those things. Or we have drones as another kind of robotic activity where we've seen system integrators take our – four of our long-range scanners to put on a location solution tag to enable to guide and control the drone and basically control it from one of our tablets. So, we're very much involved also on the robotic automation side, but we think maybe that the smart infrastructure is the more enabling, the bigger opportunity for automation. If you look at SmartLens, SmartPack, SmartFreight, all of these things where you have a system that is situationally aware, can know in real time exactly what's on the shelves, it can automate that data capture, it can automate the analytics of being able to determine that you're running low on a certain piece of merchandise and you can automatically send an action to a person or to a, say, robot to replenish that good. So, for us, I see it as a big net opportunity and we're looking to see how we can kind of participate across that continuum of both augmenting humans to be more productive, but also taking advantage of smart infrastructures and other tools that can deliver those improvements. Does that answer your question? Paul Coster - JPMorgan Securities LLC : Yeah. It does. So, I mean in the future, it need not have a human being in the picture is the way I inferred that. And so, there's nothing out of scope. All right. Got it. Thank you. Anders Gustafsson - Zebra Technologies Corp.: Yeah. Yeah. Operator : This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson - Zebra Technologies Corp.: Thank you. As we wrap up, I want to thank the Zebra team and our partners for another quarter of strong growth and strong results. And we look forward to welcoming the Xplore team once we close the transaction. So, have a great day, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,018
| 4
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2018Q4
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2018Q3
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2018-11-06
| 8.967
| 9.54
| 10.698
| 11.142
| null | 14.82
| 15.5
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Executives: Michael A. Steele - Zebra Technologies Corp. Anders Gustafsson - Zebra Technologies Corp. Olivier Leonetti - Zebra Technologies Corp. Joachim Heel - Zebra Technologies Corp. Analysts: James Ricchiuti - Needham & Co. LLC Jason A. Rodgers - Great Lakes Review Brian P. Drab - William Blair & Co. LLC Jeffrey Ted Kessler - Imperial Capital LLC Keith Housum - Northcoast Research Partners LLC Paul J. Chung - JPMorgan Securities LLC Operator : Good day, and welcome to the Third Quarter 2018 Zebra Technologies Earnings Release Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Michael A. Steele - Zebra Technologies Corp.: Good morning, and thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our third quarter highlights. Olivier will then provide more detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Xplore Technologies business. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I'll turn the call over to Anders. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered exceptional third quarter results with strong performance across the business, resulting in record sales and profits. Sales, EBITDA margin and earnings per share all exceeded our outlook. As you can see on slide 4, we reported net sales growth of nearly 17% or 15% on an organic basis; an adjusted EBITDA margin of 21.1%, a 190 basis point year-over-year improvement; non-GAAP diluted EPS of $2.88, a 54% increase from the prior year; and $194 million of cash flow from operations. We achieved strong, broad-based growth across the business, including double-digit sales growth in North America, EMEA, Asia-Pacific as well as all of our key vertical markets. We grew each of our major product and services categories including mobile computing, data capture, our specialty printing portfolio, supplies and support services. Demand continues to be strong from our direct customer relationships and through the channel. Additionally, in the third quarter, we closed on the acquisition of Xplore Technologies, a leading enterprise-grade tablet manufacturer. This acquisition positions us as the leading provider of enterprise tablet solutions, an underpenetrated and relatively fast-growing category for Zebra. We have been significantly expanding profit margins while at the same time investing in our employees and initiatives to drive sustainable growth. Our leading portfolio of solutions, strong order backlog and pipeline of opportunities support a strong finish to the year and provide solid momentum into 2019. With that, I will now turn the call over to Olivier to review our financial results and to discuss our 2018 outlook. Olivier Leonetti - Zebra Technologies Corp.: Thank you, Anders. Let us begin with a walk through the P&L. As you can see on slide 6, net sales grew 16.7% in the third quarter, which translated to 15.1% on an organic basis before the impacts of currencies and acquisitions. We saw solid results in each of our reporting segments across all regions and the primary vertical markets that we serve. Enterprise Visibility & Mobility segment sales increased 18.8%, led by especially strong demand in mobile computing. Asset Intelligence & Tracking segment sales increased 8.1%, driven by solid growth in printing solutions. Turning to our regions. Sales growth in North America was 18%, driven by outperformance in our mobile computing, data capture and printing categories. We saw particular strength in retail and e-commerce, as well as transportation and logistics. EMEA sales increased 10% with strength across most geographies and all major product categories. We continue to see especially strong demand in retail and e-commerce, transportation and logistics as well as healthcare. Sales in our Asia-Pacific region were up 20% with broad-based strength. Most countries grew double-digits. We saw exceptional strength in India and Australia, and our China business has recovered from weaknesses earlier this year. Latin America sales increased 6%. We saw particular strength in printing solutions. All sub-regions grew with the exception of Brazil due to election-related uncertainty. Adjusted gross profit increased $76 million or 18%. Adjusted gross margin increased 40 basis points, primarily driven by continued improvement in our go-to-market execution, favorable business mix shift in the AIT segment and favorable foreign currency exchange impacts. These factors were partially offset by a higher volume of relatively lower margin, large orders. Adjusted operating expenses increased $27 million from the prior-year period, primarily reflecting growth in the business, higher incentive compensation expense due to improved business performance and continued investment in growth and productivity initiatives. We improved adjusted operating expense leverage by 160 basis points as compared to Q3 last year. Third quarter 2018 adjusted EBITDA margin was 21.1%, a 190 basis point increase from the prior-year period. This was driven by operating expense leverage and higher gross margin. In addition to EBITDA margin expansion, a decreased tax rate and lower interest cost from our debt restructurings drove non-GAAP earnings per diluted share to $2.88, a 54% year-over-year increase. Turning now to the balance sheet and cash flow highlights on slide 7. At quarter end, we had $1.9 billion of debt on the balance sheet. In the first nine months of this year, we paid down $346 million of debt principal, supported by strong free cash flow of $412 million. The $238 million increase in free cash flow as compared to the first nine months of 2017 was primarily driven by increased operating profitability as well as less acquisition and integration costs. Slide 8 shows our path to financial deleveraging. Continued debt pay-down and strong EBITDA growth enabled us to achieve a 2.2 times net-debt-to-adjusted-EBITDA ratio as of the end of Q3, which is now well within our targeted range of between 2 times and 2.5 times. Let us turn to our outlook on slide 9. We entered the fourth quarter with a solid order backlog and strong end market demand for our leading portfolio of solutions. We expect Q4 2018 net sales growth to be between 7% and 10%, which assumes an approximately 2 percentage point positive impact from the acquisition of Xplore Technologies and a neutral impact from foreign currency translation. Fourth quarter 2018 adjusted EBITDA margin is expected to be approximately 20%, which assumes higher gross margin as compared to the prior year and slightly higher operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $2.80 to $3. Note that this Q4 outlook assumes a modest impact from tariffs that have been enacted to-date on certain products, accessories and components that we source from China. For the full year 2018, we now expect to exceed $575 million of free cash flow. This increased outlook is primarily due to higher EBITDA. You can see other updated full year 2018 modeling assumptions on slide 9. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson - Zebra Technologies Corp.: Thank you, Olivier. We are very pleased with the progress we made in the third quarter, and we are on track for a strong finish to the year. As you see on slide 11, we remain focused on our key priorities to build upon our industry leadership and drive shareholder value. First, we continue to outpace the competition through our innovation, unmatched scale and strong relationships with customers and partners. We saw strong broad-based demand for our products and solutions. Several areas that have been driving solid growth include our family of Android mobile computers and software, mobile voice and data communications applications, tabletop printers and our RFID solutions. We have gained meaningful market share across our business this year, and we continue to invest in the core portfolio to further differentiate our offering. We had a record number of launches across our product and solutions categories in the third quarter, including the next generation of several popular Android mobile computer solutions. We continue to see robust demand from retailers, as we help them to implement their omni-channel shopping and fulfillment strategies. We have also experienced increasing demand from transportation and logistics as well as manufacturing customers, as the Android mobile computer adoption rate accelerates. Second, we are focused on driving growth in attractive markets where we can leverage our competitive advantages. We plan to scale existing categories where we are underpenetrated and operationalize entry into new markets that advance us as a solutions provider. We expect to gain traction in these markets through both organic and inorganic investments. In the third quarter, we acquired Xplore Technologies, which significantly enhances our product lineup and provides a complete enterprise tablet portfolio. Representing our first acquisition in nearly four years, Xplore's offerings serve existing vertical markets for Zebra and provide inroads into new markets, including public safety, government, utilities and oil and gas. Third, we are advancing our Enterprise Asset Intelligence vision to enable every frontline asset and worker to be visible, connected and optimally utilized. We are doing this by leveraging our deep knowledge of workflows and capitalizing on key technology megatrends, such as cloud computing, mobility and the proliferation of smart devices. Our Workforce Connect software application is one example of bringing EAI to life. I will elaborate more on this solution in a minute. Lastly, we have enhanced Zebra's financial strength and flexibility by increasing cash flow and optimizing our capital structure. As Olivier mentioned, we are well within our targeted debt leverage range, and we have increased our expectation for free cash flow to record levels. Now, turning to slide 12. Zebra provides a digital view of the entire enterprise. Our products and smart infrastructures sends information about assets, products and processes. The information including status, location and condition is then analyzed in real-time to determine the best possible operational action. The result is reduced friction in workflows, improved productivity and greater insight into business operations. Our approach focuses on actions and outcomes that can be optimized by knowing and analyzing what's happening on a real-time basis, adding a performance edge to the frontline. Savanna, our data intelligence platform, is an essential component of our overall offering. This platform powers the intelligence behind our cloud-based data-driven solutions. We are investing in our capabilities in this area and collaborating with an expanded number of partners. We are capturing increasing amounts of data at the edge of our customers' operations, and we intend to help them maximize the value of this critical information. We help businesses across many industries to digitize their operations and transform their workflows to stay relevant and compete effectively in today's marketplace. We create smart data-powered environments for our customers that reflect reality better than traditional systems of record. Slide 13 highlights the primary vertical markets that we serve; manufacturing, healthcare, transportation and logistics as well as retail and e-commerce, which all grew double-digits in Q3. Our intimate knowledge of operational workflows in each of these verticals is the key reason enterprise customers seek our help with end-to-end solutions. Across verticals, use cases are evolving to address increasing demands. In manufacturing, our customers need to know where the equipment, materials and people are in real-time across their supply chain. As a proof point, in the automotive industry, we have been implementing RFID and other locationing solutions that have streamlined plant floor workflows, reducing manual tasks and increasing productivity. In healthcare, our solutions allow care providers to monitor patient conditions while being mobile. Immediate communication among team members is vital for optimum patient care. A medical center in the New England area chose Zebra as their partner to drive their patient safety initiative. Our workflow solution enabled them to comply with regulations and reduce medication dosage scanning errors by 80%. We are also expanding use cases by driving increased clinical collaboration and optimizing workflows. Labor is the most significant operating cost in hospitals, and healthcare organizations are working with us to explore more effective ways to manage their limited resources while improving patient care. In the transportation and logistics business, we are well known for track and trace and proof-of-delivery use cases. Our offerings have been evolving to provide real-time visibility of assets at every point in the supply chain and implementing solutions that translate the real-time information into immediate actions that maximize effectiveness. Transportation and logistics providers are challenged to find enough workers to meet the increasing demands on their business. A key factor includes the $2 trillion of e-commerce business that continues to grow double-digits and drive small parcel delivery orders. We have been launching a number of innovative pilots that address this challenge through product and software solutions that optimize cargo loading and routing activities. In retail, our solutions have been historically used to enhance productivity such as inventory management. More recently, we have been driving transformative solutions to address increasingly complex challenges including omni-channel fulfillment models, sales floor effectiveness and elevating the overall in-store experience. Billions of dollars are lost due to missed execution at the point of sale due to inaccurate inventory and other related factors. Our solutions can increase real-time inventory accuracy to nearly 100%, providing meaningful sales uplift and significantly reduced shrinkage. We are particularly pleased by a recent win with a large global retailer, which fulfills their objective of consolidating their mobile business applications, voice, and various employee communications. We are providing a streamlined solution which includes rolling out our TC51 enterprise mobile computers across their store base over the next several months. Our mobile computers are replacing consumer-grade phones and devices, an encouraging trend that we have seen over the past few years. This solution also includes our Workforce Connect software application to enable this retailer to marry all of their voice and data communications onto one device. Store associates will now be empowered to perform multiple tasks seamlessly. In summary, we are helping enterprise customers to solve their increasingly complex business workflow challenges. We partner with our customers to enable their strategy, utilizing the most effective solutions with the highest ROI. With that, I'll hand the call back to Mike. Michael A. Steele - Zebra Technologies Corp.: Thank you, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : Our first question comes from Jim Ricchiuti with Needham & Company. Please go ahead. James Ricchiuti - Needham & Co. LLC: Thank you. Good morning. Two questions. One, a little bit more long term in nature, we're seeing increasingly articles about cashier-less stores, increased automation in retail as well as logistics. And I'm just wondering if you could talk about the conversations you might be having with some of your retailers and potentially logistics customers as you think about some of the newer products and when we might see more meaningful contributions from these and how they tie into their plans? Anders Gustafsson - Zebra Technologies Corp.: Yeah. First, when people hear automation, the – their minds tend to go to kind of robotics. But when we think about automation, we kind of define it as intelligent automation and that's automation that automates the data capture, the analysis of the data, the decision or action part of it. So, it's a little bit more broader, more intelligent focus on it. So, for us, it's a kind of continuum of making the workers more productive, but moving all the way up to using robots or smart infrastructures to deliver kind of those insights or execute on those. But intelligent automation for us is a big net opportunity. It is a natural extension of our EAI strategy, and we have – it leverages the same critical capabilities as EAI, and we see a good number of opportunities in each of the, kind of, the segments; of sense, analyze, act, the different stages there. But we help our customers solve business problems, and we do that with making humans more productive, using robots or having smart infrastructures that can automate different tasks for them. So, it's a continuum for us. And you look at some of our newer solutions like SmartLens. It is a smart infrastructure, we call it, right. Or I'll start with historically how retailers have taken inventory and execute on that workflow. They started out going out just manually count what's on the shelves, then they used mobile computers with reading barcodes and adding up the items, kind of automatically but manually then telling somebody else to go and replenish it. Then, with RFID, you can do it somewhat more automated. But with SmartLens, you can now totally automate that workflow and in real-time know at all times what merchandise you have on the shelves. And when it reaches a certain threshold, you automatically generate – the system automatically generates a purchase order or a work order to replenish that on the shelf, and that can be done by a human or by a robot. So, this is very much an automated activity, and that can also be a part of a frictionless checkout store. I don't think there's one technology that can solve all those use cases. Cameras can do a lot of things, but cameras aren't going to be the best way of telling what – a pair of jeans from another pair of jeans, different sizes and so forth. So, we see that we have a lot of different type of solutions to help to drive that automation. And net-net, we see it as a big opportunity for Zebra and it's kind of the sweet spot for EAI, and we are quite excited about what we do there. James Ricchiuti - Needham & Co. LLC: And is this an opportunity that you see really beginning to contribute incremental revenues either late fiscal – late 2019 or is it something looking out to calendar 2020? Anders Gustafsson - Zebra Technologies Corp.: So, we are getting some revenue from this today but it's off a smaller base, so good growth but off a smaller base. So, we expect that to continue to grow nicely. I'm not going to try to predict kind of when the knee in the curve will occur. But we do see that as something that will contribute more and more to our growth as we go along. James Ricchiuti - Needham & Co. LLC: Thanks very much. Operator : And our next question comes from Jason Rodgers with Great Lakes Review. Please go ahead. Jason A. Rodgers - Great Lakes Review : Yes. Obviously, some very strong growth, especially in the EVM segment. Wondering if you could talk about the impact of large mobile computing. Are you expecting those to play out in the fourth quarter and going into next year? Anders Gustafsson - Zebra Technologies Corp.: Yeah. We had – across all our product segments, we have very broad-based strength across products, across regions, across our vertical markets. And so, we're clearly very pleased with the performance we had in Q3. Mobile computing was particularly strong this quarter. And I think we're also executing well across the entire value chain, which is driving both the revenue growth as well as some of the margin expansions that we're seeing. So, specifically for mobile computing, there was – had an exceptional quarter quite frankly, I think, in mobile computing, double-digit growth in all regions, strong performance in both the channel and in our direct sales activities. We're seeing some new trends now that – and our Android devices are not just having new deployments, but we're starting to replace some of our original first implementations of Android devices back in 2014. We're also seeing a trend that many of our customers are starting to consolidate a number of applications and devices onto our mobile computers. So, you can take – in retail, somebody would have a mobile computer that would have a, say, Wi-Fi cordless phone and other devices like that, and they are trying to put most of those onto one single device to get less weight on the person, but also give greater (00:27:14) effectiveness and efficiencies. So, there's a lot of new good ways of – that we see driving growth for us here. I think the depth and breadth of our portfolio is a definite competitive advantage for us, and we have invested materially and also innovating on top of the device. So, Mobility DNA is a big differentiator. It's a lot of tools and utilities that makes it easier to deploy and manage devices. OVS gives unprecedented visibility and manageability of the devices also. And then, lastly, LifeGuard, our cybersecurity service that – where we can patch devices through the life of the device. But clearly, the Android transition is the key for our mobile computing growth here. We have well over 50% market share for Android, and we are approaching 50% for our overall mobile computing business, too. But we see continued strong potential for growth in our Android business. There are still about 10 million legacy Windows devices in the market that are waiting to be upgraded. We are starting to see good traction beyond retail, transportation, logistics, manufacturing are accelerating. Healthcare is doing a lot of Android devices also. Another benefit with Android is that the lifecycle is somewhat shorter than the old Windows devices. There's more innovation going on in and around Android that offers new value for customers that they see sufficiently – see as sufficiently valuable for them to kind of look at refreshing and upgrading their devices. And if you look out a little bit further, in 2021, North America will turn down the 3G service. So, if there's any field mobility applications leveraging 3G, they will have to upgrade at that point to 4G or 5G as it might be (00:29:14) so – but overall, we see a lot of reasons to be excited about the Android business. Jason A. Rodgers - Great Lakes Review : Thank you for the detail there. And just as a follow-up, looking at the long-term sales growth targets that you laid out, would you expect to achieve those next year despite the difficult comps you'll have in EVM? Anders Gustafsson - Zebra Technologies Corp.: So, we are always challenging ourselves to maximize our profitable growth. We've been making a lot of investments – organic investments in driving profitable growth for – not just for 2018, but for 2019 and beyond. We won't be providing any outlook for 2019 today. But we have a strong conviction in our growth opportunities and that's not changing. We feel we have a very strong competitive position, a very diversified business and we have many levers to pull in order to drive growth including EI and automation that we talked about earlier. Jason A. Rodgers - Great Lakes Review : Thank you. Operator : And our next question comes from Brian Drab with William Blair. Please go ahead. Brian P. Drab - William Blair & Co. LLC: Hi. Good morning. Congrats on the great results. Just following on that Android question, did – I'm not sure (00:30:34) answer if you mentioned where you think you are in terms of – talk about the 15 million devices and maybe there are about 10 million left in a recent comment you made. Where – can you quantify where we are in that transition from Windows to Android? Anders Gustafsson - Zebra Technologies Corp.: Yeah. I'll start, and I'll let Joe comment on it here also. We – I think when we first started talking about this, we mentioned we estimated there was about 15 million Windows devices in the market. I think earlier I said we estimated to be about 10 million left today to be upgraded. And as we upgrade old Windows devices, there are still new Windows devices being deployed. So, the pool of legacy Windows devices is still pretty substantial. So, we believe we still have a lot of runway to pursue. And also, some of that I think as I talked about of somewhat shorter lifecycle and a consolidation of new applications onto the devices are driving new use cases for Android. Joachim Heel - Zebra Technologies Corp.: Yeah. This is Joe Heel. I might add that we're thinking about the Android transition now as multiple waves where we are in the retail which was clearly the leading edge of the adoption is most of the large retailers have now adopted Android. But we're seeing T&L and manufacturing warehousing spaces in particular just ramping up, which also coincides with some of the product launches that we are putting into the market. The second thing is that the adoption in T&L and manufacturing will likely have a longer tail than we're seeing in retail, as there are bigger transitions that need to occur in order for those verticals to adopt. For example, applications that need to be rewritten. And then, third, what's adding I think to our excitement is that we are seeing refreshes already of the original retail adoption. So, if you overlay all of those three adoption curves, you can – you'll get a more differentiated picture of where we are and in particular of the potential still ahead. Brian P. Drab - William Blair & Co. LLC: Okay. Thanks. That's really helpful. And then, second question, just on tariffs, can you just go through where your manufacturing base is, Jabil (00:33:13) and otherwise and how – what percentage of the incoming components that are made in China actually fall on a list on one of these tariff lists? And maybe just give us a little more granularity about why you're not seeing that much impact from tariffs. Anders Gustafsson - Zebra Technologies Corp.: Yeah. The tariff situation is clearly very dynamic and fluid situation today. Zebra like – like many other companies, we import a substantial number of products from China. But only a fraction of our products are impacted today. So, that limits it to certain data capture products and some other accessories. So, for 2018, the impact is quite modest. For January 1 of next year, when the tariffs go up to 25% on some parts, we have a taskforce or working group that is cross-functional working group within Zebra that's working with a lot of our supply chain partners to basically assess all possible actions that we can take to mitigate the impact of tariffs. So, that would include things like changing supply chains to outside of China, setting them up somewhere outside of China, bringing in new sources of supply, changing product specs to be able to avoid certain things. Also, we're considering doing some price adjustments to mitigate some of that impact. Some of those actions will be immediate or have immediate benefit and some of them will take a little bit longer like moving a supply chain so – but we feel we're all over this and have a good plan for how to attack it. Brian P. Drab - William Blair & Co. LLC: Okay. Thank you very much. Operator : And our next question comes from Jeff Kessler with Imperial Capital. Please go ahead. Jeffrey Ted Kessler - Imperial Capital LLC : Thank you. I know you're not going to go into 2019 numbers. But what I'm interested in is, with the momentum that you have right now in certain – not just in certain product categories, but in certain verticals that have come to the floor in the last couple of quarters, I'm wondering what you see for 2019 as perhaps, number one, the driving horizontal markets that you'll be – that you see and the driving vertical markets that you see that might be a little bit different than in 2018? Anders Gustafsson - Zebra Technologies Corp.: Jeff, what will be different in 2019 versus 2018? Jeffrey Ted Kessler - Imperial Capital LLC : Yes. Both in terms of vertical markets but also in terms of some of the horizontal capabilities that you have out there, too. Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, starting on the horizontals, thinking of that more as the product side, we obviously now have Xplore Technologies as part of our lineup. I think that's a great addition to our portfolio. It fills out the, say, more limited tablet portfolio we had before and it opens up new opportunities and new verticals that we didn't really serve very well before, like government and public safety, oil and gas and so forth. Generally, we have a very strong portfolio across our main product categories. So, we feel that our portfolio is probably as strong as it has been for a long time, and we continue to release a lot of new products. So, we feel we have a good position from that. And our, say, EAI type new solutions, our new intelligent edge solutions are also starting to ramp and we are bringing more of those to market. So, from a horizontal perspective, I think we're well-placed. There's always more things we could have. But I think this gives us a good toolbox to go out and talk to our customers about the ways we can help them improve their businesses. From a vertical perspective, I think the – maybe there's a change from 2018 to 2019. It will be how we see manufacturing maybe particularly stepping up and becoming a faster growing vertical. The last couple of quarters manufacturing has been growing faster than it had for the prior – in the prior year or so. It's the – it had been a laggard in the Android transition, but it's one of the larger opportunities for converting old Windows devices now to Android. We have launched several new products that are particularly aimed at manufacturing like some of our new tabletop printers and they've been very well received. So, manufacturing is doing very well. T&L, I think, will continue to perform the way it has over the last couple of years. It's a very large industry, and some of the leading players have adopted Android already. But we see others coming onboard in 2019 to roll out Android, and we see expansion from our traditional handheld devices to more wearables. Printing is also accelerating growth there, and we have a lot of our new intelligent edge type solutions in T&L. So, it positions us nicely as a thought leader to be going there and to help in some of those other newer automated workflows. And maybe, last, I talked about healthcare which I expect to be the fastest growing vertical for us over the longer term. The – it's still a relatively underpenetrated vertical for us. Technology has not been as well adopted, generally speaking. But it is a very attractive market for us. The electronic health records is the catalyst for this. But mobility and connectivity are becoming more bigger catalysts for investing in technology there. Our value proposition across all our verticals is – tends to focus on driving efficiencies. But in healthcare, the – our ability to help improve the quality of care is a big deal for us. And from a geographic perspective, healthcare started off very much in the U.S. But we see – we're seeing it grow in other parts of the world, UK, China, Australia, Middle East and so forth. And we've also invested in a number of purpose-built devices for healthcare like our TC51 for healthcare. We have a DS8100 healthcare scanner. We have printers for healthcare. So, we have a strong portfolio there also. Jeffrey Ted Kessler - Imperial Capital LLC : Okay. Thank you. My second question is a little more subtle but it's how – essentially, it's focused on how you bring in more product in a vertical market from your lead product. I'm assuming that, in different vertical markets, you have a lead product that has gotten you in there. Which vertical markets have benefited the most from the fact that you have either a 4G opportunity for them or you have an Android opportunity for them or you have for that matter a – just something that cuts down on inventory mismanagement that brings in much more business from the rest of the vertical? Anders Gustafsson - Zebra Technologies Corp.: Yeah. We put a lot of emphasis around the better together story after we combined with the Enterprise business. So, how can we make sure that our printers, mobile computers and scanners kind of work better together? We're not trying to make them work worse with anybody else's, but we want them to work better with our solutions. And we've worked also very hard with our resellers to make sure that they focus on selling the full portfolio. And the resellers that do that, they are growing substantially faster than resellers that are focusing more on a single type of product. So, I'll let Joe fill in maybe a little bit more on specific examples within the verticals. But this is an area that we put a lot of emphasis around to figure out how do we maximize this. Jeffrey Ted Kessler - Imperial Capital LLC : That would be great. Joachim Heel - Zebra Technologies Corp.: Yeah. Let me give you some other – from the beginning, after we completed the acquisition of the Enterprise Solutions business, cross-selling has been a big focus for us, right? So, when you talk about a lead product, it sometimes differed. In some cases, it may have been a mobile computer that we were strong in and we brought in printing. And in some cases, it was printing. But let me give you some more specific examples. Healthcare is a very good one. Anders mentioned it already. Our strongest position in healthcare originally was in the printing space, right? We had printers in particular for wristbands and we've really leveraged that substantially into mobile computing. As electronic medical records emerged, we went to those same hospitals and we showed them how they could then use that information that was on the wristband, but also combine with other use cases in order to improve the productivity and deliver better patient care. Another one that's very current, Anders alluded to it earlier, is we have in many retailers positioned our mobile computers as lead products and they've used them for productivity applications, such as inventory management. They're discovering that those same devices with a software upgrade can be used to communicate within the store, an application for which they currently spend money on other products in many cases. And they could actually reduce their operating budgets by having our products take on more of those use cases. So, that gives us an opportunity to augment our presence with software. And a third one that I think we're particularly excited about is, if you look at the solutions areas that we've been looking at. So, take for example RFID in retailers that are deploying RFID. We have a strong presence today with our handheld RFID readers, which are typically a mobile computer combined with a sled (00:43:29) and many of those same retailers are now in the pilots with us looking at the infrastructures like SmartLens, where they could then go beyond what the handheld reader allows them to do and have continuous real-time visibility to their inventory that SmartLens provides. So, there's maybe three examples. Jeffrey Ted Kessler - Imperial Capital LLC : All right. Great. Thank you very much. I appreciate that for additional color. Operator : Your next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum - Northcoast Research Partners LLC : Good morning, guys, and congratulations on another strong quarter. Anders Gustafsson - Zebra Technologies Corp.: Thank you. Keith Housum - Northcoast Research Partners LLC : Just following up on the tariffs really quick as I can, was there any pull-forward of revenue in this quarter and do you anticipate any in the fourth quarter? And then, second to that is what's your end customers – what are they saying in terms of demand in terms of what their impact kind of (00:44:23) from how they're being impacted by tariffs and how can it impact their underlying business and how much that translates to business with you guys? Anders Gustafsson - Zebra Technologies Corp.: Yeah. First, on the pull-forward one, that's certainly an easier question for us to answer. So, there was no pull-forward into Q3, and we're not forecasting any pull-forward into Q4. We manage our – the inventory position with our distributors very carefully. We tend to have them in a relatively narrow band or days of hand of inventory. We don't want them to be sitting on too much inventory. We certainly want them to have too little inventory. And they're all in – within that relatively narrow band of inventory. So, we feel that we've – there's no particularly pre-buying to take advantage of this, and we don't expect that to be the case in Q4 either. With respect to what our end customers are saying and how that might impact us, I think it's fair to say that, so far, they have not really asked too much of this. And it is very much depending I think on what happens after this and we don't want to speculate about any possible list (00:45:36) or anything like that. I think the current tariffs that are in place we would see as having modest impact on the business, and we can largely mitigate that effect. So, we are talking to our customers about what we are doing to help mitigate it. And so far, I think they have been comfortable that we have a good plan for what we're doing to minimize the impact on their business. Keith Housum - Northcoast Research Partners LLC : Okay. Appreciate it. And just for a follow-up and changing gears on to your services and software which I think you guys would say is one of your underpenetrated markets, obviously, hardware has had some exceptional growth over the past year. But is there a place in your head that you believe that software and services will start growing above the hardware growth? And do you expect it to ramp up? Is this a year out, two years out? I guess, the progress that you're seeing on software and services, where do you stand in terms of where you'd be perhaps a year ago? Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, the – we do a lot more software than people probably recognize. And if you look at our engineers, the vast, vast majority of our engineers are software engineers. And if you look at this kind of value that we deliver in a mobile computer or printer or even scanner, it's very largely driven by the software. Look at Link-OS in printing it makes it go (00:46:57) from being a less sophisticated printer to a much more connected, good network citizen in our customers' networks. We have a number of other solutions that are also leveraging much more software. So, if you look at SmartLens, SmartPack, a lot of those types of things, our OVS solution is a pure software solution, we monetize those in a variety of different ways. But it still has often a hardware component to them because they – we often deliver that specialized software with a specialized piece of hardware as a solution. And our customers have been, I think, particularly keen for us to do it that way. But we are always looking at opportunities for us to have more of a pure software revenue stream and move into more of as-a-service type of delivery mechanisms also. Joachim Heel - Zebra Technologies Corp.: Yeah. Maybe the other thing, Keith, to notice, we think of our software very much as a part of a solution. And so, all the solutions that we have been talking about for some time we are in pilot with many of our customers, those have substantial elements of software in them that we will intend to sell as a solution. So, if you look for the growth of those solutions, I think that will be the best indicator of when the software starts to take hold. Keith Housum - Northcoast Research Partners LLC : Yeah. I guess, that's the question is – if I look at the numbers now, it doesn't look like they've really taken hold yet. Is it a quarter or two out, or is this still perhaps a year or two out where we'll start to seeing the software and services line starts really to ramp up? Olivier Leonetti - Zebra Technologies Corp.: Yeah. Keith, you mentioned it. Services and software are bundled together. So, you cannot truly conclude. But what I would say – and this is from a lower base, our software business, when we are able to split it from hardware, is going at a multiple of the hardware growth, but from a lower base. Keith Housum - Northcoast Research Partners LLC : Okay. Thank you. Operator : And our last question today will come from Paul Coster with JPMorgan. Please go ahead. Paul J. Chung - JPMorgan Securities LLC : Hi. Thanks. This is Paul Chung on for Coster. Thanks for taking my questions. So, first off, you exceeded EBITDA margin expectations this quarter and most likely for the year. So, what's your kind of initial view on the pace of expansion in 2019? And what are some puts and takes there? Your integration costs are finally mostly behind you. But do you see kind of more opportunistic costs? Are you kind of comfortable with your OpEx levels here? Olivier Leonetti - Zebra Technologies Corp.: So, as we have indicated before, we believe we have the ability to improve our EBITDA rate. We want to manage rate, but also dollars. So, at some stage in the year, we will increase EBITDA dollar at the expense of rate. But we believe we have the ability to leverage the P&L either on the gross margin line or on the OpEx line, while keep investing in our business as we have done now for a period of time. Paul J. Chung - JPMorgan Securities LLC : Okay. And is there any update regarding your long-term target? Olivier Leonetti - Zebra Technologies Corp.: Not at this stage. As Anders indicated, we feel we have a strong conviction about our business, and we'd come back to you with more detailed numbers for 2019 when we close the quarter in Q4. But we clearly have opportunities to scale and improve. Paul J. Chung - JPMorgan Securities LLC : Right. And then, my other question, now that you've kind of hit your leverage targets, should we expect the Zebra of old, where most of your free cash went to share buybacks. It looks like you may hit north of $600 million in free cash in 2019 by my calcs. Thank you. Olivier Leonetti - Zebra Technologies Corp.: Your calculation is correct. The team has done – the Zebra team has done a great job at managing the company for cash and profitable growth. We will reach the bottom of our leverage target by the end of this year. As you sense from the call and as you sense from the results we have been posting for now a number of quarters, we feel very excited by the end markets we serve and by the competitive position of our company in those markets and we see as a result exciting opportunities either organic or inorganic to invest in our business. We believe we have many opportunities to deliver by investing in our business. We have many opportunities to deliver an attractive return. Share buyback and dividend would be contemplated, and they are not off the table but you sense where our focus is. Paul J. Chung - JPMorgan Securities LLC : Thank you. Appreciate it. Operator : And this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson - Zebra Technologies Corp.: Yeah. So, as we wrap up, I want to thank the Zebra team and our partners for an exceptional quarter. We expect to close the year strong and are well positioned into 2019. So, have a great day, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,019
| 1
|
2019Q1
|
2018Q4
|
2019-02-14
| 10.154
| 10.84
| 11.383
| 11.67
| null | 14.96
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Operator : Good day, and welcome to the Fourth Quarter and Full Year 2018 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Mike Steele : Good morning. Thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our fourth quarter and full-year highlights. Olivier will then provide more detail on the financials and discuss our 2019 outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Xplore Technologies business. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I'll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered exceptional fourth quarter results. We executed well driving strong profitable growth across the business and extended our lead in the market. Sales, EBITDA margin, and earnings per share all exceeded our outlook. As you can see on Slide 4, we are pleased to report net sales growth of nearly 11% or 9% on an organic basis; and adjusted EBITDA margin of 21.1%, a 120-basis point year-over-year improvement; non-GAAP diluted EPS of $3.10, a 33% increase from the prior year; and free cash flow of $309 million. We achieved strong performance across our business, including double digit sales growth in North America, Asia Pacific and Latin America. We grew each of our major product and service categories, including mobile computing, data capture, special printing, supplies and support services. Demand was solid through the channel and from our direct customers. We say particular strength in healthcare, manufacturing, and retail and e-commerce. Our record Q4 results cap an outstanding full-year financial performance of 11% organic sales growth, 20.7% adjusted EBITDA margin, and $721 million of free cash flow. We continue to build on our industry leading offerings by investing in our people, operations, and technology to drive a sustainable growth. We have strong momentum entering 2019, supported by our order backlog and pipeline of opportunities. With that, I will now turn the call over to Olivier, to review our financial results and to discuss our 2019 outlook. Olivier Leonetti : Thank you, Anders. Let us begin with a walk through the P&L. As you can see on Slide 6, net sales grew 10.8% in the fourth quarter, which translated to 9.1% on an organic basis before the impacts of currencies and acquisitions. We saw solid growth in each of our reporting segments and across all regions. Enterprise Visibility & Mobility segment sales increased 11.6%, led by especially strong demand in data capture and mobile computing products. Asset Intelligence & Tracking segment sales increased 4.3%. Turning to our regions. North America sales grew 11%, driven by double-digit growth across our mobile computing, data capture, and printing categories. We saw particular strength in healthcare, retail and e-commerce, and manufacturing. Sales growth to small and mid-sized accounts was exceptional. EMEA sales increased 6% with relative strength in data capture, mobile computing and printing supplies. Sales in our Asia-Pacific region were up 12% with strength across major product and service categories. Our China business grew mid-single digits and most countries grew double-digits. Latin America sales increased 10% as economic and political conditions stabilized. We saw particular strength in printing solutions. All sub-regions grew, including Brazil. Adjusted gross profit increased $72 million or 15%. Adjusted gross margin increased 190 basis points, primarily driven by continued improvement in our go-to-market execution, favorable business mix shift in the EVM segment, and favorable foreign currency exchange impacts. Adjusted operating expenses as a percentage of net sales increased 10 basis points from the prior period reflecting higher incentive compensation expense, due to improved business performance. Fourth quarter 2018, adjusted EBITDA margin was 21.1%, a 120-basis point increase from the prior year period. In addition to EBITDA margin expansion, the decreased tax rate and lower interest cost from our debt restructurings drove non-GAAP earnings per diluted share to $3.10, a 33% year-over-year increase. Turning now to the balance sheet and cash flow highlights on Slide 7. In 2018, we paid down $657 million of debt principal supported by strong free cash flow of $721 million. The $293 million increase in free cash flow as compared to 2017 was primarily driven by increased operating profitability, lower acquisition and integration cost, and exceptional working capital management. We ended this year with $1.6 billion of debt on the balance sheet. Slide 8 shows the path to our 1.8 times net debt to adjusted EBITDA ratio as of year-end. We reduced the leverage ratio by approximately 1.4 terms in the past year leaving us well-position to continue to invest in the business. We have updated our target range for net debt leverage to be between 1.5 times to 2.5 times. This expands the lower end of the range by [indiscernible] to allow for additional flexibility in our capital structure. Let us turn to our outlook on Slide 9. We entered 2019 with a solid order backlog and strong end market demand for our leading portfolio of solutions. We expect Q1 2019 net sales growth to be between 6% and 9%, which assumes an approximately 1.5 to 2 percentage point positive impact from the acquisition of Xplore Technologies and approximately 1 percentage point negative impact from foreign currency changes. We believe Q1 2019 adjusted EBITDA margin would be approximately 21%, which assumes operating expense leverage offset by lower gross margin as compared to especially favorable gross margin in the prior year period. Non-GAAP diluted EPS is expected to be in the range of $2.75 to $2.95. We expect full-year 2019 net sales growth to be between 4% and 7%, which assumes an approximately 1 percentage point positive impact from the acquisition of Xplore and approximately 50 basis point from negative impact from Foreign Currency changes. Full-year 2019 adjusted EBITDA margin is expected to be slightly higher than 21%, an improvement from 2018 as we continue to drive operating leverage in the business. We believe that full-year 2019 free cash flow will exceed $625 million. We expect to drive higher EBITDA than 2018, and unlike 2018, we are assuming that working capital will be a use of cash in 2019. Also note that our 2019 outlook assumes a modest level of tariff on certain products, accessories, and components that we source from China. It’s a freed situation and our teams have been working diligently to address the types that have been enacted to date. You can see other full-year 2019 modeling assumptions on Slide 9. Note that our 2019 outlook does not include any projected results from the acquisition of Temptime Corporation, a recently announced transaction that we expect to complete soon this quarter. Temptime’s annualized sales exceeded $40 million. The acquisition is expected to generate approximately $0.15 to $0.20 of annualized adjusted EPS accretion. Anders will discuss the acquisition in a few moments. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson : Thank you, Olivier. We are very pleased with the progress we made in 2018. Slide 11 shows our key strategic areas of focus. Successful execution of these priorities drives our industrial leadership and value for all stakeholders. First, we continue to drive market share gains through our innovation unmatched scale and strong relationships with customers and partners. We saw exceptionally strong broad-based demand for our products and solutions in 2018. We are capitalizing on technology trends in the industry, including the transition to the android operating system in mobile computing and ongoing transitions in data capture to 2D and RFID. We are also addressing underpenetrated market segments and geographies. We had a record number of launches across our product and solutions categories in 2018. Our mobile computer, data capture, and printing portfolios have never been stronger. This investment will continue to benefit us in 2019 and beyond. Second, we are focused on driving growth in attractive markets where we can leverage our competitive advantages. We plan to scale existing categories where we are underpenetrated and at the new markets that advance us as a solutions provider. We expect to gain traction in these markets through both organic and inorganic investments. This includes highly selective acquisitions that will accelerate our strategy to advance our enterprise asset intelligence vision. We target high growth near adjacencies where we have a right to play seeking businesses with a differentiated value proposition, which can transform work flows. As a proof point, on January 28, we announced our intention to acquire Temptime Corporation. Temptime is the leader in designing and manufacturing a time temperature monitoring portfolio that meets the strict specifications of the largest global health organizations vaccination programs. This acquisition is a great fit and will advance the integration of smart supplies into our enterprise asset intelligence vision as we incorporate these new capabilities. We have the unique ability to scale this technology deeper into the healthcare industry, as well as drive it into other key opportunities such as food safety that can benefit from increased asset visibility. Third, we are advancing our enterprise asset intelligence vision to enable every frontline asset and worker to be visible, connected, and optimally utilized. Our expertise in workflow solutions across our primary vertical markets enables us to continue to strengthen and expand relationships with our customers and partners. I will elaborate further in a minute. Lastly, we have enhanced Zebra’s financial strength and flexibility by increasing cash flow and optimizing our capital structure. Our financial flexibility remains a key priority as we invest in the business to accelerate our traction in high growth adjacent areas. Now turning to Slide 12, Zebra provides a digital view of the entire enterprise to enable enterprise asset intelligence. Our products and smart infrastructures sense information about assets, products, and processes. The information, including status, location, and condition is then analyzed in real time to determine the best possible operational action. The result is reduced friction in work flows, improved productivity, and greater insight into business operations. I like to spend a minute on how hardware, software, and the Cloud are essential to our solutions. Our products are ultra-rugged and reliable with purpose driven designs that are tailor made for the frontline and its work flows. There is no one size fits all solution. Every device specification is designed to maximize productivity and safety for a particular use case. In addition to the hardware, software is a critical differentiator for us. Our products include software that make them easy to integrate and intuitive to manage. We call this our DNA software layer, which is integrated across our mobile computing, data capture, and printing portfolios. Additionally, we have been developing new software applications and tools that improve automated data collection and analysis, maximize device security, and enhance ease of use, all of which are increasingly critical to our enterprise and government customers. The innovation starts with our team, nearly two-thirds of our engineers specialize in software systems and user interface development. Our growing team continually works to enrich our portfolio of smart products and solutions. Another integral part of our solutions ecosystem is Savanna, which is our intelligent edge platform that powers our Cloud-based data driven solutions such as motion works, SmartPack trailer, and work force connect with real time data. We have been collaborating with an increasing number of our independent software vendor partners to accelerate the use of Savannah to deploy new solutions that solve problems for our customers and improve their performance edge. As a thought leader in our industry, we are at the forefront of this opportunity. Just as we have been with other key transitions, including enterprise, Android adoption, Cloud-based printing, RFID, and 2D barcode scanning. We are seeing evidence of our EAI vision as we help businesses across many industries digitize their operations. We are a driving force in advancing key technology megatrends, including Cloud computing, mobility, automation, and the proliferation of smart devices; each of which are critical components to this transformation. Slide 13 highlights the primary vertical markets that we serve, manufacturing, healthcare, transportation of logistics, as well as retail and ecommerce, which all grew double digits in 2018. We are leveraging our strong commitment to innovation and deep industry expertise to deliver innovative end-to-end solutions for customers to compete effectively in an evolving marketplace. In manufacturing, our customers need to know where their equipment, material, and people are in real time across their supply chain. They are looking for trusted partners, who can increase their operational visibility, while reducing cost and complexity. Recently, a global automotive manufacturer purchased a wide variety of our latest generation mobile computers and tablets for their assembly line warehouse and quality control processes. Data security and product life cycle management were the customers other key considerations as they’ve transitioned to an all Android enterprise operating system environment. Our ability to facilitate seamless system integration and guarantee operating system upgrades and security patches for the life of our products or differentiators that helped us win this business. In healthcare, our solutions track essential clinical equipment and enable care providers to monitor patients, while being mobile, which translates into increased patient safety and reduced cost. We recently received our largest healthcare order ever from one of the most prominent healthcare organizations in the world. This customer will be using our purpose-built TC51 mobile computer to consolidate various communications tools to streamline collaboration and provide an improved level of patient care. In the transportation and logistics business, our offerings provide real time visibility of assets at every point in their supply chain, including the loading dock, warehouse, and point of delivery. The increasingly on demand economy and shortage of labor has pressured enterprises to investing in innovative solutions to drive productivity. We recently expanded our relationship with a long-time global customer by implementing a locationing solution that compliments their existing SmartPack installation. The total solution assesses real time aircraft container utilization and facilitates more efficient staging and loading of shipments. In retail and e-commerce, we have been driving transformative solutions to address increasingly complex challenges. Last month, at the National Retail Federation Expo, we showcased 20 innovative solutions that help retailers execute on omnichannel fulfilment, sales floor effectiveness, and elevate the overall in-store experience. Walgreens had a prominent presence at our booth this year as they are in the process of rolling out our ET50 tablets and TC51 mobile computers to all of their U.S. stores. This initiative complements their existing ecosystem of Zebra scanners and printers. And our booth, Walgreens demonstrated how it’s assisted selling and inventory management applications run on Zebra’s products to boost productivity and improve the customer experience, while connecting its associates and customers nationwide. We are seeing a trend at Walgreens and many other retailers to equip all of their associates with mobile tools that empower collaboration and with co-workers and customers. In summary, we are helping enterprise customers to successfully address their increasingly complex business challenges. Now, I’ll hand the call back over to Mike. Mike Steele : Thanks Anders. We’ll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : [Operator Instructions] And our first question comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason Rodgers : Good morning. Wanted to ask a question about the EBITDA margin guidance, you beat last year's guidance by over a point and your initial guidance for this year is actually targeting less margin improvement then you're forecasting a year earlier. So, wonder if you could discuss why that is and factors that could lead to similar outperformance in the margin for 2019? Olivier Leonetti : So, good morning, Jason. So, we are planning indeed to have for the full-year a higher EBITDA margin, slightly higher EBITDA margin, and we’re guiding Q1 at about 21%, you have some mix elements, which could impact one performance in a particular quarter, but as we have demonstrated over now, a number of quarters, we believe we have the ability in the year to leverage OpEx, but also to leverage a gross margin, but you could have an anomaly in one quarter and another. So, nothing specific in terms of trend Jason. Jason Rodgers : And then just looking at the top line. As far as your guidance, you have the first quarter there, but you will be facing increasingly difficult comps as the year progresses. Do you think you can continue at that mid-to-high single-digit organic growth rate as you look past the first quarter? Anders Gustafsson : We feel good about the business. We have been driving profitable growth for a long time now and our solutions have moved from being more viewed as tactical productivity tools by our customers to more enablers of our customer strategies. So, I think we’re moving up in the kind of hierarchy of importance for our customers. We have a strong track record of execution and I think the output outlook is prudent. So, we feel that we are well-positioned for 2019. We entered a year with good momentum. A solid portfolio of products and solutions it’s the most competitive portfolio I think we’ve ever had and we continue to gain share in the markets. So, we feel pretty good about where we are. Olivier Leonetti : And let me give you a bit of additional colors on the year. So, we have obviously a strong Q1 guide. We have more visibility for Q1. We are well within the quarter. We entered the quarter with a solid backlog. And regarding the full-year, we would consider this guide as actually being prudent based upon the visibility we have regarding our business. And an important point Jason, this is not different than another year. And we feel confident about our end markets and our ability to compete. Jason Rodgers : And if I could just squeeze one more in. Just the outlook for the large deals on a mobile computing side and your latest estimate for how many devices are still left in the field that need to convert? Anders Gustafsson : Yes, we still see approximately 10 million legacy android devices to be in the field today waiting to be refreshed and upgraded to android. In the last several years, we have had a strong performance of our larger deals, but if you look at 2018, I’d say we had a balanced portfolio there. We saw good growth from our larger deals, but we also saw good growth from our channel. We saw also good growth from our small and medium businesses now. So, we certainly have many different avenues to pursue in order to drive that growth. Joe any assumptions? Joe Heel : Yes. I would add. Especially in the visibility towards large deals, you are right. We had a substantial number of large deals in particular in the retail space in 2018, but we do in those 10 million legacy devices that are still out there, we see opportunity for continuing momentum in areas such as logistics and warehouse coming up in the next months and year, as well as new used cases that our customers are beginning to realize can be deployed on our devices such as; consolidating multiple technologies they have today onto our device or expanding used cases from the handheld form factor to other form factors like tablets and larger screen. So, we see continued opportunity for large deals Jason. Jason Rodgers : Very good. Thank you. Operator : Our next question comes from Jim Ricchiuti of Needham & Company. Please go ahead. Jim Ricchiuti : Hi, good morning. Thank you. Looking at your R&D spend, the last couple of quarters, and we’re seeing a little bit of a bump up in that area, and I wonder if you could comment on that as it relates to new product development if we're going to be seeing a faster pace in terms of product introductions? Thank you. Olivier Leonetti : Let me take the first part and then Andres and Joe would take the other one. So indeed, we have increased the level of spending in R&D and the composition of the R&D spend is – has changed some. We are investing more if you were to look into the details into also future capabilities. And we believe that this investment has paid off for the company and part of the gaining shares top line performance is a result of this investment. Joe Heel : Yes. I think that we certainly feel that we have made a very productive investments in R&D. Our products portfolio or solution portfolios are the most competitive that have ever been. We launched more new products in 2018 than we’ve done in any other year in the history of the company. So, I think we feel very confident that the investments we made in R&D are delivering a solid ROI. It has been supporting our growth. It’s been supporting our market share gains. Jim Ricchiuti : And my follow-up question just to relates to EMEA, it appears that you’re seeing some moderation in the growth rate there, and I’m wondering is that a case of just tougher comps, tougher comparisons or are you seeing any signs of slowing which some companies have alluded to? Anders Gustafsson : So first, starting a little bit broader, we had strong broad-based strength across all our product segments, regions, vertical markets in Q4. Asia-Pac, North America and Latin America were each double digits in Q4, but all regions, including Europe was up double digits for the full-year. We saw – all major product categories were up. Healthcare, retail, manufacturing, they were all up double digits, and all four vertical markets were up double digits for 2018. So, I think it's very broad-based performance there. In Q4, we continued to execute very well and we’ve – from everything we’ve seen, we believe we continue to extend the lead in the market that we have, and our competitive position is strong and getting, I would say, stronger based on the strength of our portfolio. And end markets were strong, you know, both channel and direct for – on the back of our valuable proposition, which resonates with our customers. Specifically, to Europe, I think we would consider it to be a solid growth. It had moderated a little bit from earlier part of 2018, but it was still good growth, and we see that momentum carrying on into 2019. We saw particular strength in Europe on our scanning portfolio and mobile computing, as well as supplies. And retail continues to be the strongest vertical for us in Europe, and our personal shopping solutions are a big driver for that. Jim Ricchiuti : Thank you. Congratulations on the year. Anders Gustafsson : Thank you. Operator : Our next question comes from Brian Drab of William Blair. Please go ahead. Brian Drab : Hi, good morning. Maybe this will be a waste a question, but I’m just thinking about the 10 million figure, and you know, the last three quarters, you’ve said it's been about 10 million, but I was wondering if you could just give us some insight or maybe a more specific estimate there? How many devices are selling annually in the marketplace, you know, across the industry? And how, you know, what percentage of those roughly are Android? And shouldn’t we be getting kind of somewhat below 10 million at this point? Anders Gustafsson : So, I think we – few years back, we started talking about, I think about 17 million, I’m going off memory now, 17 million devices, so we’ve always been able to convert a number of those. But the reason is not going down faster, is that – on the one hand, you know, we are shipping a lot of Android devices. You know, the vast majority of our devices are now Android, but it’s still a meaningful amount of Microsoft devices that we are shipping too, but our – I’d say most other industry players are still predominantly shipping Microsoft devices. So, while we kind of eat into the 10 million from one end, it’s getting replenished on the other end from other players. So, it’s not going down as fast as you might perceive, it should do based on the volume of devices we ship, but, you know, its – there’s still a good amount of devices to go after here, and we expect that by – you know, the vast majority of these devices will be upgraded to Android by 2020 or late 2020. Brian Drab : Okay, alright. I’ll follow-up more later on that one. And then for my second question, you know, maybe I’ll make it a two-part question, if I could? So, with respect to your guidance, could you possibly rank order how you’re thinking about end markets in terms of contribution to the growth rate in 2019, you know, retail, manufacturing, healthcare, transport? And then, maybe the second part of the question, could you do the same, take a stab at rank ordering where you're expecting the most growth out of the product lines in terms of data capture and mobile computing printers? Thank you. Anders Gustafsson : It’s still hard to rank order each of these, but I can give you some indications or where we see particular strength or if there's anyone we feel would be – maybe lagging here. So, on the vertical markets, which was I think your first question, you know, healthcare grew the fastest for us in Q4. I would expect healthcare to be over to – not just 2019, but over the next several years, the fastest growing vertical market. But we do see a fairly similar growth rates across the – you know, our four verticals. If you look in 2018, we had double-digit growth in all four of our verticals. So, we don’t expect that any one of them will kind of standout and carry the load for the company. You know, a few years back, retail was maybe more pronounced as the driver, but now we see it more balanced. You know, manufacturing was a little weaker earlier, but we see the Android adoption to kind of pickup in manufacturing this coming year, particularly around the warehouse. And from a region’s perspective, again, we had, you know, double-digit growth in all four regions this past year. So, we see them all performing well. Asia-Pacific will be the one we would expect to grow the fastest over the kind of the foreseeable future, not just the next quarter or a couple of quarters, but over longer-term. It can be a bit variability within quarters, but you know, North America has performed very well too. Europe was a little weaker than the average in Q4, but we still see good growth for Europe as we go into 2019. I hope that helps. Brian Drab : Okay. Yes, thanks. And I’ll follow-up more later, but congratulations on a great 2018. Olivier Leonetti : Thank you, Brian. Operator : Our next question comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman : Yes, good morning Anders. Anders Gustafsson : Good morning. Richard Eastman : And Mike. Just – and Joe. Just a quick question, first question, it was around gross margins. I mean again, if you look certainly in the quarter and for the full-year, both the AIT and EVM segments saw 100 plus basis point of gross margin improvement for the year, and I'm curious how you view that? You know, how structural is that that the gross margins here in both segments is it, you know, are you thinking that as somewhat of a baseline here moving forward? And maybe you could just give a little bit of color around both pieces as to how and – you know, you deliver that gross margin from is quite impressive. Olivier Leonetti : So, we have been increasing gross margin significantly, as you said, year-on-year by about a point. We have been highly focused as a team on gross margin. Every element of the value chain add a role, manufacturing, procurement, product design, go-to-market, and we believe that that would keep being the case going forward. We believe we have the ability to increase gross margin as a business, and we actually don't think we play – we’re playing our best game today. And we think that the two main segments should follow directionally the same pattern and have the ability to expand gross margin rate. Anders Gustafsson : As Olivier said, you know, this is a company-wide activity. I think if there's one number or ratio that is deeply ingrained in our culture, it’s – [or two, growth and gross margins], so it’s something that the entire company is paying attention to and working on. Richard Eastman : Did price play a significant factor in either of the two segments? Anders Gustafsson : Yes, I would say, our commercial discipline has improved. We are paying more attention to what appropriate commercial terms would be. So, I think we’re a little bit more scientific in how we go about doing that. Olivier Leonetti : Mix is a play – mix, sorry to interrupt Richard, mix would be a play and also us being able to add solutions to our offering is also a driver of enhanced gross margin performance. Richard Eastman : Awesome. I mean, just a quick question as a follow-up, my follow-up is just as it relates to the EBITDA improvement that you're kind of forecasting for 2019, I think in difference to the first question, again, it appears as though maybe you're looking for, you know, 50 basis points of adjusted EBITDA improvement. So, you know, putting that together in the same equation with the gross margin maybe plus 100 bps, is the thought here that, you know, we drive gross margin up and redeploy into, you know, R&D and maybe feed on the street or the channel? And are we kind of settling into, you know, the – Zebra’s business model maybe being a 50 basis point a year type of target for EBITDA margin improvement? Olivier Leonetti : No, no, indeed. So again, Richard, our ability to improve both gross margin rate and OpEx, including – by the way as we invest dollar in R&D, we believe we are good to be able to scale R&D dollars as a proportion of revenue dollars. We are prudent as a company, and the improvement we have in term of EBITDA rate in the year we believe is in the category of being balanced and prudent. I’m not too sure I would necessarily agree with the flaws and so on you’re mentioning. Anders Gustafsson : As Olivier mentioned earlier, having leverage across the P&L is a key part of our philosophy and how we manage it. So, we want to drive improvements in gross profit, we want to see leverage in the OpEx side and certainly we want to see that translate into higher EBITDA margins. Richard Eastman : Alright, great, well thank you and tremendous year. Anders Gustafsson : Thank you. Operator : Our next question comes from Paul Coster of JP Morgan. Please go ahead. Paul Coster : Yes, thanks for taking my questions. So, backlogs, our pipeline is up as well, can you give us some sense of how much visibility the backlog gives you either in sense of the quarter or even the year, and as for the overall backlog plus pipeline, what’s in the mix that points to trends in your business? Thank you. Anders Gustafsson : Yes. The pipeline that we have as we enter a quarter gives us obviously much better visibility into the quarter. It doesn’t necessarily tell us much about the second half of the year. But having a bigger backlog as we go into quarter gives us a lot more confidence obviously about the outlook. The pipeline is more what drives the longer-term outlook and we have a very diligent and disciplined process to work with our sales teams and our direct customers, our channel partners to develop pipelines for all the direct customers, but also for different segments and doing bottom up and top down and triangulate in a variety of ways. So, that’s what gives us more of the visibility for the second half or the out quarters and maybe Joe Heel want to add something. Joe Heel : Yes. Both our backlogs, which we have continuously building and have contributed significantly to the success we had in 2018, as well as the pipelines have geared towards the visibility of about two quarters at a very granular level. To give us visibility beyond that, we have expanded for our largest customers and for large deals in particular visibility to three years, where we look at how we expect our business with individual customers to evolve over a three-year time period. So, that gives us a longer-term although it’s more of a qualitative view of where things are evolving. If you look at trends that we can see in that, one of the trends that we already talked about earlier is the fact that those remaining 10 million devices that we see out there, a significant portion of them are in the logistics warehouse and manufacturing space. We also see in terms of trend, the opportunities in areas that we call adjacencies in the earlier comments, things like tablets and RFID are showing up quite prominently in that visibility we’re getting from that pipeline discipline. Paul Coster : Excellent. The other question I have is, it sounds like the small-to-medium size customers are even stronger in North America than the enterprise customers, can you comment on that why that might be? Joel Heel : A similar trend that we just talked about in terms of manufacturing and T&L, there’s a correlation between these is that the first adopters of the Android solutions that we put out were large customers, and now medium size and smaller customers are adopting those solutions as well. Now, Android is only one example in the area where this takes place, this is also true for some of the other innovations that we’ve brought to market, some of the solutions we’ve brought to market. And I think we’re seeing now that some of these solutions are well established in the market that are SMB customers supported by our channel partners and our channel ecosystem are now gaining the confidence to also adopt those solutions, which is giving us a second wave of growth for many of those. Anders Gustafsson : I would just emphasize that the strength in the SMB market didn’t just happen to us. No, that’s a consorted effort. We have developed a number of initiatives to help boost our business at the lower end of our market to help penetrate that more deeply, because that was an area that we felt we were not as well penetrated as we were in some of the higher-end markets. Paul Coster : Thank you. Operator : Our next question comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. I appreciate the opportunity and congratulations on the call, on the quarter and the year. Can you guys – is it possible to prioritize, I guess, some of the growth drivers are for, you know, not necessarily the mobile computer business, but they did a capture in the printing business? I think you guys covered a lot of the growth drivers in the mobile computers, but I want to understand how the other two segments are still growing very strong as well? Anders Gustafsson : Yes, there is a number of, you know, I’ll start by just some strong secular growth trends that are driving growth across all our product lines. You know, the e-commerce is one, you know, the omni-channel piece, the on-demand economy, those are all broader secular trends that are requiring more track and trace type technologies, so it helps us under the mobile computing side, but it also helps us on printing, on scanning, you know, supplies, so all of those areas. Then we see when we get into these, say, newer areas that once we deploy our first roll-out, the customers sees the flexibility of many of our new products by being so much more connected. So, if that’s a mobile computer or a printer, you know, they can do a lot more with it. So, they see more and more new used cases that they can apply. You know, if I go back again to the old Microsoft days, you know, I think that an average mobile computer will probably run a couple two, three applications. You know, today, we routinely see customers running 30 applications on one of our devices. So, those are great drivers for it, and I will say the competitiveness of our portfolio is very strong today. You know, we launched more new products in 2018 than we’ve done in the history of the company, and they’re all ramping up nicely, and helping us to extend our lead into markets and driving growth. Keith Housum : Great, thanks. In my follow-up, you know, Olivier can you just kind of share us some of your logic in terms of expanding the range for your leverage target from 2 to 2.5 down to 1.5 to 2.5? Olivier Leonetti : We want to have flexibility to manage our cash. We want to invest in priority in the business either organically, we mentioned R&D, go-to-market would be another one, or through M&A, and we are in the process of finalizing a new acquisition with Temptime after Xplore. Another one we discussed, Keith, in prior calls, once we reach the bottom of our range, we believe that share buyback would become a consideration. So, that's a bit of a rationale for the range as it is set up now. Keith Housum : Great, thank you. Anders Gustafsson : Thank you, Keith. Operator : Our next question comes from James Faucette of Morgan Stanley. Please go ahead. James Faucette : Great. Thank you very much for the frank conversations this morning. I wanted to dig in really quickly a little more on pipeline and invisibility. How would you compare the visibility in pipeline that you have today versus, say, a year ago, both in terms of [REIT], but also in terms of make up? It seems like there’s been a lot of conversation about more small and medium-sized businesses. Are they also making up a greater proportion of your pipeline and visibility? And I’m just trying to get a little bit color on how it may vary today versus a year ago? Anders Gustafsson : So, I’ll start, and then I’ll have Joe provide some more detail. But I’d say, the overall visibility from our pipeline is probably similar to what it was a year ago, may be a little better, but it's more balanced and will probably be the biggest change. We were going into 2018, I’d say, our mobile computing and retail segments were – we were more dependent on those pipelines to support kind of the growth. Today, the – it’s much more balanced. You know, we expect our scanning portfolio to have a very good year, you know, printing to a very good year as well, not that they didn’t have it last year, but we have a stronger pipeline for those areas. So, similarly across the vertical markets, we ended up with a very balanced growth in 2018, and we see healthcare, T&L, manufacturing driving more growth this year and equally on the geographic side, we’re very diversified and we have a good pipeline for each of our geographies that supports the outlook. Maybe Joe? Joe Heel : Yes, I would say, from a sales perspective, increasing pipeline visibility is an ongoing quest, and one that we've invested in quite significantly in the last year to improve our capabilities on a number of dimensions. One dimension is to improve visibility, in particular, in the printing and scanning areas where the deals are smaller, to get that visibility sooner and at a more granular level. And second would be to get more visibility out to longer term, right. With the growing importance of large deals in our business mix, having visibility to those is extremely important for both our planning purposes internal, as well as guidance we give and other things like that. So, we have invested in both of those and it is helping us. Olivier Leonetti : I mean, James, an additional color yet if I may, we have been very intentional over the last more than two years to really diversify the business, and you see this diversification being reflected in the financial performance of the company, and in the guide as well. James Faucette : Great, I appreciate that Olivier. And then, just a follow-up question for you Olivier. And when you look at – I appreciated, and I think we all appreciate the clarity as to the type of headwind you're expecting from FX. But can you give us a little bit of insight into how you formulate that, kind of what the exposures are, and then, what you're using as reference points to come up with your expected headwind for this year? Olivier Leonetti : So, FX in the second half of 2018 started to be neutral to the financial performance of the company. It would be a slight headwind in 2019. The reason for this is that we’re edging against the euro, which is the only currency really against which we have some exposure. But we have many levers to manage our P&L. FX is one of them, and we believe that we have enough levers to be able to adjust to different effects and still deliver a good financial performance. James Faucette : That’s great. Thank you so much. Operator : And our last question will come from Saliq Khan of Imperial Capital. Please go ahead. Saliq Khan : Great, thank you. Hi Anders, Olivier. Guys, two quick questions on our end. First one being is, what did you hear at the NRF conference that gives you a bit more confidence that many of these retailers are willing to open up their wallets, invest in new retail technologies? Are you seeing improved purchasing decisions on their part as well? Anders Gustafsson : You know, I think we saw – first, maybe I think NRF was a great show for us this year. We had a very exciting booth and we had record traffic through the booth; we had record number of meetings with customers; and the feedback we got was very, very good. So, we certainly felt that was a great show and it helped to give us some confidence for the year. I’d say, the larger retailers, particularly say in the US, have largely been committed to an omni-channels e-commerce type strategy for the last couple of years, and we've seen quite a few orders from that. But what we are seeing is the – that trend is moving kind of further down into tier 2, tier 3 retailers, so we see more customers, more retailers wanting to make this – a kind of similar type of investments in new solutions to enable them to execute on their omni-channel strategy and compete against e-tailors. So – and the – I think our types of technologies are, you know, essential to their thinking. You know, they see us as a partner who can help enable them to pursue those strategies and help them realize those strategies. So, it was a great show from all aspects for to us and Joe. Joe Heel : Yes, I might add, you know, some of the things we mentioned earlier were very prominent at NRF, and did give us a lot of confidence. For example, what we talked about already with the new used cases that we’re seeing, retailers are embracing those. For example, the voice collaboration between their associates since one of those giving a device to everyone of their workers, not just a few selected that are involved in inventory management. Those types of trends give us confidence. And another important trend that we see support for is that the first wave of adopters who went into deploying mobile computing solutions on an android operating system are early on, for example with our MC40 device are thinking of refreshing those at this point. So that means there is longevity and continued opportunity in the retail space. Saliq Khan : Got it guys and thank you, and this was my follow-up to that. What did you change over the past year within your either sales or your channel strategy, especially in this type of growth rate, are you seeing a faster service and software versus hardware sales as well within that article? Anders Gustafsson : Generally speaking, we saw faster service and software revenue growth in Q4 than we’ve done before. There was a very – we’re very pleased with the performance we saw there. Generally, the software content in our solution is going up and up and up. If you think of the history of the company, we started off with say relatively dump devices that could read a barcode and transfer that information to another system that would do something with it to our android devices where you read it. You can manipulate the data, you can gain actions from it. You can do a lot with that. Next step now is to have much more smart infrastructure. So, things that can automate the data capture that can automate the dispensing of actions too. So, software is becoming a bigger and bigger part of what we do and how we develop new solutions to that more and more value to our customers. Joe Heel : A few additions to things we’ve changed and done in our sales and channel strategy over the course of the last year. One is, we have invested some of the improvements that we’ve had in our economics. We have reinvested those into a go-to-market resources, both internally, as well as with our channel partners. Our commitment to our channel has continued to expand and the importance of our channel program has only increased as we have expanded the benefits and membership in that program. The membership in our program is growing quite significantly over the last year. We’ve also invested structurally in the organization in sales and go-to-market in a dedicated solutions group, sellers that are specialized and focused on selling the solutions that make up the core of our intelligent edge to realize or EAI strategy. So, we have a dedicated group of that now in every one of our regions. So, those are some of the highlights of changes. Saliq Khan : Perfect. Thank you, guys. Operator : This concludes our question-and-answer session. I would like to turn the conference back to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Thank you. As we wrap up, I want to thank the Zebra team and our partners for another great quarter and an exceptional 2018. We’re off to a strong start to 2019 and see a solid year ahead. We look forward to welcoming the Temptime team once we close the transaction. Have a great day, everyone. Operator : The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
|
ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,019
| 2
|
2019Q2
|
2019Q1
|
2019-04-30
| 11.055
| 11.375
| 11.941
| 12.645
| null | 15.02
| 16.73
|
Operator : Good day, and welcome to the Q1 2019 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead sir. Mike Steele : Good morning. Thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will start with our first quarter highlights. Olivier will then provide more detail on the financials and discuss our second quarter and full year outlook. Anders will conclude with progress made on Zebra's strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us as we take your questions. Also throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Xplore Technologies and Temptime businesses. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now I'll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone and thank you for joining us. Our team executed well and drove solid profitable growth in the first quarter. As you can see on slide 4 we reported net sales growth of 9% or 8% on an organic basis; an adjusted EBITDA margin of 21.1% a 20 basis point year-over-year improvement; non-GAAP diluted EPS of $2.92 a 14% increase from the prior year; and free cash flow of $27 million. We achieved strong performance across Asia Pacific, EMEA and North America. Our team drove growth across the vertical markets we serve and demand remained strong through the channel. Our data capture and mobile computing product categories performed especially well. We also scaled operating expenses while at the same time investing in our employees and initiatives to drive sustainable growth. Additionally, in the first quarter we closed on the acquisition of Temptime Corporation, a leader in time-temperature monitoring which is an attractive growth opportunity for us. Our solid start to the year and leading portfolio of solutions provides us confidence in our outlook for 2019. With that I will now turn the call over to Olivier to review our financial results and to discuss our outlook. Olivier Leonetti : Thank you, Anders. Let us start with the P&L. As you can see on slide 6 net sales grew 9.1% in the first quarter which translated to 7.9% on an organic basis before the impacts of currencies and acquisitions. We saw growth in each of our reporting segments and across most geographies. Enterprise Visibility & Mobility segment sales increased 11.6% led by especially strong demand in data capture and mobile computing products. Asset Intelligence and Tracking segment sales increased 1.2%. We realized strong run rate business which was partially offset by fewer large printer orders in North America than the prior year. Turning to our regions. In North America sales grew 7% driven by double-digit growth in our mobile computing and data capture categories. We saw particular strength in health care and retail. Sales to small and mid-sized accounts remained strong. The EMEA sales increased 9% with relative strength across data capture, printing and mobile computing. We saw broad-based growth across the continent. Retail was particularly strong with continued traction in RFID. Sales in our Asia-Pacific region were up 12% with strength across all major product and service categories. Most countries grew double-digits including China. Latin America sales decreased 3%, primarily due to lower sales in Mexico, due to geopolitical weakness. Adjusted gross profit increased $37 million or 8%. As expected, adjusted gross margin decreased 50 basis points from a strong margin rate in the prior year period, primarily driven by less favorable business mix in both operating segments. We expect favorable year-over-year margins in Q2 and the full year, as I will cover in my outlook commentary. Consistent with one of our principles, adjusted operating expenses as a percentage of net sales decreased 100 basis points from the prior year period. We achieved this operating leverage while continuing to make meaningful investments to drive organic growth. First quarter 2019, adjusted EBITDA margin was 21.1%, a 20-basis point increase from the prior year period. We drove non-GAAP earnings per diluted share of $2.92, a 14% year-over-year increase. Turning now to the balance sheet and cash flow highlights on slide 7. In the first quarter of 2019, we generated $27 million of free cash flow. This was $71 million lower than the prior year, reflecting increased working capital usage, including higher incentive compensation payouts tied to exceptional 2018 performance. Additionally, as expected, the timing of certain working capital items that benefited the fourth quarter of 2018 had an unfavorable impact on Q1 2019 cash flow. Keep in mind that we are committed to a target of 100% free cash flow conversion, which fluctuates by period due to various short-term factors such as those I just covered. We had net borrowings of $146 million in the first quarter, which were primarily used to fund the acquisition of Temptime. We ended the first quarter with $1.7 billion of debt on the balance sheet. As of the first quarter, we had 1.9 times net debt to adjusted EBITDA ratio, which is within our targeted range of 1.5 times to 2.5 times. Let us turn to our outlook on slide 8. We expect Q2 2019 net sales growth to be between 7% and 9%, which assumes an approximately 2.5 to 3.5 percentage point positive impact from recent acquisitions, and an approximately 50 basis point negative impact from foreign currency changes. We believe Q2 2019 adjusted EBITDA margin would be in the range of 20% to 21%, which assumes a high gross margin both sequentially and from the prior year. Non-GAAP diluted EPS is expected to be in the range of $2.80 to $2.95. We are raising full year 2019 net sales growth to be between 5% and 8%, which assumes an approximately 2 percentage point positive impact from recent acquisitions and approximately 50 basis point negative impact from foreign currency changes. Full year 2019 adjusted EBITDA margin is now expected to be between 21% and 22%, an improvement from 2018 and our prior guide. We continue to drive operating leverage and gross margin improvement in the business. We expect that full year 2019 free cash flow will exceed $625 million. We continue to expect to drive higher EBITDA and unlike 2018, we're assuming that working capital would be a use of cash in 2019. You can see other full year 2019 modeling assumptions on slide 8. With that, I will turn the call back to Anders to discuss progress on our strategic priorities. Anders Gustafsson : Thank you, Olivier. We are very pleased with the progress we made in Q1 and the momentum in our business. Slide 10 shows our key strategic areas of focus, which support our industry leadership and drive value for all stakeholders. First, we continue to outpace the competition through our innovation, unmatched scale and strong relationships with customers and partners. Our mobile computer, data capture and printing portfolios have never been stronger. This has been accomplished through focused R&D investment to build upon our best-in-class offerings. We continue to see meaningful opportunities to address targeted underpenetrated geographies and market segments in our core business. We are capitalizing on key technology trends, including cloud-based printing, RFID and the transition in data capture to 2D imaging. Another trend has been the migration to the Android operating system, which now represents more than half of enterprise mobile computing sales in the industry. Many large retailers have made the transition, but we are early in the adoption curve in the warehouse environment. Second, we are focused on driving growth in attractive markets, where we can leverage our competitive advantages. We plan to scale existing categories where we are underpenetrated and enter new markets outside the core that advance us as a solutions provider. We expect to gain traction in these markets through both organic and inorganic investments. We target high-growth near adjacencies where we have a right to play, seeking businesses that can transform flows with their solutions. An organic example is in RFID, where we have been launching new fixed and mobile products and solutions that provide our customers significantly higher tracking accuracy for various use cases. From an inorganic growth perspective, we gained traction in smart supplies with the acquisition of Temptime Corporation. Temptime is the leader in designing and manufacturing a time-temperature monitoring portfolio that meets the strict specifications of the largest global health organizations' vaccination programs. Our business is to scale this technology deeper into the healthcare industry, as well as drive it into other use cases that can benefit from increased asset visibility. Third we are advancing our Enterprise Asset Intelligence division to enable every front line asset and a worker to be visible, connected and optimally utilized. We are doing this by leveraging our deep knowledge of workflows and capitalizing on key megatrends. I will discuss this more in a minute. Lastly maintaining our financial flexibility remains a key priority, as we invest in the business to accelerate our traction in attractive markets. Now turning to slide 11. Zebra enables our Enterprise Asset Intelligence vision by providing a digital view of the entire enterprise. Our products and solutions sense data from assets products and processes. This information, including status and location, is analyzed in real time to determine the best possible operational action to improve productivity and give greater insight into business operations. Our purpose-built products include a software layer which makes them easy to integrate and intuitive to manage. Additionally, our new software applications and tools improve automated data collection and analysis, maximize device security and enhance ease-of-use. Another integral part of our solutions ecosystem is Savanna, our cloud-based platform that powers our intelligent edge solutions with real-time data. Savanna is a key enabler of a wide range of our data-rich offerings. A newer example is our Workforce Connect software application which enables our customers to marry all of their communications onto a single mobile computer. Our team is encouraged by the additional opportunities we see to leverage the valuable data that is accessed through Savanna. We have been collaborating with an increasing number of our independent software partners, to utilize this platform to deploy new solutions that address our customers' challenges. The rise of machine vision, analytics and artificial intelligence is driving a new wave of intelligent automation which is complementary to our core business and a natural extension of our vision. Unlike, repetitive automation intelligent automation leverages our Sense, Analyze, Act framework to improve workflow efficiency with or without a human operator. A key example is our recent venture investment in a company that specializes in the collaboration of humans and robots to fulfill orders on the warehouse floor. We have made strong progress on our Enterprise Asset Intelligence division, as we helped businesses across many industries, digitize their operations and gain a performance edge. Zebra is benefiting from key technology megatrends including mobility, automation, cloud computing and the proliferation of smart devices and sensors, each of which are critical components to this transformation. Slide 12 highlights our primary vertical markets, Healthcare, Retail & Ecommerce, Transportation & Logistics and Manufacturing. In Healthcare, our fastest growing vertical, we are tracking clinical equipment and enabling caregivers to monitor patients while being mobile. These solutions translate into increased patient safety and reduce costs. We recently signed a new record healthcare deal for Zebra, with one of the largest health systems in Canada. This customer is initially deploying, premium handheld imagers and a range of desktop and mobile printers to manage specimen handling, wristband identification and other use cases. This Zebra solution increases productivity, and improves the overall level of patient care for this customer. In Retail & Ecommerce, we are a trusted strategic partner, for many of the largest companies in the world. We support their goals to drive their productivity metrics, and improve customer satisfaction. An increasing number of our customers are equipping their associates and shoppers with our mobile computers that empower them with their real-time information they need to successfully execute omni-channel fulfillment and elevate the overall in-store experience. Additionally, it is common for our customers to deploy a wider range of our solutions for their various use cases. Examples include our mobile computers and printers, flatbed and handheld 2D scanners as well as RFID solutions. At the ProMat trade show earlier this month, we showcased innovative solutions that help our manufacturing and transportation and logistics customers, digitize their supply chain and modernize their warehouses. These include the next generation of Android mobile computers, RFID products and solutions to provide a digital view of their trailer loading process, and worksite activities. According to our research, our customers are faced with, daunting scale challenges driven by the on-demand economy. Due to this increased volume, more than half of warehouse leaders plan to either add warehouses to their operations or enlarge current facilities over the next five years. By helping to drive increased productivity and efficiencies, we can help limit the scope of these costly expansions. At the ProMat showcase Purolator a leading Canadian freight package and logistics Solutions Company, demonstrated how they are using software on Zebra's mobile computers, for track and trace, dispatch and hub management operations. Together with a trusted partner, we have implemented a five-year as-a-service deployment model for Purolator. This solution will improve delivery time, increase worker productivity and enhance customer service. In manufacturing, our customers are looking for trusted partners who can increase their operational visibility while reducing cost and complexity. A notable example can be found with a major Latin American food manufacturer. The project includes plant floor solutions using our ET50 tablets and ZT400 series industrial printers across all their facilities in the region. It was a consultative engagement, which was initiated by our experts assessing this customer's operations and prioritizing optimal solutions. We were recently awarded the sizable data capture deployment with a customer outside of our traditional verticals. A large Italian gaming company recently rolled out our products to comply with the European Union anti-money laundering directive. They need to efficiently capture certified identification data from their customers for lottery ticket purchases and our solution best met their unique needs. We are pursuing additional opportunities with other prospective customers who need to comply with this regulation and similar directives. In summary, we are excited about the innovative solutions we are implementing with a diverse set of enterprise customers worldwide. Secular trends including the on-demand economy and increased regulation are driving increasingly complex business priorities that Zebra is uniquely positioned to address. Now I'll hand the call back over to Mike. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : Thank you. We will now begin the Q&A session. [Operator Instructions] And today's first question comes from Jim Ricchiuti of Needham & Company. Please go ahead. Jim Ricchiuti : Hi, good morning. Two questions. First, I wanted to focus more near term on the environment for mobile computing. You're continuing to see good strength in that market and we've talked about the upgrade opportunity. But it appears that it's much more than that that this is not just an upgrade opportunity, but it's also a market expansion story tied to associates using more of these. Is there any help, you can give us in terms of how we might think about the growth rate for this portion of the business over the next year or so? Anders Gustafsson : Yeah. Thank you. First, all our product lines grew this past quarter. They were fueled by the innovative and broad portfolio of products and solutions that we have. And I think also our deep understanding of our customers' vertical workflows and how we can leverage data at the edge is great enablers of new use cases and a way for our customers to derive data, or derive value out of our solutions. So we're very excited about the opportunity we have across all our product lines and we're enabling several megatrends such as the on-demand economy with this. And specifically to our mobile computing portfolio, we had broad-based growth in Q2 and we've had great momentum in the business for several quarters now. I think I'd highlight two key drivers that we see; one is new use cases and the other one is in the Android conversion across the industry. First, then on the new use cases, I see that as a good long-term driver for the business. Three specific sub-points, I guess here. First, we are seeing a lot of our customers consolidate multiple devices or applications onto a mobile computer. So if you think historically they would have a printer, a scanner, or not printer but scanners and walkie-talkies, desk phones or PBX extensions. All of those things can now be consolidated onto our mobile computers and the Workforce Connect will be a great example of a software application that we developed that helps do this. And that makes the ROI very strong for purchases of mobile computers. Second trend will be around our customers are looking to have -- put a device in the hand of every worker, so that they're reaching much further into their operations to deploy technology and obviously that's a great driver for us. And third and I talk about screen size, so our tablet business. The tablet side of business the bigger screen sizes are growing as a market faster than the traditional mobile computers. And we're seeing more site managers getting tablets to digest the data that's being ingested by our mobile computers. So those are our three kind of new use cases that we see driving growth. And then on the Android transition that continues to be a good catalyst for us. Now more than 50% of the market is Android and so less than 50% of new devices sold are Microsoft. There are still substantial amount of Microsoft devices going into the market. And we have approximately 60% market share of the Android space and approaching 50% overall. So it's still a huge potential here with approximately $10 million legacy Windows devices in the market that over time will need to be converted. And maybe Joe Heel you want to add a little bit to this? Joe Heel : Yes. The Android transition has been a terrific opportunity for us and we do see that continuing in the space that Anders described with about 10 million devices left. Where are those devices? Well, you see that we've -- the core retailers have adopted our solution quite broadly. And now we're seeing the expansion in T&L in manufacturing. The warehouse is really the frontier that we're working on right now as well as mid-tier accounts right, where the larger accounts have adopted now the mid-tier is adopting. And one of the things we're seeing that you can also see in the market is that before a customer can adopt their software application has to be available on Android. And so we've been working hard with ISVs who have come to our program in very significant numbers to help them move their applications to Android and that's I think the indication that the expansion into the warehouse and the manufacturing space is where the Android migration will go next and the rest of those 10 million computers will be what we will pursue. Anders Gustafsson : Yes. So you can see there are many reasons for us to be excited about the mobile computing portfolio. Jim Ricchiuti : That's helpful, Anders. I have one other question if I may. As you look at the business and look back over the last one to two years, are you surprised at all by the increased pace of change with respect to how retailers and some of the logistics operators are moving to adopt automation technology? Are we seeing something that appears to be more of an acceleration versus where you might have thought the market was going to be a year ago? Anders Gustafsson : I'd say the -- we're not particularly surprised. I think we've expected this and worked for this for a long time. I often kind of joke and say tell people that overnight successes took years to happen and so we've been working on a number of these initiatives and new solutions to enable these changes and this higher pace of change. So we've been at this for a long time, but it may not necessarily become apparent to outsiders how long we've been working at it. It comes across as being maybe we're an overnight success. Joe Heel : I mean as one point of evidence. Almost five years ago, we put forward division of Enterprise Asset Intelligence, right, which is sense, analyze and act. And the automation is a natural part of that and we're just seeing increasing opportunities to bring together all these technologies that we've had in the past and the innovations that we'll bring to market in the future to capitalize on that automation trend. Jim Ricchiuti : Thanks a lot. Operator : And our next question today comes from Jason Rodgers of Great Lakes Review. Please go ahead. Jason Rodgers : Yes, I wonder if you could talk a little bit more about the unfavorable business mix that you saw in both segments in the quarter and perhaps mention some of the factors that give you confidence that mix will improve in the second quarter? Olivier Leonetti : So good morning, Jason. I believe you are referring to the margin trend, is that correct, Jason? Jason Rodgers : Correct. Olivier Leonetti : Yes. So in the quarter and that was part of our Q1 guide, we had a gross margin rate being lower than Q1 last year. If you remember Q1 last year was a strong margin rate. What expected -- what happened in Q1 as expected was two things. One, the Zebra Retail Solution which is a very -- which is a high-margin business was very focused in Q1 last year. This year this revenue will be spread. The impact on the quarter is about 20 basis points. And then you add some business mix impacting also the margin. Now implied in our guide is that we expect Q2 margin to be higher than Q1 of 2019 and we expect the rest of the year margin to be higher than last year. And if you look at our P&L over the last two years, you have seen that we've been able to scale margin up. We believe that this year would be no exception and we feel comfortable about the levers we have to achieve that goal. Jason Rodgers : And then as far as the leverage that you have I believe perhaps last quarter you talked about the net debt-to-EBITDA approaching the bottom of your range around 1.5 times by midyear. Do you have an update on that target? Olivier Leonetti : Absolutely. So in the -- at the end of Q1, our leverage ratio was 1.9 times. We have a target. We have said that during our last call target leverage of 1.5 to 2.5. We believe and you can sense that from the remarks from Anders and Joe, we are very excited by our end markets and by our ability to compete. As a result, in terms of capital allocation the priority would be to invest in our business either organically or through M&As. We believe that that would provide us with the best adjusted return. Now share repurchase will become a consideration if we stay below our targeted leverage on a sustainable basis. Jason Rodgers : Okay. Thank you. Operator : And our next question today comes from James Faucette of Morgan Stanley. Please go ahead. Erik Lapinski : Hi, team. This is Erik on for James. Thanks for taking our question today. I just wanted to ask like as you're thinking through the current demand environment, have you seen any softening of RFPs or cancellations or pushouts? Anders Gustafsson : We have not seen any pushouts or any particular softening. The year has progressed very much the way we had expected. So if you go back to 2018 we had a very, very strong growth rate and the annual guidance we've given here is for that to moderate, but I think that has been entirely expected by us and projected. So far, I would say the year is progressing pretty much the way we expected it to. Erik Lapinski : All right. Thank you. That's helpful. And just thinking through that, if you're -- are there any areas where maybe your models have ticked down or may have ticked up or still pretty much where you're expecting? Olivier Leonetti : Pretty much as expected at this stage in terms of top line and profitability. And when you look at the quarter also and that has been a theme you see that we have a very diversified business either by region, by product, by vertical. So we think -- we are feeling good about where we are as a company and we are serving important secular trends. So we are feeling good about where we are as a business. Erik Lapinski : Thank you. That’s it for me. Operator : And our next question today comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman : Hi, guys. Good morning. Just a question around the AIT, the printing business. Could you just speak maybe a little bit to the core growth in the quarter? You still have some tough comps in Q2, Q3. Just curious how you expect that business to play out through the balance of the year. And also it's interesting I presume you've got some price there, but the gross margin was quite good relative to what we were thinking. So maybe just kind of address the pricing and the growth rate in printing if you would? Anders Gustafsson : First AIT had a good performance in the quarter. We grew on the back of strong supplies performance and within supplies, we had a relative strength within wristband and RFID. The overall printer market had fewer large deals, the large orders in Q1, which also we saw less large deals than we did a year ago. But that was offset by particularly strong run rate business for us. But looking a bit more longer term, we have a very strong and fresh portfolio of smart connected printers with really unrivaled manageability through our Link-OS operating system. That's a great differentiator for us. We've launched a number of new printer products over the last 12 to 18 months, which are being very well accepted by the market and helping to ramp. So we are quite excited about our printing portfolio and the growth prospects we see in the market. Specific to pricing, I'll see if Joe had any comments on that. Joe Heel : Well, I give you two pointers that are perhaps more a mix point, which is on the one hand the higher end of our product range. The tabletop printing range had a strong quarter. If you look carefully in the regional piece, you'll see that Asia-Pacific did well where a lot of the regional printing business in the high-end is concentrated. And another area where mix improvement has helped us is in the supplies business. We've always said that supplies is a growth opportunity, and we've focused recently on making the mix move towards the more profitable parts of that portfolio. Richard Eastman : And just as a thought there. Was there anything in the channel -- was there any inventory adjustments in the channel moving from the fourth quarter into the first quarter? Any pull into the fourth quarter based on pricing or programs or anything like that? Anders Gustafsson : No, we didn't see any pull-ins into Q4 particularly, and there was nothing out of the norm that was going over that channel. The channel inventory is within the normal range of days in the inventory as we set out with them, and the channel performed very well though for us a strong run rate. So it was all good. Richard Eastman : Okay. And then, just as a follow-up, Anders. Could you maybe talk just generally about Xplore, now that you have that acquisition integrated? What does the product roadmap look like there? Is there an OS upgrade opportunity there? You mentioned larger screens maybe being a factor in mobile computing. But just any thoughts you can have around Xplore and maybe what their product roadmap looks like as you move forward to stimulate growth there? Anders Gustafsson : Yeah. I'll start, and then, I'll ask Joe to provide some extra color also. But, overall, our big screen or tablet portfolio is performing very well that includes then the Xplore Technologies portfolio but also ET50 tablets that we had before. And with the Xplore acquisition, we've become the clear number two in the tablet space. So quite excited about the opportunities we see there. We have already launched a number of new products for Xplore which have been well received, and we are looking to here to soon launch our Android products for Xplore. So we're looking to basically extend the traditionally Android portfolio of mobile computers into the tablet portfolio also, and we've had already the ET50 on Android for some time. We've also now fully integrated organizationally the Xplore into Zebra, and all the IT stuff will be done here this quarter. Xplore is now part of our PartnersConnect, partner program. So every reseller around the world has the ability to sell our full tablet portfolio, and all our sellers are incorporating that also. So overall, I think we feel very good about what's going on with our tablet portfolio and the growth prospects we have. Joe any further thoughts? Joe Heel : I'll add one other thing that we're particularly excited about, which is, as Anders mentioned, the flagship product of the Xplore line that we just launched is the L10. We launched it on Windows, and coming up towards the middle of the year is the Android launch of that same product line. That's significant, because one of the big drivers as we talked about earlier of our growth in Android has been our ability to bring our platform, our Android platform and Mobility DNA, and all that differentiating capability we have into the market. And now, we're bringing that to the market in ultra-rugged tablets. There's nothing like that in the market today. And what it provides customers is now a complete portfolio from the refreshed, so this is the other great change that's coming, the refreshed ET50, so there'll be the ET51 and 56 as a semi-rugged Android tablet complemented with now the Xplore rugged tablets also on our Android platform. There's nothing like that in the industry. So we're very excited about that as being a major expansion for the Xplore portfolio. Richard Eastman : Awesome. Thank you. Operator : And our next question today comes from Brian Drab of William Blair. Please go ahead. Brian Drab : Hi. Good morning. Thanks for taking my question. The first question is just on the guidance and what it implies for the second half of the year. I just want to make sure that I'm understanding this correctly. So the guidance for 5% to 8% revenue growth for the year, if you hit the midpoint in the second quarter, the growth in the first half will be about 8.5% and the guidance implies then about 4.5% in the second half including a net tailwind from FX and acquisitions. Can you just talk about how, number one, the outlook for larger orders appears to be developing for the second half of the year? And number two, what you're expecting for relative growth between EVM and AIT for the second half of the year? Olivier Leonetti : So, good morning Brian. So your calculation is correct. We feel confident about the numbers you have mentioned based upon the visibility we have and that despite strong comps. And the reasons for this confidence, I'm not going to spend too much time on this, is based upon the strong secular trends we are today serving. In term of large orders, we are not planning for large orders at this stage to be a significant part of our business. And in terms of growth profile between the various businesses, we think mobile computing still being strong. We believe that data capture would be as well stronger performance. But as we indicated before, printing supplies and also services and software are going to contribute to the growth and offer us various avenues to keep growing the company and post good profitability profile. Brian Drab : Thanks Olivier. Can I just clarify that, do you think in the second half of the year that EVM continues to grow at a faster rate than AIT as we saw in this first quarter? Olivier Leonetti : That's the planning assumption today indeed. Brian Drab : Perfect. Olivier Leonetti : And we covered the drivers behind that earlier Android and new use cases. Brian Drab : Perfect. Thanks. And then it's been a couple of quarters since you've commented on the potential positive impact of a rollout of -- or more extensive rollout of 5G capability across the infrastructure. Can you talk about what impact 5G could have on your business and the timing of that impact potentially? Thanks. Anders Gustafsson : First 3G services are expected to be turned down by 2021. So that would be one driver towards -- upgrading towards between the 4G or 5G devices. 5G rollout we haven't announced when we will have launch our first 5G device. But I would say, we are not highlighting us much, because we don't see it as a real near term or certainly a 2019 opportunity. But longer-term, 5G can have a great impact on our business. It can really make the drive further connectivity at the edge of the network. You can have a lot of different types of devices connected and leverage data including mobile computers or printers and even scanners. So if you think of small warehouses or retail stores that might decide to not implement Wi-Fi going forward, they might just go for a 5G as the connectivity for the store and have all the applications in the cloud instead. So, I think, there's many drivers that can be very helpful to our business based on 5G. Brian Drab : Okay. Thanks Anders. Operator : And our next question today comes from Keith Housum of Northcoast Research. Please go ahead. Keith Housum : Good morning guys. I was hoping for a little bit more color on the Xplore acquisition. I understand the commentary that you guys provided here. But if I look at the numbers that is provided here both in the fourth quarter and this quarter, it appears that Xplore has actually been slowing down from when you guys bought it. Were there challenges that were existing in the business or has some of the business moved over to the Zebra tablets that suggests that it's underperforming now and you guys will expect it to accelerate here from -- from here on in. But hoping for some color for that? Anders Gustafsson : Yes. So I'll start and then Joe will provide some extra color. But first I'd say Xplore is performing in line with our expectations from when we made the acquisition. So we are quite pleased with the performance overall. It's meeting our expectations. One thing to remember beginning of 2018 there was -- Xplore had some very large refreshes that kind of made those quarters look stronger than say an average trend line would be. And we hadn't expected that some of those large refreshes to repeat this year, but those are still customers and we're still supporting them, but not for the same volumes. Joe? Joe Heel : Right. So Keith perhaps the way to look at it is if you take those large refreshes from the prior year in our plan we had not expected that those would repeat this year. So our target and that's why Anders said it's performing according to our plan is to grow quarter-on-quarter without those large refreshes. And if you look at that that's exactly what you see. So we're quite pleased with how that's developing. Keith Housum : Got it. Appreciate it. And then Anders do you have a little more color on I guess one of the earlier questions where we're talking about EBITDA margin guidance going throughout the year as well as gross margins. I believe you referenced that you had some leverage to pull to expand gross margin as the year progresses. Can you provide a few examples what some of those gross margin opportunities would be? Olivier Leonetti : So let me cover that Keith. Keith Housum : Sure. Olivier Leonetti : So we believe that we have the ability to improve margin and scale OpEx and actually this is an operating principle for the company. We have demonstrated that over the last two years and we are demonstrating that in our guide also this year. To answer to your question, specifically on margin, we are using a series of levers. First of all, COGS levers, how do we optimize our supply chain? So design for value adding more and more combined parts between the various devices. And also we're optimizing the way we price and the way we price to value. And having software, hardware packaged together allows us to sell on an ROI basis rather than just -- not only on price. And on OpEx just to finish my discussion here, we believe that as we are growing the business we are able to add dollars in OpEx, but nevertheless scale. And you saw in the quarter Keith we scaled OpEx as a proportion of revenue by about 100 basis points and we do the same this year as we did over the last two years. Keith Housum : Great. Thank you. Operator : And our next question today comes from Andrew Buscaglia of Berenberg. Please go ahead. Andrew Buscaglia : Hey, guys. Just a question on -- so one of your larger competitors saw some destocking with their distributors in the quarter. Sounds like you guys never really see that. Can you talk a little bit about that and if you looked into that where you saw any impacts related to that? Anders Gustafsson : Yes. We can't comment really on what our competitors have said or what's been going on with their business. But from a Zebra perspective, we did not see any destocking in the channel in Q1. We managed our days on hand inventory ratios with our distribution partners which is just the ones who hold inventory. The resellers don't hold inventory regularly. We always manage the days on hand ratios very carefully. So we want them to have adequate stock to be able to support the market, but we don't want them to have a more and be I'd say heavy as that impacts their profitability targets and how much they can invest in other programs to help us drive demand. And our sales team is incented on sales out, so there's no particular incentive for them to drive sales in if it doesn't have a clear path to get sold out. So for us the channel performed very well. We had strong sales out data and we saw no signs of destocking. Andrew Buscaglia : Okay. And your cash flow in the quarter was that in line with your expectations? I mean, it was a little lower than I was expecting and you're going to have a little bit of a ramp to catch up to your guidance looks like. Olivier Leonetti : You're right. We are still -- as again another principle, we are managing cash to ensure that we have a free cash flow conversion of about 100%. We might not need that ratio in every single period. And in Q1 that was one of those. That was expected. Two reasons for this. We had a strong cash conversion cycle at the end of Q4, if you remember Andrew, and that's an impact in Q1. And also we had high incentive compensation payments in Q1, as we paid our bonuses due to the exceptional performance in 2018. But we are driving this business to drive about 100% free cash flow conversion and we have, to your point, some catch-up to do, but we believe we have the plan to do this. So, we are confident about the cash flow numbers we communicated to you Andrew. Andrew Buscaglia : Okay. And maybe one last one, if I may. I mean, this Temptime acquisition, I think, is pretty interesting. You guys going a little bit deeper in healthcare, medical. Is this sort of a tip to what you'll -- where you want to continue to invest? Or is it more so we just think of this as a one-off that it came up at the right price and you took it. Anders Gustafsson : Well, Temptime is that we still focus -- was a great acquisition for us. It really helps us in two areas. One, we've talked about supplies as a near adjacency where we are not as penetrated. We don't have the market share that we think we should have. And the other one was around the connecting the digital and -- the physical with the digital, so kind of the EAI aspect of the supplies here. So, Temptime could address both of those. We thought that was very attractive and exciting for us. I'm not sure how many specific opportunities we'll have to do that again, but we -- so I'm not sure I will say this is a trend that we'll see more of those. But we like the supplies business and we clearly like the EAI aspect of this of how to digitize our supplies business. Andrew Buscaglia : Okay. Thank you. Operator : And our next question today comes from Jeffrey Kessler of Imperial Capital. Please go ahead. Jeffrey Kessler : Thank you. Thank you for taking my question. I was interested in your comment about the Latin American food manufacturer that the way you want it was on a consultative engagement. Are you seeing a better mix of, if you want to call it, gaining a contract at the C-level relative to going in and just dealing with the facilities people or the security people et cetera, et cetera. Are there going to be more of these types of, if you want to call it, longer term trust-oriented value proposition negotiations that you can identify for specific vertical markets? Anders Gustafsson : Yeah. We -- some of the areas where we can provide particular insight is that we have very deep knowledge of our customers' vertical workflows. So, we have a team of people who regularly go out and live a day in the life of our customers, so they can be working alongside a nursing hospital or doing ride-alongs with a delivery truck driver or something like that to see how they are performing their duties and how we can apply technology to better help them, make their operations more productive, but also improve the customer experience or the patient experience. And then when you start leveraging the access to data that we have today that we didn't necessarily have the same say five years back, we can do more things around how we can offer greater insights into their business and enable our customers to be even more productive around those areas. So, I think we now have better access and we've invested in the capabilities to help assess our customers' operations and for how they can apply technology to achieve their business goals. So, this is very much a part of how we want to engage with our customers and some are more receptive than others, but it's been a great example of how we try to leverage the skill sets we have. And Joe, any further thoughts? Joe Heel : Yes. I'm so pleased that you noticed this. This has been a centerpiece of the transformation we've been driving in our go-to-market. And we talked a lot about how we want to bring solutions to market, but not often how we do that and how we do that is exactly as you've mentioned in this example in Latin America highlights. When we take a solution like location solution to market, we spend a lot of time with the auto manufacturer, understanding their workflow and advising them how they can optimize that workflow by knowing where all the parts are. Or when we're implementing a SmartPack solution, we run a pilot and then some intensive consultative work with the customer to help them understand, how that will help them increase in their trailer load efficiency for example. And so this is a centerpiece of what we're doing. We're dedicating close to 10% of our sales force are ready to this type of consultative selling and we expect that only to expand. Jeffrey Kessler : Great. And can I have a follow-up on your -- any tweaks or any new trends that you were seeing in your partners program? It was -- obviously it got off to a somewhat rough start years ago and then it kind of blossomed. What is going on right now in the partners program that has you believing that you can add -- it will be additive to your value proposition beyond what it's already done? Anders Gustafsson : Yes. I mean the partner program has been in place now for three, four years. And it's been well accepted I think by our partner community. They believe it's adding value and helping to kind of structure how we work together. So we're not envisioning any say large changes to it. It is working well and we are helping drive more cross-sell as an example out of this. We've seen partners that sell more than one product. They have overall higher growth rates than the average growth rate of the partner. And we continue to add new partners to the program as we expand. The one thing that we have put increasingly more emphasis on is our independent software vendors. So we commented a little bit on that earlier. But we see ISVs as an integral part of our overall partner program and our go-to-market capabilities. These software vendors are a big enabler of the Android transition also as they now have crossed more and more verticals started to put their software from traditional legacy Windows environments to Android. And that's kind of one of the prerequisites for us being able to provide the Android devices on the back end of that. Any further comments, Joe? Joe Heel : Well, I think the main part that I would highlight is Zebra has been and has increasingly been since at the Enterprise acquisition a channel-centric company. So our channel centricity, the percentage of revenue we do to the channel is well over 80%. And every year since the acquisition that has gone up further. So our partners have noticed this. They have grown faster than the rest of the Zebra business. And not only that, but the registered partners and our largest partners have concentrated a larger portion of business with them. So this has been an attractive value proposition and journey for them. And the changes that we have made recently were intended to make this even more attractive, I would say in two ways. One, is we've introduced some specialization for example in health care and in RFID, we've introduced specializations that allow partners who may not be among the largest partners, but have a specialty capability to be successful and flourish economically and that's attracted new partners to the program. And the second one is there's a great deal of interest among the partners in the solutions that we have been talking about recently. And this has been on the one hand a blessing for us, but we've had to manage it carefully because onboarding partners into these complex consultative solutions conversations is more demanding and we can't do that in as broad based array as we can with products. But for those partners that we've onboarded this has been an attractive additional value proposition they can take to market and differentiate their business. So those have been some trends in the portfolio. Jeffrey Kessler : Thank you, very much. Operator : And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Thank you. I want to thank the Zebra team and our partners for a strong first quarter and solid momentum into Q2. We are looking forward to ringing the closing bell at the NASDAQ market site in Times Square tomorrow to celebrate Zebra's 50th anniversary and honoring all who have contributed to our company's growth and success over the past five decades. So have a great day everyone. Operator : Thank you. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
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Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,019
| 3
|
2019Q3
|
2019Q2
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2019-07-31
| 11.571
| 11.8
| 12.879
| 13.105
| null | 16.06
| 15.3
|
Operator : Good day, and welcome to the Second Quarter 2019 Zebra Technologies Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Michael Steele : Good morning, and thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission.During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will start with our second quarter highlights. Olivier will then provide more detail on the financials and discuss our third quarter and full year outlook. Anders will conclude with progress made on Zebra's Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us, as we take your questions.Also throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Xplore Technologies, Temptime and Profitect businesses. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least one-year.Now I'll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team executed well and drove strong profitable growth in the second quarter. As you can see on Slide 4, we reported net sales growth of more than 8% or 7% on an organic basis. And adjusted EBITDA margin of 21.2%, a 150 basis point year-over-year improvement and non-GAAP diluted EPS of $3.02, a 22% increase from the prior year.We continue to outpace the competition through our innovation, unmatched scale and deep relationships with customers and partners, our mobile computing, data capture and printing portfolios have never been stronger. This has been accomplished through focused R&D investment to build upon our best-in-class offerings. We saw a broad-based global growth in Q2, with solid performance both the direct and through the channel. Operational discipline and cost efficiencies enabled us to accelerate profit growth without compromising our investments in our employees and growth initiatives. Enterprise mobile computing was a bright spot, growing double digits, as we continue to extend our lead in the industry, through the broadest selection of Android powered solutions. Enterprise workers are utilizing our mobile computers for a variety of new use cases.We are also benefiting from the multi-year transition to Android from the Windows operating system. Organic investments in initiatives to diversify growth are paying off. For example, RFID solutions and our Workforce Connect software application, were additional bright spots in the second quarter. We also continue to see acquisitions as a vector of profitable growth for the company and the way to penetrate attractive adjacent market opportunities.In the second quarter, we announced and closed on the Profitect acquisition. Profitect is the leading provider of prescriptive analytics, which is an attractive growth opportunity for us and advances our position as a solutions provider as well as our Enterprise Asset Intelligence vision. Overall, our solid first half performance and leadership position in the market provides us confidence in our outlook for the year.With that, I will now turn the call over to Olivier to review our financial results, discuss our outlook and our new $1 billion share repurchase authorization. Our strong balance sheet and cash flow generation afford us the ability to return capital to shareholders, while continuing to invest in our business. Olivier Leonetti : Thank you, Anders. Let us start with the P&L. As you can see on Slide 6, net sales grew 8.4% in the second quarter, which translated to 7% on an organic basis, before the impacts of currencies and acquisitions. We saw diversified growth in each of our reporting segments in most regions. Enterprise Visibility & Mobility segment sales increased 9.2%, led by particularly strong demand in mobile computing and support services. Asset Intelligence & Tracking segment sales increased 2.9% with growth in printing, supplies, services and retail solutions.Turning to our regions; in North America, sales grew 7%, primarily driven by strength in mobile computing, services and RFID. We saw particular strength in retail and healthcare and had some major competitive wins. EMEA sales increased 9% with relative strength in mobile computing and services. We saw growth across most countries. Retail and transportation and logistics, were particularly strong with continued traction in RFID. Sales in our Asia-Pacific region were up 7% with relative strength in our mobile computing and printing categories. We realized strong growth in Australia, Southeast Asia and China. Latin America sales were flat, primarily due to lower sales in Mexico due to continued geopolitical weakness. Adjusted gross margin expanded 100% -- 100 basis points from the prior year period, primarily driven by go-to-market discipline, as well as increased productivity and cost efficiencies, particularly in support services.Consistent with one of our key operating principle, adjusted operating expenses as a percentage of net sales improved 100 basis points from the prior year period. We have a balance approach of driving operating leverage, while continuing to make prudent investments in growth initiatives. Second quarter 2019, adjusted EBITDA margin was 21.2%, a 150 basis point increase from the prior year period. We drove non-GAAP earnings diluted share of $3.02, a 22% year-over-year increase.Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $165 million of free cash flow in the first half of 2019. This was $68 million lower than the prior year period, entirely due to the increased working capital usage in the first quarter, which we previously discussed. Free cash flow generation in the second quarter was higher than the prior year period, and we expect a strong second half performance. Our 1.8 times net debt to adjusted EBITDA ratio is below the midpoint of our targeted range of 1.5 to 2.5 times. As Anders mentioned, today we announced that our Board has authorized a $1 billion share repurchase program. Our strong balance sheet and cash flow profile enable us the flexibility to maintain our debt leverage target range, one, investing in our business, including acquisitions and repurchasing up to approximately 2% of our shares outstanding annually.Let us turn to our outlook on Slide 8. We're currently cycling our prior year third quarter exceptional performance. That said, net sales growth in Q3 2019 is expected to be between 3% and 5%, which assumes an approximately 2 percentage point positive impact from recent acquisitions and then approximately 1 percentage point negative impact from foreign currency exchanges. We believe Q3 2019 adjusted EBITDA margin would be approximately 22%, which assumes higher gross margin and operating expense leverage from the prior year. Non-GAAP diluted EPS is expect -- is expected to be in the range of $3.15 to $3.35. We are maintaining our full year 2019 net sales growth to be between 5% and 8%, which assumes approximately 2 percentage point positive impact from recent acquisitions and approximately 1 percentage point negative impact from foreign currency rate changes.Given that we are assuming about 50 basis points additional adverse impact in FX from our prior guide, we have effectively increased our organic growth guide by approximately 50 basis points. Full year 2019 adjusted EBITDA margin is now expected to be approximately 22%, an improvement from 2018 and our prior guide. Our team has been driving gross margin improvement and operating leverage at the high-end of our expectations. We continue to expect that full year 2019 free cash flow will exceed $625 million. Unlike 2018, we assume that working capital would be a use of cash in 2019. You can see other full year 2019 modeling assumptions on Slide 8.With that, I will turn the call back to Anders to discuss the progress we are making on our Enterprise Asset Intelligence vision. Anders Gustafsson : Thank you, Olivier. We are very pleased with our Q2 results and the momentum we see in our business.Now turning to Slide 10; we are advancing our Enterprise Asset Intelligence Vision to enable every frontline asset and worker to be visible, connected and optimally utilized. Zebra enables this vision by providing a digital view of the entire enterprise. Our products and solutions send data from assets, products and processes. This information including status and location is analyzed in real-time to determine the best possible operational action to improve productivity and provide greater insight into business operations.An integral part of our solutions ecosystem is Savanna, our cloud enablement platform that connects our devices and powers our intelligent edge solutions. Savanna benefits our partners and customers by providing visibility of workflows at the frontline of business. In June, we launched Savanna Data Services, which delivers sensor information, data analytics and event triggers through application programming interfaces or APIs to enable workflow optimization. Savanna supports developers through a self-service web portal with monetizable API-based data services, which empowers our partner community and end customers to build secure, scalable, digital services with ease and speed. It is a clear step forward in elevating our reputation as a solutions provider, enabling customers to enhance the analytics layer of the sense analyze act framework. As a proof point, Dawdle, a London based e-commerce service provider has been an early user of Savanna Data Services. They have been leveraging print from cloud APIs to reduce the deployment time of its ship from store proposition.Longer term, they expect to use the blockchain ledger of Savanna to distribute data across the supply chain to reduce return handling costs and get items back into inventory more quickly. We've also been advancing our Enterprise Asset Intelligence vision through acquisitions, the most recent being Profitect in Q2. Profitect complements our growing suite of other Zebra software applications including Workforce Connect, MotionWorks and our visibility services offering. Additional Profitect's offerings, its technology and talented team, expands our relevancy deeper and wider in global retail operations. The solution identifies areas for improving inventory and pricing accuracy, idle stocks and sellable merchandise and assortment discrepancies. Overtime, we expect to leverage Profitect's artificial intelligence and machine learning capabilities to address all of the vertical markets we serve.We also intend to incorporate Profitect's functionality into Savanna to further build out the analyze and act layers of the platform, benefiting both Zebra and our partners. The acquisitions we have made over the past year enable us to scale attractive existing categories where we are underpenetrated and enter high growth new markets outside the core, that advance us as a solutions provider. In addition to Profitect, Temptime has enabled us to expand our smart supplies offering into time temperature monitoring and Xplore has augmented our enterprise tablet portfolio with best-in-class ultra-rugged form factors.We have made solid progress on our Enterprise Asset Intelligence vision, as we help businesses across many industries digitize their operations and gain a performance edge. We are doing this by leveraging our deep knowledge of workflows and capitalizing on key technology megatrends including mobility, automation, cloud computing and the proliferation of smart devices and sensors, all of which create opportunities for Zebra.Slide 11 highlights the range of vertical markets we serve, including health care, retail and e-commerce, transportation and logistics and manufacturing, as well as other attractive markets that broaden and diversify our growth opportunities. In healthcare, our fastest growing vertical, our solutions translate into more efficient operations and increased patient safety. We recently implemented a clinical mobility solution with Nemours Children's Health System that empowers its staff to improve operations at its two hospitals, including remote patient monitoring. This customer replaced its smartphone consumer devices used by nurses with our healthcare purposed TC51 mobile computers to improve connectivity, durability and collaboration. We helped to provide a seamless bridge between the medical devices and electronic health records for a 360 degree real time view of patient health and status for optimal care. Our improved capabilities are as a solutions provider are moving us up the stack with healthcare providers like Nemours.In retail and e-commerce, we are a trusted strategic partner with the leaders in this space. We have found that most retailers see significant opportunity for improvement with their omnichannel fulfillment capabilities as they stretch to meet consumers' heightened expectations. Our customers are deploying a wide range of increasingly complex solutions that can include RFID, professional services and software applications such as Workforce Connect. We are also seeing an increasing number of our customers equipping their associates and shoppers with our mobile computers that empower them with the real-time information they need to successfully execute omnichannel fulfillment and elevate the overall in-store experience. This increase level of tech investment delivers a high ROI to the customer and is necessary to compete effectively. The prominent department store chain recently chose to upgrade its mobile computers in their stores with our latest Android powered TC52 model to enable their new omnichannel strategy. As this retailer rolls out our solution, we are providing professional and support services to ensure a smooth transition. We have seen many competitive takeaways like this one, with prominent retail and e-commerce players, who require a best-in-class enterprise grade solution.In transportation and logistics, most customers site capacity utilization, labor shortages and expedited delivery requirements as top challenges they face over the coming years. By helping to drive increased productivity and efficiencies, Zebra can help bring their operations to higher level with their current workforce and resources. The results of our recent warehouse vision study, show that more than three quarters of respondents say that, augmenting workers with technology is the best way to introduce automation in the warehouse. As a thought leader and trusted advisor, we are demonstrating a number of proven ways to meet this need. For example, Zebra will be rolling out a solution with the global transportation and logistics customer over the next year. We will be enhancing the effectiveness of parts of delivery in Europe with that solution featuring TC57 mobile computers, various professional and support services, and the monitoring of the load density of the customers air cargo containers.In manufacturing, our customers are looking for trusted partners, who can increase their operational visibility and efficiency. A notable example can be found with a major Asian contract manufacturer, who is rolling out our RFID solutions on its plant floor, to increase accuracy and reduce costs. Beyond our traditional verticals, we are excited about our opportunity in adjacent markets. For example, we are well positioned to make new inroads into the federal public safety market. Our TC57 and TC77 enterprise class mobile computers as well as our L10 and XSLATE R12 rugged tablets are now certified for use on the FirstNet network. Our offering is ideal for a wide variety of mission-critical applications inside and outside the four walls.In summary, we are excited about the innovative solutions we are implementing with a diverse set of customers worldwide to address their increasingly complex business priorities. The success we are realizing in the marketplace demonstrates the progress we are making with our Enterprise Asset Intelligence vision. We continue to focus our investments in solutions that extend our lead in the industry and drive shareholder value.Now, I'll hand the call over to Mike. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question today comes from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : Thanks for taking my question. Can you talk about -- so just digging into your guidance, so implies a fairly large ramp in the Q4, and Q3, it looks a little bit more muted? Can you talk about the -- which reflected in your guide, and I get the sense your margins are strong, but I get the sense your holding back a little bit on the top line there? So what's -- how did you come up with that guide? Olivier Leonetti : Good morning, Andrew. So we are guiding at this stage for nominal growth of about 3% to 5%. That would translate into a 2% to 4% on an organic basis. And if you remember last year in Q3, we had a very strong growth about 15%. So you have to take this guide in the context of a tough compare and to answer a bit more specifically to your question. At this stage, we are planning to have growth across our portfolio either from a product standpoint or regional standpoints. And we feel good about the guide, we are presenting to you today, based upon our ability today to cover key trends in the market. From a profitability standpoint, our guide includes leverage on the EBITDA line at about 22%, that would be about 100 basis point improvement in term of profitability. And as you have seen now for a few quarters where we believe, we have OpEx or gross margin leverage in the P&L due to the operational discipline we have in the company and that is also reflected in our guide. Andrew Buscaglia : Got it. And I think there's a little bit of confusion with regards to when your bigger competitors having substantially weaker results. What -- I guess, can you comment on, what you're seeing? Do you think -- I think you're gaining share generally. What are you seeing in the channel and -- yes, if you could talk a little bit more about inventories at distributors? Anders Gustafsson : Yes. First -- I won't be able to comment on other competitors results or anything like that, but we feel good about where we are. We have a strong and compelling vision for the company that we have been executing diligently on over the last several years, specifically in Q2. I think we executed very well and drove strong profitable growth across the company. We had solid performance in Asia Pac, EMEA and North America both direct and through our channel. We saw from a product perspective, particular strength in our mobile computing portfolio and services and from the vertical perspective, retail, e-commerce as well as transportation logistics were strong performers. But all that verticals were up for the first half. And yes, we have -- today, we have a strong competitive position. Basically on the base of the strength of our product portfolio, and I think also our value propositions are resonating very well with our customers. And specifically on the inventory position, let's say, we manage channel inventory very carefully every quarter all the time. We continue to have the channel inventory be within -- comfortably would be within the band of what we consider to be normal. So there's nothing unusual for us in that area. And maybe sales, so we compensate our sales people on the sales out. So there is no incentive to drive, say overstocking of the channel. Andrew Buscaglia : Okay, got it. Thanks guys. Operator : The next question comes from Jim Ricchiuti with Needham & Company. Please go ahead. James Ricchiuti : Thank you, good morning. I'm wondering as we look out at the second half guidance, what is that I assume for larger deals. I wonder, can you characterize your larger deal pipeline, you clearly had some -- it sounds like some competitive wins thus far this year. Olivier Leonetti : So we are not planning and then normal amount of large deals. They are not totally contemplated in the guide, we are putting forward, Jim, and maybe Joe can complement. Joe Heel : Yes. Large deals have become an important part of our portfolio. And in the second half, we expect a number of large deals, but as Olivier said, not unusable for that part of the year, in particular Q4, is usually a large deal quarter and we don't expect an unusual number of large deals in this year relative to previous years. James Ricchiuti : Thank you. And just my follow-up question, just as it relates to the macro environment, it seems like you're seeing pretty good strength in your core markets. But where are you, if at all seeing signs of potential caution from the customer base? Are you seeing it in the smaller markets like manufacturing, which is very fragmented, but still a reasonably sizable part of your business? Anders Gustafsson : I'd start by saying that our solutions have become much more foundational to our customers' strategies. They are -- our customers are much more dependent on our type of technology to be able to execute on their top priorities. Things like we help them increase workflow efficiencies particularly important in tight labor markets. We provide real-time guidance to the front line of their employees, and hence the customer patient experience and we do all this through our partner ecosystems. So our business -- we've worked hard on making sure that we have diversified our business as much as we can across geographies, products and verticals. And I think that is helping us. Every quarter, we'll see some countries or some verticals have some ups and downs, this is no different. Last year was maybe a little unusual in that -- it was very broad based, but we mentioned last quarter and it still holds through that -- Mexico would be a little soft based on geopolitical environment, but generally, we saw a strong performance across most of our sub-regions across the world. James Ricchiuti : Thank you. Operator : The next question today comes from Paul Coster with JP Morgan. Please go ahead. Paul Coster : Yes, thanks for taking my question. So Anders, I know many investors are concerned the so-called Androids upgrade cycle might be peaking. Can you give us your latest thoughts on where we stand in the replacement of Windows CE and Windows Mobile? And why you believe that the growth might persist beyond this year? Anders Gustafsson : Yes. First, I'd say -- from a broader perspective, I'd say that we are seeing a broad and innovative portfolio of products and solutions more broadly across the entire portfolio driving solid growth across the business. So Android and mobile computing is one aspect. But this is something that's much broader for us than one product line. Again, I go back to some of the things that I think differentiates us in the market of some things like our deep understanding of work flows and giving our customers the ability to leverage data at the edge to take more good real-time decisions to help to optimize and drive their businesses. So we're very excited about opportunities in all of our product lines. And there's several megatrends that support the growth like the on-demand economy.Now specifically to mobile computing, we have seen great growth over several years now. And we're certainly very excited about the progress we made and the outlook we have for that business. There are several drivers for the growth we've seen. Now there's things like a number of new use cases they are being deployed that's underpinned by the strong portfolio of software capabilities that we have developed for our mobile computing portfolio. So this new use cases, I think, the best being long-term growth drivers. A couple of examples, a lot of our customers are looking to consolidate multiple devices or multiple applications onto our mobile computers. One example will be many verticals and many customers are using or have historically used dedicated PBX or wireless PBX phones for people. Now with our Workforce Connect application, we can consolidate that device and that use case onto our mobile computers.Another trend we're seeing is that our customers are looking to put more and more technology in the hands of all their people. So pushing technology further into the organization, so the trend of having a device for everybody is gaining a lot of traction. And I'd say also our big screen portfolio of mobile computers, so tablets and vehicle-mounted computers are seeing a lot of new use cases and interest also. Now specifically to the Android transition, it clearly has been the catalyst for growth for us. We still have over 60% market share in Android. And the overall market -- mobile computing market is now more than 50% made up of Android devices. We still think that there's lots of potential in this market. We anticipate or we forecast that there is still about approximately 10 million legacy Windows devices in the market. And these devices are not all going to be converted to Android by 2020, when Microsoft stops supporting their older mobile operating systems. So this conversion cycle will take longer. We see good drivers.Our software continues to be a great driver and new devices -- we released some new devices specifically to capitalize on the warehouse transition, that's ramping up now, so our MC33 and MC93 products. So Android is clearly a great driver, but there's only one of several long-term drivers for our mobile computing business. Paul Coster : Quick follow-up. You're obviously investing a lot in software. You're acquiring your way into software data services, cloud applications, APIs and some. How is this expressed in your business model, because I know some folks looking in vain for the software line and it's not there. So just translate into margin improvement on the hardware side? Anders Gustafsson : Well, first I'll give you a couple of thoughts around our software business and the strategy for it. We've gone from having kind of made historically, say downward devices to smarter devices and now more smart infrastructure. So very much focused on driving a performance edge for our customers and its entire portfolio and software has become a great differentiator for us. Our Software DNA layer makes it lot easier for our customers to integrate, manage and their suites of Zebra products. So the -- specifically we launched the Savanna Data Services, that's a great new capability for us that enables Zebra and our partners and our customers to more easily access data as well as enable Zebra to monetize that data. It also then helps demonstrate thought leadership for us and moves us up the stack as a solutions provider and it will help pull through our broader solutions as well. Software is still a modest part of our overall business, but software as a differentiator is something that's embedded into all our devices also, but we do expect it to continue to be a bigger and bigger part of our business. Olivier Leonetti : And to complement Paul on the business model impact. Clearly, the strong gross margin performance of the company, which we have posted now for several quarters is also due to the strength of the software offering and you don't see that necessarily in the software line in the P&L, but it's reflected also in the strong gross margin we have hardware, as Anders said. And these software offering allows us to sell based upon return on investment basis rather than just speed and feeds. And we are as a result, perceived as a thought leader in the industry and that is reflected in the way we price. Paul Coster : Thank you. Operator : The next question today comes from Brian Drab with William Blair. Please go ahead. Brian Drab : Hi, good morning. I was wondering if we could just maybe drill into Slide 6 a little further and just curious on the 3% growth in AIT. Can you talk about may be just specifically within that segment, first, in terms of end markets, retail manufacturing, P&L, which were above or below 3%? And then it would be great too, if you could mention in terms of geographies for AIT, which were above or below 3%? Thanks. Anders Gustafsson : Yes. I will start here. So first, AIT grew in Q2. We did see fewer large deals in Q2 2019 versus last year. So we were not able to replicate all of the large deals that we saw last year, and they were mostly in retail but also some other ones. In the -- within our printing portfolio, I'd call out RFID printers as a particularly strong growing segment of our portfolio. But overall, our printer portfolio, overall AIT portfolio is positioned very well, and we like the grow prospects we see in the market here. We do have a strong and fresh portfolio of smart connected printers, which has really an unrivaled manageability through our Link-OS and that's a great differentiator. From a regional portfolio, we saw good growth from printing in Asia Pac, and we saw it in Europe particularly. I think I would call out those two as the strongest areas for us. Even China had good growth for us, which is a good printing market. So we were up high single digits in China as well. So if we are offsetting some of the discrete electronics manufacturing by penetrating other manufacturing sectors in China like automotive and other heavier manufacturing. Does that answer your question? Brian Drab : Yes. I mean, I was hoping maybe -- yes, that's all helpful, obviously. But I was hoping maybe more specifically like -- and I guess you're saying retail was below 3% and manufacturing and T&L were above? I mean, I still feel like I'm guessing at the specific answer to my question. I'm trying to read between the lines and I guess 3% from the other regions were below -- I mean some are above and below. I'm just trying to reconcile this with what we're seeing for some of the CapEx trends in these end markets. Olivier Leonetti : The way we model our printing business is actually we are not seeing today any key outliers as Anders and Joe mentioned earlier, you can have a vertical of particular country being an outlier in a particular quarter. But we would characterize printing as being strong across the majority of the portfolio. That was the case in Q2 and that's also our assumption in the rest of the year. No particular outliers really, Brian. Brian Drab : Okay, thanks. And then just a follow-up on a different topic; so the Android business is doing very well. And these products are relatively new in your portfolio and whenever there's a new product, obviously, there's opportunity to take some of the manufacturing cost out over time. And I'm wondering is that a key lever that you might be able to pull over time as kind of optimizing the cost to manufacture these Android products? Anders Gustafsson : So we always look at -- we do value engineering routinely as part of our product roadmaps and look at bringing out costs and based on volume, we renegotiate pricing with our suppliers. I would say here that we have been actively doing this for some time. And the cost -- the margin position now on Android products are very much in line with the margin position on our legacy Windows devices. So we -- this is not something that we haven't done. This is something that we have been doing actively for some time. Brian Drab : All right. Okay, thanks. That's helpful. Thank you. Operator : The next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. Question for you, Olivier, when you're talking through the geographical growth, it sounds like retail and healthcare continues to be a significant driver of that growth. Quite honestly, it's been several years we're seeing that. And we're expecting to perhaps say T&L and warehousing and manufacturing perhaps contribute more to that growth here this year and perhaps into next year. Can you provide a little more color on the growth you're seeing in those segments? And are they jumping onto the Android train? Or is there still a little bit time before you see it happening? Anders Gustafsson : So I'll take that for you here. But first, you asked basically about T&L and manufacturing and any other kind of vertical for us. But transportation and logistics goes up very strong in Q2. It's up double-digit in Q2. It tends to have a very solid growth profile. If you look at the last 18 months, T&L has done very well. There is some strong secular trends that supports that. You see T&L providers are facing expedited delivery times, labor shortages. A number of new economics that comes with delivering one box every household versus a number of boxes to corporations. So all of those things are kind of being good backdrop for us to talk about how we can help introduce automation and technology to help address those issues. I think we are uniquely positioned in many ways to help our customers drive those or capitalize on those issues. In transportation and logistics, the Android is having a particular play now in the warehouse transition. The warehouse is now starting to really ramp moving from Microsoft to Android. And we see our Intelligent Edge Solution. So SmartPack, location solutions, RFID and so forth to also be particularly well-suited for the P&L space and the warehouse and giving us thought leadership position also.If we then move to manufacturing; manufacturing was not as quite as robust in Q2. But it has performed very well over the last 18 months or so. We -- our portfolio is increasing, enabling industry folder out. So we see manufacturing as a sizable market opportunity for us. Manufacturers are looking for increased visibility into their supply chain. And the Android transition is also accelerating within manufacturing. Also, our location solutions has manufacturing as its primary vertical market. Joe Heel : I'd like to add one more thing. This is Joe Heel. We spoke before about the fact that of the legacy Windows devices, about 10 million, we think remain to be replaced in the market. And if you look into more detail into that, our remaining installed base, we believe the majority of that is in the warehousing and manufacturing space. For a variety of reasons, those customers have been slower to adopt those technologies. But we do expect that that adoption will now pick up. And you see this reflected in the fact that we've released just in the past quarter the MC33 -- the MC93, I apologize, and before that, the MC33, which are the flagship devices that serve that warehousing manufacturing market. And we're seeing good adoption in that space as evidence of the Android transition now focusing heavily on warehousing manufacturing going forward. Keith Housum : Great, very helpful. And then I get this question often, I know it's a very imprecise science year. But the 9 million to 10 million mobile computers that we think still have or installed windows. That number really hasn't moved probably over the past year or maybe in 18 months that we've been talking about it. Is there anymore precision that we can get on -- are you guys are getting at a number to say that, that number still remains at roughly that same range? Or you still adjust, this is our best guess based on incomplete data that's out there? Anders Gustafsson : It is incomplete data, I guess, and that -- we can't go and identify each and every one of those 10 million devices. But it has come down in the numbers we've used on our calls over the last 18 months has come down. But I'd say the reason hasn't come down may be faster is that -- there was only last year that the market switch to be more -- over 50% Android from Microsoft. So there's still a substantial amount of legacy Windows devices being sold into the market. So while we are, say, eating into the installed base from one end, we're adding to it or the industry is adding to it on the other end with new legacy devices. Keith Housum : Yes, good one. Joe Heel : I think the one dynamic that has perhaps surprised us a bit as well is that in those segments that still have very high penetration of Windows mobile computers, our customers have continued to buy mobile computers at relatively high rates. There are some markets around the world where more than 50% of the mobile computing revenues are still in the Windows category. So that's prolonged. The Windows existence and -- will also prolong the transition cycle to Android going forward. Anders Gustafsson : So maybe I'd add a couple of questions that kind of talks about Android being having peaked or being close to peaking. We certainly don't see that. We expect the Android transition to continue for some time, and when you then couple that with the proliferation of new use cases and deeper penetration of devices into corporations, we believe mobile computing is going to be a good growth business for some time. Keith Housum : Got you. Good point. And if I could just squeeze one more in here in terms of the share repurchase. Did I hear you guys say that you guys are on a cap the share repurchases at 2% of the share outstanding annually? And then are you guys willing to take on additional debt to be opportunistic with the share repurchases? Olivier Leonetti : So Keith, you summarized it well in term of what we're planning to do. So let me give a bit of background of why the buyback. So one, we achieve now our -- the bottom of our leverage range of about 1.5. We will achieve that in the third quarter start of the fourth quarter. That's why we believe that buyback should be on the table. And we believe that the strength of the cash flow of the company will allow us to invest in the business, invest in M&A and still do a buyback. And to your point, we plan to buy back within a 12 months period, about 2% of the share outstanding. Would we go higher opportunistically? We would see. Keith Housum : Great. And so -- are you willing to take on additional debt in order to fund those debt repurchases? Olivier Leonetti : We don't think we need to do that. The strength of the cash flow will allow us to finance buyback with the cash of the company. Keith Housum : Great, thanks guys. I appreciate it. Operator : The next question comes from Richard Eastman with Baird. Please go ahead. Richard Eastman : Yes, good morning. Could Olivier or Anders, could you just speak to pricing and price capture in the quarter? And what actions were taken if any on pricing in both the channel and quite frankly, I know and the larger projects, it is a bid process. But has pricing inched up on the large bid opportunities as well? Anders Gustafsson : So we work in a competitive environment. We've had strong competitors, and it's always been a competitive market. We've been able to focus very much -- our attention on making sure that we have very compelling portfolio of solutions that are attracted to our customers, and we are certainly looking to see us getting a premium in the market. I think we have been able to achieve that for a long time. Obviously, we have to compete on occasion for deals, but we've so far been able to do that well and offsetting any price pressure with additional cost reductions to maintain or even now increase our gross margins. But I wouldn't characterize that the price pressure or the competitiveness of the market is particularly different today than it was three months ago or six months ago. Maybe, Joe, you have any further comments? Joe Heel : Our margin picture always has two parts. We already talked about the large deals, Anders described that very well. And the other part is what happens in our run rate, which is the pricing of the transactions. It goes primarily in smaller quantities to distribution. And we've developed, I think, a very good level of expertise to work closely with our distributors and partners to understand exactly where the market price is and to price that in the competitive way so that we can continue to grow. And we've been pleased with our ability to realize a good pricing in that segment, while continuing to gain share. Richard Eastman : Could I -- and just to put some clarity on that. When I look at the adjusted gross margin year-over-year, I think, it's up 100 bps, 100 basis points. Is there a price capture piece of that? The price year-over-year on a consolidated basis with the channel, with the products, did it add 20 basis points to that gross margin improvement? Or is there a number, Olivier, that you could just slice out of that and say, look, on a consolidated basis, both through channel, through direct that we're capturing so many basis points of that 100 as price? Olivier Leonetti : It's difficult to answer with precision. We -- the strength of the margin is due to multiple drivers. The way we price the value of what we offer and also the supply chain efficiencies that I mentioned earlier. I wouldn't point to one in particular, and it's very difficult to pass all the pieces, Richard. Richard Eastman : Okay. Is -- sorry. Anders Gustafsson : No, I was going to say, we mentioned earlier software becoming a bigger part of our portfolio. That's helpful. I should also mention services has been able to improve margins quite nicely in Q2. And we expect that to continue to be a strong margin contributor. Richard Eastman : Okay. And then could I ask again. Just against that consolidated 7% core growth for the quarter. Did the channel grow at or above that in the direct business? I think you alluded to some of the retail wins maybe not as great this quarter. But just a growth rate on large direct wins averse the channel? How did it look relative to the 7% core? Anders Gustafsson : So one, it does change quarter-to-quarter. In Q2, our direct sales were stronger than the growth in the channel. But in Q1, we saw it the other way. There the channel is stronger than the direct sales of the large deals. Richard Eastman : Okay. And just my last question; I'm looking at maybe explore revenue was a little bit below where I thought it might come in. Now arguably, we just straight line the acquired revenue per quarter. But I'm curious if you could maybe just speak a little bit to the Xplore acquisition and maybe what's -- how you're may be repositioning or investing in their product portfolio to whether you're expanding their adjacent markets or what's the investment strategy at Xplore? And what's the hope for benefit there going forward? Anders Gustafsson : Yes. As a reminder, first, we bought Xplore to really help strengthen our broader big screen mobile computing portfolio, right. That includes Xplore, our ET5 portfolio tablets in our vehicle-mounted computers. And this portfolio as a whole has been growing very nicely and that includes Q2. We had very good growth across the portfolio in Q2. And since we acquired Xplore, it has really helped us cement us as the clear number two in the rugged tablet space. We think -- we continue to think of that is a very attractive market. Our new Xplore products have been very well received, and we have our first Android-powered Xplore tablets now available in the market. The integration is going well. And we now working on really optimizing the go-to-market to help drive scale and efficiencies. We've got in all -- this is -- Xplore is now available for all our partners to resell. And we're looking to see how do we capitalize also in some of the near adjacencies where Xplore has some strength that hasn't been historical strengths of Zebra. And Joe, can help. Joe Heel : Yes. So perhaps you asked about, how we are investing and as you said repositioning. And I would specifically identify two things. The first, Anders, just identified, which is the tablet market has additional vertical depth that outside of the core verticals that we've been talking about Zebra for many quarters now. Things like government, public safety and utility segments would be examples of such areas. And we are repositioning and investing in penetrating those segments, number one. And number two would be, the announcement that we just made to launch the L10 Android version. I think it's a very important additional investment. Why is that? Because it enables us to leverage that strength that we talked about earlier. Our software capabilities, our mobility DNA capabilities in Android, we can now leverage that into tablet space, and we think that will differentiate us. So those are two areas of investment we've made. Richard Eastman : Okay, very good. Thank you. Operator : The next question comes from James Faucette with Morgan Stanley. Please go ahead. Erik Lapinski : Hi, this is Erik on for James. Thanks for taking the question. You mentioned a global customer roll-out in transportations and logistics including low-density monitoring. Just wanted to ask, is this including your SmartPack solution? And maybe on that, if you can talk about how trials have been progressing, if you have more color on just timing to prove ROI there? Anders Gustafsson : Yes. So that specific reference was to SmartPack. And our broader portfolio of what we call Intelligent Edge Solution, SmartPack, SmartLens, RFID, location solutions and so forth, is progressing nicely. We have a growing pipeline of pilots. And we're certainly working hard to make sure we can convert all of those pilots into proper commercial roll-outs over time. But we feel, we're making good progress and it's also truly helping us or position Zebra as a thought leader and it pulls through a lot of our other products as well. And Joe, have some more comments. Joe Heel : Yes. Two more sort of flavors of color here. You can think about the expansion first in the way that Anders mentioned going from smaller trials where we're really trying to prove the technology and also prove the ROI of the solution to the customer to roll-outs that include hundreds or thousands of back doors where we now monitor the loading. And we now have multiple customers where we are rolled out in that sense. And we see that continue to expand. The other direction of expansion is there are multiple use cases within the solution. So you can monitor not only the loading of trailers, but you can also monitor the loading of air cargo containers for example. And there are other examples of how this technology and this solution can be expanded. We are doing so in both of these directions. Erik Lapinski : That's great, that's really helpful. Thank you. And then maybe just if you could us get a sense of how you're thinking about your capital allocation strategy given the newly announced share repurchase program? And if that potentially impacts any plans for M&A and your strategy there? Olivier Leonetti : So the priority for us is to invest in our business, either organically and inorganically. We believe that M&A would be a strong vector of growth for the company. And we believe that based upon the strong cash flow of Zebra that we can invest in the business and still return excess cash to a buy back. So no big change at this stage, Erik. And as we have reached now the bottom of our targeted leverage range, we believe we can do the three investments I've mentioned, organic, inorganic and buyback. Erik Lapinski : That's great. Thank you. Operator : And our last question today comes from Jeffrey Kessler with Imperial. Please go ahead. Jeffrey Kessler : Thank you, and thank you for getting me on the call. I wanted -- you alluded a little bit to the institutional market before. I want to know if you could update us a little bit on penetration into not just what you call safe cities, government civil projects, but also the education market, K-12 and college, which seems to be in other areas of security and tracking and AIDC. We're seeing a lot of growth in that specific market [indiscernible] gestating for so long. Anders Gustafsson : Yes, I'll start and then Joe will provide some extra color. But first, on the public safety market. That we talked about that on the call today. We think that is an attractive market opportunity for us in the range of several hundred millions of dollars. And I think its market has pushed to grow materially as rugged computers becomes a valid choice and enables new use cases there. Historically, the public safety market has been made up of either kind of traditional dedicated first responder devices that you are familiar with. But also there's been a lot of consumer devices in that space. And we think that there is room for our mobile computers as well as a good way of augmenting that market and providing growth for Zebra. And maybe some other thoughts from Joe here. Joe Heel : Yes. If you look at the public sector opportunities, including education, I think, we would say we see the majority of the opportunity in the public safety first, and in government, second. I think that would be sort of our order of opportunity priority at the moment. Jeffrey Kessler : Okay. And secondly, I'm wondering if you -- have you taken into account the -- with regard to your -- with Forex guidance, the possibility that Forex could be better or worse and expected in particularly places like the UK if things don't get organized there? Is that in the guidance already? Olivier Leonetti : It is. And by the way, FX at the moment is a headwind. And as we've said before, we have multiple levers to manage the P&L of the company. And we believe that we can manage FX as well. Jeffrey Kessler : All right, excellent. Olivier Leonetti : Thank you. Jeffrey Kessler : Go ahead, I'm sorry. Olivier Leonetti : That's what it, Jefferey. Jeffrey Kessler : Okay. Thank you very much. Olivier Leonetti : You take care. Operator : This concludes our question-and-answer session. I would like to turn the call back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Thank you. So as we wrap up, I want to thank the Zebra team and our partners for another quarter of excellent execution and for delivering strong financial results. I also want to welcome the Profitect team to Zebra. Have a great day, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
|
ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,019
| 4
|
2019Q4
|
2019Q3
|
2019-10-29
| 12.058
| 12.375
| 13.359
| 13.715
| null | 15.02
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Operator : Good day, and welcome to the Q3 2019 Zebra Technologies Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Michael Steele : Good morning. Thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission.During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of the slide presentation.This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will start with our third quarter highlights. Olivier will then provide more detail on the financials, discussing our fourth quarter outlook and our decision to diversify our global sourcing footprint. Anders will conclude with progress made on Zebra's Enterprise Asset Intelligence vision. Following their prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us, as we take your questions.Also throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Profitect, Xplore Technologies, and Temptime businesses. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least one-year.Now I'll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team executed well and drove profitable growth in the third quarter. As you can see on Slide 4, we reported net sales growth of 3%, which was on top of 15% growth in the prior year period. And adjusted EBITDA margin of 22.7%, a 160 basis points year-over-year improvement. And record quarterly non-GAAP diluted earnings per share of $3.43, a 19% increase from the prior year.Growth in our North America and EMEA regions was partially offset by soft spending environment in China. However, our diversified business is enabling us to successfully navigate an uneven global macro economy. We continue to extend our lead in enterprise mobile computing through the broadest and deepest portfolio offering. Enterprise workers are utilizing our mobile computers for an increasing number of use cases. We are also benefiting from leading the multi-year transition to Android from the Windows Operating System.Services was a bright spot, growing double digits, as we realized higher support and repair attach rates. RFID, location solutions, and Zebra Retail Solution also performed particularly well in the quarter. Operational discipline and cost efficiencies enabled us to drive profitable growth without compromising investments in our organic growth and in our employees.Also of note, we confirmed our decision to diversify the sourcing of most of our U.S. volumes out of China. This work together with other actions we have taken is expected to substantially mitigate the recently enacted Section 301 List 4 tariffs by mid-2020.Overall, we are pleased that our value proposition and industry leading portfolio of products and solutions is resonating with customers worldwide. Our team is winning business with a broad range of leading enterprises, including our largest win in Zebra's history with the U.S. Postal Service, which we announced this morning. We have solid momentum in our business as we finish the year and enter 2020.With that, I will now turn the call over to Olivier to review our Q3 financial results and discuss our Q4 outlook and the initiative to diversify our product sourcing footprint. Olivier Leonetti : Thank you, Anders. Let us start with the P&L. As you can see on Slide 6, net sales grew 3.5% in the third quarter, which translated to 3% on an organic basis before the impacts of currencies and acquisitions. We saw growth in each of our reporting segments.Enterprise Visibility & Mobility segment sales increased 2.7%, led by growth in mobile computing and support services. Asset Intelligence & Tracking segment sales increased 3.5% with growth in printing, services, location solutions and Zebra Retail Solution.Turning to our regions. In North America, sales grew 6%, primarily driven by strength in mobile computing, services and every RFID. We saw particular strength in healthcare, retail and transportation and logistics. EMEA sales increased 2% with quality strength in data capture, printing and services. We saw growth across most countries.Retail and transportation and logistics were particularly strong and we saw continued traction in RFID. Sales in our Asia Pacific region declined 5%, entirely due to macro softness in China. Latin America sales declined 2%, due to fewer large orders in Mexico.Adjusted gross margin expanded 130 basis point from the prior year period, primarily driven by go-to-market discipline, cost efficiencies, and favorable business mix, all of which was partially offset by 20 basis point net impact from List 4 tariffs.Consistent with one of our key operating principles, we drove operating leverage, while continuing to make prudent investments in our growth initiatives. As a result, adjusted operating expenses as a percentage of net sales improved 70 basis points from the prior period.Third quarter 2019 adjusted EBITDA margin was 22.7%, a 160 basis points increase from the prior period. We drove non-GAAP earnings per diluted share of $3.43, a 19% year-over-year increase, which includes a $0.03 EPS impact from List 4 tariffs.Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $376 million of free cash flow in the first nine months of 2019. This was $36 million lower than the prior year period, entirely due to the increased working capital usage in the first quarter, which we previously discussed. Free cash flow generation in the second and third quarters was higher than the prior period, and we expect a strong finish to the year. Our 1.6 times net debt to adjusted EBITDA ratio is near the bottom of our target range of 1.5 to 2.5 times. We continue to pursue opportunities to lower our cost of debt while maintaining a flexible structure. We recently amended our credit agreement, which we lower our cost of borrowing by approximately 25 basis points, as the lower pricing becomes effective in late October. This action along with an expanded European accounts receivable factoring program positions us for lower of the whole cost of debt.In Q3, we repurchased $20 million of shares under our $1 billion share repurchase authorization. Our strong balance sheet, and free cash flow profile provides us the flexibility to maintain our debt leverage target range while investing in our business, including acquisitions, and returning capital to shareholders.Like many other technology companies, we have been sourcing the vast majority of our products from China. On Slide 8, we provide a detailed update on the impact to Zebra from the Section 301 tariffs on products imported to the U.S. As previously mentioned, Zebra is paying a 25% tariff on List 1 to 3, which includes certain scanners, components and accessories. We have substantially mitigated these tariffs through a combination of supply chain moves and pricing adjustments.Starting midyear, we began executing on an initiative to diversify our global sourcing footprint to mitigate List 4 tariffs that were announced in August, which impacts mobile computers and printers. We're working with our contract manufacturing partners to replicate production lines in order to move most of our U.S. volumes to broader Asia. These actions are expected to result in up to $30 million of one-time pre-tax charges through mid-2020, plus between $10 million to $15 million of capital expenditures. With these supply chain actions, along with modest price adjustments announced in September, we expect to substantially mitigate List 4 tariffs by mid-year 2020.In the fourth quarter, we expect these tariffs to negatively impact gross profits by $5 million to $10 million. The impact is expected to peak in the first quarter at between $15 million and $25 million, as we realize a full quarter of impact and should moderate through mid-2020, as we launch ultimate sources of supply. As we taken no action, we would face greater than $100 million of annualized tariff duties.Let us turn to our outlook on Slide 9. Net sales growth in Q4 2019 is expected to be between 4% and 6%, which is on top of an 11% nominal growth in the prior year period. This outlook assumes an approximately one percentage point, positive impact from recent acquisitions, and an approximately one percentage point negative impact from foreign currency changes.We believe Q4 2019 adjusted EBITDA margin would be between 22% and 23%, which assumes operating expense leverage and a lower gross margin entirely attributable to a $5 million to $10 million expected net gross margin impact from List 4 tariffs.Non-GAAP diluted EPS is expected to be the range of $3.55 to $3.75. The estimated negative net tariff impact is between $0.08 and $0.15, and we’re assuming a negligible impact from share repurchases. That said, we will be opportunistic with our share repurchase program.We continue to expect that full year 2019 free cash flow will exceed $625 million. You can see our order full year 2019 modeling assumptions on Slide 9.With that, I will turn the call back to Anders to discuss the progress we are making on our Enterprise Asset Intelligence vision. Anders Gustafsson : Thank you, Olivier. We expect to finish the year strong despite an uneven macroeconomic environment and incremental tariffs.Now turning to Slide 11. We are leveraging our deep knowledge of workflows to help businesses across many industries digitize their operations. Technology mega-trends including mobility, automation, cloud computing and the industrial Internet of Things are enabling us to drive new use cases and transform the workflows of our customers. We serve a wide range of vertical markets including retail and e-commerce, transportation and logistics, manufacturing, and healthcare, as well as other attractive markets that diversify our growth opportunities.Retail continues to be a vibrant vertical end market according to third party research firm IHL Group. There's also significant investment by retailers to improve omni-channel capabilities to meet increased customer expectations. We are a trusted strategic partner with many of the leading retailers and e-tailors. Recently a major U.S. grocer selected Zebra to roll out 39,000 of our TC52 mobile computers over the next two years. Store managers, department heads and associates will utilize them for multiple in-store applications, including customer service, inventory management, out of stocks, planner brand compliance, backdoor receiving and store audits.Another solution that is enabling retailers to drive a higher level of inventory accuracy is RFID, which we have been deploying to improve our customers' omni-channel capabilities. In the transportation and logistics space, we are seeing particularly strong demand for our solutions. For most IT and operational decision makers, labor recruitment and productivity are top challenges in the increasingly on-demand economy. With innovative solutions to drive increased productivity and efficiencies, Zebra can bring their operations to higher level with their current workforce and resources.We have secured a substantial number of global business wins recently, including our largest deal of all-time with the U.S. Postal Service, where we will help them deploy 300,000 TC77 mobile computers over the next several years. This solution will feature our mobility DNA suite of software tools that increase worker productivity and strengthen data security. We will also provide accessories, helpdesk support, repairs, maintenance, and software applications and development.In manufacturing, our customers are looking for trusted partners who can increase their operational visibility and efficiency. More than 80% of manufacturers plan to implement just in time operations within the next five years. Being able to stock only the items they need, reduces inventory cost and waste. We are pleased that three leading North America, dairy manufacturers recently chose Zebra's new TC77 mobile computers and ZQ520 mobile printers to enhance their direct store delivery workflows.The global healthcare system is facing significant challenges including staff shortages, rising costs and life threatening medical errors. Healthcare providers are turning to Zebra's technology to improve patient safety, increase staff workflow efficiency in comply with new regulations. We were recently awarded our largest European order of healthcare purposed TC52 mobile computers. This healthcare facility handles blood donations across more than 75 centers. We enable the customer to automate the patient journey and benefits from our superior product and software lifecycle management.Now turning to Slide 12. We are building upon our strong foundation, expanding our role as a solutions provider. Zebra is uniquely positioned to deliver Enterprise Asset Intelligence, which is our vision to enable every frontline asset and worker to be visible, connected and optimally utilized. We pursue this vision by advancing our capabilities in the sense and life act framework. Our products and solutions sense data from assets, products and processes, providing a digital view of the enterprise. This information including identity, location, and status is analyzed by the growing set of software solutions from Zebra or our industry leading channel partner and developer ecosystem, which then drives direction action naturally within frontline workflows.As we discussed last quarter, our organic investments and acquisitions have been enhancing our capabilities on the sense analyze act spectrum. Savanna, our data intelligence platform, connects our devices and powers our Intelligent Edge Solutions. Savanna benefits our partners and customers by providing visibility of workflows in giving perishable frontline data at home, so it can be leveraged via machine learning and artificial intelligence to generate new insights that drive business performance.As we have discussed, our acquisitions are advancing this vision, including Temptime’s temperature intelligence solutions, and explores ultra-rugged tablets. Additionally, Profitect’s prescriptive analytics solution compliments a growing suite of other Zebra software applications, including Workforce Connect, MotionWorks, and our visibility IQ managed services offering.Looking ahead, we are focused on investing in key growth areas that are adjacent to our core business and where we have the right to play. These include computer vision, machine learning, artificial intelligence, and intelligent automation. Computer vision is an exciting emerging sensing technology that enables the automatic extraction and understanding of useful information from a digital image or video. Zebra currently utilizes aspects of computer vision in new offerings such as SmartPack. However, we see substantial opportunities that are not yet sufficiently addressed in the marketplace. Because of this, we are investing in experienced engineering talent with a skillset and capabilities to address emerging computer vision use cases in various vertical markets. For example, in retail, computer vision software and tools can be used to assess inventory levels, support shelf scanning, monitor checkout activity, and enable frictionless checkout. Artificial intelligence and machine learning are critical to building out our analytical tools and capabilities.Our acquisition of Profitect and their talented team expands our relevancy deeper and wider in retail. And overtime, we will expect to leverage their capabilities to address additional vertical markets.We also intend to incorporate Profitect's functionality into Savanna to further build out the analyze and act layers of the platform. The rise of computer vision and analytics is driving a wave of intelligent automation, which is also natural extension of vision. Unlike repetitive automation, intelligent automation leverages our sense analyze act framework to improve workflow efficiency with or without human involvement. A key example is our recent venture investments in companies that specialize in the collaboration of humans and robots to fulfill orders in the warehouse.We look forward to showcasing new Zebra solutions that leverage these enabling technologies at the upcoming National Retail Federation trade show in January. Our customers’ demand information about what is happening at the operational edge of their business, so they can run smoother, safer and smarter. As a thought leader, Zebra is being requested by customers worldwide to address their increasingly complex business priorities. We are responding to this call by continuing to focus our investments in solutions that extend our lead in the industry, advance us as a broader solutions provider, and ultimately drive shareholder value.Now I'll hand the call back over to Mike. Michael Steele : Thank you, Anders. We will now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from James Ricchiuti of Needham & Company. Please go ahead. James Ricchiuti : Thank you. Good morning. I was wondering if your Q4 guidance reflects, perhaps reflects a larger than normal contribution from large projects? Anders Gustafsson : Our expectation for Q4 is that we will have a fairly normal distribution of large deals. We certainly don't expect it to be a higher proportion of larger deals than normal. James Ricchiuti : Okay, that's helpful. And you cited a couple of times the strength in RFID. And I'm wondering if there's any way you can provide a little bit more color on that the type of growth you're seeing maybe where you're getting traction in RFID and just your general view of that market? Thank you. Anders Gustafsson : Yeah. RFID is enabling our customers to gain real time visibility into their supply chains. And we're seeing an acceleration of growth in RFID, due to now being able to lower the cost of implementation having improved level of accuracy and enhanced software capabilities for RFID generally. Companies are also much more eager to innovate around their supply chains. So that's all driving a stronger adoption for RFID. And we've invested in both the product and the go-to-market side, so we have strengthened in our go-to-market capability to have greater reach and more skillsets in that area. And we are seeing strong double digit growth in our portfolio, which includes now strong performance in our fixed readers, but also our handheld readers, as well as industrial and mobile printers. We also have our location solutions activities within our LS, we talked about that as being up nicely in Q3 and some other newer solutions like SmartLens that level RFID to be able to always be able to sense inventory in a retail store as an example. So, overall RFID solutions are getting much more traction, interest from our customers and we’re participating nicely in that growth. James Ricchiuti : Thanks. One quick one. Was that UPS contract that you announced congrats on that by the way, were you be incumbents or was that a competitive win? Anders Gustafsson : So the contract was USPS, and we were not being incumbent. James Ricchiuti : Thank you. Operator : And our next question will come from James Faucette of Morgan Stanley. Please go ahead. Erik Lapinski : Hi. Erik on for James. Thanks for taking our question. Maybe just quick. During the quarter, you had released a couple press releases on wins in the public safety market. Is that becoming an interesting end market for you to focus on? Maybe anything we should be thinking about there? Anders Gustafsson : Yeah, I’ll start and then I’ll ask Joe Heel to add some extra color. But yeah, we think the public safety markets and first net as an example to be good, incremental growth opportunities for us. Those are several hundred million dollar markets that are today served predominantly by either very unique purpose built devices or consumer devices. And we believe that there’s a good opportunity to introduce our type of solutions in that market. And as you’ve seen, we’ve had a few press releases where we’ve been able to secure wins for our explore tablets and mobile computers and printers. So, we see that as an attractive new growth market for us. Joe Heel : And I would add – excuse me – that we’ve invested in resources dedicated specifically to serving the federal and state and local government entities in the United States, but also have added resources and other countries around the world to serve the market. The explore acquisition has brought to us some of those resources because explore, as you may know, already had a footprint in that particular area. And combined those resources are a push for us into this attractive new segment. Erik Lapinski : Thank you, it’s really helpful. And then maybe just on some of the strength you’re seeing in T&L, how much of an impact are newer solutions like SmartPack having on that? Olivier Leonetti : So, first, I’d say our value propositions are resonating across all our vertical markets. And all our vertical markets are up year-to-date, so we’re seeing good growth across all of them. But number of the challenges that customers are seeing around having to drive increased workflow efficiencies in tight labor markets being able to provide real time guidance to the front line of their business, and enhancing customer and patient experiences. All of those, our solutions here are much more foundational to us being able to help our customers execute on their strategies, specifically to T&L. Q3 was a particularly strong quarter for T&L Plus, we’re up double digits, strong double digits.We’ve seen very healthy secular trends that are helping to drive our growth, expedited delivery, labor shortages, ecommerce overall with the share volume of deliveries are great drivers. And the T&L industry, they’re introducing a lot of automation and technology to help address these challenges. And I’d say we are uniquely positioned to help them with these needs. The warehouse transition to Android is a great driver also in the T&L space as they have lots of warehouses obviously, and I’d say in the last year, we’ve actually won a number of very attractive postal contracts with the USPS being the most recent one. Our – you asked about some of our other solutions, so I would say our Intelligent Edge solutions like SmartPack, location solution, RFID wearables, they are all happy to demonstrate our thought leadership in the industry and office smaller base, they’re growing quite nicely. Erik Lapinski : Great, thank you. Operator : Our next question will come from Brian Drab of William Blair. Please go ahead. Brian Drab : Good morning. Thanks for taking my questions. First, I’m just looking at the tariffs and the guidance that you gave for the first quarter and in 2020. And my thinking about this correctly, if I should do the simple math and if you have a 20 million impact in the first quarter that we’re going to see maybe 170 or 200 basis points impact on gross margin and maybe around a $0.25 or $0.30 EPS impact. I don’t know, Olivier, if you could help put a finer point on that impact. Olivier Leonetti : That’s correct, Brian. Your math is correct. At the midpoint 20 million would be a good estimate. Brian Drab : Okay. Okay. Thanks. And then just on the USPS project, congratulations on that. And over what time period do you think that those 300,000 would be deployed? Anders Gustafsson : Yeah, firstly, we’re very pleased and proud of the trust that the USPS has placed in us to be that partner on this project. This project augments our relationship with them. USPS was already a customer of other products and solutions from Zebra. This is a multiyear contract. It’s the largest in our history. So, we are obviously very pleased with that. The social involves us rolling out 300,000 TC77 mobile computers, also the full suite of our mobility DNA software tools, other more customized software solutions as well as managed and professional services. This is a multiyear contract, so we would expect delivery to start ramping up in the first half of next year and go on for a couple of years, two years. Brian Drab : Okay, thanks a lot. Operator : The next question will come from Paul Coster of JP Morgan. Please go ahead. Paul Coster : Yeah, thanks for taking my question. I’d like to sort of take Brian’s question a little bit further on the tariff mitigation. And it looks to me like your intention is to slowly one down the impact over the course of 2020. Would it be fair to say we’ve got something like $50 million hit to gross margins over the course of the year and by the fourth quarter, when you’re lapping the effects of this quarter’s action will have no year-on-year degradation in gross margins? Olivier Leonetti : Good morning, Paul. Actually, we believe that we will have mitigated substantially the impact of tariff by midyear next year. So, as we discussed earlier, we would more than 15 to 25 impact in Q1. The impact in Q2 will be lower and pretty much immaterial in the second half of the year. Paul Coster : As you sense that the cost structure that you’ve achieved in reconfiguring the supply chain will be equal to or better than that which you originally had in China tariffs aside? Olivier Leonetti : On in aggregate, it will be about the same cost structure. Paul Coster : Okay, thank you. Operator : And the next question will come from Keith Housum of Northcoast Research. Please go ahead. Pardon me, Mr. Housum. Keith Housum : Sorry, I’ve had on mute. Good morning, guys. In terms of understanding growth in the quarter, do you understand how much of that growth came from some of your more tangential products, so we’re talking about growing the proper folio? How much of that coming from the newer products or the non-core products? Anders Gustafsson : Well, first to say, I think we executed very well in the third quarter. We had, 30% growth but that was on top of 15% growth in the Q3 2018 timeframe. We did see solid performance in North America and EMEA, which is partially offset by software spending environment in China, which really attributed to the entire shortfall. We did see particular strength in our mobile computing portfolio and services and from a vertical perspective healthcare T&L we’re very strong, but all verticals are up-to-date. And our new solutions, they’re smaller base but they are growing quite nicely overall. So, we were quite pleased with how we are progressing with our intelligence Intelligent Edge solution set. Keith Housum : Got it. As a follow-up. The move with the supply chain outside of China, can you help us understand I guess the experience you guys have done with your contract manufacturers, and should we can be concerned at all with the risk that might be associated with issues that may popup that may either with ultimate additional costs or perhaps delays in the supply chain? Anders Gustafsson : So, we have a long relationship with these partners that it’s a handful of companies that we have worked with to assemble our printers, mobile computers in China so far, and we have been sustained with the same partners moving to other locations in Southeast Asia. We are obviously focusing very much on both speed and making sure we can continue to have excellent quality. We’re doing a number of things to minimize the risk of any disruption. So we are not changing the supply side, most things we are just changing the assembly locations. We have a lot of experienced managers from these companies that we will augment with our own team to ramp up these facilities. So, we think that this is very doable and compared to, when we’ve outsourced our supply chain printers back in 2010 timeframe. This would be a somewhat less complex undertaking. Olivier Leonetti : And Keith, two additional points if I may. First, the countries where we being to go on not Greenfield countries, that’s point number one. And point number two, we’re duplicated lines, meaning we could always at any time keep supplying the U.S. market from our plants in China, if needed. Keith Housum : Great. Thank you. Operator : Our next question will come from Richard Eastman with Robert W. Baird. Please go ahead. Richard Eastman : Yes, good morning. Perhaps you could just touch on maybe the role price plays here going forward kind of covering the delta between tariff costs and supply chain mitigation efforts. Just a thought maybe around one price, any price increases become effective. And then is there a price contribution, is it a point or two that plays into the fourth quarter revenue guide? Anders Gustafsson : So, by far the main aspect of our tariff mitigation strategy is to move the supply chains out of China to avoid tariffs overall. We have announced some modest price increases, but the vast majority of the savings and the effort goes into the moving of the lines. We want to make sure that we compete for the long term and that we will be able to continue to gain share and have a competitive position in the market and continue to earn our customers trust. So, we’ve been very selective in how we’ve applied price increases. So, it’s a modest part of the overall mitigation. It is somewhat mitigating the impact, but it is not offsetting the impact. Richard Eastman : Okay. And as a component of the fourth quarter revenue guide, is it as much as a point or is it just any order of magnitude there? Olivier Leonetti : It would be [indiscernible] in that Rick. Richard Eastman : Okay. Okay. And then just a question around the U.S. Postal contract. Given the accessories and the device management software and the support there, is that – are the mobile computing sales, are the gross margins on that contract going to be similar to what we’re currently delivering in EVM? Anders Gustafsson : Obviously, the USPS contract was a competitive process and we had to compete on both offering the best overall value to our customers, which include a superior product but also competitive price. So, we are not able to explicitly talk about the margins on specific individual deals, but rest assured that this is a creative accretive to our P&L and add shareholder value to us. Richard Eastman : And was that a competitive advantage against some of the device management software and was there a competitive advantage in the bidding process for that contract that goes beyond just the hardware mobile computing product? Anders Gustafsson : Yes, I think the USPS and I would say virtually all our customers are looking at the overall offer and software thing a bigger part of that, that’s a differentiator and something that they can leverage to minimize the cost for implementing maintaining and supporting the fleet after this has been deployed. Richard Eastman : Good. Okay. Thank you. Operator : And our next question will come from Jeff Kessler of Imperial Capital. Please go ahead. Jeff Kessler : Thank you. Thank you for taking my question. First question is about on your – I guess on your fourth quarter and year beginning call, you talked about how your consultative process had begun to grow to about quarter about 8% or so, of revenues were generated by deals that were actually negotiated almost entirely at the C-Suite level. And I’m wondering if you could give us an update on the ability on what you’ve done over the course of the year, in basically getting a top down on the omnibus type of contracts, just because of a longer a longer live relationship that seems to be developing? Anders Gustafsson : Yeah, I don’t necessarily remember the specific numbers you’re quoting there, but we do have a lot of excellent relationships with executives of many of our customers. I think that goes back to our ability to help them solve their biggest issues, their priorities. We can help them implement their strategies much more. So, they see us as a much more valuable partner and therefore want to understand what we have to offer and how we can work together over a longer period of time, not just over delivering a specific project. So, our vision, our solutions ability to help our customers deliver on their priorities are great drivers for establishing what executive level relationships. Joe Heel : I would add two things. This is Joe Heel. Over the last few years, large deals, deals that are over a million dollars have been the fastest growing segment of our business overall. And those deals generally require that we have relationships at all levels of the organization, including at the senior levels. And so we’ve been developing a both our sales force, our partner relationships, and our relationships with our customers in such a way that they can support us winning those types of deals. And we think we’ve been somewhat successful in that.The other piece that’s played into that is that many of the newer solutions that we’ve spoken about and that Anders mentioned earlier, things like SmartLens or SmartPack, those are solutions aimed at solving a particular business problem and those are generally business problems center of our customer strategies and therefore have the attention of senior decision makers in those companies. And they help us in order to build those relationships, but also to address those needs and then be successful with those types of sales. Jeff Kessler : My follow-up is, when we’re looking at some of the newer, smaller, faster growing businesses, some obviously healthcare comes to mind and certain areas of the T&L, certain specialty areas of the T&L area. Can you talk about where gross margins had been and where they are now relative to the rest of the company? Are they at company level yet or is this the type of thing where we’re going to see, hopefully going to see an improvement going that reaches or perhaps exceeds the average GM of the company? Olivier Leonetti : So Jeff, few things. One does new solutions; despite being expanding are growing at a much higher great rate than the company average. So faster growth. And the gross margin profile of those new solutions is higher than the company average, because of – as Anders and also Joe mentioned because of the value we’re providing the economics for both parties, our customers and ourselves are better. Jeff Kessler : Okay. Thank you very much. I appreciate it. Operator : Our next question will come from Andrew Buscaglia of Berenberg. Please go ahead. Andrew Buscaglia : Hey, guys. Can you talk a bit about the use of your initiative to drive sales from the supplies market? Has that helped your margins this quarter and in generally with the USPS contract as you deliver more sales related to ancillary products, should that help your margins longer term? Anders Gustafsson : So, estimate supplies and USPS, I think. So first on supplies, that’s you know, one of our adjacent markets that we put a fair bit of effort behind to make sure we can drive attractive growth. It's been growing nicely over the last several years. And we're focusing both on adding new capabilities, new differentiation that are more in line with our Enterprise Asset Intelligence vision. I would highlight that we've in-sourced the capability of supplying RFID tags, so smart tags, as well as our Temptime labels, which can indicate exposure to temperature over either short or longer periods of times.From a margin perspective, the overall margin profile of our supplier’s businesses a little lower than our corporate average, but not much. And we obviously working hard to make sure that we improve both the growth rate and the margin rate for that. For USPS, you know it's a complete contract and includes accessories and other products. I'm not really in a position to comment specifically on the margin profile of the different sub components of the contract. But you know, again, it's accretive to our bottom line and to drive attractive shareholder value. Andrew Buscaglia : Okay. And then really, you know, with that USPS contract, you said it was the biggest one in your history, I believe. Are there other deals out there like this that you see as potentially moving forward over the next 12 to 18 months? Anders Gustafsson : So, there's not a lot of contacts that are in one signed contract gets to be this large, but we have a lot of customers that have very large install basis, but they tend to buy more over time versus having a one contract. So there's a number of customers that have substantial installed basis that are in the same ballpark as USPS, Andrew Buscaglia : Okay, thank you. Operator : Our next question will come from Jason Rodgers of Great Lakes Review. Please go ahead. Jason Rodgers : Yes, just wanted to ask about the share repurchase, what level you have implied in your 4Q guidance. And with then at the bottom of your ranger very close to the bottom, what are your thoughts to accelerating share repurchase to help offset the tariff impact in the first half of next year? Thanks. Olivier Leonetti : So, Jason, we are not assuming buyback – the impact of buy backing our EPS wrench. The reason for this is we believe is the best way to really describe the operational performance of the company. Having said that, we expect to be in the market in Q4 to our buyback program. And our level of participation will depend on stock price levels. But again, no buyback impact in EPS guide. Jason Rodgers : Okay, thank you. Operator : And our next question will come from Paul Coster of JPMorgan. Please go ahead. Paul Coster : Yeah, thanks for taking my second question. Just wanted to look at the Windows to Android upgrade cycle where it stands, how the competitive landscape has changed if at all this year? And what the duration of the upgrade cycle remains to be in your opinion? Anders Gustafsson : Yeah, first, our mobile computing business continues to perform very, very well. You know, we had a strong quarter in Q3 and that was on top of an exceptional quarter last year. You know, we have several drivers that are supporting that growth, you know. The number of new use cases continues to expand. I'd say, our software capabilities is a great driver for this. We're also seeing, you know, consolidation of multiple devices or applications on top of our devices. Workforce Connect is a good example of that where our employees used to carry a mobile computer and a say PBX wireless phone that's now been consulting to one device, one Zebra device where running a bulls app. You know, the trend of having a device for every worker is also a big driver. We've seen lots of our customers want to make sure that as many of their workers are connected as they can. And today, we estimate about a third of eligible employees do have a device, so we see great opportunity to continue to drive penetration deeper into our customer accounts.Specific to the Android transition, that that continues to be a great catalyst for us. We still estimate about 10 million legacy Windows devices in the market. And we continue to also still enjoy over 60% market share of Android in the enterprise. The tail side of those 10 million devices, legacy Windows devices being upgraded or refreshed to Android will probably be longer than what we had originally expected. [Technical Difficulty]So thanks to Zebra team and our partners for delivering another quarter of strong profitable growth. I also want to acknowledge that this week, we celebrated the fifth anniversary of the highly successful enterprise acquisition. Our team has transformed our organization and the industry. And we have a tremendous opportunity ahead of us. I appreciate everyone's dedication as we continue our journey. Have a great day everyone. Operator : The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,020
| 1
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2020Q1
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2019Q4
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2020-02-13
| 12.68
| 13.01
| 13.89
| 14.09
| null | 16.17
| 18.13
|
Operator : Good day and welcome to the Q4 and Full Year 2019 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning and thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission.During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our fourth quarter and full year highlights. Then Olivier will provide additional detail on the financials and discuss our 2020 outlook. Anders will conclude with recent progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us as we take your questions. Also throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Cortexica, Temptime, and Profitect businesses for the 12 months following each acquisition. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year.Now, I'll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning everyone and thank you for joining us. Our team drove profitable growth in the fourth quarter. As you can see on Slide 4, we reported net sales growth of 4.6%, adjusted EBITDA margin of 21.4%, which expanded by 30 basis points, and non-GAAP diluted earnings per share of $3.56, a 15% increase from the prior year. We posted a record level of EPS, although it was at the lower end of our guidance range due to tariff expenses at the high end of our expectations and prioritizing a higher mix of large mobile computing year-end budget orders, each of which impacted gross margin.Our diversified business is enabling us to post solid growth despite an uneven global macro economy. The continued soft environment in China was more than offset by growth in our North America and EMEA regions. We grew all our major verticals led by healthcare, retail and transportation and logistics. We drove double-digit growth in our enterprise mobile computing portfolio which capped another exceptional year. Our customers utilize our mobile computing solutions for new use cases on the Android platform as we benefit from our leadership in the transition from the sun-setting Windows operating system.We also continued to drive higher service attach rates on our product sales, which bodes well for future quarters. RFID was another bright spot in the quarter, growing strong double digits. Lower operating expenses enabled us to expand EBITDA margin, despite transitory tariff expenses that weighed on gross margin. By mid-year, we will have a more diversified sourcing footprint, which will enable greater operational flexibility and mitigate the tariffs.In Q4, we acquired Cortexica Vision Systems to accelerate our computer vision capabilities, which I will discuss later on the call. For the full year, Zebra delivered solid results with 5.5% sales growth, 90 basis points of adjusted EBITDA margin expansion, 18% non-GAAP EPS growth and $624 million of free cash flow. We continue to build upon our industry-leading offerings by investing in innovative technologies that elevate our role in enabling the intelligent enterprise. We are entering 2020 with a solid order backlog and we are optimistic that we can drive another record year of performance.With that, I will now turn the call over to Olivier to review our Q4 financial results and discuss our 2020 outlook. Olivier Leonetti : Thank you, Anders. Let us start with the P&L. As you can see on Slide 6, net sales grew 4.8% in the fourth quarter, which translated to 4.6% on an organic basis before the impacts of currencies and acquisitions. We saw growth in each of our reporting segments. Enterprise Visibility and Mobility segment sales increased 6.3%, led by growth in mobile computing and support services. Asset Intelligence and Tracking segment sales increased 1.2% with relative strength in Services and Zebra Retail Solutions.Turning to our regions; in North America, sales grew 8%, primarily driven by strength in mobile computing, services, and RFID. We saw broad-based strength across our primary vertical markets. EMEA sales increased 4% with relative strength in mobile computing and services. Eastern and Southern Europe were bright spots in the quarter. Sales in our Asia-Pacific region declined 8%, primarily due to continued macro softness in China due to trade tensions. Latin America sales were flat. Adjusted gross profit increased nearly 1% from the prior year period. Adjusted gross margin contracted 190 basis points to 45.8%, primarily driven by a nearly full percentage point net impact from List 4 tariffs and an unfavorable sales mix of large year-end budget orders. We view this Q4 rate as exceptional and not a new normal. Adjusted operating expenses declined $12 million from the prior year period and improved 230 basis points as a percentage of sales. This improvement was primarily due to reduced project spend and lower incentive compensation expense, partially offset by the inclusion of expenses from recently acquired businesses. We will continue to drive a balanced approach of driving operating leverage while making prudent investments in growth initiatives.Fourth quarter 2019 adjusted EBITDA margin was 21.4%, a 30 basis point increase from the prior-year period, including the temporary one point negative impact from tariffs. We drove non-GAAP earnings per diluted share of $3.56, a 15% year-over-year increase, which includes the $0.16 negative impact from List 4 tariffs.Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $624 million of free cash flow for the full year 2019. This was lower than the prior year period, as expected, primarily due to the timing of working capital items. We paid down $312 million of debt in 2019 after the funding of acquisitions and venture investments. We ended the year with 1.3 times net debt to adjusted EBITDA ratio, which is the lowest level since the acquisition of the Enterprise business more than five years ago. We repurchased $47 million of shares in 2019. Our strong balance sheet and cash flow profile provide us ample flexibility to invest strategically and return excess capital to shareholders.On Slide 8, we provide an update on the anticipated impacts to Zebra from the Section 301 tariffs on products imported to the U.S. We are on track to diversify our global sourcing footprint, which will mitigate List 4 tariffs that became effective in September, impacting our mobile computers and printers. We continue to work with our contract manufacturing partners to replicate lines in order to move most of the U.S. volumes to broader Asia. These actions are expected to result in up to an additional $25 million of one-time pre-tax charges through mid-2020 plus $10 million to $15 million of capital expenditures. With these supply chain actions, we expect to substantially mitigate tariffs by mid-2020.In the first quarter, we expect these tariffs to negatively impact gross margin by approximately $10 million and decline to $5 million in Q2 as we launch alternate sources of supply outside of China.Let us turn to our outlook on Slide 9. We entered 2020 with a higher-than-expected order backlog and solid pipeline of opportunities. Our contract manufacturers and all the areas of our supply chain in China have experienced delays as workers returned from the new year later than usual due to the coronavirus outbreak. Our outlook incorporates our best view of the coronavirus impact. We expect net sales growth in Q1 to be between 4% and 7%. This outlook assumes an approximately one percentage point positive impact from recent acquisitions and then approximately 1 percentage point negative impact from foreign currency changes.We believe Q1 adjusted EBITDA margin would be approximately 20%, which assumes improved operating expense leverage and a lower gross margin attributable to a $10 million impact from List 4 tariffs and approximately $4 million of additional freight cost due to the supply chain delays from coronavirus. Non-GAAP diluted EPS is expected to be in the range of $2.90 to $3.10. The estimated negative impact from tariffs and additional freight cost is approximately $0.22. We assume a negligible impact from share repurchase. That said, we will continue to be opportunistic with our share buyback program. Also, we estimate that we could have an additional $0 million to $50 million impact to sales related to the coronavirus outbreak if the situation becomes meaningfully different than expectations.We expect full-year 2020 net sales growth to be between 4% and 6%, which assumes an approximately 30 basis point positive impact from recent acquisitions and an approximately 1 percentage point negative impact from foreign currency changes. Full year adjusted EBITDA margin is expected to be slightly higher than 22%, an improvement from 2019 as we work to drive gross margin expansion and operating leverage. We do not believe that the coronavirus outbreak, as we understand its potential impact today, will have an material impact on our full-year outlook. We believe the risk to be mainly in timing of order fulfillment in near-term.We expect that full year 2020 free cash flow will exceed $700 million, a substantial increase from 2019. You can see other full-year 2020 modeling assumptions on Slide 9.With that I will turn the call back to Anders to discuss the progress we are making on our Enterprise Asset Intelligence vision. Anders Gustafsson : Thank you, Olivier. We are optimistic about our business as we enter 2020 and we believe we can continue to successfully navigate an uneven global macroeconomic environment. Now turning to Slide 11. We collaborate closely with customers to transform their workflows, so that they can achieve their strategic goals. The value proposition we bring to the market has translated to sales growth in each of our primary verticals for Q4 and the full year. In healthcare, our fastest growing vertical, we are addressing a broad set of challenges that hospital systems are facing across their operations. These challenges range from bedside care to the management of medical supplies and equipment throughout their supply chain. As an example, we have been rolling out mobile computing solutions to the National Health System in the U.K., enabling digitization at the bedside to treat patients, which improves the level of safety and generates real-time and actionable data to optimize the entire supply chain.For manufacturers, Zebra addresses their needs across their business. These include planned floor productivity enabling the smart warehouse and optimizing field operations. Our solutions are resonating with customers because we can demonstrate a positive ROI for our solutions even in a challenging environment. We are excited that multiple prominent manufacturers in North America recently deployed multi-million dollar Android mobile computing and printing solutions to help maximize their productivity in B2B workflows including direct store delivery.In the transportation and logistics space, our customer staff are overextended and their end customers expect service and information instantly in an increasingly on-demand economy. The success we are seeing in this vertical is attributable to the real-time visibility we are bringing to our customers' supply chain, which enables them to increase productivity.I would like to call out our team's success in becoming a partner of choice for nearly all of the largest postal systems around the globe, including the US Postal Service, which will begin to deploy our mobile computers in the second quarter. We empower postal carriers with the mobile technology to increase productivity by scanning, tracking and tracing packages across their network with high level of data security.In retail and e-commerce, omnichannel fulfillment is a critical area where retailers are making significant investments. RFID has become an increasingly important option to improve omnichannel capabilities because it can deliver close to 100% inventory accuracy. As more and more items are source tagged at the point of manufacturer, RFID gains momentum. We are currently deploying an RFID solution to several hundred stores for a major apparel retailer. This customer conducts daily scans of the entire store with handheld RFID devices in less than one hour, which is driving increased sales uplift and lower inventory shrinkage. This customer has also purchased several thousand of our combination RFID readers and barcode scanners for their point of sale transactions. We are pleased with the strategic relationship we have forged with this customer as we collaborate on proofs-of-concept to address additional in-store use cases that can improve their top and bottom-line results.Now turning to Slide 12. As a trusted strategic partner, we orchestrate the end-to-end workflows for customers in the primary verticals that we serve. Last month at the National Retail Federation Expo, we showcased how we accomplish this in retail and e-commerce through a full suite of innovative solutions. These solutions address many operational challenges our customers face as they reinvent their business models. Prescriptive analytics, machine learning, computer vision and mobile computers for all associates are a few key enablers to intelligent retail that we featured at the show.Advancements in technology now allow retailers to generate an unprecedented amount of frontline data on their stores through mobile automation systems, shelf edge cameras, mobile computer scans, inventory, point-of-sale, RFID and other sources. This heavy flow of information is actionable in real-time with our software solution.Zebra prescriptive analytics, formerly known as Profitect analyze massive data streams utilizing machine learning to identify variations in the data in real time. The most impactful recommendations are instantly prioritized and sent directly to workers' mobile devices to take action for optimal outcomes. We have deployed our proven offering with many leading retailers including the Home Depot, Walgreens, Family Dollar, ASTA, REI, Ahold Delhaize and many more. Computer vision capabilities are becoming an increasingly important component of our offering in retail and other vertical markets we serve.In Q4, to further accelerate our capabilities in this area, we acquired London based Cortexica Vision Systems, whose talented engineering team has been developing vision-based analytics and artificial intelligence solutions that include object recognition through machine learning, image and video analysis and visual search. At the NRF Expo, we introduced solutions with our innovative computer vision capabilities, including a flatbed scanner that can visually identify fruits and vegetables, as well as our new intelligent automation solution SmartSight that features a robotic vision system which rolls through store aisles. The system can identify critical issues such as stock-outs or price discrepancies and direct a worker through a mobile computer to correct the situation. We plan to leverage our enhanced computer vision capabilities in next generation offerings to address emerging use cases in markets that we believe represent a multi-billion dollar opportunity.We were proud to feature Office Depot at our booth this year. They demonstrated how they have deployed Zebra's purpose-built mobile computing solutions to empower their associates to transform the customer experience and improve operational efficiency across their stores and distribution centers. Their solution includes our Workforce Connect software application for efficient collaboration among associates. There is a strong and growing trend at many retailers to equip all their associates with mobile devices that enable collaboration with co-workers and customers. We are ensuring that we have the appropriate purpose-built portfolio of mobile computers for our enterprise customers to empower their entire workforce. We featured some of these at NRF and we expect to roll out additional offerings later this year.In closing, our core product offering continues to resonate well in the market. We are broadening our role as a strategic solutions provider, partnering with our customers C-suite. And we are continuing to invest in capabilities that digitize and automate enterprise operations. We've opened large, new attractive market opportunities for Zebra including intelligent automation and computer vision applications, new point-of-sale solutions and mobile devices for all. Now, I'll hand the call back over to Mike. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : [Operator Instructions] The first question will come from Jim Ricchiuti of Needham & Company. James Ricchiuti : Hi, good morning. Thank you. Two questions, first, I wanted to just talk a little bit about the strength you're seeing in the order book entering 2020, I'd like to know, particularly, which areas of the business and geographies. And then I have a follow-up question as it relates to some of the color you're providing with respect to the coronavirus risk. So just on -- first on the areas of the business where you're seeing the strength. It sounds like good strength in RFID, but I wonder if you could talk a little bit more about it and the sustainability of that strength. Thank you. Anders Gustafsson : Yes, thank you. First, I think we -- our team executed very well in Q4, we were up almost 5% and that was on top of a 9% growth in 4Q '18. So we had a very tough compare. We saw very solid performance in North America and EMEA. That was offset by softer spend environment, particularly in China. We did see particular strength in our mobile computing portfolio, but also in services and RFID, as you mentioned. We grew all our vertical market -- verticals that we serve, led by healthcare as the fastest with strong double-digit growth followed by retail transportation logistics and manufacturing and for the full year 2019, all verticals we're up also. So we have a very diversified business which is enabling us to post solid growth despite now being in a more uneven global macroeconomic environment. And I guess lastly, we're quite confident that we grew share in 2019. James Ricchiuti : And so you see those trends as with respect to your guidance-- those same trends are playing out in your Q1 outlook. Anders Gustafsson : Yes, I think we have a good outlook for the first quarter of 4% to 7% growth. And that's over an 8% growth of the last year. We entered the year with a solid backlog, we have healthy inventory levels in the channel and so we expect now faster year-over-year growth starting to kick in here faster than Q4, and we continue to see North America and EMEA as the strongest geographies for us and we also currently expect China to continue to show softness. I don't know, go-to-market side, I think we have good discipline around our offerings and pricing and our value proposition continues to resonate well. For the first quarter, though, we aren't expecting the USPS to participate, that roll out will start in Q2. James Ricchiuti : Okay. Thank you, Anders for that. And just with respect to the coronavirus, I think we all appreciate the challenges of trying to forecast the business with these fast moving developments. But I'm wondering, as you see the business now, are you -- does your guidance for Q1 anticipate any revenue potentially shifting out into Q2? I mean, you've highlighted some additional freight expense and then the $0 million to $50 million impact that you identify on sales, is that -- I wonder if you could talk a little bit about whether that is more supply chain related or potentially demand related that you're anticipating. Thank you. Olivier Leonetti : Let me answer to this question, Jim. So as you indicate that the situation is obviously very fluid. We have new news every day. Our base case or the 47% growth for Q1 assumes the impact of the coronavirus as we know it. So for example, we have reflected shifting demand, lower demand in China, additional freight cost and to give you a bit more colors on what is going on with our supply chain, our teams are taking their pills pretty much multiple times a day, all our Tier 1s, our key partners are back to work and ramping productions. Our Tier 2 partners are largely back to work and ramping production every day. And our supply chain is operating with some manageable bottleneck. So the situation is fluid and we believe we can manage the impact of the virus as we know it. If we were to have an impact in Q1, we don't think it would be the case, on top of what we put in the guide. We believe that the impact will be timing and that our full year guide would be intact.Now, let me comment on the additional $0 million to 50 million additional potential risk on the top-line. Again, that's not our expectation. Our expectation is that we would be able to mitigate the impact of the tariff as we know it, but if the ramp of our production was not to be as per our expectation, we wanted to give you some bookends about the potential impact and we size the impact to $0 million to $50 million, again would be timing if that unlikely scenario was to materialize. Anders Gustafsson : Okay, then just one thing to add to that. We've talked on earlier calls about our supply chain diversification strategy to mitigate the impact of tariffs. So our manufacturing in Vietnam and Malaysia for printing and mobile computing is now ramping up and would have an impact on the quarter also. James Ricchiuti : Thank you. Operator : The next question will come from Meta Marshall of Morgan Stanley. Meta Marshall : Great, thanks. Maybe first question just on -- you mentioned the USPS deal coming in, in the second quarter. And just maybe what explicit you've built into the year as far as that deal, just given the size and magnitude. And then maybe second question just -- you're below kind of your net debt target at this point. So just how -- and you are going to generate a meaningful amount of free cash flow in the next year. So just how are you thinking about use of free cash? Thanks. Anders Gustafsson : So, yes. Thank you. I'll start with the USPS part. So first, we are very proud of our USPS win. That's a big win for us and it augments the relationship we had with USPS. They were already customer of our other product and solutions before. The specific solution helps the USPS optimize the visibility of package delivery and also the execution across their carrier network. This is a multi-year contract. It's the largest in the history of the company and I think it highlights the strength of our value proposition here. The award includes our TC77 mobile computers, Mobility DNA, some custom software, as well as, managed and professional services. The ramp-up is -- it will start in Q2 and the -- our outlook assumes the majority of orders will be deployed in 2021.We've taken a prudent view here and only included the orders that we have visibility into our 2020 outlook. As the U.S. 3G cellular service providers will be ending 3G service at the end of 2021, that is definitely a consideration for the roll-out cadence and we expect that the USPS will basically be done by, with the entire roll-out, before the end of 2021 to make sure that they have devices they can work on, on the 4G network. And I said -- maybe come back to that later, but we won a lot of other good postal service wins that Joe can pick up on. Joachim Heel : Yes, just as additional context, right, postal services around the world are making the transition that many of our customers are making from Windows-based to Android-based devices and we've been fortunate to participate in and win the largest tenders in each of the four regions we participate in. In Asia, we won the largest deal, which you know about with Australia Post, in Latin America, earlier in 2019, we won the largest deal there. And recently we've also won the largest deal in the European postal system, all of which have transitioned to our Android computer. So postal service is one of those areas of strength for us at the moment. Olivier Leonetti : Let me cover your cash allocation question. So as you indicated, as you related to, our leverage ratio at the end of the year was 1.3 times net debt to EBITDA, the lowest since the Enterprise acquisition. Our business has a strong cash flow generation, we would be investing in the business organically, but also deploy our cash through M&A and also investments in our venture fund. We also will deploy cash to a buyback program. As a reminder, we have -- we had an authorization for $1 billion buyback authorization. We bought to date about $47 million and we would be in the market this year. We believe that, over the year, we'd buy back above 2% of the market cap of the company and we would be more opportunistic in a particular quarter, based upon the behavior of our stock price. But the guide for EPS in Q1 does not assume any impact from buyback. Meta Marshall : Got it. Thanks, guys. Operator : The next question will come from Brian Drab of William Blair. Brian Drab : Hi, good morning. Thanks for taking my questions. I just wanted to ask following those comments, Anders about the USPS. The majority of orders you said would be delivered in 2021. This is, well, public knowledge that this is a $570 million max contract, it doesn't seem like it's impacting the 2020 year as much as -- at least I was expecting, I mean, I was thinking maybe this is like a $150 million a year and would add three points of the growth rate in 2020. It doesn't look like you've incorporated that much in the 2020, given it's starting in the second quarter. But when you say the majority in 2021 in the contract, should we -- like those devices should be delivered by the end of 2021. I think some people including me -- I'm being left with the impression that maybe this could be like $400 million or $300 million plus in revenue in 2021 just from this contract. And I -- can you just help us reconcile that if I'm way off? Anders Gustafsson : Well, first the -- we have a -- basically looked at the delivery schedule that we have received from the USPS which is the baseline we have for what we've included in 2020 and that assumes that the majority of orders will be delivered next year. Now there is certainly an opportunity that some of that can be pulled in, but that's not part of our base case, we want to -- our base case is that whatever they have told us today will be as the -- as their projected delivery schedule is what we put in our guide and our outlook. But there is -- no, there is opportunities that can be better. Brian Drab : But... Olivier Leonetti : Yes, we will consider -- we would consider the holdup assumptions we have factored in the guide to be prudent. Brian Drab : Well, I need -- I'm looking for more specifics than just that. You know what I mean? I think that if you say what you said so far in the call, I guess I would reasonably model it like $400 million in revenue from 2021 from this contract. Olivier Leonetti : Yes. That's the best information we can... Brian Drab : Is that -- and is there any shipment to this contract you think beyond 2021 or it's pretty much, you said it's done really with deliveries by the end of '21? Anders Gustafsson : In there is -- there can be deliveries afterwards, true, there includes, also, other parts of it, repairs and other services that could come with it and they have the opportunity to continue to replace damaged devices or buy beyond what they have initially said. So the contract doesn't end at the end of 2021 and the number they have put out in the --the total dollar volume put out by the USPS envisions that this is not a two-year contract but a longer contract. Brian Drab : Okay. Is it possible that you could have deliveries that total more than $300 million in revenue to this contract in 2021? Anders Gustafsson : I don't think we want to comment on the specific dollar amounts for this contract. We can kind of -- we've tried to share what we know today and what we think is a prudent outlook for 2020 and I think we have to leave it at that. Olivier Leonetti : And, Brian we have also a few large accounts as part of the portfolio as well. So USPS is obviously one of them, but not the only one. Brian Drab : All right. It's the only one that I saw a $570 million figure associated, that's why I'm asking about it and it's the largest in the company's history, as Anders has mentioned. So, and then just where are you with the 15 -- where is the industry with the $15 million figure in terms of the upgrades? What's your latest view or comment on that? Thanks. Anders Gustafsson : Yes, so the -- on Android, broadly, as I've said, we have a number of good drivers for the Android business, I'd say three clear strong drivers. First, we will be around new use cases. If you go back and look at the number of applications or use cases, our customers used mobile computers for, say five years back, it was probably mid-single-digits. Today, most of our larger customers are probably more like 50, 60 different use cases and applications and we think that is going to continue to expand. So that's been a great driver. The Android transition from the legacy Windows operating systems continues. There were several of the older Windows OS versions that went out of support at the end of January of this year. Our best estimate is that there is still approximately 10 million legacy Windows devices in the market that needs to be upgraded. Our market share in Android continues to be very strong at 60-plus percent and the warehouse migration there is still gaining momentum, I'd say, and a great opportunity for us.At the second half of last year, certainly in Q4, we did start to see also, I guess, a new driver and that's Android refreshes. So it's now five years since we started shipping Android and some of those devices are now getting ready for a refresh. The earlier devices we had don't have the memory or processing capabilities to support all the different use cases, all the different applications our customers are putting on it as well as the processing requirements required by -- to run the newer -- the most recent android versions.And lastly, I'd say, also, as a new trend we're seeing is, our customers are looking for to deploy mobile computers much more densely or deeply into their organizations, they are looking to have basically a device into the hand of every employee, particularly in healthcare and retail. We are expanding our portfolio of solutions to enable our customers to have the right device for the right worker, where we can then generate a positive ROI for them in those areas. We have had an order in Q4 from a large U.S. retailer, which included our new EC30 device, which was intended to be basically deployed to all their employees. And that drives also a lot of Workforce Connect applications because most of those applications of use cases are predicated on driving greater collaboration between store employees or inter-store employees and customers. Brian Drab : Okay, thank you for all that detail. I appreciate it. Anders Gustafsson : Yes. Operator : The next question will be from Keith Housum of Northcoast Research. Keith Housum : Good morning, guys. I was hoping for a little bit more color on the guide. If -- it looks like the full year guide is actually a little bit more conservative than the first quarter. Especially, I can appreciate the fact that the postal service will be more back-end loaded sort of 2021, but still it should add, I think, approximately a few points of growth for the third and fourth quarter and you have easier comps you are going against. So what are you seeing on the horizon, I guess, that gives your full year guidance and perhaps a little bit lower than what we might expect based on the first year guidance -- first quarter guidance? Olivier Leonetti : So, we believe -- so as you indicated, Keith, most of the USPS order will be deployed next year. We believe that for the remaining of the year that this outlook is prudent. It's going to be a more than respectable growth based upon what we see in the market, based upon the strength of our go-to market, based upon the strength of our product and solution offering, we believe that we should be able to deliver this prudent rest of the year guide, Keith. Keith Housum : Okay. So are you forecasting processes -- the overall demand market to actually be decreased or they kind of maybe get a little bit worse? Is that part of your expectations for economic growth? Olivier Leonetti : That's not the case. So far, if you look at the performance of Zebra, Q4 of 2019 was stronger than Q3. Q1 guide is going to be stronger than Q4. So, we see an acceleration of the business. But based upon the various macro events and other phenomenon happening in the market, we believe it's the most prudent approach to guide in the way we did. Keith Housum : Okay. And a follow-up question for you on operating expenses. R&D was up, sales and marketing was up perhaps a bit more than we thought. Are those increases, I guess, quarter-over-quarter, is that more due to acquisitions or was there perhaps a change in intent in R&D to increase investment there? Olivier Leonetti : So if you look at OpEx as a proportion of revenue, we have been scaling that ratio significantly every quarter, actually even more in Q4. If you look at the R&D line, we indeed add the impact of acquisitions playing out in the quarter. But the key principle we have in mind as we manage the P&L of the company is to scale OpEx as a proportion of revenue rather than looking only at OpEx. And we have been able to do that every quarter, mainly in Q4, actually. Keith Housum : All right, thank you. Operator : The next question will come from Richard Eastman of Robert W Baird. Richard Eastman : Yes, good morning. Olivier, could you just double back for a second to the gross margin degradation we saw in the quarter and maybe just provide a little bit of color around both AIT and the EVM decline year-over-year in basis points? If you could just sift through that a little bit, you mentioned tariffs, you mentioned this large order. Was that in the mobile computing side? And just maybe sift through that a little bit just to give us a sense of maybe that -- it's an unusual number here and not to model that kind of going forward. Olivier Leonetti : Absolutely. So as you indicated, and I would go through the details in a second. The Q4 margin profile wise was exceptional and the guide for Q1 and the full year of 2020 implies us going back to normal. So going back into the details, Richard, we -- relative to the implied guide we had for Q4, our margin rate was lower by about 1 point. As I indicated in my prepared remarks, this 1 point degradation is due to large margin orders that we have to shift to meet our customer year-end budget demands. That impacted AIT and EVM but mainly mobile computers.And if I was to go through the various elements of impacts trying to bridge the point, the lower point we had a margin relative to our guide, the impact of higher tariffs than expectations were about 40 basis point. The impact of higher freight as we had to expedite those large orders, the impact was about 20 basis point and the lower margin due to the mix of large orders was about 40 basis points. So you see the full impact, the full break of the one point. Now we are working all the time on initiatives to improve gross margin. We believe we have a nascent set of activities, we will launch in 2020 to improve gross margin. We could go into the details, if you want, Richard, and we feel definitely that Q4 was an exceptional point. Richard Eastman : Could you -- when you look out to '20, for the full year in '20 and you look at the gross margin, perhaps year-over-year, would you expect you're taking out some of the cost of the tariff and the supply chain that comes out of the adjusted number? So should we expect to see 20 to 40 basis points of gross margin improvement for the full year when we look out to 2020? Olivier Leonetti : So we believe that we will increase gross margin 2020 over 2019, net of the elements you mentioned, so tariffs and exceptional freight cost. And why am I saying that? Let me give you maybe a few examples of the levers we're using. So from a pricing standpoint, for example, we have been addressing more and more reach verticals part of the market, healthcare being one of them, for example. We have been deploying resources to maximize, this is actually not the only one, the segment mix improvement will drive margin up. That would be one.We're also launching a new tool, we have been piloting this tool now for about a year. The new tool for pricing transactional orders using machine learning has been launched, as we speak. We believe that, that will improve our margin profile as well. And from a COGS standpoint, very quickly, we are designing to value our products that has been a constant with platforming also, our various products are using the same platform across various product lines and one which will have also a material impact on the margin profile for 2020 is that we have reset our service network outside North America. And that will significantly improve the margin of our service business and now more so a material impact on the margin of Zebra as a whole. So again a nice set of activities to keep improving the margin profile of the business as we have done now for a number of years. Richard Eastman : And just -- maybe just one last question along similar lines here, but as we have moved production out of China into Vietnam, I think you mentioned Malaysia, does -- number one, does that -- is that mostly mobile computers and printers or are there scanners being done there? And then just by definition, is that movement to Vietnam and Malaysia, do you pick up some basis points of gross margin or lower COGS on that movement out of China just structurally? Anders Gustafsson : So, I'll take this one. So first, the objective here is to move U.S.-bound volume out of China to ensure we can mitigate tariffs. We are moving out our printing volume to Vietnam, and most of our mobile computing volume to Malaysia, but also going to some other countries. On the scanning side, that was already outside of China. That was in -- we manufacture our scanners in Mexico and in Taiwan, primarily. But with these programs looking to wrap up by middle of this year, we would expect to largely mitigate all the tariff impacts.From an ongoing gross margin perspective, we think of them as neutral today, while, say, labor cost might be a little lower in Vietnam. Early on, we will have a little bit more freight cost moving piece parts and other components into Vietnam. But over time, we will work on making sure that we get that to be an improvement to our gross margins. Richard Eastman : Okay, excellent. Thank you. Operator : The next question will come from Paul Coster of J.P. Morgan. Paul Chung : Hi, this is Paul Chung on for Coster. Thanks for taking my questions. So just a follow-up on mobile computers. Are you still kind of selling Windows-based mobile computers and is that kind of keeping the opportunity at 10 million units? And then you mentioned you're seeing more Android refreshes happening, suggesting maybe a lifecycle of five years. Is this kind of a shorter lifecycle than your legacy products and what are the main factors kind of driving that refresh, assuming this contribution is quite low at the moment kind of relative to your new deployments? if you could confirm that as well. And I have a follow-up. Anders Gustafsson : All right, I'll see if I -- hope that I can remember. I'll start with the -- if we are selling Microsoft devices into the markets still? And the answer is yes. We -- I think it was 2017 for us where we switched over to make Android at the highest volume of our business, but we do still sell and support our customers who have existing deployments of Microsoft devices. But it's fair to say that I don't -- I can't think of a large new customer that have selected Windows. It is basically to service the existing installed base of those accounts and over time, they are -- I would say, they are all looking to migrate to Android. Now we have the, I'd say, the highest proportion of our volume in Android. So if you look at other players in the industry, they are still selling more Windows devices and some of them are selling more Windows than Android even. And if you look at some markets like Asia, Windows is still quite a strong platform there. It might seem a little counterintuitive as some of those software packages have gone out of support, but that is what we're seeing.So on the one hand, we are eating into the 10 million legacy devices by shipping new Android devices, but on the other end of that volume, we and others are adding new Windows devices also. Olivier Leonetti : And just to complement, we see that as a positive trend. We have been able to post a strong sales performance in mobile computing despite the market still buying a lot of Windows due to, as we said earlier, new use cases, and also a device for hold being a new trend in this part of the market. Anders Gustafsson : And I'll also touch on the Android refresh and then I'll ask Joe Heel here to add in some more color. But on the Android refresh, we started shipping our TC55 and MC40s about, give or take, five years back. Those devices bode on the, say, longevity in the market, wear and tear, but maybe more so based on the memory capacity processing speed and so forth are no longer able to support our customers objectives. Our customers are looking to deploy many more applications which all use memory and processing speed and also if you're looking to upgrade to newer current Android versions, they all require more memory and more processing speed.So -- I think this is a fair comment around Android overall that the refresh rate will be higher than for Windows devices. There is a lot more innovation going on around the Android platform than there was historically even when Windows was, say, a fresh and the default operating system platform for the industry. So we do expect to see a higher level of Android refreshes than we did on or shorter lifecycle for our Android devices than we did for Windows. Joachim Heel : Yes. Perhaps there's some additional color on that. I think you are seeing five-year lifecycles at this point, but we do see customers making their ROI calculations often with three-year time horizons now. So we do expect that the life expectancy that our customers will have will trend in that direction. And if you think from the customer perspective, you'll -- we would say -- we would cite three things that customers are saying are driving them to these refreshes. One is applications. There is a significant increase in applications that customers are putting on our devices where they originally may have used to adjust for inventory management, now they use it for a customer application, they use it for voice communications. There is a significant increase of those applications.Number two, with those applications come new demands on the technology. The technologies need more memory, as Anders was saying, in addition to the inherent technology requirements, driven by the ongoing Android upgrade cycles, Right? Those are on very short 18 months or so intervals. And then the last piece is reuse cases that are being put on devices all the time where they're being used for purposes that five years ago were not even being envisioned. So all three of those are driving the increased refresh -- shorter refresh cycle and increased refresh volume. Paul Chung : Thanks for that. And then switching gears on new products, particularly the kind of new automated robots you were showcasing at NRF, do you have any kind of customers highlighting that solution in groceries, and are you seeing any kind of actual demand to deploy these solutions or are we kind of bit early? And then if you could also provide an update on SmartPack solution for trailers. Do you see any momentum there? Just kind of want to get a sense for solutions in the pipeline, kind of newer solutions and which ones you think will have the biggest impact in the near term. Thank you. Anders Gustafsson : First, I'd say that our new solutions is going to be Intelligent Edge-type solutions, have been growing very nicely for the last several years. So obviously off a smaller base, but the growth rate has been quite attractive and met with our internal expectations for 2019. At NRF we showcased a number of new solutions. We had our SmartSight solution with our EMA robot. We had our MP7000 flatbed scanner with color camera, we had Smart Edge with our heads-up displays, so you saw a number of new solutions that are quite different from the type of solutions that the industry has offered before. On SmartSight, first that -- we've been developing that for several years, we have it in pilots with some large customers. So we certainly expect that there'll be demand for it. We are working with a number of our customers to figure out how can we be best introduced into their environments.And our Smart Edge with the heads-up display, that's, I think, a very attractive solution. It helps to really modernize the whole interface with warehouse management systems and drive great productivity improvements and the heads-up display is just one way that we can render those benefits, but they can be done in a variety of other ways also. And I think, Joe, can add some additional value on how we've been doing with customers on these. Joachim Heel : Sure. So first of all with the -- you also asked about SmartPack. SmartPack is one of the solutions we have great expectations for. And we introduced that with a large U.S. lead customer where we have a very broad deployment with tens of thousands of dock doors deployed and we now have several other customers that are piloting this in an advanced mode and we have one customer now in Europe, which is a significant milestone to take this to another continent, that is broadly deploying this across their European network of thousands of dock doors. So we're confident about the SmartPack solution being one of the successful ones.The other two that are worth mentioning in our IEF portfolio of solutions are RFID. RFID, we've had this in the prepared remarks, has been extremely strong for us for quite some time. We believe this solution has reached a tipping point and the other one we would mention is Workforce Connect as a solution for collaboration that leverages our mobile computers has also been a very strong solution for us in across multiple large customers. Paul Chung : Thank you very much. Operator : The next question will be from Andrew Buscaglia of Berenberg. Andrew Buscaglia : Hi, guys. A quick question on -- so you made the comment that you saw some more share gains in 2019, which is -- it's -- I think that's fairly well known, but it's sort of a double-edged sword in that I'm trying to get a sense on your pricing and your pricing power this year. Do you have concerns that your competition will maybe use pricing as a lever, and I guess what fortifies you from side stepping that? Anders Gustafsson : So, if I understood you correctly, you're asking if our competition is using pricing as a lever to compete against us? Andrew Buscaglia : Yes. And if that is a concern of yours, given you're selling... Anders Gustafsson : Yes, well, it's a competitive -- first it's a competitive market. We are working in some very attractive but competitive markets and price is definitely a factor. Now, that's not new. I wouldn't say that pricing is any more competitive today than it has been historically. We try to differentiate ourselves by making sure that we have the best solutions, first and foremost, and we tend to win with a premium over our competitors. So we -- I think our -- for a variety of reasons, the breadth of our solutions, the innovation around our solutions and some of the uniqueness that we have that others can't match, enables us to get that extra premium. It's not intimate, but it is a meaningful premium. And then, Joe, maybe you... Joachim Heel : I'll add two things. So we do pay significant attention to the subject of pricing. I'll give you two specific examples or data points. One is in the mobile computing area where we have the majority of -- we have had some of the significant share gains, we talked about earlier. The majority of those deals are done on, what we would call, a price concession, so special prices given to our customers. And we have a great discipline within the company of managing those price concessions. And so we pay a lot of attention to that from a sales management perspective.The second thing you heard in the prepared remarks that we're introducing some capabilities in the pricing area and we are deploying some software and capabilities that allow us to manage pricing at a very granular level, precisely because this is a very important lever for us. Andrew Buscaglia : Got it. Okay, that's helpful. And, Olivier, you mentioned pushing more into the software and services. It's obvious that's kind of the route you guys are going long term, but do you care to talk about or do you have an internal vision or target of where you see that as a percentage of your portfolio? And then, I guess, what's the strategy? Do you still want to get out with more products like more things like SmartSight before you really go all-in focus on that side of the business or will we continue to see software kind of roll-out in tandem with products? Olivier Leonetti : So, if you look at the service and software part of the portfolio, it has been, particularly this year, growing at a higher rate than the overall company average. The reason for this, as you start to have a sense, is based upon all the new capabilities we are launching and being as a company, a true orchestrator of our customer's workflows and that drives an increase in the revenue for this part of the market, but also an increase in the profile for -- margin profile for the company overall because of this impact. Where that could go? Those markets are large and we are excited about our ability to win and play in those markets. Andrew Buscaglia : All right, thanks guys. Operator : And this concludes our question and answer session. I would now like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Thank you. We are committed to supporting our employees, customers and partners as we work through the coronavirus situation. We are optimistic about 2020 and we see much opportunity ahead. I am grateful and excited that our Zebra team and trusted partners have positioned us for continued success.I would also like to welcome the Cortexica team and the talents they bring to our organization. Have a great day, everyone. Operator : Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.
|
ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,020
| 2
|
2020Q2
|
2020Q1
|
2020-04-28
| 13.079
| 13.007
| 14.152
| 13.708
| null | 16.82
| 13.53
|
Operator : Good day, and welcome to the Q1 2020 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today’s earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin with our first quarter results. Then Olivier will provide additional detail on the financials and discuss our outlook. Anders will conclude with opportunities to advance our Enterprise Asset Intelligence vision and trends we are seeing in our end markets. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Cortexica, Temptime and Profitect businesses for the 12 months following each acquisition. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I’ll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. First, I would like to say that our top priority at this time is to health and wellbeing of our employees, customers and partners. We are grateful to all of the frontline workers, especially those sacrificing their personal safety, so that all of us can continue to live and work safely through this challenging time. Those on our customers’ front lines are heroes serving in hospitals, grocery stores, delivery vehicles, warehouses and other parts of the central supply chains that help keep our lives as normal as possible. Many Zebra employees are also on the frontline supporting the build and repair of products and solutions that are essential to our customers, doing their jobs safely and efficiently. To all of those heroes, we say thank you. The financial results we published this morning reflect a challenging first quarter environment. We realized a net sales decline of 1%. Adjusted EBITDA margin of 19.1%, which contracted by 200 basis points and non-GAAP diluted earnings per share of $2.67, a 9% decrease from the prior year. We had a strong start to the year and January and February generally played out to our expectations; however, late in the quarter as COVID-19 evolved into a global pandemic. We experienced significant supply chain disruption including product manufacturing delays, restrictions on transportation of goods, and a temporary closure in late March of a key distribution center supplying the Americas. We took extraordinary steps to produce and supply our mission critical products to customers around the world. Our team was agile, pivoting our resources quickly to closely monitor the situation and take bold action. For example, we chartered plans to expedite product delivery from China to North America and Europe to meet customer commitments. Despite best efforts, we were unable to completely fulfill our order book in the quarter, resulting in a high backlog as we entered Q2. Production in China is now returning to normal and we have stabilized our global supply chain through mitigating actions. In addition to the supply chain challenges, we saw softer demand through the channel globally and China sales were very weak with COVID-19 exasperating trends that had already been soft due to trade tensions. However, in any environment, enterprises worldwide utilized our solutions to address the evolving needs of their customers. In this changing environment, our solutions have become even more necessary for our customers. I would like to highlight a few notable Q1 wins supporting critical used cases in omni-channel, e-commerce and healthcare. One of the world’s largest mass merchants purchased 40,000 of our ZQ6 series mobile printers to address a number of front of store use cases, including online store pickup, pharmacy fulfillment, and shelf tagging. Additionally, we deployed several thousand TC5 series mobile computers to a large e-commerce player in Asia. This follows our competitive takeaway win last year of their printing and scanning business. With COVID-19, this e-tailers demand is growing exponentially. They have been hiring staff and we are working with them on additional solutions. In healthcare, we supported the NHS Nightingale temporary hospital in the UK. We provided an installed solutions supporting the identification and flow of COVID-19 patients. Nurses at NHS have also been using our TC5 series healthcare mobile computers to arrange virtual visits between patients and their loved ones. As expected, transitory effects of tariffs and expedited shipping expenses weighed heavily on Q1 gross margin and EPS. We have taken decisive actions to mitigate this impact which drove operating expense leverage, despite lower sales volume. We continue to remain agile and take appropriate action as results are pressured due to these challenging macroenvironment. With that, I will now turn the call over to Olivier to review our Q1 financial results and discuss our outlook. Olivier Leonetti : Thank you, Anders. Let us walk through the P&L on Slide 6. Net sales declined 1.3% in the first quarter, less than 1% on an organic basis before the impacts of currencies and acquisition. The COVID-19 pandemic caused supply and demand impacts to our consolidated sales growth of approximately seven percentage points. Despite our sales decline, we believe that we generally are performed in the market globally. Our Enterprise Visibility & Mobility segment sales was most impacted by the COVID-19 disruption and sales decreased 2.9%. The largest supply chain impact was the temporary closure in North American distribution center that Anders referenced, which delayed shipments of mobile computers into the channel. Asset Intelligence & Tracking segment sales increased 3.2% with relative strength in printing and Zebra retail solutions. We saw a solid growth in managed and professional services across both segments of the business, primarily driven by solid attach rates on increased product sales over the last 12 months. Our Locations solutions business was lower due to a pause in project spending. Turning to our regions, in North America, sales were flat, declining mobile computing due to COVID-19 supply chain challenges was offset by growth in all other major categories. EMEA sales increased 7%, with relative strength in mobile computing, printing and services. We saw particular strength in Central Europe. Sales in our Asia Pacific region declined 21%, driven by COVID-19 impacts on top of continued softness in China due to trade tensions. China was down 35%, driving most of the original sales decline. Latin America sales declined 11% led by lower mobile computing sales, largely impacted by supply chain disruption. Adjusted gross margin contracted 200 basis point to 45.2%, driven primarily by List 4 tariffs and expedited freight as well as unfavorable large order mix. Adjusted operating expenses declined $5 million from the prior year period and improved 10 basis points as a percentage of sales. This improvement was primarily due to prudent cost management and lower incentive compensation, partially offset by the inclusion of expenses from recently acquired businesses. First quarter adjusted EBITDA margin was 19.1%, a 200 basis point decrease from the prior period driven entirely by lower gross margin. We drove non-GAAP earnings per diluted share of $2.67, a 9% year-over-year decrease inclusive of $0.17 negative impact from the transitory effects of tariffs and expedited freight expense. Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $95 million of free cash flow in Q1. This was higher than the prior period, primarily due to lower use of working capital. We repurchased $200 million of shares in Q1, leaving $753 million of remaining capacity under the authorization. From a debt leverage perspective, we ended the quarter at the modest 1.5 times net debt-to-adjusted EBITDA ratio. Turning to Slide 8. We are well equipped to navigate the unprecedented global environment that we are facing. As I just mentioned, our balance sheet is in excellent shape with low debt levels and $740 million of capacity under our revolver. We deliver mission-critical solutions, increasingly diverse end-markets. Our capital-light business model has a highly variable cost structure due to all outsourcing of product manufacturing and driving the vast majority of our sales volume to third party distribution. We also have a strong free cash flow profile with a flexible cost structure and capital expenditures typically less than 1.5% of sales. We also have a track record of preserving profitability and cash flow in challenging times. We use a playbook to take appropriate actions in various scenarios, preserving capacity for investments in the business that improve our competitive position. Let us turn to our outlook. Given the low visibility due to COVID-19, we are withdrawing our outlook for full year net sales, adjusted EBITDA margin and free cash flow. We now expect these three metrics to be lower than last year, which would we address to cost actions we announced our profitability and cash flow. Q2 and Q3 expected to be particularly challenging quarters based on macroeconomic forecast, independent market research and feedback from our partners and customers. In this freed environment, we have done extensive scenario planning and identified many operational and financial levers that we can pull. It is imperative that we stick to our principles of acting swiftly to preserve profitability while doing no harm to the business to reinforcement of our culture. This enabled us to prioritize strategic investments, so that we are much stronger than the competition as the market rebounds. As Anders mentioned, we entered the second quarter with a strong backlog driven by temporary supply chain disruptions from the pandemic. As the virus has spread, end market weakness is affecting all of our major geographies across the globe. The impact is more pronounced in our run rate business through the channel as third party distributors are calibrating inventory levels. Given these pressures and elevated uncertainty, we expect net sales to decline in Q2 between 11% and 17%. These outlook assumes an approximately 50 basis point positive impact from recent acquisitions and an approximately one percentage point negative impact from foreign currency changes. We believe Q2 adjusted EBITDA margin would be between 18% and 19%, which assumes lower operating expenses and the lower gross margin reflecting a $5 million impact from List 4 tariffs and approximately $9 million of cost to mitigate supply chain disruption from COVID-19. Collectively, these transitory items, I expect it to impact margin by approximately 150 basis points and EPS by $0.22. Non-GAAP diluted EPS is expected to be in the range of $2.10 to $2.50. Please reference other 2020 modeling assumptions on Slide 9. On Slide 10, we provide an update on the anticipated impacts to Zebra from the Section 301 tariffs on products imported to the U.S. We are generally on track to diversify our global sourcing footprint by mid-2020, despite some modest delays due to COVID-19, particularly in our Malaysian facility. In Vietnam, we have been ramping our expectations. This initiative is expected to mitigate our geographic concentration risk. It also adds the immediate benefit of substantially mitigating List 4 tariffs that became effective last September, impacting our mobile computers and printers. We continue to work with our contract manufacturing partners to replicate production lines in order to move most of our U.S. volumes to broader Asia. These actions are currently expected to result in approximately $20 million of onetime pretax charges in the first half of 2020, plus approximately $10 million of capital expenditures. In the first quarter, tariffs negatively impacted gross profit by $7 million. We expect this impact to decline to $5 million in Q2 as we launch alternate sources of supply outside of China. With that, I will turn the call back to Anders to discuss our Enterprise Asset Intelligence vision and market trends. Anders Gustafsson : Thank you, Olivier. Slide 12 highlights how we are enhancing the value proposition for our customers. Our solutions are even more critical today than ever as we give the frontline and edge by empowering them with technology to do their job most effectively. Industry-leading companies trust Zebra to equip their workers and facilities with the solutions that bring their mission-critical operations to the next level. We are uniquely positioned to address this challenge because we have a deep understanding of workflows and unmatched access to frontline operational data from our vast installed base. We can address big global problems such as ensuring food safety across the supply chain or a broad range of more localized issues like increasing bed turns in the hospital, modernizing distribution centers to satisfy e-commerce demands or ensuring that retail associates and store inventory are optimized to maintain product availability. We have been bringing our Enterprise Asset Intelligence vision to life for our customers. We are doing this by enabling them to identify their assets through barcode, RFID and computer vision. Locate their assets with our vertical-specific solutions and understand their condition, such as temperature, trailer capacity and device security, so that their frontline workers can take the best next action in real-time. Methods for sensing, analyzing and acting on operational data from the frontline of business have undergone massive transformation in past years as the on-demand economy has taken hold. Inefficient manual processes have evolved into workflows that are augmented and enriched by purpose-built technologies, including hardware, software and intelligent edge solutions that bring it all together. Businesses are now demanding information about what is happening at the edge of their operations so that they can run their entire operation smoother, safer and smarter. They generate large volumes of data and are uncertain how to take all those disparate points of information and effectively put it to work in near real-time. We have been investing in software solutions and services that help our customers leverage real-time data to better orchestrate their workflows and gain a performance advantage. Investments in advancing our capabilities in this area remain a top priority. On Slide 13, we highlight the primary vertical markets that we serve. Exciting longer-term growth remain and new ones are evolving as customers in these markets are pressured to improve their technological capabilities in an increasingly on demand economy. That said, we are seeing mixed trends in this challenging environment, depending on the subsector. Many of our customers are deemed essential businesses, while various others may be temporarily closed for business. In health care, the pandemic dramatically increases the need for additional acute care capacity, which is the primary area that we serve. Our suite of purpose-built health care solutions are enabling pop-up hospitals, drive-through testing facilities and labs to scale quickly and provide safe and efficient care. Other parts of health care have seen a slowdown as government mandates in many locations have paused noncritical care and elective procedures until further notice. Approximately 2/3 of our business in retail is the mass merchants, grocers and e-tailers who are serving essential customer needs. Many retailers rely on our technology to execute their omnichannel fulfillment effectively. E-commerce and Buy Online Pick Up In Store transactions have increased as more consumers navigate purchasing from their homes. However, social distancing and stay-at-home orders are further impacting department stores and certain apparel retailers who are heavily reliant on in-store purchases. In the transportation and logistics space, increased online purchasing from households is driving incremental parcel volume and delivery, which drives increased demand for our solutions. Conversely, government-mandated restrictions are severely pressuring passenger airlines, rental car providers and certain segments of the distribution industry. The manufacturing sector has been challenged with global trade tensions and is facing additional challenges today as stay-at-home orders have deemed many discrete manufacturers, such as auto, aviation and specialty goods, nonessential. That said, some of these customers have been created with their idle operations by producing medical equipment like ventilators, utilizing our solutions. Many segments within process manufacturing, such as food and pharmaceutical companies, remain essential and are less impacted. In closing, we are confident that our business fundamentals and strategy are sound and that this crisis will not last. By focusing on serving our customers’ needs and continued investment in innovation, we expect to extend our market leadership position as the market rebounds. Now I’ll hand the call back over to Mike. Mike Steele : Thanks, Anders. We will now open the call for Q&A. We ask that you limit yourself to one question and a follow-up, so that we can get to as many of you as possible. Operator : Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : Hey, guys. Thanks for taking my question. I wanted to touch on your Q2 sales guide. You had a good backlog into the quarter, and it seemed as though you Asia – your North America sales seemed to be okay this quarter. So I’m wondering, is this just a function of your backlog? And beyond that, is there a concern you just haven’t quite seen the effect of this hit other regions outside of Asia? Anders Gustafsson : Andrew, good morning. We have today a lower visibility of the business due to the impact of COVID-19. And we are basically pegged as a business to the economy. And a lot of what we see in Q2 is a question mark on the length of the stay at home and also the impact of the various stimulus packages, either current or to come. And if you study the company over the recent past, we have an history of rebounding quickly when the economy restarts. Now when it comes to Q2, specifically, what we see today is obviously the impact only due to COVID, we believe we are in a strong competitive position. We believe that, for example, in Q1, we have gained shares. We had a strong backlog entering the quarter. And we see today from a top line standpoint mainly an impact being more pronounced on run rate, which is part of the business going through distribution. And we have seen our distributors, partners adjusting the level inventory. So this is what we see today going on. But we believe we have a strong value proposition, which works well in good and bad times, and we’re going to be ready to manage this downturn, Andrew. Andrew Buscaglia : Okay. And then your guidance for EBITDA margin. I think it was a bit ahead of where some people were expecting. Directionally, is this a function of your gross margins being up sequentially? What’s really – what’s behind that margin guidance? That’s – sort of ballpark. Anders Gustafsson : So if you look at – of course, so if you look at EBITDA, at the midpoint, the EBITDA margin will decline year-on-year by about 270 basis points, so 270 basis points. 1.5%, so 150 basis points is due to one-off items, either associated with tariffs or associated with the management of the pandemic, mainly impacting our freight expense. And then the balance is a point of margin being lost due to run rate mix. So if you look at today, if we disaggregate the revenue between bid and run rate, run rate margin is much higher than bids, and we have seen the run rate of revenue declining. However, the margin profile for run rate and bid have been increasing sequentially now for a few quarters. So what you see at play in the profitability is a margin impact and largely – large proportion of the margin impact being due to tariff and C19. From an OpEx standpoint, we believe we’re going to be able to retain the OpEx as a proportion of revenue constant or relative to last year. Andrew Buscaglia : Okay. Got it. Thank you. Operator : And our next question today comes from Paul Coster at JPMorgan. Please go ahead. Paul Coster : Yes, thanks for taking my question. I’ve got two. The first one is, can you give us your latest thoughts on the USPS projects? And I know as we throw the second question in now and that is, it sounds like you expect the channel to destock. Is that a 2Q phenomenon in the guidance? Or do you think it will take more than one quarter for them to do that? And can you quantify that in any way? Anders Gustafsson : Yes. Good morning, Paul. I will take both of these ones. First, on USPS. USPS contract continues as per our expectations. As we’ve talked about before, this is a multiyear contract. We certainly feel very proud of it, biggest in our history. I think highlights the strength of our value proposition and the strength of our relationships. Our teams – our respective teams, the Zebra team and the USPS team, they continue to work very closely together. Both sides are very engaged. So there’s no expectations or signs from our side that this will be pushed out in any way. As we said in our last quarter call, we do expect to begin ramping up in Q2, or ramping deliveries in Q2. And we do assume or expect that the majority of all the orders will be deployed by the end of 2021 as the backend is kind of gated by – when the U.S. carriers stop 3G service. And at that point, USPS will need to have moved off to new devices. We have received new orders beyond the current orders, so some new use cases, but within same framework for an additional 30,000 units. So, the business with USPS for us continues to be good. And we certainly look forward to starting to deploy in earnest. And then the other one on destocking the channel, at the moment I would say on a global basis, our distribution partners who are the ones who hold inventory are holding a normal days on hand inventory. We don’t see it being high or low, particularly, it’s going to be within the band considered to be normal. What we tend to see early in the downturn is that when sales out goes down, from a disti perspective, they adjust their days on hand, which means they don’t have to buy as much in the short term. And then that tends to be more of a one quarter type of activity. So here we are assuming that there will be a reduction in the run rate for our distis and partners, which will cause some level of lesser inventory or maintain – you have maintain the same level of days on hand inventory. Thank you. Operator : And our next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning guys. Anders you are one of the few guys that’s been around since the great recession back in 2008, 2009. Can you give me some of your thoughts in terms of how, I guess, your customers are responding now? And is there that same level of fear now that you had back then? I think we understand how your business has changed. But what was your interpretation of how the customers are reacting? Anders Gustafsson : I think the – obviously, there’s a very different drivers for this crisis versus the 2009 crisis. So I’d say our customers today are probably not as – well, back up and say, it very much now depends on which kind of vertical or sub segment of the business you are in. I think in 2009 every customer has concerns about liquidity, and so forth. Here we have a bit of a have and have not. So if you’re a mass merchant, a grocer, e-tailer, or in healthcare, some of the delivery businesses, you are doing very well. They are super, super busy. And if you are more of a brick-and-mortar retailer selling apparel, you might be having shut down all your stores. I think from a customer behavior perspective, I’d say when the orders around work-from-home started to be enacted it probably took two, three weeks for our customers to kind of scramble and get themselves organized to adapt to the new kind of working environments. They were very focused on just making sure their operations were – continue to run. But in the last – the last month I’d say they started to come back and start engaging with us on both current and more future oriented projects. And we are trying to be – make sure we make good use of video conferencing to continue to engage and have the sessions with our customers. And I don’t perceive that our customers overall or maybe as concerned with how long, or how are they going to come out of this recession. Maybe it feels like they have a bit more confidence. Keith Housum : Got it, thank you. And then, I think, I heard some of this in your script, but can you clarify again, like what percentage of your business do you think has done to essential customers? Anders Gustafsson : We didn’t talk about it from the entire business, but if you look at retail specifically, which is our largest vertical, two thirds of our business there goes to mass merchants, grocers and e-tailers. And those are all deemed essential. Yes, we’ve seen some interesting trends there that as people are adjusted to buying from home, not necessarily visiting the store as much. So Buy Online Pick Up In Store has become much more popular. Grocery volumes have gone up materially, but Buy Online Pick Up In Store has gone up exponentially. And I think that’s a consumer behavior that is unlikely to work back to what it was. I think consumers have now learned a new way of shopping that they like. Then if you move, look to healthcare there we have, I would say, the majority of our business is tied to essential activities, acute care, specifically. And we have been part of pop-up hospitals, drive-through test facilities and just scaling existing the care facilities to be able to take care of the number of Covid-19 patients that come in. But obviously there’s parts of healthcare that has been deemed non-essential, but that’s a smaller part of our business that do elective care and so forth. Within transportation logistics, that’s a – I can’t really have – I don’t have a good percentage number, but a good part of that business is obviously also a part of the essential economy, making sure that the essential supply chains work all the way from pharmaceuticals, to food, to e-commerce. I’d say here for us the last mile of delivery so many more deliveries to households today and the last mile delivery drivers tend to have our type of devices. And so that’s been helpful. But on the other hand, we see other transportation logistics businesses like aviation, auto, rental car companies and so forth that are under a lot of pressure. And lastly, manufacturing, there, I’d say a lot of the discrete manufacturers, such as auto, aviation and specialty goods, nonessential. They make up less than 5% of our total revenues. While most, I would say, process manufacturing companies like food and pharma are deemed essential for us. Joe Heel : An additional point, Keith, as well, which we think is important, we think that the current situation would actually accelerate the secular trends we are serving. E-commerce, tracking, digitization of workflow, we believe that those trends are going to be even more important going forward. Anders Gustafsson : Yes, I think, to that point we see that our solutions have become more necessary for our customers as we really do empower the frontline workers across all the end markets. So, these are the people who cannot perform their duties from home. They have to be in hospital, a grocery store or a delivery truck. So I think the crisis is helping to accelerate trends around digitization, automation across the industries. Operator : And our next question today comes from Jim Ricchiuti with Needham & Company. Please go ahead. Jim Ricchiuti : Hi thank you. Good morning. I had a question on – Anders, maybe I just wanted to go back to your comment about the haves and have nots, and that Slide 13 where you talk about some of the essential parts of the business in terms of vertical channels. Is it fair to say that the essential components, whether it’s retail, e-commerce, healthcare, that that’s been – you are anticipating that as a net benefit in the first half of the year? Or put it another way, would you expect that that potentially if we’ve seen increasing investments in those areas that falls off in the second half in addition to the recessionary pressures that you are seeing in the traditional markets? I’m just trying to get a sense as – I think you can’t give guidance for the full year, but I’m just trying to get some feel for how that essential business might change from Q2 to Q3. I think you alluded to Q3, Olivier, being a particularly challenging quarter. Olivier Leonetti : Yes. So we’re going to stop short of trying to give real color or guidance on the full year here. But I would say for us we do – our expectations is that this is a not a long-term change in how we operate and the world operates, but more of a several quarter activity. So we certainly expect it to impact Q2 and Q3. And then depending on how quickly the world rebounds we will follow. I’d say for us one of the benefits we have is that we have a very robust business, a very diversified business across product lines, vertical markets and geographies. And our value propositions tend to work in good times and bad times, right. Good times, our customers are expanding, they are investing in the business and they use our equipment to help them do that. In tougher times, they tend to trade OpEx for CapEx. So they try to use us to get more efficiencies. Say, right now at the eye of the hurricane here, we are seeing, obviously, the – many of the essential businesses are being very busy this year than they had been before. I think how they are behaving today is that they are generally very focused on just making sure they can scale up their operations and, scale up the use of technology, but not necessarily having the bandwidth to think very creatively about how to leverage new solutions. I think that will come when the world settles down a little bit more. Customers that are not operating today, say, people who have had to shut down their operations, we are talking to them, still to make sure that we stay engaged and figure out how can we help them drive more of the digitization and automation of their businesses as they come back. So we feel that we are – we want to engage with all the customers that we have. But the – obviously, the ones that are essential are much more active in both running their businesses and in looking to figure out how to scale them. Joe Heel : Let me add something it is Joe Heel speaking. The concept Jim, that you mentioned about the haves and the have nots that Anders described earlier, also applies to a certain extent within the central customers. So, for example, in healthcare customers, you have of course COVID-related activity which is at the moment receiving a lot of attention, and funding, and therefore also activity from us. But you also have elective procedures which are being put off and corresponding investments that hospitals are making are being postponed. Within retailers, you see a lot of things around Buy Online Pick Up In Store, but for example, automation activities like we showcased with robot solution that we introduced earlier, those are being paused. Now the good news is that we’re not yet seeing a drop off in confidence among those customers. The customers are still engaging with us remotely on those longer term solutions. And so we expect that that have not part will continue even in those essential sectors in the future. Operator : And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead. Erik Lapinski : Hi, this is Eric on for Meta. Thanks for taking our question. Maybe just staying on the question of kind of conversations with customers, it sounds like for the most part you’ve seen maybe a pushing off of projects. But can you help us, I guess, contextualize, like how much could the reason potential just scaling down of maybe the size of some orders? Or have you seen any potential cancellations from may be customers most impacted? Anders Gustafsson : So today we’ve only seen a limited number of push outs. We have not seen any cancellations or any scaling down of orders, as you put it. I think – and the customers that have pushed out tends to be the ones that are not operating today at all. Erik Lapinski : Got it. That’s helpful. And then maybe just changing gears a bit. On share repurchases, understanding you kind of capitalize on the lower share price in the quarter. Like how should we think about the pace moving forward? Would you continue to be opportunistic? Or should we kind of expect may be more focused on cash flow preservation just looking at the uptick there? Olivier Leonetti : So we feel strong about the cash flow generation of the company as we said, as I said, we believe we can protect the majority of the free cash flow of the company, even during this downturn. Now the priority for cash allocation is going to be to invest in the business either organically or inorganically. We bought $200 million worth of shares, so it’s about 2% of our shares outstanding. So at this stage, we are going to be mainly investing in the business and buyback would not be a priority. Now it’s not going to be totally off the table, but not a priority. Operator : And our next question today comes from Richard Eastman at Robert W. Baird. Please go ahead. Richard Eastman : Yes, good morning and thank you. Could you perhaps – Olivier could you perhaps just expand a little bit on the supply chain issues that you had in the quarter? And maybe just speak to this Malaysian facility, which I’m assuming was a subcontractor facility had some closure and some downtime. Is it up? And do you – could you just kind of give us a sense of how much revenue that may have impacted the first quarter? Anders Gustafsson : I think I’ll start with this and then Olivier can help fill out some details. So if you go back until our Q4 call, we highlighted that COVID-19 would have an impact on our supply chain, but it was on the supply side of things. Since then the China has largely returned to normal. It took a little longer than expected, I would say. And there was dependent partly on where our contract manufacturing partners were located. So they had to return workers through a two-week quarantine periods, and so forth. But by the end of the quarter, our Chinese contract manufacturing partners were all working at over 90% capacity. So I think they became back a little bit slower, but it came back. We also then in the quarter tried to ramp up both our Vietnam and Malaysia facilities. And timing was a little more challenged as we were supposed to do that the Monday after the lunar New Year. And obviously no Chinese people were allowed to travel there to help set it up and to teach people. But we were, I think, quite agile and creative. So we set up video facilities so that we have people in China sitting and watching via video, what people in Vietnam and Malaysia were doing, to teach them as well as we could. And Vietnam facility has come up very nicely. It manufactured the same number of printers that we had expected, while the Malaysia facility started off a little slow, but then it got shutdown based on the Marshall Law that Malaysia implemented. But we’re using the same techniques to get that facility up and running. The impact on Q1, I think, was very modest from that perspective. We’ve diverted and try to make get as much out of China as we could. It had similar impact on tariffs as we now have to manufacture everything in China, or the vast majority of our products in China instead. And going forward, we expect that supply chain issues are going to be largely behind us. And what you see reflected in our guide for Q2 is many, some demand precious. Joe Heel : Yes, actually I think call out to our supply chain is in order. They’ve done an excellent job of being agile and working in a very dynamic situation to make sure that the – all these issues had minimal impact on Q1 and Q2. Richard Eastman : And then just as a follow-up question, are there any receivables or credit issues that you are watching within – the virus don’t hold a lot of inventory, but are there any credit issues so we – that you are watching carefully? Joe Heel : So we are spending a lot of time on working capital, obviously DSO, most particularly. So far, the answer is no. And the way – again, we feel strong about our balance sheet, we feel strong about our free cash flow and we feel strong about our working capital. And we want to use, in selected cases, the strength of our balance sheet to increase the competitive position of the company. So from a credit standpoint so far no particular issues, and we want to help our partners to navigate through this difficult time using our balance sheet. Olivier Leonetti : And one more thing maybe just to add some color on this. One thing that, I think, benefits us here is that our partners, their business is to resell our products. So if they are cut off from supply of our products, if they can’t get access to our products, their business goes away. So there is a strong incentive from our partners to pay us to make sure that they can stay current and continue to do business. Operator : Our next question today comes from Brian Drab with William Blair. Please go ahead. Brian Drab : Hi, good morning. Thanks for taking my questions. I was wondering first if there’s any way that you could help us make, trying to quantify the backlog that you’re entering the second quarter with and maybe compare that to a typical quarter. Do you typically enter a quarter with, say, two or three weeks of backlog? And you have doubled that. Can you talk in some terms like that to give us a stance? Olivier Leonetti : So the size of the backlog entering the quarter was not out of the ordinary. And this size was slightly higher due to some of the dispatch center issues we mentioned. So we had to shut down for about a day at the end of the quarter, one of our dispatch center and that was about $20 million below. So that would be part also of the opening backlog. Nothing out of the ordinary. Anders Gustafsson : Yes, you can think of it as, the business continued to do well through the first quarter. So order flow was normal. And the one additional thing was that the $20 million that we couldn’t ship out of the North America or the Americas distribution center that flipped into Q2. Brian Drab : Okay, that seems smaller than I would have thought. So that’s on, I mean like 2% of revenue so that’s enough for you to call that out. There is no other source of additional backlog entering 2Q? Anders Gustafsson : Nothing of significance out of the ordinary. Brian Drab : Okay. And then I was just curious, it was – why did that facility, if you can talk about this, why did that distribution center have to shut down? Was that a state-driven decision or was there an illness there? And do you think that this is potentially a risk in the going forward with other distribution centers and facilities? Thanks. Anders Gustafsson : So this was an outsourced facility, and there was a case of COVID-19. So they shut down for 36 hours and came back and ran a little slower. But even before then, we had started to take some pretty dramatic, drastic actions in making sure that we had team A, B, C, and so forth that we had put out more spacing between people taking a lot of actions to make sure that if anybody worked to get infected, it would impact as only a small team and not the entire facility. So if something like that were to happen again, I would expect it to have much less impact than it had in the first quarter. Another one, which is of size also, the quarter was very backend loaded for obvious reasons, right. The supply chain started slowly at the start and ended up strong. So we had to ship a lot in the last few days of the quarter, and a day of shipment was worth much more than ever before. But we are confident that today largely the risk from a distribution center standpoint is going to be mitigated going forward. We have very good plans to mitigate those risks now. Operator : And our final question today comes from Jeff Kessler with Imperial Capital. Please go ahead. Jeff Kessler : Thank you. You have mentioned briefly the three acquisitions that you’ve made that were not part of the original discussion. Could you just update us on whether or not investment in them is going forward? And if so, what role have they played or could they play later on in the year and into 2021? Olivier Leonetti : So I assume you talked about Temptime, Profitect and Cortexica. Jeff Kessler : Yes. Olivier Leonetti : Yes. So I’d say all three are performing well. Temptime was the first one we made in the beginning of the 2019. They designed and manufactured visual time-temperature monitoring solutions. It goes on – a lot of them goes on vials of vaccines in the developing world. Obviously, great – it’s very topical today, although we don’t have a vaccine yet for COVID-19. Jeff Kessler : Kind of why I’m asking the question. Olivier Leonetti : Yes. So we are obviously in contact with WHO and others to make sure that when that happens that we can offer our solutions to ensure that the transportation of that vaccine can be temperature controlled and quality controlled. Profitect was the second acquisition we did in June of last year. They do the prescriptive analytics taking lots of different data inputs from a variety of sources, primarily in retail, and using machine learning, AI to detect anomalies. And I’d say that’s even more critical today as retailers are trying to figure out what they have on the stores, what errors they have and how to quickly be able to assess and rectify that with – and being less dependent on having a physical presence in the store to be able to do this. And lastly, Cortexica, which was the computer vision company we acquired at the end of last year, this is a smaller business, mostly focused – our intent with that is to really leverage the competency of that team less so the kind of the product or the revenue stream. So they are very – been very active in engaging with building out our computer vision capabilities around our EMA robot, particularly, but also solutions. And they’ve been a great addition to our team, they have great skill sets. Jeff Kessler : Okay. Thank you. My follow-up is will be quick. It has to do with your partner program. You mentioned that some of your partners are essentially, if you don’t provide them product they have nothing to sell. The question is about have you made any tweaks in that program during this period of time as you’ve seen ebbs and flows in – ebbs and flows in your supply chain and going into through the channel that increases for some folks and have been decreasing for others? And what have you been doing with your partner program too, if you want to call it, to make it more efficient for both them and you? Anders Gustafsson : Yes, I think this is an excellent question for Joe Heel. Joe Heel : So in our partner program, we’ve had a lot of requests from partners that we help them both technically with training, but also financially and with the program terms, in particular, like many of the programs, we have some elements in the program that are – or you can think of it like a frequent flyer program, where you have to reach certain levels. And we have already announced that we are adjusting those program terms, we’re essentially extending it for an additional year. We are also adjusting some of the thresholds that partners need to reach in order to earn their rebates. These are the typical things that you would do in response to a changing business environment when the partners can earn their targets. And I think so far it’s been quite well received because it means that the partners will be able to operate their businesses at the different levels and still achieve their targets. Operator : Ladies and gentlemen, this concludes the question-and-answer session. I’d like to turn the conference back over to Mr. Gustafsson for any final remarks. Anders Gustafsson : Thank you. Yes. I would like to thank our employees, customers and partners who are working the frontline. We remain committed to supporting you through this challenging time. Be safe, everyone. Operator : Thank you. This concludes today’s conference call. You may now disconnect your lines. And have a wonderful day.
|
ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,020
| 3
|
2020Q3
|
2020Q2
|
2020-07-28
| 12.136
| 11.75
| 12.111
| 12.135
| null | 17.75
| 21.49
|
Operator : Good day, and welcome to the Second Quarter 2020 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning. Thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today’s earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will begin with our second quarter results. Then Olivier will provide additional detail on the financials and discuss our outlook. Anders will conclude with progress in advancing our Enterprise Asset Intelligence vision and trends we are seeing in our end markets. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Also, throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired businesses for the 12 months following each acquisition. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now, I’ll turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. First, I would like to emphasize that our top priority continues to be the health and wellbeing of our employees, customers and partners. I am particularly grateful for all of the frontline workers, including medical professionals who continue to serve our communities and keep us safe. Zebra and many of our many of our customers' workplaces have commenced reopening plans, and I am very proud of the ability of our teams to effectively serve our customers and partners, while working remotely through the peak of the pandemic. In Q2, our teams remained agile and executed very well through pandemic. It has been inspiring for me to see our employees rally to keep the business and each other moving forward. Although, the financial results we published this morning reflect a challenging second quarter environment as we navigated through the peak of the crisis. Zebra's longer term prospects have strengthened as secular trends to digitize and automate workflows have accelerated with the pandemic. In Q2, we realized a net sales decline of 12%. Adjusted EBITDA margin of 18.3%, which contracted by 290 basis points and non-GAAP diluted earnings per share of $2.41, a 20% decrease from the prior year. As the virus spread end market weakness affected all of our major geographies, particularly our Asia-PAC and Latin America regions. The impact was most pronounced in our run rate business, which required our distributors to reduce their inventory levels. However, sales growth in services was the bright spot and enterprise mobile computing relatively outperformed. Although, premium shipping costs due to the pandemic impacted gross margin more than we had anticipated. We diligently managed discretionary costs across the company to preserve profitability and cash flow. Despite the challenging environment, our enterprise customers have been prioritizing spend with Zebra. Our solutions are a key enabler of their strategy to digitize their operations, as well as supporting the central use cases during pandemic. Large order volume was strong across vertical markets increasing over the prior year. I would like to highlight some notable Q2 wins from large customers supporting critical use cases. A leading home improvement retailer expanded their relationship with us by purchasing 10,000 of our printers to address multiple front-of-store use cases, including curbside pickup and in aisle label printing. Their shift to mobile on demand printing is expected to significantly improve worker productivity and replaced a competitor's stationary printers. We also secured a competitive takeaway win with a federal retail commissary to deploy more than 7,000 mobile computers. Our solution enables this customer to satisfy multiple use cases, including curbside pickup. We were pleased to support a large healthcare organization by providing a wide range of mobile computers, scanners, and printers to quickly ramp their point-of-care and clinical communication needs as they added 4,000 hospital beds to treat COVID patients. Additionally, as expected, we began deploying TC7 Series mobile computers to USPS postal carriers in late Q2. We expect the majority of the deployment to occur in 2021. We continue to collaborate with these customers to support their essential needs and drive it further improvement in their workflows. I am pleased that we have substantially completed our global product sourcing diversification initiative, despite modest delays due to the pandemic. Replicating production lines outside of China into broader Asia mitigates supply chain risk, and enables us to avoid tariffs on our U.S. imports. With that, I will now turn the call over to Olivier to review our Q2 financial results and discuss our outlook. Olivier Leonetti : Thank you, Anders. Let us walk through the P&L on slide six. Net sales declined 12.9% in the second quarter, which is 12% before the impact of currencies and acquisitions. Despite our sales decline, we believe that we continue to outperform the market in these challenging environment. As Anders mentioned, large order volume was stronger than the prior period. Our performance was untimely due to a sharp decline in small and midsize business to the channel, which disproportionately impacted printing and data capture. We are encouraged that distributor inventory levels are healthy and sales out trends have been improving. Our Enterprise Visibility & Mobility segment sales decreased 5.4%. We grew services revenue and mobile computing relatively outperformed. Our Asset Intelligence & Tracking segment has been most impacted by the global recessionary environment, with sales decreasing 24.9%. Printing and supplies each declined double-digits. Services was a relative outperformer. Managed and professional services performed particularly well with growth driven by strong product attach rates over the past 12 months. Our location solutions and Zebra Retail Solutions offerings were extremely soft due to pause in project activity due to the pandemic. Turning to our regions. In North America sales declined 7%. Services grew and mobile computing was relative outperformer. EMEA sales declined 13%. We achieved solid growth in services and slight growth in mobile computing. We saw strength in Central and Northern Europe. Sales in our Asia-Pacific region declined 21%, driven by COVID-19 impacts. China improved sequentially from Q1, but was the largest contributor to the original sales decline. Japan and Korea were bright spots in the quarter where our go-to-market investments are delivering results. Latina America sales have been hit particularly hard by the pandemic and macroeconomic factors and declined 33%. All geographies declined double-digits with the exception of Mexico. Adjusted gross margin contracted 360 basis points to 44.1%, driven primarily by two points of impact from unfavorable business mix, two points of impact from premium freight cost, other COVID mitigation and China import tariffs, partially offset by improved services margin. Adjusted operating expenses declined $44 million from the prior year period and improved 50 basis points as a percentage of sales. This improvement was primarily due to prudent cost management and lower incentive compensation. We were able to encompass -- to accomplish this while preserving our research and development projects. Second quarter EBITDA margin was 18.3%, a 290 basis point decrease from the prior period, driven entirely by lower gross margin. We drove non-GAAP earnings per deleted shares of $2.41, a $0.61 or 20% year-over-year decrease, which is inclusive of $0.27 negative impact from the transitory effects of premium freight expense and tariffs. Turning now to the balance sheet and cash flow highlights on slide seven. We generated $322 million of free cash flow in the first half of 2020. This was more than double the prior period, primarily due to a lower use of working capital and our expanded accounts receivable factoring program. Additionally, in Q2, we made a $31 million incremental investment in Locus Robotics, the market leader in autonomous mobile robots for fulfillment warehouses. From a debt leverage perspective, we ended the quarter at the modest 1.3 times net debt to adjusted EBITDA ratio, which provides us ample financial flexibility. Turning to slide eight. We have been successfully navigating this unprecedented global environment. As I just mentioned, our balance sheet is in excellent shape with lower debt levels and $915 million of availability under our revolver, allowing ample capacity for business investment. Our capital light business model, flexible cost structure and strong free cash flow profile allows us to preserve profitability and cash flow in challenging times. The reliable cash flow generation gives us a competitive advantage as we prioritize investment in the business through any environment. Let us turn to our outlook. We believe Q2 was the peak impact to Zebra from the pandemic. We remain in the recovery phase and expect sales trends and profitability to improve in the second half of the year. We entered the third quarter with a solid backlog. We have seen an increase in business activity and our deal pipeline is building nicely. Based on these factors, we expect Q3 net sales to decline between 3% and 7%, which is a meaningful sequential improvement from Q2 trend. This outlook assumes an approximately 50 basis point negative impact from foreign currency changes. We would continue to preserve profitability while doing no harm to the business. This enabled us to prioritize strategic investment so that we emerge stronger as the market rebounds. We believe Q3 adjusted EBITDA margin would be approximately 19%, which assumes lower operating expenses and the lower gross margin, reflecting higher larger order mix and approximately $9 million of transitory premium freight expense. Non-GAAP diluted EPS is expected to be in the range of $2.65 to $2.95. The premium freight cost expectation equates to $0.14 EPS impact. You can see other modeling assumptions on slide nine. Note that our outlook does not include any projected reserves from the pending acquisition of Reflexis. Anders will discuss the strategic acquisition in a few moments. With that, I will turn the call back to Anders to discuss our Enterprise Asset Intelligence vision and end market trends. Anders Gustafsson : Thank you, Olivier. We are excited to announce the acquisition Reflexis this morning, which we expect to close by early Q4. Reflexis is a leading provider of intelligent workforce management, task execution and communication solutions for the retail, food service, hospitality and banking industries. Combining Reflexis market leading platform with Zebra's complementary software offerings, including Zebra Prescriptive Analytics and Workforce Connect provides us the unique opportunity to unify the store associate experience. We also expect that Zebra's scale vertical market expertise and go-to-market footprint will drive substantial synergies, not only in retail, but in other key vertical markets, such as healthcare. Reflexis is a high growth recurring revenue business with sales of $66 million in 2019, which doubled over a three-year period and the gross margin profile approximately 20 points higher than Zebra's corporate average. The next slide illustrates how this acquisition fits into our broader vision. Slide 12 highlights how we are building our capabilities as a solutions provider. Our deep understanding of workflows and unmatched access to frontline operational data from our vast install base uniquely positions us to solve complex challenges at the edge. It is our top priority to invest in software solutions and services that help our customers leverage real-time data to better orchestrate their workflows and gain a performance advantage. Methods for sensing, analyzing and acting on operational data from the frontline of business are transforming with emerging technologies, such as computer vision and machine learning. Increasingly large volumes of data are generated and captured from our products. Enterprises are asking us to help them put that data to work by amassing disparate points of information to drive actions to their frontline workers in near real-time. Our intelligent edge solutions, including our SmartX and MotionWorks offerings demonstrate how we are enhancing the value proposition for our customers by addressing a wide variety of use cases across their business. This evolving suite of solutions enables Zebra to fuel our customer's workflows we did so they can be fully optimized. Reflexis' capabilities will be enhanced when they are combined with Zebra Prescriptive Analytics, worker collaboration and physical inventory software solutions. For example, Reflexis can provide dynamic prioritization of tasks extending across a broader set of data driven activities, such as stocking shelves, receiving a truck while delivering an order curbside when integrated with our Zebra Prescriptive Analytics and Workforce Connect applications. Ultimately, through this acquisition, we expect customers to find even greater value in equipping all of their associates with mobile computers. On slide 13 we highlight the primary vertical markets that we serve. We are excited about our longer term opportunities in our end markets, as customers are driven to improve their technological capabilities in an increasingly on demand economy. Since our last quarterly update, we are seeing improvement in this challenging global environment, although it is still a mixed picture depending on the sector. In healthcare, our fastest growing vertical, clinical care remains critical and is the primary area Zebra serves. Our healthcare solutions help hospitals flex their capacity needs as the pandemic evolves. Our solutions are being used in labs and drive through testing facilities to provide safe and efficient care. Non-critical care and elective procedures are resuming. Longer term, we believe the need for increased visibility into the entire patient journey will drive increased demand for our solutions. Approximately two-thirds of our business in retail is to mass merchants, grocers, and e-tailers who have been prioritizing investment in our technology for their omni-channel fulfillment. E-commerce and buy online pickup at store transactions have increased dramatically through the pandemic. Department stores and apparel retailers have been reopening their doors, which has been critical to those heavily reliant on brick and mortar sales. In the transportation and logistics space, strong e-commerce growth continues to drive parcel volumes and last mile delivery, which is favorable to Zebra. Conversely, passenger airlines, rental car providers, and parts of the distribution industry are resuming activity yet far from capacity. The manufacturing sector continues to be the most impacted in the current environment with COVID-19 and global trade tensions. Discrete manufacturers in aviation, auto and discretionary specialty goods have been particularly challenged during the heart of the crisis. Many segments within process manufacturing, such as food and pharmaceutical companies, have been less impacted. In closing, we are successfully navigating through this challenging environment and are confident that our business fundamentals and strategy are sound. By continuing to focus on advancing our Enterprise Asset Intelligence vision and addressing our customer's needs, we expect to emerge from this crisis in a stronger competitive position. We continue to be very optimistic regarding our longer term prospects as secular trends to digitize and automate workflows accelerate with the pandemic. Now, I'll hand the call back over to Mike. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : Hey, guys. If I dig into your guidance a little bit. So, I'm having a hard time with your guidance for Q3 getting to that, 19% EBITDA margin. In that I feel like it could be higher. So, I'm wondering, you're with your top line sales kind of guide where it was or where it is, much better than expected. It really implies not much expansion on gross margins. It's if that's what I -- if I'm correct there, can you confirm that? And talk a little bit about why you can't do or why you wouldn't expect it to a little bit better there in margin. Premium freight costs and stuff in there. Olivier Leonetti : Yeah. Good morning, Andrew. So, you're right. We expect in the quarter EBITDA margin to be around 19%. So, OpEx as a proportion of revenue will decline year-on-year and gross margin should -- rate should decline due to two factors. First, plenum freight, that would be about the point of impact in the quarter, but also mainly higher level of large deals in the quarter. We had mentioned that now for two quarters. Our business, large deal business is doing very well, actually growing year-on-year and expected to grow in Q3 and in Q2 and our run rate business has been impacted mainly by the pandemic. We believe that this trend will not last, that's point number one. We believe that run rate is starting to increase and will keep increasing. And an important point on the like-for-like basis, margin has been improving. Andrew Buscaglia : Okay. Okay. So, the gross margins sequentially will be up. Olivier Leonetti : Correct. Andrew Buscaglia : And then, if you could just talk about your backlog, it sounds like you have a strong backlog. Anyway you can quantify that? Like, what is your visibility beyond Q3 there? You mentioned some large orders or -- yeah, you talked to some potentially larger orders. Can you just provide some additional commentary on that? Olivier Leonetti : Yeah. We entered Q3 with a solid backlog position. It was quite strong considering the overall environment, but that was driven by the high proportion of larger deals. So, we've seen a lot of our larger customers, particularly in retail and T&L accelerate their investments. And they also then -- in this case gave us the orders prior to the start of the quarter. And that gives us, obviously, a great deal of confidence in the outlook we give for Q3. Joe, I don't know if you have any further comments here. Joe Heel : Well, we have a strong backlog position, as Anders and Olivier said. Some of the projects are multi-quarter, so we do have some backlog already building for future quarters, but it's too early to determine how strong relatively our future quarter backlog will be. Olivier Leonetti : But it's correct to say -- the pipeline for Q4 is good. So we feel encouraged about kind of the way that the market seems to be recovering. And the final comment, Andrew, we're not giving, of course, a guide for Q4. Too many uncertainties at the moment for obvious reasons. But we believe that Q4 from a revenue standpoint and profitability standpoint will be an improvement relative to Q3. Andrew Buscaglia : All right. Thank you, Olivier. Operator : The next question is from Jim Ricchiuti of Needham & Company. Please go ahead. Jim Ricchiuti : Hi, good morning. A question I have is just -- as we've gone through the pandemic and seeing the impact on brick and mortar retail, e-commerce, I'm wondering if you could talk a little bit about the changes in customer behavior. I mean, your -- if you could talk in terms of things that you see changing in the market, as we start coming out of this. What do you see it doing to the business? And I assume you've seen some early indications out of this, things like ship from store and whatnot. Anders Gustafsson : Yeah. I'd say in this environment, our solutions have become even more critical for our customers than they were before. And we are uniquely positioned to empower frontline workers across all our end markets. So I'd say the crisis has been accelerating a number of secular trends around digitization and automation. And I think that probably spans all our vertical markets, all four key vertical markets. If you dig in a little bit deeper on retail, I'd say grocers, which were certainly on a large part of our customer base before, e-tailers, grocers, mass merchants are about two-thirds of our business, but the growth in just grocery revenues, but particularly buy online pickup-in-store has been quite significant. And we've seen grocers across the -- particularly in the U.S. but across -- certainly Europe and the U.S. invest materially in enabling, scaling up their ability to do omni-channel in particularly buy online pickup at store. So that has been a big change. I think buy online pickup at store has gone from being more of a niche application before to now mainstream. And I'd say across the board in retail that customers who say we're in segments that were struggling a bit more before or during the downturn, I think everybody recognizes now that they can't be a 100% reliant on in-store purchases that omni-channel and the e-commerce side of their businesses needs to grow or expand. So, we see people spending more and more -- giving more attention to kind of omni-channel part of their business and how to be able to respond to situations like the one we had in Q2. Joe Heel : Maybe I can add one or two things. This is Joe Hill speaking. Generally speaking, besides, the buy online pickup-in-store, productivity and resiliency are at a premium for our retailers and think not only at the store, but also the warehouses. And so, the types of solutions that we have in improving productivity warehouses, where there's less reliance on workers to do tasks, including things like the investments that we made in Locus Robotics, are going to be an increasing trend in retail, which also helps improve their resiliency when there are incidents, for example, in a warehouse. And this also extends to contact free solutions. One of the features of BOPIS is that it's contact free. And there are other contact free elements of the retail interaction that we think will be here to stay, for example, payment transactions or contracts free kiosks as opposed to interaction with workers. So, those are a few other trends that we're seeing that generally benefit us in retail. Jim Ricchiuti : And my follow-up question is on Reflexis. How long have you known them? And is this acquisition -- does it fill in some areas of your solution set that maybe where you had some holes? And is the -- is there any customer concentration within Reflexis that you can talk to? Thank you. Anders Gustafsson : Yeah. So are very excited about the addition of the Reflexis team to Zebra and that business. We've known each other for quite a long time. Reflexis has been a premier IC partner of Zebra. And we've been in dialogue with them about this transaction for some time. The transaction very much helps to augment our Enterprise Asset Intelligence vision of empowering every worker at the edge with insights that drive real-time action. So, this is entirely consistent with our broader vision. And it leverages our existing software assets and some of our hardware. So, if you think of Zebra Prescriptive Analytics, which looks at all sorts of data sources to glean insights and drive actions that can now fuel Reflexis' engine of driving actions, too. And our Workforce Connect can be one of the ways that we augment the Reflexis platform to have a more efficient way of communicating between employees and workers to ensure the right person get the right action at the right time. Olivier Leonetti : And in terms of customer concentration, Jim, the asset has a low level of concentration of sales towards a few customers, and Reflexis has been performing extremely well during the pandemic. Anders Gustafsson : It's -- obviously, we serve most retail customers. So, there's a lot of overlap. And we think there's great opportunity for us to do some cross-selling and up-selling across the portfolio. If you look specifically at how the customer base of Reflexis has performed during the lockdown, two-thirds of their customers were open and operated like normal. About one-sixth had some partial shutdowns or slowdowns, and one-sixth were fully shutdown, but are now open. Operator : The next question is from Paul Coster of JPMorgan. Please go ahead. Paul Chung : Hi. Good morning. This is Paul Chung on for Coster. Thanks for taking my questions. So, just a follow-up on Reflexis. It's kind of somewhat of a departure from your typical acquisition as it's mostly software. Should we kind of expect a shift to the software to continue? And if so -- if we think about gross margins longer term, should we expect kind of a structural step-up to your current gross margins of 47% as your strategy evolves? And I have a follow-up. Anders Gustafsson : So, first, I think, the acquisition of Reflexis is very consistent with our broader approach that we've talked about for some time to align with our strategy of either driving growth in our core -- identifying, acquiring companies that expand our leadership in the core or rapidly grow in near adjacencies or accelerate our Enterprise Asset Intelligence vision. And Reflexis fits into the accelerating the Enterprise Asset Intelligence vision. I don't think -- we don't think of it as a big departure from how we have thought about the business, or how we have executed over the last few years. Software has become a bigger and bigger part of it. The last three acquisitions now including Reflexis have been pure software acquisitions. Although, I'm not saying that, that by any means, it's going to be -- that's the only thing we're focusing on for the future, but we are building more and more software assets and software capabilities. And even internally, more than two-thirds of our engineers are software engineers. So, software is clearly a very important part of how we deliver value to our customers, even if that is as a standalone software offering or as a more integrated solution between hardware and software. Olivier Leonetti : We believe that the asset will indeed increase the overall margin of the business, I mean, not only because it's software, but also because of the impact it will have on the hardware part of the business as well. So, very synergic from a revenue and margin standpoint. Paul Chung : Okay. Great. And then just on your SMB channels, are you starting to see demand pick up in July as business start to reopen? Have you also kind of seen some consolidation in the channels, maybe some of the smaller players kind of given some liquidity concerns we've been hearing about? And how does that kind of impact your pricing over time in your view? Thank you. Anders Gustafsson : Yeah. I'll let Joe comment here also afterwards. But we have seen -- I guess, first, stabilization and signs of improvement in our run rate business and -- which we tend to kind of talk about them as run rate and SMB as being the same, but they're not necessarily the same, but it's not. Now, I think the SMB segment was harder hit by the shutdown. Most SMB companies were not deemed essential and therefore, were shutdown harder. And we have also more manufacturers that's part of our SMB or run rate business, but we are seeing them return to more healthy outlook and sequential growth. We also say that our -- we work hard to make sure that we maintained healthy inventory levels within our channel. So, when sales out numbers went down a little bit in Q2, sales in went down more. So, the end markets were somewhat healthier than our sales numbers would indicate. But now we're in a position to start growing with them as the economy expands. Joe Heel : Two additional comments. Remember that nearly half of our business is outside of the U.S. And in regions, including Asia, as well as in Europe, we are seeing the run rate business improve. Whereas in the U.S., it's still a bit too early to say that we have a sustained improvement. But, for example, in several countries in Asia, we are seeing growth in our run rate. Second, in terms of the channels themselves, it is fair to say that our channel business among our larger partners has been stronger than it has been among our smaller partners. It may be too early to speak of a consolidation, but it would be -- but at least that is what we are seeing. Paul Chung : Thank you. Operator : The next question is from Keith Housum of Northcoast Research. Please go ahead. Keith Housum : Good morning, gentlemen. Glad to hear that the large deals are holding up strong. I guess, Anders, are you seeing any large deals being pushed off because of the current environment? Or are you finding that the prioritization of these projects hold better than I guess what they might see for other products or projects? Anders Gustafsson : We have seen larger deals push into future quarters more dependent than on the type of customer. So, some would be retailers that had to shutdown altogether in Q2. They tended to push if they had bigger orders on the books into future quarters. Another example will be around, say, RFID, which often requires more in-store activities and also focus more on apparel or fashion retailers. So, anything that had to do with -- where we had to go into our customers' facilities to setup and implement the solutions would get pushed. But that's been offset by other customers that were operating and had to really scale up their operations to deal with the increased business that we're getting as part of the shutdown. Keith Housum : Great. Great to see that. And then as you look at I guess the intelligent edge solutions, can you discuss the progress you had with those solutions during the quarter versus the services growth? I think, if I heard right the managed services were grew during the quarter. But how did intelligent edge solutions do like Savanna most importantly? Anders Gustafsson : Yeah. I think, our -- many of our software solutions did very well. If you look at, say, Zebra Prescriptive Analytics, as an example, we were able to win several new customers in Q2, and we were able to win and implement those customers without actually having to go on site. So that was one of the benefits of having a software solution like that. But other intelligent edge solutions that require onsite proof-of-concepts, pilots and so forth, they tended to be pushed out, and we're not growing the way we had expected. Keith Housum : Great. Thank you. Operator : The next question is from Meta Marshall of Morgan Stanley. Please go ahead. Erik Lapinski : Hi, team. This is Erik on for Meta. Thanks for taking our question. Maybe we could just go back to the retail side quickly. I mean, given some of the drivers you had noted, do you expect any sort of digestion period with some of the e-commerce or grocery customers following the investments that they have been making? Or do you think that kind of those investments just continue to scale as kind of the economy recovers? Anders Gustafsson : Yeah. The -- I'd say the larger orders that we've seen in retail in the last quarter or plus are really to help our existing customers scale their operations. So, it's not -- they're not necessarily building ahead or anything like that. So, I don't see a need for them to, say, pause or catch or deploy and catch up on the operations side with what they have deployed. But obviously there's many customers and somehow different profiles than others. But generally, they are just basically trying to deploy devices into existing use cases where they scale in line with the number of headcount they have or the revenues they have for those applications. Erik Lapinski : Got it. That's very helpful. And then maybe just a quick follow-up and kind of returning to some of the gross margin impacts from the larger deals. Was the initial shipments to kind of USPS also a factor in there? And should we maybe be expecting a similar impact to gross margins just as those shipments really ramp up into the first half of next year? Olivier Leonetti : So, Q2 had an USPS order. This order was shipped at the end of the quarter, so relatively material to the quarter. USPS is ramping in Q3. But as we have said before, the large majority of the USPS order will be shipped next year, probably in the first half of next year. And we're not going to talk about margin, of course, of USPS today. But usually large deals have a lower margin and run rate, so it would impact the company rate. Erik Lapinski : Got it. That's helpful. Thank you. Operator : The next question is from Brian Drab of William Blair. Please go ahead. Brian Drab : Hi. Thanks for taking my questions. I'll just ask one question at the moment. And I apologize if you've discussed this to some extent. There's simultaneous calls going on. But I know you're expecting about $20 million in costs associated with the move of manufacturing out of China that are adjusted out of the adjusted EPS figure. But you have other costs that you're incurring this year. I guess, there's about $19 million of premium freight and other costs in the second quarter, $9 million in premium freight in the -- or coming in the third quarter. And just as we're trying to assess costs this year that likely won't be present next year. What is the estimate for total premium freight in 2020 and other costs in 2020 that likely won't be present in 2021, for example, incentive comp, maybe down this year that comes back next year? And what -- I can't remember what was the situation in the first quarter. Was there premium freight in the first quarter as well? Olivier Leonetti : So, it's -- let me try to cover the key points on this. So, if you look at, going forward, in terms of transitory cost, we are now done and our supply chain did an amazing job in diversifying our supply chain out of China. So, this work is done. And we're not going to have any impact due to tariff going forward. So that's not part of Q3 and obviously, forward P&L. So that's point number one. Point number two. We're going to have some impact due to premium freight in Q3. I mentioned in my prepared remarks that about $9 million -- about 80 basis points worth of margin rate, that will decrease towards the end of the year. And we believe that this trend should now stop going forward. So that would be a second item. When it comes to OpEx. We have been able to manage OpEx and adjust OpEx as revenue was declining. We'll keep doing that in the year. Now you are asking, do we have some of those OpEx reductions, which are going to be permanent? We believe so. It would be premature to mention a number today, because we want to keep investing in the business as well. Brian Drab : Okay. But Olivier, if I can just follow-up. What I'm driving at is the transitory costs, what's the total estimate for 2020? And then -- so we can model 2021. You're not -- you called out $19 million in the second quarter, you called out $9 million in the third quarter. Olivier Leonetti : Yeah. Brian Drab : What -- those costs and also including tariff costs, it seems like there's going to be like $50 million, like 5, 0 or something, in that range of costs this year that we shouldn't expect and we shouldn't model for next year in that -- in total. Olivier Leonetti : Yeah. Your number is about right. I mean, if I was to give you the phasing and maybe we can take that after the call of today. Tariff impact in Q1 was about one point. That is transitory. In Q2, the impact of tariff and premium freight was about two points. Premium freight impact in Q3 will be about one point. And we believe that all those transitory costs to a large extent will be gone by Q4 onwards. And we take the details after this call as well. Brian Drab : Sounds good. Okay. I'll talk to you later. Thank you. Brian Drab : Thank you. Operator : [Operator Instructions] The next question comes from Richard Eastman of Robert W. Baird. Please go ahead. Richard Eastman : Yeah. Just I'm looking kind of at the decrementals, kind of similar line of thought here. But the decremental here in the second quarter at the adjusted EBIT line was about 40%. And that's obviously absorbing some of the tariff costs, the freight cost, probably offset by some OpEx reductions. Is that -- is the 40% decremental kind of run into the third quarter? And then, presumably -- and maybe fingers crossed here, decline in the fourth quarter with some of these transitory costs out of the number? Olivier Leonetti : You're right, Rich. If you look at today, in terms if you look at Q2 and Q3, we believe we're going to be able to scale OpEx as a proportion of revenue in about the same level. And then in terms of margin, we're going to have over those two quarters the same impact of large bid mix, which would impact gross margin. But we believe that largely those trends will stop as we enter into the fourth quarter. That's why I indicated during an earlier question that profitability in Q4 will certainly increase relative to Q3 and Q2. Richard Eastman : Okay. Okay. I got you. And then just maybe a quick thoughts around what appears to be maybe more cyclicality in the printer business in general, AIT. Thought being that, is that business impacted much more as run rate business through the channel? Or is it just simply easier to defer purchases of a printer, given the payback on the printer just defer it for a couple of quarters. I mean, how do you kind of view that on the printer side of the business? Anders Gustafsson : Yeah. The printer business is more -- has a much higher proportion of run rate as part of its revenue stream. It supports more SMB and manufacturing customers. So, the profile of the customer base is -- was more exposed to COVID-19 shutdowns or slowdowns. I'd say if we dig into the printing portfolio a little deeper, our card printing business was particularly hard hit. Card printing, they do -- they support events. Obviously, there weren't a lot of events in Q2. Badges for employees, drivers' licenses, all sorts of things that were hit more harder. But we did start to see -- particularly manufacturing opportunities to resurface in Asia-PAC later in Q2. And if you look at our supplies business, Temptime had a very strong Q2 and grew its vial monitoring solutions for existing vaccines. And we were doing things in emerging markets for COVID-19 test kits. And once we get a proper vaccine, we see opportunities for that to continue to do well. We also worked here on making sure that the channel had appropriate inventory positions. So, we did reduce inventory in the channel, but kept the days on hand just stable. So, we're coming out of this with a healthy inventory position where we can grow the business now in line with how the economy grows. But we do believe that we actually gained share in printing in the first half of this year. So, based on all our data points, we believe that we actually gained some share. Richard Eastman : Okay. Joe Heel : And one further data point just on that. In China, our printing business is rebounding faster than our other businesses. So that gives you an indication that there is a positive trend that will likely come back at the end of this cycle. Richard Eastman : I see. Okay. All right. Very good. Thank you. Operator : The last question comes from Jeff Kessler of Imperial Capital. Jeff Kessler : Thank you. Thank you for taking my question. Firstly, with regard to your TAM. It appears -- a couple of years ago, you gave a number with regard to $9 billion or $10 billion out of the total market in the AIDC area. Clearly, with some of the new software that you've developed internally, but also with some of these acquisitions, you've expanded the total available market that you can play in and also the niche -- if you want to call it that niche, that you are actually directly affecting. Can you speak to how -- particularly this last acquisition that you've just announced, can you just discuss the size of the marketplace that you are now affecting relative to where you were just a couple of years ago? Anders Gustafsson : So, we've talked about our core markets being around $10 billion in size and that we have we've had an incremental $15 billion market size in our adjacent markets, right? The -- and some of those adjacent markets that took us from $10 billion to $25 billion in total size will include tablets, supplies, RFID. Our -- many of our software solutions are new. And there is no -- it's a little difficult to say what the TAM is because they -- you could calculate it by, say, if every retailer on the planet were to deploy it, the TAM would be very, very large. It's not quite that today, but it is a substantial TAM and it's a higher -- faster growing market than our core markets. So, clearly, this expands our addressable markets and positions us to participate in additional high growth markets where we also get attractive synergies by being able to cross-sell and up-sell. Jeff Kessler : Okay. And follow-up is, you've talked about the recovery in your business. But the fact remains is that at least in the United States, maybe not in Asia or in parts of Europe where they seem to be recovering from the virus faster, we seem to be still in somewhat of a state of a mess here. And it maybe some time before the virus allows business to operate at a more normal pace. Is the improvement that you're talking about in the third and fourth quarter? How much of it is basically based in the fact that Asia -- parts of Asia and parts of Europe are actually recovering and helping you and relative to the U.S.? And is the percent -- is your geographic pie going to shift at all in the second half of this year and perhaps into the first half of this year until there's some type of vaccine to -- and more importantly, the U.S. kind of gets its COVID-19 act together, if you want to call that? Olivier Leonetti : I think you summarized it well. We see all the regions improving in Q3 and Q4 relative to Q2. But the main recovery is outside North America. You're absolutely right. Jeff Kessler : Okay. Joe Heel : Although, I think, in the second half, we have a substantial number of large deals that are North America centric, with North American customers having increased demand for the products that they have been buying from us previously. And so, I think, our overall deal mix will not shift that much, even though the recovery in particular on the run rate will be stronger outside of the U.S. Jeff Kessler : Great. Thank you very much. I appreciate it. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Yeah. Thank you. So, to wrap up, I would like to thank our employees, customers and partners who are working in the frontline during this challenging time. And we're also looking forward to welcoming the Reflexis team once we close the transaction. Stay safe everyone. Operator : The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
|
ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,020
| 4
|
2020Q4
|
2020Q3
|
2020-11-03
| 11.732
| 11.613
| 12.684
| 13.097
| null | 21.24
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Operator : Good day, and welcome to the Third Quarter 2020 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning, and welcome to Zebra's Third Quarter Conference Call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Slide 2 conveys that the forward-looking statements we make today are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our acting Chief Financial Officer. Anders will begin with our third quarter results, then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress on advancing our Enterprise Asset Intelligence vision and trends in our end markets. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Now let's flip to Slide 4 as I turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. We are honored that our solutions are empowering frontline workers in the battle against COVID-19. I am proud of our employees' resiliency and focus on serving our customers' critical needs during these challenging times. Our top priority continues to be protecting the health and well-being of our employees, customers and partners as businesses continue to progress with their reopening plans. In Q3, our results continued to be pressured by the global macro environment. For the quarter, we realized net sales growth of 30 basis points; adjusted EBITDA margin of 20.3%, which contracted by 240 basis points; and non-GAAP diluted earnings per share of $3.27, a 5% decrease from the prior year. As a result of excellent execution by our teams and a faster than expected recovery in demand, each of these measures exceeded our outlook. Demand from our large strategic customers has been at record levels, driven by accelerated trends to digitize and automate workflows. Not surprisingly, the pandemic has disproportionately impacted our smaller customers in certain end markets, which has resulted in a significant shift in business mix. Together with premium shipping costs, this has weighed on gross margin. In light of this pressure, we have continued to diligently manage discretionary costs to preserve profitability and cash flow. Despite the challenging environment, our enterprise customers have been prioritizing spend with Zebra, and I would like to highlight some notable Q3 success stories. We expanded our relationship with a leading e-commerce retailer experiencing significantly increased order volumes. They require trusted technology solutions that enable improved supply chain and order fulfillment execution to empower their labor force. We are deploying our mobile computing, scanning and printing solutions across their growing global footprint. Innovation, quality and value are critical partner attributes cited by this customer, and we are proud that our team is delivering to their high standards. The hospital system in Denmark has chosen to replace a competitor with our clinical point-of-care solution. In Q3, they began a multi-quarter deployment of our health care-purposed TC5 Series mobile computers and accessories, which will interface seamlessly with their electronic medical health record system. We have continued to deploy TC7 Series mobile computers to USPS postal carriers as planned and are now pausing through their peak holiday season, expecting to resume in late Q1 with the goal of completion by mid-Q3. We are proud that we are able to help our customers meet their mission-critical needs in an increasingly on-demand economy. We continue to view acquisitions as a vector of profitable growth for Zebra and a way to elevate our role as a solutions provider. In early September, we closed on the Reflexis acquisition. In a few minutes, I'll elaborate on how this acquisition is synergistic to our offering. With that, I will now turn the call over to Nathan to review our Q3 financial results and discuss our Q4 outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. Net sales increased 30 basis points before the modest net impact of currencies and acquisitions. As Anders mentioned, large order volume was much stronger than the prior year. This was offset by a decline in small and midsized business through the channel, which disproportionately impacted printing and data capture. Our Enterprise Visibility & Mobility segment sales increased 4%, driven by solid growth in mobile computing and services. Our Asset Intelligence & Tracking, including printing and supplies, continue to be most impacted by the global recessionary environment with sales decreasing 7% from the prior year. This was a notable 18-point sequential improvement from the Q2 decline. We realized solid growth in our managed and professional services and Zebra retail solutions. Location solutions declined from last year due to lower project activity during the pandemic. We realized significant sequential improvement in each of our regions from Q2 as we continue to recover from the peak of the pandemic. In North America, sales increased 6%. Mobile computing and data capture returned to solid growth, and services continued to perform well. EMEA sales were flat. Services and mobile computing were bright spots. We also continued to see strength in Central and Northern Europe. Sales in our Asia Pacific region declined 13%. China was a bright spot, returning to modest growth. Latin America sales declined 20% with all major product and service categories declining. Adjusted gross margin contracted 390 basis points to 43.8% driven primarily by more than 3 points from unfavorable business mix and nearly 1 point from premium freight cost, which was partially offset by improved services margin. Underlying margin trends across the business, excluding mix dynamics, remain healthy. Adjusted operating expenses declined $17 million from the prior year period and improved 150 basis points as a percentage of sales. This improvement was primarily due to disciplined cost management and lower compensation expense while preserving our planned investments in the business. Third quarter adjusted EBITDA margin was 20.3%, a 240 basis points decrease from the prior year period, driven entirely by lower gross margin. We drove non-GAAP earnings per diluted share of $3.27, a $0.16 or 5% year-over-year decrease. Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $482 million of free cash flow in the first 9 months of 2020. This was $106 million higher than the prior year period, primarily due to a lower use of working capital as well as our expanded accounts receivable factoring program. Our balance sheet is strong. From a debt leverage perspective, we ended Q3 at a comfortable 1.8x net debt to adjusted EBITDA ratio, 0.5x higher than last quarter, due to financing the acquisition of Reflexis. Now turning to Slide 8. We have demonstrated that we can deliver solid results in a challenging economic environment while continuing to invest in our future. Our consistently strong free cash flow generation is driven by our capital-light business model, flexible cost structure, diversified end markets, strong execution and disciplined cost management. Let's now turn to our outlook. We are encouraged by the faster-than-expected recovery with small and midsized businesses and are beginning to realize the benefit of pent-up demand from many customers who have paused their spending earlier in the year. Based on these trends and our healthy channel inventory levels, we expect Q4 adjusted net sales to increase between 3% and 7%. This outlook assumes an approximately 150 basis point additive impact from the acquisition of Reflexis and a neutral impact from foreign currency changes. We believe Q4 adjusted EBITDA margin will be between 21% and 22%, which assumes modest operating expense leverage from the prior year. Gross margin is expected to be slightly lower than last year, reflecting higher large order mix in a soft but improving macro environment as well as an offsetting year-on-year impacts of premium freight and tariff expense. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $3.90. You can see other modeling assumptions on Slide 9. Note that we now expect free cash flow to be at least $650 million for the year, which is higher than 2019. With that, I will turn the call back to Anders to discuss how Reflexis is synergistic with our Enterprise Asset Intelligence vision as well as trends in our end markets. Anders Gustafsson : Thank you, Nathan. Slide 11 highlights how we are building on our foundational capabilities to elevate our value proposition with customers as a solutions provider. Our unmatched access to frontline operational data from our vast installed base of products uniquely positions us to solve our customers' complex challenges at the edge. We are investing in emerging technologies that help our customers better orchestrate their workflows by leveraging real-time data to gain actionable insights. We are excited to have Reflexis onboard, which further helps Zebra bring our Enterprise Asset Intelligence vision to life for retailers and other end markets. Reflexis is a demonstrated leader in intelligent workforce management and task execution. Their platform is utilized by hundreds of retailers around the globe to drive employee productivity and retention while also improving customer engagement. Reflexis is synergistic with our existing suite of solutions as a service. As you can see on Slide 12, these include : SmartCount, which is an innovative self scan and physical inventory management solution; our SmartSite robotic solution, which uses automated intelligence to help identify issues on the store shelf in real time; our Workforce Connect data and voice communication and collaboration application for mobile workers; and Zebra Prescriptive Analytics, which provides data-driven insights and a prioritized list of prescriptive actions that help maximize efficiency and reduce shrinkage. Zebra's suite of solutions work in unison with our product portfolio to provide real-time contextual tasking. This capability is critical for successfully addressing the inevitable unplanned events that occur throughout the workday. Over the next few quarters, we will continue to invest in the seamless integration of Reflexis' market-leading platform with our complementary software offerings to optimize the experience for frontline workers. We are also investing in our go-to-market efforts to drive accelerated traction with our unmatched suite of solutions. We believe that our enterprise customers will realize a compelling ROI by empowering all of their associates with these solutions. On Slide 13, we provide an update regarding the mixed impacts we are currently seeing in the primary vertical markets that we serve. We also highlight the exciting longer-term opportunities in our end markets as customers invest in our technology in an increasingly on-demand economy. Trends are improving since our last quarterly update, although it is still a mixed picture depending on the sector. In health care, our solutions helped hospitals intelligently flex their capacity to serve patients. There was a pause in noncritical care during the peak of the pandemic, straining the budgets of health service providers, which is changing now that elective procedures are assuming. Longer term, the need for increased real-time visibility into the entire patient journey and the demand for innovative solutions to provide safe and efficient care continue to make health care a high-growth end market opportunity. Retailers are prioritizing investment in our technology for their complex omnichannel fulfillment strategies and related warehouse automation needs. Demand from large retailers is at record levels as e-commerce and buy online-initiated transactions have increased dramatically through the pandemic. We have also begun to resume business with many department stores and specialty retailers that have been reopening their doors. In the transportation and logistics space, strong e-commerce growth continues to drive parcel volumes and last-mile delivery, which is favorable to Zebra. Passenger airlines, rental car providers and other related businesses remained challenged. The manufacturing sector continues to be most impacted with COVID-19 and global trade tensions. Key segments within process manufacturing, such as food and pharmaceutical companies, have held up relatively well, continuing to operate through the pandemic. We've seen mixed trends in discrete manufacturing with those in aviation and discretionary specialty goods, particularly challenged, a bright spot is our solid recovery in Chinese manufacturing. In closing, we are successfully navigating through this challenging environment while we continue to invest in advancing our Enterprise Asset Intelligence vision. This is enabling Zebra to emerge from this crisis in a stronger competitive position. We also believe that our longer-term prospects are strengthening as secular trends to digitize and automate workflows have accelerated. Now I'll hand the call back over to Mike. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. [Operator Instructions] Operator : [Operator Instructions] Our first question will come from Tommy Moll with Stephens. Thomas Moll : Anders, I wanted to start on the Reflexis deal. Could you articulate for us how important integrating software as part of your revenue mix will be going forward? And what are some of the strategic rationales? In other words, what does that allow you to do in terms of increasing stickiness with the customer relationship? What are the other advantages it brings to Zebra? And then as a related point, as you do head into more software-driven sales, should we think about that market as one that's more competitive than where you've traditionally competed? Or how do you want to frame up the competitive dynamics there? Anders Gustafsson : Yes. That's good. I'll start, and then I'll ask Joe Heel to help out also. First, just -- Reflexis is a great company. We're very excited that it's part of our portfolio, part of the Zebra family here now. I mean it's been a demonstrated leader in intelligent workforce management and task execution for many years, and it's been deployed by hundreds of retailers around the globe to help drive employee productivity and retention. And many, many of those customers are common to Zebra and to -- also to our Zebra Prescriptive Analytics solution. So when we look at Reflexis and Zebra Prescriptive Analytics and other software solutions we have, we see them as being very synergistic with our overall solution. If you think of our framework around Sense, Analyze and Act, I think that's probably the easiest way maybe to show how we think about creating more complete solutions for our product customers. But we have had historically a great strength around the sense and some in the analyze part, but being able to sense what's happening in the physical world has been kind of our foundation. But over the last few years, we have expanded our capabilities around the analyze and the act side quite a bit, and both Zebra Prescriptive Analytics and Reflexis are examples of that. And now when we -- prior to actually the acquisition of Reflexis, we had a number of customers ask us to do more tight integration between Zebra Prescriptive Analytics and Reflexis. They felt that, that would be something that would help get more value out of those investments. Zebra Prescriptive Analytics is going to continue to feed actions into Reflexis' action engine to help combine all the different actions that the retailer might do in a prioritized way. And then we look and leverage our other software assets like Workforce Connect to be able to let it all tie it back into our mobile computers. So our store associates can either scan items in the store or enter other data that can be fed into ZPA or into Reflexis but also then be receiving updates or actions from that so that the Reflexis system can deliver even greater value by being able to do that. And for Zebra as a whole, with our suite of solutions as a service, we can become more strategic to our customers. We can start enabling them to address more complete workflows. And by that, we can increase the ROI of our overall solutions and be a more strategic thought partner as they think about how they develop their business. So we definitely feel that this is a very compelling path for us and very excited about what we can do with this. Joe, you want to add something? Joachim Heel : Yes. Perhaps I'll underline two things that you touched on. One is the fact that we're synergistic, not just on the product level, as Anders described, how we think we can bring together the different product capabilities we have, but certainly also on a go-to-market and sales level, where we have a very strong share in the retail market already, and bringing Reflexis to those retail customers is immediate cross-sell opportunity that we have. We're actually discovering that it also works the other way around. That Reflexis has some customers that they can bring us into and cross-sell that way. And that leads into the strategic opportunity that Anders described, right, which is -- Reflexis generally has a strong presence in the operations side of retailers. And this now gives us an opportunity to solve their problem strategically. And this perhaps also addresses the second part of your question around do we see this as a more competitive space. Certainly, there are different competitors in the pure workflow software area. However, none of them have the capability that we have to bring together the Sense-Analyze-Act part of the EAI vision and to solve the problem holistically. So we look at this as a space where we can now differentiate ourselves actually from both the traditional competitors that we had and the competitors that Reflexis currently has. Anders Gustafsson : Just to round out, say, I've been on the phone with many of the largest customers of Reflexis over the last month or 2, and I'd say that, formally, they are very excited about the combination. They are passionate about the Reflexis solution, but they also see the value that a combination with Zebra and the extra resources we can have and how -- our vision for how we can continue to add value to their operations. So I think so far, it's been a great feedback from the market and from our customers. Thomas Moll : That's all very helpful. As a follow-up, I wanted to shift to some of the end market commentary you offered, Anders, specifically within retail and e-comm. It just sounds like some of the larger customers have accelerated their plans for the omnichannel integration or leaning into their e-commerce platforms. So 2 related questions. How durable do you see that trend being -- or maybe you could frame up qualitatively, if not quantitatively, how far ahead you think your current backlog gives you visibility into maintaining a robust pace of sales? And then moving to the smaller customers or potential new smaller customers, are you seeing anything -- not even in terms of order trends, just interest level that suggests that maybe the playing field here has expanded? If you just look around the retail landscape, they're a lot more engaged in omnichannel or talking about it at least now than there were a year ago. So I just wonder if maybe there's a TAM aspect to this dynamic as well where it's shifted in your favor? Anders Gustafsson : Yes. I'll start, and then I'll ask Joe to add a little bit of color to it also. First, I think in this environment, our solutions have become even more critical for our customers. We are, I'd say, uniquely positioned to empower frontline workers across all our vertical end markets. And COVID-19 has been accelerating a number of secular trends around digitization and automation, and it's probably most apparent in retail around e-commerce, around omnichannel and buy online pick up at store. Here, we've seen, particularly around mass merchants, grocers and e-tailers, that they have been the most -- the quickest, I guess, to pick up on this, and that's about 2/3 of our business. But I'd say, the largest retailers have been the -- mostly been the most aggressive or the earliest to start adopting and investing in solutions around omnichannel and e-commerce. They have seen a great growth in their omnichannel and buy online, pick up at store businesses. And they have -- still believe that there's lots of market share that they can continue to grow and take. So they are continuing to invest heavily in building out their capabilities and scaling their capabilities compared to where it was, say, just 6 months back. For smaller retailers, they -- I'd say generalizing a bit now, they were maybe not quite as quick to invest in omnichannel capabilities. It's a big investment and a complicated one at times. But I think the COVID-19 and the changes in customer buying behaviors and the step-up in change in how comfortable consumers are with omnichannel and buy online, pick up at store, as an example, has made it, I think, abundantly clear for smaller retailers, too, that if they want to compete, they need to build these types of capabilities. So we see the pipeline of business around these larger trends around digitization, automation and particularly in retail as quite robust. And we think that this is a trend that will be going on for quite some time. And we're just saying that, I think for now, we see then the pipelines of these types of opportunities as we look into 2021 as being as robust as we would have expected them to be in prior years at this time. Joe? Joachim Heel : Yes. I'll add perhaps 2 thoughts. I do think there is a TAM expansion that's going on, but I see it a little differently than you were perhaps suggesting. One big area of -- it has to do with the fact that in order to enable all of these omnichannel capabilities, you need a deep capability in the company more broadly than just at the front where the items are being picked up. And 2 things in particular that you need to do that, I think, favor us in this case is, number one, you need to enable your associates in your store because that's where most of the instant omnichannel capabilities is being created. And that means you need to digitize and give every worker a device in some form, and we're far from that today. So that's a TAM expansion. And the second piece is you need to extend that modernization into your supply chain, and we're seeing a lot of activity in terms of digitizing and automating the supply chain, and that's clearly related to this acceleration of e-commerce. Operator : Next question comes from Jim Ricchiuti with Needham & Company. James Ricchiuti : Follow-up on that some of the last commentary that you were making, Anders. And it sounds like you're still anticipating a fairly robust environment with your larger customers. So it's not as, potentially, there's some digestion from the investments that they have been making. And then as it relates to the small medium segment of, it wasn't if -- to what extent you are seeing a recovery there? I mean, is there the potential over the next 1 to 2 quarters that you could have both areas of the business, both large accounts and the SMB, actually moving in a consistent fashion toward stronger growth? Anders Gustafsson : Yes. First, I think we're seeing a faster-than-expected improvement in our end markets, and we're cautiously optimistic about how the economy will recover into 2021. I think here, our industry leadership and our investments in our business will also enable us to rebound stronger than our competitors. And to that point, that's why we feel confident to guide for a both top and bottom line growth in Q4. When we looked at our Q3 performance here, our run rate was improving. It's not back to pre-COVID-19 levels, but it is definitely improving and strengthening. And I think that was something we saw globally. And our large deals were obviously very strong in Q3, but we still have a good pipeline into our larger customers and how they're looking to invest in Q4 and beyond. Joe, do you want to add anything to this also? Joachim Heel : Yes, perhaps just 2 things. If you look at our pipeline as an indicator, it's as strong as it was on a relative basis a year ago. So we have a strong pipeline that gives us good confidence, and our run rate has been recovering. We didn't say that clearly enough, but it's clearly a driver of the growth that we've been seeing, and we expect that to continue as well. James Ricchiuti : Got it. And just as a follow-up question. This relates more to some reports that we've begun to see, including one by a large retailer that had been considering deploying in-store robots for inventory analysis and has now pulled back apparently on that initiative. And I know you guys have looked at that market. But I guess my question is, if you look at the opportunities there, does it appear that it looks like some of the major retailers may opt for simply putting more devices in the hands of store personnel as opposed to maybe looking at some of in-store automation with robots and things like that? Anders Gustafsson : Yes. First, I'd say that -- I don't think that our customers see one solution as being able to solve all problems for them. Deploying more devices or putting more devices in the hands of more associates is clearly a trend and something that our customers see as being able to drive a high ROI and enabling all of them to be connected to their applications and systems and be able to be fully utilized in that respect. With respect to the robot solutions, you mentioned also, we believe that there is a good market opportunity for those types of solution, in addition to using handheld computers. We have our Smart Sight solution for this, and I think that's progressed very nicely since we announced it in -- at NRF this year. We've seen an increase in demand and pilots from any customers, particularly, I would say here now in the last few months from grocers. I think so far, our pilots have proven the technology, and we've been able to prove the ROI around -- just based on labor savings alone, and the accuracy of our reads have been very strong. And we -- here is an area where we leveraged our Cortexica acquisition. So we've employed a lot of the computer vision technologies from that into Smart Site, into some of our other solutions to accelerate our ability to extract useful information from digital images. So we see a good, healthy pipeline of customers who are interested in piloting this solution with us. And we have pilots in North America and Europe at this stage. Although it's also fair to say that we -- COVID-19 has made it harder for us to engage on customer sites, which is making it a little slower to ramp these pilots up. But the interest is as high as it was pre-COVID, I would say. Joe, any further comments from you? Joachim Heel : I'd like to add maybe one thing here. Let's remember what were the retailers trying to solve with this robotics automation solution. What they're trying to solve is the accuracy of inventory in the store, and there are many different capabilities and solutions that solve the inventory accuracy problem in the store, and they are suited differently to different types of store formats as well as merchandise assortments. And while we do believe that there is a place for the robotic inventory accuracy improvement, other solutions like RFID or simply using the data from associates' devices like you can do with Zebra Prescriptive Analytics are capable solutions for certain store formats and merchandise assortment. So the key, in our mind, will be having the capability to look at all of these different solutions and bring them to a customer. And that's what we're going to be in a position to do, including the robotic automation. Anders Gustafsson : Yes, I think that's a good point just on -- to emphasize, again, from -- going back to the first question we had. This is where the breadth of our portfolio enables us to go in and talk to our customers about what is the problem you're trying to solve and then look at how can we bring our solutions, our technology to bear to best solve the problem they're trying to solve versus coming in and saying, "Okay, I have a -- whatever your problem is, my hammer is what's going to solve it." So I think this is a great example of how the breadth of our solution plays to our advantage. Operator : Our next question will come from Meta Marshall with Morgan Stanley. Meta Marshall : Great. Maybe a couple of questions for me. One on the Denmark Healthcare win. Just any context as to -- was that your traditional kind of partner ecosystem that brought you into that deal? Was that a more health care-focused partner that brought you in? And then just maybe on the improvement that you're seeing in SMB. Are there any particular geographies or particular type of customer that you're seeing more movement from? Anders Gustafsson : Yes. Again, I'll start and then I'll ask Joe to provide some extra color. So first, on Denmark. The Denmark health care win we had, and it's a very exciting win for us. And I would say, almost uniformly, our health care partners are uniquely focused on health care. It's very rare that we have partners that are strong in, say, retail or manufacturing and also in health care. Those are very different end markets. The solutions are very different. The problems are very different. So it tends to lead to a much more vertically oriented entire value chain for us. Then around SMB, we did see improvements in our run rate across all geographies on a sequential basis. I think that this is something we expect to -- that we'll continue to see as the economy recovers into Q4. We've certainly seen a good progression of the run rate in the SMB business here as we get into Q4 but also as we look further into 2021. Joe, any more comments from you? Are you muted, Joe? Joachim Heel : I am. I do apologize. 2 comments. On the health care partners, one particular type of partner that is very important for us in the health care space are the electronic medical records companies. We have excellent relationships with them, both from an ISV and a resale perspective, and that has been a good source of growth for us in the health care market. In the SMB segment, the one -- other one I would call out, in particular, is China. So in China, we've seen a resurgence, I think, of the -- in particular, manufacturing customers that are so essential for our printing business, and they have certainly contributed to the return of that business. Operator : Our next question will come from Richard Eastman with Baird. Richard Eastman : Yes. I just wanted to explore the gross margin for a minute here, the adjusted gross margin by segment here. Both segments were down 300 to 400 basis points. Maybe a little bit surprised around AIT segment being down. So my question maybe is two-fold. I mean, first of all, around the freight expenses, we're using the term in a premium freight. Is the freight expense up structurally, given the realignment around our subcontract manufacturing base? Or is that specifically to the urgency around some of these e-commerce large orders and getting to here? What does that impact? Nathan Winters : Yes, Rich, so I'll take this. I want to start by -- I think our teams have been executing well on what we can control around gross margin. And if you look at the drivers, it's pretty consistent across both of our segments both from an unfavorable business mix as well as the premium freight costs. And if you look at the -- one of the 3 points, and again, spread between both segments from both large deal mix as well as unfavorable business mix. And just an example, in Q3, the mix of large deals was actually greater than what we saw in Q2. Another example, which speaks to the AIT point, if you look at our printer business, it has a larger proportion within run rate and exposure to the manufacturing vertical, along with generally higher gross margin. And then another point on premium freight costs. And to answer your question, really, it's from capacity constraints not so much from the change in our manufacturing footprint. And we're seeing our cost per kilo up 2 to 3x from what we saw pre pandemic, so again, just as some of the capacities come offline with reduction in air travel internationally. And I think what's important, if you look at the underlying gross margin trends, excluding the mix dynamics, they do remain healthy. And as the economy recovers and our run rate business improves, so will gross margin, which you'll begin to see here in Q4. Richard Eastman : And AIT has the same, again, large order impact on AIT on the printer side of the business as it does on the MC and scanning? Nathan Winters : What I'd say it's less reliant on large deals, but it has a higher proportion within the run rate -- a higher proportion of run rate business. Richard Eastman : Okay. And when you look at -- let's move out when things normalize here around the mix of business between the channel and large orders and then this -- kind of this freight, this premium freight starts to dissipate, are we still kind of at this normalized gross margin level for Zebra, that's, let's call it, 47% with modest upside? Is that still a normalized gross margin here? Nathan Winters : Yes. So as we get past the pandemic, we do expect to get back to pre pandemic levels for both EBITDA rate and gross margin rate. And like I said, the like-for-like margins remain healthy. We also would expect the vast majority of our OpEx to return as the environment normalizes. We have, I'd say, some bit of that will be permanent savings that we'll look to reinvest around the OpEx side. But again, we do get -- we do expect to get back to the pre-pandemic levels, both in EBITDA and gross margin rate. Anders Gustafsson : Maybe just to add one thing to that. We continue to also develop our portfolio. So as you think of our -- the software solutions we talked about here earlier, they tend to come with a higher gross margin certainly, and scale, we would expect them to have a very attractive EBITDA margin, too. Richard Eastman : Understood. Yes. And then just my second follow-up question, just around the sales and sales channel. Just a quick question. When we look at the fourth quarter revenue guide of plus 3 to plus 9, is the assumption in there that the channel, both North America as well as Europe, is up year-over-year? Is that assumption in your guide -- revenue guide for the fourth quarter? Anders Gustafsson : So your question was if the channel is expected to be up year-over-year? Yes. Richard Eastman : So channel and run rate. I'm sorry. Anders Gustafsson : As in run rate, yes. Okay. So yes. So I'll start here again, and I'll have Joe provide some extra color again. But first, we're quite pleased to be able to guide for both top and bottom line growth year-over-year in Q4 here, but the 3% -- 3% to 7% expectation in growth, and that includes 150 basis points of positive impact from Reflexis. First, the large deal activity remains very strong, but the underlying business is recovering faster than we expected, and we are also benefiting from some pent-up demand in Q4. As we entered Q4, though, we also had a strong backlog that helped us in this area. The higher large order mix that we've seen compared to prior year will continue but not the same degree as in Q3. So we do expect the run rate and the channel business to continue to sequentially grow. And Joe, any more color for you? Joachim Heel : I don't think I have anything to add. You said it. Operator : Our next question comes from Brian Drab with William Blair. Brian Drab : At this point, I guess 2 quick follow-up questions to the recent questions that you were just addressing. So I appreciate that gross margin should get back to the pre-pandemic level. I'm wondering if you could put a finer point on that. Is that something that we could expect in 2021? Or does the large postal service order maybe weigh on that somewhat in the near term? Is that a longer-term expectation? Or is that a 2021 expectation? Anders Gustafsson : I think it's a little too early for us to give a detailed 2021 guidance at this stage, but we do expect that our gross margins will continue to sequentially improve, along with the economy and along with the improvement in our run rate business. Brian Drab : Okay. And then, Anders, you just highlighted also that the software business, of course, should be a tailwind for gross margin as that business grows and which Reflexis, it's obviously a bigger piece of the business. Can you give us any sense for it? How -- what percentage of revenue now we are at in terms of software? Is it -- can you even say if it's more or less than 5%? I know it's not something you've really said in the past, but it's becoming a more meaningful piece, and we don't really know how to model the impact on gross margin without some sense for that. Anders Gustafsson : Yes. Obviously we're very excited about the software business, and our software and services business has been growing quite nicely. The software business as a whole, I think, is still in the single digits for us, but it's been, as I say, has been growing quite, quite nicely. And we would expect it to be a much bigger part of our business as we go forward. Operator : Our next question will come from Keith Housum with Northwest Research. Keith Housum : And Nathan, congratulations, and welcome to the call. Guys, want to dig in a little bit further into the U.S. postal service. Anders, I think I heard you say that the deal is on a pause until late first quarter, and then we will finish up in 3Q of next year. So is the plan still to end, I guess, late summer? I'm just trying to get a little bit more idea on the third quarter. And in terms of a pause, are we talking the end of the first quarter, so don't expect much in the first quarter of '21 from the U.S. Postal Service? Anders Gustafsson : Yes. First, the pause that we now have is a planned activity from USPS. This was always their intent to not deploy new devices during Canada peak season, and it will start ramping up again in the second half of the first quarter. So the Q1 would be certainly lower than Q2 and Q3, and we expect that late summer, we will be basically wrapping up. And then we'll continue obviously with other projects and expansions of this project with USPS. Keith Housum : Great. And then just as my follow-up. In terms of the Temptime business, can you just perhaps cover, is there an opportunity with that business to take advantage of perhaps COVID-19 vaccine that might be out there on the horizon? And how is that business doing? And how does that go to play here? Anders Gustafsson : Sorry. You said Temptime? Keith Housum : Correct. Anders Gustafsson : Yes. So Temptime has been doing very well in Q2 and Q3 based on the traditional vaccines that they cover, all the vaccine vials that we cover there. We are working with WHO and a number of pharmaceutical companies, logistics companies, to ensure that we are well-positioned to provide solutions with respect to a COVID vaccine when that becomes available. We have received initial orders from people who are kind of proactively looking to build up the -- an inventory and capabilities for this, but they have been quite small, but we expect that, that can be a nice addition to the business in 2021. Operator : Our next question will come from Blake Gendron with Wolfe Research. Blake Gendron : I do want to circle back on the deal size evolution here. I know we've been talking about it this morning. But if you were to quantify the year-over-year impact of deal mix in terms of bps or whatever, that would be super helpful. And then on a scale of 1 to 10, 10 being pre-pandemic normalized mix versus 1 being sort of the trough where large deals dominated in the second and third quarter, I would imagine, where do you expect the fourth quarter to be just because you do anticipate some of the smaller deal size coming back? And then as an offshoot to that on working capital, you offset some of the receivables friction with payables and things like that. Are the receivables, AR, is that impacted by deal size as well, where we should expect maybe a little bit of friction just given the mix? Nathan Winters : Yes. So to answer your first question around the growth we're seeing in both respect to the large and nonlarge deals. So again, just to clarify, when we say large deals, those are greater than $1 million. In the third quarter, the large deals grew over 35%, and our nonlarge deals were down over 15%. And that -- hard to put a 1 through 10 classification on it. I would say, as we get into Q4, it is going to be slightly higher large order mix than the prior year, but definitely not to the same degree as Q3, and we'd expect that to continue to maybe go back to pre-pandemic levels as we head into 2021, as we see a gradual recovery in the economy. And on your last question around AR factoring. I wouldn't say that we've seen any additional friction relative to deal size. It had a modest impact on our year-to-date cash flow, and we'd expect to see a relatively modest impact on our full year guide. Anders Gustafsson : Maybe just one more -- add to this and the prior question. So we've had a lot of focus on investors on USPS and the impact of USPS had on our business. And U.S. is obviously a large deal, but it was not what drove our Q3 overachievement. USPS came in very much as per our expectations. Blake Gendron : Understood. I appreciate that additional color. And then a follow-up, if I could, on the regional growth, you broke it out in the slide deck. Looks like North America, Europe, Latin America, kind of trending actually a little bit better than maybe some of your indicators would suggest. APAC was down pretty heavily, maybe more so than other companies have disclosed, at least directionally. So on Asia Pacific, is the issue there, just -- first of all, is it a discrepancy? And then is it due to China versus non-China? Is it health of specific end markets or customers? Is there something going on with the channel inventory levels there? I'm just trying to get a better feel for, I guess, the weakness in APAC. Anders Gustafsson : Well, first, more globally, I'd say what you see globally and also in Asia Pac is some of the secular trends that are supporting our business have accelerated as part of COVID. So around omnichannel, the digitization and automation, those are all -- those are global trends. And in Asia Pac, that we have -- our business has been driven more by, say, a run rate business rather than large deals. So the run rate business in manufacturing has been larger parts of our Asia Pac business than in other areas. And specifically in Q3, I think the COVID-19 drove bigger declines in Southeast Asia and India, where good parts of those countries were more or less shut down. So that was more impactful for Asia Pac. But Asia Pac was up from -- sequentially from Q2, and China actually returned to growth. And as I said, we have new leadership in China, a new General Manager who's doing a great job there for us. We did also see some relative strength in Australia in Q3. Operator : Our next question comes from Andrew Buscaglia with Berenberg. Andrew Buscaglia : I just wanted to clarify something on the USPS award. So you said you're going to wrap up most of the deal -- or most of that award by end of Q3. I think the deal was -- the award was $570 million in total or upwards of. I guess, what portion of that will be fully wrapped up? Because I know there's follow-on stuff that is comprised within that $570 million. Anders Gustafsson : Yes. I think the contract award was up to a maximum of $575 -- $570 million. I don't think at this stage, we can give you -- I won't break out and say specifically how large the volume for the USPS will be as part of this contract. Andrew Buscaglia : Okay. Okay. Also in your Q4 guide, it was a nice guide, and I think about 1/3 of your sales is EMEA, which didn't quite rebound as much as North America, and now we're starting to see lockdowns again. So I guess what have you contemplated in that guide? Is it conservative? And does it take into account, kind of what's going on in Europe? Anders Gustafsson : So we feel confident in our sales guide for Q4. It reflects the positive momentum we have in the business. We entered the quarter with a strong backlog. We had very healthy levels or lower levels of inventory in the channel. So the quarter is actually more front-end loaded than normal. So we do see that has -- as giving us great confidence in our guide. But there's obviously still continued pressures from COVID and some uncertainty around this. I'd say, though, with -- specifically to Europe and some of the lockdowns there that I think if you compare this to April when -- or end of March when the lockdown started, I think now companies -- most of the first -- most of the lockdowns are intended to be more on the aspect of the social life rather than enterprises and business life. And I think companies like ourselves we have learned, I think, how to operate much better in this environment. So I would expect that the impact of a lockdown would be less severe now, and the lockdown would, again, I think, drive some of the trends that we've talked about around omnichannel and buy online, pick up in-store and so forth, which would have some offsetting positive impact for us. Operator : Our last question today will come from Jeff Kessler with Imperial Capital. Jeffrey Kessler : What -- when you talk about providing a full, let's call it, recurring revenue SaaS-type of solution that you're developing going forward, which vertical markets have been -- which vertical markets do you think have been most interested in at least talking about how to get to a, if you want to call it, a full Zebra solution for them at this point? Anders Gustafsson : I'm not sure if I can say that any vertical has more -- been more excited about this than others. Maybe I can say, though, that our -- if you look at some of our more recent software acquisitions like Reflexis and Zebra Prescriptive Analytics or Profitect, as it was previously known, the primary vertical markets that they address have been retail. So we're probably further along in retail than we are in other markets. But I say I would highlight health care is certainly an industry or a vertical that has a lot of interest in broader solutions and acquiring them as a service. Jeffrey Kessler : Okay. And a follow-up, in terms of what types of services and/or technologies might be add-on to USPS, once you've done the first part of the contract? Would that be instructive for other -- for other areas in which you might be able to expand your total available market? Anders Gustafsson : Yes. I'm not sure if I want to get ahead of ourselves and talk about what possible business we might win from USPS in the future. USPS is a customer of many of our products already, so printing, scanning and mobile computing services, some software solutions. So I see opportunities for us to engage across a broad suite of solutions, but I don't know that I want to highlight any specific ones for you. Jeffrey Kessler : Okay. And just quickly, in that line of thinking on new types of technology, with regard to your mobile scanners and with the other technologies that you're employing, have you been taking a look at the increase in other types of identifiers, such as BLE or NFC? Other types of technologies that may be complementary to what you're using right now? Anders Gustafsson : So I guess the broad answer will be yes. We're certainly looking at all sorts of data capture type of technologies. And our mobile computers, many of them have NFC already. So we're always looking to see how we can provide the right type of functionality to enable our customers to get the best ROI for those solutions. Joachim Heel : Yes. You might -- this is Joe Heel. You might remember that we introduced the proximity monitoring solution. That's based on Bluetooth low energy, which is built into our devices. And NFC technologies, for example, are used in solutions we have for railway ticketing. So those are all technologies we're already using, and we think have more potential in the future. Operator : This will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Yes. To wrap up, I would just like to thank our employees, customers and partners who are working in the frontline during this challenging time. Our team is executing well through the pandemic, and we are proud that our technology solutions are helping enterprises navigating through the challenges of COVID-19 as the world recovers. Stay safe, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,021
| 1
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2021Q1
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2020Q4
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2021-02-11
| 11.834
| 12.16
| 13.738
| 14.42
| null | 22.6
| 26.17
|
Operator : Good day, and welcome to the Zebra Technologies Fourth Quarter and Full Year 2020 Earnings Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning, and welcome to Zebra's fourth quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Slide 2 conveys that the forward-looking statements we make today are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year, on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our fourth quarter results. Then Nathan will provide additional detail on the financials and discuss our 2021 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Now let's flip to Slide 4 as I turn the call over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. I am proud of our employees' resiliency and focus on serving our customers critical needs during the pandemic. Through their efforts, we were able to deliver exceptional results to close out a challenging 2020. For the quarter, we realized adjusted net sales growth of more than 10% or more than 8% on an organic basis; an adjusted EBITDA margin of 23.5%, a 210 basis point year-over-year improvement; non-GAAP diluted earnings per share of $4.46, a 25% increase from the prior year; and strong free cash flow. Each of these measures significantly exceeded our outlook. We generated more business in Q4 than any other quarter in our history. Our teams executed well to satisfy a faster-than-expected recovery in demand from smaller customers through our distribution channel, particularly for our printing solutions. Demand from our large customers also continued to be strong due to their need to digitize and automate workflows in an increasingly on-demand economy. We also drove improved profitability and cash flow, while investing in research and development projects to drive sustainable, profitable growth. Our record Q4 results capped a challenging full year 2020, in which we realized slight declines in sales and earnings per share. However, we did achieve record free cash flow of $895 million for the year. With that, I will now turn the call over to Nathan to review our Q4 financial results in more detail and discuss our 2021 outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q4, we returned to profitable growth after a particularly challenging first 9 months of the year. Net sales increased 8.3% before the impact of currency and acquisitions. Our sales mix of large and small orders normalized to pre-pandemic levels, driven by a recovery of our run-rate business, which was driven in part by pent-up demand. Our Asset Intelligence & Tracking segment, including printing and supplies, significantly benefited from the recovery in smaller business demand, with segment sales increasing 14% from the prior year. Our Enterprise Visibility & Mobility segment sales increased 5.6%, driven by solid growth in enterprise mobile computing solutions. We also realized strong growth in services and software, driven by our managed and support services and Zebra retail solutions. From a regional perspective, we realized solid year-over-year growth in North America and significant growth in EMEA, while Asia Pac and Latin America were slower to recover. In North America, sales increased 6%. Printing, supplies, data capture and services were bright spots. In EMEA, sales increased 20%. Printing, supplies, mobile computing and services grew double-digits as we saw strong demand through our partner distribution channel. APAC sales were down 4% year-over-year, yet increased sequentially. Printing and mobile computing were bright spots, and we saw modest growth in China. Latin America sales declined 15%, with all major product and service categories declining in a challenging macro environment. Adjusted gross margin expanded 200 basis points to 47.8%, driven primarily by a $12 million recovery of China import tariffs paid in prior periods and improved services and software margin. Business mix had a negligible impact on year-on-year margin comparisons. Additionally, this quarter's results were impacted by $10 million of premium freight costs. Adjusted operating expenses increased $28 million from the prior year period and improved 20 basis points as a percentage of sales. We continue to diligently manage costs, while accelerating high-return investments in the business. Fourth quarter adjusted EBITDA margin was 23.5%, a 210 basis point increase from the prior year period, primarily driven by higher gross margin. We drove non-GAAP earnings per diluted share of $4.46, a $0.90 or 25.3% year-over-year increase. Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $895 million of free cash flow in full year 2020. This was $271 million higher than the prior year. Free cash flow conversion of 130% was significantly higher than our target of 100%, primarily due to timing of customer collections and vendor payments. Lower 2020 payments of incentive compensation, taxes and interest also contributed to the improvement. Our balance sheet remains strong. From a debt leverage perspective, we ended 2020 at 1.2x net debt-to-adjusted EBITDA leverage ratio, which is comfortably below our target maximum of 2.5x. Let's now turn to our outlook. We entered the new year with a strong order backlog and healthy channel inventory levels. We are encouraged by the pickup in demand, primarily from our smaller customers, which includes pent-up demand from those who had paused spending during the peak of the pandemic. This momentum, along with our sales pipeline, positions us well for double-digit sales growth for the first quarter and full year 2021. In Q1, we expect adjusted net sales to increase between 25% and 29%. This outlook assumes a 300 to 350 basis point additive impact from the acquisition of Reflexis and foreign currency changes. We anticipate Q1 adjusted EBITDA margin of slightly higher than 23%, which assumes gross margin expansion and operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $4.30 to $4.50. For the full year 2021, we anticipate adjusted net sales growth between 10% and 14%, with growth moderating through the year as we cycle more challenging comparisons and navigate a continued uncertain global economic recovery. This outlook assumes approximately 3 percentage points additive impact from the acquisition of Reflexis and foreign currency changes. We anticipate full year 2021 adjusted EBITDA margin between 21% and 22%, which assumes gross margin expansion from the prior year. We expect free cash flow to be at least $700 million for the year. We do not expect to repeat the exceptionally high level of free cash flow conversion that we achieved in 2020. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Anders to discuss how we're advancing our Enterprise Asset Intelligence vision in our end markets. Anders Gustafsson : Thank you, Nathan. Our team has done a fantastic job executing in a challenging environment. We have strong momentum entering 2021, supported by our order backlog and pipeline of business. We continue to build on our industry-leading offerings by investing in our people, operations and innovation to drive sustainable growth. In 2020, we acquired Reflexis and launched a record number of new products and solutions to ensure that we continue to advance our industry leadership position. Slide 10 highlights how we are building on our foundational capabilities to elevate our value proposition. We are uniquely positioned to solve our customers' complex operational challenges. Our unmatched access to frontline operational data from our vast installed base of products and solutions can be harnessed to gain real-time actionable insights. The result is a more intelligent enterprise, with optimized workflows. Through the pandemic, there has been a dramatic increase in the adoption of omnichannel and online shopping. Retailers need proven solutions to overcome the significant fulfillment challenges posed by this profound behavioral shift. If goods are not delivered or made available for pickup, as promised, the retailer risks losing its shopper to a competitor. To address this issue, retailers have been prioritizing their capital spend in our broad portfolio of solutions with a sense of urgency. We are enabling retailers to generate an unprecedented amount of valuable data captured through mobile computers, point-of-sale systems, RFID and other intelligent automation solutions, all of which are critical to digitizing their operations. Key benefits to the retailer include : better operational visibility and insights; increased employee collaboration and labor productivity, improved inventory accuracy, well-equipped associates with real-time actionable information, and more satisfied customers. Last month, we participated in the National Retail Federation's virtual sessions, where we showcased how Zebra's solutions help retailers deliver a superior omnichannel shopping experience. At one of the sessions, AutoZone explained how our Reflexis workforce and task management solution equipped their associates with highly flexible mobile technology that enables enhanced customer responsiveness and provides insightful data for analytics and reporting. We are proud to enable AutoZone to go the extra mile to delight its shoppers. Now turning to Slide 12. We continue to be excited about our opportunity to help our customers meet their mission-critical needs in an increasingly on-demand economy. As a trusted strategic partner, we orchestrate end-to-end workflows for customers in a variety of end markets. As I mentioned, retailers continue to prioritize investment in our products and solutions to address their omnichannel fulfillment strategies and related warehouse automation needs. In Q4, we secured multi-million dollar orders from a range of e-tailers, mass merchants, grocers, department stores and auto parts retailers. In transportation and logistics, strong e-commerce growth continues to drive parcel volumes, while last-mile on-demand fulfillment has become increasingly important. The Italian Post recently selected our printing and scanning solutions for their 13,000 post offices. Separately, the deployment of our TC7 Series mobile computers to United States Postal Service carriers is on track to resume as expected in late Q1, with a goal of completion in Q3. In health care, the need for increased real-time visibility into the entire patient journey as well as the demand for innovative solutions to provide safe and efficient care continue to make health care, our highest-growth end market opportunity. In Q4, we grew our relationship with one of America's leading health care providers. New acute care applications have made it increasingly important for this customer to equip more of their clinicians with mobile computers. The most recent use case we addressed was COVID drive-through testing with our health care-purposed TC5 Series mobile computers, which seamlessly interfaces with their electronic medical record system. Although the manufacturing sector has been hardest hit in 2020, we are optimistic regarding our prospects of returning to growth soon. We see vibrant opportunity to increase automation in workflows, and we are viewed as a visionary in this market. In Q4, we also secured notable wins beyond our traditional end markets. This included a competitive takeaway win with a leading waste hauler in North America. This customer initiated a multiyear rollout of our ET5 Series tablets, accessories and related services for its dispatch application, which is improving training and productivity among its drivers, dispatchers and supervisors. Another important win was with one of the largest metropolitan police departments in the United States. Using our TC7 Series mobile computers, along with ZQ5 Series mobile printers, they implemented an automated parking citation application that generated enough revenue to cover their technology investment in a matter of months. In closing, we continue to find substantial opportunities in our primary end markets, and we are excited about the emerging prospects we see in newer markets. We are well-positioned for ongoing success as the need to digitize and automate workflows continues to accelerate. Now I'll hand the call back over to Mike. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. [Operator Instructions] Operator : [Operator Instructions] The first question comes from Andrew Buscaglia from Berenberg. Andrew Buscaglia : So your guidance -- such a strong Q1 guidance, yet for the full year, it seems conservative. And can you talk about what you're expecting towards -- more towards the back half of the year? Because your guidance implies, maybe for EVM, more low single-digit growth, AIT probably going negative in Q4. What's built into that back half? Any color would be great. Anders Gustafsson : First, our industry leadership and our steadfast investments in the -- in our broad solutions is what's enabling us to rebound stronger and, I think, faster than our competitors. So we do expect double-digit growth for Q1, but also for the full year 2021. And obviously, this is a strong rebound from a more challenging 2020. We do feel as confident as ever about our business. We do expect growth across all our regions, verticals and business lines as we look at 2021. But we are a bit more cautious about our -- the assumptions we put into our second half forecast, given the global macro uncertainty that we're facing. And we're also starting to cycle so much tougher comps in Q4. We should also mention that we're not assuming any growth in large deals or large accounts in the second half of 2021. Andrew Buscaglia : Okay. And how much of USPS is in the Q1 guide? Because that's such a big guide. And then maybe any other color you can give us on USPS into Q2 and Q3, maybe the percentage that's accounted for per quarter or something? Nathan Winters : Yes. So on USPS, the rollout is progressing as we expected. The teams are continuing to be highly engaged. As we noted, the current rollouts around our EMC, the 300,000 TC77s. And the 300,000 rollout, we've paused that since October going into the election and holiday season, and we do expect that to resume in late Q1. And really, a modest impact in our Q1 guide. And then for the full year, we expect USPS about 1 point of our sales growth -- or the USPS growth to account for about 1 point of our full year growth, primarily in the first half of the year. Andrew Buscaglia : Okay. So not much -- so that Q1 guide, not much -- that's all pure organic. Very little related to USPS. That's just pure like end market demand. Is it primarily in EVM? Or is it -- or is there sort of a bulky order in AIT, or one or the other? Nathan Winters : Yes. So that's correct on USPS, and I'd say broad-based across both segments in Q1. Andrew Buscaglia : Both? Okay. All right. Anders Gustafsson : Yes, it's been nice to see the business have performed very nicely in Q4 and the outlook for Q1 across all our products and verticals. Operator : The next question is from Tommy Moll of Stephens. Thomas Moll : Anders, I wanted to start with a follow-up on your retail and e-commerce end markets. And in the second half of last year, maybe most of last year, once the pandemic took hold, it sounded like within those end markets, it was larger customers who were leaning in quicker into some of the omnichannel capabilities that you offer. Then in today's commentary, you indicated that some small customer activity has resumed and looking positive. Maybe some of that's on the printer side, but I'm curious what you could give us on the mid- or smaller-sized customers within those retail and e-comms end markets? Anything changing for the better there? Or any context would be helpful. Anders Gustafsson : Yes. First, I'd say that across all the verticals that we play in, we are uniquely positioned to empower front-line workers to perform their duties better and more effectively and with higher customer service, particularly where COVID-19 has helped accelerate some of those secular trends around digitization and automation. So each of our 4 primary verticals had a positive growth trajectory as we entered into 2021, and we're making good progress also in some newer expansion verticals that we talked about in our prepared remarks. Now specifically for retail and e-commerce, I said we saw a step change in consumer adoptions of omnichannel and e-commerce as part of the early phase of COVID. If you look at in-the-store, buy-online, pick-up-at-store and other delivery use-cases, we're growing very rapidly. And in the warehouse, a lot of investments in technology to help automate them are also necessary for retailers to transform their business models. And we're starting to see pilots for our Enterprise Asset Intelligence solutions starting to resume. Another trend that we see in retail is around equipping all associates with a device. That's also very synergistic with our Reflexis workforce and task management solutions, where they work very much hand-in-hand. And the strength we saw around more small and medium-sized businesses was broad-based. It includes retail. Also, e-commerce is probably a little less of smaller companies, there's more large businesses. But the small and medium-sized business strength that we saw especially expand across the 4 verticals that we work in. Joachim Heel : Perhaps in addition from my side, Joe Heel speaking, the -- in the depth of the pandemic, in the Q2, Q3 time frame, we saw that the large retail and e-commerce customers have the wherewithal to continue investing and, in fact, charged headlong, if you will, into transforming their businesses. Whereas small and medium-sized customers paused their spending and were a bit cautious. In particular, outside of the U.S., we saw this phenomenon. But we also learned that the solutions that we have, in particular on the printing and scanning side, are essential to these customers. And they ultimately need to come back and refresh those. And that is driving a lot of the pent-up demand that we were seeing in Q4 as they returned to make those essential purchases. Thomas Moll : That's very helpful. And Anders, you referenced something I wanted to ask as a follow-up, relating to the proof-of-concept-type pilots that you have with some retailers, where, potentially, all associates in the store have some kind of device. What additional color could you give us there just in terms of what inning we're in, in terms of those pilots, when there might be an opportunity for some larger scale commercialization of that concept? And then I noted, let's see, last month, end of January, you introduced a new mobile computer series at EC5x and the description there sounded like it might be tied to this pilot concept. So I wonder if you could comment on that product innovation as well to the extent it's related. Anders Gustafsson : Yes. For our customers to introduce a device for every worker, that's a great opportunity for Zebra, great expansion for us. Our estimate is, today, that in retail, about 1/3 of all store associates are equipped with a device. And I'd say, today, the -- it varies greatly between retailers, how deeply they are penetrated into their associate base with devices. Some are much further along than others. We are -- we have worked to basically expand our portfolio of mobile computing devices to ensure that we have kind of appropriate form factors and price points to enable our customers to take this more deeper into their associate base, and we expect that this will be a continued trend. I'm not sure I expect it to be kind of big step-function changes in behaviors, but more looking to continually add to -- add devices to the store associate base to be able to ensure that they are all connected and able to take advantage of all the other digital tools and solutions that the retailers offer. I don't know, Joe, if you have any? Joachim Heel : Yes, I wanted to just point out 2 other things that I think address this question. One, you're right about the release of the EC5, it's EC50 and EC55, which are devices that combine a consumer-like form factor with all of the advantages that we bring to the enterprise Android ecosystem. And so we expect that, that device, in particular, will play a role in this trend of a device [ for all ]. But I also wanted to point out another synergistic part of our strategy, which is the acquisition of Reflexis. Well, Reflexis, as you know, does task and workforce management and, therefore, needs to reach every worker within the enterprise, in particular, of course, retail, which is their dominant vertical. And so, therefore, having a device in the hand of every worker now all of a sudden becomes essential again, and now we're in a great position to meet that demand. Operator : The next question is from Jim Ricchiuti of Needham & Company. James Ricchiuti : Anders, I wanted to just follow-up on the comment about the second half and the assumptions around large deals. How does that -- you say you're not assuming large deals. How does that compare with prior years because, typically, some of that large deal activity does materialize, I would assume, as you're going through the year? Anders Gustafsson : That's correct. We -- I'd say this is more a matter of limited visibility into the second half than it is, that there's a certainty that there won't be growth in larger deals. I think this is similar to how we generally, I think, forecast our years. So yes. James Ricchiuti : Okay. And I wonder if you could -- my follow-up question is just regarding component constraints. We're hearing throughout the supply chain tightness in semiconductor components. And I'm wondering to what extent that's impacting you guys as you think about your supply chain? Anders Gustafsson : Yes. We've definitely seen the lead times extending. And -- but our team is working diligently, and I think we are on top of it. We have incorporated whatever visibility we have to extended lead times for our semiconductors and other components into our outlook also, particularly for the second half. Operator : The next question is from Meta Marshall with Morgan Stanley. Meta Marshall : Great. I guess I just wanted to dig into how you guys are thinking about gross margins into Q1 and into 2021. Clearly, you guys saw a pickup in kind of your smaller customers, which would have helped gross margins in Q4. You clearly have some large deals and still some kind of overhang from freight as you head through 2021. So just how we should be thinking of the progression of gross margins through 2021? And then maybe just as a second question, just given the kind of very healthy cash flow that you guys saw in 2020 and kind of the continuation of that into 2021, how do you guys kind of think about balance sheet prioritization currently? Nathan Winters : Yes. So if you look at our full year guide, EBITDA of 21% to 22%. We expect gross margin to improve year-on-year, primarily due to the order size mix normalizing, which we saw in Q4 and implied in our Q1 guide. We do expect premium freight costs to persist around $30 million to $40 million, yet declining in the second half as air travel returns. And within the full year guide, we do expect OpEx to increase as a percent of sales once you include a full year of Reflexis as well as the majority of our spend returning post-COVID, including incentive compensation and travel, particularly in the second half. I also think it's worth noting when you look at the full year EBITDA guide, Reflexis, as we stated, is going to be a dollar-neutral year, yet slightly dilutive given the investments in go-to-market and the platform. Then we do expect that to scale over time. On your second question, if you look at free cash flow, $895 million, a strong finish to the year, really around improved core working capital performance, particularly in AR. We saw very strong collection activity and some early timing at the end of the year as well as our Q4 sales were front-loaded, driving some of the benefit. As well as small incremental AR factoring, lower taxes, interest expense and incentive comp kind of driving the year-on-year beat. So when we look at -- for 2021, we do expect it to decline, but primarily due to just the exceptional 2020 performance and really more normalizing the free cash flow conversion rate over the 2-year period. Operator : The next question is from Paul Coster of JPMorgan. Paul Coster : I'm just wondering if we are at the sort of inflection point for the company in terms of the sort of mix shift and margin outlook. As the AIT business sort of comes back a bit, will be a bit driven by the smaller accounts here, obviously, has higher margins. But you've also got the software and services business growing faster. As far as I can figure it out here, you're probably seeing in excess of 50% growth for the Reflexis business, which has, what, 20 percentage points higher gross margins than the rest of the business. So it sort of feels to me like we're heading towards a new margin structure over the next 3 or 4 years. Can you comment on that? Anders Gustafsson : The margin structure or more on the business inflection, generally? Paul Coster : Well, not -- yes, the margin, I guess it's related, obviously, Anders. But are gross margins going to be expanding from here on out? And is the business mix, I suppose, going to be permanently changing here? Anders Gustafsson : Yes. Okay. I think Nate is best positioned to answer that. Nathan Winters : Yes, Paul. So if we look at margin and margin expansion over time, we do believe we can go higher, and we have many levers to achieve that. I think, as you mentioned, scaling some of the newer markets with richer gross margin, Reflexis being one of those proof points. We always continue to focus on driving higher gross margin and productivity through all of our operational efficiencies across the business. And we've had a track record of doing that and driving profitable growth. And we do expect EBITDA margins to get back to the pre-pandemic levels in '21, and we really don't see any reason that, that should be constrained as we move forward in terms of continued expansion. Paul Coster : I guess I'm not asking my question very well. But with the -- is there going to be a mix shift towards AIT and service and software? And will that drive up the margins structurally over the long-term, not just to pre-pandemic levels, but to sort of almost pre-MSI acquisition levels? Anders Gustafsson : Yes. I'd say, first, maybe think about the business around our core near adjacencies and around the Enterprise Asset Intelligence or Intelligent Edge Solutions, so more the newer stuff. I do believe that our core business, AIT printing and scanning side, including services, are very healthy, good shape, and I expect them to continue to grow at a nice rate over the longer term. I don't expect printing to kind of break out from the pack here. Printing has been a bit more up and down over the last year. So we have probably a little bit more of a pent-up demand in printing solutions than we had in some of the other solutions. But if you look into our -- the Enterprise Asset Intelligence vision that we have in the Intelligent Edge Solutions, I do expect our software assets and some of our more intelligent automation solutions to grow faster than the company average from a gross margin perspective and, obviously, scale will help us here. But also as we invest in some of the newer solutions, we will -- there will be a kind of investment phase first, and then we will see margins expanding, we believe, quite nicely once revenue is starting to grow. Does that answer your question? Paul Coster : Yes. Yes, it does. So just one in passing, on the -- with respect to Reflexis, am I right that it's posting more than 50% compound growth at the moment? And can you just comment on the growth rate for Temptime as well? Anders Gustafsson : So we aren't commenting on the specific growth rates that they have. But Reflexis has been growing at a nice double-digit growth rates for the last several years, and we have high expectations that will continue to do that and that it will also help accelerate some of our other -- growth of some of our other software assets that will be benefiting from being associated with and incorporated into the Reflexis platform. And Temptime has had a nice growth over the last few years. And we do see this year the opportunity to accelerate growth as we support COVID-19 vaccine rollouts, also distribution. So we do expect a double-digit growth for our Temptime business as well. Operator : The next question is from Joe Aiken of William Blair. Joseph Aiken : This is Joe on for Brian today. I want to start -- you mentioned in the prepared remarks some wins beyond your traditional end markets. I think you mentioned a waste hauler in particular. I was wondering if you can maybe just provide a little more color. Any context around what brought you into that win? And maybe what the opportunity is in some different nontraditional end markets that you're seeing and how meaningful that could be going forward? Anders Gustafsson : Yes. I can start with this, and then Joe can also provide some extra color here. But as we have made -- maybe -- so first of all, on the product side, we've invested in addressing some of the use cases that we see in some of these new emerging verticals, government, utilities and so forth. But also, we made meaningful go-to-market investments. And we can say they probably started with our acquisition of Xplore. But then we've tweaked our other products to also address these use cases more. So it's been a big focus of ours and investment of ours over the last several years to make sure we position ourselves for this. And we now have a portfolio of solutions and partners that can help us get into these opportunities and win them. Joe? Joachim Heel : Yes. I would only add that the end markets that have shown some particular promise are government, both federal and state and local as well as the broader -- so service industry, where the waste hauling example fits in. The Xplore acquisition, where Xplore has a strong market, the rugged tablets are a strong product offering into those markets, has been instrumental in leading us there. But it also has been something we've been pursuing for some time, but it does take some time to build up the channel infrastructure as well as fine-tune the product offering and hire the appropriate type of dedicated and expert sales reps who can operate in those verticals. And we feel we now have that in place, and it's beginning to pay off. Joseph Aiken : Great. That's really helpful. And I know, on some past calls, you've talked about the transition to Android on the mobile devices in the past and the benefit you're seeing from that. Is that transition largely over at this point? And maybe just to put a finer point on that, what percentage of devices do you estimate that you're shipping today are running Microsoft operating system? Anders Gustafsson : Yes. First, around our mobile computing platform, overall, we saw solid growth in Q4. We did benefit from a recovery in the small and medium-sized business segment there also. There's 3 trends that I think are worth highlighting. The Android transition is one of those, but I'll start with new use cases. We talked earlier about the second trend, which was around -- worth putting a device in the hand of every worker. But the use cases that's probably been the biggest driver, think about the omnichannel and retail. Health care is a newer vertical, which largely is new use cases. And then the third trend around the Android transition. We still have lots of momentum around the Android transition and a lot of opportunity left in that. We have -- our market share in Android is still around 60%, but Android now makes up about 80% of our mobile computing sales. We've often talked about the transition from -- transitioning older legacy Windows devices to Android. But today, I think the opportunity to refresh existing installed older Android devices is actually bigger. Our estimate is that they're now low double-digit millions of Android devices in the market with a somewhat shorter refresh cycle than the old Windows devices used to have, and which we expect that there's about a high single-digit million Windows devices out there. So it's more of a balanced perspective, and we certainly like to get both of those. And -- but Android has been a great catalyst for growth for us. Operator : Next question is from Richard Eastman of Robert W. Baird. Richard Eastman : Just a quick question. Could you tell us -- the China tariff rebate impacted gross profit margin, did that impact the EVM margin? Was that solely confined to EVM? Nathan Winters : It was -- thanks for the question. So out of the $12 million, $8 million was associated with EVM, and then $4 million was for AIT in the fourth quarter. Richard Eastman : Okay, okay. Yes, in Q4? Okay. And then just a question around maybe the balance that you saw in your go-to-market. So for all of '20, can you just kind of tell us how the direct business did relative to the channel? I'm just thinking sales growth or decline? Anders Gustafsson : Yes. I can start, and then Joe can provide some additional color also. Our direct business obviously did very well because we had a strong large deal activity, but also a lot of the larger customers that we worked with, we have been supporting through channel partners. So our channel centricity, so that's how much of our revenues go through channel partners, was actually, I think, at an all-time high in Q3 or Q4. So we have maintained a high degree of channel centricity in the business. Joe? Joachim Heel : Yes, exactly. I mean our strategy has been and will be to be a channel-first go-to-market approach. And I think that's paid off very well for us here in the pandemic because the strong relationships with our partners have been instrumental in helping us recover faster, and we're seeing that in particular in the run rate. But as Anders said, a large -- if you recall, the contribution of large deals made to our second half, in particular, it's remarkable that the channel centricity, percentage of business going through the channel, has expanded in light of that, right? And that is part of our strategy. Richard Eastman : When you speak to some of the smaller and medium customers, is that visibility coming through from the VARs? I mean, again, we speak about the channel, but we obviously put distribution in there versus the VARs. And I guess my question is, what's the visibility on the VARs in the smaller and medium-sized customers rebounding in '21? Do you have that visibility either in orders? Or is it kind of frontlog and conversation with VARs or... Joachim Heel : Well, so we rarely have visibility to the specific individualized orders on small and medium businesses, right? We have the distribution and channel in between. But what we know is that our distributors have a very strong outlook for the upcoming quarters, at least, and are ordering strongly with us. As we indicated, our order volumes have been strong. And that's, I think, a reflection of that optimism that our distributors are feeling, in particular, also from SMB customers. Richard Eastman : I see. So when you look into '21 -- I'm really, really trying to get at is, obviously, the gross profit margin assumption, as Nate pointed out, is higher in '21. And is the mix of end-customers there from small to medium? Obviously, you mentioned large orders in the back half of the year, you're a little cautious there. But is that mix supporting that upward migration in the gross margin when you think about '21? Anders Gustafsson : Yes. We expect to have a more traditional mix of business in 2021 than we had in 2020, where, for Q2 and Q3, particularly, large deals were kind of overrepresented. And we do -- as Joe said, we -- our visibility around individual smaller deals are not great, but we are -- our channel account managers do meet with our channel partners and work on forecasts and looking at specific deals and what support they need from us and so forth. So we do have some level of visibility. But obviously, the further out in time you go, the less clear that visibility is. Richard Eastman : Yes, I understand. And just staying on this gross margin for 1 more second. From a pricing perspective, what's the assumption going into '21? Do we -- are we able to capture enough price to recover some of the COGS inflation that we're seeing in the business? I mean it would appear so, but is there any price increase, a net price increase that you might expect? Or is it mainly kind of net pricing? Anders Gustafsson : So maybe, first, I think, when you talk about COGS increase, is that the freight charges you're referring to? Or... Richard Eastman : Yes, so there's freight charges and just any other cost inflation in the supply chain, in your supply chain. Anders Gustafsson : Yes. I think we -- we don't modify our pricing based on what we believe to be a temporary cost inflation for freight. But we do have a lot of analytics and thoughts around our overall price points and where the market is. And we do always strive to get a premium for our brand. So pricing and margin is obviously a very strong focus that we have across the company. But we haven't necessarily gone and changed our price list because of this. Joe, if you want to add anything to that? Joachim Heel : Well, yes, maybe another way to think about this is, if you looked back at 2020, the mix of our business, in terms of small versus large, was skewed towards the large, right? Because as I said, the small -- yes, so there was a pause in purchasing from the small that resumed towards the end. But in the long-term analysis, small was down relative to the long-term average. In 2021, we expect that, that mix will return closer to normal and, therefore, simply because of the mix effects, we think that the average price points would normalize as well as a result of that, right? That is an effect. Operator : The next question is from Keith Housum of Northcoast Research. Keith Housum : Congratulations on a good quarter and good guidance. Just trying to unpack the printer growth a little bit more. Can you help me understand that, in terms of that growth, is a substantial part of that growth being driven by not only the SMBs, but also growth in the supplies business as well? Anders Gustafsson : Yes. We had, obviously, great growth in both printing and supplies. Both printing and supplies were up double-digits in the quarter. Our printing business is up across the portfolio. We did, I think, benefit from some pent-up demand, particularly in EMEA. Remember, EMEA also was hit harder early on in the pandemic. So there was probably a little bit more of a rebound to be had there. I'd also say, though, that we have, early in 2020, we took a number of actions to strengthen our go-to-market and strengthen our channel ecosystem, particularly around printing. And I think that is now bearing fruit for us also. So we are more competitive, and that's helping to accelerate our share gains in printing, specifically. But we did see our business through -- or our smaller business -- small and mid-sized business recover quite nicely. We recovered faster than we had expected. I think it's fair to say, in Q4, manufacturing has been a relatively light vertical. We have a much -- strong vertical for printing, generally, but lighter over the last year, but that was also coming back and strengthening. And RFID was actually a very strong quarter for printing. I think it was a record quarter for print RFID. And then on supplies, we did see a strong performance in supplies, particularly in North America. And Temptime also had a strong fourth quarter. But overall, though, I'd say that we have a very strong portfolio of smart and connected printers that have an unrivaled manageability through our Link-OS operating system, and that is a true differentiator in the market. Keith Housum : Okay, appreciate it. And then just a follow-up, I think a comment made earlier during the Q&A, and I think the commentary was that the U.S. Postal Service will contribute about 1% growth for the year, with most of that coming in the first half, but I also heard you guys say that it's going to be only very modest for the first quarter. So that could imply, if my -- if my math is right, that you guys could have a $400 million contribution in the second quarter from the U.S. Postal Service? Is that right, and does that include, I guess, ancillary projects as well as the main 300,000 devices being fulfilled? Nathan Winters : Yes. So if you look at the USPS for the year, regarding the size of the rollout, I think if you look at the 300,000 printers and what we expect to deliver in the -- throughout 2021, I think you can -- you really do the implication of we're selling about 2 million mobile computers annually. And that can help you infer in terms of an average price range. I think the number you have for Q2 is a little bit higher than what we'd anticipate in terms of the full year implied guide. Anders Gustafsson : Yes. Remember, we've talked about earlier, the total volume of mobile computers for USPS, this contract is about 300,000 over 2 years. Keith Housum : Understood. Understood. Yes. Just doing the math there, I guess, that $400 million, roughly, I understand it might be a little bit high. It seems a little bit more than a lot of us were assuming for the entire value of the contract. And we realize you guys fulfilled some last year as well as what you'll fulfill this year. So it seems, again, perhaps higher than what a lot of us were assuming. Anders Gustafsson : Yes. As I said, I think the best way for you to think about USPS this year is the 1% of our growth in 2021 is coming from growth of our USPS business. And I wouldn't say Q2 is the only quarter, but Q1 will start ramping up towards the end of Q1, but Q2, Q3 will certainly be part of it. Keith Housum : Oh, it's 1% of your growth, not 1% of your business? Okay. Got it. Joachim Heel : Correct. Yes. Anders Gustafsson : Yes, yes. 1% of our growth, yes. Operator : The next question is from Blake Gendron of Wolfe Research. Blake Gendron : I want to follow-up there with some of the growth commentary. So [Audio Gap] Dollar impact from what you would consider pent-up demand to be greater or less than 4Q? And do you expect some pent-up demand follow-through into the second quarter? And I guess, longer term, I mean, are we going to see this pent-up demand idiosyncrasy show up in subsequent years just based on the replacement cycle? Or is it going to normalize fairly quickly as we recover here on the pandemic? Anders Gustafsson : Well, yes, the pent-up demand concept is a little hard to get -- be overly specific about the impact of it. But I'd say that, starting with our products and solutions, are now mission-critical for our enterprise customers, and they need that to compete effectively in their on-demand economy. The sales to our larger companies, larger customers that we talked about in an earlier question, remained strong. And they have prioritized spend with us to better position themselves to address the newer automation and digitization trends like omnichannel, as an example. And I'd say our larger customers who are better positioned to pivot their businesses early in the pandemic, to align with how consumers wanted to behave how the economy was working at that point, while smaller customers had to kind of pause spending or certainly cut back on it. But I think, now, we see the smaller companies coming back and other customers are also realizing that they need to invest in order to compete. Competing in the same way they did prior to COVID is not necessarily going to be a successful formula. And I think that part of this is also that we have been able to execute very well during the pandemic, and we've been able to gain share. Our supply chain has shown great agility to be able to respond to customers that quickly want to ramp up their order volumes, and I think we were able to do that well and seize some opportunities that way. So we have been realizing some good demand from this pent-up demand, you can say, which helped us in Q4, and I expect it to help us in Q1 here also. But more broadly, though, as we look forward, we are very excited about the business overall and the growth prospects that we have not just in Q4, Q1, but the longer term, based on our ability to help our customers digitize and automate their businesses. Nathan Winters : Yes. And Blake, just to add, this is Nathan. It's obviously, as Anders mentioned, a tough one to quantify. If you look at our Q1 guide, we kind of think of the pent-up demand is likely contributing low double-digit growth on top of mid-teen growth from what you can say is our normal growth rates the impact of acquisitions, FX, as well as cycling from a comp perspective versus last year, where we had -- we started to feel the impacts of COVID late in Q1 last year. Blake Gendron : Yes, that's helpful. I understand it's tough to quantify and disaggregate everything. But the longer-term growth outlook is kind of what I was getting at, and that's constructive. My follow-up is on EVM. I'm just wondering, over the last, call it, 12 months or through the pandemic, what the growth of existing customers is with EVM versus new customer wins? How you see that evolving, I guess, here over 2021 and beyond? And is there any major margin difference between one or the other? Or should we think about EVM kind of along the same lines and delineate large versus small customers in terms of margin difference? Anders Gustafsson : Yes. I'd start by saying, new customers -- if you're looking for kind of brand-new customers that haven't done any business with us, it's rare that we have those because most companies are doing some level of business with us. So it's probably more that we have new awards or new use cases with those customers. Again, it's -- we can only -- we really only have visibility into that for our larger customers. And I think we've had a good healthy clip of new customers, and I expect that we will continue to add new use cases, new applications. If you look at our portfolio of solutions, we've invested meaningfully to ensure we can expand the number of use cases that help address our customers' most pressing problems. So we feel good about our competitive positioning and our ability to win some of these new use cases. They may not necessarily be brand-new customers, but they're brand-new use-cases. Joe, I don't know if you have any comments? Joachim Heel : Yes. I mean I would add, I mean, to your point about is there a big margin difference between the 2, I would say, not noticeably. The new customers that we are able to acquire, so ones that were previously competitor customers, there have been meaningful ones, of course, right? I mean, USPS is one example of those that was in the last 12 months. But they do range from the small to the large and, therefore, I would expect, without having done the analysis, that there isn't a meaningful margin difference between the 2. Blake Gendron : That's very helpful. One more, if I can sneak it in here. Your balance sheet is in great shape. I wonder if you could just level set the capital allocation thoughts here, and maybe update us on the M&A pipeline? Nathan Winters : Yes. I'll start. We ended the year at 1.2x net debt-to-adjusted EBITDA, which is below our 2.5x target maximum. Our priority remains organic and inorganic investment in the business, and we're excited about the opportunities we see both of those -- in both of those areas. We do have our share repurchase, and we believe that's a flexible way to return capital. And we'll remain opportunistic in that approach, which is evidenced by our $200 million repurchased in 2020, and we'll continue that into this year. Anders Gustafsson : You know, on M&A, we're certainly very excited about the outlook for our business. And M&A is a -- we think of it as a growth vector for the business. We think of M&A as a way for us to accelerate the execution on our Enterprise Asset Intelligence vision. So it's not a stand-alone growth driver. It is something that we think about how -- and a way for us to accelerate the execution on our vision. We're targeting, I'd say, select bolt-on acquisitions as well as higher-growth acquisitions that can truly help move our Enterprise Asset Intelligence vision forward. We see good opportunities in digitizing and automating supply chains and different workflows. And we -- as Nate talked about, we have a strong balance sheet that can support that. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for closing remarks. Anders Gustafsson : Yes. To wrap up, I would like to thank our employees and partners for our exceptional Q4 results and a strong start to 2021. And as we continue to navigate the pandemic, our top priority continues to be protecting the health and well-being of our employees, partners and customers. So stay safe, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,021
| 2
|
2021Q2
|
2021Q1
|
2021-05-04
| 12.784
| 13.483
| 15.154
| 15.93
| null | 28.85
| 29.71
|
Operator : Good day, and welcome to the First Quarter 2021 Zebra Technologies Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's first quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Anders Gustafsson : Thank you, Mike. Good morning everyone, and thank you for joining us. Our team delivered exceptional first quarter results, with strong performance across the business, resulting in record sales and profits. For the quarter, we realized; adjusted net sales growth of 28% or 25% on an organic basis; and adjusted EBITDA margin of 25.3%, a 620 basis point year-over-year improvement; non-GAAP diluted earnings per share of $4.79, a 79% increase from the prior year, and strong free cash flow. Our teams executed well to satisfy a stronger-than-expected recovery in demand from smaller customers through our distribution channel, and continued strong demand from large customers to digitize and automate their workflows in an increasingly on-demand economy. We realized strong broad-based demand with double-digit sales growth across our four regions, each major product and solutions category, as well as in all of our vertical end markets. We also significantly expanded profit margins, driven by favorable business mix and lower travel expenses, while at the same time, we continued to invest in initiatives to drive sustainable profitable growth. Given our momentum and pace of innovation, we are increasingly confident in our growth prospects. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q1, adjusted net sales increased 28.3%, including the impact of currency and the Reflexis acquisition, and 25% on an organic basis, reflecting broad-based demand for our solutions. Direct sales to large customers grew double-digits, and we saw even higher growth from smaller customers through the channel, partially driven by pent-up demand. Our Asset Intelligence & Tracking segment, including printing and supplies grew 21.4%, while Enterprise Visibility & Mobility segment sales increased 26.8%, driven by exceptional growth in enterprise mobile computing. We realized strong double-digit growth in services and software. And also had strong growth in our RFID solutions, which is beginning to rebound from the depths of the pandemic. We recognized double-digit growth in all regions. In North America, sales increased 28%, with mobile computing, printing, services and supplies each growing double-digits. In EMEA, sales increased 22%, with solid growth across all sub regions and solutions offering. APAC returned to growth with sales up 19% led by strength in China, Australia, New Zealand and India. Latin America also returned to growth in all sub regions, with sales increasing 31%. Adjusted gross margin expanded 370 basis points to 48.9%, primarily driven by favorable business mix, and higher service and software margin. The favorable year-on-year impact from China tariffs was offset by $11 million of incremental premium freight charges. Adjusted operating expenses as a percentage of sales improved 280 basis points. We have been accelerating high return investments in the business, while prudently managing discretionary costs. First quarter adjusted EBITDA margin was 25.3%, a 620 basis point increase from the prior-year period, reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.79, a $2.12 or 79.4% year-over-year increase. EPS growth also benefited from lower interest expense and a lower share count, partially offset by a slightly higher tax rate. Now turning to the balance sheet and cash flow highlights on Slide 7. We generated $214 million of free cash flow in Q1. This was $119 million higher than the prior year, primarily due to increased profitable growth. In Q1, we had $13 million of venture investments in two companies that provide real-time asset visibility and artificial intelligence solutions. Our balance sheet remains strong. From a debt leverage perspective, we ended Q1 at a modest 0.9 times net debt to adjusted EBITDA leverage ratio. Anders Gustafsson : Thank you, Nathan. I am encouraged by the strengthening demand across our business, which allows us to increase our 2021 outlook. Our team has done an outstanding job navigating us through the pandemic. Slide 10 illustrates how we are working with our customers and partners to advance our Enterprise Asset Intelligence vision. By leveraging Zebra's leading portfolio of products, solutions, software, and services our customers can overcome some of their most complex operational challenges and transform their frontline workflows to achieve higher levels of performance. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : And the first question today will come from Damian Karas with UBS. Please go ahead. Damian Karas : So you had mentioned that some of the first quarter sales strength was on pent-up demand from your smaller customer base. But just thinking about the current order strength you're seeing as you progress through the second quarter, would you still characterize some of that as pent-up demand? Are we kind of past that at this point and it's really more reflective of your underlying run rate demand, if you will? Anders Gustafsson : Well, and first, we are very pleased with our first quarter results here and the outlook we could provide. We - the business is supported by some strong secular trends that have accelerated during the pandemic, like omnichannel and - so most companies today are very focused on automating and digitizing their businesses. And for us, that resulted in double-digit growth across all regions, across all products and solutions, as well as all verticals, so very broad-based demand for us. We did see particularly strong growth from small and medium-sized customers, and that was partly driven by pent-up demand, but it's only partly driven by pent-up demand. Yes, but - we also saw strong demand from our large customers, our larger strategic accounts. And I think another factor here was that based on our performance, I'm - I certainly expect that we continue to take share in the market. Nathan, do you want to add something? Nathan Winters : Yes. So this time on the pent-up demand. I think one, it is an estimate, so this isn't a precise deal reconciliation. And we think it is recovering most of our 2020 miss to our original plan and guidance last year and recovering that here in the first half of the year, which is contributing low double digits, both in the first and second quarter. Damian Karas : Okay, that makes sense. And then, I think you spoke in the past that, sort of, later in the year is when you start seeing sort of the larger projects, if you will, larger orders. At this point, do you have some visibility there that you've kind of baked that into your guidance in the back half or should we still expect that there could be some larger projects that haven't taken hold yet? Anders Gustafsson : I think what we've said is, it tends to be that our visibility into the larger deals or into our pipeline overall increases with time. So the closer - the further we enter the year we get better visibility, we'll have to be through the second half and Q4. So part of what you see today is that we have gained some better visibility into both - how we expect the run rate to progress, but also on some of the larger deals. But we don't have perfect visibility, so clearly there is opportunities for deals that we don't necessarily have in our stored as high likelihood in our pipeline today. Joe, do you want to add something to this? Joe Heel : Yes. I would say that the large deal momentum has continued evenly throughout the year. And we have prospects for large deals in the second half, just as we did in the first half. One of the large deals that you're aware of is the USPS deal, which is of course contributing to our Q2 and Q3 as we have said. Operator : And the next question will come from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Anders, it's sounds like compared to a quarter ago, when we talked both in terms of geography and market, it sounds like everything or nearly everything is better than expected, a quarter ago. But if you had to pinpoint maybe one geography or one end market that's improved the most, just as a driver for the raised revenue guidance, what would you point us to? And if I'm mistaken, and if there is any geography or end market that's gotten a little weaker over the last quarter that would be good to know. Although, maybe just based on your tone and comments today it sounds like there weren't any? Anders Gustafsson : This is a hard question today, because we have broad-based demand. I don't think we've ever had a quarter where we've had each of our four regions, each of our verticals and each of our main product categories all growing double-digits. So it's hard to pick who stand out as particularly strong or weaker. But I'll probably just highlight maybe North America as particularly strong, as being also our largest region here, we grew by 28%. So we saw very broad-based demand across basically all our portfolio, the entire portfolio. But printing supplies, mobile computing, RFID, services, software, they were all up double digits. And we had strong wins across all our vertical markets in North America. And our newest vertical, the government vertical also demonstrated good growth. And I think demonstrates the investments we've made in both product and the go-to-market for the government vertical paying off here now. On a - from a vertical perspective, maybe healthcare, just want to highlight. It's been our fastest growing vertical for some time and we expect it to continue to be the fastest growing one. It had a very nice performance in Q1. I think the transformation in healthcare is accelerating. It started off in acute care, but it's moving into other areas now, like ambulatory care, contact tracing, even remote patient care. And healthcare patients are now expecting or demanding a more digital experience and they prefer that also. And our purpose-built solutions are critical for healthcare providers to be able to improve the overall patient journey to drive - and to drive greater productivity for the healthcare providers across their operations. And some of our solutions in healthcare also used specifically, but for COVID response like drive-through testing and vaccinations, cold chain logistics and so forth. Nathan Winters : Maybe I can add something too. If you look at the regions nominally, the one that's swung the most from last quarter was Latin America. Latin America was the one that was hardest hit in the pandemic and has rebounded the most, but it's also our smallest region. In terms of verticals, another one that is notable is manufacturing, which was hit very hard in the pandemic as well and we're seeing some good rebound in that area. I think the biggest swing that we haven't mentioned yet is one of deal size and customer size, right? So, notably our run rate and the purchases by small and medium businesses have accelerated and are catching up now to what was a big driver in past quarters of the larger customers, investing in e-commerce and digitization. We're now seeing that in the small and medium business, which of course manifest in our run rate. Tommy Moll : Thank you, both. That's very helpful. If I could ask one follow-up. Anders, I wonder if you could update us on some of the pilots you have with retail customers, where all our or at least a lot more of the store associates are carrying one of your devices. What's the progress there? How are you making the ROI case to the potential customers? And to what extent does reflect this factor into the strategy there? Anders Gustafsson : Yes. The device for all is a big opportunity for us. We're very excited about how that's progressing. We see the theme around how most companies wants to automate and digitize their operations is playing a big role in driving this. Across every vertical, I would say, our customers are looking to put technology in the hands of more of their employees and be able to have them be connected and be able to both enter data, as well as react to data. We see the relationship with Reflexis as very synergistic. And that, if you have a mobile device you can now look at inventory stock-outs, or other information and upload that to the Reflexis task engine, which now can make smarter decisions, can prioritize the highest ROI action, and then mobilize that to the right worker at the right time by - through somebody who then is carrying a mobile device. So it's a very strong synergistic portfolio that adds basically - and the network effect it adds to the value of both device and both solutions by having both under one roof. The progression on deeper penetration is also progressing. So if you go back, 7 years, 8 years or something, our large supercenter in retail might have had seven or eight devices and today they routinely would have maybe 70 or 80, but they may have several hundred employees. And we think that having a shared device for those associates when they are in the store is big objective for, I would say, the vast majority of our customers. And that's progressing. We have some good examples of where we've provided - expanded our portfolio to provide that kind of full range of devices across the price and performance curve. And where we've combined software and devices to really enable much deeper penetration. And Joe, maybe you want to share some examples of this? Joe Heel : Yes. I'll give you one example of the connection of our device for all and our SaaS software. One of the largest retailers in Australia is using our EC30 devices together with Workforce Connect to enable their associates to do tasks in the store, but also communicate with one another. And that's one of the key use cases, which is - and by the way also enabled by Reflexis in the future is to have the associates be able to interact with each other, which requires that all of the associates have a device. So, I think that's a pretty good example of it. Tommy Moll : Great. Thank you, both. We'll keep our eyes out for more progress on those fronts. But I'll turn it back for now. Thank you. Operator : And our next question will be from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : I was hoping you could talk a little bit more on gross margins in the quarter, which were obviously very strong. Can you break out what - you mentioned software and then that Reflexis or just acquisitions in general helping? Can you break out what that contributed in the quarter? Nathan Winters : Yes, Andrew, this is Nathan. Firstly, our teams have been executing very well on what we can control. You see that through the gross margin improvement year-on-year up 370 basis points. About two-thirds of that is related to business mix, as well as volume leverage. We have especially high mix of large orders, due to the recovering small and medium business that Joe mentioned earlier. And about a third of that was from expansion of our service margins, as well as the Reflexis acquisition. And most of that coming from expansion within our service business. I think the one thing to also note, as we stated last year, we look at our underlying gross margin trends. They remained healthy throughout 2020. And we expected the overall margin and we're seeing that play out to improve as the mix has returned. Andrew Buscaglia : And EVM had particularly very strong gross margins, 49%, is that sort of the run rate we're looking at going forward? I know you have those freight expenses coming in. But yes, is this sort of, kind of the path you're taking? Are you - do - you think you can grow or expand margins even from that kind of elevated level, given some of this software and services integration? Anders Gustafsson : I think, over time, we do expect for our margins to improve. I'd say, Q1 was especially favorable due to the strong mix of small and medium-sized business. But I think as that normalizes to more of a normalized level as we move forward, we do expect EVM margins to improve over time, particularly as you mentioned with the growth and expansion of our software solutions. Andrew Buscaglia : Okay. And maybe just last one. In Q2, stuff got into that guidance unless you - if you assume a pretty big ramp in SG&A? So, do we expect a step down in gross margins just in Q2, for some reason or given the freight expense? Nathan Winters : Yes. So if you look at our Q2 EBITDA guide of 21% to 22%, it is up nearly 3 points year-on-year due to favorable business mix from 2020. Sequentially, it is down 4 points, most of that is due to lower gross margin. As we said, as deal size, I think, comes back from the exceptionally high level we are - we had here in Q1. And you also have CRS seasonality, a slight care for recovery in the first quarter all lowering gross margin sequentially. As well as we do expect higher OpEx, as we continue to accelerate investment in our new solutions both in R&D and go to market. Operator : And the next question will come from Jim Ricchiuti with Needham and Company. Please go ahead. Jim Ricchiuti : Just wondering if - what kind of headwinds you might be seeing or anticipating for the full year, just as it relates to what we've all been hearing about component constraints, higher raw material prices? And just along those lines, do you anticipate potentially having to take any pricing actions going forward just given the supply chain issues? Anders Gustafsson : Yes. I would first characterize the supply chain issues that we're working on in two categories. One is, logistical bottlenecks and the other one is around the industry-wide semiconductor shortages that has been in the press quite a bit lately. First on the logistical bottlenecks. That's really caused by an increase - a combination of increase in demand when combined with a reduction in commercial air traffic sort of fewer commercial airplanes, which used to cover or carry a lot of commercial freight also. Then you have - add on a little bit of container shortages and port congestion on top of that. But this has resulted in air and ocean rates on - pretty much on all our key routes, having increased by a factor of two, since the start of the pandemic. So, we are incurring premium freight cost as a result of this. And we are prioritizing customer - meeting customer expected delivery dates. So, we have been using - leveraging all modalities of freight to get our devices and products to our customers, including chartering flights from Europe - from China to Europe and the US. But this has had a negative - a negligible impact on revenues. And I'd say, our supply chain team has done an outstanding job of being able to manage this and minimize the impact on the business. They had issues around the semiconductor shortages and this impacts some of our products more than others. Our teams are - have been doing a great job of managing all angles of optimizing allocations for us. We have a history of thoughtful contingency planning, which I think is helping us here. We tend to qualify multiple components when we can and even have multiple suppliers when practical. We have seen, again, modest increases in surcharges related to sourcing these components. But despite the - both of these issues that I mentioned, we are confident in the full year sales outlook that we gave. The outlook incorporates both of these points. And lastly then on the price action you asked about. We continuously assess pricing based on the competitive environment. So, we always look at that, but there is - we have no imminent plan of addressing or having, let's say, a broader price increase to address these supply chain issues. Jim Ricchiuti : And thank you. And the follow-up. Just on the AIT business. And I'm just wondering how - what you're seeing in the market - in the legacy - this legacy part of your business compares with previous recoveries and other economic cycles? Anders Gustafsson : Yes. We had an exceptional quarter for print. The growth rates were well above average - corporate average. We - as we saw growth across the portfolio and certainly pent-up demand had been an issue here. Smaller customers through the channel, it was recovering quite nicely. And we also over the last year or so, taking some steps to strengthen our go-to-market around our eco channel - channel ecosystem. And I think that's made us more competitive. And we've been able to accelerate some share gains. Our printing - RFID printing business was also particularly strong. And even the supplies business was doing very well. Tempt time was up double digits. So it was a very strong performance across the board. And maybe also highlight that, Joe mentioned earlier, the manufacturing was up very strongly in Q1 after having had a tougher go in 2020 and a little bit further - beyond that also it would further that out. And printing is the most exposed to manufacturing. So when manufacturing goes up that would have a disproportionate impact on our printing business. Operator : The next question will come from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : A quick question. Some of these smaller customers come back. What are they asking you for that may be different from - what they were asking you from before. Clearly, they still going to face some challenges in the competitive environment. Just wondering, what they're asking you for in particular? And then maybe on the healthcare opportunities. Just as you move past some of these kind of COVID boosted use cases, where are you seeing the most traction in these cases there? Thanks. Anders Gustafsson : Yes. I will start, and then, I will ask Joe to also provide some color here. So first on smaller customers and what we're seeing, what's different. I'd say two things, Meta. One is, irrespective of size, I would say, pretty much all customers across all verticals are looking to figure out how can they digitize and automate their businesses more. And they do look to our type of solutions to connect the physical world to the digital world, to really help them connect that physical workflow - those workflows into applications and automate them better. So that is a broad-based theme across basically all sizes of customers and verticals. The other point that would be - our larger customers who generally able to pivot to a COVID operating world better. They were generally seemed to be essential businesses - were deemed to be essential business, while many of our smaller customers, many of them are in manufacturing had to shut down. And now as they come back, I think they are looking to make investments that enables them to compete with some of their larger presence who have made more - who have invested earlier in those digitization and automation themes. Joe, do you want to add anything to this? Joe Heel : I think you said it well on the small-and-medium businesses. Clearly, the pent-up demand portion of - we're still most pronounced among the SMBs, I would say, and they're catching up more on their pent-up demand. But beyond that, it is really those small-and-medium businesses going to the next level of digital transformation, just as their larger resident have. And you get also asked about healthcare. And - on the healthcare beyond COVID 19 use cases, we're seeing an expansion, as Anders has mentioned in the prepared remarks into new areas of healthcare like ambulatory care, like remote patient care. So the use of tablets, for example, in order to enable remote patient care is a big use case. Communication, of course, is the big use case. And one that we're also seeing a lot of interest in is, asset and people tracking in hospitals, locating the right person, or locating the right asset for a particular procedure. Those are new use cases and are driving some of that accelerating demand . Operator : And the next question will come from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning guys, and congratulations on a great quarter, and the solid guidance. Just want to unpack the gross margin growth, again, just a little bit more? Software and services obviously had a great step up compared to in the fourth quarter or in the first quarter last year. And I understand last year's step up was due to European services improvement, something that's getting further improvement this time around. And this 47%, roughly, gross margins, is that sustainable going forward? Is this like a new normal for you? Nathan Winters : Keith. So just - first part of your question, to the growth in both our service and software. Now again, seeing on both ends, right at the - the addition of Reflexis gross margin being higher than the company average is helping. But also from an organic basis, up nearly 7 points year-on-year from our core service business. And part of that is due to the actions we took over the last several years to improve efficiency and streamline the repair operations and the team is continuing to work that. And then the other is, now with double-digit revenue growth, I've seen that volume leverage flow through the P&L is the other big driver of the margin improvement. And we do expect that to continue to grow year-on-year as we grow the top line, as well as improve efficiency in the operations. Keith Housum : Great to hear it. And then, in terms of your overall growth, I understand there's multiple drivers of your revenue growth. But can you touch on perhaps the growth that's been contributed from the new products and perhaps expansion into new markets that you're perhaps, we're not doing as well in before? Just trying to dimensionalize some of the growth aspects there? Anders Gustafsson : Yes. So, when you say new products, you mean new types of solutions, or were just new products more generally? Keith Housum : I mean, more types of new solutions, looking for new customers, new use cases. And perhaps, your prior generation of products that did not have previously addressed. Anders Gustafsson : Okay. Yes. I'll start and Joe, you can provide some - year also. So I'd say, we did see RFID having a very strong quarter in Q1. RFID had a tough going last year, but that's really started in Q2. So there was - Q1 last year was more of mill, was pretty reasonable quarter. So this is a strong rebound for RFID. And we see these types of solutions which are more contactless is having a great - being in demand and see more deployment of them. I would say, also our software solutions are having great traction. The combination of the Reflexis, Zebra Prescriptive Analytics and Workforce Connect provides a very differentiated value proposition for us. And each of those offerings by them - and of themselves are performing very well. But when you then combine it with as a suite and then look at the - how they interact with our mobile devices that provides a very compelling offering, which we see having great, great opportunities for us to continue to grow. And some of our other intelligent edge solutions are still probably a little slow in ramping as we've had - still have a hard - we don't have access to our customers' facilities to the extent we used to, to do pilots and proof of concepts and other types of engagements like that. But we expect that to ease up here as we get through COVID and get back into more normal way of operating with our customers. Joe? Joe Heel : Yes. I'll add - maybe add a couple of things that could be helpful. In terms of the mobile computing segment. We talked about the device for all. And as Andrew said, previously described, we are seeing an expansion of this. This isn't necessarily always a big game, where someone just rolls out devices to everyone. But an expansion to additional sets of people, right? That you can - now you use it for transport in a hospital, not just for nurses, for example. So that's been a big expansion. But we've also had some very innovative use cases. One of them, we recently published in the press release for a tire change, that is now using our devices to not only keep track of the tires in the inventory, but also measure the tread gap and offer a new service to a customer. That type of innovation, I think is, is going to be providing new use cases as well. And I'm also quite proud of our ability to grow the tablet segment, that we accelerated through the acquisition of Xplore some time ago and to combine with our own ET tablets, and we have some very good traction there. From a vertical perspective, two that I would call out is the government and healthcare segments. The healthcare segments have seen a good acceleration internationally. You know that we've always had a reasonably strong position in North America. But now we're seeing deals in Japan and Australia, in the U.K. that are sizable, right, where these institutions are modernizing their infrastructure globally. And government is, we've mentioned is an area, not just in the U.S., but also in other countries again, around the world that we've made substantial go-to-market investments, and we're now seeing accelerated growth. Most of the mobile computing, but also some printing opportunities with governments around the bar. Operator : The next question is from Richard Eastman with Baird. Please go ahead. Richard Eastman : Yes, good morning. Just very quickly on the gross margins. It - did the chair - the China tariff benefit, did that all fall into the EVM gross margin? Anders Gustafsson : It would have fallen between both EVM and printing. So we had both - I don't have the exact split off them, but it was... Richard Eastman : Okay. Anders Gustafsson : So equally - or proportionately weighted between EVM and AIT. Richard Eastman : Okay. And then just - is there any visibility on that? I mean, going forward, Q2 to Q4, is that benefit continue? Nathan Winters : But, do you expect the benefit to continue? We have not included that into our guidance for the quarter or the year in terms of incremental benefit. As - quite frankly, it's very hard to predict when and how the claims we've processed will be approved and paid. But it's something we continually work and actively manage. But yes, it's pretty tough to predict the timing of when we expect to get the recovery from the government. Richard Eastman : I see. Okay. And then just, just maybe as a second question around the core growth in the quarter was 25%, I believe. Could you just speak to what the growth relative in the channel was versus direct? And does the U.S. Postal Service fall in the direct piece that you're going to hopefully define for me? Anders Gustafsson : Yes. I'll - I think, Joe can probably provide most colors. But the USPS will be in Channel customer, I think, Joe. And second, our Channel business had a fantastic quarter, with I believe stronger growth than what we had in our direct accounts. Joe? Joe Heel : Yes, I can confirm that. So our strategy has and remains to be Channel-centric, with the vast majority of our revenue going through the Channel. And I'm happy to report that our Channel has once again grown faster than our business overall, and has therefore expanded the portion of revenue that goes through the Channel. Richard Eastman : Is - and just lastly, and related to this. I've got a question on just the press release that came out a little bit ago here, kind of mid -April. But you talk about this PartnerConnect Alliance Track. And it's complementary to the independent software vendor track. But just talk about maybe this expansion of non-selling VAR partnerships. And just, what that brings to the table here? And is that, there is an investment made in these channels? But just, maybe just speak to that, how that expands the opportunity set for Zebra? Joe Heel : Do I need to take that, Anders? Anders Gustafsson : Yes, please. Joe Heel : Yes. Of course, VARs has been the core of our PartnerConnect program. We've added ISVs, especially in the Android transition because of the importance that the software that runs on our devices has and how the customer comprehends that as an integrated solution and wants to buy it that way. So we recognized ISVs as influencers of the customers, aligned ourselves closely with those and, and are proud to have some of the largest ISVs in our program. But we've also recognized that there are other important influencers. I'll give you an example to make this real, which is, if you think about network equipment providers. People that provide WiFi infrastructure, for example, for a customer. Almost similar to the ISVs. They are looking to provide solutions to customers, like for example, locationing capabilities, right, within the environments that they outfit. And by working with us, they can enable such solutions. And we recognize that and created this Alliance Track in order to allow us to work more effectively with those kinds of partners. And it's paying off very nicely for us. Richard Eastman : So it's basically lead generation. I mean, is that what you look to it? These other influencers around ID products?... Joe Heel : It is lead gene... I'm sorry, go ahead. Richard Eastman : No, that was my question. Joe Heel : Yes, it is lead generation, but it is perhaps even more effective in allowing us to close the opportunities, right? When a customer sees that we're aligned and that we're working together, we have a greater chance of winning. Operator : The next question will be from Brian Drab with William Blair. Please go ahead. Brian Drab : Just first on the EBITDA margins. I guess the full-year guidance implies that the - first of all, you gave us the 21.5% midpoint for the second quarter, but then the full-year guidance implies the same kind of 21.5% level for the third quarter and fourth quarter. I'm wondering if that's kind of fair to assume that, that will be the run rate for the balance of the year and no big swings between third and fourth quarter? And also, is the premium freight headwind something that will persist or is that - can that fall off maybe later in the year? And I'm just wondering, how much conservatism might be baked into that 21.5% after putting up 25.5% almost in the first quarter? Nathan Winters : So if you look at our full-year guide of 22% to 23%, we do expect gross margin in that to improve year-on-year, and particularly our software solutions grow. And we do expect premium freight cost of $50 million to $60 million, which we've raised by $20 million and most of that coming in the second half. Because we really don't see any change in those expectations from what we're seeing here in the first half, or at least it's hard to predict when the - particularly the supply side will come back around commercial air travel. And that's also $20 million higher than all of our 2020 transitory costs, including tariffs. And we also expect to continue to invest in and grow OpEx as we accelerate investment in some of the high ROI opportunities and including the continued integration of our software offerings with Reflexis. Brian Drab : Okay, thanks. And then, can you provide some details on the competitive environment as you're seeing it? Anything you can share in terms of what your share of the mobile computer market is now from your perspective and what your share of the bar coding equipment market is? Just that so much has changed in the last year with the industry just exploding. And then also within mobile computing, can you talk about what percent was Android versus Windows-based in the quarter? Thanks. Anders Gustafsson : All right. I'll start and we'll see if I missed anything. But if - so competitive environment. First I'd say, we are very confident in our competitive positioning. I'd say as confident as we've ever been probably. We're coming out of COVID 19 with good momentum and it provide - we've actually gained share as we've gone through last 2020 here. We took the attack of continuing to invest in new solutions and staying as close as we could with customers. We actually launched more new products last year than we've done in the other year in history, and I think that's coming back to benefit us here now. Our markets are, we think very attractive. We have some strong secular growth trends. I mentioned kind of the trends around digitizing and automating workflows as a broad theme that I think that's something that's very broad-based and very - we believe will be something that companies will invest in for several years. The - we have some strong advantages also. We have our scale, our go-to-market network, the ecosystem we have there. So there is a number of things that will make us a formidable competitor from that perspective. And lastly, I'd say our vision. Our Enterprise Asset Intelligence something that differentiates us from our competitors. When our customers look, talk to us, they are not looking to just buy device for here and now, they are looking to see how they can partner with somebody who can help them drive that digitization and automation of their operations into the future. From a share perspective, we get share data from independent sources and they tend to lag. So we only have Q4 data. But we had a record share in mobile computing over, I think it was over 50% on print and we - the Number 2, I think is, I believe 12%, certainly directionally in that area. On print, we have a low 40%, 43% I think it is... Nathan Winters : Yes. Anders Gustafsson : And our next second competitor is low double digits. I think also about 12%. And in scan, we have about 30%, where the second largest is more like 24%. So, we have strong position across our business. And your last question was about the mix of Android and - Windows. And we now have over 85% of our mobile computing sales are Android. Operator : Please proceed Mr. Anders, if you needed to answer the question further. Anders Gustafsson : Well, I just - our share in Android remains particularly strong. We probably have approximately 60% of the share of Android, so we're particularly strong in that Android element. Brian Drab : Yes. That's a good answer. Operator : Thank you, sir. And the final question will come from Blake Gendron with Wolfe Research. Please proceed. Blake Gendron : Thanks for squeezing me on here. I want to start with cash flow. So relative to the wording of at least $700 million in the prior guidance, the current guide is appreciably higher. So I'm wondering, how we can think about free cash conversion in the context of both, Number 1 growing software mix and Number 2, the healthy channel growth that you mentioned. I would imagine that hardware-led pent-up demand recapture would see some working capital drag in 2021. But as we look into 2022 and beyond, is there a way we can think about free cash conversion that's perhaps structurally different from what it's been in the past? Nathan Winters : And so, the first part of your question is just in terms of the full-year guide of greater than $850 million really just aligns to the increased profitable growth outlook for the year. So no notable changes in - from a working capital perspective relative to our last guide. Our target year in and out - year-in and year-outs be at 100% free cash flow conversion. This year it'll be slightly lower than that just because of the strength we had in 2020. But we don't see that noticeably changing and something we can achieve over time as we look - as we move forward. Blake Gendron : Okay, that's helpful. And then one quick follow-up here. Interesting win with the tire customer. And that application seems like if all the machine vision - there is a large machine vision competitor, that is a small handheld scanner device. Business somewhere in Zebra's purview, there's a little bit of overlap. Do you think that this overlap increases, particularly in the manufacturing realm? Is there any M&A to do here? A lot of what we're hearing in terms of automation, AI deployment within the manufacturing facility is coming from the Machine Building customers, which seems like it's on the periphery of what Zebra does, but that would be helpful perspective. Anders Gustafsson : Yes. Machine vision is a very exciting, sensing and data acquisition technology for us that helps us enable intelligent automation solutions. We've already incorporated machine vision into a number of our solutions like SmartPack, SmartSight, our MP7000 flatbed scanners for the color camera. So, we just clearly see great opportunities to continue to leverage machine vision to create unique solutions for our customers. The tire tread depth sensor, that is an accessory that we put on our mobile computers to be able to do, but it's another example of how we're trying to find use cases where we feel that we have a strong right to play and where we can be competitive. I now expect that machine vision is going to be continued area for us to invest. We acquired a company called Cortexica about 18 months back, I think it is now, that was basically as an engineering team that has deep expertise into machine vision. Their focus was on figuring out how to extract useful information from digital images and video and we put - they put, they have been a great addition to our team and helping our other solutions - accelerate the deployment of our other solutions. Operator : Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Yes. So to wrap up, I would like to thank our employees and partners for their focus, dedication and resiliency, leading to exceptional Q1 results and an improved outlook for 2021. Our top priority continues to be protecting the health and well-being of our employees, partners, and customers as we recover from the pandemic. Stay safe everyone. Operator : Thank you, sir. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
|
ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,021
| 3
|
2021Q3
|
2021Q2
|
2021-08-03
| 14.131
| 14.935
| 16.78
| 17.735
| null | 29.42
| 28.57
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Operator : Good day, and welcome to the Zebra's Second Quarter 2021 Earnings Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. . Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning, and welcome to Zebra's second quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Anders Gustafsson : Thank you, Mike. Good morning, everyone. And thank you for joining us. Our team delivered exceptional second quarter results with strong performance across the business resulting in record sales and profits. For the quarter we realized adjusted net sales growth of 44% or 40% on an organic basis; an adjusted EBITDA margin of 23.6%, a 530 basis points year-over-year improvement. Non-GAAP diluted earnings per share of $4.57, a nearly 90% increase from the prior year and strong free cash flow. Despite ongoing industry wide supply chain challenges. Our teams successfully satisfied stronger-than-expected demand from customers both direct and through our distribution channel. Similar to Q1 we realized robust broad-based demand with double-digit sales growth across all four regions, each major product and solutions category, as well as in all of our vertical end markets. Our customers continue to digitize and automate their workflows with a sense of urgency in the increasingly on-demand global economy. We also significantly expanded profit margin across our business more than offsetting escalating global supply chain costs. We also continued our balanced approach to scaling operating expenses, while investing in initiatives to drive sustainable profitable growth. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q2, adjusted net sales increased 44.4%, including the impact of currency and acquisition, and 39.8% on an organic basis, reflecting broad-based demand for our solutions from customers of all sizes. We realized particularly high growth from our run rate business through the channel partially driven by pent-up demand, while continuing to see strong growth in direct sales to large customers. Our Asset Intelligence & Tracking segment, including printing and supplies grew 51.2%, while Enterprise Visibility & Mobility segment sales increased 35.1% driven by exceptional growth across all major categories, including enterprise mobile computing and data capture. Note that we also realized double-digit growth in services and software along with very strong growth in our RFID solutions, for which deployment activity has snapped back as this customers recover from the pandemic. We recognized double-digit growth in all regions. In North America, sales increased 39% with all major categories growing double-digits. In EMEA, sales increased 44% with solid growth across sub regions and solutions offerings. APAC again realized strong growth with sales up 20% led by strength in China, Australia, India and Japan. Latin America also continue its recovery with exceptionally strong growth in all sub regions with sales increasing 79%. Adjusted gross margin expanded 390 basis points to 48%, primarily driven by favorable business mix, a $12 million recovery of Chinese import tariffs, higher support service margins, and contribution from our recent high margin acquisitions. These benefits were partially offset by higher premium freight charges, which we'll discuss further in a moment. Adjusted operating expenses as a percentage of sales improved 180 basis points. We continue to scale OpEx, while prioritizing high return investments in the business. Second quarter adjusted EBITDA margin was 23.6% a 530 basis point improvement from the prior year period, reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.57, a $2.16 or 89.6% year-over-year increase. EPS growth also benefited from lower interest expense, partially offset by a slightly higher tax rate. Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $514 million of free cash flow in the first half of 2021. This was a $192 million higher than the prior year, primarily due to increased profitable growth. In Q2, we acquired Adaptive Vision for $18 million to advance our Machine Vision solutions and made $4 million of venture investments. Anders Gustafsson : Thank you, Nathan. I'm encouraged by the strengthening demand across our business, which allows us to further increase our 2021 outlook. Slide 11 illustrates how we're working with our customers and partners to advance our Enterprise Asset Intelligence vision, by leveraging Zebra's industry leading portfolio of products, solutions, software and services, our customers can overcome some of their most complex operational challenges and transform their frontline workflows to achieve higher levels of performance. We help businesses across industries implement tailored solutions that digitize and automate their operations, enabling them to compete more effectively. With our innovative solutions, our customers associates can now anticipate and react in near real time, utilizing insights driven by advanced software capabilities, such as artificial intelligence, machine learning, prescriptive analytics and Machine Vision. Now turning to Slide 12. As a trusted strategic partner, businesses in a variety of end-markets turn to Zebra to help optimize end-to-end workflows. I would like to highlight several recent wins across our end-markets, which demonstrate how Zebra Solutions are improving productivity, customer service and patient care. Large European Postal Service will be deploying approximately 80,000 TC27s to their carriers. Continuing a long standing relationship, they're upgrading to the latest mobile computing solution, which will enable them to more effectively handle increased parcel volumes and a broad range of use cases. It's another proof point of successful collaboration with post and parcel services around the globe, including our current business with the United States Postal Service. We're also helping a large North American steel manufacturer to optimize and digitize its operations. This customer is adding more than 1,000 of our ET56 tablets to their operations, which will allow them to eliminate manual paper processes by implementing electronic proof of delivery to automate and expedite the invoicing process. Michael Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : We'll now begin the question-and-answer session. Your first question comes from Damian Karas with UBS. Please go ahead. Damian Karas : Hi, good morning, everyone. Anders Gustafsson : Good morning. Damian Karas : So I just wanted to ask you a little bit about the component shortages, obviously still we're able to drive some pretty strong growth in the second quarter and expecting to see that in the third quarter as well. But would you be able to quantify how much of a drag if any of the component shortages are on your sales this year? Anders Gustafsson : Yes, I'll start and then I'll have Nathan to also help out here. So the first - I'll start on the kind of industry wide semiconductor shortages. They've been very well documented by the press, obviously over the last few months, and we're impacted. So the impact though is not uniform across all components, some components are impacted much more than others. But it's much larger number of components that we can have working that we would do in a normal quarter. But I'd say our team is doing a great job in working all angles to optimize our allocations. And there's been great collaboration between our sustaining engineering groups to ensure we can qualify new alternative components that have less lead time. So to ensure, we get as much available product to provide to our customers as we can. We did raise prices here recently to mitigate some of the impact of the increased component costs. And so despite these shortages, and the price increases that we have increased, we're quite confident in the increased full-year outlook that we announced today. Nathan Winters : And Damian, just to answer the question on the Q3 and full-year guide, the risk associated with the shortages have been incorporated in our outlook, but it'd be really tough to quantify, I think it will be really constructive to speculate on what that number could be unconstrained. Damian Karas : Okay, that's really helpful. And then wanted to ask you a little bit about the frayed headwinds. I mean, second quarter despite having those I think you were able to outperform on the margin front. So just curious, why we shouldn't - but you're expecting a pretty abrupt drop here 300 basis points in the second half. Why would - shouldn't we expect you to kind of be able to manage those as we're in the second quarter. And I guess additionally in - should we be thinking that next year, you will be able to kind of completely reverse these premium freight expenses? Anders Gustafsson : So, maybe if you take us to back on just where we're seeing the bottlenecks, because there's really three different areas in terms of - and the incremental costs. One, which we've seen earlier in the year we've talked about in our previous calls around the lower international commercial air travel, container shortages, port congestions around the supply side of it, that's where we're seeing our air and ocean rates 2 to 3x since the start of the pandemic. And those really have not come down over the last several months. If anything's oceans gone up, air rates have stabilized. In addition, because of the global supply constraints along with increased global demand, we're now expediting component parts from our Tier 1 and Tier 2 manufacturing partners. Along with shipping a higher percentage of printing perspective - in particular via air versus ocean. And so those are also really driving the step change in terms of the transitory cost from Q2 into the second half. In addition, you have the manufacturing shutdowns in parts of Southeast Asia, and particularly for us, Vietnam and Malaysia due to COVID that have further constraint supply. So as we see today, you're expecting the impacts to persist at least through the end of the year. It's hard to say when those will abate into next year. But again, the team is doing a great job of managing the impacts with our customers really through extraordinary actions and communicating the lead times. So as you look at our second half guide, I think there's two things to think of. One is the step change increase in terms of the incremental cost. And in Q2, we also had $12 million of China tariff recovery that we don't expect to repeat in the second half that was an offset in the second quarter. Damian Karas : Understood. Thank you very much for the insight. Good luck. Anders Gustafsson : Thank you. Operator : Our next question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Good morning, and thanks for taking my questions. Anders Gustafsson : Yes. Tommy Moll : Anders you've talked about a robust backlog and pipeline. Any comments you could give to augment there would be helpful. Do you have any sense of whether the momentum is sustainable through the year-end and even in the next year? And any comments you could give us on channel inventory levels as best you understand them would be appreciated as well? Thanks. Anders Gustafsson : Yes. I will start here. And then I'll ask Joe, he'll also provide some color. And you're first may be we obviously very excited about and pleased with the performance we had in the second quarter. We exceeded the high end of the guidance range here. To the previous question, the extraordinary collaboration between our supply chain and sales teams to satisfy a very strong demand in a supply constrained environment. The strong secular trends that have been supporting our business for a long time, they have accelerated through COVID. And we don't see any abatement in those trends they're continuing to build. I'd say our customers across pretty much all our vertical markets are prioritizing how digitizing and automating their workflows. I think omnichannel is probably the best example. In retail of - the retail vertical or most retailers investing meaningfully in building out their omnichannel capabilities and digitizing their operations that way. We did see double-digit growth in all regions, as well as across all our product and solutions categories as well as across our main four main vertical markets. We did see our small and medium sized customers do particularly well. So the growth we saw here was definitely part - too large to be driven by our small, medium sized customers. And that was partly I think a result of pent up demand. But we see that largely being behind us at this stage. But even our large strategic accounts performed very well with strong growth. And based on this performance, I do expect that we will continue to take share in the market. Our inventories are healthy in the channel today, but it may be at the lower end of our expected ranges. Joe. Joachim Heel : I think that's fair. I mean on the inventory side, we're working hard with our distribution partners to keep our inventory at the levels that we need to sustain the demand. But at the same time to serve every possible demand, which is at the moment as you can tell very, very strong. And we're trying to serve all of the demand we can, and taking our inventory to the lower end of - what we consider our healthy range. When it comes to the backlog in the pipeline. It is very strong as you're seeing, and what I can underscore when Anders was saying this, pandemic has definitely triggered a wave of digitization and automation in our customers that is leading to projects and demand that we did not see before the pandemic. So that is a sustained driver of momentum that we see. And we also were enjoying because customers are aware of the supply shortages. We're enjoying good pipeline visibility, our customers are working with us to give us that visibility far in advance. And that gives us confidence for continued growth into the next year. Tommy Moll : Thank you both. Those are helpful answers. Anders, I wanted to follow-up with a question on Adaptive Vision and your entry into the Fixed Industrial Scanning and Machine Vision markets. A couple part question here does it any context you could give us around any prior relationship you had with Adaptive Vision or how you came to know the asset. Anything you can do to frame the size of the market opportunity where you think you've got a good shot at competing? And then what advantages you bring in those markets they're adjacent to the markets where you currently play and have substantial share, but what advantages do you bring in these new markets? Thanks. Anders Gustafsson : Yes, I'll try to summarize this here. But firstly, we're excited about the - our entry into the Fixed Industrial Scanning and Machine Vision market. These are solutions that really accelerate our enterprise as an intelligence vision. This is more on the sense side of the sense analyze act framework, but it helps us to provide some new ways of capturing data that we can then analyze and enable our customers to act on. This is a very attractive market we see, but it's quite fragmented. It's a multi-billion dollar market that our new portfolio then can address. Although we're not addressing the entire market on day one, but we're continuing to invest in it to add functionality, to add capabilities so we can go after bigger and bigger part of the market and be ready for folks in initially mostly on the text industrial scanning market. Our value proposition we believe is very strong and their focus is on ease of use of these types of solutions as well as the ability to upgrade cameras and devices in the field. So those are we believe two strong differentiators that we have. The Adaptive Vision is a great way for us to augment the cameras that we had and the software we had developed. It's a way for our customers to more easily be able to develop and build and implement applications for how to basically engage in Machine Vision or Fixed Industrial Scanning or incorporating Machine Vision and Fixed Industrial Scanning into their workflows. And we've been familiar with Adaptive Vision for some time and we've been looking at ways to augment our own internal software development in that area to make sure we can come up with a really strong offering and we felt that Adaptive Vision had a very attractive solution, very strong solution and there was a nice fit with Zebra. Tommy Moll : Thanks, Anders. I'll turn it back. Operator : Our next question comes from Jim Ricchiuti with Needham and Company. Please go ahead. Jim Ricchiuti : Hi, good morning. Thanks for the additional color on some of the costs issue that you're incurring in terms of freight and components. I wonder if you could spend a few moments talking about OpEx, both sales and marketing. G&A up by a healthy amount sequentially, admittedly with those significantly higher sales, but I'm just wondering how we might be thinking about OpEx in the second half of the year. And I have a follow-up Anders, for you on some of the acquisitions? Nathan Winters : So I think from an OpEx perspective, if you look year-on-year, there's a couple major drivers in terms of the overall increase that really impact every quarter. The first was last year, we took some actions mid-year around salary reductions in the peak of the pandemic to help offset the impact as well as lower incentive comp, as we're obviously below our plans and targets for the year. So those two alone drive a significant increase year-on-year along with a full-year of Reflexis in the P&L and starting to again, invest particularly in R&D and go-to-market with some of the discretionary costs increases. So if you look for the second half of the year, I'd say the ramp in the first half will continue. But I wouldn't expect to see a real step change increase from where we saw spending in the second quarter. But again, the year-on-year increases are all pretty consistent for each quarter. Jim Ricchiuti : Thanks, Nathan. Anders, you talk about the acquisitions, both Adaptive and Fetch, you talked about I think is being a fragmented market. And I'm wondering to what extent might we see you in addition to internal development of these technologies look at potential additional M&A to expand your footprint? Anders Gustafsson : Yes, it's obviously hard for me to comment on specific opportunities here. But we're excited about both of these markets, the Fixed Industrial Scanning, and Autonomous Mobile Robot markets. And we have had long standing organic development activities that we now have augmented by the acquisitions of Fetch and Adaptive. But I'd say first, more generally about M&A first we're very excited about our business and the outlook for our business and we do see M&A as a vector for growth. I think the Adaptive Vision or the Fetch Robotics acquisitions are, we're excited about them, we think that we can deliver good growth and good returns on those. But we do look at all M&A opportunities as a way for us to accelerate and advance our EI Vision. We're targeting selective bolt-on acquisitions that also have high growth. Look at around, what I talked earlier about the customers need an interest in digitizing and automating a number of workflows across all of their supply chains. So that provides good opportunities for us to continue to add to our capabilities. And so we do look at M&A as a way for us to accelerate that growth. And we have a strong balance sheet that can support M&A activities also. Jim Ricchiuti : And your pipeline for M&A? Anders Gustafsson : Yes, we obviously have a team that looks at the scans kind of the market broadly around our target areas where we have particular interest. There is a - we have a good healthy pipeline over opportunities. You never know what will work out, where we'll come to terms or not, but we do have a healthy pipeline of opportunities. Jim Ricchiuti : Thank you. Operator : Your next question comes from Paul Chung with JPMorgan. Please go ahead. Paul Chung : Hi, thanks for taking my questions. So, just another follow-up on Machine Vision fixed industrial scanner. So, how large is this business today and will the solution eventually kind of be led with software similar to your peers kind of resulting in very accretive margins, what is the strategy to kind of take share from larger players in the industry, maybe competitive pricing and then another on M&A in general, very strong free cash flow, high quality earnings provides you kind of a nice cushion for broader opportunities. Should we expect kind of continued preference for software solutions over time and resulting kind of higher margins longer-term? Anders Gustafsson : Yes, I'll start and I will also ask Joe to comment on this here. But I think your first question was around the Fixed Industrial Scanning Machine Vision market. We believe it's a very attractive market, it's near adjacency to what we do. And it's a quite a fragmented market, if you looked at the market share table there, there's one or two players that have resource share, but then it's a long tail of smaller players, we're entering the market primarily through our or initially with our Fixed Industrial Scanning portfolio, which is the closest to our core competencies and the use cases where we have a very strong right to play. But we are adding both, say on the capabilities both on the hardware side, on the camera side, but primarily here on the software side to be able to then address a larger part of that market. Software is a big differentiator in all our devices, right, if you look at mobile computing, print and scan, the majority of our engineers, a huge part of the differentiation in the value add comes from the software. And we certainly expect that to be the case here also. So we're investing in building more of that software capability, that division was in inorganic way to accelerate some of that, but we also do that organically. We should also not underestimate or minimize the importance of the investments we're making in the go-to-market. I mentioned earlier, I think that we're putting in specialized to track in our PartnerConnect Reseller program to specifically address recruiting Fixed Industrial Scanning and Machine Vision partners to help accelerate that growth. Maybe Joe, you can expand on that a bit? Joachim Heel : Yes, exactly. I was going to comment specifically on your question about what's our strategy to take share. So you know that we have the Fixed Industrial Scanning and the Machine Vision parts of - Fixed Industrial Scanning is a natural extension of the leadership that we have in the scanning part of the market. And we're of course translating that technically, to succeed in the Machine Vision part, that's where the software piece is essential. And the acquisition of Adaptive now gives us industry leading software capability. So we fully expect to translate that into share gains. But there's more to it than that, we specifically want to use the software to enhance that ease of use value proposition that's critical to these customers, how easy is it to use and to deploy and that's also important for the second part of the strategy to win which is using partners as a way to compete in this market. All of these solutions are deployed through partners. For us, we're a very partner centric company, as you know. And that is also what we're going to use to compete and win in the Machine Vision space and making our software easy to use is a value proposition not just to the end-users, but to those partners specifically. So hopefully that's helpful. Paul Chung : Yes, very much and lastly on Fetch Robotics, I know it's early days, but if you could talk about how you see this business ramping, how material revenues can be over time, kind of from a small base, the margin outlook, competitive environment, all that good stuff, some key customers, you hope to get, some cross selling opportunities. And if you could expand on kind of use cases beyond warehouses and fulfillment centers? Thank you. Anders Gustafsson : Yes, that's a broad question, it can take a while to answer all of it. So I tried to give you a high level response here. But first, we haven't closed on the acquisition yet. But we are certainly excited about it. We have worked with Fetch as a venture investment for quite some time. So we believe we understand the market, we understand the team and we see great opportunities to leverage the Fetch's broad portfolio of AMRs. They have the broadest portfolio of Autonomous Mobile Robots in the industry. And they have a very, very strong, very capable Cloud based software platform for how to deploy and manage these robots, then you'll see that, we've been more focused on technology enabled the workers in warehouses and by combining those two to be able to control and optimize both the flow of robots and the workers. We think we can offer a superior ROI to customers in manufacturing, in warehouses and a number of these use cases. Fetch has, say, initially been mostly focused on the markets. So more movement of goods. But we see there's a number of other use cases that are also growing fast where they have that solutions that are very well suited to pursue those also. And here's another area where I think our strength that we have in our go-to-market organization, I'll ask Joe to comment on this also, will augment as well, we know virtually all of these large customers in transportation logistics, in manufacturing, retail in whatever industry or vertical we're going after. And we can help I think with providing those introductions and position our broader automation workflow solutions with those customers. Joachim Heel : Yes, a particular attribute of the market that we're focusing on is that we're targeting those areas where humans and robots work together. And so the notion of a Cobot, right, that collaboration between the two is at the heart of the strategy. So that means we're targeting use cases like person to goods picking, and conveyance. And those use cases allow us to take advantage of a broad installed base we already have, or workers in warehouses have mobile computers, and they're now being augmented by robots. So this means that we can take advantage of the orchestration between the two. And there's really no one else in the market that can do that to the extent that we can. And as a result, we're taking this strong platform capability that that Fetch has with robots that can go across a broader range of use cases than anyone else, and can deliver products with safety and speed that no one else can, and combining it with the orchestration of humans to achieve overall productivity improvements that are unequaled and that's really the strategy. Paul Chung : Thanks so much. Operator : The next question comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great, thanks. On the price increases, you guys noted, can you just give us a sense of the degree or how broad they were and how much like, are you expecting those prices increases to be transitory. So the channel may hold less inventory in the near-term, just how you see that interaction and just maybe a second question, just getting a sense of the Postal Service concentration this year, the USPS deal, so it's expected to be primarily Q2, Q3 of this year. Thanks. Anders Gustafsson : I'll start and then I'll ask Nathan to comment here also, but first on the price increases, pricing is obviously something that is very important to us and something we continue to assess and address. We do regular checks to make sure that our solutions are priced competitively to the end users as well as our partner community have the right profitability, part of our overall go-to-market activities here. The competitive actions or competitive positioning is obviously a key part of how we assess pricing here. And we believe that the price increases that we have now announced are appropriate, they respond to some of the competitors who have also announced price increases but everybody hasn't. So we believe that we have kind of assessed this based on a very granular based on products and geographies to make sure that we don't put ourselves any competitive risk with these. We see the cost as being transitory, and we want to play this kind of a long-term game here, though of making sure we maximize the value of the corporation longer-term, we don't want to cede market share in the short-term for that either. Nathan Winters : And then from USPS perspective, the rollout is progressing as expected, and as we communicated earlier in the year, this is for the current rollout of the full EMC solution of 300,000 units to the carriers and with the goal of completing largely completing here at the end of the third quarter. Meta Marshall : Great. I mean just coming back to project, which is like is there just a range we should think of kind of on the - just on the top line of what that impact is across the portfolio or is that just too difficult to assess kind of at this point? Nathan Winters : I'll take that, we just rolled the price increases out last week. I would say from a full-year perspective, it's within the margins from the full-year revenue. Meta Marshall : Okay, great. Anders Gustafsson : On the rollout price increases, there's a lag time between us announcing and being effective in the market. So you can see this will be impacting our Q4 business rather than Q3. Meta Marshall : Okay, great. Thank you so much. Operator : The next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys and congratulations on a great quarter. Just looking at the cost of goods sold here and the transport costs at being the premium freight cost. Is there anything in the adjusted EBITDA margin guidance and thought process as suggested some of the impact will be perhaps longer-term, for example, increased labor costs or anything else in there that again will perhaps go on beyond the rest of this year? Anders Gustafsson : Yes, Keith the way into two buckets. If you look at the labor costs, or the raw material costs increases, that's what the price increases we've taken is meant to largely offset that. So if we think about from a mitigation of the inflationary prices, I think that's as we go into the fourth quarter and into next year, those would be largely mitigated with the price actions we've taken. And the logistical bottlenecks are the one that from the timing, I think, is still to be played out. Again, I think we expect but no changes between now and the end of the year. But really, we're taking kind of one quarter at a time and reacting accordingly to optimize and maximize profitability as best we can. Keith Housum : Okay, fair enough. Nathan Winters : Maybe just build on that a little bit. So the logistics and the semiconductor component cost, we consider those to be transitory. On the labor side, there's always some upward movement in labor rates. But if you think of the amount of labor that goes into our cost of goods sold, it's very small. So that is not, it's single digits, I think high single digits, part of our value-add is from labor. So it's not something that meaningfully changes the P&L. Keith Housum : Got it, got it. And looking at your full-year guidance, Anders, historically you guys have always had a very strong fourth quarter sequentially big up tick from the second and third quarter, is the guidance you're providing here suggests perhaps even roughly a flat fourth quarter. So is there the thought process that the business has kind of pulled ahead during the year or how are you thinking about the fourth quarter, any potential upside to that? Anders Gustafsson : Well, I think the fourth quarter, the implied guide for the fourth quarter that we had in our full-year number here which certainly would indicate this growth, not as strong growth as we've had in the first half or - we guided for Q3. But Q4 was a very strong quarter last year. So there was - we saw great recovery in the fourth quarter. But we do see continued strong demand from our customers, the momentum is very strong, we don't see that abating. This is more of a tougher compare than anything, Nathan you want to go or add anything to that? Nathan Winters : Yes, I think from a sequential standpoint, Keith the terms of the typical update from Q3 to Q4, I don't think it reflects anything from a weakness in the fourth quarter as much as just strength we're seeing here in the third quarter. And as we've noted earlier, when you look at our days on hand inventory and the strength, I wouldn't say sales pull-ins are not a major factor. It's really just that acceleration of investment from our customer base. And if anything, where we're getting the visibility is in the backlog and funnel, as Joe mentioned in terms of giving us confidence in the full-year, particularly the fourth quarter guidance. Keith Housum : Okay, thanks. I appreciate it. Operator : The next question is from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : Good morning, guys. Anders Gustafsson : Good morning. Andrew Buscaglia : So I wanted to ask on R&D, your spending this year on track, spent about $560 million or so. And I'm wondering how much of this or last call 12 months is related to this Vision and AMR kind of push. And then secondly, at what point could you start to really leverage that R&D line Do you need to be spending flat cost $550 million a year going forward? Nathan Winters : First, I'd say R&D investments is a key activity for us, that is what really drives our longer-term growth. And I would say if you look back over the last several years investments we've made in in-product development, and R&D has had a great return for us. So we want to make sure that we have a portfolio of fresh solutions that offer real value to our customers that we can compete and grow the business. We look at our R&D investments across number of horizons, we can say our investments in our core that would have a very short-term return kind of the near adjacencies, which would have a little bit longer returns a couple of years to three years. And then more innovative new solutions, more of the enterprise asset intelligence type of solutions here, which we have a little longer-term payback as they're more ground up innovations. In many areas, you mentioned Fetch specifically, we developed our own robots with SmartSight before, so there certainly been a way for us to both learn the industry. But there's also attractive ways for us to leverage those investments across. So when we do make acquisitions, we see that as a great way for us to augment our own internal programs and drive us into new high growth adjacencies where we can make a difference. So that answers your question. Andrew Buscaglia : Yes, that's helpful. And if I heard correctly, you got the nice healthcare award this quarter it's like that that area is taking kind of a backseat to all excitement going on retail and e-commerce and logistics. But kind of - can you update us on healthcare in terms of, are you still seeing that narrative play out post-COVID where people are accelerating investments in automation there. Anders Gustafsson : Yes, I think across all our verticals first. I mean COVID has accelerated the secular trends that we've talked about around our all our end-markets are driving solutions that help to digitize and automate their workflows and empower frontline workers to be connected and optimally kind of utilized. Each of our primary vertical markets grew double-digits in the second quarter. And we continue to invest in expanding into each of these ones. Specifically for healthcare I'd say, we saw healthcare - our healthcare markets, they started in more acute care, but it's been moving into other areas like outpatient, remote patient care, COVID testing, vaccine distribution. So our efforts in healthcare continues to expand into new areas. It's also expanding geographically. So the win we've talked about today was in Europe. And I think the paid healthcare patients are taking a book out of their e-commerce or kind of online shopping activities. Also, they're seeking a more digital experience, which is putting some extra pressure on healthcare providers to make sure they can offer similar type of experiences for the patients. And let's say here, our purpose built devices and solutions are critical for healthcare providers not only to improve the patient journey, but also to drive greater productivity for the healthcare providers. Joachim Heel : Yes, I might add that. In healthcare, there's two other phenomena that will drive continued growth. One is that we know that healthcare systems depending on where in the world you are, this is in a different stage. Have pulled back on some of their spending, because they didn't have income from the elective procedures that they usually enjoyed. And as we come out of the pandemic, we see more of that income returning to for profit hospitals, and then their ability to spend on these solutions returns as well. And we've seen that, and the international growth is another big dimension. Anders mentioned the European piece, but we also see significant interest in different parts of Asia that we hadn't seen to that extent before. So they were the two more growth factors that we expect. Anders Gustafsson : Just one more comment on this will be. I expect the healthcare to continue to be our fastest growing vertical over the longer-term. But it's great to see that, we have this diversity in the business across our main four verticals, and some other newer ones coming up. But in Q2 here, manufacturing, which was our fastest growing vertical. Manufacturing was the one that was the hardest hit by COVID-19. And the macro was a bit tougher going into that with tariffs and other things. But the opportunity to increase automation in workflows through wearables and heads up displays and the need to track and trace work are important sourcing components at sub suppliers through assembly all the way through distribution is putting - providing great opportunities for us. So all our vertical markets performed very well, but manufacturing was actually the strongest one for us in Q2. Andrew Buscaglia : Okay. Thanks Anders. Operator : Last question is from Rob Mason with Baird. Please go ahead. Rob Mason : Yes, good morning. Thanks for the question. Anders or Joe wanted to get your thoughts on how quickly you thought you could pull together the channel. The partners to be able to sell the - your Fixed Industrial Scanning Machine Vision products. And I'm curious also if you envision those being two separate channels, or both products will go through the same channel. And then also relatedly, I guess maybe what percent of your existing channel is suitable to sell those products? Anders Gustafsson : Yes, I'll start and Joe can provide some extra color here also. So, the - we have worked on our go-to-market strategy and our channel engagements. This is since we started working on the product and to solutions. So this is not something we can doing serially, this has been something we've done in parallel to a large degree. So we - you can say there's a Venn diagram of partners out there, their partners who we currently have, who are also in the Fixed Industrial Scanning Machine Vision space that we're obviously having a great - already not have a relationship with. And with EC expansion to add our Fixed Industrial Scanning and Machine Vision capabilities to their portfolio, but also recruiting new partners that are not necessarily see if our partners today, but they're strong in that space. And we've seen good interest and response rates for them, from them. And I think they have been impressed with our solutions. And they see how we can add value to them. So this is obviously a big part of what we need to do now and for the next year to ensure that we deliver the revenue growth that we are intending or planning for. But so far, I'd say that the response from the channel has been very positive. Joachim Heel : Yes, I appreciate that. You're asking this question, because channel is central to our go-to-market strategy, right? We're very channel centric company. And, as we were designing this go-to-market approach, this we spent a lot of time on this. First week created a dedicated track in our PartnerConnect program, which is very important to serve the needs of these particular partners. A percentage of our current partners are also Machine Vision, distributors and sellers. I would estimate that that's a small percentage. The majority of Machine Vision partners, we do need to create, we no need to recruit - I'm sorry. And we have made great progress in recruiting these partners already. We have a very strong group of partners that have already signed up to sell this force. And that's because of what we were talking about earlier, that we've designed the product with a particular value proposition geared towards partners. We wanted it to make easy for those partners to deploy and sell the solutions. We think that's critical to success. And that's essential in how we've designed the product. And so we're very pleased with both the number of partners, we've already been able to recruit. And the pipeline of additional partners that we have that that is interested in selling our products. Rob Mason : Very good. Just one follow-up. Nathan, the China tariff recovery, it was a nice contribution in the second quarter. What's assumed in the third quarter or second half for that or the potential for that to recur? Nathan Winters : Yes, so we have no incremental amount assumed in the second half guide. Our total claim was just over $30 million, and we've recovered $27 million to-date. So I'd say that the large majority that's left is in reconciliation. So I would expect the amount that's left to go is fairly small. And we - the timing that's a little bit unknown, just as we reconcile of those last few batches of transactions. Rob Mason : I see. And just to clarify as well in your guide. You've assumed nothing for fetch, because it hasn't closed. But just how we should we think about the profit impact that small business are now, but assume you're planning to invest fairly heavily or aggressively and it would that being material in the second half or fourth quarter. Nathan Winters : So it is not assumed in the guide, since we haven't closed and that's about a $10 million run rate revenue business. And I'm profitable at this time as it scales. But I think that material within the within the margins of our overall guide. Rob Mason : Okay, very good. Thank you. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Anders Gustafsson for any closing remarks. Anders Gustafsson : So to just to wrap up, I would like to thank our employees and partners for going above and beyond to serve our customers as they stretch to meet heightened expectations in the increasingly on-demand economy. While we are focusing on maximizing profit or growth in the business, our top priority continues to be protecting the health and well-being of our employees, partners, and customers as we recover from the pandemic. We're also looking forward to welcoming the Fetch Robotics team once we close the transaction. Thank you and have a great day everyone. Operator : The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
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Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,021
| 4
|
2021Q4
|
2021Q3
|
2021-11-02
| 15.641
| 16.415
| 18.15
| 18.602
| null | 29.92
| 31.23
|
Operator : Good day, and welcome to the Third Quarter 2021 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. . After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's Third Quarter conference call. This presentation is being simulcast on our website at investors. zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filing. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Nathan Winters, our Chief Financial Officer. Anders will begin with our third quarter results then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered exceptional third quarter results that exceeded our outlook, supported by robust, broad-based demand for our solutions. For the quarter we realized adjusted net sales growth of 27% or 23% on an organic basis. An adjusted EBITDA margin of 21.7%, a 140% basis point year-over-year improvement. Non-GAAP diluted earnings per share of $4.55, a 39% increase from the prior year and strong free cash flow. Our customers are prioritizing investment in our solutions to digitize and automate their workflows in an increasingly on-demand global economy. We realized double-digit sales growth across all 4 regions with particularly strong growth in EMEA. Favorable business mix, and higher service and software margins enabled us to expand our gross profit margin despite escalating freight costs. Our teams have been diligently leveraging alternative modalities of transport and expediting shipments to mitigate the impact of continued industry-wide supply chain challenges. We also scaled operating expenses while continuing to invest in initiatives to drive sustainable, profitable growth. For that, I will now turn the call over to Nathan to review our Q3 financial results in more detail and discuss our Q4 outlook. Nathan Winters : Thank you, Andres. Let's start with the P&L on slide 6. In Q3, adjusted net sales increased 26.6%, including the impact of currency and acquisitions and 23.2% on an organic basis, reflecting broad-based demand for our solutions from customers of all sizes. Our asset intelligence in tracking segment, including printing and supplies, grew 12.1%, while enterprise visibility and mobility segment sales increased 27.9% driven by exceptional growth in mobile computing. Note that we also realized double-digit growth across services and software. All four regions grew double digits. North America sales increased 14% with particular strength in mobile computing, supplies, and services. EMEA sales increased 39% with strong growth across all major solutions offerings, particularly mobile computing. APAC sales grew 17% with strength across most geographies, including China. And in Latin America, sales increased 41% continuing its strong recovery with double-digit growth in all major offerings. Adjusted gross margin expanded 130 basis points to 45.1%, primarily driven by favorable business mix, and higher service and software margins. These benefits were partially offset by significant premium freight charges, which we will discuss further in a moment. Adjusted operating expenses as a percentage of sales improved 30 basis points as we continue to prioritize high return investments in the business. Third quarter adjusted EBITDA margin was 21.7%, a 140% basis point increase from the prior year period reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.55. $1.28 or 39% year-over-year increase was benefited from lower interest expense and a favorable tax rate. Turning now to the balance sheet and cash flow highlights on slide 7. We generated $798 million of free cash flow through the first 9 months of 2021. This was $316 million higher than the prior year, primarily due to increased profitable growth. Our balance sheet remains strong. From a debt leverage perspective, we ended Q3 at a modest 0.5 times net debt to adjusted EBITDA leverage ratio, which provides us ample flexibility. In the first 9 months of 2021, we invested more than $300 million to acquire Fetch Robotics and adaptive vision to advance our intelligent automation solutions in manufacturing and the warehouse. We made $24 million of venture investments in 4 portfolio companies. In addition, we made $38 million of capital expenditures and $25 million of share repurchases. On slide 8, we show the multiyear impact of transitory costs primarily related to expedited freight due to supply chain bottlenecks caused by the pandemic, as well as tariffs on China imports. Our supply chain team continues to take extraordinary measures to satisfy customer demand in an exceptionally challenging environment. Global freight costs are elevated for all modalities of delivery across our supply chain. This includes higher shipping cost per kilo, a significant shift from ocean to air freight, as well as increased costs to expedite component parts to our Tier 1 manufacturers to meet customer commitments. In Q3, compared to pre -pandemic rates, we incurred incremental premium freight costs of $44 million, which were $36 million higher than the prior year. For Q4, we now expect approximately $55 million of premium freight costs based on the higher spot rates we are seeing in the market, which translates to a 4% point negative gross margin impact. We expect premium freight costs to abate as component supply and freight capacity improves. Let's now turn to our outlook. Our robust sales pipeline and strong order backlog is supported by a broad-based demand for our solutions as enterprises look to automate their operations to satisfy increasing consumer expectations. Despite extended lead times and uneven inventory availability, we expect fourth quarter adjusted net sales to increase between 8% and 12% year-over-year. This outlook assumes a 2% point additive impact from acquisitions and foreign currency changes. We anticipate Q4 adjusted EBITDA margin to be slightly higher than 21%, which assumes gross margin contraction from the prior year due to significantly higher premium freight expense, which I discussed earlier. We're also experiencing product component inflation, which we expect to largely offset with price increases that became effective in September. Non-GAAP diluted EPS is expected to be in the range of $4.20 to $4.50. We have increased our free cash flow outlook to be at least $950 million for the year due to higher-than-expected profitability. Please reference additional modeling assumptions shown on slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence Vision in new and existing markets, with spotlights on our acquisition of Antuit and our healthcare vertical. Anders Gustafsson : Thank you, Nathan. I am encouraged by the strengthening demand across our business and the bold actions our teams are taking to navigate supply chain challenges. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, solutions, software, and services. By transforming workflows, Zebra's customers can address complex operational challenges to achieve higher levels of performance. By closely collaborating with our partners and customers, we help businesses across a variety of end-markets to implement solutions that maximize their return on investment. Human labor is a scarce resource. Our innovative solutions empower their workforce to do their jobs more effectively by navigating constant change in near real-time, utilizing insights driven by advanced software capabilities, such as machine vision, prescriptive analytics, and artificial intelligence. In October, we acquired Antuit for approximately $145 million to further advance our Enterprise Asset Intelligence Vision. This high-margin software-as-a-service business generated sales of approximately $27 million in 2020, nearly doubling over a 3 year period. Slide 12 illustrates how the AI powered demand forecasting solution ensures that its retail and consumer product customers have the right inventory, at the right time, at the optimal price, whether it's fulfilled through online ordering, or in-store shopping. Antuit's cutting-edge offering complements our suite, the workflow software solutions, including reflexes, Zebra prescriptive analytics, workforce connect, and smart count, which works together to increase the performance of labor and inventory across the integrated supply chain. Our growing software suite will help our customers break down silos between planning and execution, giving them a competitive advantage that can increase revenue and margins as they navigate the increased demands of omni-channel fulfillment. Now turning to slide 13. Businesses partner with Zebra to optimize their input and workflows. I would like to highlight a few recent key wins across our end markets that demonstrate how Zebra's solutions are improving productivity and service levels. In retail, Zebra is enabling improved execution of omni-channel fulfillment as more consumers shop online. We recently secured our largest win-to-date in India, providing TC21 mobile computers and printers to help a local retailer compete more effectively against its larger omni-channel and e-commerce global competitors. We're also enabling a Japanese supermarket chain to provide an improved customer experience with our EC55 personal shopping mobile computing solution. Over the next several quarters, a leading home improvement retailer will be deploying 90,000 TC52 mobile computers to a broader number of associates in their stores. Key use cases include item locationing, best-in-class long-range imaging, mobile point of sale, and ecommerce functionality. Competitive differentiators for this win included our seamless network connectivity, best-in-class noise cancellation, and enterprise leading durability. Our mobile computers will also have full desktop functionality when inserted into workstation cradles. This retailer is also deploying our Workforce Connect software as a service solution, which enables associate to associate instant collaboration as well as the associated to group and store to store communication. A leading North American transportation and logistics Company is deploying 9,000 TC-77 mobile computers to their truck drivers for loading and delivery used cases. This solution will increase productivity, improve inventory accuracy, log driving times, and track regulatory compliance. Turning to Slide 14, we highlight how healthcare providers are using as Zebra solutions to digitize and automate the patient journey and address labor challenges. Our recently published Vision Study highlights that 95% of decision-makers expects to increase spending in healthcare IT, and clinical mobility in the next year. We have some exciting recent strategic wins that demonstrate our value proposition. We recently secured a takeaway win of a leading U.S. healthcare provider with more than 150 hospitals and approximately 2,000 sites of care. This customer selected Zebra to provide a multi-year rollout of 85,000 scanners for a wide range of use cases, including bedside nursing, surgery, pharmacy, and inventory management. They also recognized our unique software tools that enable real-time event tracking to prioritize patient care. A large Eastern European public hospital system recently placed an order to provide 19,000 TC25 mobile computers to nurses across 100 hospitals. Hospitals are facing labor shortages made worse by the pandemic, which puts patient safety at risk. Zebra's solutions, including printers and wristbands, reduces the administrative burden on the nursing staff, and allows for more efficient patient care. Our value proposition to this customer also includes real-time tracking of costs of supplies, equipment, and medicine. Additionally, Zebra is growing our long-standing relationship with GE Healthcare who's solution encompass utilizes Zebra's Bluetooth beacon technology for medical equipment asset management. This solution improves asset utilization and prevents unnecessary equipment replacement purchases. Caregivers also benefit by reduced time searching for medical equipment, which can increase time dedicated to patient care. In closing, the pandemic has accelerated trends that have been driving Zebra's business, including omni-channel shopping adoption, the desire for track and trace across the supply chain, and the need for a more digital healthcare experience. Our core markets are vibrant and our prospects to scale new expansion markets are bright. We are steadily navigating through significant transitory, industry-wide supply chain challenges. That said, we continue to be as excited as ever about our long-term profitable growth prospects. Now I'll hand the call back over to Mike. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : We will now begin the question and answer. At this time, we will pause momentarily to sample our roster. The first question today comes from Tommy Moll with Stephens, please go ahead. Tommy Moll : Morning, and thanks for taking my questions. Anders Gustafsson : Good morning. Tommy Moll : Anders, I wanted to start on your Antuit acquisition, wondered if you could highlight a couple of ways in which it might be synergistic with your portfolio and I really -- I had two buckets in mind. First, just in terms of scale, you've got more robust go-to-market capabilities, more robust R&D dollars you can put against it. So what would you highlight for us there? But also just in terms of the portfolio and fit, so if I'm a customer what augmented capabilities will you be able to deliver with the software platform given you've got other software adjacencies and hardware opportunities to deliver a solution versus what the portfolio or rather what Antuit would have done as a stand -- pure standalone business? Anders Gustafsson : Yeah. I'll try to go through and give you some insights to each of those points. But the first, this helps us in our -- to augment our solutions around improving retail store execution for our customers, as well as for consumer products companies. It is very synergistic with our Enterprise Asset Intelligence Vision. And we talked about our Sense-Analyze-Act framework here. And this is very much around the Analyze and Act part of this, enabling our customers to sense what's happening in the real-world, analyze this information, and act on it in their real-time. The solution that Antuit offers is a demand sensing solution this call. But they take in lots of different data feeds. anything from in-store sales to weather, social media. And you use that to determine basically what demand trends will be. And they can be very quick and do this much better than say traditional models. If you take an example like when COVID happened, Antuit's algorithms we're able to better and quicker adjust to this new environment. And it's very synergistic with our other offerings, particularly on the software side where --take Reflexis where Antuit's insights will generate actions for our Reflexis ' task management solution. So they can be to go and replenish something -- move inventory from the back of store to the front of store or other parts of the supply chain. So it is very much works synergistically with our broader software solution, as well as with our devices. So our mobile computers will generate insights that Antuit can analyze and put into its AI algorithms to derive better insights from. And with this broader set of solutions we position Zebra to be more of a strategic solutions partner to our customers, and we have access to more customers and more executive level people as our customers than Antuit will have individually. So therefore, we think that this fits very well with our broader strategy. Tommy Moll : Thank you. Joachim Heel : One other addition, this is Joe Heel. If you think about the customer set, you mentioned go-to-market that Antuit targets. It is primarily merchandising executives in retail and in packaged goods. Of course, that retail is a very strong segment for us so that should give us the ability to leverage our scale to the benefit of Antuit's offering. And conversely, we have a position in packaged goods, but the Antuit will give us a stronger offering to further expand our offerings in general, not just Antuit but in the way Anders described into packaged goods. Tommy Moll : Thank you both. That's very helpful. I wanted to pivot for my follow-up to the margin. And again, we appreciate the transparency you've offered around the premium freight headwinds and the trajectory there. So we're looking at $55 million for Q4. And My question really is the following. If you think about how the fourth quarter is progressing both in terms of the realization of some of the pricing actions you've taken, then also you've got on the cost side, it's dynamic and presumably changing on a day-to-day or week-to-week basis. If you think about where you'll likely end the quarter once all that rolls through versus the full quarter outlook you gave, I think it was above 21% for the quarter, does it feel like the exit rate is probably a little better than that average or how do you see things shaping up here in real-time? Nathan Winters : Hi, Tommy. Maybe just to start with the fourth quarter. As you mentioned here, we'll be slightly above 21%. That is down from prior year, a little over 2 points so 4 points that's the premium freight but offset by favorable business mix as well as improved service margin as well as improvement just in the underlying product margin. And as you mentioned, we have raised prices to offset the component pricing -- so the unit price. I think -- So that's something we're continuing to monitor and assess as how the transitory impacts play out. I would say from a logistics and freight perspective, we do expect that to moderate through the first half of 2022. But I'd say it's something we're managing day-to-day, week-to-week. And we'll see how the quarters play out in terms of when we start to see a meaningful benefit from where we are at today. Tommy Moll : And Nathan, just to make sure I'm tracking you here. It sounds like the pricing actions are really more targeting the product aspect of input inflation rather than the freight. Am I hearing you correct? Nathan Winters : That's correct. We have not raise prices to offset the transitory premium freight expenses, but that's something we'll continue to assess as this plays out. Tommy Moll : Great. Appreciate the insight and I'll turn it back. Operator : Our next question comes from Andrew Buscaglia with Berenberg, please go ahead. Andrew Buscaglia : Guys, just on that question around margins. How were you able to manage supply constraint issue in securing parts for your products. And it seems broadly across most of industrial customers and then companies in general, that is the constraints will continue into next year. So I guess what are you doing on that side of things is to manage -- you talked about the freight cost, but just wondering in terms of securitization of parts. Anders Gustafsson : Yeah. I'll start the higher level here. And so if you look at the broader backdrop, demand has wrapped -- rammed very fast over the past year. And we have now prioritized meeting our customer needs and commitments. And while we are not always able to meet our traditional lead times due to these industry-wide supply chain challenges, we have been working with our partners and customers to make sure that we can deliver very strong double-digits year-over-year growth. And I'd say based on feedback from our customers and partners, we've been managing this better than our competition. Specifically to -- for how to secure parts, we're looking at the semiconductor industry shortages that has impacted the availability and pricing of some parts more than others, or some of our devices more than others. This is a highly dynamic environment than if we get, say, we sort out and get good news on some parts while the next day we get some more challenging news on other parts. So it is very much of a dynamic environment for us. But I'd say our teams have been working very well -- done exceptional job of working all angles to figure out how to mitigate these issues. Starting with -- we've been built more resiliency in our supply chain by putting a new assembly plants across Southeast Asia so we're less dependent on any particular plant. And in Q3 for instance, we had to move volume between plans based on COVID outbreaks. So that was a great way we trust to leverage us. We also worked really hard to engage with our semiconductor suppliers to make sure that we get our fair share, so we get appropriate allocations of parts and we 're having a large part of our engineering team working on redesigning our devices to qualify new alternative components that are not as exposed to or limited with supply. So we're doing all of these things to ensure that we can meet our customer needs as well as possible here. But as I said, it's a dynamic environment. It's difficult to predict how exactly it's going to play out. But based on our conversations with our suppliers, I'd say we expect the gradual improvement by mid-2022 on the component side. Andrew Buscaglia : Okay. Yeah, that's helpful. You do stand out as someone who has managed these constraints very well and you're right in the line of fire of that issue. So I thought it does sound like you have the capabilities in place to keep that going. And I think -- On the demand side, I thought that your AIT sales would be a little bit higher. How much of that is related to the -- that supply constraint issue, or are you seeing any sort of moderating in demand? Anders Gustafsson : First, I'll say we continue to drive innovation across the entire portfolio of products and solutions, and we're helping our customers digitize and automate their operations. And the core business is very vibrant, and we're very excited about the adjacent expansion opportunities that we have. Now specifically for printing, we had a very solid -- we delivered very solid growth across the regions in printing. Printing was up across most of its portfolio. We had particular strength in manufacturing, which tends to deploy mostly tabletop printers. We also saw strong run rate of smaller business through our channel. But it's fair to say the printing was disproportionately impacted by supply chain challenges and that was -- that includes both component issues, but also that our main assembly plant in Southeast Asia had to almost shutdown based on COVID and we had to shift a lot of the volume from Vietnam to China. So that took some capacity out of the quarter. But it was -- still it was very good quarter for printing. We could've done probably a little bit better, but we still believe that we continue to gain share. Certainly year-to-date we gained a lot of share in printing. And also in the AIT segments here we had very strong growth in supplies across all regions and that includes our Temptime portfolio and in Q2, we launched our new Soho printer, very excited about that. That's off to a good start. Andrew Buscaglia : Thanks, Anders. Operator : Our next question comes from Jim Ricchiuti with Needham and Co, please go ahead. Jim Ricchiuti : Good morning. I'm wondering if you could -- how you would characterize your large projects business. Anders, you highlighted a few nice wins and I'm also wondering to what extent that business is being impacted by the component constraints, the logistics challenges, whether customers are themselves being impacted by bottlenecks elsewhere and their supply chain that's affecting the timelines for when these projects are going to go forward. Anders Gustafsson : To start with, our large customers, our larger projects are -- continue to do well. We saw growth in that year-over-year. But the mix between our run-rate business and large customers has moderated, gone back to a bit more what we would see us historically normal rates versus what we saw a year ago. I don't think we can say we've seen any impact on our customers roll-out schedules based on supply chain issues. And we clearly worked really hard with our large customers as well as our channel partners to make sure that we understand what is true demand, what our customers truly need to have in order to run the business versus what they might want to have or think of as more risk buys so we can satisfy all our customers, but particularly our larger customers here. But the demand from them continues to be strong and as -- in line with what we've seen previously. And maybe Joe Heel, do you have any additional color here? Joachim Heel : Yeah, I would echo what you said. We have not seen any delay in large businesses due to bottlenecks on our customers parts elsewhere. And we have had some extraordinary wins even in this past quarter. As you know, the large projects are somewhat lumpy here and there, but we had double-digit growth nearly in the large projects business as well, including some extremely nice wins in multiple geographies. So we're very pleased with it. Jim Ricchiuti : Got it. And a follow-up just I appreciate the colour on your expectations, looking out to the first half of next year as it relates to components and some of the unusual freight costs you're incurring. I'm wondering how we should be thinking about your operating expense levels over the next several quarters. Only because things are beginning to normalize. We have presumably trade shows starting to occur again, and I'm just wondering if we need to be mindful of some temporary cost savings you might have benefited from this year being layered back in over the next several quarters. Anders Gustafsson : Hi, Jim. I think it's fair to say that as we go into next year, we do expect some of the discretionary spend, particularly on travel and trade shows to peak up. But I'd say it's no different than any other variable we managed within the year in the pluses and minuses, and still expect to grow despite some of those incremental costs that we'll incur. And as usual, we'll find offsets in efficiencies to mitigate that impact as we go into next year. Jim Ricchiuti : Got it. Thank you. I will jump back in the queue. Operator : Our next question comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. Thanks. I wanted to maybe first ask a question just on seasonality. I know a lot of your retail customers still tend to be as active in Q4, but we're also dealing with a labor shortage. So just any kind of perceptions of what you're seeing as far as seasonality in the Q4. And then maybe a second question. Clearly, your highlighting success within healthcare. And this has been a continued area of success for you guys. Are you able to use your traditional go-to-market or the partnerships that you think you could explore that would further accelerate that opportunity? Thanks. Anders Gustafsson : Thank you. Meta, I'll start and then I'll ask Joe Heel to provide some extra color here also. But first on seasonality, I think seasonality this year has been similar to what we would normally have seen, but a slight increase this quarter-over-quarter in Q3 and into Q4. So not a huge difference from that perspective. Obviously, demand has been strong and very broad-based. That certainly helps on the overall demand profile. But I don't think that the seasonality has meaningfully changed and Joachim comment on that in a second. On the part on healthcare, yeah, healthcare has been our fastest-growing vertical if you look over the last several years and I would expect it to continue to be our fastest-growing vertical not necessary every quarter but over a longer period of time. And we have built up a -- we said first week, we're leveraging our traditional sales team but we have a dedicated healthcare sales team within our sales organization, and we have largely dedicated health care partners. If you take somebody who's expert in manufacturing and send them to hospital, that's -- the language is different, the solutions are different. So it really warrants to have more specialized partners, and we have a large number of specialized, both regular resellers, but also ISVs and other partners to help us make sure that we have as robust go-to-market organization and capability as we can. Joe? We lose Joe? Joachim Heel : I'm sorry, you're lucky that this is Joe Heel. I would add to each of those points respectively the following. On the seasonality, the one additional thing we have seen is that retailers have been ordering further in advance, right? They're seeing, of course, the shortages that exist in the supply chain and are working with us to anticipate those. So that means that we can plan how to comply to them further in advance and so on. Our reflection of their seasonality is pulled forward in that regard. In terms of healthcare and the go-to-market that we use there, as Andrew said, yes we have specialized partners in those areas that we have been building out over the last few years. Two other things that I think characterize our go-to-market and routes to market in particular, one is we have a higher than average investment of our own resources. We have learned and determine that being present in those hospitals, which is of course a more fragmented customer seat -- customers set is important. And therefore we have made more investments in our own resources in one those areas. And we are more present together with our partners, of course. And then the second is that we've also learned that we need to expand our partner set to more, let's say, non-traditional partners, which would include in particular ISVs. They're very important ISVs for electronic health records that we need to form partnerships with, and OEMs. There are important OEMs that participate in this -- in the healthcare segment, and we have formed some very strong alliances with those as well. And that's helped us with our growth in healthcare. Anders Gustafsson : There's 1 more point in this. We have -- as we've worked with our customers now, particularly Joe mentioned retailers, we have greater visibility. The supply chain constraints have enabled us to get greater visibility into their requirements. And our pipeline is more robust, and we enter the quarters with greater backlog than we normally would, but it's not like we are -- they've been pulling forward demand. But if I look at -- look into the future, the more robust pipeline and backlog gives us better visibility as we look into next year. Meta Marshall : Great, thank you. Operator : Our next question comes from Paul Chung with JPMorgan. Please go ahead. Paul Chung : Hi, thanks for taking my question. So just a follow-up on margins. f we think about EBITDA margins, X freight costs, maybe you are in that mid 20s percent range, you mentioned maybe some temporary costs come back, but is this the more normalized margin profile we should expect maybe in second half of '22 when some of these costs fade a bit? And as your software product mix continues to accelerate can we see further expansion there, that have a follow-up? Anders Gustafsson : Yeah, Paul. I think if you look back at our track record of driving, we have a track record of driving profitable growth. We will exit the year around 23% and that's a 150 basis points improvement from where we exited 2019, despite the transitory cost increase. We do believe EBITDA margin can go higher. We have many levers to achieve that. We mentioned one, we're scaling new markets that have traditionally richer gross margin, whether that be software or the fixed industrial machine vision markets. We're entering along with the team continuing to driving higher margin and productivity through the operational efficiencies across the business, which we've always done. Again, we do expect margins -- EBITDA margins to improve beyond this year, particularly as the transitory freight abates. Paul Chung : Thanks. And then your free cash flow in the quarter pretty much paid for Fetch, so your flexibility continue. Inorganic expansion is really quite good. Debt level is in a good place. Where are you looking to expand the portfolio and what leverage levels are you comfortable with? Reflexis, Antuit, those driving higher-margin software mix, we continue to expect priority on software moving forward as well. And then you mentioned adaptive vision as well. If you could provide an update on how that business is going. Anders Gustafsson : I'll start on the M&A side of this. M&A continues to be a priority for us. We are certainly very excited about the outlook for the business and we do see M&A as vector for growth. We're quite pleased with the recent acquisitions of Fetch, Antuit, and Adaptive Vision as well. We look at M&A as a way for us to accelerate our strategy to advance our Enterprise Asset Intelligence Vision and we're targeting select bolt-on acquisitions as well as some high-growth acquisitions that would truly advance our EEI Vision. We see opportunities in digitizing and automating supply change and workflows more broadly. And as you said, we have a strong balance sheet that can support our M&A opportunities. Then on Adap-division, that's part of our machine vision fixed industrial scanning solution set. We acquired them it back in Q2 and they provide software solutions that help our customers to design in machine vision or fixed industrial scanning solutions in their workflows. And to be able to do -- more easily extract useful information from their digital images that they take. And so it's an integral part of our machine vision solution and helps to make sure that it is an ease -- our solutions are easier to implement than our competitors. So it's one of our value propositions. And so far we're very excited about the overall entry into that market. Paul Chung : Thank you. Operator : Our next question comes from Brian Drab with William Blair. Please go ahead. Brian Drab : Hey, good morning. With such great momentum in a number of end markets, I'm wondering, Anders, are there any end markets where the impact of COVID related sales, and sales stimulated by the pandemic has been delayed and end markets where it's not going to be really a headwind for like a tough comp in 2022 where maybe it's the rental car market or healthcare market that took a while to get going, do you see any end markets that just have yet to really drive growth as it relates to the pandemic, where we'll see incremental growth in '22? Anders Gustafsson : The pandemic has really accelerated a number of secular trends that's supporting our business and helping to drive enterprises to implement our type of solutions. The themes around how to digitize and automate our customers' businesses is I'd say high priority cross all over to the markets, across all end markets and geographies. How to improve front line worker efficiency and reduced friction from those workflows. So I don't think there's any -- I can't think of any meaningful market that would be hampered by this environment or really lagging from this. This is a pretty broad-based picture. We did see early on during COVID say that healthcare was hit hard. Was it the -- they -- their traditional acute care business was, for healthcare provider, largely shutdown. And if it wasn't truly acute, they wouldn't admit patients and became only taking care of COVID, but that has rebounded and we're now surpassing 2019 levels. Brian Drab : I guess, Anders, can I interject and just say I don't think I asked the question as clearly as I wanted to. But do you see any end markets where you look at the end market right now and say, okay, that's starting to kick in, whereas it hasn't to-date where you're excited about incremental growth going forward. Joachim Heel : Anders, would you like me to say something? Anders Gustafsson : Yeah, I will take just a couple of comments on this and see -- there are certainly areas that -- and then Joe Heel, you can provide some extra color. I'll just highlight one market I think that we can see that is starting to kick in and that will be hospitality. Hospitality was largely shutdown for most part of COVID and that's coming back and we do see a number of our pipeline for opportunities within the hospitality segment is recovering nicely. And Joe, maybe you have some other other ideas. Joachim Heel : Yes. I was going to mention 3 of 1 perhaps that you might not expect. Hospitality is one. Another one that has a longer curve where we expect benefits to continue is manufacturing, which has been recovering really nicely. You saw that already this quarter, but we expect that to continue, there's much to be recovered there. And a third one that you might not think of would be Japan. Japan has been a market that has been on the sidelines for a bit, in particular, during the pandemic. But many of the Japanese customers have not yet migrated to Android. And now that they are seeing the recovery from the pandemic, they're doing that. So there is a market opportunity there that is extending strongly we believe into the next year. Brian Drab : And what percentage of revenue is in Japan roughly today? Anders Gustafsson : It's a small part of our revenue stream today, but it's a nice upside opportunity for us. Joachim Heel : Right. Brian Drab : Okay. And then just the last question on software. Are you able to give us an update since there's been so many acquisitions and growth in software and you're making the comments that the margins are being aided by higher -- the overall margin being aided by higher margin in software. Where are you in terms of the size of that software business? I know you don't shy away from saying percentage of total revenue historically from software, but just curious if you could give any comment on that or when do you envision software being 5% or 10% of sales down the road. Any quantification or clarity on that 'd be helpful. Anders Gustafsson : If you look at our software, the SaaS portfolio of the business, it's still small, mid single-digit as a percent of the Company and we haven't stated a target or an aspiration in terms of what's the right mix. Obviously it's area of the business we expect to grow organically faster than the core business over time, and it's a priority from an M&A perspective. But in terms of -- we haven't -- we don't have a set date in terms of what percentage of sales we want to get to by a particularly year except for again to continue to build out the suite of offerings we have and it turned into a driver of organic growth. Brian Drab : Thanks for taking my question. Operator : Our next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys, and congratulations on a good quarter. Just want to revisit the supply chain challenges once again. Is there a feeling that the supply chain challenges are peaking now and perhaps you're on a slow way to recovery or we're not quite sure if it peaked quite yet and you still have to work through it? Anders Gustafsson : There are different parts of supply chain challenges here. Now, we've talked a little bit about the semiconductor issues. We also have more logistics issues around ocean freight and airfreight. I would think that on the freight side, I would expect quicker recovery and that we -- I would expect that to moderate as we get into the first half of 2022. So I think we're probably at peak rates and capacity constraints, but not that there will be a binary improvement in this area that it goes from whatever it is today to what it was prior to COVID. It will be a gradual improvement, I think. On the component side, I think we wouldn't expect it to get any worse, but I think again, we -- as I mentioned earlier, we would expect a gradual improvements by mid-2022. Does that help? Keith Housum : Great. It does. And then the component side, is it primarily with chips or does it seem like the issues are popping up and is playing like whack-a-mole, and you got 1 issue here that you've maybe resolved, but you go to a different issue. Anders Gustafsson : I think it's largely on the semiconductor side, but it does move around. So we secure -- was a bit backing up on steps. So even before COVID, even before this, every quarter when we started, we would have certain parts that were on allocation or that we need to define more. But so that's a normal part. But the number of parts today is much higher. And one -- we work on in solving for one part, then next week some other part pops up. So the frequency and the number of parts so much that are on allocation or longer lead times is greater. But we try to make sure that we work very closely with our semiconductor suppliers to let them know what our true requirements are and we've signed a long-term supply agreements, price agreements, and so forth to make sure that we get proper consideration when they do allocate the parts and -- but it's a complex process but I think we've been managing it very well so far. Keith Housum : Great. I appreciate it. And then moving over to the software, you've got to flex now for at least a part for over a year. In terms of the approach to the sales, is it still a direct -- primarily as a direct deal and is it the same as your regular sales force or you have a different software sales force? And then how does Antuit go-to-market and how do you envision some of these things together going forward? Anders Gustafsson : I'll start and then Joe Heel can provide some -- exchange sides here also. But -- For Reflexis or our broader software portfolio, we have set up dedicated software sales teams within our broader set -- a go-to-market organization. So you can think of our traditional account management teams would be able to start the conversation, qualify and account to some degree, and then bring in our software experts to do a lot of the more technical part of the selling activities. So we -- but with that is -- and into a more dedicated part of the organization make sure we have the right level or depth of knowledge and insights. We are doing this largely direct today, but we are also working with expanding our portfolio of partner portfolio here. And there's a number of other type of resellers and system integrators who are interested in working with us to be able to represent us and participate in predict size, doing implementation services. And Antuit, we specifically, with Antuit here now, we are initially keeping the Antuit sales team somewhat separate because we want to make sure we keep the focus and dedication to that. But leveraging again, the account teams access to accounts as well as the broader expertise we have in our software go-to-market side. Joe. Joachim Heel : I think you said it well. I have nothing to add. Anders Gustafsson : Okay. Keith Housum : Great. Anders Gustafsson : It's good. Keith Housum : Great. Thanks, guys. Appreciate it. Operator : Our next question comes from Damian Karas with UBS. Please go ahead. Damian Karas : Hey. Good morning, guys. Anders Gustafsson : Morning. Nathan Winters : Morning. Damian Karas : I think you've covered a lot of ground. You did highlight particular strength in mobile computing, I think most notably in Europe. Maybe you could just elaborate on what you're seeing that's driving that. To some extent, is this a matter of Europe just catching up or are there any particular end markets, customers, or outside projects that are driving that mobile computing strength in Europe? Anders Gustafsson : I'll start again and then Joe can also add some extra colors on Europe. But first I'd say we're very pleased with Q3 as overall, we've seen great demand and we've just been able to drive our revenues to exceed the high end of our guidance range. And our customers are aggressively pursuing a digital enterprise transformation strategies, which is causing us to basically exceed our expectations as far as revenue growth this year. We talked about the supply chain issues as being a moderator on this, but we've still been able to deliver double-digit growth across all the regions in each of our product segments. And we continue to see strong growth from both our smaller customers as well as our large strategic accounts. And based on our performance, I clearly expect that we are continued to take share in the industry. And we entered Q4 with a strong backlog and we have a healthy pipeline which I think provides good visibility into 2022. Specifically for Europe, I think we say -- I think we saw -- Europe obviously add a fantastic quarter and saw strength in nearly all the sub regions of EMEA and growth was across all our verticals with particular strength in transportation logistics. And that was driven by some very attractive large postal services wins and retail was also very strong vertical for us. From a product perspective, mobile computing and services were particularly strong while the printing business was more impacted by supply chains. Joe, any further comments? Joachim Heel : Yes. I would say that the strength in Europe was perhaps a little bit of an artifact of us trying to get the optimal mix of supply that's available to the customers that we have. If you look over more than one quarter, you will see that the strength North America and Europe is pretty much exactly on par. So we're seeing equal strength in both over 2 or 3 quarters here. This was more of a one-quarter artifact I'd say. Damian Karas : Understood, that's really helpful. And I guess we've all seen the headlines since last quarter on Honeywell's actions taken against the IBRA (ph) -- investors. I do have some questions on this. And maybe you could just give us an update on the ITC case and that pending litigation. How would you expect these matters to play out? Anders Gustafsson : First, we have a policy of not commenting on ongoing litigation, so it's hard for me to provide a lot of color, as much color as I'd like here. But clearly we have a -- we plan to vigorously defend our positions here. And I'd like to also remind everybody that we have the broadest and deepest intellectual property portfolio of the industry. And we will remain laser-focused on extending our lead and taking share of the market and to beat our competitions in the marketplace. Damian Karas : Okay, great. Appreciate it. Thanks a lot guys. Anders Gustafsson : Thank you. Operator : Our next question comes from -- well, our last question comes from Rob Mason with Baird. Please go ahead. Rob Mason : Good morning, and nice job on the quarter as well. A lot of ground has been covered. I was just -- I was curious though if you could delineate your growth by channel during the quarter. It sounds like both sides, both run rate business and large deal business, were both strong, but I was curious how each one might have waited out. And then maybe you -- if you could comment as well just on how the backlog -- strong backlog that you mentioned as well, how that might be weighted between those channels. Anders Gustafsson : Yeah, I'll have -- Joe, do you want to take the lead on this? Joe? Joachim Heel : Yeah, sure. I can take the lead if you like. So in the past quarter, our direct channel mix was slightly higher than in the past. So we had a little bit more in our direct business than -- rather than our channel business. But our channel centricity, so the percentage of our business that goes to channel remains extremely high as is our strategy in the over 80% range. And our backlog continues to be very strong. As we entered into the current quarter, we've had a very strong backlog again and we're already building backlog for future quarters, as you might not be surprised to hear. Rob Mason : Does the backlog favor large deal versus the channel? Can you distinguish that or draw a distinction? Joachim Heel : Generally, yes. Rob Mason : Same as last year. Joachim Heel : Generally, this backlog was more productive. Yes. Rob Mason : Okay. And then a number of nice wins that you commented on during the quarter. One in particular, the U.S. home improvement win. I'm just curious, was that a -- were you the incumbent in that account or was that a competitive takeaway? Joachim Heel : In this case, we were the incumbent. Anders Gustafsson : We were the incumbent and there was a refresh of an earlier Android implementation. Rob Mason : Yeah. That's -- maybe it's where I headed -- was headed with the question because I recall that was one of your maybe larger or I think you had a large early win in Android with home improvement retailer in the U.S. And I'm just curious, are you starting then now to see refreshes more broadly on your Android installs? And if so, I'm just curious if you can make a stronger determination around how the life -- I guess the lifespan of those devices is fairing versus legacy devices. Anders Gustafsson : Yeah. So we are definitely seeing a number of our customers that were early adopters of Android now upgrading or refreshing to second-generation Android. And the refresh cycle for Android devices is a bit little faster than it was with Microsoft. The level of innovation on the platform is higher. So you can think of the number of new Android versions coming out is quite frequent and they tend to require more memory, faster processor speed to run properly. And that combined with our customers putting more and more applications on the devices, so that also drives more memory as an example. So there's a number of things that are causing our customers to want to upgrade and refresh the portfolio at a faster pace than what they -- what we saw with older Microsoft platforms. Rob Mason : And you mentioned as well, that's going to a broader set of user and their customer. I'm just curious if you could -- is there an order of magnitude that you could speak to? Anders Gustafsson : Yes, definitely much deeper penetration of devices into our customers' operations. The value of having every worker be digitally connected and aware is a priority, I would say, for virtually all our vertical end markets, but particularly in retail and healthcare. And we talked about how today roughly our estimate is that 1/3 of retail store associates have access to a mobile device. And when we talk to our retail customers, they certainly have an aspiration to get that to be much, much higher. And similarly, in healthcare, we did a Vision Study, I think it's a couple of years back now where the expectation there was to bring it from about 60% up to 95% over next few years. Rob Mason : Great. Thanks for taking the questions. Operator : Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : And to wrap up, I would just like to thank our employees and partners for their extraordinary efforts to drive or to serve unprecedented customer demand in a supply constrained environment. And while we are focused on maximizing profit growth in the business, our top priority continues to be the health and safety of our employees, partners, and customers as they recover from the pandemic. We would also like to wish a warm welcome to the Antuit team. Thank you and have a great day, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Goodbye.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,022
| 1
|
2022Q1
|
2021Q4
|
2022-02-10
| 17.356
| 18.33
| 19.125
| 19.7
| null | 29.23
| 30.36
|
Operator : Good day everyone and welcome to Zebra's Fourth Quarter and Full Year 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Mike Steele, Vice President of Investor Relations. Sir, you may begin. Mike Steele : Good morning and welcome to Zebra's fourth quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our fourth quarter and full year 2021 results. Then Nathan will provide additional detail on financials and discuss our 2022 outlook. Anders will conclude with progress made on advancing our enterprise asset intelligence vision along with an updated view of our served market opportunity and revised long-term sales outlook. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning everyone and thank you for joining us. Our team delivered solid fourth quarter results in an exceptionally challenging supply chain environment. For the quarter, we realized adjusted net sales growth of 12% or 10% on an organic basis, adjusted EBITDA of $319 million, a 4% year-over-year increase and adjusted EBITDA margin of 21.7%, a 180 basis point decrease. Non-GAAP diluted earnings per share of $4.54, a 2% increase from the prior year and strong free cash flow. Customer demand is stronger than ever for our solutions that digitize and automate workflows. We realized sales growth across all four regions, supported by exceptional strength in mobile computing, with particularly strong growth in Asia Pacific and Latin America. Supply chain constraints limited us from fully satisfying our customer demand, particularly for certain data capture and printing offerings. Our teams have been aggressively working to mitigate the impact of the unprecedented industry-wide supply chain challenges by securing new sources of supply, utilizing alternative modalities of transportation and expediting customer shipments. Premium freight costs exceeded our expectations and significantly weighed on gross margin, which was partially offset by higher service and software margin. We also scaled operating expenses while continuing to invest in initiatives to drive sustainable, profitable growth. Our solid fourth quarter performance closed an outstanding full year 2021 in which we generated record sales, EBITDA margin, earnings per share and free cash flow. With that, I will now turn the call over to Nathan to review our Q4 financial results in more detail and discuss our 2022 outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q4, adjusted net sales increased 11.7%, including the impact of currency and acquisitions and 10% on an organic basis reflecting broad-based demand for our solutions. Our Asset Intelligence and Tracking segment, including printing and supplies, grew 3.1% despite significant supply constraints on our printer products and cycling very strong prior year results. Enterprise Visibility & Mobility segment sales increased 13.2%, driven by exceptional growth in mobile computing. We continue to drive solid growth across services and software with strong service attach rates and expansion of our software offerings. We recognized solid growth in all four regions. North America sales increased 4% with strength in mobile computing, supplies and services. EMEA sales increased 9%, driven by strong growth in mobile computing. Asia Pacific sales grew 29% with strength across all major geographies, including China. And in Latin America, sales increased 42%, continuing strong double-digit growth in all major offerings. Adjusted gross margin declined 210 basis points to 45.7% due to unprecedented premium freight costs partially offset by higher service and software margins. We will discuss transitory costs, including premium freight further in a moment. Adjusted operating expenses as a percentage of sales improved 40 basis points as we scaled our cost structure while continuing to prioritize high-return investment opportunities in the business. Fourth quarter adjusted EBITDA margin was 21.7%, a 180 basis point decrease from the prior year period, entirely attributable to lower gross margin from transitory impacts, partially offset by operating expense leverage. We drove non-GAAP earnings per diluted share of $4.54 and $0.08 or 1.8% year-over-year increase, which also reflects lower interest expense and a slightly higher tax rate. Turning now to the balance sheet and cash flow highlights on Slide 7. In 2021, we generated more than $1 billion of free cash flow for the first time in our history. This was $115 million higher than the prior year, primarily due to increased profitable growth. Our balance sheet remains strong. From a debt leverage perspective, we ended the year at a modest 0.5x net debt to adjusted EBITDA leverage ratio, which provides us ample flexibility. In 2021, we invested $452 million to acquire Antuit, Fetch Robotics and Adaptive Vision to advance our solutions offerings in retail, manufacturing and the warehouse. In addition, we made $34 million of venture investments in five portfolio companies, $59 million of capital expenditures, $257 million of net debt repayments and $57 million of share repurchases. On Slide 8, we show the multi-year impact of transitory costs primarily related to expedited freight due to supply chain bottlenecks caused by the pandemic as well as tariffs on China imports. Our team is making heroic efforts to satisfy customer demand. This includes dedicating substantial engineering resources to product redesigns, negotiating long-term supply agreements with new and existing suppliers, shifting virtually all transport to air promotion and expediting component parts and finished goods to meet customer commitments. Global freight rates have reached record high cost per kilo for all modalities of delivery across our supply chain. In Q4 compared to pre-pandemic rates, we incurred incremental premium freight costs of $67 million, which is higher than we had anticipated in our prior outlook, and $58 million higher than the prior year. Partially offsetting this impact were $4 million of refunds of China import tariffs, which was $8 million less than we received in the fourth quarter of 2020. In total, these transitory items had a combined unfavorable gross margin impact of $66 million year-over-year. I will discuss our assumptions regarding the 2022 impact of transitory costs in a moment. Let's now turn to our outlook. We entered the year with a strong order backlog and healthy sales pipeline supported by broad-based demand for our solutions. Our expected sales growth of 1% to 3% for the first quarter has been capped by what we can deliver to our customers due to extended lead times and limited availability of component parts. Our outlook assumes an approximately 1 percentage point additive impact from acquisitions and foreign currency changes. We anticipate Q1 adjusted EBITDA margin to be approximately 20%, which assumes gross margin contraction from the prior year due to unfavorable sales mix and expected premium freight costs of $60 million, which translates to 340 basis point unfavorable impact to the prior year period. We also expect increased operating expenses as a percent of sales primarily due to our entry into multiple expansion markets since last spring and resuming in-person events. We believe total supply chain impacts, including transitory costs and product availability, are peaking in Q1 with recent improvements in freight capacity and better visibility and supplier commitments to component supply into the second quarter. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $4. For the full year 2022, we expect adjusted net sales to grow between 3% and 7% with the assumption that supply chain constraints steadily abate throughout the year. This outlook assumes a net neutral impact from acquisitions and foreign currency changes. We anticipate full year 2022 adjusted EBITDA margin between 23% and 24%, which assumes total transitory cost impacts, including premium freight expenses of approximately $140 million to $160 million. This is slightly higher than the impact we realized in 2021. We expect our free cash flow to be at least $900 million for the year. Please reference additional modeling assumptions shown on Slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our enterprise asset intelligence vision and to provide an update on our served market opportunity and long-term growth expectations. Anders Gustafsson : Thank you, Nathan. I am encouraged by the strong demand across our business and the bold actions our teams are taking to navigate the supply chain challenges. Slide 11 illustrates how we digitize and automate the frontline of business by leveraging our industry-leading portfolio of products, software and services. By transforming workflows with our proven solutions that generate an attractive return on investment, Zebra's customers can effectively address their operational challenges, which have become increasingly complex through the pandemic. Our innovative solutions empower the workforce to do their jobs more efficiently by navigating constant change in near real-time, utilizing insights driven by advanced software capabilities such as prescriptive analytics, intelligent automation and machine vision. We are raising our long-term organic sales growth expectations to 5% to 7% from our former expectation of 4% to 5%. On Slide 12, we provide a refreshed view of our served markets totaling approximately $30 billion, which are supported by mega trends, including the on-demand economy, asset visibility, mobility and cloud computing and automation. These trends have become increasingly important to our enterprise customers and we remain well positioned to meet their needs with our comprehensive solutions. Today, the vast majority of Zebra sales are in our core, which remains vibrant and is now expected to grow 4% to 5%. We have the broadest and deepest offering among the competition and believe that our continued focus and investment will advance our leadership position. Our near adjacencies provide ample opportunity to expand and have a generally higher growth profile than our core. The most promising categories include RFID solutions for use cases that demand the highest level of workforce productivity and inventory accuracy. Smart supplies, including dynamic temperature monitoring as well as the opportunity to equip a broader set of frontline workers with our expanded offering of mobile computers. Beyond our core and near adjacencies are rapid growth expansion opportunities that are transforming workflows across the supply chain. We have entered these areas through organic and inorganic investments over the past 18 months and they represent a low to mid-single-digit percentage of Zebra sales. In mid 2021, we launched several fixed industrial scanning and machine vision smart cameras. We also acquired Fetch Robotics to give us the broadest portfolio of autonomous mobile robots in the industry. We have also been building a compelling software suite that optimizes retail execution and demand planning, which includes Reflexis workforce and task management, Zebra Prescriptive Analytics, Workforce Connect, SmartCount and antuit.ai powered demand forecasting. Collectively, we are serving an approximately $6 billion market in these exciting expansion areas. We are early on our journey and have the opportunity to extend our capabilities deeper into the areas of machine vision, warehouse automation and workflow optimization software over time. Now turning to Slide 13. Businesses partner with Zebra to help optimize their end-to-end workflows as they strive to meet the increasing demands of consumers. I would like to highlight several recent key wins across our end markets. A global apparel retailer is deploying a Zebra solution of 32,000 TC52 mobile computers along with Workforce Connect voice collaboration software and our software solution that transforms mobile computers into workstations on demand. We are enabling this retailer to improve associate productivity and communication in both front of store and distribution center applications, eliminating the need for walkie-talkies and full desktop computer workstations. Our mobile computers will also provide the benefit of stable network connectivity, improved security features and battery management tools. This competitive takeaway win from a major consumer device provider demonstrates our superior value proposition versus the competition. In another recent win, Zebra's Reflexis workforce management solution has enabled a U.S.-based specialty retailer to optimize scheduling for more than 25,000 employees and provide enhanced self-service reporting and analytics to support accountability and performance. We have expanded our relationship with a leading international energy company to empower thousands of convenience store associates in the United Kingdom with Workforce Connect and Reflexis workforce management applications on their Zebra mobile computers and tablets. Our solution enables the store associates to automate their daily responsibilities, maximizing productivity and streamlining task management and administration. We have expanded our relationship with a European auto manufacturer, augmenting thousands of their Zebra mobile computers with RFID readers to enhance quality control in production lines and allow secure employee system access. We continue to collaborate with this customer to pilot promising new solutions to further optimize their operations. In health care, a large hospital system in the Southern United States purchased TC52 mobile computers and our Workforce Connect software application to enable mobile access to the medical record systems as well as facilitate instant communication between nurses and other clinicians. Zebra has selected over competing consumer device providers because of our reputation for comprehensive enterprise solutions. In closing, we are working diligently to navigate through industry-wide supply chain challenges, which limit our ability to fully satisfy strong customer demand in the near-term. That said, the pandemic has accelerated trends that have been driving growth in Zebra's vibrant markets, including e-commerce adoption, the need for real-time track and trace across the supply chain and the shift to a more digital healthcare experience. We continue to be very excited about our growth prospects. Now I'll hand the call back over to Mike. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : Ladies and gentlemen, with that, we’ll begin today’s question-and-answer session. [Operator Instructions] And our first question this morning comes from Tommy Moll from Stephens. Please go ahead with your question. Tommy Moll : Good morning and thanks for taking my questions. Anders Gustafsson : Good morning. Nathan Winters : Good morning. Tommy Moll : I wanted to start with your revenue outlook. So looking at your first quarter guidance in the full year, it looks like you're expecting a step down sequentially in the first quarter and then revenue builds through the quarters for the rest of 2022. Can you walk us through the assumptions in that cadence across the quarters? And specifically, if you could provide detail on what assumptions you have for the deal business. That would be helpful. Thank you. Nathan Winters : Thanks, Tommy. So if you look – we entered the quarter, as we said in our prepared remarks, with a very strong backlog, good bookings momentum here early in the quarter. The guide of 1% to 3% really reflects constrained supply, not demand, driven by very specific and certain component shortages within our Printing and DCS business. Without that, we would expect to be at least as high as our full year guide unconstrained. But with that said, we do see improved visibility into those components later in the quarter and into the early part of the second. So we'd expect a solid rebound in Q2 and then gives us line of sight to our full year guide. And on the full year guide of 3% to 7%, and as we said in the prepared remarks that confident as ever about our business. We do anticipate improved supply chain constraints throughout the year. It's obviously a dynamic environment, but we've secured commitment and we do see improved visibility here over the next few months. And that would also assume increased growth in the last nine months of the year, again, due to the strong backlog demand, along with the recent targeted price increases that go into effect here at the end of the month. Let's say all that while being somewhat cautious in our overall growth assumptions given the supply chain challenges. Tommy Moll : And Nathan, would you be able to share any embedded assumptions on the deal business? I know sometimes you have more or less visibility there. So I'm just curious what you've embedded in the outlook today? Nathan Winters : Overall, it does, particularly if you look from an EBITDA rate, we do assume a favorable deal mix. So a slightly higher percentage of run rate versus deal mix compared to 2021. But obviously, that becomes a little bit harder to predict as we get into the second half of the year. Joe Heel : I could add some color as well. This is Joe Heel speaking. As you saw in Q4, we had strong large deal flow. And if we look at our backlogs and pipelines, we also have continued strong large deal flow. We have no shortage of demand. Tommy Moll : Thank you, both. And if I could pivot to a higher level question here. Anders, I appreciate the update you provided on the long-term outlook around revenue. I'm curious for any additional context you could give us on the thought process there and what went into that revised outlook? And then specifically on the double-digit expansion opportunities that you provided, I noticed the ones on your slide are areas where you've already entered either organically or inorganically. Are there any other expansion opportunities that may not be on that slide where we could expect potential for continued M&A and/or organic investment? Thank you. Anders Gustafsson : Yes. First, we've – so we raised our longer term growth outlook to 5% to 7% over cycle versus the historical number we had of 4% to 5% that we had in place since 2014 when we did the Enterprise acquisition. Over the last seven or eight years, we have overachieved that target and we've been more in line with 7%, and we see our overall markets being very strong. We served by some very strong secular trends that are helping to drive demand and as we help to digitize and automate our customers' operations and their workflows and our competitive position remains very, very strong. And we think we have great opportunities in our core. The core continues to perform very well, but also in our adjacencies and in our expansion markets. So you asked specifically about the expansion markets, we include in there only things that we have identified so far where we have plans – or more than plans where we have solutions that are in the markets. So could it expand? Sure, absolutely. It can expand. But we looked at sizing the market to the solutions we have today and the type of applications that they address. So we're not going after – we're not including, say, the entire markets for these funds, but only the markets that we can address today. So as we continue to add functionality that will possibly add to solutions, that total market, served market can expand. We certainly see those as very attractive markets. We have a strong right to play. And we have a differentiated value proposition like in fixed industrial scanning or in robotics. And those markets, we expect to have a materially higher strong double-digit growth rates versus our core, and they will then augment the overall growth rates we have for the company. Operator : And our next question comes from Andrew Buscaglia from Berenberg. Please go ahead with your question. Andrew Buscaglia : Good morning, guys. I wanted to ask a little bit more on the margin outlook near and long-term. So on the price side, you said you raised prices, do you have capacity to potentially raise again? And then on the cost side, are you – if need be, that is obviously. And then on the cost side, are you assuming everything is being shipped by freight again for the most part of the year – sorry, by air, excuse me. Are you assuming freight to ship by air, not land? Nathan Winters : Yes. So a few – maybe I'll start with the last question there. If you look from our assumptions, particularly in Q1, we are still assuming that we're almost shipping, particularly in printing, exclusively via air versus ocean. Although, we do expect that to shift as we move throughout the year. So getting back to more normalized levels in the second half. So that's assumed in the full year guide from a margin rate perspective. Now when you look at the price increases, particularly the one we did here this month, that ranged from 0% to 8%. Again, it was not a general increase similar to what we did in September. It was very specific to the product family region based on a competitive position as well as the cost increases we're seeing in those respective product families. And that represents a little less than point of sales growth contribution for the year. And it is something we'll always continue to assess and look at. And if we need to increase prices again based on the competitive positioning and/or the inflationary environment, we'll do so. Andrew Buscaglia : Yes. Okay. And on that long-term guidance slide, I was surprised to see that core market, first off, can you update us on what do you think your market share is in that? I believe it's close to 50% last time you gave us that update. And then I'm surprised to see that, that's still 4% to 5% CAGR, just given the world sort of changed in the last couple of years. Yes, just wondering how you're thinking about that. Anders Gustafsson : So our market share is very strong. We peg overall market share at about mid-40% for our core, where mobile computer would be a little bit higher. Printing is thereabout so maybe a little higher and a little lower for scanning. But the overall market share, we peg around mid-40%. And the growth rate is based on independent market research for those markets as well as an expectation that with the focus in investments we're doing, we will be able to continue to gain some share, although not quite at the same pace as we have for the last several years. Andrew Buscaglia : Okay, all right. Thank you, guys. Operator : And our next question comes from Jim Ricchiuti from Needham & Company. Please go ahead with your question. Jim Ricchiuti : Question about RFID. There's been quite a bit of activity in that market fairly high profile use cases that have been publicized recently. And I'm wondering, does this represent an incremental growth opportunity? Or does it perhaps shift some revenues from some of the conventional business, your core business. And I'm wondering if you could, number one, talk about the opportunity? And could you – and I'm not sure you've ever really sized that portion of the business. Can you elaborate on that perhaps? Thank you. Anders Gustafsson : Yes. So we include RFID in the adjacent markets for us. It's – we've been in the RFID space for a long time. So it is very much a close adjacency to our core, where we have a strong right to play and our solutions are very much tied together. I would think of it as it's not either or type thing that customers either by RFID or the buyer regular solutions, our RFID solution go on top of our traditional products. So if you want to say, print and encode an RFID label, it is one of our traditional label printers with an RFID encoder attached to it. And similar, if you want to read the labels that is an attachment to sled or something like that on our mobile computers. So it is an incremental part of our core business, but it's not the supplement. Or it's a supplement, but not a substitute for our core. And the market continues to grow very nicely. We've seen apparel retail, probably the main driver so far. We're looking at in-store inventory accuracy as one of the big drivers. But it's been spreading across more different categories within retail but also we see now moving into other industries, so manufacturing being able to track components or subassemblies through a supply chain or in health care to be able to do a number of attractive use cases there also. Joe Heel : Maybe I’ll add something, Jim. I would say that there’s definitely an incremental piece to it, but there’s also some substitution. I’ll give you two quick examples. In apparel retail, most of the supply chain has replaced barcoding with RFID now, at least in the more advanced retailers, and that’s probably a substitution. Because they’re using that now throughout their operations as they would have before barcodes. On the other hand, we see a lot of applications, for example, pallets. Pallets have in the past, hardly ever been tracked. But with RFID, we can now track them. And so putting RFID labels on pallets is a great way to ensure much greater efficiency of pallet logistics, which is surprisingly a big problem. So that’s an indication of the incremental nature that we do see. Jim Ricchiuti : So if we take some comments recently from UPS, where they talk about working on some smart logistics centers where they’re replacing, I think they said something like 20 million potentially using RFID to replace 20 million manual scans simply with traditional barcode. It sounds like you still see a lot of opportunity even if there’s some impact on the core business? Anders Gustafsson : Yes. We see that as a nice addition to the business because, one, they would have to augment, say, either printing or mobile computers with RFID capabilities or they could also, of course, use overhead RFID readers, which will be a new business for us with UPS. So we see that as a very attractive adjacent growth opportunity for Zebra. Jim Ricchiuti : Got it. Thank you. Operator : Our next question comes from Meta Marshall from Morgan Stanley. Please go ahead with your question. Unidentified Analyst : Hi, team. This is Eric on for Meta. Thanks for taking our questions and congrats on navigating through another tough quarter and outperforming our expectations. I guess, just maybe to start off on the high-level growth target you put out, do you think every vertical has the potential to be a 5% to 7% growth vertical across your end markets? Or is that more skewed to certain customer bases? Anders Gustafsson : We expect the broad-based growth across based on the entire business of verticals, geographies and product lines. Specific to verticals, I’d highlight health care and manufacturing as two high-growth opportunities for us. They have high need for – to digitize their operations and workflows, and say today, there’s an underpenetration – relative underpenetration of our type of technologies within those verticals. Unidentified Analyst : Got it. That’s helpful. And then maybe if I could also ask on just some of the investments you’re making and from kind of an operating leverage perspective. You’ve been pretty consistent in delivering operating leverage. But if you were to more aggressively grow into some of your expansion areas that could there be a situation where your top line growth is higher, but earnings growth more mirrors top line growth? Or do you still think even through those investments, you would be able to kind of grow your profitability ahead of revenue? Nathan Winters : Yes. So as you mentioned, we’ve had a long track record of driving profitable growth. And at a EBITDA level and EBITDA margin, we believe that can go higher, and we have many levers to do that. Maybe if you look at our full year guide here of 23% to 24% in the midpoint, that’s 2 points higher than we were in 2019, while expanding into these new expansion markets. And those expansion markets come with higher gross margin and the team has continued to focus on operational efficiency, by the way, growing at 2 points despite the transitory cost increases. So yes, it’s definitely still an objective for the company and something we can continue to do over the long-term. Unidentified Analyst : Got it. Thank you. Operator : And our next question comes from Keith Housum from Northcoast Research. Please go ahead with your question. Keith Housum : Good morning, guys. Joe, I’m just trying to unpack the information on the price increases between what you guys in September here and in January and compare that to your annual growth rates. I mean, as you think about that 3% to 7% annual growth, how much of that is coming from, I guess, new unit growth versus just the pricing increase that you guys have been able to roll forward? Joe Heel : Yes, Nathan, I think you have a good summary of that. I can add some to it. Nathan Winters : Yes. So Keith, so I said earlier, the price increases that went into effect here in the end of this quarter is a little less than 1 point of growth contribution for the year, and then the remainder of that would be driven by the strong backlog and the demand for the product. So it’s a relatively meaningful, but a relatively small part of the overall growth for the year. Joe, anything you want to add? Joe Heel : Did that answer the question, Keith? Or did I miss something? Keith Housum : I’m trying to combine the February increase you guys come through at the end of the month with the one that you passed through in September. If you take both of those combined, what does it do to you with that? Nathan Winters : Yes. Maybe Keith, it might be a little over a point. The 1 here in February is larger in size. And you just have – both of those slightly impacted by timing in terms of they went into effect in terms of our full year impact on 2022. Keith Housum : Okay. And as a follow, a secondary question, in terms of like the supply chain, we’re hearing different comments in terms of the supply chain because you got the raw materials issue and then you have logistics. It sounds like from your guidance here, you expect both of those to improve quite a bit before the end of the year, if not totally abate. And I appreciate the efforts you’re doing in terms of the design and I guess, getting secondary sources. But is there one or two things you can point to that gives you the confidence that things will be improved before the end of the year for both these items? Anders Gustafsson : Yes. First, as context, I’d say that we provided a record profitable results for the full year of 2021 and record Q4. And we were able to do that in a very challenging supply chain environment. The situation is clearly very volatile and Omicron as an example, has impacted the pace of recovery across all the verticals we serve and globally. But the demand environment is very strong and has ramped very fast over the past year or so. And we continue to put our customers first. So we prioritize making sure we can meet our customer delivery times and customer commitments to the extent we can. Now there are times when we have not been able to meet the traditional lead times the way we would like, but that’s all been supply chain related. But we’re working very hard with our partners and our customers to minimize any impact on our customers’ business or our partners business in this area. And we do believe that the challenges are peaking, and we anticipate both freight and component availability to improve as we go through the year here. Specifically on the component side, I’d say that the impacts on availability and pricing of components that we source there is. So it’s – some are much more impacted than others. So it’s certainly a very dynamic environment in that way. But we – as we said, we’ve been working very – all angles to make sure that we secure as much of supply as we can. We have worked on building more resiliency overall into our supply chain. We have been negotiating long-term supply agreements with both new and existing suppliers. We are working with our suppliers to ensure we get our fair share of allocations. And we’ve dedicated a substantial part of our engineering organization to product redesign to basically design out long lead time parts. As we look into kind of Q2 and the rest of the year though, we do have better visibility and better supply commitments to some of these critical components as we enter Q2. So that’s part of what gives us the confidence for the full year. And so we do expect some gradual improvements as we go through the year. Nathan Winters : Keith, I would say from a freight perspective, our air and ocean rates towards the end of the fourth quarter were 5x higher than what they were pre-pandemic. And as we’ve said, expediting both component parts, finished goods and shipping almost exclusively all of our printing air versus ocean. But rates are beginning to recover from the peak in December, still significantly higher than even the first half last year and definitely from the beginning of the pre-pandemic. And we’ll need some time to get print back on the ocean. And I think we still believe that these are largely transitory, but the world has changed, and we need to wait and see how the landscape settles to the extent that will go all the way back down to zero, that we’ll have to wait and see how that plays out. Anders Gustafsson : And did you – Keith, did you ask about non-semiconductor shortages also? Keith Housum : I didn’t, but you’re welcomed to answer that one as well. Anders Gustafsson : Yes. So there’s some inflationary environment across all the commodities, but we would not have been – not to the extent that we will make that a talking point in our earnings calls, if it weren’t for the semiconductor side. Keith Housum : Great. Thanks. Good luck, guys. Anders Gustafsson : Thank you. Operator : Our next question comes from Damian Karas from UBS. Please go ahead with your question. Damian Karas : Good morning, everyone. Anders Gustafsson : Good morning. Damian Karas : Good morning, Andres. I wanted to ask you guys, if you could maybe give us a sense on where you think you are for the core business in terms of the timing of the replacement cycle? I know that those devices are typically sort of recycled every five, six years or so. But just thinking about the really strong year you had last year, it looks like you’re expecting another positive year of growth in 2022, how should we think about the 5% to 7% growth rate kind of when we get past this year, thinking about the demand you’ve seen and whether you need to see a step down first or whether that 5% to 7% is kind of sustainable from here? Anders Gustafsson : Yes. So first, the 5% to 7% growth rate is meant to be through a cycle. So there will be some – some years will be stronger, some will be maybe a little weaker. We certainly have been in that case if you look at the past seven years since we had the 4% to 5% rate. But I don’t see any reason why from a demand perspective, there will be any kind of step downs in the early part of the cycle here. We see a very strong demand environment and the refreshes of our product lines that we – that happens to mobile computing to scanning and printing all our products. We talked mostly about it from a mobile computing perspective, where Android has – first, I said, driven an acceleration of refresh rates because there’s so much innovation going into the Android platform. So deployments or products that are deployed, say, five years back, have a hard time now to support the most recent Android versions or all the applications that our customers want to put on the devices. So we’ve seen a shorter refresh cycle for Android versus the traditional Microsoft devices that we had earlier. And that’s all baked into our assumptions for this year. But it’s – we are certainly seeing many of our large deployments that happened in for 2015, 2016 or even 2017 that are now looking to refresh and/or have already refreshed in the process of refreshing. And I don’t know, Joe, if you had any further color for this? Joe Heel : Yes. I was going to give you one example, Damian. So in 2015, we closed the largest deal at that time in Zebra’s history in mobile computing, which was a postal service in Europe with the first purchase of TC70 at that time. And they have just refreshed their mobile computers last year. So it was about a six-year cycle for them. And you can see that others have followed suit. And as Andrew said, the replacement cycles have gotten shorter. So going from five to six years, closer to the three to four year period, in many cases. Damian Karas : Okay. Great. That’s really helpful. And I appreciate all the detail around your addressable market and the long-term growth rates. I’m just curious on the margin front, what that means for your profile? I think the software side, obviously, higher gross margin relative to your business today. But thinking about those expansion areas, what does it mean for your guys’ margin kind of near-term as those businesses grow and longer-term as well? Thanks. Nathan Winters : Yes, Damian, and I mentioned this a little bit earlier on the comments – the question from Eric, but we didn’t have an explicit target on EBITDA margin, although we do believe it can continue to scale and grow over the cycle. And as you pointed out, many levers to do that, including the – all these expansion markets typically come with higher gross margin and that will come through an EBITDA as we scale those respective businesses as well as churn through some of the transitory costs that are currently within the P&L. And I think ultimately, our goal is to continue to drive double-digit EPS growth through all the levers we have available to us. Operator : And our next question comes from Brian Drab from William Blair. Please go ahead with your question. Brian Drab : Hey, thanks for taking my questions. I'm bouncing between two calls at the moment, and I missed a little bit of the Q&A. So sorry if I repeat something, but the post office project, the larger post – I know there's a lot of post office projects, with the large one that was, I guess, completed here at the end of 2021. What sort of headwind is that to your overall sales growth rate in 2022? And I know you're replacing that with a lot of business, but I mean, it would be great if you could make any comment on the large project. Nathan Winters : Yes. So the initial deployment for USPS, we did complete in the – late in the third quarter, early fourth quarter, but our teams have continued to remain highly engaged with the post office. We have a healthy pipeline of opportunities here for 2022. And our current assumption within our 2022 guide is that we will sell less to USPS. So we are cycling through that. But again, have many other opportunities, as Joe mentioned earlier around other large deals in the pipeline, just like we do any other year to offset that and continue to grow. Brian Drab : Okay. So it's not material enough that you would tell me that like without this difficult comparison that you would have forecasted growth of a couple of points higher for 2022 barring this one big project? Nathan Winters : That's right. Again, every year, we have a large deployments and rollouts. And again, we have new and other opportunities to offset that to reach the – our full year guide for 2022. Brian Drab : Okay. Okay. And then I'm just curious in the core part of your business that you're forecasting long-term growth of 4% to 5% for, how does that break down these days between AIT and EVM? Anders Gustafsson : The growth between AIT and EVM is actually quite similar. It's not materially different. EVM would likely have a slightly higher growth rate, but not materially so. Operator : Our next question comes from Rob Mason from Baird. Please go ahead with your question. Rob Mason : Yes, good morning. A lot of grounds have been covered already. But my question, Anders, just to go to some of these expanded areas in your introduction this year, the fixed industrial scanning and machine vision. I'm just curious if you could point to any kind of key progress points on those products? I know only in the marketplace maybe half the year. But key progress points around channel development, customer receptivity and what should be the expectations for that those areas and specifically fixed industrial scanning and also the Fetch business. How should we think about those in 2022? Anders Gustafsson : Yes. No, happy to do that. And I'll ask Joe to also then provide some color after my comments here. But the expansion that we feel today that we can address about $6 billion of opportunity there. The fixed industrial scanning machine vision part is about $2 billion, warehouse autonomous mobile robots is approaching $1 billion and our software solutions are about $3 billion. So that gives you kind of the overall scope of that. We are very excited about all three of these. We have good traction, good customer receptivity on the fixed industrial scanning machine vision side, we have some very attractive wins already, and we continue to add functionality, so we can address more and more of the market. But one particularly attractive win, I think, for us last year or in – I think it was Q4 was in automotive, where we could read – there was a bake-off and we showed very well on our ability to read some DPM type of markings, was better than for the competition, and we were selected based on that. But I'd say here also the overall value proposition we have in fixed industrial scanning around the ease of use and the ease of upgrades using software to operate rather than having to change your cameras are very well received. And we are also working hard on – we have established a new fixed industrial scanning machine vision track in our PartnerConnect program. So we want to make sure we recruit partners to help us scale the business in a very cost-effective way and get better reach that we can do ourselves in that time frame. And we've always been very partner-centric. So we think this is a great way to both provide new opportunities for our existing partners as well as recruit new partners from that industry. Joe Heel : I can add a little bit. Maybe just to underline that PartnerConnect. We've made excellent progress in recruiting partners. We set ourselves a goal, both in the U.S. and Europe to recruit the premier partners that deploy these solutions. And that's very important because these are complex solutions set up in these manufacturing and warehouse environments. We've made excellent progress in doing that. And the reason that we've been able to do that is that Andres called ease of use. And that's particularly important for partners because they want to set up new solutions quickly and with few resources. And that's where our solutions are different from the rest of the market is that you can do that much faster with our solutions and that's what's attracting many partners. So we're very pleased with that. On the Fetch business, I think we have the big milestone that I hope you've taken note of is that we've expanded from conveyance robots. So robots that move things from point A to point B in the warehouse to fulfillment robots, which are ones that are used to support pickers in e-commerce fulfillment activities. That's a large and very fast-growing part of the market, as you can easily imagine. And we've had an outstanding win here with one of the big e-commerce players here in the fourth quarter already, which, of course, is going to be a very important reference for us. So we're very pleased with the progress in both machine vision and the autonomous mobile robots. Rob Mason : Excellent. Go ahead, Anders. Anders Gustafsson : Joe, I just want to add on the AMR side. We have a very differentiated value proposition in the warehouse automation space, where our robot competitors, they work very hard on optimizing the movement and the use of the robot. And people who are more on the equipment side would try to optimize the movement of workers. Since we have both, we're trying to optimize the overall workflow and coordinate the movement of robots and frontline workers to drive the most productivity enhancements. And I think that value proposition resonates very well with customers. Rob Mason : I see. I see. And just as a follow-up, Joe, to go back to the progress you've made recruiting partners, I'm just curious if you have a percentage that are existing Zebra partners that have added and expanded versus, I guess, entirely new partners? Joe Heel : We do. So we have a good number of our existing partners have already been active in the machine vision space. I would tell you though that the majority of partners that we expect to have will be new partners that are specialized and highly proficient in this area as their exclusive or dominant focus. But we do have a good number that we're starting with already. Operator : Our next question comes from Paul Chung from JPMorgan. Please go ahead with your question. Paul Chung : Hi, thanks for taking my questions. So nice record free cash flow for the year. You have some nice flexibility to kind of continue M&A. You got some low net leverage levels. So should we expect kind of a similar pace of acquisitions, maybe more tilted towards on the software side? And then what kind of leverage levels are you comfortable with? Anders Gustafsson : Yes. I'll start and then Nathan can talk about the leverage levels here. But first on M&A, we view M&A as a top priority for us, and we're very excited about the outlook for the business, and we see M&A as a vector for growth. We're not looking to do M&A for the sake of M&A, say, but this is to help accelerate our Enterprise Asset Intelligence vision. So think of Fetch was a great example of how we could accelerate our reach and expand our Enterprise Asset Intelligence vision here into the warehouse automation space. So you can expect that we can be looking at some targeted bolt-on acquisitions as well as high-growth acquisitions that truly advance our vision. And we do see opportunities in digitizing and automating workflows that is kind of the sweet sport for what we're looking for. And yes, as you noted, our balance sheet is strong, so we can support a certain number of acquisitions. Nathan Winters : No, I think just add, we ended at 0.5x net debt-to-EBITDA ratio. And again, comfortable with the overall debt levels. And that gives a lot of opportunity and flexibility to address the M&A market, as Anders has mentioned. Paul Chung : And then your views on share buybacks. Is this more kind of offset some comp levels or what's your view there? Nathan Winters : That's right. Obviously, the first priority is investment in the business, both organically and inorganically. But we still believe share repurchase is a good way to return capital to shareholders. We were active in the fourth quarter, and we've been active to date here in the first quarter with share repurchases. Operator : And ladies and gentlemen, our final question this morning comes from Brian Lau from Wolfe Research. Please go ahead with your question. Brian Lau : Hey, good morning, everybody and thanks for squeezing in here. Anders, you gave a lot of good examples of some wins this quarter on both the hardware side and then the software offerings for Reflexis and Workforce Management. Just curious about the go-to-market strategy there, how you're bundling those when you're approaching customers? Are there two or three sets of kind of sales teams? Or is it a more kind of holistic sales approach? Thanks. Anders Gustafsson : Yes. I'll start and here since Joe – this is Joe's organizational, let Joe provide some color here also. But yes, we have – we put a lot of thought into how we go to market and how we ramp these new solutions because we have two objectives here. One, we want to leverage the broader relationships that we have with our existing customers, but we also need to have a real focus on these newer solutions. They are smaller today than our more established core solutions. So we want the team that are very dedicated, very focused on them and understand those use cases and those technologies very well. So if you take our software solutions as an example, we have a dedicated software sales team that are kind of owning the software opportunities, but they work very much through our traditional account managers to get introduced to the accounts to get help in navigating those and understanding what the issues are and so forth. So it is a sales overlay strategy for most of these opportunities, but very much leveraging the – our traditional account managers. And Joe, do you want to add anything to that? Joe Heel : Yes. I would add. I mean, if you – Anders described the objective well, right? We have a very strong presence, right? If you think about the fact that 94 of the Fortune 100 in the U.S. are now Zebra customers. We have account managers on those, and we want to leverage those. And then on the other hand, we have specialists that need to bring specialized expertise, but also a special understanding of the specific personas that are making the purchases, which would be, for example, human resources purchasers or store operations purchasers. These are – these overlay organizations Anders called them, we also refer to them as specialist sales organizations. These are meaningful organizations, which have both salespeople. They have application engineers or consultants. They have business development in them, and they have channel management in them. So these are becoming large organizations that are dedicated to driving that particular frame in concert with the account managers that are now maintaining the overall relationship for us across the multitude of offerings that we have. Operator : And ladies and gentlemen, with that, we'll conclude today's question-and-answer session. I'd like to turn the floor back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Thank you. So just to wrap up, our primary focus continues to be the health and safety of those on the front line, and I would like to thank our employees and partners for their extraordinary efforts to serve customers and deliver record 2021 results in a challenging supply chain environment. We are optimistic that we are now seeing the peak of these challenges, and we are working hard to minimize these impacts. So thank you, and have a great day, everyone. Operator : Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,022
| 2
|
2022Q2
|
2022Q1
|
2022-05-03
| 18.555
| 18.78
| 20.046
| 20.41
| null | 24.27
| 19.68
|
Operator : Good day. And welcome to the First Quarter 2022 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, today’s event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead sir. Mike Steele : Good morning and welcome to Zebra’s first quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today’s earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our first quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2022 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now let’s turn to slide four as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered solid first quarter results in an exceptionally challenging macro environment. For the quarter, we realized adjusted net sales growth of greater than 5% and adjusted EBITDA margin of 19.9%, a 540-basis-point decrease and non-GAAP diluted earnings per share of $4.01, a 16% decrease from the prior year. Customer demand remains strong for our solutions that digitize and automate workflows. We realized sales growth across all four regions supported by exceptional strength in mobile computing with particularly strong growth in Asia-Pacific and Latin America. Our teams have continued to manage supply chain constraints as we navigate significant global macro uncertainty including COVID-19 lockdowns across Asia. We were able to secure more supply in mobile computing and scanning than we originally anticipated, which more than offset the impact of suspending shipments to Russia in early March. However, we were unable to fully satisfy customer demand particularly for our printing products. Supply chain costs were greater than our expectations and significantly weighed on gross margin, which was partially offset by higher service and softer margin. Operating expenses as a percentage of revenue increased due to acquisitions in our expansion markets and resuming in-person events. Overall, we are pleased that our first quarter sales and earnings performance exceeded the high-end of our guidance ranges despite extreme supply chain challenges including transitory costs that were higher than our expectations. With that, I will now turn the call over to Nathan to review our Q1 financial results in more detail and discuss our revised 2022 outlook. Nathan Winters : Thank you, Anders. Let’s start with the P&L on slide six. In Q1, adjusted net sales increased 6.1% including the impact of currency and acquisitions, and 5.4% on an organic basis, as we successfully secured a greater supply of mobile computers and data capture products than we had anticipated. Our Asset Intelligence and Tracking segment including printing and supplies declined 8.1% due to significant supply constraints on our printing products, as well as cycling strong prior year results. Enterprise Visibility & Mobility segment sales increased 11.6% driven by exceptional growth in mobile computing. We continue to drive solid growth across services and software with strong service attach rates and expansion of our software offerings. We recognized growth in all four regions. North America sales increased 2% with strength across the portfolio with the exception of printing. EMEA sales increased 2% driven by strong growth in mobile computing. Asia-Pacific sales grew 28%, with strength across all major geographies, including China. And in Latin America, sales increased 31% with exceptional growth in Mexico. Adjusted gross margin declined 430 basis points to 44.6% due to unprecedented premium supply chain costs and unfavorable product mix, partially offset by higher service and software margins. We will discuss our supply chain expenses further in a moment. Adjusted operating expenses as a percentage of sales increased 100 basis points, primarily due to new business acquisitions in our expansion markets, as well as increased marketing activities and employee travel costs as we return to in-person events. First quarter adjusted EBITDA margin was 19.9%, a 540-basis-point decrease from the prior year period, primarily due to negative gross margin impact of unprecedented supply chain costs. Non-GAAP earnings per diluted share was $4.01, a 16.3% year-over-year decrease. Turning now to the balance sheet and cash flow highlights on slide seven, our balance sheet remains strong. From a debt leverage perspective, we ended the quarter at a modest 0.8 times net debt-to-adjusted EBITDA leverage ratio, which provides us ample flexibility. In Q1, we generated $40 million of free cash flow, which was lower than last year, primarily due to higher incentive compensation payments given our exceptional 2021 performance and the higher use of working capital as sales volume shifted to later in the quarter. We also made $305 million of share repurchases, as we have been opportunistic in a volatile market. On slide eight, we showed the impact of transitory costs related to industry-wide supply chain disruption caused by the pandemic. Our team continues to work all avenues to satisfy strong customer demand, including product redesigns, long-term supply agreements, buying critical components in the spot market, along with expediting component parts and finished goods to meet our commitments to our customers. In Q1, we incurred incremental premium supply chain costs of $69 million as compared to the pre-pandemic baseline, which is higher than we had anticipated in our prior outlook. In total, transitory items had a combined unfavorable gross margin impact of $57 million year-over-year. Over the past year, these elevated supply chain costs have continued to evolve. At this point, approximately one half of the impact is associated with buying critical components on the spot market at elevated prices and expedited shipping of our printing products via air versus ocean. We expect this portion of the impact to improve throughout the year based on committed volumes from our key suppliers. The remaining half of the impact is associated with elevated freight costs. In Q1, we saw shipping cost per kilo improved and we assume March pricing holds through the remainder of the year. The war in Eastern Europe and lockdowns at manufacturing sites in China have elevated our supply chain costs above our prior expectations and delayed the improvement we had expected. We now anticipate approximately $200 million of premium supply chain costs for the full year. This impact is net of the anticipated impact of a price increase announced last week across our product portfolio that will become effective as we enter the second half of the year. Let’s now turn to our outlook. We entered the second quarter with a strong order backlog and healthy sales pipeline supported by broad-based demand for our solutions. Our expected sales growth of 3% to 7% is limited by what we can deliver to our customers due to extended lead times and limited availability of component parts, amplified by COVID-19 lockdowns across China. Our guide assumes steady improvement in Chinese manufacturing output. Our outlook also assumes a neutral impact from acquisitions and foreign currency changes. We anticipate Q2 adjusted EBITDA margin to be between 20% and 21%, which assumes gross margin contraction from the prior year due to unfavorable sales mix and expected premium supply chain costs of $60 million, which translates to an approximately 260-basis-point detrimental margin impact as compared to the prior year period. We also expect increased operating expenses as a percentage of sales, primarily due to our entry into multiple expansion markets since last spring and resuming in-person events. Non-GAAP diluted EPS is expected to be in the range of $4.05 to $4.35. For the full year 2022, we are reiterating our outlook of adjusted net sales growth between 3% and 7%. Demand continues to be robust and product supply is improving, which offsets the headwind of 1 point to 2 points of sales into Russia and global macro uncertainty that has escalated since our prior outlook. This sales growth outlook now assumes a 50-basis-point detrimental net impact from foreign currency and business acquisitions due to the significant move in the euro since our prior update. We now anticipate full year 2022 adjusted EBITDA margin of approximately 22% to 23%, which is 1 point lower than our previous guide due to our revised expectation of supply chain costs, which are $60 million higher than the impact we realized in 2021. We now expect our free cash flow to be at least $800 million for the year, which we have reduced due to the increase in expected supply chain costs, as well as the anticipated increased use of working capital due to the timing of sales and inventory replenishment. Note, that our outlook excludes the pending acquisition of Matrox Imaging, which Anders will cover in a moment. Please reference additional modeling assumptions shown on slide nine. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence vision. Anders Gustafsson : Thank you, Nathan. I am encouraged by the strong demand across our business and the bold actions our teams are taking to navigate the supply chain challenges and the uncertain global environment. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, software and services. By transforming workflows with our proven solutions, Zebra’s customers can effectively address their complex operational challenges, which have been magnified by the pandemic. We empower the workforce to do their jobs more efficiently by navigating constant change in near real-time, utilizing insights driven by advanced software capabilities such as prescriptive analytics, intelligent automation and machine vision. We were very excited to resume active participation in trade show events. At MODEX 2022, the world’s premier supply chain show, Zebra showcased our solutions, which provide intelligent automation to help warehouses increase their productivity as e-commerce accelerates. Attendees were interested in the dynamic orchestration between our autonomous mobile robots and warehouse associates equipped with our wearable technology, which significantly increases pick productivity. Zebra also demonstrated how our fixed industrial scanners and autonomous mobile robots work together to increase efficiency and reduce costs in warehouse operations. At HIMSS, the leading Global Healthcare Conference, customers were excited to see how our solutions are designed to connect critical equipment, patients and caregivers to address challenges across their operations ranging from patient identification to pharmaceutical supply chain visibility, our both featured track and trace technologies, including scan and print solutions that increase the accuracy of inventory supply management to improve throughput, reduce waste and inform sourcing decisions. We also highlighted how Zebra’s RFID solutions can further improve health care operations and patient safety. Earlier this year, we raised our long-term organic sales growth expectations to 5% to 7% and provided a refreshed view of our served markets as noted on slide 12. These expectations are supported by megatrends, including the on-demand economy, asset visibility, mobility and cloud computing, and automation. These trends have become increasingly important to our enterprise customers and are now a higher priority as labor shortages and cost inflation continue to bring more challenges. Our announcement in the March to acquire Matrox Imaging, a recognized leader in machine vision, underscores our commitment to scaling into these expansion markets. Slide 13 illustrates how the Matrox acquisition will enable us to create a comprehensive portfolio of fixed industrial scanning and machine vision solutions, building on our smart camera product launch last year and augmenting our growing expertise in software and deep learning. Matrox brings a complementary offering of products and solutions, including advanced smart cameras, vision controllers and 3D sensors, as well as one of the most sophisticated software imaging libraries in the market. These solutions capture, inspect, assess and record data from industrial systems in factory automation, electronics, pharmaceuticals and semiconductor industries. Customers benefit from increased productivity and improved product quality. With this acquisition, Zebra will become even better positioned to serve our customers’ increasingly complex needs regardless of where they are on their automation journey. Matrox generates annual sales of approximately $100 million, with a higher profit margin profile than Zebra. The $875 million acquisition is expected to close midyear. Now turning to slide 14, businesses partner with Zebra to help optimize their end-to-end workflows as they strive to meet increasing demands of consumers, I would like to highlight several recent key wins across our end markets. A truck stop operator in North America recently began rolling out our task management and prescriptive analytics software solutions to its more than 700 locations. We are addressing this customer’s need to track and optimize its internal supplies and retail inventory levels in real-time, while prioritizing and directing employee resources to the highest value opportunities. A feedback loop on task execution is critical, as the aim to maximize productivity and customer satisfaction. A large supermarket operator in Europe has expanded its use of Zebra products, including mobile computers and scanners to address click and collect use cases for buy online pickup in-store transactions, price checking, loss prevention, inventory, reallocation among stores and improved product availability. This expansion win demonstrates the productivity benefit of a more connected and empowered workforce. One of the largest railroad freight companies in North America is deploying our TC57 mobile computers to its train conductors and employees working in the rail yards. They use the devices to ensure cargo is on-boarded to the correct train or truck for the next leg of its journey and to automate time and attendance tasks and daily activity of the train crew. The ruggedness and productivity of the Zebra solution was a key differentiator in this competitive win against the consumer device. In another recent win, a regional health care system expanded their use of Zebra solutions, replacing desk phones with our TC21 mobile computers and deploying TC52 mobile computers with our Workforce Connect application for instant clinical communications, including secure texting and calls. We continue to collaborate with this customer to explore additional solutions that can further optimize their operations. We were also very pleased that Rakuten, a large third-party logistics provider selected Zebra’s autonomous mobile robots to improve the productivity of their warehouse operations. This fulfillment solution will improve picking efficiency, eliminating unnecessary steps for its frontline workers. The connectivity of the associates through wearable technology increases the ability to share prioritized tasks in real-time to create additional efficiencies. In closing, we continue to be very excited about our growth prospects. The pandemic has accelerated trends that drive Zebra’s vibrant markets including digitizing the healthcare-patient journey, e-commerce adoption, and real-time track and trace across the supply chain. We are working diligently to navigate through near-term industry-wide supply chain challenges and to satisfy strong customer demand for our solutions. Now, I will hand the call back over to Mike. Mike Steele : Thanks. Anders. We will now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : Thank you. And ladies and gentlemen, today’s first question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Good morning and thank you for taking my questions. Anders Gustafsson : Good morning. Tommy Moll : Anders, I wanted to start on the topic of some of the pricing actions you have announced. I am just looking back through notes here and I think there was one in September, another one in February and now it sounds like one in April. So what can you tell us there about how realization has gone thus far, what feedback or pushback if any you have gotten when these have been announced and if you are able to quantify for your full year revenue outlook, how much you think you will realize on a year-over-year basis, that would be helpful to know as well? Thank you. Anders Gustafsson : Yeah. I will start and then I will have some of my colleagues here add to this also. But we continue to assess and address pricing issues based on competitive environment and the inflationary environment as well. As you mentioned, we have implemented targeted price changes in September of last year and February of this year that was across the product portfolio and the intent for those was to substantially offset, the realized component cost increases that we have seen. We implemented the latest price increase last week, which was intended to partially mitigate the premium shipping costs that we have experienced and we will continue to assess this pricing -- our pricing environment and make sure that we do what we can to offset the increased costs that we are experiencing. I will let Joe Heel talk a bit more about the impact on customers here. Joe Heel : Yeah. Tommy, we have been quite pleased with the impacted pricing increases have had so far in the market in the way they have been accepted by our customers. Our larger customers have generally received them with understanding, as they see price increases elsewhere in the business as well and have accepted them, and in our run rate, we have been pleased with the resiliency that we have seen as the run rate has grown despite the fact that we have increased the price. So, overall, we are quite pleased with the realization. Nathan Winters : Yeah. Tommy, this is Nathan. Just the last point of your question, so if you aggregate the three price increases, it’s nearly 2-point of sales growth contribution for the full year. So, again, just to remind it is not a general increase, but they were targeted across product families and regions, and each one has a lag before you feel the full impact in the P&L as we honor committed pricing on specific deals and other contracts we have with certain customers. Tommy Moll : That’s all very helpful thing. Thank you. On Matrox, I wanted to shift gears here. I guess to start, anything you can share just in terms of P&L, revenue CAGR historically or prospectively and maybe in terms of the market? Margins you have called out is accretive to Zebra there at least a couple of public peers with substantially higher margins, both at the gross and operating margin lines? I know you probably can’t give us exact numbers. But anything you can do to just situate us on what the profile looks at Matrox would be helpful. But maybe at a higher level as well, just help us situate the Matrox platform with your existing vision platform that you have built organically and what avenues are open to you through Matrox that weren’t previously? Thank you. Anders Gustafsson : I will start and then I think Joe will help out here also. First, we announced the -- our intent to acquire Matrox Imaging back in March, and they are a recognized leader in machine vision and I think that underscores our commitment to the important expansion market for us. You might remember we launched our own fixed industrial scanning portfolio last year and Matrox very much complements our fixed industrial scanning by being clear -- one of the clear leaders in the machine vision. So we are sort of very excited about what this combination can bring to us. It sort of helps us scale our business much faster and creates a very comprehensive product and solutions portfolio. And I’d say here also, Matrox has one of the absolutely most sophisticated software libraries for machine vision in the industry and we are very excited about what we can do with that together. So we feel we have a very strong platform that we can now grow off. And I think the acquisition will help Zebra to serve our customer’s needs better whether they are just beginning on their automation journey or have very complex needs. And at Zebra, we have already recruited over 100 channel partners in this space. So we feel that we are able to bring the best of Zebra and the best of Matrox to bear here. So very complementary product offerings, very complementary go-to-market activities, where we are leveraging our channel centricity and able -- we are able to bring that expertise to Matrox to help accelerate their growth Joe Heel : Perhaps, the only thing I’d add on the go-to-market side is that, recruiting channel partners is the primary thrust for developing the go-to-market opportunity, but we also see a good opportunity in bringing machine vision applications to our existing large customers. I think in particular about our P&L and our manufacturing customers are looking to automate warehouses and production facility. And we already are seeing good traction as those customers have engaged with us on the fixed industrial scanning side with our existing portfolio and as they have heard about our announced acquisition of Matrox, they are very eager to engage with us on the machine vision side as well. So we see a lot of good traction on the go-to-market part. Nathan Winters : Yeah, Tommy has already got a three-headed answer here. But as we said, $100 million run rate, it’s in an attractive market that’s growing high-single digits and we would expect for us to participate in that. And from a margin standpoint, it is accretive to our overall Zebra’s EBITDA rate, but not quite to maybe some of the other competitors in the market just based on size and scale of the company where it’s at today. Tommy Moll : Three-headed answer, but a multipart question. So thank you for indulging there. Operator : Thank you. Ladies and gentleman, our next question today comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. Anders, looking at the supply chain issues, which is obviously very fluid in China today, can you perhaps describe where Zebra is right now in terms of working with your key vendors and getting the supplies you need. I mean, is it still a matter of uncertainty or do you feel like the worst is past and things are going better for you guys? Anders Gustafsson : Yeah. I think we believe that the situation improved through Q1 and we see it as improving over the year, but not a snap back into pre-COVID situations. We have been building more and more resiliency into our supply chain over the last several years, when tariffs happened, we set up new facilities in Malaysia, Vietnam, Taiwan, Mexico and so for. So we are much less dependent on China as an assembly facility. We have also worked hard on signing up long-term supply agreements with both new and existing suppliers and that is beginning to benefit us given the strong performance we had in Q1 on revenues and the solid guide we gave on Q2 outlook here. We are also continuing to buy critical components on the spot markets, that’s helping to optimize our allocation with suppliers and we have been dedicating now for quite a long time a substantial part of our engineering resources to product redesigns to minimize the impact of these long lead time components. So I think we feel we have a better visibility today, better supplier commitments and then coupled that with the product redesigns, which eliminates the need for some of these long lead time components. We feel we are in a better -- in a gradually improving environment throughout this year. Keith Housum : So just to be clear, the ongoing issues were shutdowns in Shanghai over the past month and right in Beijing are not impacting your supply chain issues correct now, is that correct? Anders Gustafsson : We don’t expect them to impact us for the quarter. There’s been -- our main Tier I assembly facilities in China are up and running, but there are some Tier 2 facilities or Tier 3 facilities that are still impacted. But based on our latest data, we expect them to be able to come online and produce what we need for the quarter. Keith Housum : Great. I appreciate that. And then just coming back to the price increases, following on Tommy’s question. I think if I remember, historically, you guys were trying not to pass on through price increases, the impact from the higher freight. With the most recent price increase, are you guys now attempting to do that because the cost comes so high, is that the issue? Anders Gustafsson : No. That’s right, Keith. The first two are more really focused around the component increases and this last one is really targeted at the premium shipping costs. Primarily, if you look at the cost per kilo that we are paying, the rates have come down quite a bit from the fourth quarter to what we are seeing in March. But we don’t expect those to -- we are holding that constant in our forecast for the full year, but it’s going to take some time before we get back to pre-pandemic levels given the current environment. Keith Housum : Great. Yeah. I appreciate that. Thank you. Operator : And ladies and gentlemen, our question today comes from Andrew Buscaglia with Berenberg. Please go ahead. Andrew Buscaglia : Good morning, guys. Anders Gustafsson : Good morning. Andrew Buscaglia : So may be just limited to the demand side a bit, so you are able to, I think, ship product to customers and able to get that -- fulfill that demand, which seems to be intact. But you are hearing some of these larger e-commerce companies talk about perhaps some lower spend on capital projects this year. I am wondering for the remainder of the year what are -- what is your assumption on where that demand is coming from? Do you see -- I think your last quarter, you still talked about some optimism around some large projects moving forward or that’s not in your guide. But maybe talk about the dynamics you are seeing and what type of demand you are seeing from individual customers? Anders Gustafsson : Well, first I’d say that, the demand environment is very strong. Particularly, say you talked about retail, but I think it goes to all verticals for us. The digital transformation is continuing at a fast pace and that’s driving strong demand for our type of solutions. And we performed above the high-end of our outlook here despite these supply chain challenges and having to suspend shipments into Russia in March. So, overall, the supply was more favorable to us in Q2 -- in Q1 and we are -- we expect demand to continue to kind of outpace or certainly in Q1 the demand outpaced our supply and that was particularly true for printers. But we did see strong growth across all regions, but particularly so in Latin America and Asia-Pacific, and mobile computing was the strongest performer on the product side. It’s hard for us to comment now specifically on individual customers, but we have a number of large customers. They tend to have to go through buying cycles. And at this stage, I think, we feel we can certainly offset any weakness that we have seen so far with -- due to this overall strong demand from the broader business and we highlighted also here that the strength of the run rate in Q1. Joe, do you want to add? Joe Heel : Yeah. I would add that we are seeing especially in the second half growth opportunities in the following areas. One is our run rate. Remember that our business has at least a third of it in the run rate, which is smaller transactions and that’s a segment of the market that has shown remarkable resiliency especially recently and so we are expecting that will continue through the rest of the year. Manufacturing and P&L have been quite strong as well for us as those sectors have been renewing a lot of their technology and there is interest in new technology areas there that drive greater productivity and efficiency, which will be needed by those sectors in the economic environment that we are in. So I think about things like automation and RFID, those are areas that we are seeing good demand come in and help us in the second half. Andrew Buscaglia : Okay. No. That’s helpful. So maybe just one other one on capital allocation, just given how the stocks act this year amongst the tough market and I know you have lowered your cash flow expectations for the year. So are -- is share repurchase becoming more of an interesting use of cash here or are you still sort of more so committed to M&A? Nathan Winters : So from a capital allocation, we said in the prepared remarks, we ended Q1 at just below 1 point from a net debt leverage perspective. So obviously comfortable with where we are at. It gives us lot of flexibility to do both, to continue to look for attractive M&A opportunities, as well as to be active from a share repurchase perspective and we were in Q1 with over $300 million of share repurchases, we have been active here in Q2 with more than $100 million of share repurchases so far. So I think the balance sheet flexibility and the free cash flow for the year gives us that ability to do both. And again, even with the Matrox acquisition, if there are opportunities that come along, we are still active in the market. Andrew Buscaglia : Okay. Thank you. Operator : And our next question today comes from Jim Ricchiuti with Needham & Company. Please go ahead. Jim Ricchiuti : Hi. Good morning. I just wanted to get into the outlook for the AIT business, as you look at Q2, in the second half. Are you assuming some easing of the supply chain pressures that potentially will help the topline in that part of the business where clearly you have been probably a little bit more heavily disrupted as well on margins? Anders Gustafsson : Yeah. First it will be more broadly across all our product categories. We continue to drive a lot of innovation across the portfolio of our solutions and that are helping to digitize and automate frontline workflows and those are increasingly important areas of investment for our customers. And I’d say our synergistic portfolio of software and services and products are solving some very critical challenges for our customers. For the Printing business, we certainly saw some supply chain challenges across most of the printing portfolio in Q1 that was driven by some actually few key components. So it wasn’t so widespread but it’s a few key components that we needed. North America and Europe was disproportionately impacted by those challenges, but it was more a global thing. But we have succeeded in securing more of those components, particularly late in Q1 and we see then the combination of having more of those components. And some of these redesigned activities we have done to ease the need for or to enable us to get more supply and we expect to see a good sequential uptick in our Printing business in Q2 and let’s say sort of the underlying demand for our Printing business is very strong. Jim Ricchiuti : Thank you. And just as it relates to EMEA, Europe, clearly some impact from supply chain on the Printing business that you have seen. But I am just wondering are you seeing, have you seen any change in demand since we have seen the conflict in Ukraine in Western Europe from either some of the increased macro uncertainty? Are you seeing any shift in the demand that you are seeing from some of your customers and end markets there? Anders Gustafsson : Let’s say so far Europe has been resilient and we have seen -- we had a very strong demand in first quarter. We obviously had been impacted by Russia and Ukraine. So we have about 1% to 2% of our revenues coming out of Russia and Ukraine, particularly Russia. But so far, I’d ask Joe to comment here also that our European customers have been quite resilient and we haven’t seen them pull back, you might have individual customers, but not across the Board. Joe Heel : Yeah. I can only echo that we have seen outside of the fact that we discontinued our sales into Russia and halted into Ukraine as well. We have not seen an adverse impact on the sales in the rest of Europe, neither in our large customer business nor in our run rate. Jim Ricchiuti : Got it. Thank you. Anders Gustafsson : I think, as I mentioned… Operator : And our next… Anders Gustafsson : … with the tight labor market that you see in the U.S. and Europe, our solutions become more important, right? This is -- our solutions help mitigate the need for adding workers. Basically, the same workforce can add productivity, can be more productive by utilizing our type of solutions, mobile computers, printers, robots, basically all our portfolio. Operator : And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. Thanks. Maybe a couple of questions for me, in the past you have given a view that about a third of retail representatives or representatives kind of have mobile devices today and that’s kind of a great opportunity for growth for you guys going forward. Just as we kind of emerge from a COVID environment. Just any update to that view of where we are or where organizations are looking to get to as far as penetration of devices? And then second question from me, just any update on kind of the healthcare market, particularly as they move past kind of COVID use cases to more kind of turning to their own transformation? Thanks. Anders Gustafsson : Yeah. I will start and then we will see if Joe wants to add something here also. But first starting on the mobile computing side, which is the device for all. First, we had strong growth this past quarter supported by very broad-based demand across all regions. And I say here, we had a particular bright spot around rugged tablets, which we don’t talk too about as much, but we were up double digits and definitely taking share in that space. We also announced a new WS50, which is the world’s smallest all-in-one android wearable and that’s going to be available for shipment now in Q2. And then more specifically to your question about empowering every worker with the device, that is clearly a strong theme for our customers. We estimate that in retail, less than one-third of all workers are currently equipped with the device. But we are now seeing -- we worked with several large retailers today, who are deploying our devices to every one of their associates. So this trend is definitely alive and progressing. Also I’d say the partnership that we have with Microsoft Teams provides another strong collaboration platform that is aimed at frontline workers and that’s helping to drive momentum and then I will go to health care and then I will -- oh, do you want to… Joe Heel : Yeah. Before you go to healthcare… Anders Gustafsson : Yeah. Joe Heel : … let me just add one thing to that point. This last point is quite important. We are beginning to see elements of the strategy that have both devices and hardware and software and services applications come together bear fruit by showing synergies in both directions. And what do I mean by that? We have already been pursuing, looking at our device customers, where we have a very strong market share and offering them some of the applications like our Workforce Connect, voice communication capability or our Reflexis task management capability and have seen good opportunity for synergies in that direction. But what we are seeing now is customers are thinking about those applications that really have their workforce collaborate. The Teams example that Anders gave and also its voice communications like Workforce Connect requires a workforce to be fully equipped, otherwise they can’t collaborate and that’s what we are now seeing is customers think in order to deploy this Workforce Connections solution or the Teams solution, I need to get a device for all our workers. We have several examples now of where that, if you will, reverse synergy has taken place and that’s a really good driver of momentum for us into that other two-thirds of workers that we have been looking forward. Anders Gustafsson : And a couple of words on healthcare. So healthcare continues to be a very attractive growth opportunity for us as we help the healthcare industry transform. Our purpose-built solutions are critical for improving the patient journey and to drive productivity of healthcare providers more broadly. We also enhance caregiving to better address patient demands and we accomplished this by automating workflows, as well as connecting assets, patients and staff from a fiscal digital perspective. We see also a number of new attractive growth opportunities such as tablets for telehealth, where just more interest around location of equipment, and I’d say, our broad portfolio of supply is playing very well in healthcare. And lastly, our solutions are also use that we talked about in earlier call for global vaccine distribution such as for polio COVID 19 or malaria. So we start to see healthcare is being a very attractive growth market for us as we go forward. Meta Marshall : Great. Thanks. Operator : Today’s next question comes from Joseph Donahue with Baird. Please go ahead. Joseph Donahue : Hey, guys. Thanks for taking the question. Could you talk about the demand you are seeing for RFID. I had some large companies announced projects that trickling down if it broad based? Anders Gustafsson : Yeah. RFID is a very attractive market for us. It’s been commercialized for some 30 years. But we now see strong demand around apparels, in-store inventory accuracy as it was the first driver and we have seen a few large public customer announcements in the last month or so, both from Walmart and UPS, which I am not talking about our participation in this program. I am just talking about the commitment they show to RFID and how many of the suppliers and partners of those companies will also have to figure out how to deliver solutions that are compatible with their processes now. So we have seen strong growth in our RFID portfolio, somewhat more hamstrung by supply chain constraints in first one, but the backlog and the momentum for us is very strong. And we have a leading portfolio of mobile reader, RFID readers, fixed readers, and our printer and coders. Joe Heel : Yeah. I think in particular, if I may add, this is Joe Heel, that a mandate like Walmart where they are asking their suppliers to tag the product going into their stores requires not only the readers that we often think are first, but it also requires printing all of those tags and getting the tags. So we are seeing a lot of increased demand now for both printers and tags in addition to readers. So there is a good momentum in RFID. This is the technology that will drive growth for some time. Joseph Donahue : Okay. Great. And then just to switch it up, you have talked earlier about redefines, are those factoring mostly now or should the effects be seen later in the year? Joe Heel : Redesigns. Anders Gustafsson : Yeah. We have been redesigning a number of our products starting from last summer to now. So some of them are already in effect and working and that was part of what helped us in Q1. Others are just coming online and some are going to be completed I think more later in Q2. So, it kind of -- we -- this is a dynamic environment and we have to hook, adjust and react to feedback we get from the market about the different components. Some components might have been okay in Q3 of last year, but they were became long lead time components in Q1. So it is an ongoing program for us. But we are seeing less and less need for it. So the resources we have dedicated to it have -- we have been able to release some of those back into regular product developments. But it is helping already and I expect that it will continue to incrementally help us as we go through the year. Joseph Donahue : Got it. Thanks. Operator : And our next question today comes from Damian Karas with UBS. Please go ahead. Damian Karas : Hi. Good morning, everyone. Anders Gustafsson : Good morning. Joe Heel : Good morning. Nathan Winters : Good morning. Damian Karas : So I am late to join here. Switching over from another call. Apologies if I repeat anything you might have already mentioned. But I wanted to ask you first about the sales trajectory and guidance. I think you are coming in above expectations for the first quarter and looking it later this year, the comps do get easier. So, I am just wondering if you could maybe comment on why the growth rate wouldn’t pick up later this year and just maybe any color you could provide sort of on the run rate for orders as you exited the quarter? Anders Gustafsson : Yeah. So if you look at our full year guide of 3% to 7%, sort of saying, you have heard earlier, which is why we are as confident as ever about the business. Strong backlog, solid orders, booking momentum here in the first part of the year and we are seeing our pricing actions taking hold, which is giving us a benefit, as well as continued improvement in supply visibility assuming. But this is also helping offset the assumed headwind of 1 point to 2 points of sales into Russia that were offsetting for the full year, as well as taking a cautious view on the second half assumptions given the broader macro uncertainties, as well as the FX volatility. So if the strong momentum definitely plays a part, but offsetting two significant headwinds between Russia, the macro uncertainty and FX. Damian Karas : Okay. Understood. And then, I wanted to ask you about working capital, more specifically, inventory. So, sequentially, inventory did move lower. Just wondering how you are positioned in terms of any raw materials, work in processes you might have on hand that kind of satisfy your near-term demand. And wondering if you will be looking to build raw material or WIP to ensure you don’t have a short per phone supply going forward? Anders Gustafsson : Yeah. So we did see a decrease in inventory here in the first quarter as we were able to ship more than what we had expected driving the sales in Q1 ahead of our guide and that is the expectation for the remainder of the year is that we would slowly build back inventory both from a strategic reserve WIP at our Tier 1 and Tier 2 suppliers, as well as ultimately building back our finished good stock in our own warehouses. But I think you won’t really see the full effects of that until later in the year and early part of next year. But that’s part of the reason for our full year free cash flow guide was to give us some flexibility if we had -- if we can build inventory later in the year then we can do that. Damian Karas : Got it. Makes sense. Appreciate the color. Best of luck guys. Anders Gustafsson : Thank you. Operator : Ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : Yeah. To wrap up, I would like to take a moment to say our thoughts are with all those affected by Russia’s invasion of Ukraine, particularly our colleagues in the region and those with loved ones, who have been impacted. I would like to thank our employees and partners for their extraordinary efforts to serve customers and deliver better than expected Q1 results, We continue to focus on prioritizing our customers’ needs in a supply constrained environment and we look forward to welcoming the Matrox team once the acquisition closes. Thank you, everybody. Operator : And ladies and gentlemen, this concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,022
| 3
|
2022Q3
|
2022Q2
|
2022-08-02
| 18.794
| 18.73
| 20.511
| 20.485
| null | 17.74
| 15.05
|
Operator : Good day, and welcome to the Second Quarter 2022 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. After todayâs presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning and welcome to Zebraâs second quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in todayâs earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our second quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2022 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now letâs turn to Slide 4 as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered solid second quarter results in a challenging macro environment. For the quarter, we realized sales growth of nearly 7% and adjusted EBITDA margin of 21.9%, a 170 basis point decrease, and non-GAAP diluted earnings per share of $4.61, a 1% increase from the prior year. Customer demand remains strong for our solutions which digitize and automate workflows. We realized double-digit sales growth in EMEA, Asia Pacific and Latin America and a slight decline in North America on strong prior comparisons. We realized growth across all major offerings including printing where we recovered nicely from a challenge in Q1. Our health care, manufacturing, and retail and e-commerce end markets each grew faster than the corporate average. Our teams successfully navigated the China COVID lockdowns and our actions to redesign certain products and secure long-term purchase agreements enabled us to generate more supply, particularly for printers. We also scaled adjusted operating expenses to drive profitability, while continuing to prudently invest in our growth initiatives. Overall, we are pleased that our second quarter sales performance was near the high-end of our expectations, and EPS exceeded our guidance range as our team executed well on our efforts to mitigate supply chain challenges. With that, I will now turn the call over to Nathan to review our Q2 financial results in more detail and discuss our revised 2022 outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q2, adjusted net sales increased 6.4%, including the impact of currency and acquisitions, and 6.9%. on an organic basis as we secured a greater supply of certain products than we had anticipated. Our Asset Intelligence & Tracking segment, including printing and supplies increased 9.7%, driven by a strong recovery in printing as we secured critical components to better satisfy record levels of customer demand. Enterprise Visibility & Mobility segment sales increased 5.6% with solid growth in both data capture and mobile computing solutions. We realized particularly strong growth in RFID solutions as well as ruggedized tablets in Q2. We also continue to drive solid growth across services and software with strong service attached rates and attractive software offerings. We realized strong growth in three of our four regions. EMEA sales increased 17%, driven by particularly strong growth in mobile computing and printing, inclusive of the impact of exiting Russia in March. Asia Pacific sales grew 14% with particular strength in India. Latin America sales increased 16% with exceptional growth in Mexico. And in North America sales decreased 2% due to supply constraints. We also cycled particularly strong mobile computing sales volumes in Q2 of last year. Adjusted gross margin declined 200 basis points to 46% due to higher premium supply chain costs and China import tariff recovery in the prior year period, partially offset by higher service and software margin. Adjusted operating expenses as a percent of sales improved 60 basis points. Second quarter adjusted EBITDA margin was 21.9%, a 170 basis point decrease from the prior year period. Non-GAAP earnings per diluted share was $4.61, a 0.9% year-over-year increase held by lower share count and lower taxes. Note, that in the quarter, we entered into a settlement agreement resulting in a $372 million one-time non-GAAP charge, which will be paid out over eight quarterly installments. Turning now to the balance sheet and cash flow highlights on Slide 7. For the first half of 2022, we generated $123 million of free cash flow, which was lower than the last year primarily due to a higher use of working capital as sales volume shifted to later in the period due to the China lockdowns; higher incentive compensation payments given our exceptional 2021 performance; and the initial $45 million quarterly installment payment related to the settlement I just mentioned. From a balance sheet perspective, as previously announced, we have significantly increased our available borrowing capacity to align with our growing business to optimize our capital structure. Our new credit facility provides us ample flexibility for organic and inorganic investment, including the recent acquisition and Matrox Imaging, as well as share repurchases through our recently announced $1 billion incremental authorization. We made $300 million of share repurchases in Q2, and from a debt leverage perspective we ended the quarter at a comfortable 1.7x net debt to adjusted EBITDA leverage ratio. On Slide 8, we highlight that premium supply chain costs have sequentially improved from peak levels. Our team has been successfully working all avenues including product redesigns, and negotiating long-term supply agreements for critical components, which has enabled us to reduce our purchases in the spot market. We have been seeing steady improvement in the supply chain environment, which we continue to closely monitor. In Q2, we incurred incremental premium supply chain costs of $56 million as compared to the pre-pandemic baseline, which was favorable to what we had anticipated in our prior outlook. In total, Q2 transitory items had a combined unfavorable gross margin impact of $35 million year-over-year and in Q3 are expected to be approximately $45 million, which is a neutral year-on-year impact net of pricing. Let's now turn to our outlook. We ended the second half of the year with a strong quarter backlog and healthy sales pipeline supported by broad based demand for our solutions. We have been experiencing a steady improvement in manufacturing output, however, our sales growth continues to be limited by extended lead times and availability of certain component parts. Our organic growth has also been impacted by approximately 1 to 2 points after stopping shipments to Russia in March. For Q3, we are limiting our sales growth to a range of 2% to 4% due to actions to reduce expedited air freight costs, and shift our printer products to ocean shipments, which will improve both Q4 growth and profitability. We're also assuming a 2 point additive impact from recently acquired businesses and a 3 point negative impact from foreign currency translation. As a reminder, approximately 25% of our global sales are denominated in Euros. We anticipate Q3 adjusted EBITDA margin to be approximately 22%, which is an increase from both prior year and prior quarter. Non-GAAP diluted EPS is expected to be in the range of $4.35 to $4.65. For the full year 2022, we are reaffirming our outlook with a sales growth range between 4% and 6% inclusive of the impact of exiting Russia. We are also assuming 150 basis point additive impact from recently acquired businesses and a 225 basis point negative impact from foreign currency translation. We now anticipate full year 2022 adjusted EBITDA margin of approximately 22%, the low end of our prior guide primarily due to the significantly stronger U.S dollar. Profit margins are expected to improve in the second half of the year as we continue to shift to lower cost freight options and prudently manage operating expenses and investments. We now expect our free cash flow to be at least $650 million for the year, which we have reduced primarily due to the approximately $150 million of settlement related payments. Please reference additional modeling assumptions shown on Slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence vision. Anders Gustafsson : Thank you, Nathan. We are entering the second half of the year in a position of strength as we closely monitor the volatile global macro environment. We have a track record of protecting profitability and cash flow in any environment, while preserving investments that drive sustainable, profitable growth. I am encouraged by the continued strong demand we are seeing across our business and the bold actions our teams are taking to mitigate the supply chain impacts. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry leading portfolio of products, software and services. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges which have been magnified since the pandemic. As we have extended our lead in industry and expanded our portfolio with compelling solutions, we have elevated our strategic position with our customers. Our trusted relationships with our 10,000 plus partners across the globe augment our capabilities, enabling us to serve more customers worldwide. And we are always excited to engage with partners who drive value. We are excited about our new global strategic alliance with Accenture, which focuses on solving complex operational challenges in retail and other end markets with Zebra solutions. We are collaborating to advance our customers strategies to drive productivity, inventory accuracy and customer service levels, among a variety of other benefits that can be realized by digitizing and automating workflows throughout the enterprise. Now turning to Slide 12, businesses partner with Zebra to help optimize their end-to-end workflows as they strive to meet the increasing demands of consumers. I would like to highlight several recent key wins across our end markets. A major global transportation logistics company is expanding its relationship with Zebra across multiple product lines to ensure a more accurate package loading using RFID technology across many sites. Zebras RFID printers and scanners are integral to flagging packages loaded into the wrong truck in real time, using RFID technology before the vehicle leaves the location. Zebra also supplied more than 3,000 tablets to assist associates in moving trailers around the yard, ensuring the most efficient placement of trucks, trailers and packages. A large supermarket operator in Europe, with more than double its fleet of Zebra enterprise mobile computers in a multiyear rollout covering warehouse, front and back of store and curbside pickup use cases, displacing consumer cell phones. The customer expects improved productivity benefits through better product availability, faster execution on click and collect use cases, and real time price checking as they drive towards the zero food waste goal. This expansion win results from the exceptional service and trust established over our longstanding relationship and throughout the RFP process. In another recent win, a major U.S convenience store chain added additional mobile computers in each of its more than 2,000 stores to augment its inventory management and merchandising use cases. This customer has a deep penetration of Zebra solutions, including our printers, mobile computers and scanners to digitize and automate its workflows. Several years ago, this customer had implemented other Zebra solutions in its warehouses, and have subsequently selected Zebra for additional use cases, as it addressed other business challenges. Additionally, a significant U.S health care product distributor expanded their use of Zebra solutions, equipping their warehouse staff with wrist and ring scanners to improve efficiency in the pick and pack use cases for their warehouse associates. Zebra collaborated with the customer and partner to ensure e-supporting of their applications to the Android operating system. We're also very pleased to be making progress in our most recent expansion markets, fixed industrial scanning, machine vision and autonomous mobile robots. We close on the purchase of Matrox Imaging in early June, and we join them at the automated warehouse trade show in Detroit. We are excited to add Matrox Imaging leading comprehensive portfolio of machine vision solutions, along with many specialized channel partners to help us scale our combined business. At automate, we also highlighted our Fetch Autonomous Mobile Robot Fulfillment solution, which we have been deploying at third-party logistics provider Rakuten. And we are excited about another recent key win with Maersk, an integrated logistics company. Additionally, Fetch AMR conveyance and material movement solutions continues strong traction in use cases for health care supply delivery, automotive spare parts conveyance and waste removal. In closing, our actions have enabled us to begin to recover from industry wide supply chain challenges and we continue to be very excited about our growth prospects as we monitor the volatile macro environment. The global labor deficit and supply chain challenges have escalated the need for enterprises to digitize and automate their operations with our solutions. We have the broadest portfolio of tailored solutions to help our customers advance their strategies. Now I will hand the call back over to Mike. Mike Steele : Thanks, Anders. We will now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : Our first question is from Tommy Moll of Stephens. Please go ahead. Tommy Moll : Good morning, and thank you for taking my questions. Anders Gustafsson : Good morning. Nathan Winters : Good morning. Tommy Moll : Anders, I wanted to start with a discussion of the omni-channel and e-commerce end markets. Your underlying volumes from what we can tell seem to be pretty strong there still. At the same time, there's been some mixed headlines from some of the key players there. So I'm just curious, what can you tell us anecdotally, from customers or across the business about the pace of that end market? Does it continue to grow? Does it feel healthy? Are you seeing anything deteriorate in terms of the fundamentals? The extent you can confirm on the guidance that you've provided, do you still see that those end markets growing in the second half? Thank you. Anders Gustafsson : Yes, I'll try to give as much color as I can here. I'll start little bit more on current performance which we saw in Q2 and then try to give you a little bit of a sense of how the -- how we look at the future here. But first, I just say that the trends to digitize and automate workflows and empower frontline workers that continues to accelerate and in driving increased customer demand for our solutions across all our vertical markets. Retail and e-commerce grew faster than the corporate average in Q2 -- still very strong prior comparisons. We do continue to see strong momentum of omni-channel implementations, which is -- which are straining our customers resources and that's also driving investments in technology and automation that is necessary for retailers to continue to transform their businesses. If you look at the -- in the actual store, expanding buyer line pickup, install use cases and delivery use cases require retailers to equip more associated with mobile computers, along with -- also implementing more workflow software optimization solutions. And in the warehouse we see investments in productivity and visibility as essential to their transformation. We've also expanded with some new attractive go-to-market partnerships like Microsoft and Google that helps to elevate our strategic positioning within the retail vertical as well as other verticals. And we have a very diversified retail e-commerce customer base, and each of those customers are on their own refresh cycle, which helps to reduce volatility for us. I also say that our pipelines remain very strong. And although this is a quite a challenging environment, there are several retailers who have recently publicly talked about their intend to maintain investments in technology as they try to continue to drive or execute on their visions and their strategies. There are certainly a few customers that are ahead of their investment curves. But I would say most are playing catch up with investments in solutions like ours, particularly in a labor constrained environment, where they need to improve productivity, inventory accuracy and customer service levels. So as I would say, this feels more like a normal year for us and that most customers are investing and proceeding with healthy -- healthily with their plans. But there are some they're pulling back a bit. But this is the value that we have of a diversified customer portfolio that allows us to not be overly dependent on any one customer. And I'd say it's also noteworthy that, we continue to grow despite the cyclicality of some of these large customers that we have, and that it's a testament to our diversified customer base. I hope that helps. Tommy Moll : It does. Thank you. And as a follow-up, I wanted to pivot to the margin outlook that you gave. So this is on an adjusted EBITDA basis. You've reported 22% in the second quarter. Guidance for third quarter is, again at roughly the 22% level. And then if you look at what's implied for the fourth quarter, just based on the full year, it's a number well north of 22%. So a margin improvement from Q3 to Q4 would be implied by your outlook. And I'm just curious what the drivers there might be. Is there incremental price here assuming, is it just is the supply chain -- elevated supply chain expenses you expect to get better? Or is it something else? Thank you. Anders Gustafsson : Yes, Tommy, if you look at our Q3 guide of 22%, I'd say just if you look year-on-year, it's up 30 bps from the last year. And when you dig into that, over 2 points increase from strong volume leverage, the pricing benefits, taking traction from what we've executed over the last 9 months, as well as we're seeing solid improvement in the underlying gross margin across the portfolio, but that's offset by nearly 2 points of FX, as we're forecasting slightly above parity. And Q3 is the first quarter where the premium supply chain costs have a neutral impact year-on-year. Sequentially from the second quarter, it's flat -- as you get some improvement from -- improvement in overall premium supply chain costs, but that's offset by FX and slightly unfavorable deal mix. So that's kind of your Q2 to Q3 dynamic. If you look at the fourth quarter, the rate increase is really driven by two dynamics. One would be continued improvement in overall premium supply chain costs, as we are taking actions here in the third quarter to reduce air freight, moving print ocean that you'll see the benefit for in the fourth quarter, as well as you get nice volume leverage sequentially in terms of revenue -- increased in revenue on a relatively flat OpEx profile. So a bit -- almost half the driver is volume leverage with the other half being continued improvement in overall cost position. Operator : The next question is from Andrew Buscaglia of Berenberg. Please go ahead. Andrew Buscaglia : Hey, good morning, guys. Anders Gustafsson : Good morning. Andrew Buscaglia : So I like to -- on that margin question. Just wondering throughout the quarter what you saw in terms of the higher supply chain costs and freight costs. Your guidance of $200 million it seems that would imply things hadn't really changed, or how would you characterize how the quarter went relative to your expectations? Anders Gustafsson : Yes. So both of the supply chain costs in the second quarter, I think first we saw a 20% reduction in the cost profile from the first quarter on a 4% higher sequential revenue profile. So I think, sequentially, we're seeing the improvement that we had anticipated in our guidance and things relative played out how we expected for the second quarter. If you look at it from a elevated shipping cost per kilo, we noted that those costs were continuing to trend down throughout the first quarter. And they held relatively flat to what we saw in March throughout the first -- throughout the second quarter. And we expect those to hold through the second half of the year. The real benefit was we were able to reduce purchases of some of the critical components on the spot market at elevated prices. And again, that was the primary driver from the improvement in Q2. And we expect that to continue to improve as we get to the second half of the year. And as I stated before, the key driver now is really managing as we increased our printer output filling up the pipeline on the ocean and start to get that benefit in the fourth quarter as it's a fraction of the cost to ship some of the larger printers on ocean versus air. Andrew Buscaglia : Yes. Okay. Okay, great. And a question on the AIT segment. So that really surprised me positively and great margin performance. But as I understand it, that segment really follows GDP if you look back to the pandemic and the pre-financial crisis. And if GDP estimates are slowing broadly, what do you foresee in that segment going forward? Are we seeing -- is there a lag here where that might deteriorate that growth? Anders Gustafsson : Well, first, I'd say that, to talk about all our product categories here that we drove nice growth across all the major product categories in Q2 and we continue to drive innovation across the portfolio. That's all helping to digitize and automate our customers workflows. And they are -- our solutions are that much more critical today as our customers are fighting labor shortages and inflationary pressure. For print specifically here, we did see very strong growth in Q2. We had nice recovery from a challenging Q1 supply situation and we had record revenues in Q2, and we manufactured and sold more printers than we've ever done in any quarter historically. And we do expect the backlog to continue to return to more normal levels or recover the delinquent backlog and also to start shipping more on ocean in Q3 and Q4. As printing has -- maybe has grown faster than GDP by a couple of percentage points, at least over the last many years, we continue to see printers having an attractive growth profile. And we have -- weâve been gaining share steadily over a long period of time. And I see no reason for why we shouldn't be able to continue to do that going forward also. So I feel good about our printing portfolio and the positioning and the growth we should be able to drive. And I'll also ask Joe, to give some perspectives here. Joe Heel : Yes. Andrew, I might also point towards opportunities that we have to continue to expand in areas beyond a pure GDP growth. I'll give you two examples. One would be a use case expansion, where we can continue track and trace is becoming increasingly important, for example, in pharmaceuticals, and expanding in those use cases can help us grow beyond GDP. And another one would be a segment expansion, for example, our entry into the SOHO printer market would be evidence of that. So I think we have opportunities to weather volatilities in a GDP. Operator : The next question is from Erik Lapinski of Morgan Stanley. Please go ahead. Erik Lapinski : Hi, team. Thanks for taking my question, and congrats on the quarter. I'd like to ask for just a little bit more detail on some of the varying regional growth drivers you saw in the quarter. International growth is particularly strong and understand different regions are in different phases of their investment cycle. So are you seeing similar trends driving growth in each region on a vertical basis? Are there certain verticals driving the strength in whether it's EMEA, or Asia Pacific that you saw in the quarter? Anders Gustafsson : I'd say there's certainly some common themes across all if you look at digital transformation, that is a strong driver for us and the trends around digitizing and automate meeting workflows, or across all regions and across all verticals. So there's a lot of commonality, I'd say in what's driving that each region has slightly different profiles as far as what verticals are strongest, and so forth. But if you look at Europe, or EMEA, which was particularly strong, a great quarter, we saw print, mobile computers and services were very strong from a product perspective. We secured a number of very attractive retail wins. And Iâd say the European or EMEA performance was particularly noteworthy considering that we also had low single-digit percent in global impact on revenues from suspending shipments to Russia in March. Asia Pac, I'd say also very strong performance, particularly if you think of the shutdown in China for a good part of the quarter. Now we did see double-digit growth across mobile computing and scanning. We had record hardware and service revenues. We did see very strong growth in India and quite pleased actually with China, which was down low single digits, even though we were lockdown for 6 to 8 weeks. And now we're seeing very nice recovery in China as we move into the second half year. And maybe on North America just say that we saw a very solid broad based demand. We had strong wins across all our core verticals, and we also saw attractive strength in our run rate business. The results here were impacted by supply chain constraints and some over allocations, some were on timing. But we recovered very nicely in printing and so strong growth in data caption or equity. And for North America, the biggest impact is really recycled some very strong prior year comparisons, USPS was particularly strong in Q2 of last year. I donât know, Joe, would you have anything to add? Joe Heel : Yes, I would only emphasize that the regional distribution of growth that we saw in Q2 is not reflective of the underlying demand situation, but much more reflective of how we allocated supply in times of shortage based on the shortest path that we have to get supply into a market. Erik Lapinski : Got it. Thanks, Joe. That was actually going to be my follow-up. But maybe if I could also ask just on capital allocation, as we think about the Honeywell settlement, obviously, that's a modest drag on cash flow. But you've -- your share repurchases in the quarter were maybe a little bit higher-than-expected. M&A has been successful. Was there any change in over the last quarter or how you're thinking about allocating capital and cash flow? Or should we think similar priorities to normal? Anders Gustafsson : We think similar priorities as normal, we were comfortable with the overall debt levels and cash positions that gives us a lot of flexibility as we enter the second half and into next year. To continue to priorities investment in the business both inorganic, organic, we have exciting opportunities in both of those and share repurchases will remain a nice flexible way to return capital to shareholders. So I'd say no change in the overall capital allocation approach as we go into the second half of the year. Erik Lapinski : Thank you. Operator : The next question is from Brian Drab of William Blair. Please go ahead. Brian Drab : Hi, thanks for taking my questions. And they might seem to lean a little bit cautious, but that's just because that's what we're hearing from investors right now across the board. But, first question, just under visibility, can you remind us, in general, what is the lead times for the different product lines and maybe for large orders versus the run rate business? Just trying to get a sense for how soon will you know if there really are challenges in some of these end markets? Anders Gustafsson : So, if are you looking at our visibility into kind of our pipeline, it certainly varies to some degree based on customer and so forth. But for our larger customers, and a large part of the market, we start the year by going through and having detailed reviews about their outlook, their investment profiles already in November, December the prior year. So we have a good perspective of what they expect to do for the year, and we stay close to them to see if there are changes. Obviously, they can always change, but it's we tend to have a good visibility from those. And we work very closely with our reseller partners to develop a pipeline for that is more than 12 months out. And we qualify that round, we are in the sales pipeline those deals are, so they something we feel we can commit to or they are more in the exploratory phase. So we tend to have a pretty good handle on that. We also have such a large volume of transactions, so we get statistically some differentiation or diversity from that, which helps. So we're not overly -- we don't -- we wouldn't necessarily over read any one signal here. I donât know, Joe, do you want to comment on that, add anymore? Joe Heel : Yes, I mean, first, I would just remind that we still have a record backlog, right. So in terms of what's driving our demand for the next quarters, that is still a very dominant force, for visibility to new orders. One good thing about the pandemic is that it has driven our customers to be much more forthcoming with their expectations of their business. We now have much better visibility than we had before, with some customers giving us up to a year's worth of at least visibility in some cases, even orders. So that's -- whether that will relax again a little bit as supply becomes more available. We'll see. But at the moment, we're enjoying much better visibility quarters ahead in many cases. Anders Gustafsson : And I'd say the bookings velocity has remained pretty stable this year. So it's very strong. We haven't seen evidence of a recession or predict a slowdown. Joe Heel : Yes. Brian Drab : Okay, thanks. That's all very helpful. And then can I just ask if you can, and I know thatâs sensitive because it's a legal issue, but around the settlement, it seems like a pretty big, big deal. And it's a large -- very large settlement. And can you make any comments as to what happened there? I guess it's primarily with the related to the scanner product line. And just wondering, can you comment at all, does that change the competitive dynamics going forward for that product line? Anders Gustafsson : So first, you're right. We wish we can say very much on that. It's a confidential agreement. But what we did settle a number of competing lawsuits with Honeywell regarding alleged patent infringement. We agreed to pay $360 million, paid over eight quarterly installments started in q2 of this year, so last quarter. And going forward, we have a royalty free, both of us enjoy a royalty free cross license, that means there's no future impact or payments. And you should just remember them from a size of the payment here that this is reflecting the relative size of our business. We are that much bigger, our market is that much larger. So that has a direct impact on that from a competitive perspective, but I don't see that having an impact. We feel very good about our portfolio, competitive positioning and our innovation. Our customers certainly resonate with our vision and our direction. So we feel good about where we are. Operator : The next question is from Paul Chung of JP Morgan. Please go ahead. Paul Chung : Hi, thanks for taking my question. So just on your EBITDA guide, it's at the low end guide, though your free cash flow kind of adjusting for the settlement was unchanged. So you could talk about the execution on free cash flow, and kind of your expectations of how working cap levels to kind of trend as we move into '23? Nathan Winters : Yes, so if you look at our free cash flow, again, the -- for the first half decrease in relative to what we expect in the second half was really around the higher use of working capital and the timing of sales, as particularly in the second quarter with the China lockdown. I mean, June was one of our, I think, our highest revenue quarters on -- in history, just given the delay of getting products out of China into ship. And that obviously has a drag on from a collection of timing. And we expect that to normalize as we go into the second half of the year. And so that's -- that'll be a big driver of the increase in cash flow as we go to the second half of the year. And I would say, overall we target 100% free cash flow conversion over a cycle. We've been over 100% the last several years, if you go back to 2020 over 130 last year over a 100. This year if you normalize for the settlement around 80%. So I think, again, what we'd expect next year to recover back closer that 100% range is that we target. But obviously you can't say above a 100% forever. So this is a little bit of a year of catching up for the outperformance in the past couple of years. Paul Chung : Got you. And then another question on guidance for both Q3 and the year. Can you help us kind of understand the gross margin versus kind of OpEx dynamic? Should we expect kind of a more modest progression here from 2Q on gross margins? You mentioned some lapping of high freight costs from Q4 of last year, but you have some FX impact here. So how do we think about gross margins for the year down maybe 100 basis points for the full year then OpEx pace maybe similar to the last quarter. I think you said flat. Was that quarter-on-quarter? Thank you. Nathan Winters : Yes, I'd say if you look at from a gross margin perspective, I think actually look at total Q3, both gross margin and OpEx from a scaling and rate perspective will be similar to Q2 and thus the similar in terms of EBITDA rate of around 22%. And as we go into the fourth quarter, you'd expect both to improve as the -- as we're able to lower some of the supply chain costs, that'll be an improvement on gross margin. And then we'll get some nice OpEx scaling as we head into the fourth quarter as we expect costs to remain relatively -- OpEx remain relatively flat from a dollars perspective as we go through the second half of the year. So those be some of the dynamics as we play through the third and fourth quarter. Operator : The next question is from Keith Housum of Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. I was hoping to unpack your second -- your third quarter guidance a little bit more of a 2% to 4%. I think, Nathan, you referenced that you guys are limiting growth to that, so you guys can move more toward the ocean freight. I guess how much of the -- of that movement actually is impacting your guidance there in terms of your top line guidance? Nathan Winters : If you look again at this, we said Q3 2% to 4%, again, we said we're entering the quarter with a strong backlog bookings around 4% organic growth. So nice results considering the loss of Russia about 1 to 2 points as well as a strong prior year compare for Q3. And, again, the actions we're taking are really around late in the quarter to avoid some of the premium air costs that are sometimes necessary to get product over and deliver before the quarter as well as the shift in moving print to ocean, so obviously that takes a few extra weeks from a timing perspective. So this is really around, what will be delivered late in September versus into October. And we think that's the right trade off for the business long-term, as at some point you have to rebuild that funnel. And that value and benefit will obviously impact Q4 and be a big driver as we head into next year as well. So tough to quantify what that is. And we're still working those plans out here over the next month in terms of exactly how much we anticipate to get onto the ocean. But, again, that's where we're really limiting that sales growth to push some of that volume to the fourth quarter to take advantage of the lower freight costs. Keith Housum : Okay. Nathan Winters : But it's clear that we do have -- we have the order coverage, therefore, this is what we're looking at supply chain and optimizing our cost profile. Keith Housum : Right. So are you saying then orders that is not impacting your growth would have been higher in the third quarter for your guide, if not this move? Or this does impact ? Nathan Winters : That's right. Thatâs right. Yes, the conscious decision to limit Q3 growth in order to improve the cost profiles are going to the fourth quarter. Keith Housum : Okay, got it. Nathan Winters : It's also a driver for why that you see a relative strength of Q4 rep versus Q3 on top line growth. Keith Housum : Right. So will the entire move to the ocean be complete then by the end of the third quarter? Nathan Winters : No, I'd say by the end of the fourth quarter. It'll be building the pipeline in the third quarter, so as we go into next year we're in a healthy position. Operator : The next question is from Jim Ricchiuti of Needham & Company. Please go ahead. Jim Ricchiuti : Hi, thank you. I know it's early days with the Matrox acquisition. But I wonder how you would characterize the progress you're making in the machine vision market. And that tends to be -- industrial machine vision tends to be a little bit more sensitive to economic cycles. And I wonder how you're viewing the demand trends in that part of the business? Thank you. Anders Gustafsson : We closed on Matrox in early June. And so, we have to 2 months into this and they've helped to create a very comprehensive portfolio of both fixed industrial scanning and machine vision solutions for us. I'd say we're very encouraged, by the first 2 months. The integration is going well. The feedback from our customers have been very positive and we are continuing to build out the partner network. So that's a great story really around how the partners we have started to sign up for our fixed industrial scanning portfolio. See great value of being able to add machine vision to their portfolio, so they can address many more of the opportunities they see from customers with our solutions and equally from a Matrox perspective that they would have the same opportunity to add fixed industrial scanning to their fixed industrial machine vision portfolio. So feel very, very good about where we are and I think the culture are meshing very well. And Joe any further? Joe Heel : Yes, I would perhaps add the following sort of from the outlook perspective. Matrox is refocused on the manufacturing sector, and has a good strength there. And we complement them very well, because we are now able to introduce them to customers in the T&L sector, in particular. And the cyclicality of those two is again different, and therefore provides us with some opportunity to continue growth through diversification between the two companies. So that's a strength we're building on. Anders Gustafsson : And there's also Matrox has similarly a strong backlog as we have on a relative basis, of course. Jim Ricchiuti : Thank you. Just follow-up question on RFID, which you call that and having calling out is as strong over the last several quarters. I know you don't break out the size of that business, it straddles both areas of the -- both the -- both parts of the business. But in general, can you give us, I wonder, a growth rate for that business? And are you seeing the profile change in terms of the types of applications? Nathan Winters : Yes, RFID has -- we've had seen great momentum around RFID for several years now with a little toss in Q2 2020 I think when we couldn't really go in and do work directly with customers. But it's been a very strong part of our portfolio and market. We know growth has been double digits and solidly in the double digits for us for quite a while. So it's still a relatively small part of our portfolio, but it is a growing part of it. You've seen some large companies publicly announce plans around RFIDs like Walmart and UPS, which is helping to drive greater momentum also around it. So retail has been the primary or the first vertical to really deploy RFID around inventory visibility, some around the checkout area as well. So -- but we are seeing RFID expand into health care, transportation logistics, manufacturing, and also globally it's not a -- this is not a U.S phenomenon say, this is something we've seen across the world and Joe anymore color? Joe Heel : I think you've covered all of the areas. Operator : The next question is from Rob Mason of Baird. Please go ahead. Robert Mason : Yes, good morning. Just one quick question on Matrox. The -- in the reference around full year EBITDA margins and how you're guiding there, you did reference FX, but as well as the recent Matrox acquisition. How long should we think about that Matrox acquisition being a headwind on EBITDA margin to the extent that's the case? Should we start to see that not deep so as we move into next years if you're going to continue to invest there? Nathan Winters : Yes, I think if you look at the guidance for the second half, Matrox is accretive to our overall EBITDA margin. So that's -- but it was more than offset with the impact of FX just given the relative size and impact. So it's not a headwind from an EBITDA rated. But it's neutral from an EPS perspective, particularly with as we -- until we pay down the debt from the debt cost. So -- but from an EBITDA guide, it was partially accretive from the last outlook. But again, that was more than offset with the headwind from FX. Robert Mason : Okay. Okay. Thanks for clarifying that. The -- and then just I will stay on maybe the cost side, just as the logistics or the premium logistics costs come down, looks like they will continue to trend down into the fourth quarter. And again, as you may be referenced, realigning your print transportation mode, should we expect that those logistic costs would continue to decline into 2023-ish, just based on what you're seeing right now, Nathan? Nathan Winters : Yes, I think if you look at the -- if we break it into three components, one of those is what are the things we can control, which is limiting the amount of buy we do on the spot market as we work with our direct suppliers. And that's one of the benefits you saw from Q1 to Q2 in the second half. So that we expect to continue to decline. Moving print to ocean, again, is another thing that we can control that we'd expect to improve. I'd say we're not expecting at least, anytime in the near future, the kind of the underlying rate or cost per kilo to improve. I don't think you'd see until there's a significant increase in capacity -- global air capacity, while you see that rate improvement that's part of the reason we did the price increase in July, was to begin to offset that with a pricing increase. So that's the other benefit driving some of the margin as we get into Q3 and Q4 as the overlays of the pricing action. So again, two of the three variables we can control and expect to continue to improve the one around kind of that underlying air rate, I don't expect to see material improvement in that until you see something changing capacity. And that's the reason for the price increase on our side. Robert Mason : Very good. Thank you. Operator : The next question is from Damian Karas of UBS. Please go ahead. Damian Karas : Hey, good morning, everyone. Just wanted to ask a follow-up on the changes to how you ship product. Because, Nathan, I know you've mentioned in the past for your business, increasing passenger travel was a key to getting that improved cost and margin profile. And it does seem consumer travel is picking up a bit. So just curious, this decision around the ocean shipment is -- would you be that as more transient kind of a tactical change? Or are you really making a more permanent structural change to the business? Nathan Winters : The are moving or printing, you can think the large tabletop desktop printer to ocean that's how we've historically shipped it before the third quarter of last year. So 80%, 90% of that we shipped on ocean just given its relative weight. So irregardless of the rates, it's cheaper to put on ocean versus air, given the size and density of those products. The rest of the portfolio has always primarily been shipped on air via air and so that's again where those air rates were apart. So, Iâd say we're going back to our normal modes of -- normal modes of transportation, with this shift here as we go to the second half of the year, Anders Gustafsson : Just one more comment on that. The reason we started putting printers on air was a based on long lead times. So that was to make sure we could prioritize meeting customer expectations of customer demand. But the intent was always to move it back to ocean as soon as supply chain constraints started to ease up a bit. And on the air capacity, certainly in, say in the U.S., and I think part of Europe, you're seeing passenger travel increase. In and out of China, I don't think we've seen a big increase and that's where the biggest bottleneck is. But we do hear, let's say, Hong Kong is looking to add more air capacity, so there will be a slight benefit to us. Damian Karas : Got it. Got it. And just to clarify, so you haven't taken any further pricing actions or plan to take any further pricing actions. It's still kind of the three rounds of increases that you previously spoke to? Nathan Winters : That's right. The last one just went into effect at the beginning of this month. And again, we'll continue to monitor if any additional necessary. I donât know, Joe, you want to â¦? Joe Heel : I was just saying this last month, beginning of July. Nathan Winters : Beginning of July -- excuse me, beginning of July. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for closing remarks. Anders Gustafsson : To wrap up, I would just like to thank our employees and partners for their extraordinary efforts to serve customers and deliver a better-than-expected Q2 results. We continue to focus on prioritizing our customers mission critical needs and scaling our vibrant expansion markets. And we would also like to wish a warm welcome to the Matrox Imaging team. Thank you everyone. Operator : The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,022
| 4
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2022Q4
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2022Q3
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2022-11-01
| 18.552
| 18.353
| 20.246
| 19.888
| 27.8
| 15.33
| 14.88
|
Operator : Good day, and welcome to the Third Quarter 2022 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this that is being recorded. I'd now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's third quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our third quarter results. Then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence Vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, everyone, and thank you for joining us. For the quarter, we realized a sales decline of 3%, and adjusted EBITDA margin of 21.1%, a 60 basis point decrease; and non-GAAP diluted earnings per share of $4.12, a 9% decrease from the prior year. We were unable to fulfill all orders due to supply chain challenges related to persistent component shortages for certain products as well as disruption in the transition to our new North American distribution center in the Chicago area. These challenges led to lower throughput than planned late in the quarter. This, along with orders from some large customers being deferred contributed to the lower-than-expected results. In North America and EMEA, cycling two prior year large mobile computing deployments and suspension of sales in Russia resulted in the sales declines. Our Asia Pacific and Latin America regions were bright spots in the quarter with double-digit sales growth. Globally, we realized sales growth with our small and medium-sized customers, which was more than offset by a decline from our large customers. From a solutions offering perspective, we drove growth across data capture, printing, supplies, services and software. These helped to partially offset the sales decline in mobile computing. We expanded gross margin over the prior year, despite significant FX pressure, yet EBITDA margin contracted and EPS declined due to the deleveraging of operating expenses from the sales decline. We have initiated meaningful actions to address the supply chain challenges, which was the primary driver for our results. These include, organizational changes and the reallocation of resources to drive improved focus and execution in our supply chain, initiating specific actions with our supply chain partners to improve operations and extending the planned transition of our North America distribution center to mitigate execution risk. Customer demand and our order pipeline generally remains healthy, yet has slowed since late Q3. Given the macroeconomic uncertainty, we see elongated sales cycles and certain projects being deferred. As a result, we are taking a cautious approach to our Q4 sales outlook and expense management while working to rightsize our working capital levels in the coming quarters to improve free cash flow conversion. At the same time, we continue to prudently invest in initiatives that advance our solutions offerings. With that, I will now turn the call over to Nathan to review our Q3 financial results in more detail and discuss our fourth quarter outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 6. In Q3, adjusted net sales declined 4%, including the impact of currency and acquisitions and down 3.2% on an organic basis, primarily due to supply chain challenges and lower sales to large customers. Our Asset Intelligence and Tracking segment increased 12.4%, driven by double-digit growth in both printing and supplies as product availability has continued to generally improve. Enterprise Visibility & Mobility segment sales declined 8.8% due to supply chain bottlenecks, including component shortages. We realized particularly strong growth in data capture solutions, including RFID and as well as rugged tablets. We also drove growth across services and software with strong service attach rates and attractive software offerings. Performance was mixed across our regions. Asia Pacific sales grew 20% with broad-based strength across the region, including China. Latin America sales increased 10% with exceptional growth in Mexico. And in North America and EMEA, sales decreased 9% and 2%, respectively, due to the supply chain challenges, lower sales to large customers and the suspension of sales in Russia. Adjusted gross margin increased 80 basis points to 45.8% and due to favorable business mix and lower premium supply chain costs, partially offset by unfavorable FX. Adjusted operating expenses increased due to acquisitions and delevered by 60 basis points due to the sales decline. Third quarter adjusted EBITDA margin was 21.1%, a 60 basis point decrease from the prior year period due to expense deleveraging on lower sales. Non-GAAP earnings per diluted share was $4.12, a 9.5% year-over-year decrease. Turning now to the balance sheet and cash flow highlights on Slide 7. For the first nine months of 2022, we generated $170 million of free cash flow, which was significantly lower than last year, primarily due to a higher use of working capital due to elevated inventory and sales volume shifting to later in the quarter. Higher incentive compensation payments given our exceptional 2021 performance and $90 million of previously announced settlement payments. We made $50 million of share repurchases and invested $6 million in venture investments in the third quarter. We ended the quarter at a comfortable 1.7 times net debt to adjusted EBITDA leverage ratio and with more than $1.2 billion of capacity on our revolving credit facility. On Slide 8, we highlight that premium supply chain costs have improved from peak levels. The actions we have taken to redesign products, targeted price increases as well as the improving freight capacity have enabled us to reduce purchases on the spot market and reduce the freight cost impact. We are on plan to move printer shipments to ocean from air late this year and into early 2023. For the full year 2022, we now expect approximately $190 million of premium supply chain costs over pre-pandemic 2019 levels, a $10 million reduction from our prior outlook. In Q3, we incurred premium supply chain costs of $30 million as compared to the pre-pandemic baseline, which was favorable to what we had anticipated in our prior outlook. In total, Q3 transitory items had a combined favorable gross margin impact of $14 million year-over-year. And in Q4 are expected to be approximately $35 million, which is a nearly $30 million reduction year-on-year. Let's now turn to our outlook. Q4 sales are expected to be approximately flat from the prior year period, with a range of negative 2% to positive 1% growth. As compared to our prior outlook, the lower sales growth is driven by softening demand, continued supply chain challenges and currency headwinds. We are confident in this guide given our relatively strong order backlog, improved quarter-to-date shipment activity and actions taken to stabilize North American distribution. We estimate a two-point additive impact from recently acquired businesses and a four-point negative impact from foreign currency changes. As a reminder, approximately 25% of our global sales are denominated in euros. We anticipate Q4 adjusted EBITDA margin to be between 22% and 23%, which is an increase from both the prior year and the prior quarter. Given our tempered view of the demand environment, we are taking a conservative approach to managing operating expenses while preserving strategic growth investments. Non-GAAP diluted EPS is expected to be in the range of $4.50 to $4.80. We now expect our free cash flow to be at least $400 million for the year, which we have significantly reduced from our prior outlook due to lower profits and elevated inventory levels that we will be working down into 2023 as we rationalize safety stock and execute on our North America distribution transition. Sales seasonality has improved to more normalized levels in Q4, which should drive the peak cash flow quarter for 2022. Please reference additional modeling assumptions shown on Slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence vision with our customers. Anders Gustafsson : Thank you, Nathan. The long-term fundamental drivers of our business remain strong. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, software and services. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, which have been magnified through the pandemic. This value proposition resonates with customers in any macroeconomic environment as it improves productivity and inventory accuracy among an extensive list of other operational benefits. As we have expanded our portfolio with compelling solutions, we have elevated our strategic position with our customers. Our trusted relationships with our partners across the globe augment our capabilities, enabling us to serve more customers worldwide. Our new fixed industrial scanning and machine vision solutions resonated well with customers and partners at recent trade shows in Stuttgart, Germany and Boston, Massachusetts. Our booths featured advanced optical character recognition supported by deep learning capabilities gained through our 2021 Adaptive Vision acquisition. Our comprehensive offering has put us in a strong competitive position. Now turning to Slide 12. Businesses partner with Zebra to optimize their end-to-end workflows as they strive to meet the increasing demands of consumers. Zebra solutions continue to represent a necessary investment, and I would like to highlight several recent key wins across our end markets A large North American retailer recently selected Zebra's TC52 mobile computers for their stable network connection, durability and camera performance. This customer maximizes value from Zebra solutions by combining our mobile computers with our Reflexis workforce and task management, Zebra Prescriptive Analytics and Intuit software. This combination enables the retailer to improve inventory accuracy and the omni-channel shopping experience for their customers. A North American-based fast food chain has chosen Zebra's handheld RFID solution to enhance inventory management. This solution will enable each restaurant to reap the benefits of a more digitized supply chain by streamlining the process to track and trace inventory from its suppliers to the restaurant. Adoption of this technology will assist the customer to comply with the Food Safety Modernization Act. A transportation company in Europe has begun rolling out approximately 20,000 mobile tablets to streamline their vehicle rental process. Zebra's exceptional service and integrated product offerings displaced a competitor and will enable associates to complete vehicle workarounds inspections in the reservation process more efficiently. The convenience store chain in Latin America is expanding their use of Zebra solutions from the distribution center to the front of store with more than 50,000 Zebra mobile computers, printers and tablets. Deployment of these Zebra solutions is expected to significantly increase productivity, inventory accuracy and improve shopper satisfaction. Zebra's Mobility DNA software, which enables intuitive device management and our compelling customer value proposition were key differentiators in this competitive win. Apparel manufacturer, BMC, recently selected Zebra's autonomous mobile robots and fixed industrial scanners for their new 50,000 square foot North American facility. Zebra collaborated with a major partner to develop a solution that would enable a flexible workflow and enhanced visibility along each step of the production line. By combining our autonomous mobile robots and fixed industrial scanners, BMC will realize powerful synergies with scanners tracking each step of production in directing the robots along the workflow. The robots streamline associates movements, enabling faster fulfillment. This flexible and scalable solution was preferred to a traditional fixed conveyance system because it saves a vital warehouse space and adjusts to demand. Additionally, we recently secured a large win with a major European retailer who selected Zebra's fixed industrial scanners to significantly reduce scan time, increasing throughput at several thousand packing stations, resulting in a faster than one-year payback on investment. Zebra's collaboration with the customer and a valued partner was integral to this competitive win. As we turn to Slide 13, I want to reiterate that the actions we have taken to address our challenges with North American distribution, elevated inventory levels and increased macroeconomic headwinds. We have executed key organizational changes and have initiated specific actions with our supply chain partners to stabilize operations and reallocate resources to address immediate challenges. We are also taking decisive steps to rationalize inventory while maintaining optimal levels of strategic components. Additionally, we are taking prudent cost actions as we realized softening demand and implementing additional pricing actions to address FX and inflation. In closing, we continue to be very optimistic about the prospects and opportunities for our business. We have the broadest portfolio of tailored solutions to enable our customers to improve their operations in any environment. The global labor deficit and on-demand economy have escalated the need for enterprises to digitize and automate their operations with our solutions. Now I will hand the call back over to Mike. Mike Steele : Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Tommy Moll with Stephens. You may now go ahead. Tommy Moll : Good morning and thanks for taking my question. Anders Gustafsson : Good morning, Tommy. Tommy Moll : Anders, I wanted to start on the comments you made regarding some deferred projects from large North American customers. Any context you can share there on end market type of project visibility to picking back up on some of this work going forward would be much appreciated. And as a related point, would you say that these projects are all the majority of or a smaller part of the demand softening that you called out late Q3. I'm sure it's part of what you described there with the softening, but order of magnitude would be helpful. Thank you. Anders Gustafsson : Yes. First, I'd say the -- we're getting some mixed signals from the market on on-demand pictures and that's, to some degree, clouded by the supply chain challenges we're seeing. But most signals, most demand signals we are seeing are constructive. Our backlog is healthy. Our pipeline is building nicely. Our run rate business is strong. And we continue to see some nice areas of strength in each region. And our retail vertical grew just even though we had a very large customer pulling back into this year and particularly in the quarter. But we have also seen some elongated sales cycles and a bit of softening in demand where some customers have pushed out some orders from Q3 into 2023. So the -- I think most -- I'll ask Joe for some extra color here also as most of those pushouts have come from the retail segment. That's also our largest segment, so it wouldn't be surprising and they tend to have more of the year-end spend that they're working on. So the overall environment is still quite healthy, but we have seen some select pushouts, Joe? Joe Heel : Yes. To put it in perspective, perhaps in terms of the miss to the outlook, the deferral of project was a minor contributor to that. Among these -- the deferral of projects, these late-in-the-quarter deferments were a relatively small number of larger projects, as Anders said, deferred primarily into 2023. That's probably as much as we can say. Tommy Moll : That's helpful. Thank you. As a follow-up, I wanted to pivot to supply chain, and you gave us quite a bit there on the North American distribution center transition. Can you give us any more -- just on the ground context in terms of the transition that's underway, some of the changes that you've made as a consequence of some of the challenges that you called out? And then I think, Anders, I heard you reference that there have been some personnel changes on this front. Anything you could highlight there would also be helpful. Thank you. Nathan Winters : Tommy, this is Nathan. I'll start with the first part. Just a little bit of background. We selected a new DC location midway through last year. And as we said on the call, we had some issues with the transition impacting shipment volumes late in the quarter, and we've implemented corrective actions, particularly on ramping back our Texas facility. That gives us some additional time to work through the transition, both from a people and process perspective. So again, I'd say although we didn't deliver the shipment volumes necessary to meet the Q3 forecast. We are now operating at levels required to deliver Q4. Still not where we want to be. But again, the Texas facility is nearly staffed to full capacity and we've had a really nice recovery here in deliveries in October. Just as context, we've shipped out nearly $200 million more in October than we did in the month of July, which is giving us both confidence in the performance of the DC as well as confidence in the Q4 guidance. I'll pass it over to Anders. Anders Gustafsson : Yes. From an organizational perspective, we have made some changes. We have promoted a new supply chain leader who leads our global operations and supply chain team. So -- and we have also streamlined the organization a bit and moved some functions or responsibilities out of supply chain to other areas to make sure we can get greater focus and better accountability around those. We've also worked closely with our supply chain partners to make sure we take some actions with them to help improve the operations. One that Nathan talked about was ramping up our Dallas Fort Worth facilities. So they're back at close to full capacity. They're almost fully staffed and operating very well at the moment. And we're working with our Chicago area, DC partner also to see how we can best help them scale their operations there. Operator : Our next question will come from Andrew Buscaglia with Berenberg. You may now go ahead. Andrew Buscaglia : Hey, good morning, guys. Anders Gustafsson : Good morning. Andrew Buscaglia : So just trying to get a sense of how much of the sales change that you've seen is related to like I guess, the nature of the deferrals and the confidence that you're going to get these orders in 2023? And I guess the phrase another way, how much is this kind of the beginning of more to come, or based on the visibility you have with these customers, do you have confidence, this is like short-term issue. Yes, it's I don't think we want to get into too much of 2023 outlook yet. But I think these have been more select customers. There's not a broad-based, say, pushout or deferrals. It's much more select on certain customers and some tougher -- particularly in Q3, we also have some very difficult comp from two large customers that were particularly strong in the third quarter. But as we said, most of our demand signals are still very strong and encouraging. And we see -- it's been -- this was really very, very narrowly focused in North America. Joe Heel : Yes. I'll add two things perhaps for perspective. One is an example of what we're seeing is a large customer who will take an order that they would have perhaps placed in Q3 or early in Q4. And now telling us we're going to split that order, and we're going to take 80% of it now and 20% of it later in 2023. That's an example of the type of thing we're getting. So it feels like there's real demand behind the order. The other thing that we're hearing from customers quite consistently is while some customers, in particular, retailers are being cautious about their business, about their revenue expectations, and those are obviously visible to you in what they say on their earnings calls. They are telling us that their investments in IT and in the types of solutions that we provide them are important to them even in more uncertain times because they need to improve their productivity, and we help them do that with our solutions. So that's certainly something we hear pretty consistently. Andrew Buscaglia : Okay. That's helpful. And you talked about last quarter and I guess this quarter again, being able to shift by -- mostly by ocean exiting Q4 I guess, where do you stand with that? And then tailwind-wise in 2023, I know you don't want to give guidance for next year, but like what -- how do you expect the cost environment to shape up for next year. And hopefully, maybe do you think that offsets some of this volatility around the sales you'll see over the next six months or so. Nathan Winters : Yes. So Andrew, maybe just context for the broader premium supply chain costs. I think what we saw in Q3 was a positive momentum, 50% reduction from what we experienced in Q2, decreasing from nearly 4% of revenue to just over 2%. And that was primarily driven by the declining shipping cost per kilo, which we're experiencing as well as benefiting from the pricing actions beginning to take effect with the price increase we did in July. Q3 shipping costs did come in below estimate. We also benefited, if you look at the mix and the $30 million for the quarter from lower North American revenue, and that's the other reason for it ticking back up in the fourth quarter in terms of overall transitory. And our Q4 guide assumes no improvement in freight rates. So it's something we're continuing to monitor it. But if you look at the overall reduction from $200 million to $190 million in premium supply chain costs, some of that's volume driven, just over half, but also $4 million of that or so was due to the lower rates we're experiencing. And I think our expectation is that we will see steady reduction into 2023 around these costs as long as the freight rates hold where they're at today. And then we're going to continue to transition from air to ocean, really late here in the fourth quarter. We did some ocean shipments into Europe in the third quarter but we really don't expect ocean shipments to pick up until late here in the fourth quarter and into 2023. And we've also seen a nice reduction in what we've had to buy in critical components on the spot market. So we're starting to see that loosen up as well. So again, we feel confident that we'll see a steady decrease. And EBITDA benefit as we go into next year. Operator : Our next question will come from Jim Ricchiuti with Needham & Company. You may now go ahead. Jim Ricchiuti : Hi, thank you. First question, just again on the deferral that you're seeing among a few of these North America customers. When you talk about it, some of this business slipping into 2023, is the presumption that this would be slipping further into 2023 into the second half just given the seasonal investments that these types of customers may make? Anders Gustafsson : I think it's -- probably don't want to give too much color on that also here at this stage, but the expectation is that won't -- they're slipping from this year into the beginning of next year, not the end of next year. I would agree with that, yes. Jim Ricchiuti : Okay. That's helpful. And Anders, I wonder if you could talk to what you're seeing in the SMB market. It sounds like you're seeing relatively good demand there. I don't want to put words in your mouth, but if you could comment on that. And also in an economic cycle, which part of the business would you see impacted more immediately, the larger customer business or the SMB business? Anders Gustafsson : Yes. Starting with the SMB business, yes, we did see strong growth globally for our small- and medium-sized customers. I think that's a good indication of kind of the confidence the broader market has in the outlook and the value that our solutions offer. The secular trends that we talked about to digitize and automate workflows and empower the frontline workers are, I would say, much more important today in a labor-constrained environment as that drives greater increase for our type of solutions across all verticals and all sizes of customers. And I think the our run rate business performed particularly well globally this quarter, which I think is -- gives us confidence around the health of the business. If you talk about kind of which verticals would be more or less impacted, I'd say, we probably get them -- gotten the most questions around our retail customer base, historically in this. And here, I mentioned earlier, our retail and e-commerce business grew in Q3 despite very challenging comps from the very large -- particularly large retailer that has been pulling back. And I think that highlights the value of having a very diversified retail e-commerce customer base, where the timing of the refresh cycles is kind of spread out and that helps to reduce volatility risks. But I think the -- in retail specifically, the focus on -- or the importance of our type of solutions to enable our customers to execute on their omni-channel and e-commerce strategies is very important. I've talked about how we believe that our solutions are now more like, say, an ERP implementation, it's harder to dial them up and down. And I think the results from Q3 gives some credence to that expectation. I'd say our health care business, which performed very well in Q2 -- in Q3, sorry, was up double digits. That is probably the vertical we expect to be the least sensitive to – to kind of recessionary forces. And here, we are also very focused on helping to transform that industry to – to be able to improve the patient journey and drive greater productivity for health care providers. The T&L vertical is -- there was one that was the hardest hit was the only vertical that was down for us in Q3. But e-commerce volumes are expected to continue to increase, and that drives greater need for real-time visibility into their overall supply chain and is a key driver for customer investments. And we enabled the last mile fulfillment for those customers, which is an important factor as consumers are expecting faster deliveries. And lastly, around manufacturing, that also tends to be -- it's a market that is more a largest in Asia for us, but it is global, and it's done very well for us over the last year or so and had a good double-digit growth this quarter. Here, we've made some -- both the -- some of the new acquisitions around -- from May trucks. And Fetch are expanding our offering and we're getting a lot of interest and early orders for manufacturing in those areas. And we've also made some quite significant and very deliberate investments in our go-to-market resources to help grow our share in manufacturing, and Joe can provide some more color on that. Joe Heel : Yes. Maybe I'll just amplify some of Anders' points. Number one, the growth in the medium-sized customers and also in the run rate has been particularly encouraging for us because that's where our supply constraints are particularly important, right? If you have supply, you get run rate. When we had supply return, our run rate rebounded. And that was a really good sign of the resilience of our run rate. That's very encouraging for us. You asked about which size of customer goes into the cycle first. And what we saw is that as we entered into the pandemic, the largest customers were the first to accelerate their purchases. And they were followed nine, 12 months later by medium-sized and smaller customers than also accelerating their purchases. Now as we're seeing some caution in the market, it's -- again, the largest customers that are being cautious first, some of the deferrals that we've referred to and that you asked about were larger customers with large orders while the medium-sized and small customers continue to go very strong with even double-digit growth. So that's the dynamic that we're seeing in the cycle. Hopefully, that's helpful. Operator : Our next question will come from Erik Lapinski with Morgan Stanley. Please go ahead. Erik Lapinski : Hi, team. Thanks. If I could go back to kind of the commentary on the run rate business you just made, I guess, just trying to get a better sense on the strength there. Do you think that's an element of customers being further behind on investments versus larger customers than And then maybe also on that point, like when we think about deferrals from the larger customers, is that related to a refresh or a new device deployment? Any kind of color you can give us there would be helpful. Anders Gustafsson : Yes. First, on the strength on the run rate business here. I think that the -- we -- I would say we don't see our customers large or small, having say, pulled forward demand and invested ahead of their capacity utilization curves with probably one exception -- one large exception. So -- and specifically for our large -- for our small and midsized customers, they tend not to have their financial capacity to invest for in advance. So they tend to be much more as the projects roll out to address more urgent business needs for them. So that would be one point on that. Joe? Joe Heel : Yes. When it comes to the run rate, it really matters what's on the shelf, right? You have small customers that are calling into distributor and what's on the shelf counts. And once we had product on the shelf again as our supply chain ramped up again over the course of the quarter, we saw that run rate rebounding. So I think that's the dynamic that there's no pull forward or that dynamic doesn't exist to that same extent in the run rate. When it comes to the larger customers, to the deferrals, we are talking about large customers that are typically doing deployments of mobile computers. You see it's pretty concentrated in the mobile computing segment. You have certain deployments that they have been planning and in some cases. But again, they were very few, and they were the minor reason for the miss in the quarter, right? But in those few cases, we're talking about deployments of mobile computers which are stretched out over a slightly longer time period, we think, into the first quarter of next year. Erik Lapinski : Got it. Okay. That's really helpful. Thank you. And then maybe just another one on kind of some of your OpEx flexibility. You did take down kind of expenses in the quarter and proved to be pretty nimble there. I guess just like where did you find those efficiencies in context of maybe some of the supply chain changes you're making? And how should we think about your ability to control OpEx in future quarters kind of sensitive to revenue? Nathan Winters : Yes. A couple of drivers behind the OpEx flexibility. I mean the first is based on our variable comp structure, there's an element of variability in there relative to how we're performing for the year. The other one is, we did a hard look at where we're hiring and what roles and what positions around the world to ensure that where we're adding heads and investing is in our growth areas that we would kind of look at and say, there's no regrets in that in terms of those hiring. So it's a combination of those two, along with, again, continuing looking at discretionary spending where it makes sense. So I think those are the three main drivers here in the short-term. And as we go into next year, we're continuing to look at where we can drive efficiencies, looking at our real estate portfolio, but all the things you would expect us to do particularly as we go into a more challenging macro environment. Operator : Our next question will come from Damian Karas with UBS. You may now go ahead. Damian Karas : Good morning, everyone. Anders Gustafsson : Good morning. Damian Karas : Good morning, good morning. Not to beat a dead horse here on the project deferrals, but could you just clarify -- one, you haven't seen any order cancellations. And two, just thinking about these customers that have pushed out orders, it sounds like you do have visibility in terms of timing of delivery in 2023, and it's not that the conversations have been, hey, let's just put this on pause until a later determined date? Anders Gustafsson : Yes. So first on the cancellation. We have not seen any large order cancellations. I think the cancellations have been very modest. And to the extent we've had any and within what we would consider to be normal. Every quarter, we have some people who cancel an order or something like that. But that's been -- that's not been a factor in the results or in the outlook here. And the deferrals they have -- they're not pause, they just deferred. So they're -- we're expecting them to come back in the first part of next year. And the -- it's not like -- they are deploying, in the meantime, not just at the same pace as they had otherwise expected. Joe Heel : Yes. But there are some indications, Damian, that give us confidence that the deployment will occur. One of them is that they're taking an order and splitting it into two, right, as I've described to you. The other is that they're already working with us on deployment plans. We do see those stock signs not in every case, but in the majority of cases. So that's why we're describing it as we are. Damian Karas : Okay. Got it. That's really helpful. And then, Nathan, I think you suggested earlier that the – the ocean freight transition is happening late this year. Correct me if I'm wrong, I thought that, that was supposed to kind of play out in the third quarter. So is there any sort of delay there, or am I missing something? Nathan Winters : So that's -- this was per our plan. We expected Q3 to start the modest shipments into Europe, which we did from an ocean perspective, but the plan and the guide around our premium costs had always assumed we wouldn't really feel any financial benefit to the move until we get into next year. As the priority for this year was to ensure we delivered enough printer volume to take care of our backlog as well as ensure we have the right products on the shelf to support our run rate business. Operator : Our next question will come from Brian Drab with William Blair. You may now go ahead. Brian Drab : Good morning. I think most of the details come out here already, but I'm just wondering if you could give us a more specific update maybe on how Matrox and Fetch have been performing relative to your expectations? And again, in this difficult environment, I know Matrox committed about $100 million revenue run rate and Fetch about $10 million. I don't know if you could update those numbers directionally even. Thanks. Anders Gustafsson : We closed Matrox in early June. And certainly very pleased with how that's going. It creates a very comprehensive portfolio, both fixed industrial scanning and machine vision solutions for us. That kind of fills out our offering very nicely. I'd say we're very encouraged by progress Matrox is performing very well, and the integration is proceeding as per our plans. I think there's a very good culture fit between our organizations. We are also building out our partners. And that's going well. These are very specialized partners who provide these types of implementation and design services. And we've been seeing good traction in being able to recruit those partners to our program. So we're certainly very excited about what's going on with Matrox. And similarly, on Fetch, I say there's a lot of interest from – from warehouse operators across all our vertical markets as well as in manufacturing for our Fetch Robotic Solutions. And our ability to really combine the frontline worker, the automation of the frontline worker and the Fetch robot to automate -- orchestrate and automate the broader workflow has been resonating very well. And we're seeing -- yes, we're seeing a lot of interest, and it's obviously a smaller business, but it's ramping quite nicely. Joe Heel : And maybe a little bit of additional color. With the business being in sort of the early stages of development, what you look for primarily are pilot deployments, right? And we're seeing a very good stream of these pilot deployments. We were also very pleased to have two larger deployments already that we mentioned, I think, in the earlier -- in the previous earnings call already that are anchor tenants, I guess, now for our Fetch Robotics business going forward. Brian Drab : Great. And then I guess just as a follow-up, when you think about Matrox and some of the incumbents in that space. What have you found has been successful for you in going up against some of these incumbents and bidding on projects? What differentiates Matrox from a company like Cognex and others in the industry? Anders Gustafsson : Yes. First, I'll say that we don't see this as a zero-sum game. There's a lot of white space for us to go after without having to kind of go up and seek out opportunities where we compete with any specific competitor. It is also a very fragmented market. I think that the market leader has probably about 20% or no more than 20% market share. So there's plenty of opportunities to pursue without having to do that. That being said, I think we feel good about the value propositions that we have with Matrox. It is known for having a very some high-quality, high-performance solutions that can solve some very complicated problems for our customers. We worked hard on -- across our fixed investors scanning machine vision portfolio to drive ease of use as a differentiator to make it as easy for our customers to deploy and get time to revenue for these solutions. And that's been, I think, resonating back very well. Also, the software upgradability of our products is a differentiator. And we've had some very nice wins against a variety of different competitors with some large marquee customers. So we feel quite excited about it. Joe Heel : One other strength, Brian, to add perhaps is -- this is a business that's conducted predominantly through the channel. And we have used our strength in the channel to recruit a strong number of channel partners, many of which are somewhat disillusioned with other incumbents in the market. And that's been a great attraction for people to come to us because they know us as a very good channel partner for them. So that's helped us also. Operator : Our next question will come from Keith Housum with North Coast Research. You may now go ahead. Keith Housum : Good morning. Hoping to understand a little bit more the North American warehouse issue. It looks new slide deck in North America was down 9%. Would you say a vast majority of that decline was due to that North American warehouse issue, or would that number have been without that issue? Anders Gustafsson : The -- I would say, the mid-term outlook was predominantly explained by the supply chain challenges related to the persistent component shortages for certain products and the disruption in the transition to our new North America warehouse. And there's probably about 45% -- $45 million on each of those. And the smallest part was the deferral of projects with about 10% of the miss to our outlook. So clearly, the supply -- the DC move was the largest part of this. Keith Housum : I appreciate that. It sounds like you're going to be forced to operate both the Texas facility and the Wisconsin facility, I guess, in peril for the next several quarters. What was the impact on profitability this quarter? And what do you think it's going to be going forward? Nathan Winters : Keith, I would say it's relatively modest in terms of the cost structure we have with both of those facilities in terms of typically pay on a cost per unit with each of the facilities. So it's -- I think it's relatively modest in the -- from an overall profitability of managing both -- we had a little bit of extra cost here in the third quarter. We had to ship some products between the facilities to get the inventory rightsized moving forward. But now that, that's corrected, it's a relatively modest impact on overall profitability to manage both sites. Operator : Our next question will come from Rob Mason with Baird. You may now go ahead. Rob Mason : Hi, guys. Good morning. Just maybe just a follow-up on the last question. When will this North American distribution center transition be complete and I guess, consolidated into one facility? Nathan Winters : So we don't -- we do not have a time frame lined up of when we'll completely exit. We've signed an agreement to stay down in Texas for the foreseeable future to ensure that we properly ramp the new facility in the right way and make sure it's -- we fully mitigate any potential risk to the future operations. And so once that that's clear, we're in shape, that's when we'll start to work on whether that -- how to complete the transition, but there's no time line set to date. Rob Mason : Sure. Sure. There was also mentioned that you will be taking some pricing actions in Europe outside the US to address currency. When will those price actions be realized? Will start to show up? And then I'm just curious as well, what was the actual FX impact on your gross margin in the quarter? Nathan Winters : Yes. So if you look at the two latest price increases we announced, they really won't have no impact until we get into next year just based on the timing of the agreements we have with our distributors. I would say, it's relatively modest compared to the previously announced price increases as it's focused around Latin America business as well as in Europe where we've already made several other pricing actions. So it's -- I'd say it's modest compared to the three we've done up to this point. If you look at it from an FX perspective, in the third quarter, it was about a one point negative impact on EBITDA margin. And as we go into the fourth quarter, FX has about a two-point negative impact year-on-year on EBITDA margin. Operator : Our next question will come from Paul Chung with JP Morgan. You may now go ahead. Paul Chung : Hi. Thanks for taking my question. So you mentioned kind of a steady reduction in 2023, our supply chain costs here a nice execution here in the second half. But can that cost move down materially in 2023 on a quarterly run rate from that $30 million to $35 million, especially as you move more products to see -- I assume there will be some lingering costs here moving forward, but just any comments there would be helpful. Nathan Winters : Yes. So I'd say as we look at it going into next year, obviously, we think there's -- just based on the second half run rate, there will be a meaningful improvement from a year-on-year perspective. And I'd say at this point, steady is probably the right word in terms of how we're looking at it. And a lot of this has to do with how freight rates hold up. So I think based on what we've seen, they've held steady to slightly down since kind of middle of the second quarter, which is really positive. But at any moment, they can swing another way if there's any other type of supply chain shocks in the system. But yes, we would expect again, steady improvement from the second half run rate as we go into next year. Paul Chung : Great. That's helpful. And then on inventories, I know there's a lot of moving pieces, but can you give us a sense for kind of timing of more accelerated harvesting, I mean, do you see any risk to kind of discounting or given the elevated levels here, or is this more about converting on some of the larger deferred products? And then as we look to 2023, when can we expect to see kind of more normalized free cash flow conversion, or is this more of a second half 2023, kind of excluding the Honeywell payment. Thank you. Nathan Winters : Yes. So maybe I'll start with the second part of that. As we look at our inventory, we'd expect this to draw down through the first half and get to maybe, say, normalized levels as we enter the second half of next year, which we think is somewhere between $600 million and $650 million of inventory. That's based on the size of the company today plus the acquisitions, as well as intentionally holding more strategic component inventory than we have in the past to improve resiliency. We have a team dedicated and working on this. A big driver of that is finishing -- getting the DC move, stabilized. We've also made several moves within our supplies business in terms of manufacturing where we've had to build some buffer stock and working through that. And for the product categories or components that that have recovered, we are planning to draw down our safety stock at our manufacturing partners over the next several quarters. And that's really the big driver of where we'll see the reduction in working capital. But as you mentioned, we expect all these actions to enable us to significantly reduce working capital and deliver free cash flow conversion above 100% if you exclude the settlement payments. And then to your first question, we have no concerns that the inventory levels create any type of risk from an excess obsolescence perspective. We have strong demand for what we have in both finished goods as well as component parts. And then there's no intention of reducing pricing beyond what's normally required in the competitive environment. I'd say alternatively, we're pushing that we have stock available for customers who may have been waiting on certainty of supply before placing an order, so using it as an opportunity. Operator : This concludes your question-and-answer session. I'd like to turn the conference back over to Mr. Gustafsson for any closing remarks. End of Q&A: Anders Gustafsson : Thank you. So to wrap up, I would like to thank our partners, customers and employees for their continued support. Our top priority is to meet our customers' mission-critical needs as we take bold actions to address our supply chain challenges, and we look forward to a strong finish to the year. Thank you, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,023
| 1
|
2023Q1
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2022Q4
|
2023-02-16
| 17.881
| 17.36
| 18.694
| 17.9
| 26.74893
| 14.3
| 14.61
|
Operator : Good day, and welcome to the Fourth Quarter 2022 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation there will be opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please come ahead. Mike Steele : Good morning, and welcome to Zebra's fourth quarter conference call. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; Bill Burns, our Chief Product and Solutions Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our fourth quarter highlights and an update on the previously announced CEO transition. Then Nathan will provide additional detail on the Q4 results and discuss our 2023 outlook. Bill will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders. Anders Gustafsson : Thank you, Mike. Good morning, and thank you for joining us. It was a strong finish to a challenging year, with sales and profitability near the high end of our outlook. For the quarter, we realized sales growth of approximately 4%, an adjusted EBITDA margin of 22.5%, an 80-basis-point increase year-over-year. Non-GAAP diluted earnings per share of $4.75, a 5% increase from the prior year, and strong free cash flow. Our team recovered from distribution challenges in North America to drive record sales volumes, which more than offset softer sales in our EMEA region. From a solutions offering perspective, printing, data capture, tablets and RFID were bright spots, more than offsetting lower sales of mobile computers. Although we continue to see cautious spending behavior with certain large customers, demand has generally remained solid, with strength in small to midsized orders. We secured a number of exciting wins, helping to drive a strong year-end and momentum into 2023. These wins included a large postal customer in Asia who expects to improve productivity and efficiency by equipping 70,000 mail carriers with our mobile computing solutions. A British grocer expects to improve their shopper experience and drive store efficiencies by deploying 80,000 personal shopper devices. And the European-based auto manufacturer plans to enable process improvement and quality assurance along all stages of the production line with 30,000 Zebra mobile computers. From a profitability perspective, we expanded EBITDA margin and increased EPS by scaling operating expenses and drove our strongest cash flow quarter of the year. As you are aware, in December, we announced that Bill Burns will succeed me as CEO effective March 1. Bill is the ideal leader to continue to advance our strategy and has the full support of our Board and executive team. Throughout his career, Bill has maintained a strong focus on culture, talent and innovation. He has been a key member of Zebra's executive leadership team since joining us more than seven years ago to lead and integrate the enterprise business, which we had just acquired at the time. Since the announcement, Bill and I have been busy meeting with stakeholders discussing the transition and Zebra's bright future. I've also been taking this opportunity to thank our employees, suppliers and partners for their support and growth collaboration through the years as we transformed our business. I look forward to continuing to ensure a smooth transition as I assume the role of Executive Chair. I will now turn the call over to Nathan to review our Q4 financial results in more detail and discuss our 2023 outlook. Nathan Winters : Thank you, Anders. Let's start with the P&L on Slide 7. In Q4, net sales increased 2.5%, including the impact of currency and acquisitions, and 3.9% on an organic basis. Our Asset Intelligence and Tracking segment increased 13.5%, driven by double-digit growth in printing. Enterprise Visibility and Mobility segment sales were approximately flat, with mixed performance among our offerings. We realized particularly strong growth in data capture solutions, including RFID as well as rugged tablets. Mobile computing sales declined, primarily due to challenging prior year compares, particularly in EMEA. We also drove growth across services and software with strong service attach rates. Performance was mixed across our regions. North America sales increased 11%, helped by the recovery from supply chain challenges and strength in data capture and printing. EMEA sales declined 7%, primarily due to the 5-point impact of our suspension of sales into Russia in March as well as lower sales to large customers in Northern Europe. Asia-Pacific sales grew 3%, with strength in Japan and growth in China despite COVID challenges late in the quarter. And Latin America sales increased 7%, with strong growth in Brazil and Mexico. Adjusted gross margin decreased 10 basis points to 45.6% due to FX, offset by lower premium supply chain costs. Adjusted operating expenses were lower, improving by 100 basis points as a percent of sales, primarily due to lower incentive compensation and effective cost management. Fourth quarter adjusted EBITDA margin was 22.5%, an 80-basis-point increase driven by operating expense scaling. Non-GAAP earnings per diluted share was $4.75, a 4.6% year-over-year increase. Turning now to the balance sheet and cash flow highlights on Slide 8. In 2022, we generated $413 million of free cash flow. Although Q4 was strong, the full year was significantly lower than last year, primarily due to a higher use of working capital due to elevated inventory, higher incentive compensation payments given our exceptional 2021 performance, and $135 million of previously announced settlement payments, which are scheduled to conclude in Q1 of 2024. In 2022, we invested approximately $880 million in the Matrox Imaging acquisition to expand our machine vision solutions offering. We made $751 million of share repurchases and invested $12 million in venture investments. We ended the year at a comfortable 1.6 times net debt to adjusted EBITDA leverage ratio, and with more than $1.4 billion of capacity on our revolving credit facility. On Slide 9, we highlight premium supply chain costs, which have continued to improve from peak levels. The actions we have taken to redesign products, targeted price increases as well as improving freight rates and capacity have enabled us to reduce component purchases on the spot market and reduce the freight cost impact. Additionally, we have increased the volume of printer shipments on Ocean Premier, which will contribute to reduced freight costs through 2023. In Q4, we incurred premium supply chain costs of $25 million as compared to the prepandemic baseline, which was favorable to what we had anticipated in our prior outlook, and $38 million lower than the prior year. We are expecting these premium supply chain costs to steadily decline in 2023. Let's now turn to our outlook. Customer demand and our order pipeline remained healthy, yet we continue to see some softening of demand and elongated sales cycles that we referenced last quarter through the uncertain macro environment. We are taking a cautious approach to our sales outlook and expense management while working to rightsize our inventory levels. For the first quarter, our sales are expected to decline between 4% and 1% compared to the prior year. Our outlook assumes a 3-point negative impact from foreign currency changes and a 150-basis-point additive impact from recent acquisitions. This translates to expectations of negative 1% organic growth, which includes a 1-point headwind from sales into Russia last year. We anticipate Q1 adjusted EBITDA margin to be approximately 21%, driven by higher gross margins from improving supply chain costs despite significant FX headwinds. We expect premium supply chain costs to be approximately $20 million in Q1, a nearly $50 million year-over-year reduction. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $4. For the full year 2023, we anticipate net sales to be in the range of a 3% decline and 1% growth. This outlook assumes a 50-basis-point net negative impact from foreign currency changes and acquisitions as FX headwinds moderate throughout the year. We anticipate full year adjusted EBITDA margin between 22% and 23%. We expect premium supply chain costs of approximately $50 million for the year, with continued improvement in product availability. We have also proactively managed operating expenses as evidenced by OpEx scaling in Q4 and recent targeted restructuring actions as we enter 2023, which enabled us to preserve strategic investments in the business. We expect our free cash flow to be at least $650 million for the year, which reflects the benefit of working down elevated inventory levels through the year, higher cash taxes and $180 million of previously announced settlement payments. Please reference additional modeling assumptions shown on Slide 10. Note that the cost of borrowing is expected to be approximately 5% to 6% this year, and our non-GAAP tax rate is expected to be approximately 19% due to the United Kingdom corporate tax rate increase. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision. Bill Burns : Thank you, Nathan. Before I talk about the progress we are making on our vision, I'd like to take a moment to thank Anders for his exceptional leadership with Zebra over the last 15 years. Through disciplined organic investment and strategic acquisitions, he's led the transformation of Zebra. He sponsored an innovative and authentic culture that has received many awards recognizing Zebra as a great place to work. Also under his leadership, shareholder value creation has significantly exceeded broader market benchmarks. I'm excited to build upon Anders legacy by continuing to advance our Enterprise Asset Intelligence vision. Slide 12 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, software and services. By transforming workflows with our proven solutions that generate an attractive return on investment, Zebra's customers can effectively address their increasingly complex operational challenges. Our innovative solutions empower the workforce to do their jobs more effectively by navigating constant change in a near real time, utilizing insights driven by our advanced software capabilities such as prescriptive analytics and intelligent automation. As I focus on moving Zebra forward, we will collaborate closely with customers and partners to continue to elevate Zebra as a premier solutions provider and work to attract, develop and retain top global talent to drive innovation. Slide 13 summarizes our served market opportunities and long-term growth profile. The fundamental drivers of our business remain intact. Mega trends, including the on-demand economy, asset visibility, mobility and cloud computing and intelligent automation, provides secular tailwinds for our business. I am proud of the progress we're making in elevating our strategic relationship with our customers. We continue to extend our leadership position in our core business and are gaining traction in adjacent and expansion markets, which have higher growth profiles. Anders and Nathan highlighted RFID as a bright spot, where we have a comprehensive solutions offering for a wide range of use cases. Our momentum continues as we were just awarded a record RFID win last week. Another highlight is our market share gains in rugged tablets as a result of our focused investment. Overall, I believe we're well positioned to deliver 5% to 7% organic growth over a cycle, with an increasing attractive margin profile as we drive continued traction across our core, adjacent and expansion markets. Now we turn to Slide 14. Businesses partnered with Zebra to optimize their end-to-end workflows as they strive to meet an increasing demands of consumers across a variety of vertical end markets. As you can see on the slide, we address a wide range of workflows and use cases across retail and e-commerce, transportation logistics, manufacturing, health care and other markets. Anders highlighted a few recent wins across these markets. The breadth of business challenges we are addressing has been expanding through our investment in new offerings and markets, enabling us to further penetrate customer accounts. For example, leveraging our existing relationships enabled us to secure autonomous mobile robot and machine vision wins with our customers in manufacturing and warehouse use cases. We see a tremendous opportunity to continue to elevate and grow our customer relationships through our expanded solutions offerings. On Slide 15, we highlight how Zebra was able to showcase how our solutions positively impact retail store operations to more than 1,300 customers at the National Retail Federation's trade show last month. At the event, we brought the modern store concept to life by demonstrating how our portfolio of solutions empower retailers to better engage associates, optimize inventory and elevate the customer experience. Our booth featured representatives from 2 prominent retailers who share how our solutions have improved their operational challenges. [Although some] improvement has realized the synergies of combining Zebra's mobile printers, mobile computers and our workflow optimization software solutions that improve the customer experience, increase efficiency and reduce friction in their workflows. Zebra's solutions have resulted in increased customer satisfaction by improving inventory accuracy and streamlining the buy online, pickup in store experience as well as over 1 million hours of annualized labor savings and reduced label waste. Vera Bradly has improved associate engagement and retention by prioritizing workloads through our task and workforce management software solutions. By leveraging Zebra's mobile devices and software solutions, they can now align the right task to the right associate in real time, and increased employee satisfaction by reducing friction in scheduling. Additionally, insights in our software solutions elevate the customers' experience for Vera Bradley by empowering frontline associates with better information, including visibility of product inventory and pricing. In closing, I look forward to working with our team to advance our Enterprise Asset Intelligence vision by fostering an innovation -- innovative culture, collaborating with our customers and partners and delivering profitable growth across our core adjacent expansion markets. Now I'll hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to 1 question and 1 follow-up so that we can get to as many of you as possible. Operator : [Operator Instructions] Today's first question comes from Damian Karas with UBS. Please go ahead. Damian Karas : So my first question is related to your sales outlook. And in particular, we've heard some of your competitors and even one of your major distribution partners recently talking about inventory channel destocking taking place. I'm just curious if you guys are seeing the negative impact from that at all? And to what extent that's factored into your guidance for the year? Anders Gustafsson : Yes. Starting on the channel inventory side, our -- the global channel inventory levels are healthy for us, and we see solid sell-through signals and -- particularly, that's true for our run rate business. Inventory levels have rebounded in 2022 for our -- in our channel. But you've got to remember that, at the end of 2021, the industry was going through some very substantial supply chain constraints and the channel was nearly stocked out. So in 2022, that rebounded to some degree, but more back to normal levels. But inventory levels, in absolute dollar terms in our channel compared to, say, pre-pandemic is up. But if you normalize that around days on hand inventory, which is how we really measure the health of the inventory in the channel, that is actually about only up by a couple of days compared to prepandemic. Damian Karas : And then switching gears to the margin trajectory here. If we kind of look at the low end of that adjusted EBITDA guidance, it doesn't suggest much improvement, especially when you kind of look at the notable step down you guys are expecting in the premium supply chain cost. So I was wondering if you could maybe just give a sense on how you're thinking about that margin guidance range? And as it relates to the $50 million premium costs, are you basically assuming that, that's more or less eliminated by the third quarter? Nathan Winters : So David, this is Nathan. If you look at our guide for the year, an EBITDA of 22% to 23%, it's a point higher than we were in 2022. And as you mentioned, the primary driver is the supply chain improvements, which is about 2 points of improvement, but that's being offset by 1 point of FX for the year, particularly here in the first half on the comps from where the FX -- the rate was a year ago in the euro. We also have pricing actions we've taken throughout the year that are flowing through, and that's largely offsetting material labor costs predicted for the year. So that's -- that's how to frame it. We're definitely seeing the flow-through from the improvement in premium supply chain costs and lower freight rates, but FX is the real headwind that's offsetting it. Operator : Thank you. And our next question today comes from Jim Rashidi at Needham & Company. Please go ahead. Jim Ricchiuti : I wonder if you could provide us with your general outlook for the projects business in '23. Are you seeing any changes? You've expressed some caution that you're seeing from some customers. But what's your outlook for that part of the business? Bill Burns : Yes, Joe, I'd say -- this is Bill. I'd say overall that, from a macro environment, we're seeing really mixed signals. As you said, we're seeing, on one hand, really elongated sales cycles and some softening of demand, especially from some select large customers. That's resulting in some delays in pushouts. We saw that in first quarter -- sorry, fourth quarter, and it's reflected in our first quarter and 2023 outlook. On the other hand, we're really seeing that we've got strong backlog and the pipeline is healthy for projects for 2023. Our run rate sales in fourth quarter were strong, and we're continuing to see that in Q1. And as we just talked about, our global -- just the inventory levels are healthy. So it's really mixed signals out there that's keeping us cautious overall. And I think that our view of that is that we're going to continue to monitor the environment in 2023. We're going to take an agile approach to really managing expenses and focus on profit margin expansion and -- but at the same time, really preserving the strategic investments we're making throughout the year. So I think, overall, we're highly confident in our solutions offering and our ability to continue to take share in 2023, but it just makes sense for us to be cautious given the macro uncertainty that's out there today. Joe Heel : Jim, this is Joe Heel. Maybe 1 or 2 additional data points on this. As we entered the year, our pipeline of large projects was about the same as it was the year before. So quite strong, and we're quite satisfied with how solid that pipeline of large deals was. When we are talking about caution and softness, I would say it's sort of the best possible thing you can hope for if you're in sales, which is, customers are keeping the projects. In some cases, they are delaying the start time at them. In some cases, they are rolling them out over a longer period of time. But I would say those are few and far between at this point, and that's really the nature of what's driving some caution on our front. Jim Ricchiuti : The follow-up question I have is just as you went through Q4 and thus far this year, have you seen any changes in demand, meaningful changes, either in some of your major geographic regions or major market verticals? Joe Heel : Yes. I can also speak to that. I think we have a few anomalies that you're aware of, right? You know about our exit from Russia prior year. So that revenue is obviously not there. You probably expected that, in the Chinese market, we would have less revenue this quarter than we had in the quarter -- same quarter prior year because of the COVID situation. By the way, that is very quickly recovering. We're seeing a quick recovery of that. So those are perhaps some of the changes. But other than that, I couldn't say that there's a major shift in region or vertical makeup of our revenue structure. Operator : And our next question today comes from Paul Chung at JP Morgan. Please go ahead. Paul Chung : So just on the EBITDA margin guide up this year, can you expand on kind of the gross margin versus OpEx dynamic and driving that outlook? Freight's coming down materially, but just want to get a sense for gross margin expansion expected throughout the year, with 1Q most likely be in the trough? And then I have a follow-up. Nathan Winters : Yes. So Paul, if you look at the full year guide on EBITDA, I mean both the supply chain improvements and FX will flow through from a margin perspective. So I think we expect margin to -- gross margin to increase throughout the year because of those two dynamics. I think from an OpEx scaling, we'd say roughly flat to in line with prior year just as we work through some of the increasing compensation and incentive compensation year-on-year. But again, I think, largely, the benefit in EBITDA would flow through mostly in gross margin. Paul Chung : And then just on the RFID opportunity, how large is the contribution to the business today? I mean, you guys have been in the market for a long time. So where are you seeing accelerating growth, and some use cases across retail and other verticals? Bill Burns : Yes, I would say that -- this is Bill, Paul. The low single digits is the size we think about. We're excited about the RFID opportunity. As we mentioned in the remarks that we've just won our largest RFID opportunity ever really in the T&L space. And we've seen RFID move from just really retail into retail supply chain, now into the broader supply chain and opportunities within transportation logistics, which is really around parcel and others that create really an opportunity of a wider served use cases. And in retail, we're seeing large retailers mandate the tagging of items within retail. We're seeing new opportunities there around loss prevention. As I mentioned, T&L opportunities, we're seeing quick-serve restaurants deploy RFID. In the NFL, we're doing both active and passive RFID. So we just renewed the contract there within -- in our relationship within the NFL. So we're excited about the RFID market. We've got the broadest and deepest set of RFID solutions today in the market, ranging and covering all those use cases I talked about. So the expansion of the use cases beyond retail is what's exciting to us, and we've got the portfolio really to go address it and we're excited about it. Joe Heel : Let me add one other thing, Paul, to that, which is, I think tipping points in the RFID market have been claimed several times in history, and I don't think we want to say that today, but there are some very exciting developments in this market that we're certainly bullish on. One of them is, last year, one of our largest retailers announced that they were converting significant portions of their operation to RFID. And the win that Bill mentioned earlier in his remarks that we just -- which was a record RFID deal, the largest in certainly our business and we believe in the industry, is in T&L. And so with two large retailer and a large T&L company adopting RFID, what this will do, we think, is that it will drive economies of scale in the market and also be a lighthouse for other competitors in these segments to adopt this technology, which provides significant improvements in throughput time and productivity, in addition to the economies of scale that delivers for the broader market. So we're pretty excited about this and foresee some strong growth for it. Operator : And our next question today comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Joe, just unpacking some of the guidance a little bit. When you're seeing deals that are being delayed or kind of spread out, perhaps can you give us a little bit of color about the momentum or the motivation that the companies have in doing so? Is it business specific issues? Are they worried about the economy, perhaps a little bit of guidance there. Joe Heel : Yes. Keith, this is Joe Heel again. What we're hearing from those customers is mostly that they are looking to adapt their spending to their budgets. And if we think about retailers, which probably make up a meaningful portion of some of those situations where we're seeing that, they are adapting their budgets to what they see as demand in for their business. And as they're doing that, they're asking to spread -- they still need our technology. I think that's the important piece that we see and why we're seeing a push out or maybe a delay in the deployment schedule. So they're trying to fit it in because they know they need this technology, but they're trying to adapt when they're spending the money to when they think it will be available in their business. I think that's the best description. Keith Housum : And Bill, just trying to unpack a little bit more about the supply chain issues as my follow-up here. Do you guys see still the middle of the year when supply chain issues really become alleviated and you're back to prepandemic levels? Bill Burns : Yes. I think that -- I mean, from an availability perspective, I think we're pretty much there. I mean we're seeing components move into reasonable, much more reasonable lead times, not all, but many. The majority of our items have come back to normal delivery time frames overall. So I think that we feel good about our supply chain and the recovery of that, really almost the majority of almost everything really in first quarter is what I say, from our supply chain perspective. Nathan Winters : Yes. Keith, the only thing -- this is Nathan. I'd add is, it's obviously a dynamic environment, and we're monitoring it in terms of events and shutdowns and things like that, that could disrupt that. And I'd also say it's also relative. If you look at -- our freight rates is a great example. It's meaningfully better than where they were a year ago or even 6 months ago, but still we're still paying 2 times to 3 times what we pay prepandemic. So I think it's also relative in terms of where we were historically to where we've been a year ago in terms of how we feel about the overall supply chain. Operator : And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Just a couple of questions for me. One, you mentioned longer deal cycles, but I guess I was just wondering, is there any change to kind of the deal sizing that they're putting together of maybe looking at some lower-cost SKUs or outfitting kind of fewer reps? Just any change to kind of the overall deal size that's worth noting? And then maybe, second, now that you've had Matrox just a couple of quarters, you did mention some kind of machine vision type wins. Just wondering kind of where you're seeing -- where you are on that integration where you see kind of the best opportunities going forward there? Joe Heel : Meta, Joe Heel here. In terms of the longer -- in terms of the nature of these longer deal cycles, generally, we have not seen downsizing of deals or down tiering of devices. I could think of maybe 1 or 2 instances. It's more what I was describing earlier to Keith where the deal is being elongated in terms of either the deployment schedule over instead of taking it all in Q1, they're going to take it over 3 quarters for the rest of the year, or they might say, I don't want to take it in Q1, I want to take it in Q2. That's the most common one. Downsizing, I would say not so much, right? We're not seeing that as much. Mike Steele : Yes. From a Matrox perspective, I can take that, Joe. I think, overall, we're encouraged certainly by the progress of Matrox. It performed well in 2022 with actually a record year. the integration is moving as planned. As kind of a quick reminder, the Matrox is really complementary to our organic investment that we made in the fixed industrial scanning and smart camera market. It really brought to us the breadth and depth of the portfolio that our partners were encouraging us to have in that marketplace. So it brought vision controllers and Frank grabbers and 3D sensors along with a portfolio of software solutions and a software library to meet many use cases in that marketplace overall. So I'd say we're happy with the progress so far. It's -- there's lots of opportunities for us out there in machine vision across manufacturing, and transportation logistics is the primary markets that we're focused on and things are going well so far. Operator : And our next question today comes from Guy Hardwick at Credit Suisse. Please go ahead. Guy Hardwick : Particularly as it pertains to your Q1 guidance, can you give us some sort of trends as to the difference between Zebra sales into the channel and then the distributor sales out of the channel, and maybe also how that differs from direct business? Nathan Winters : So maybe just to frame the Q1 guide of minus 4% to minus 1%, again, as we mentioned before, we have, again, backlog and pipeline to support the outlook. We've actually had a solid start to the quarter, both in shipments into the channel as well as we're seeing nice momentum from a sales out, particularly on the run rate business. We're also realizing some nice price realization, which is about 1 point of benefit in the quarter. So I'd say, early on, again, seeing nice momentum both from a sales in and sales out. I'd say the -- but the guide also reflects, as we've talked about before, more the uncertainty in the environment and that cautious behavior, particularly as a lot of our customers are finalizing their capital budgets for the year. And the other thing important to note is that Q1 takes the full effect of the Russia headwind for the year, which is about 1 point for the first quarter. So I would say, no meaningful difference between what we're seeing within our own activity with the channel as well as from a sales out perspective, that's noteworthy. Guy Hardwick : Just to follow up. Is it correct that the gross margin benefit from supply chain, declining supply chain headwinds should be most significant in Q1? Nathan Winters : From a year-on-year perspective, if you look at the EBITDA guide of approximately 21%, the supply chain benefit or the premium supply chain benefit is about 3 points, but that's offset by 2 points of FX. So that's -- those are the kind of main drivers from a year-on-year. But yes, you're right. From a year-on-year perspective, Q1 last year was about the peak in terms of premium supply chain costs. Operator : And our next question today comes from Rob Mason at Baird. Please go ahead. Rob Mason : I just wanted to circle back again to your commentary around the run rate business. Several times you've commented on healthy sales there, sell out. I'm just curious, how much visibility do you have into the bookings trends in that part of the business? And is it seeing any of the elongated deal cycles or any sense of that? Joe Heel : Joe Heel, here. The run rate has been very strong, I would say, for Q4, in particular, and we're seeing that continue into Q1. We -- in terms of visibility, this is the type of business where people obviously don't book big deals with us. They go to distributors and buy what they have on their shelf. So the visibility is typically based on our conversations with distributors and what they're telling us, they're seeing as their order intake. And so it's much less of a visibility. But what we have so far, even in the first weeks of this quarter, has been very strong. So we've been pleasantly surprised, in particular, for printing and scanning, which were areas of our business that we didn't have as much stock over the course of the last year. And as a result, we're very pleased to see that, that run rate in printing and scanning in particular, is so resilient, right, that customers are staying loyal to us and continuing to buy again from the distributors. Anders Gustafsson : Maybe there's two further points on that. One will be that we don't necessarily have the same visibility into each and in every deal, but this is one where you have a large number of orders, so you get kind of a more statistical confidence from that. And if you look at historically, our run rate business tends to be more of a longer cycle business for us. If we have a strong quarter, it tends not to be kind of one strong quarter and then it drops down. It tends to be that we have four to six quarters of strength in those -- in that cycle. So it's followed by maybe one or two quarters of a little softer demand. So we would expect this to continue for a few more quarters. Rob Mason : Understood. Understood. And then I wanted to go back to your geographic commentary. I think when you mentioned Asia, you called out Japan was strong. I think, historically, Japan has not necessarily been a large market for you. Could you just outline maybe what you're seeing in Japan, what your expectations might be there? If anything is changing on that front? Anders Gustafsson : First, we're very pleased with the performance of the quarter. We had record sales. We came in above the high end of our outlook. We executed very well, I think, and recovered from the distribution network challenges that we had in Q3, and we drove double-digit sales in North America. We talked earlier about the strength we've seen in kind of run rate business, and we see that certainly in small and midsized customers. And we had particularly strong growth from a solutions perspective with print, data capture, RFID, tablets, but partially offset by lower mobile computing sales in Europe, due in part to the exit from Russia in Q1 of last year. Now Asia-Pac was -- had a good performance, particularly when you consider COVID in China. We have very broad-based growth, and we saw nice growth in China, Australia and New Zealand. But Japan, as you mentioned, is kind of the standout here. They have -- we had exceptional growth in Japan. We have invested in driving penetration in the Japanese market over the last several years, both from a go-to-market perspective, but also from a product perspective. And this large postal carrier win that we mentioned is kind of the latest evidence of that. So we now have a very strong position in Japan in mobile computing, which is one of the largest markets in the world that we really didn't have much of a presence before. Joe Heel : And I'll add one thing to that. So Japan is the third largest market that we operate in. And it's one, as you say correctly, where our share in the past had been relatively low. But two important things have changed that I think have given us some really good momentum here. Andrew has mentioned it. The first thing that's changed is that the market has begun to embrace Android. And this may seem like it's out of pace, and it is much later than many other markets in the world that, that market has made the mobile computing shift from Windows to Android, and that has given us a big opportunity, right? Because many of the local Japanese competitors, who have dominated that market, have not been as quick with Android as we have, and that has given us an opportunity, and that's a great example is this postal carrier deal that Anders mentioned. That's what we did. The second thing that we've done is, we have shifted our go-to-market strategy to focus more heavily on partners. And so we're working with some of the largest systems integrators now in the Japanese market. That's how we won this the postal carrier deal. That's how we've won several other large deals, in particular, in retail around mobile computing. And the combination of those two are really giving us some momentum we hadn't seen in any of the years before. Operator : And our next question today comes from Brian Drab at William Blair. Please go ahead. Brian Drab : I was just wondering if you could talk a little bit more about what you're seeing in the different verticals? I'm not sure you've really sell that out this morning in terms of manufacturing, retail, transportation, logistics, health care. I assume you want to give expected growth rates for those verticals in 2023, but if you could even give ranges or rank order where you're expecting the most strength or the weakest performance? Anders Gustafsson : That can be a long answer. So I'll give you -- start a little bit high, and then we can pick up a couple of the verticals maybe here, but across all our verticals, as I said, we are seeing very strong secular trends to digitize and automate workflows and empower frontline workers in a much more labor-constrained environment. And these trends continue to drive an increased need for our type of solutions across a wide range of vertical end markets. You specifically mentioned manufacturing. We had a very strong performance in Q4 in manufacturing. We had a number of very significant wins that we were very proud of. We are mentioned the one in the automotive side in my prepared remarks. There are some attractive trends in manufacturing that are helping to drive our business here. One is around the business must invest in traceability tools to create more sustainable supply chains. Another one is around industrial automation investment trends in productivity and visibility. And those present opportunities for our solutions, including machine vision and our autonomous mobile robots or Fetch solutions. We've certainly seen very strong traction with machine vision in manufacturing and have some attractive early wins here. We are very excited about what we -- what and our Adaptive vision acquisitions can bring to our customers and partners here. I can dig into other verticals also, but see if you have any other questions here. Brian Drab : Well, I mean I was just wondering if you could comment, even just briefly or just a bullet point on each one, transportation logistics, up or down in 2023, health care up or down, retail up or down, just directionally even, and anything on all of the four major verticals you play in? Anders Gustafsson : I think that we probably will leave kind of the outlook around the overall corporate level. But maybe I'll just say that for -- in retail, in 2022, we had approximately flat sales in retail vertical with some very broad-based growth that offset the pullback of one very large customers. So you can see the strong momentum we have across the industry where we could offset a very large customer pulling back in a pretty big way. So the diversification we have across all of these verticals is definitely helping us to mitigate kind of volatility and drive more consistent results. Operator : And our next question comes from Tommy Moll of Stephens. Please go ahead. Thomas Moll : I wanted to start on the revenue outlook you've provided for 2023, which you've described as embedding a cautious approach. When you use that word cautious, are you primarily referring to some of the spending patterns among the large customers that you referenced? Or is this more a philosophical adjustment you've made where you look at your opportunities and maybe you discount the probability of conversion on some of these deals higher than you typically would just given the macro uncertainty? Nathan Winters : Tommy, this is Nathan. I think, as you look at the full year guide, which is about, from an organic perspective, slightly down at the midpoint, as you mentioned before, I think it's a combination of the two, right, both kind of cautious in the overall assumptions due to the macro environment and how that's going to play out through the rest of the year as well as to your other point of how we kind of look at each -- look at some of those large opportunities and probability weight those for the year. And we think, we believe the range we provided is given that overall uncertainty. Bill Burns : Yes, I'd just add that I think we feel good about our business. I think this is really all about macro uncertainty. I mean I think we think that we're going to continue to take share in 2023. That's how we see it. We're the leader across the core markets we serve. We've got attractive opportunities across the adjacencies and the expansion business we've invested in. So I think we feel good about our business. I think the uncertainty really is around what's happening around macro, and we're clearly seeing some of that come through in our results in Q4 and our guide for Q1 and '23. Thomas Moll : And if the macro were to deteriorate, could you rank order or maybe just identify one or two of the key verticals where you would expect to see that pressure first versus maybe some of the verticals where you would expect more a secular growth trend through the year? Is that possible? Bill Burns : I'm not sure we'd see it as separate verticals. What I'd say is that the across the diversification of our solutions and our verticals actually give us kind of resiliency in a downturn, which would dampen some of the cyclicality. So I think this diverse solutions based that we have in product portfolio and the new investments we're making is dampen cyclicality across that customer base. So I'm not sure we'd see it as one worse than the other. I mean, Joe may want to add to it. But I think that we think overall that we're going to take a disciplined approach to OpEx during the year and focus our investments. I think that, from that perspective, I don't think we see one vertical over another. Anders Gustafsson : You could think of maybe as health care as one that will be more resilient. I think the economic cycles will probably not impact health care as much. So it's been our fastest-growing vertical over quite a while, and we would expect that to continue to do well. more irrespective of the economic outlook. Operator : And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Gustafsson for any closing remarks. Anders Gustafsson : So as I wrap up my 62nd earnings call, I would like to again thank our partners, customers and employees for their contributions in transforming Zebra. I am proud of the progress we have made together and believe we will continue to prosper with Bill as our next CEO. I also want to thank our analysts and investors for your continued support of Zebra. Although this will be my last earnings call, I look forward to ensuring a smooth leadership transition and starting my new role as Executive Chair, while continuing to support Bill and Zebra's ongoing success. Have a great day, everyone. Operator : Thank you. Ladies and gentlemen, this concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
|
1969
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2019-12-23
| 2,023
| 2
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2023Q2
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2023Q1
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2023-05-02
| 17.426
| 17.433
| 17.984
| 17.838
| 25.95702
| 16.53
| 16.13
|
Operator : Good day, and welcome to the Zebra Technologies First Quarter 2023 Earnings Conference Call. Today, all participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be opportunity to ask questions. Please note, this event is being recorded. And at this time, I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's first quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth, our year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with our first quarter highlights. Then Nathan will provide additional detail on the Q1 results and discuss our revised 2023 outlook. Bill will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now, let's turn to slide 4 as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning, and thank you for joining us. Our team executed well in a challenging macroeconomic environment, delivering first quarter sales and earnings results above the midpoint of our outlook. For the quarter, we realized sales of $1.4 billion approximately in line with the prior year; and adjusted EBITDA margin of 21.4%, a 150 basis point increase; and non-GAAP diluted earnings per share of $3.94, a 2% decrease from the prior year. Regional sales performance was mixed with growth in Asia Pac and North America mostly offsetting declines in EMEA and Latin America. From a solutions perspective, printing, data capture and RFID were bright spots, while sales of mobile computers declined. We continue to see cautious spending behavior by enterprise customers with a decline in large orders and growth in small to midsized orders. From a profitability perspective, improved gross margin drove our EBITDA margin increase. Higher interest and tax expense resulted in a slight earnings decline. I would now like to spend a moment on our sales outlook. As the risk of broader softening of industry demand has materialized, we have reduced our full year outlook. Late in Q1 and into Q2, demand trends softened across our end markets, particularly for mobile computers in EMEA and North America as customers' CapEx budgets tightened and IT device spending contracts. We are mitigating the impact of softer sales with targeted go-to-market actions to drive additional demand and incremental cost actions. We will continue to take an agile approach to managing throughout this uncertain near-term environment. I will now turn the call over to Nathan to review our Q1 financial results and provide additional details on our revised 2023 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on slide 6. In Q1, net sales decreased 1.9%, including the impact of currency and acquisitions and were 0.3% lower on an organic basis. Our Asset Intelligence and Tracking segment increased 28.4%, led by strength in printing as we lapped significant supply constraints in the prior year period. Enterprise Visibility & Mobility segment sales declined 11.2%, with mixed performance among our offerings. We realized strong growth in data capture solutions and RFID. Mobile computing sales declined, primarily due to large customer order deferrals, slowing demand through distribution, and the impact of ceasing sales to Russia in March of 2022. Additionally, we also drove growth across Service and Software with strong service attach rates. Performance was mixed across our regions. North America sales increased 1%, due to strength in printing and data capture, helped by the recovery from supply chain challenges. EMEA sales declined 4%, primarily due to a 350 basis point impact of our suspension of sales into Russia. Asia Pacific sales grew 6%, driven by strong mobile computing growth in Japan. And Latin America sales decreased 1%, with relative outperformance in Brazil and Mexico. Adjusted gross margin increased 290 basis points to 47.5%, primarily due to lower premium supply chain costs, partially offset by FX and lower service margin. Adjusted operating expenses increased 130 basis points as a percent of sales, primarily due to a return to normalized sales and marketing activity and strategic investments in the business, partially offset by a reduction in G&A expense. First quarter adjusted EBITDA margin was 21.4%, a 150 basis point increase driven by gross margin expansion. Non-GAAP diluted earnings per share was $3.94, a 1.7% year-over-year decrease due to increased interest expense and a higher tax rate, partially offset by fewer shares outstanding. Turning now to the balance sheet and cash flow on slide 7, in Q1, we had negative free cash flow of $92 million, which was unfavorable to the prior year period primarily due to the timing of inventory payments, higher interest cost and cash taxes and $45 million of previously announced quarterly settlement payments, which are scheduled to conclude in Q1 of 2024, all of which was partially offset by favorability in the timing of customer collections, and lower incentive compensation payments. In Q1, we also made $15 million of share repurchases and invested $1 million in our venture portfolio. We ended the quarter at a comfortable 1.6 times net debt to adjusted EBITDA leverage ratio, which is well below the top of our target range of 2.5 times and had approximately $1.3 billion of capacity on our revolving credit facility. On slide 8, we highlight premium supply chain costs, which have continued to improve from peak levels. The actions we have taken to redesign products, along with the improving freight rates and capacity, have enabled us to reduce component purchases on the spot market and reduce freight cost impact. In Q1, we incurred premium supply chain costs of $15 million, as compared to the pre-pandemic baseline, and $53 million lower than the prior year. We are expecting these premium supply chain costs to continue to decline. Let's now turn to our outlook. We continue to see enterprise customers defer large orders and are also realizing lower sales into the channel as distributors adjust to softer demand trends as well as our improved product lead times and their higher cost of capital. For the second quarter, our sales are expected to decline between 9% and 11% compared to the prior year. Our outlook assumes a two-point negative impact from foreign currency changes and a one point additive impact from recent acquisitions. We anticipate Q2 adjusted EBITDA margin to be approximately 20%, driven by expense deleveraging from lower sales volume, partially offset by higher expected gross margin from improved supply chain costs. We expect premium supply chain costs to be approximately $15 million in Q2 and more than $40 million year-on-year reduction. Non-GAAP diluted EPS is expected to be in the range of $3.20 to $3.40. We are reducing our full year 2023 sales outlook by three points. We now anticipate net sales to decline between 2% and 6%. This outlook assumes an approximately 50 basis point net negative impact from foreign currency changes and acquisitions. Second half sales are expected to benefit from easier year-on-year comparisons, our recently announced price increase, and abating FX headwinds. We have a solid pipeline of opportunities that gets us to the high end of the sales range, but are embedding caution in our outlook, given recent demand trends in the uncertain macro environment. We expect full year adjusted EBITDA margin of approximately 22%, which is the low end of our previous outlook. We now expect premium supply chain costs of approximately $40 million for the year, as we are seeing faster-than-expected supply chain recovery. We have been proactively managing operating expenses through targeted restructuring actions and discretionary cost controls, and we expect sequentially lower operating expenses in the second half of the year. We now expect our free cash flow to be between $450 million and $550 million for the year, which reflects increased caution in our revised full year outlook. As a reminder, cash flow is impacted by increased cash taxes and $180 million of previously announced settlement payments. We continue to be focused on rightsizing elevated inventory on our balance sheet as component lead-times have normalized. Working capital variability over the past year has been significantly impacted by global supply chain dynamics. Our fundamental business model is unchanged and we believe the actions we are taking will enable us to deliver greater than 100% free cash flow conversion as we normalize inventory levels. We are focused on achieving a 100% conversion over a cycle, which is now included in our long-term executive incentive compensation plan. Please reference additional modeling assumptions shown on slide nine. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision. Bill Burns : Thank you, Nathan. While customer spend is pressured near-term, our solutions are essential to our customers' operations, and we are well-positioned to benefit from secular trends to digitize and automate workflows across our served markets. Slide 11 illustrates how we digitize the front line of business by leveraging our industry-leading portfolio of products, software, and services. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, including scarcity of labor and improving productivity in challenging times. We empower the workforce to execute tasks more efficiently by navigating constant change in near real time, utilizing insights driven by advanced software capabilities, such as artificial intelligence, machine learning and prescriptive analytics. Now, turning to slide 12. We are focused on advancing our Enterprise Asset Intelligence vision by continuing to elevate Zebra, as a premier solutions provider through our compelling portfolio. In March, at the ProMat manufacturing and supply chain trade show, Zebra, along with our partners, showcased the depth and breadth of our innovative solutions for manufacturing, logistics and the broader supply chain. Our industrial automation solutions, including autonomous mobile robots, machine vision and fixed industrial scanning, are synergistic with technology-equipped frontline workers. At the show, we featured Zebra solutions at each stage of warehouse operations, including receiving, storage and fulfillment. It demonstrated how we improve key outcomes for our customers, such as enhancing supply chain agility, improving production quality and maximizing utilization and productivity. As you can see on slide 13, Zebra powers the front line of business across retail and e-commerce, transportation logistics, manufacturing, health care and other markets. Businesses partnered with Zebra to optimize their end-to-end workflows, as they strive to meet the increasing demands of customers across a variety of vertical end markets. The business challenges we are solving have expanded through our investment in complementary offerings that enable us to further penetrate customer accounts. I would like to highlight several wins across our end markets. We are beginning to deploy the record RFID win, we mentioned on our last call. This global transportation logistics provider plans to tag every package that enters their facilities with RFID and coated labels to enhance tracking visibility. Zebra solutions improved productivity, enable faster error detection, driving cost savings and increased customer satisfaction. In addition to our RFID offerings, this customer is also deploying our mobile computers as an integral part of the overall solution. A major e-commerce provider in Europe recently expanded their use case of Zebra's fixed industrial scanners at several thousand packing stations. This enables the customer to continue to significantly reduce scan time and increase throughput, particularly for their more complex packing needs. The support and collaboration with Zebra and our partner was a key differentiator among our competition. A large Australian supermarket chain has replaced consumer-grade devices with our Zebra rugged tablets and scanners to enable faster and more accurate buy online, pick up in store and home delivery fulfillment. Zebra's enterprise-grade solution, along with our commitment to sustainability, including our recycling program and eco-friendly packaging, were competitive differentiators in securing this win. A Latin American manufacturing company recently selected Zebra mobile computers and mobile printers to help streamline delivery and warehouse operations. Delivery personnel will benefit from synergies between these products, while warehouse employees realize similar efficiencies with Zebra scanners and desktop printers. This manufacturer shows our products for reliability and durability and considers us a strategic partner in their technology journey. A regional bank recently selected our workforce management software for all branch locations, displacing a competitor. Our solution is expected to drive cost savings through more efficient scheduling and allocation of people resources. We are pleased about the benefits our solutions are delivering in our customers' mission-critical operations. Slide 14 reiterates challenges that have materialized since our last guide. We believe the actions we are taking, which include working closely with our customers as they look to deploy solutions to drive efficiency within their businesses, increasing our focus on accelerating growth in underpenetrated markets and driving incremental cost actions within our business will allow us to exit 2023 stronger, positioning us to deliver profitable growth, increased market share and improved free cash flow. In closing, we are facing near-term headwinds and have taken actions to drive a stronger second half. Our long-term conviction in our business is unchanged. Moving forward, we are focused on driving profitable growth in our core and expansion markets, collaborating closely with our customers and partners to continue to elevate Zebra as a premier solutions provider in attracting, developing and retaining top global talent to drive innovation. I will now hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : We will now begin the question-and-answer session [Operator Instructions] Today's first question comes from Tommy Moll with Stephens. Please proceed. Tommy Moll : Yes. Thanks for taking my questions. Bill Burns : Good morning. Nathan Winters : Good morning, Tommy. Tommy Moll : Bill, I wanted to start on the topic of run rate versus large customer demand. It sounds like the run rate business might have been a little bit stronger in Q1, but maybe also got a little weaker towards the end. So any commentary you could give us on one versus the other would be appreciated. And specifically, when you're talking about the potential for channel destocking, is that more a run rate driven phenomenon, or is that not the right way to think about it? Thank you. Bill Burns : Hey, Tommy, I would say that in the first quarter, our sales growth in -- we saw sales growth in run rate or non-large deals, which moderated towards the end of the quarter. And I would say that if we kind of characterize where we're at today that through the majority of Q1, we saw that our sales opportunities were developing as we had expected, and it allowed us to deliver on our first quarter guide. And I think that as we got later into the quarter towards the end of Q1 and into April, while our run rate continued to be strong in the first quarter, we saw that begin to moderate. But the real challenge has been around large customers and really tightening their CapEx budgets further as we got to the second -- the end of Q1 and into Q2. And we saw new projects not receiving the funding that our sales teams had expected in the near-term. So we saw a number of projects really in our sales funnel that were planned for Q2 and early Q3, really become deferred. And we especially saw this in retail and again, in specifically in North America and EMEA. So that ultimately, that slowing demand of larger deals and overall, a bit of moderating of our run rate, has really impacted our distributors that are looking to adjust their working capital levels that -- to really these -- the slowing demand of large deals and some of the moderating of run rate, we've also seen our lead times improve. So our distributors are having to hold less inventory as our lead times improve. And of course, they've got an increase in cost of capital and holding costs as they adjust their days on hand to the right level. So overall, these pressures really led us to say, hey, our Q2 guiding that down further and then ultimately look at the full year is despite run rate being strong in first quarter, we saw it moderate. And large deals are really in large customers, specifically around retail in EMEA and North America are really driving our guide for the full year. Tommy Moll : Just to continue with that theme, Bill, as you mentioned, some of the incremental weakness that drove your revision to the full year outlook really didn't manifest until late first quarter into the second quarter, it sounds like. Nonetheless, the outlook does imply a fairly healthy improvement in terms of revenue in the second half versus the first half. At this point, though, how much visibility do you have there? It feels like some of these conversations, particularly on a large customer side may still be early with a lot of question marks. But if I'm wrong in that characterization, please let me know. Thank you. Nathan Winters : Yeah, Tommy, this is Nathan. And then just a little color on the full year guide. So if you look for the full year down 3.5% on organic sales in the midpoint, as we said in the prepared remarks, we do have a pipeline of opportunities and actions to get to the high end of the range, how we're being cautious in the assumptions and what we expect out of the pipeline due to the uncertain macro environment, and the cautious behavior we're seeing. I think the other thing that's important to note is as we go into the second half, we have easier year-on-year comps, particularly in Q3 as well as we have the recently announced price increases that will benefit in the second half as well as a favorable FX from our last guide, helping offset some of the macro headwinds. So all those factors, a lot of factors played into some of the first half or second half dynamic, as well as what we believe we've taken a conservative view at the pipeline and actions we have as we look at the second half guide. Tommy Moll : Thank you both. I’ll turn it back. Operator : The next question comes from Damian Karas with UBS. Please proceed. Damian Karas : Hey, good morning, everyone. I have a follow up… Bill Burns : Good morning. Nathan Winters : Good morning, Damian. Damian Karas : Morning. Just a follow-up question on your comments, Bill, about some of these project deferrals. Just for clarification, right, are we talking about the same kind of select handful of large customers, North America retail and EMEA retail, or are there additional large customers that are mimicking these behavior or just kind of a combination of both of those factors? I'm curious if thinking about kind of future execution and delivery, do you have any kind of sense on time line on that, or are they just kind of on pause for the moment? Bill Burns : Yeah. I think maybe it's worth covering the vertical markets as we -- and what we saw in Q1. So predominantly retail, I would say that from a T&L perspective, we continue to see customers invest in visibility and productivity solutions. And Transportation & Logistics was up in Q1. In Q1, we also saw strong growth across manufacturing as they continue to invest in industrial automation and productivity within manufacturing. And healthcare also continued to be strong. So it really was around -- on retail. And those customers, ultimately not all retail customers, but a significant number of those across EMEA and North America had pushed out projects that were in our sales funnel for Q2 and Q3 out. And I think that ultimately, as Nathan said, allowed us to take or drove us to take a more conservative view of the funnel and pipeline for second half year. And maybe Joe wants to comment more on that. Joe Heel : Sure. So Damian, I wanted to underline one thing first, and then maybe I'll give you some examples because I thought you might -- someone might ask these questions. I put together a few examples to illustrate what we're seeing. I want to underscore that by and large, we're not seeing cancellations from these large customers. We're seeing deferrals of the decision and, in some cases, deferrals of the deployment. And the majority of those deferrals are to the second half of this year, to Q3 and Q4, which goes in part also to Tommy's earlier question about what confidence do we have, right? That's where we're seeing in most of those push. I'll give you two examples. One of our large US customers in the retail space, by the time we last spoke here in the first quarter, had ordered about $3 million from us. And they had told us that they were going to be ordering by the end of Q2, an additional $20 million. Since then, in the last three months, they've taken $6 million and said we're still going to order that in Q2, but we still don't have the purchase order yet. They're still trying to secure the budget for it. They have $10 million that they moved to Q3 and another $4 million that they moved to Q4. At least that's what they've told us so far. Of course, to your point about the visibility, will they actually order it then? We will see. But that's the current state of what we know and what's changed since we last spoke. Another even larger customer in the US, also a retailer, had ordered $5 million by the time we were speaking last year in February, and had indicated that they were planning to buy $35 million by the end of Q2. Since then, they have said $11 million of that we're going to order in Q3. And $24 million, we will not have budget for this year, but we plan to order it in 2024. So that gives you an idea of how things are moving and how these deferrals are happening, hopefully. Nathan Winters : I think just one thing to add, that's both -- those are two good examples of the decline for the overall year and the full year guide. But at the same token, while we have a pipeline and actions that are above -- towards the high end of the range, but yet being conservative on assuming all those deals won't get pushed further. So I think that's the -- trying to find the balance there around what we're hearing from our customers and the visibility, with also understanding that it's not certain until we get the PO. Damian Karas : Understood. Appreciate that color. I also wanted to ask you about your margin guidance. It seems you're actually expecting higher gross margins than previously. So is that the case? And could you maybe walk through the changes underlying your margin guidance for the year? Thank you. Nathan Winters : Yes. So look, our full year EBITDA guide of 22%, that was the low end of our prior range. We are seeing favorable gross margin trends, but that's being offset by the lower volume. So again, if you look at an aggregate, nearly one point higher than last year, primarily due to the supply chain improvements. And you can see it from our versus our prior guide of reducing those transitory or premium supply chain costs for the year from 50% to 40% as both the freight rates improved, and we're having to buy less components on the spot market. And that's still being offset. Those two points improvement are being offset by about one point of FX. Despite the improvement in FX with our hedging program, there's still a headwind for the year on FX. And again, I think a couple of things. The pricing actions we've taken over the past 1.5 years are offsetting the material and labor cost inflation or recouping some of that degradation over the past year, and we have actions identified to adjust our cost structure with the lower volume. Operator : The next question comes from Jim Ricchiuti with Needham & Company. Please proceed. Jim Ricchiuti : Hi. Thank you. I just wanted to drill down a little bit more, if I can, on the deferrals. And you may have mentioned this, and I apologize if you did. But are the deferrals that you're seeing, are they skewed more in North America, or are you seeing that same kind of level of deferrals in EMEA? Bill Burns : Yes. I would say, Jim, it's really both. And again, it's centered predominantly around retail. We believe ultimately have seen some moderation of demand in the other vertical markets, T&L and manufacturing, but it's predominantly retail and it's predominantly North America and EMEA. And I think it's Important, as Joe said, to say that these projects haven't been canceled, and our customers still have conviction about the value we ultimately deliver to them around improve productivity, increased visibility across supply chains, more effective and efficient operations within retail. All those are important because these projects, while they're moving out are still -- have strong return on investments for our customers. They're making tough decisions around CapEx in the short-term to adjust in a macroeconomic environment. But what they're telling us is that as their CapEx loosens up inside their organizations, they expect to move ahead with these projects. And the challenge in retail is because we've seen them continue to move out, we've had to take a conservative view of the outlook. And as Joe said, some of those projects have moved into 2024. But our customers are still committed to do those. So I think that we're seeing that, ultimately, our customers can only hold off from buying for so long, that we have mission-critical solutions. And they truly deliver value to our customers that make them more effective and more efficient in their business each and every day. And I think we feel that, ultimately, they are going to buy these projects and they're going to move forward. It's really an issue around timing and it's really North America and EMEA in retail is the primary challenge at the moment. Jim Ricchiuti : Got it. And I wanted to just follow up with a question only because you mentioned it several times, the strength in RFID. Is that mainly from this large North American logistics customer, or is this -- are you seeing the strength in other areas of logistics, or is it also a function of what we're seeing and hearing in retail? And is that sustainable as you go through the year? . Bill Burns : Yes, I would say that we're seeing broad-based demand for RFID across supply chains in general. So, all the way from retail through transportation logistics all the way back into manufacturing, so it is broad-based. We have the broadest and deepest RFID portfolio of solutions of fixed readers, handheld readers, mobile printers, software and solutions as well as our labels. So, we expect that we'll continue to benefit from the strength in RFID. I don't know, Joe, if you want to add anything to that, but I think that we feel good about the RFID portfolio beyond this large win in C&O. Joe Heel : We do. And I would underline, Jim, the broad-based nature of this demand. We're seeing it in health care, for example, we're seeing it in T&L, where entire package operations that were previously barcode-based are being driven by RFID now for greater efficiency and fewer errors. And we're seeing it in multiple regions of the world. We're seeing it strong in Asia-Pacific, but also strong in Europe where labor costs are high and RFID can have an outsized impact. This is a broad-based movement. Jim Ricchiuti : Thank you. Operator : Our next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning guys. In terms of looking at the guidance for the full year, can you kind of help me with some context in terms of how you're thinking about the overall macro economy and how changes in the macro economy may affect your guidance, the good and the bad? Bill Burns : Yes, I'd say, Keith, that I'll start, and then I'll let Nate or Joe want to jump in. But we're clearly seeing a softer macroeconomic environment that is having our customers take a more conservative view of their CapEx budgets and -- in first half year, and we're seeing less certainty in those budgets for second half year. So, a bit of the unknown, mostly in retail and again, mostly in North America and EMEA where we're seeing this, it's most pronounced there. What it results to for us is directly elongated sales cycles and opportunities that we thought we're going to close in Q2 and be deployed in early Q3 as moving out. And Joe gave the examples of all the business isn't moving out. Some portion of it is doing that, and some is moving into Q3 and Q4 from Q2 and others is moving into 2024. So, we think that ultimately, we've taken a more conservative view of our pipeline and the opportunities we expect to close in second half year. There's lots of reasons why we believe that guide is the right one as Nathan covered. But we also believe that our T&L manufacturing customers, where we saw strong growth in first quarter, even at the end of Q1, we're seeing them moderate a bit due to the macro environment. And we're taking a cautious view overall of what our pipeline and the projects within it because of it. But I think ultimately, we feel good about our business. We feel good about the value we bring to our customers, and this is really all about the macro environment and specifically in -- more pronounced in retail in North America and EMEA. Keith Housum : Maybe if I can tweak that question just a little bit. I guess, does your guidance include, I guess, a soft or hard landing in the US and Europe, or do you go look at that context? Bill Burns : Well, I'd say that we've had a tough Q1 from a mobile computing perspective, with double-digit declines in Q1. We see Q2 continue to be challenged from a mobile computing perspective. But, we saw strong growth in other parts of the portfolio like data capture and print. So I think, overall, what we're seeing is mobile computing remaining challenged in first half. And then in second half, we see some of these projects moving forward and then continuing into 2024. So we don't see the environment being a hard landing or much different than what we're guiding to at the moment, which is we were delivered on our first quarter guide, which ultimately was down. But we see Q2, obviously, we knew it was going to be our toughest quarter, and we see recovery in the second half. But modest, and we believe we can deliver on our guide. Keith Housum : Great. Thank you. Operator : The next question comes from Joe Giordano with TD Cowen. You may proceed. Joe Giordano : Hey. Good morning, guys. So I'm just curious on -- coming out of COVID, you put in a ton of assets. And I'm just curious on thoughts on the replacement cycle of that. So as we go into a soft patch here, what's the ability of customers to like extend, when they need to refresh this stuff? I'm just curious the deferrals that Joe mentioned, are these like new, new expansions, or is this like refresh of old product that is getting pushed out? Just curious there. Thank you. Joe Heel : Yes, why don't I start right away. This is Joe Heel. The investments we've made over the last few years in customer success have given us a really good insight as to what our installed base is and how our customers are using it. And that has generally revealed to us that the usage cycles have shortened, and that the replacements that are being contemplated now are things that have gone in approximately three years ago or even less than that. And of course, we have just launched a brand-new set of our mid-range and high-end mobile computers and the value tier was released last year. So those are coming right into that refresh cycle that we're seeing from those customers. And that's another reason why we're quite confident that while these customers are deferring decisions and deployments as we speak, they will have to purchase shortly. And we have pretty good confidence in that. It's the timing that we're uncertain about. Joe Giordano : And then just a follow-up, Nathan, if things do get cyclically worse here, how should we think about risk of, like inventory obsolescence on things that you have on the books, if the channel stays tough, things like that. Thank you. Nathan Winters : Yes. I would say, there's always a risk in a technology business of excess and obsolescence. That's something the team actively manages in terms of when we put something in -- a lot of that's in our control in terms of the life cycle of a product, when we end of life a component or our finished good. And today, we look and say there's still demand for what we have in inventory on a component level. The team has a series of actions, working with our suppliers to reduce purchase commitments where we can and drive programs where we have available stock with the commercial team. So today, I don't feel -- I think there's -- again, there's always risk given our business model, but I would say nothing more -- not more than we've had in other times. Joe Giordano : Thanks, guys. Operator : The next question is from Meta Marshall with Morgan Stanley. Please proceed. Meta Marshall : Great. Thanks. You guys noted the benefit of price increases in the second half. I just wondered, given the macro environment, if there's been any pushback to that or kind of shrinking of the amount of units to kind of keep with the same dollar amount that you've seen in response to that? And then maybe just as a second question. You noted backlog was a benefit to printing, kind of, in Q1. I just wondered, is there any meaningful kind of backlog or pent-up orders kind of across the space that we should be mindful of for the year? Thanks. Bill Burns : Joe, do you want to take the price increases? Joe Heel : Yeah. So Meta, we increased prices last year outside of North America towards the end of the year, and we have increased them in North America here in the first quarter. We have a very analytical approach to doing this where we literally analyze by product and by region where we stand competitively and what economics we can afford for our channel partner's because we want them to thrive. And as a result, we looked at that and we said we have additional headroom in North America, just as we saw that at the end of the year outside of North America. We have implemented those and we have seen generally good traction with those, and they're going to have a meaningful impact in terms of helping us to mitigate the challenges that we outlined earlier. Nathan Winters : And if you look at the overall backlog position, I'd say it's normalized from where we were over the past several years, in line with what we need to deliver for the second quarter. I think the positive news, both for print and DCS as we've largely worked through our delinquent or aged backlog, as supply has improved, still have some backlog to work through for both of those businesses. But in aggregate, I think we go back more to normalized levels, if not a little bit higher than we were pre-pandemic, but enough to definitely support our 2Q guide. Meta Marshall : Great. Thanks. Operator : Our next question comes from Rob Mason with Baird. Please proceed. Rob Mason : Yes. Good morning. I had a question just around your thought process on the channel distribution level, I guess, destocking. Is that a process that you think can be complete here in the current quarter, or does that extend into the second half as well? Nathan Winters : There's a few -- I can take a couple of things, I'll start. One, if you look at our overall inventory, I think in aggregate, remains healthy. However, as we highlighted before, there is our realigning, or aligning their days on hand to say, with the moderating demand as well as the improved lead times in the cost of capital. So we work closely with all the distributors, so they have the appropriate days on hand levels and that is recalibrating to the slower demand. You'll definitely see variations across distributors or regions due to the various dynamics. And that's why we look at it as a range in aggregate. But I'd say, overall, we think those levels are in line with where we were pre-pandemic. But obviously, we think that is definitely an outsized impact in Q2 relative to the rest of the year, as the demand has softened here over the past month or two. Rob Mason : Does your guide at the midpoint take it down 4%? Does that assume that the run rate business would be down this year also? A – Bill Burns : I think that we've seen moderating, Rob, in the run rate business. We saw it -- in Q1, small to medium deals continue to grow. But as we got later into first quarter, we saw some moderating of that run rate business. So I'd say that we see it moderating. The real challenge seems to be around large customer orders and larger deals and run rate, because we're continuing to see growth in DCS growth across our printing business. We hadn't talked about it, but services and software were positive and delivered growth in first quarter as well. So we continue to see that throughout the year. So there's certainly bright spots. But the challenge isn't as much around run rate, I would say, is really around larger deals and larger customers. Rob Mason : Understood. Maybe just last question to follow up on that. The -- how do you think about -- again, in a situation like this where deals are being pushed and conservative outlooks on IT budgets, how do you feel about how the adjacent expansion areas perform relative to your core business? Are those at the same level of risk, or how do you view those differently just given different growth dynamics there? A – Bill Burns : Yes, I'll start. And then I'll let Joe jump in. I think as I said, we saw growth in services and software in first quarter. So we continue to see that our software value proposition to our retail customers across Reflexis offering, Prescriptive Analytics, our Antuit. offerings, our Workforce Connect, has value to our retailers. And that falls into really an OpEx spending versus CapEx inside retail. We're seeing that strong interest in in our fixed industrial scanning and machine vision solutions. As we said, manufacturing continues to be more spending and focused on continuing to drive productivity inside their environment. So we're seeing opportunities there inside fixed industrial scanning, inside T&Ls, another opportunity. Again, we have lots of places where we can grow our market share across both those two segments. And we're seeing that Fetch from autonomous mobile robot and warehouse automation perspective, both fulfillment and material movement, and that applies again to T&L with 3PLs and then manufacturing with good movement, again strong interest there. So those businesses are much smaller, but I think we're continuing to see interest across our customers, and then we have lots of room to grow market share in things like machine vision and fixed industrial schemes. Joe Heel : Yes, Rob, I would also point out some of the near adjacencies have been very strong contributors for us, not just in the last quarter, but recently. Tablets, for example, has become our fastest-growing mobile computing category, and we now have a number one market share position in tablets. That's been a terrific contributor. We're seeing those use cases only expand in areas like healthcare in areas like manufacturing that we hadn't even considered initially. And I mentioned earlier, RFID, right? How that's been a broad-based growth driver for us. And by the way, the same is true for what we did in bioptic scanning, where we now have a very strong market position. So those adjacencies that are close to our core have contributed very nicely. Operator : The next question comes from Brian Drab with William Blair. You may proceed. Blake Keating : Hi. Good morning. This is Blake Keating on for Brian. Bill Burns : Good morning. Nathan Winters : Good morning. Blake Keating : Just wanting to dive a little bit into the second half implied guidance. I know it's already been asked a little bit, but I was curious just to hear outside of retail, what's driving your confidence in that second half revenue guide, if there's any end markets that are really -- that are growing or -- any color you can give there? And then how we should think about that in volume versus price? Bill Burns : Yes, I would say that across T&L, that our customers continue to struggle with labor constraints and are looking to add to visibility across the supply chain, across their -- your networks. We've seen some positives where T&L customers continue to make investments despite some of the challenges around the macro environment. So two examples of that is our postal win in Japan and the RFID win in North America. T&L show that some large projects and outside of retail are clearly continuing and our customers see the value in our solutions. So I think that T&L manufacturing is another area where we're seeing really investment in that business around industrial automation and opportunities, as I mentioned before, around fixed industrial scanning and machine vision. So they delivered solid growth in Q1. And they continue to invest in infrastructure to be more effective and efficient and productive within both their environments, T&L and manufacturing, and we expect that to continue to grow. But to moderate from the strong growth we saw in Q1 due to macro environments. Health care is -- we saw strong results in Q1, and it's less sensitive and less correlated to the macro environment. So we feel good about health care as well. So I think those are areas that outside of retail that we've taken into account for our second half guide. Joe Heel : And so -- and what I would add, Joe Heel here. By and large, we have not seen the deferrals of either project decisions or deployments nearly to the same degree in any of the three verticals Bill mentioned, T&L manufacturing or health care. They've had steady demand. Now we're expecting that some of that may moderate a bit because it was -- they were all up very strongly in Q1. But nevertheless, we expect those will continue to contribute. One other area that we're investing in that we think has some good growth potential is government. We're seeing some -- for reasons that are probably obvious, we're seeing some strong demand in the government sector. Nathan Winters : And one thing I'd add, just on the second half, I mean for the full year, we're expecting about 1.5 of benefit in price, including the most recent announcement. And I think I'll just get back. If you look at the second half, the implied guide around minus 2% again. But on much easier comps, if you look at just the trajectory of the business last year and the first half growth versus second half as well as the favorable FX impact. So those are, again, some different dynamics when you look at the first half versus second half for the year. Blake Keating : Got it. Thank you. And then just lastly, on the Matrox acquisition, I was just curious how the business is trending and how we should think about it moving forward? Bill Burns : Yes. I think, I would say, overall, with the Matrox acquisition and Adaptive Vision, that it really creates a comprehensive portfolio of solutions across fixed industrial scanning and machine vision. So we marry our organic investment plus the acquisition of Matrox and Adaptive Vision to the portfolio. It really is what our customers and partners were looking for is to -- some of our customers are just beginning their automation journey. Others are -- have increased complex, use cases that they're trying to deploy solutions and they're looking for a provider, both our channel partners and our end customers that can provide the breadth and depth of that solution from hardware to software. From a Matrox perspective, specifically, we've seen continued progress. It's performed as expected, and the integration is proceeding as planned. We're looking to diversify our customer base there and really continue to grow the top line of that business. And that means that how do we extend our channel network and our partner community; we're working on expanding that. We're focusing on manufacturing opportunities. Examples could be automotive or battery manufacturing are two areas in which we see opportunities for us. And then, ultimately, leveraging the synergies, I said, across the two acquisitions in our organic portfolio. We're seeing strong interest from our customer base. We were just at ProMat manufacturing and supply chain trade show, and we saw strong interest from our customers. So we feel good about where we're at with Matrox and the opportunities we have ahead of us for machine vision and fixed industrial scanning. Blake Keating : Got it. Thank you. I’ll pass it along. Operator : Today's last question comes from Guy Hardwick with Credit Suisse. Please proceed. Guy Hardwick : Hi. Good morning. Bill Burns : Hi. Good morning. Guy Hardwick : I think, three months ago, you guys said on the Q4 call that channel inventories were only a few days higher than pre-pandemic levels. But, I think, Nathan said in answer to Rob's question that channel inventories are now back to pre-pandemic levels. Did I hear that correctly? First of all. And it sounds like in your prepared remarks that Q2 guidance in particular assumes further destocking. So based on your Q2 guidance, can you quantify what the difference could be between sell-in and sell-out in Q2? Nathan Winters : Yes. So, I think, again, just sort of maybe clarify the comment in terms of -- we look at it in terms of an absolute range. So, I think, we're still in that same range we were in from a pre-pandemic, no different than we were in Q4, maybe just a little bit on the higher end. And so, we don't have a sales out to sales in reconciliation. I would say that, historically, when the velocity of the channel slows, we see an outsized impact as the distis moderate and manage their days on hand. So if they're selling over sales out of the channel that requires less inventory to support that, which means they're not going to make the same type of stocking orders. So it has an outsized impact on what we see from a sales end. So there's always a disconnect there based on, as you see the markets improve or decline. I think in Q2, that's amplified a bit by the improving lead times and their higher carrying costs. And I would just say, the opposite is true when the macro improves, we tend to see an accelerated recovery. But, again, that's not assumed in our full year guide. Guy Hardwick : So there is an assumption of destocking in Q2. So it suggests that underlying demand is better than your sales guidance you gave. Nathan Winters : That's right. As you would expect, if you have lower sales out of the channel that requires less inventory in the channel to support that business. Guy Hardwick : So Nathan, last question for me. Just what is your FX assumption? FX rate assumption for the full -- rest of the year? Nathan Winters : Yes, we take the spot market as we put the guide together. So sitting around whatever, just around $1.09 to $1.10 to the euro. . Guy Hardwick : Thank you. Operator : This concludes today's question-and-answer session. I would now like to turn the conference back over to Mr. Burns for any closing remarks. Bill Burns : Yes, I'd like to thank our partners, customers and employees for their support and dedication in this challenging in a certain environment. It's an honor to serve as CEO, and I'm excited about the opportunities ahead of us. Thank you. Have a great day. Operator : The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
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Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,023
| 3
|
2023Q3
|
2023Q2
|
2023-08-01
| 17.085
| 16.635
| 17.43
| 16.97
| 20.95
| 16.24
| 16.52
|
Operator : Good day, and welcome to the Second Quarter 2023 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's second quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth, our year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. Additionally, note that our Asset Intelligence and Tracking segment now includes our RFID solutions and we have recast quarterly segment results since 2021 in a schedule included in the Appendix of our earnings press release. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with our second quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2023 outlook. Bill will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now, let's turn to Slide 4 as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning and thank you for joining us. Our second quarter results were impacted by weakening demand and cautious customer spending behavior across our end markets. While these results are certainly disappointing to us, we'll spend some time today discussing the drivers that are having the greatest impact, as well as the actions we are taking to control what we can in a difficult demand environment, including our expanded cost reduction initiatives. For the quarter, we realized sales of $1.2 billion, a 16% decline from the prior year and adjusted EBITDA margin of 21.2%, a 70 basis point decrease, and a non-GAAP diluted earnings per share of $3.29, a 29% decrease from the prior year. Let me now put these results in context. On our last quarter call, we discussed the broader softening of industry demand as customers tightened their CapEx budgets and IT device spending slows. During the second quarter, those trends accelerated as we saw more cautious spending behavior by our customers of all sizes across our vertical end markets and regions. While all end markets declined, demand was weakest in retail and e-commerce and transportation logistics as many customers are absorbing capacity they build out during the pandemic. These dynamics have been exacerbated by our distributors focus on reducing their inventory levels, which accounted for approximately 20% of our Q2 sales decline. Our distribution channel has been aggressively driving down inventory as end user demand has slowed, product lead times have recovered, and the cost of holding working capital has increased. Although global macro indicators have been resilient, the goods economy has underperformed the services economy, and certain key indicators most relevant to our industry have become significantly weaker, including IT device spending. This particular metric has been most correlated with mobile computing where sales declines have accelerated year-to-date following more than two years of very strong demand. Growth across RFID, data capture, supplies, services and software were bright spots in the quarter. From a profitability perspective, improved gross margin and cost controls enable us to achieve our EBITDA margin and EPS outlook for the second quarter. In our current market environment swift action is needed and we are taking a number of steps to position us to deliver profitable growth and improve free cash flow. Slide 5 summarizes key industry challenges that have intensified since our prior update, and our actions to address and mitigate the impacts. These actions include reducing spending across the organization, including additional restructuring actions to drive an incremental $65 million of net annualized operating savings as we exit 2023, increasing our focus on accelerating growth in underpenetrated markets, and continue to work closely with our customers as we continue to digitize and automate their environments. Our revised full-year outlook incorporates the slowdown and deceleration across our end markets, including a significant reduction in near-term demand in the mobile computing market, destocking buyer distributors, as well as a partial year benefit of our expanded restructuring actions. Given our limited visibility in this environment, we are cautious in our assumptions and not expecting a recovery in 2023. We expect the reset of our cost structure and shift of our go-to market resources to drive sales growth and improved profitability as our end markets recover. We'll continue to take an agile approach to managing through this uncertain near-term environment. I will now turn the call over to Nathan to review our Q2 financial results and provide additional details on our revised 2023 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 7. In Q2, net sales decreased 17.3% including the impact of currency and acquisitions and were 16% lower on an organic basis. Our Asset Intelligence and Tracking segment was flat, strengthen in RFID and supplies was offset by a decline in printing as we lapped particularly strong prior year results. Enterprise Visibility & Mobility segment sales declined 23.6%, driven by a sharp decline in mobile computing, partially offset by growth in data capture solutions. Additionally, we drove organic growth across service and software with strong service attach rates. Sales declined across our regions driven by broad-based double-digit declines in mobile computing. In North America, sales decreased 11%. EMEA sales declined 24% with pronounced weakness in Eastern Europe. Asia-Pacific sales decreased 17% driven by China and India with growth in Japan and Australia. And Latin America sales decreased 6%, partially offset by growth in Brazil and Mexico. Adjusted gross margin increased 200 basis points to 48%, primarily due to lower premium supply chain costs in favorable business mix and pricing, partially offset by expense de-leveraging and unfavorable FX. We are pleased to see gross margins recovering from the inflationary headwinds we experienced over the past couple of years. Adjusted operating expenses deleveraged 310 basis points as a percent of sales, partially offset by lower incentive compensation and cost controls. Note, that as we began to see demand soften, we announced incremental restructuring plans that are expected to drive $65 million of net annualized operating expense savings as they're implemented. Including previous actions taken over the past year, our total net annual cost savings is $85 million. Second quarter adjusted EBITDA margin was 21.2%, a 70 basis point decrease driven by operating expense de-leveraging partially offset by improved gross margin. Non-GAAP diluted earnings per share was $3.29, a 29% year-over-year decrease. Increased interest expense contributed to the decline partially offset by fewer shares outstanding. Turning now to the balance sheet and cash flow on Slide 8. For the first half of 2023, negative free cash flow of $144 million was unfavorable to the prior year period, primarily due to a greater use of networking capital due to higher cash taxes and payments for inventory. And $45 million of previously announced quarterly settlement payments, which are scheduled to conclude in Q1 of 2024, partially offset by lower incentive compensation payments. In the first half of 2023, we also made $52 million of share repurchases and invested $1 million in our venture portfolio. We ended the quarter at a 1.8x net debt to adjusted EBITDA leverage ratio, which is below the top end of our target range of 2.5x and had approximately $1.1 billion of capacity on our revolving credit facility. On Slide 9, we highlight the impact of premium supply chain costs on our gross margin over the past 2.5 years. The actions we have taken to redesign products and increase price along with improving freight rates and capacity have enabled us to avoid component purchases on the spot market and reduce the freight cost impact. In Q2, we incurred premium supply chain costs of an incremental $5 million as compared to the pre-pandemic baseline and $51 million lower than the prior year quarter. As we enter the third quarter, we believe these costs will have been fully mitigated, which is the key lever to margin recovery. Let's now turn to our outlook. As we enter the third quarter, we are seeing sharp broad-based declines across most of our product offerings, which continues to be amplified by distributors recalibrating their inventory to lower demand trends. Our Q3 sales are expected to decline between 30% and 35% compared to the prior year. This outlook assumes double-digit declines across each of our core product categories with distributor destocking accounting for approximately one-third of the decline. We anticipate Q3 adjusted EBITDA margin to be between 10% and 12% driven by expense de-leveraging from lower sales volume, partially offset by higher gross margin from cycling $30 million of premium supply chain costs in the prior year period. Non-GAAP diluted EPS is expected to be in range of $0.60 to $1. Given our Q2 results in the continued challenging demand environment, we are significantly reducing our full-year outlook, expecting a sales decline between 20% and 23%. This assumes the Q3 sales trajectory continues through the remainder of the year. We're seeing broad-based declines across our end markets as we enter the second half with significant uncertainty in this environment. We expect full-year adjusted EBITDA margin of approximately 18%. We expect increased de-leveraging on significantly reduced sales volumes expectations partially offset by early benefits from cost reduction actions as most of the actions will be implemented by early Q4. We plan to continue to align our cost structure with the long-term trajectory of our business. We now expect free cash flow to be positive in the second half, but negative for the year given lower sales and earnings expectations. Our cash flow will be impacted by new restructuring charges, increased cash taxes due to change in R&D expected regulation and $180 million of previously announced settlement payments. We continue to be focused on rightsizing inventory on our balance sheet as component lead times have normalized. However, we now expect minimal inventory reduction in 2023 due to our lowered sales outlook. We are focused on achieving 100% cash conversion over a cycle, which is one of the metrics in our long-term incentive compensation plan. Please reference additional modeling assumptions shown on Slide 10. Note that we have improved our expected 2023 non-GAAP tax rate by 1 point due to favorable geographic mix. With that, I'll turn the call back to Bill to discuss how we're advancing our Enterprise Asset Intelligence vision. Bill Burns : Thank you, Nathan. While sales are pressured near-term, over the long-term, our solutions remain essential to our customers' operations, and we are well-positioned to benefit from the secular trends to digitize and automate workflows across our served markets. We are focused on advancing our Enterprise Asset Intelligence vision by elevating Zebra as a premier solutions provider through our compelling portfolio. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, including scarcity of labor and the need to improve productivity. We empower the workforce to execute tasks more effectively by navigating constant change in near real time, utilizing insights driven by our advanced software capabilities such as machine learning and prescriptive analytics. Now turning to Slide 13. I would like to highlight several key mega trends, which supports Zebra's growth and customer value propositions over the long-term. These include automation, mobility and cloud computing, and artificial intelligence. Our customers rely on Zebra to help them take advantage of these key mega trends, which drive their growth strategies. As you can see on Slide 14, Zebra's enterprise mobile computers are critical to the front line of business. We are excited about our innovation roadmap and new solution launches that advance our value proposition. Labor is a scarce resource and leveraging technology is a key way our customers can advance their operations. Our solutions empower enterprises to increase collaboration and productivity and better serve customers, shoppers, and patients by enabling and expanding number of use cases across our end markets. Our enterprise mobile computing installed base has expanded significantly over the past several years due to the perforation of use cases and the investment in Zebra solutions should rebound as technology refreshes or reprioritized. On Slide 15, we highlight a few areas that are advancing our capabilities to serve our customers evolving needs and are expected to be profitable growth drivers for Zebra as we continue to scale them. Collectively, these offerings are approaching $0.5 billion of annualized sales and have a long runway for growth. First, we are a leader in advanced location solutions through RFID. We have been driving strong double-digit growth in recent years with the heightened importance of real-time inventory accuracy. We are now addressing an expanding set of use cases throughout the supply chain, including our previously announced large win with a global transportation logistics provider, which highlights the long-term growth opportunity for RFID solutions. Second, we believe investments in our machine vision business, which is accretive to our growth and EBITDA margins, positions us well for long-term growth. We continue to invest in innovation and go-to-market efforts to further diversify and scale in attractive subcategories. Strong growth in certain end markets, including warehouse distribution, and electric vehicle manufacturing has partially offset weakness in the semiconductor industry. An example of our recent success is a win with the U.S.-based global auto manufacturer who has been transitioning to electric vehicle production. The ease of use of our solutions was a key differentiator as the manufacturer capitalized on the disruption in the auto market to modernize its processes with more flexible solutions. And lastly, our workflow optimization software offerings include workforce and task management, communication and collaboration tools, inventory visibility and demand planning. Recent notable wins include our workforce management solution for location staffing at a large North America bank and our retail demand forecasting solution for a North America consumer packaged goods company. The actions we are taking to improve profitability of our software offerings, including migration to a cloud-based platform are expected to enable software to become EBITDA margin accretive in 2024. In closing, our long-term conviction in our business remains unchanged. While customer spend is pressured near-term, over the long-term, we believe we're well-positioned to benefit from secular trends to digitize and automate workflows. We'll work to continue to elevate our position with customers through our comprehensive portfolio of solutions while taking the actions needed to improve profitability and position us for success both in the current environment and in the future. I will now hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up, so that we can get to as many of you as possible. Operator : [Operator Instructions]. Our first question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Bill, you referenced the reset of the trajectory for e-commerce including parcel. I wanted to dig in on that a little bit. Do you have any sense of how long that reset appears to need going forward. And how widespread is this? And I ask that second part because there's certainly one fairly high profile, maybe the most high profile end user there where these trends I think are well known at this point. But anything you could do to highlight and maybe other examples would be helpful as well. Thank you. Bill Burns : Yes. I think overall that we've said that what we've seen in the market is that as the goods economy is clearly weaker than the service economy, which is resulting in we're seeing more of our customers really absorbing the capacity that they bought through the pandemic, and that extends beyond just the largest e-commerce retailer we've talked about in the past, but to other e-commerce even our retail customers and into transportation logistics customers as well. And we've seen softness now spread into other markets. But specific to your question, I think that I guess maybe a good example of that is recently we've seen a large logistics company talk about really what's been detrimental to their volumes, right? And I think it is this idea that the overall industrial economy is slowing, right? Clearly focused on goods and not services. And they've said, look, that's slowing obviously because of all the macroeconomic indicators, right? Inflation interest rates slowdown in global trade. It's also being driven by consumers buying less, right? And then this reset of e-commerce coming out of the pandemic to the levels of purchases of goods slowing down transportation logistics package delivery as well, which has really been detrimental to the entire industry overall from a volume perspective. So we're seeing this additional capacity built out in e-commerce players. We're seeing it in retail, and I wouldn't say it as much as excess capacity is really, they have what they need for now, and as the goods economy slows, they eventually will come back and buy more. But for today, they've got what they need. We're seeing it move into parcel delivery with transportation logistics, but also spread into other markets as well. As you know, in first quarter we talked about slowing down of large orders and large customers. We've seen that move into mid-tier and smaller customers as well. So it's more broad-based than we had seen in the past. And we think it really is the two years of very strong demand we've seen, especially in mobile computing across our entire customer base is now being absorbed and into the marketplace and then ultimately, that's why we're seeing the decline in the short-term. And that will come back as the macro indicators come back, as people buy more goods than services, as you know they use this excess capacity within their environment. They will buy more from us. And we'll see that inflection point at some point, but right now we're not seeing it. We're clearly seeing our demand be pressured because of it. Tommy Moll : Bill, you mentioned an inflection point, which is the theme for my second question here. I'm using the mid-points of your revenue guidance for the third quarter and the full-year, and just looking at what's implied in the fourth quarter. And at least on the mid-points, it looks like the implication is from third quarter to fourth quarter revenue steps up somewhere in the mid-single-digit range on a percentage basis. I just want to unpack that a little bit. Is that an inflection that you think you have visibility too? Is it just there's some ranges in here and it depends on what you want to assume within those ranges, or is there anything you can point to maybe that's impacting 3Q disproportionately, but not 4Q? Thank you. Bill Burns : Yes. Kind of a combination answers there probably is that overall, we would say that, why do we believe our guide, right? And as we looked at Q3 and Q4, clearly in Q3, you're seeing more destocking from a distribution perspective than you are in Q4. But I think that we've taken an approach that basically for the guide for Q3 and full-year, where we see the demand trends that we'll continue that begin to deteriorate really in Q1 and continue through Q2. We'll continue from a booking and sales velocity perspective, it'll remain about the same for the full-year. We're assuming that a significantly lower conversion of opportunities within our pipeline than historical levels just because of these push-outs of large orders by our customers. And we've removed expectations really for recovery in year-end -- at year-end in fourth quarter. But the reason you see that the uptick there is really because we're seeing an oversize effect of our distributors destocking inventory levels as their end demand continues to slow. So ultimately our sales out of distribution, when that slows, they hold a specific days on hand inventory and they need to buy less from us because they're selling less out. They need less in inventory. And I think that the -- we see an oversize effect when end demand slows. So in fourth quarter, we're seeing less of the destocking than we were in Q3. The destocking is also driven by the fact that our delivery times have shortened and their cost of capital's gone up. So there's pressure on inventory and to lower those inventory levels really as their end demand is slowed and we're seeing a bit less of that in fourth quarter. So that's really the trajectory we're seeing around. We believe ultimately we're seeing -- in the process of seeing really the bottom in Q3 and Q4 and do see an inflection point in 2024. But the difference between Q3 and Q4 is really predominantly based on inventory destocking levels. And we expect to exit year-end with the right levels of inventory for what is the end demand that our distributors are seeing. So we see destocking taking place through the second half year, and then being really at the right levels for the demand that our distributors are seeing as we exit the year. Operator : Our next question comes from Damian Karas with UBS. Please go ahead. Damian Karas : Bill, maybe you could just elaborate a little bit on the demand environment for your end customers kind of moving past the distribution destocking impacts, but you talked about declines across all end markets and all customers. I mean, what do you think are the biggest drivers of that change over the past few months here? Is it your end customers really are facing sales pressures and budgetary constraints, or do you think to some extent your customers are just feeling a lot better about their productivity, now that supply chains have almost kind of uniformly eased across the globe? Bill Burns : Yes. Maybe I'll start and then I'll add Joe can jump in as well. Really, if we look back to our May call, we talked about broader softening of industry demands. And those trends really have accelerated in Q2 as we saw more cautious spending on the part of our customers, again, after two years of really strong demand for our products and solutions. And we see this as really broader global macro weakness, but we've seen particular impact from that in EMEA and in China and China we expected more recovery out of COVID that we haven't seen in slower economic factors within China. Retail and e-commerce, as we've talked about a little bit earlier on Tommy's question really is driving that, that trend as they're absorbing capacity, but coming out of the pandemic, but we've seen it more broad across other industries as well as we worked our way through Q2. We're seeing an increased number of push-outs from a project perspective as well, or those projects being reduced in size. And Joe will talk a little bit more about that overall, but I would say that, the dynamics that we're seeing around distribution is one element of it, but the end demand clearly is slowed, and that's what's driving the distribution destocking of inventory is really about end demand. That's really, and after two years of really strong demand, we're now ultimately seeing that it really is in Zebra, we're seeing this across industry trends like IT device spending that ultimately our -- we're seeing that same trend that that IT device spending is correlated to our mobile computing market, which we see as the biggest impact of this slowdown. But it's really broad-based across IT devices and through that we expect to continue to outperform our competition, but clearly disappointing demand levels from an end market, but maybe Joe wants to jump in. Joe Heel : Yes. Maybe if a little bit of additional color. So first, the declines in our larger customers were larger than the declines in our mid-tier and small, run rate business as we would call it. And that helps us understand this better because we track, of course, we have direct contact with our large customers and we see what's happening to individual deals there. Now what we've been seeing is that a lot of those deals hundreds of millions of dollars have pushed out of the first half into the future or in some cases have disappeared as deals altogether. I'll give you some examples of those, but before I do this behavior has accelerated in the second quarter. So, for example, in North America, the amount of push-outs that we've seen relative to the first quarter has tripled. Now let me give you just a few examples, right? So you can -- you see what's driving this and what's happening, right? At the beginning of Q3, we had a grocer who came to us and said, I want to buy $4 million worth of your mobile computers. And midway through the quarter they said, we're not going to do this deal in Q2, we're going to do it in Q3. I'm sorry, I said Q3 at the beginning, my mistake. So they came at the beginning of Q2, said, we want to buy this. And midway through the quarter they said we now want to do this deal in Q3 rather than in Q2. So a good example of what we would call a push-out. But we also had another grocer who at the beginning of the quarter was indicating that they're going to buy over $5 million worth of mobile computers. And they came and said, we now want to do take these $5 million of mobile computers, but we want to buy them over the next five quarters equally distributed, which of course, delays our revenue trajectory. We also had a DIY retailer who wanted to buy $7 million at the beginning of Q2 and came to us during the quarter and said, my budgets have been cut. I can't do this project right now anymore. We'll do it sometime in the future, but I can't tell you when. So these are three different examples that all impact our Q2 revenue and indicate that our customers' budgets are under pressure to the extent that they're trying to extend out when they buy from us, which diminishes our revenue. Hopefully that's helpful. Damian Karas : Yes. That's all very helpful. So could you maybe tell us like what proportion of firm orders you've actually seen canceled? Joe Heel : I can answer that directly. We have had no or virtually no firm orders canceled. So all of what I was describing to you were movements in our pipelines. Generally, we have not seen orders that we've already taken or backlogged canceled. Damian Karas : Got it. Okay. Appreciate it. And then I -- the bright spot in the quarter seems to be the gross margin recovery. So should we be thinking 48% is the appropriate run rate for gross margin or given your portfolio of assets now with machine vision and Amer's [ph] and so forth, is there possibly some upside to gross margin down the road? Nathan Winters : This is Nathan. Again, as you mentioned, I'd say gross margin was a bright spot in the second quarter hitting 48%, which we haven't achieved that level since the first half of 2021 when we had a bit more revenue and the euro was at a $1.20. So obviously the bright spot in the quarter, including the reduction in the premium supply chain costs down to $5 million and then negligible as we enter the second half of the year due to all the nice work by the team redesigning products getting our printer capacity back on ocean. So again, I think we feel good about gross margin. I think that's a -- the 48% is a new baseline. There will be fluctuations, as we move quarter-to-quarter based on deal size, that is one dynamic that's helping us with the lack of large deals is a benefit to gross margin. But there's other tailwinds that we have going through the remainder of the year, including FX assuming it stays at its current level. So I think that's the right watermark, but I'd say quarter-to-quarter there'll be fluctuations as with just general mix and business dynamics. Operator : Our next question comes from Jim Ricchiuti with Needham & Company. Please go ahead. Jim Ricchiuti : All right. Thank you. So as we think about the Q3 guidance and the implied outlook for Q4, it sounds like you're expecting at least geographically some worsening conditions in North America. Just if we look at what the organic decline was in Q2, is that the way to think about how the geographic distribution looks into the second half of the year? Nathan Winters : Yes. Maybe I can give just a little bit more color on the guide and then to your point on the some of the regional dynamics is just to read what Bill mentioned earlier, the guide is supported by the most recent sales and bookings velocity and we're not assuming any type of recovery as we enter the quarter or as we move through the quarter. So you really see that I'd say across all our geographies. So I think that it's -- if you look at the similarities across each region, they're very similar in terms of being impacted by mobile computing tougher year-on-year comps for the business like print. So what we've effectively done is said, what is that velocity we're seeing in the end markets? How does that continue through the third quarter and into the fourth quarter? And again, removing some of the upside or opportunities to ensure that we have the right baseline to build from here, but I'd say the dynamics are very similar across each of the regions as we go through the second half. Jim Ricchiuti : And does your guidance assume slowing in the areas of the business that have been relative bright spots, you highlighted data capture RFID and the recurring business, the supply service presumably holds up a little bit better. But what kind of assumptions are you making for these areas that, that have been more of a bright spot for you? Bill Burns : Yes. I would say that, RFID continues to be a bright spot and continue to see growth across multiple applications, not just retail. Our supplies business continues to be positive from not just an RFID perspective, but a broader supplies business in our Temptime acquisition as well. Services and software we think will be clearly bright spots in the second half year. Data capture is a tougher compare in second half. So I think what you're still seeing is in print and data capture solutions a fair amount of variation across supply chain availability in 2022 that were cycling through in 2023, so you see strong growth in first half with tough compares in second half across those businesses, which still remain challenging from as you look at the numbers overall that you're seeing -- still seeing the supply chain dynamic take place in comparison from prior years. So data capture solutions is just a tough compare in second half. Operator : Our next question comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. Thanks. I guess just putting into context, do you think you're seeing the greatest impact to the refresh business, which with just elongating hardware cycles, is this just slowdown in new builds or slowdown in new use cases? I guess I'm just trying to get a sense of you prepared yourself to the mobile IT market. We've seen some lengthening and refresh cycles in those markets over time as devices improve. And so is this just lengthening refresh cycles that may be more permanent or just kind of more macro impact to new builds or new use cases? Bill Burns : I think we're seeing clearly the refresh cycles, we would say, are elongated as people are using those assets and making tough business decisions at the moment. They can only hold off so long in those technology refreshes. And you've got to remember the strong demand over the last two years has put a lot more devices in the hands of frontline workers. So when they go to refresh those devices that will be a higher number of devices that they refresh. In the short-term, they're consuming capacity they built in e-commerce and transportation logistics and even our retail customers where they've bought a lot of devices through the pandemic and they've got to work through those devices, but eventually they will buy more. We're still seeing -- there's still a great opportunity for us to continue to underserved hands, more devices in the hands of frontline workers across all of our vertical markets. And Joe can talk a little bit about more about that. So I think we're still seeing that there's plenty of bright spots for new applications for our devices and leveraging our retail software, for instance, on our devices within retail and communication, collaboration, visibility, AI and leveraging, workers with more information leveraging your mobile devices. So the longer-term trends continue despite the challenges in short-term demand. And Joe, do you want to add to that? Joe Heel : Yes. I would underline that specifically that I think we're seeing is an extension of the sales cycles not a diminishing set of use cases in any way. In fact, I think it's almost the opposite. So the examples I gave earlier were all examples of extending sales cycles. And what we're seeing with our customers is that in fact they're discovering during this period how they can use their devices and the Zebra solutions for more use cases. So we're seeing more use cases in the store like communication or flexible checkout advising customers on where to find goods and products in the store are being added to the devices that they have. And we're of course fueling that because we're releasing new use cases. For example, we just released the ability to take payment directly on our devices, right? So I would say very clearly it's an elongation of sales cycles, new use cases are alive and well. Meta Marshall : Got it. And maybe just is -- do you expect any -- you noted that you were renegotiating some supply agreements. Is there expected to be any cash charges with those or just anything we should be mindful of as part of the restructuring? Bill Burns : No. Not as part -- not as part of the restructuring, Meta in terms of obviously the team's working on renegotiating supply agreements to maximize cash with the demand changes. But we'll work each one of those and make sure it's the right economic decision for the short and long-term. But those -- that is not included as any part of the restructuring charges. Operator : Our next question comes from Brian Drab with William Blair. Please go ahead. Tyler Hutin : Good morning. This is Tyler Hutin on for Brian. Thanks for taking my questions. Bill Burns : Hi, Tyler. Tyler Hutin : Hi, just starting off with pricing, I believe you may have mentioned the full-year benefit before, and I was just wondering if that has changed due to even more softening in what you would expect from volume growth. So is there any -- can you give us a expectation for full-year benefit from pricing? Nathan Winters : So we expect the full-year pricing benefit to be around 2 points. It's a little bit higher than our previous guide with the most recent price increases that went into effect late in the second quarter. But we're actually seeing those actions hold and stick in the market. So I'd say it's again about 2 points for the year. And I think just to again these were very specific targeted actions, not broad-based, and it's something we monitor constantly to ensure that we're competitive in the market. And that the -- I wouldn't say any part of the volume decline is related to the pricing actions. Again, because most of these are broad-based across the industry and very targeted at where there's opportunity to ensure we maintain our market share position in each of the markets and products we operate in. Tyler Hutin : Okay. Thank you for that. And just following-up, can you describe the opportunities that you're seeing with the government like what products, et cetera? And has this been an unexpected contribution in 2023? And will that be supplemental to your sales volume when other demand picks up? Thank you. Joe Heel : This is Joe Heel. Yes. So we've been working with governments around the world and have been seeing an increasing level of demand and opportunity there. And of course, we have commensurately increased the resources that we have put into this. Where we saw the North American government is the largest part of that. And of course, there are multiple different levels of that. State and local has been a growth area for us for some time. Specifically for example, outfitting police forces with tablets in their cars or parking enforcement handhelds devices with mobile printers have been the staple of our business there. But recently where we've been successful and have extended our engagement is with federal and state governments. And there are of course some very large contracts. You can see contracts with defense and in logistics areas that are increasingly important. And we've seen an increase in interest in those same levels in governments outside of the U.S. And of course, that has a little bit to do with some of the geopolitical situation that we find ourselves in and the governments needing in particular the types of solutions we provide to enhance the logistics behind some of those operations. Operator : Our next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning guys. I was hoping you could unpack the -- Bill Burns : Good morning, Keith. Keith Housum : I was hoping you could unpack the commentary regarding the customers digesting what they previously bought. Certainly, we're aware of one or two e-commerce guys that probably overbought, but I guess the people are digesting what they previously bought. Are they questioning the ROI that they previously experienced? I mean, perhaps just a little bit more color on the digestion commentary. Bill Burns : Yes, Keith, I mean, I -- they're not questioning the ROI at all. They're clearly seeing the benefit of our devices that are mission critical in their environment. What they're really seeing is that, that extends beyond e-commerce to parcel delivery for instance. So we're seeing that in our T&L customers that are saying if you look at what they've said around parcel delivery, the entire industry's down as the result of kind of e-commerce resetting to kind of pre-pandemic growth rates, and they build out capacity, assuming it was going to be much stronger than that. I would say in retail, they've bought the devices they have, so I wouldn't say it's absorbing beyond what they need in most cases. Now, some bought ahead because of supply chain challenges, right? They knew that they needed the devices they bought ahead for a project, but in most cases, they just have what they need. And they're -- I think to the earlier question continuing to use those devices in other applications or just making tough budget decisions that ultimately they'd like to buy more, but they're leveraging what they have today instead of purchasing new because there's pressure from either their CFOs and others on IT, spending and CapEx within their environments and a certain macro environments. So I think it's in some cases using capacity. In other cases, it's just leveraging what they have today and they don't need anymore. In some cases they bought ahead because of supply chain challenges. But we saw a significant increase in demand over the last two years and now we're seeing ultimately that demand slow and then we'll see growth from here. Joe may want to add something. Joe Heel : Maybe to make it concrete, let me give again just a few examples, right? So if you're in a retailer, you buy our devices typically with an expectation of a growth trajectory, which means how many associates you will have in your store, or how many new stores you will open. And so those retailers that some of examples I gave earlier had planned for a certain growth trajectory, and then they've seen that growth trajectory change and lower. And so as a result, the ROI hasn't really changed for them, but they just see a lower demand trajectory, which then they're translating into lower purchases with us, right? I'm looking at I have four pages of individual deals that we look through and where customers have done exactly this. And here's an example of one where it says, customers working through gear they already have on hand not ready for additional orders until Q3. That's literally the type of thing we're hearing. And I don't think it has anything to do with the ROI, it's simply about the expectation for demand. Keith Housum : All right. I appreciate that. As a follow-up, is the same issues extending to the machine vision and robotics segment, perhaps any commentary you can offer on how that's progressing? Bill Burns : No. We feel good about our machine vision business. When we acquired Matrox, at the same time we developed organically solutions in the low end of that range in fixed industrial scanning. And we acquired Adaptive Vision, which gave us software capabilities around things like optical character recognition. We knew when we acquired Matrox that they were heavily weighted in their sales to the semiconductor industry. And we all know that has slowed. But our objective all along was to really diversify that customer base as a smaller private company. Ultimately, they hadn't made the investments to go-to-market that we're making diversify it. We're seeing that the diversification is working. Our focus on things like electric vehicles, electric vehicle battery manufacturing, pharmaceuticals, really a broader push for us into manufacturing is working. And as we're driving into also into e-commerce opportunities, T&L, so we're seeing that the traction of diversification work within the business, despite the challenges with semiconductor in the short-term, which we were well aware of when acquiring the business. I'd say our organic investments as well are paying off in that space. From robotics perspective, I think it's just early days. We've got working solutions today moving pallets at customers for goods transport. We have goods being transported on smaller sized robots in multiple different applications. We're OEMing some of our robots in hospital environments delivering pharmaceuticals. We're picking e-commerce orders that that was one of the areas we've invested in since owning the business beyond just goods transport, but it's still early days. It's a small business and there's a large growth trajectory expected in that marketplace today. But it just takes time. You got to do early pilots with customers. You got to prove in the ROI and ultimately you see deployments and growth beyond that. So we feel okay about a robotics business. It's just small at the moment. Operator : Our next question comes from Joe Giordano with TD Cowen. Please go ahead. Joe Giordano : Just I kind of wanted to just square up the commentary about push-out and your customers kind of changing. I guess like, if we step back, big picture, everything we hear, granted the industrial economy, the data has been pretty horrible, but every -- I guess the takeaway has been that the consumer's been really resilient and that the consumer recession that people saw coming isn't happening or hasn't happened. So like, how do you square that commentary with what you're hearing directly from your customers who are kind of leveraged to those consumers who maybe aren't getting as bad as people thought? Bill Burns : I mean, I think we're seeing it, and I think you're seeing more people point to this, that it really is the service economy that's holding up, right? It's -- I think coming out of COVID, people are looking for more experiences. They're doing more travel this summer. They're saying, look, I'm going to take that trip no matter whether the cost of the flights or vacation are more expensive than it was in the past. I'm going to go do that. I mean, I don't know about you, but every flight I get on, every seat's taken, right? But I think from a goods perspective, we clearly are seeing a slowdown in customers buying goods. I think of Joe mentioned the DIY retailers, right, as is the interest rates have gone up, new housing sales have gone down and therefore people buy less from do it yourself retailers as an example. So I think people bought a lot of goods during COVID for their homes that now they're spending on experiences instead. So I think that while we're seeing the broader economy hold up, I think we're seeing goods purchases decline, and we're seeing that in where e-commerce is still growing, it's now reset back to a more traditional growth rate off the very high as we saw through the pandemic, which has then flows through to how many parcels have delivered from e-commerce. And I think that the -- and as Joe said, the expectations within our retail customers brick-and-mortar retail of how much they are going to sell has slowed so all that is playing a role in this. I think that it's really around goods versus services in the macro environment. Joe Giordano : And apologies if you said this already I'm kind of multi-tasking a couple calls here, but can you comment on what Matrox did specifically in a quarter on growth and maybe where they're at year-to-date? Bill Burns : Yes. So I think that I said earlier in the call that, we're happy with the machine vision progress we've made with the Matrox acquisition, the acquisition of Adaptive Vision and our organic investing in machine vision. We knew when we purchased that business that it was heavily weighted towards semiconductor. And one of the objectives we have is for Joe and our marketing teams to focus on expanding markets beyond semiconductor into pharmaceutical, electrical vehicle manufacturing, transportation logistics, e-commerce that are all big users of machine vision and fixed industrial scanning. And we're seeing early progress and wins in that area. So we're pretty happy with the progress overall, I think that we're excited about the machine vision business overall. It's closely adjacent to our scanning business and we're seeing good results so far despite the headwinds associated with semiconductor. Operator : Our next question comes from Brad Hewitt with Wolfe Research. Please go ahead. Brad Hewitt : Hi, good morning, and thanks for taking my question. Bill Burns : Absolutely. Brad Hewitt : I'm curious if you could elaborate more on what's embedded in your second half guidance in terms of pipeline conversion rates and any further project deferrals, and then also what drives your confidence that the full-year guide is properly derisked from here? Bill Burns : So maybe I'll start. So again, if you look at the, what's embedded in the guide for the second half, one, it's supported by the most recent sales velocity. If you look, we are assuming significantly lower conversion rates on our pipeline of opportunities than we've had historically used due to the continued push-outs of orders that we've discussed earlier in the call. So again, a much lower conversion rate assumption on those deals. And again, the other impact which is you have to include is this the overall size impact of destocking within the channel. But again, we're assuming kind of that similar type of velocity through the year-end. And I think the other important assumption is we're not having -- we're not assuming there's any type of potential year-end spending or new large deployments in the fourth quarter, which we typically see as we approach the end of the year. Joe Heel : I'd say probably, as we look beyond, right, the second half, where our customers can only hold off so long on deployments of our products, they're really mission critical in their environments as they look to serve the other customers. And over time they will use the excess capacity they've purchased or we'll see the macro environment get better from a goods economy perspective, and they will begin to buy again. So I think that long-term we see that our value proposition remains very strong with our customers. Our relationships remain strong and across all of our core markets, our adjacencies to those core markets and our expansion investments will all continue to grow again as we see things from the macro environment improve, and our customers work through some of the demand that they've created over the last couple of years and the purchases they've made -- we'll continue to grow again. Brad Hewitt : Okay. That's helpful. And then I'm curious what you're seeing in your run rate business and how you expect that business to trend in the second half of the year. And also, does your guidance assume any negative mix shift from a softening of run rate in the second half? Bill Burns : Yes. So we -- again, as we said earlier, we saw reduction in the velocity of our run rate business particularly in the second half of Q2, so kind of late May and into June. And we're assuming that trajectory continues through the remainder of the year. So I'd say no further deterioration, but definitely not any type of incremental improvement. And also that's why you see as you go into the fourth quarter kind of the year-on-year comps get more challenging, which is why you see the increase in terms of the year-on-year decline in the fourth quarter greater than in the third quarter. Just as that, that velocity continues to no assumed improvement that the comps get tougher as we move through the end of the year. Operator : Our next question comes from Rob Mason with Baird. Please go ahead. Rob Mason : So I mean, it looks like the run rate business has followed the large project business slower. I think you indicated earlier that's typically the pattern, but I'm curious if you think about a recovery scenario, perhaps looking out into next year or whenever this -- it happens, would you expect the run rate business to also follow the larger project business up or has just the -- what's happened in retail in particular changed that dynamic? I'm not sure that retail's overrepresented in large project, but maybe my impression is it might be. Bill Burns : Yes. I think in the -- historically we've seen large deals are the first to decline and the first to recover, right? So that's what we've historically seen and we'd expect the same here. The mid-tier and run rate has slowed clearly in second quarter and that likely you don't see as large an effect as quickly in that business you've seen see a longer-term trajectory. And then the reverse of that is it recovers, but as you said, we would expect large deals to recover first and then mid-tier and run rate to follow in that recovery is how we typically see it, but you see more pronounced swings in large deals than you do certainly in run rate or mid-tier. Rob Mason : Understood. And then just as a follow-up, Nathan, how are you feeling about inventory obsolescence risk at this point? And if a pause were to last multiple quarters, long of a pause, before that becomes a greater risk. Nathan Winters : Look, overall, I think the -- obviously, we would -- we were expecting better results on inventory as we entered the year. I think the team is doing everything in our control working with our suppliers to reduce the committed volumes that are coming in. It's obviously a challenge though as the volume has continued to decline. So we're kind of chasing and -- chasing down when it relates to the inbound inventory supply that we have coming in. But like I -- when I look at E&O, I think again there's always risk in a technology business, so that's not different. But where we have supply, it's primarily in our run rate kind of high volume type of business. So when the volume returns, we have the components for it. So -- and this isn't unique SKUs or products for kind of one-off type products we have in the portfolio. The vast majority is around kind of our mainstream product portfolio. And so again, as the volume recovers, we'll burn through that component inventory, and that's their value. If you look at where the primary increase is at, it's in components. So this isn't fully finished goods, which again gives us that flexibility to flex between different SKUs, different customers that we have given that most of the increase is in components sitting at our Tier 1 manufacturing partners. Operator : Our last question comes from Guy Hardwick with Credit Suisse. Please go ahead. Guy Hardwick : Just trying sort of dissect your comments on channel inventories and runway business. I think Nathan, you said the guidance in Q3, a third of it's accounted for by channel destocking. And then -- but I think you said that continues at kind of a similar rate in Q4. So just wondering what you -- has there been any -- what are the kind of the very latest indicators you're seeing in terms of sellout from the channel? Has there been any signs of stabilization yet? And if not, I mean, what is your kind of view where channel inventories could be at the end of the year? I mean, will the destocking continue into next year? Nathan Winters : Yes. So maybe just to clarify, so if you look at the guidance assumptions for the third and fourth quarter, it assumes that similar velocity of demand, so that includes 80% of our business is the channel so that kind of similar velocity from Q3 to Q4. Then you have the -- again, the outsize impact of destocking in the third quarter. So we do not plan to destock as much in the fourth quarter as again the -- and that's really the driver of the sequential improvement in our revenue between Q3 and Q4 is that differential. So the expectation is that we will exit the year with our days on hand balance in the distributors at its normalized level where we expect the business to be so that we go into 2024 with both that kind of run rate trajectory and the inventory balances in the channel appropriately set so we have a clean slate as we enter 2024. Guy Hardwick : I mean, if we take a kind of three or four year view on channel inventories, would you expect channel inventories to be back to pre-pandemic levels in terms of days on hand? Would it still be elevated relative to say 2019, 2020 levels? Nathan Winters : Yes. So again, two different points. I think from a days on hand, we've always stayed relatively within the boundaries we have as a business, and that's -- we measure our partners and channel partners on that as part of their incentive plan. Again, the absolute dollars increased over the last two to three years in balance as our revenue increased. And those balances are declining now that our volume's declining. But the -- we -- again, we spent a lot of time with our partners ensuring that they have the right levels of days on hand inventory to support the business. And those vary by product family by region and what the business needs are. So again, we're a little bit higher than that range today, just given the velocity decline we saw late in the second quarter. We're going to get that corrected here in the third and then a little bit more in the fourth, so that we go into 2024 again with a clean sheet. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. Bill Burns : Yes. While our spend is pressured certainly in near-term, over the long-term, we believe that we are well-positioned to benefit from secular trends to digitize and automate workflows within our customers environments. To wrap up, I'd like to just thank our customers, partners, and employees for their support and dedication over to our long-term success. Have a great day, everybody. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,023
| 4
|
2023Q4
|
2023Q3
|
2023-10-31
| 14.332
| 11.673
| 14.212
| 11.323
| null | 20.39
| 22.1
|
Operator : Good day, and welcome to the Third Quarter 2023 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. And I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning, and welcome to Zebra's third quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with our third quarter results and actions we are taking. Nathan will then provide additional detail on the financials and discuss our Q4 outlook. Bill will conclude with progress we are making on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning and thank you for joining us. As expected, our third quarter performance was impacted by broad-based softness across our end markets and elongated sales cycles. This resulted in a significant decline in sales with expense deleveraging impacting profitability. We will spend time today discussing our results, and the demand environment as well as the progress we have made to rationalize our cost structure and shift our go-to-market resources to drive sales growth and improve profitability as our end markets recover. For the quarter, we realized sales of $956 million, a 30% decline from the prior year and adjusted EBITDA margin of 11.6% and a 950 basis point decrease and non-GAAP diluted earnings per share of $0.87, a 79% decrease from the prior year. We saw broad-based softening of demand in late Q2, which continued throughout Q3 as customers demonstrated more cautious spending behavior across all our end markets and regions. These dynamics have been exacerbated by our distributors reducing their inventory levels, which accounted for about one-third of our Q3 sales decline. As a reminder, our distribution channel has been aggressively driving down inventory as end-user demand has slowed, product lead times have recovered and cost of holding working capital has increased. We believe this reset will largely complete by year-end. Although we experienced declines across all product categories, services and software were bright spots in the quarter. As we enter Q4, potentially all the cost restructuring actions now implemented, we expect to see a significant sequential improvement in profitability. These actions are now expected to yield net annualized cost savings of $100 million, which is an increase from our previous expectation of $85 million. On Slide 5, we summarize drivers of demand trends across our end markets. Our three largest end markets, representing more than three-quarters of our sales volume are indexed to the goods economy, which has been significantly underperforming the services economy. While each of our primary end markets declined, demand was weakest in retail and e-commerce and transportation logistics as many customers are navigating a challenging environment and absorbing capacity built out during the pandemic. As you see on the slide, despite current demand softness, there are several themes that we expect to drive investment in our solutions over the long-term, including labor and resource constraints, real-time supply chain visibility, track and trace mandates and increased expectations from shoppers and patients. Turning to Slide 6. I'd like to review the actions we are taking to address and mitigate the impacts of the soft demand environment and position ourselves for long-term success. In late Q3 and early Q4, we implemented most of the cost restructuring actions that are driving $100 million of net annualized operating savings. We are reallocating resources to accelerate growth in underpenetrated markets, including Japan, along with government and manufacturing sectors, and to capture the potential of new use cases that leverage our solutions to digitize and automate environments, including RFID and machine vision. We are also renegotiating long-term supply agreements and working with our contract manufacturers to drive down component inventories. And as part of our long-term incentive plan, we added a free cash flow conversion [Technical Difficulty] to improve profitability and drive sales growth as our end markets recover. While we believe we are seeing a leveling of demand trends and the peak of distributor destocking activity, we are not seeing signs of a market recovery based on customer behavior. Therefore, we remain cautious in our planning through the remainder of this year and the first half of 2024. We'll continue to take an agile approach to managing through this uncertain environment, and we remain disciplined with respect to our cost structure and cash flow. I will now turn the call over to Nathan to review our Q3 financial results and discuss our fourth quarter outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 8. In Q3, net sales decreased 30.6% and 29.6%, excluding the impact of FX. Our Asset Intelligence & Tracking segment declined 25.8% primarily driven by printing. Enterprise Visibility and Mobility segment sales declined 31.4% with pronounced weakness in mobile computing. On a positive note, we drove growth across service and software with strong attach and renewal rates. We saw double-digit sales declines across our regions. In North America, sales decreased 25%. EMEA sales declined 39% with broad-based declines across the region. Asia-Pacific sales decreased 32% driven by China and Southeast Asia, and Latin America sales decreased 15%, driven by Mexico. Adjusted gross margins decreased 100 basis points to 44.8%, primarily due to expense deleveraging from lower sales volumes, partially offset by favorable premium supply chain costs. As these supply chain costs have been fully mitigated, we are no longer including a slide as part of our earnings presentation. Adjusted operating expenses delevered 910 basis points as a percent of sales. Note that the bulk of the previously announced restructuring plans to drive operating expense savings were implemented in late Q3 and early Q4. Third quarter adjusted EBITDA margin was 11.6%, a 950 basis point decrease driven by expense deleveraging. Non-GAAP diluted earnings per share was $0.87, a 79% year-over-year decrease. Increased interest expense contributed to the decline, offset by a lower tax rate. Turning now to the balance sheet and cash flow on Slide 9. For the first nine months of 2023, negative free cash flow of $193 million was unfavorable to the prior year period, primarily due to lower earnings, including the impact of restructuring actions and higher interest costs. Greater use of net working capital due to higher cash taxes and payments for inventory and $45 million more of previously announced quarterly settlement payments, all of which was partially offset by lower incentive compensation payments. We ended the quarter at 2.2x net debt to adjusted EBITDA leverage ratio, which is below the top end of our target range of 2.5x and had approximately $1 billion of capacity on a revolving credit facility providing ample flexibility as we navigate a challenging environment. Let's now turn to our outlook. As we enter the fourth quarter, we are seeing sales velocity out of the channel stabilize on a sequential basis and destocking activity moderate as expected. Our Q4 sales are expected to decline between 32% and 36% compared to the prior year. This outlook assumes double-digit declines across our major product categories, with distributor destocking accounting for approximately one-fifth of the sales decline. We are in Q4 with the necessary backlog and pipeline to support our guide. That said, we are not seeing compelling signs of a market recovery as we look to the first half of 2024. We anticipate Q4 adjusted EBITDA margin to be approximately 16%, driven by expense deleveraging from lower sales volumes, partially mitigated by the benefits of our cost restructuring actions. Despite anticipated expense deleveraging, we expect year-on-year gross margin improvement as we cycle $25 million of premium supply chain costs in the prior year period. Non-GAAP diluted EPS is expected to be in the range of $1.40 to $1.80. Our Q4 outlook translates to an expected full-year sales decline of approximately 21% at the midpoint, which is 50 basis points favorable to our prior guide and an EBITDA margin of approximately 18%. We expect our free cash flow to be positive for the second half of 2023 and negative for the full-year. We continue to be focused on rightsizing inventory on our balance sheet and in driving 100% cash conversion over a cycle. Please reference additional modeling assumptions shown on Slide 10. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision. Bill Burns : Thank you, Nathan. While sales are pressured near-term, our solutions remain essential to our customers' operations, and we are well positioned to benefit from the secular trends that digitize and automate workflows. We are focused on advancing our Enterprise Asset Intelligence vision by elevating Zebra as a premier solutions provider through our compelling portfolio. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, including scarcity of labor and the need to improve productivity. We empower the workforce to execute tasks more effectively by navigating constant change in near real time, utilizing insights driven by advanced software capabilities such as artificial intelligence, machine learning and prescriptive analytics. We continue to advance and innovate our offerings. This includes several product and solution launches across our portfolio, including our Zebra Pay solution, which equips retail associates, hospitality workers and logistics employees with the mobile point-of-sale device that accepts a variety of payment options almost anywhere. At our Annual Software Customer User Conference, we unveiled our Zebra Work Cloud suite of software solutions, which address four critical enterprise functions, workforce optimization, enterprise collaboration, inventory optimization, and demand intelligence. The user experience is tailored to customer-specific business priorities and integrate it into a single application. This unique software suite, coupled with our mobile computing platform, differentiates us and expands our market penetration opportunity. In collaboration with Qualcomm, we demonstrated a generative AI large language model for handheld mobile computers and tablets without requiring connectivity to the cloud. Is the competitive differentiator, which will enable Zebra partners and customers to create new ways of working by further empowering the frontline worker and driving additional productivity gains. We are confident that the innovation roadmap across our business will continue to elevate our customer value proposition. As you can see on Slide 13, customers leverage our technology to optimize workflows for the on-demand economy. Our solutions empower enterprises to increase collaboration and productivity and better serve customers, shoppers and patients. I would like to highlight some recent wins by our team. A global technology provider recently selected Zebra's machine vision solution to automate a previously manual inspection process for the manufacturing of engraved component parts. Our solution ensures high quality and traceability, reducing expensive material waste and false errors. We look forward to exploring opportunities to expand our relationship with this customer. A large health care system in Europe is using our mobile computers, printers and RFID solutions to enable real-time tracking of medical equipment, significantly reducing the time caregivers spend searching for critical assets throughout the hospital. A large retail pharmacy chain, selected Zebra's work Cloud task management software to improve store productivity and effectiveness by streamlining communication and accelerating on-site inspections and marketing promotion updates. Optimizing task assignments and store walks drives accountability and frees up staff to focus on customer-facing activities. A large North American retailer refreshed our mobile computers across their stores and added RFID technology to improve inventory accuracy, supply chain efficiency and customer satisfaction, the more frequent cycle counts. During the competitive review, Zebra demonstrated the most cost-effective solution for their needs. Lastly, a large Asian retailer decided to add Zebra's communication and collaboration software to their Zebra mobile computers. This subscription-based solution drives store associated connectivity benefits while displacing the legacy phone system. In closing, our long-term conviction in our business remains unchanged. While customer spend is pressured near-term, over the long-term, we believe we are well positioned to benefit from secular trends to digitize and automate workflows. We will continue to elevate our position with customers through our innovative portfolio of solutions, while executing on actions to position us well for profitable growth as our end markets recover. I will now hand it back to Mike. Michael Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible. Operator : And we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brad Hewitt from Wolfe Research. Brad, please go ahead. Brad Hewitt : Hi, thanks. Good morning everyone. Bill Burns : Good morning, Brad. Nathan Winters : Good morning, Brad. Brad Hewitt : So I was wondering if you guys would be able to provide some preliminary thoughts on the overall growth setup for 2024, and how we should think about that relative to the 5% to 7% long-term growth algorithm. You talked about the first half kind of being a little bit more challenging. And then of course, comps is in the second half, but any thoughts on the growth outlook for 2024 preliminarily would be helpful. Nathan Winters : Thanks, Brad. I guess I'd start with what we're seeing today. And from a Q3 perspective, we finished at the high end of our outlook in a challenging demand environment. And as we said, we're seeing leveling of demand trends overall and really in Q3, the peak of distributor destocking, but we're not yet seeing signs of market recovery based on our customers' behavior. So we saw really all region verticals declined in Q3 and along with customers of all sizes, but it was most pronounced in large enterprises. There were some bright spots in the quarter. Services and software are examples of that. I'd say is we're certainly not guiding to '24 at this time. But we're not seeing really compelling recovery yet and the idea that we're going to remain cautious for the remainder of the year. And really, as we look into the first half of '24, we're seeing very -- we have very challenging compares ahead of us. So I'd say that for the moment, still challenging demand environment that we would see that in '24 and the remainder of the year, we're going to remain cautious. Brad Hewitt : Okay. That's helpful. And then maybe if you could talk about what you saw in Q3 from a bookings perspective and how bookings looked sequentially as well as what you expect bookings to look like in Q4? Nathan Winters : I would say that, again, with demand challenging from that perspective, bookings were as we expected going into -- during Q3 and then as we enter Q4, we've got the bookings trajectory to feel good about our guide for Q4 overall. But again, not seeing quite signs of recovery yet, but feel that we've got the order velocity to be able to deliver on our guide for Q4. Operator : And our next question comes from Tommy Moll from Stephens. Tommy, please go ahead. Tommy Moll : Good morning and thank you for taking my questions. Bill Burns : Good morning, Tommy. Tommy Moll : I think I heard in your prepared comments, you described the velocity on the sell-through as having stabilized. And I wanted to circle back to that topic. One, just to make sure that, that's correct. And two, if you think about that sell-through velocity at some point, and maybe you could tell us when that is when would you expect an acceleration there, just given that you'll have some product refresh cycles where a lot of your installed base is approaching end of useful life, and it's less of a discretionary spend on the part of the customer. Nathan Winters : Yes, I think, Tom, we view the word leveling is we've seen those demand trends level out in Q3, and we're seeing that kind of into Q4. And we're seeing that from a destocking perspective, the biggest impact has been Q3 and again, less so in Q4, and we believe that will be behind us by year-end. And again, while we're not guiding to '24, maybe a little more color to add to what I said on the first question, we don't see compelling signs of recovery yet, right? And therefore, our guide for fourth quarter. And then as we look into first half of '24, we see very challenging compares. But that said, we're not seeing customers cancel projects. They continue to push them out. And they can't do that forever. We're seeing use cases across our products and solutions continue to grow within our customer environment. They will resume deployments as they use the excess capacity across retail and e-commerce across transportation logistics and as our customers around the world see the macro uncertainty abate. So we've seen this in similar downturns where typically, they last for Zebra quarters, not years. So as we go through the year, we do see some progression. And while our visibility for the second half would remain very challenging at the moment, we would be clearly cycling through easier compares at that time and really due to the restocking -- that the destocking, sorry, that we were seeing in the second half of this year. So I think that's how we'd see it at the moment. Tommy Moll : And to follow-up on the destocking theme, it sounds like you expect most of that to be behind you by the end of the year. And my question is just relating to the visibility there. If 60 days on hand is typical or something in that ZIP code for your channel, broadly speaking, do you have any idea where you sit today? And is there a view that, that will remain the "normal level," or could there be some period of time where we end up below that, just given conservatism among your channel partners at this point? Thanks. Nathan Winters : Hey Tommy, this is Nathan. As we said, from a global channel inventory, which again, we measure on days on hand, and as you said, the average is around 60 days, two months, but that varies -- you can see quite a bit of variation based on the product type and by region. So again, it's not consistent globally. And as we said, we -- in the end of Q3, better than we did in Q2, so the days on hand and the relative inventory balances decreased throughout the quarter. I'd say still slightly higher than the normal range despite those decreases. And that's why we expect distributors will continue to lower their inventory here throughout the fourth quarter, but we do expect to exit the fourth quarter within our normal operating levels. And that's something we work with very closely with our distributors on in terms of where they try to get to what products do they need to support the markets. And so again, as we enter next year, we expect kind of the destocking to be and where it needs to be as we move forward into the year. Operator : And we move to a question from Damian Karas from UBS. Damian, please go ahead. Damian Karas : Hi, good morning everyone. Bill Burns : Good morning, Damian. Damian Karas : Good morning. So not to beat a dead horse here on the demand environment and recovery. But Bill mentioned not seeing signs of that as you think about early 2024, I get that you're seeing that based on your order patterns, but based on your customer conversations, I mean, what do you think it's going to take to see that inflection of demand to drive that? And where would you see it first? Thinking about the various markets you play in and your diverse set of customers? Bill Burns : Yes. What I'd say is that overall, we'd have to see strengthening certainly of a goods based economy. And our customers overall will resume deployments as they -- some of the macroeconomic uncertainty around the good based economy abates. And in T&L and e-commerce, we've seen significant capacity built out during the pandemic and that excess capacity has to be used within their environment. And that's across their entire environment where we've built that capacity that now is more being used and demand is more normalized levels than the accelerated levels through the pandemic. I would say overall, when we see the broader demand across the industry, we're seeing that where first, likely large customers first is what we'd expect that large customers, the first area where we saw it challenging from a demand environment, so we'd expect that to return first. And then from their midsize and run rate would follow. I don't know, Joe, if you want to add anything. Joachim Heel : Yes. Maybe just a little bit on that point. During the supply-constrained phase, we had given some priority to some of our larger customers. So that's where a large amount of the volume and the capacity that went into the market went. And that's where we're seeing the steepest declines at this point. So I would expect that, that's also where we would see the first signs of recovery where those customers would begin purchasing again. And we are staying very close to those large customers as we're seeing them sweat their assets longer, we know exactly when they are reaching those points in the product life cycle where they will need to refresh. And we're working with them on plans that will fit their budgets. And you can imagine, as we're going into 2024, they're coming up with new budgets and we're working with them on doing that. So that's perhaps where I would look first. Damian Karas : Got it. That's really helpful. And then maybe if we could switch gears and talk about gross margins. Curious how you are thinking about what those look like from here, is there a further downside from the third quarter just based on the volume levels you're seeing? And how should we think about the kind of the new baseline or normalized gross margin? Nathan Winters : Yes, Damian. So if you look just maybe for context on Q3 gross margin, obviously, down year-on-year by about one point to 44.8%, volume deleveraging was a major driver of the decline as we did see favorability in premium supply chain costs. Now that those are entirely mitigated. So that was a two-point favorable impact as well as we're seeing nice traction from the pricing actions we've taken over the last several years and continued to strengthen our service and software margins. So if we look at our underlying gross margins with the pricing actions we've taken to offset component cost increases, inflation with the freight cost declining. Really now the focus is on rebalancing our manufacturing and distribution capacity to the lower volumes so that we can again, start to see those margins recover as we go into next year. So I think the -- as we look here at the second half is the low watermark just given the sharp volume declines and making sure we reset capacity to that while giving us flexibility to grow as the market recovers. Operator : We now have a question from Keith Housum from Northcoast Research. Keith, please go ahead. Keith Housum : Thank you. Good morning guys. If you perhaps focus a little bit on Zebra's own inventory levels, which obviously are still high compared to historical levels. Is this more component cost product parts, or is it more finished goods? And then second to that is, do you guys have minimum purchase agreements with your OEMs where if you're not making the minimum purchases, you're going to have penalties you'll incur? Nathan Winters : Keith, so just on our own inventory, as expected, our inventory balances stayed relatively flat to where we were at the end of the second quarter. We don't expect to see a material change as we exit the year. And as we said before and as you stated, the primary increase from where we'd expect to be is all around component -- consigned components that are at our Tier 1 manufacturers. So these are inventory that we made purchase commitments on going back to a year, 1.5 year ago at really the peak demand as well as the peak supply chain challenges and issues where the lead times were out greater than a year. So really absorbing those inbound components as our demand decrease. I think the team has done a phenomenal job working with all of our partners to reduce those purchase commitments. If you look at our outstanding purchase commitments, we've cut those in half since the beginning of the year. We've driven down finished good balance since the beginning of the year. So we're making traction, although you don't see it in the headline numbers. So really now, it's around getting stability in the demand signal to our suppliers so that we can in right size those inbound components. If you -- to your last question, we don't have a minimum purchase agreement that it has penalties. Obviously, we work with our Tier 1 manufacturers to have different tiering in terms of volume on our purchase price to cover their overhead. But there's not a, I'd say, a penalty per se at certain volumes, it's just making sure that they have the right capacity within their cost structure. Keith Housum : Okay. If I could follow-up on that. And as we look forward to like 2024, is there a rule of thumb or where do you think your inventory level should be under optimal level? Because, of course, we'd assume that you'll have some positive free cash flow next year as that gets worked down? Nathan Winters : Yes. So I would say, if you look at base, if you go back to our historical turns and you account for some of the M&A over the past couple of years, we said about a $200 million reduction would get us back to say, normalized levels. When and how quickly we can achieve that is the question. And some of that depends on, again, some of the demand stability as we go into next year. But that $200 million reduction would be entirely in consigned inventory components at our manufacturers. Operator : We'll take a question now from Joe Giordano from TD Cowen. Joe, please go ahead. Joseph Giordano : Hey, good morning guys. Bill Burns : Good morning, Joe. Joseph Giordano : So I'll ask a couple of higher, bigger picture kind of questions. We've dug into the near term dynamics quite a bit here. I've had a lot of questions about like longer term, what is a shift from potentially into kind of fixed automation mean for you guys? So you have huge share in mobile computers. And then what happens as you get more and more of these kind of big RFID-type fixed mounted scanners instead of having a person make scans. Like what does that mean for you over time if the percentage of scans being done by humans goes down? Bill Burns : Yes, I would say that the investments we're making across the portfolio, including new areas such as RFID and machine vision both play to exactly that. We see a need for both handheld devices, handled scanning, mobile printing just as we do fixed table operating and fixed industrial scanning/machine vision as well as RFID readers. So that's why we've got a broad base across the portfolio as our customers continue to digitize and automate their environments. Ultimately, there are places where a fixed industrial scanning machine vision imager makes more sense than someone holding hands -- something in their hand or a hand scanner. RFID does very similar type things, but you marry RFID technology along with barcode scanning. So we think of machine vision and fixed industrial scanning is closely addition to our scanning business, really fixed versus handheld, and we see RFID portfolio the same way where we've got handheld RFID readers and fixed RFID readers across the portfolio just as we have tabletop RFID printers in mobile. So we think that mobility is going to continue to be an important aspect of our business, but fixed is as well as we're seeing more fixed infrastructure, more automation in our environments. And that's why we're invested in both. And I think that machine vision and RFID both represent attractive markets for us for that very reason. Joachim Heel : And Joe -- this is Joe Heel, I'll add. I think this is also an opportunity for us to add additional value to our customers, specifically because in both areas, the customers will need more than just the hardware solutions that they might buy from us today as a handheld reader, for example, they will need, in particular, software and other accessories. And so if you think about our machine vision business, a very important part of that is the software component, which, by and large, we don't provide today when it comes to a handheld scanner. But in the machine vision, environment, we do provide that. So it's a great opportunity for us to create additional value for customers, but also for us at Zebra. Joseph Giordano : That was a very good answer. I just want one more on -- we talked about the trends are not yet improving, but some of the true weakness in the destock is getting away. So as we come out of that, which I assume we do at some point, when I think back to your 2021, 2022, you're doing $17.5, $18.5 of earnings, how do you categorize those years? So revenue was obviously very strong, but margins were maybe somewhat pressured from some of the supply chain, and what you guys had to do to deliver. So like what would it -- what kind of market -- end market dynamics do you think would need to be in place to get earnings back to levels like that? Because my guess is that you don't need revenues to be nearly that high. Bill Burns : I think that overall, we would expect to see continued progression in margin as our markets recover overall. So I would say that we would expect to get back to the levels that we've had in the past, and there's no reason why we wouldn't. There's been a lot of challenges in moving pieces over the last several years, including tariffs, supply chain challenges that the significant increase demand we saw over the last two years driven by the pandemic and building out of capacity. But I think that returning to the profitability levels that we've had prior, we see that continuing to progress throughout in 2024 as we get back to more normal levels of demand and our customers begin to buy again. And as we continue to be very thoughtful around our costs, right? So I think we're going to continue to be cautious in spending as we have been. We are taking $100 million of annual cost out of the business in 2024 and that will also add to profitability along with demand returns. So we see profitability to continue to progress, and there's no reason why we can't get back to past levels. That's how we see it. Operator : And we will take a question now from Meta Marshall from Morgan Stanley. Meta, please go ahead. Meta Marshall : Great. Thanks. Maybe a couple of questions for me. The health care market has been kind of a source of strength over the past couple of years. Just wondering if there's kind of any commentary about that market maybe being less consumer goods related than the others? And then maybe the second question, you noted kind of a step-up in investments in the manufacturing market. That's already kind of a pretty strong market for you. So I guess, is that kind of a combination of bringing robotics machine vision into that market, or just kind of what are kind of some of the areas that you think are unexploited there? Thanks. Bill Burns : I would say that health care and manufacturing less declines than the other markets, so less impacted overall, but they are still seeing the same trends at a broader market. I would say, overall, in health care, our -- has been in the past, our fastest growing vertical market, but our smallest. As health care continues to look to improve productivity, enhance patient safety, clearly automating workflows and digitizing assets within that environment creates an opportunity for the full breadth of our solutions portfolio across scanning, printing, mobile computing, RFID all play a role within health care. We're also announcing new opportunities across health care in things like tablets for home health care or telehealth all remain opportunities for us. So we're -- we like the health care market, and we continue to develop very specific products for the health care their market overall. I'd say in manufacturing, while we've got a strong base within our manufacturing customers, a lot of that is really tied to more of their logistics and distribution network more so than kind of assembly and on the line. And I think you said it best already machine vision, robotic automation for -- in the manufacturing environment with good transport demand planning for our CPG customers with Antuit, all leverage or give us more strength to meet the demands of that marketplace overall. So we've shifted sales resources to focus on manufacturing and continue to look to recruit more partners in that area. We see that as an area for Zebra where we're less penetrated than others, primarily because we are in certain product areas, print and for instance, on the manufacturing floor, but we could do more there in our new solutions. So we clearly see manufacturing and health care is both opportunities for us to grow moving forward. Operator : Thank you. We will take a question from Andrew Buscaglia from PNB Paribas. Andrew, please go ahead. Andrew Buscaglia : Good morning, guys. Bill Burns : Good morning, Andrew. Andrew Buscaglia : Yes. So just -- I know you don't give guidance for '24, but you are talking to kind of how you think the things trending into the New Year. And I'm wondering if you could talk about maybe a range of scenarios with distributors starting to restock potentially. I guess what drives the slope of that restocking? Like in terms of like is there the psychology of the distributor more aligned with what their end customer is providing them with the confidence to restock those shelves, I guess what I'm trying to ask is like, how do you view the cadence of that restocking event if it were to occur next year? Joachim Heel : Yes. So I can address some of that, Andrew. Over the course of the last few quarters, we've gotten a lot tighter with our distributors in both understanding and agreeing on the objectives that they have in their business, which have changed. And in particular, the increasing cost of capital has led them to set very aggressive inventory targets for their business. And then using those targets, to ensure that we stay in sync as demand has been relatively volatile, right? So demand has come down, they have adjusted their inventory to match that, and that's what we're calling destocking. So if you now think about that in reverse, what has to occur is that they have to start seeing improvements in sales out, which we, of course, are working very heavily. We generate the majority of our demand with our sales force working together with our partners. So we're working with them to generate that sales out demand. As soon as they see that tick up again, we're pretty confident that they will follow with stocking in lockstep to achieve those DIO or days of inventory outstanding targets that we have now really good visibility to and a clear understanding with them as well as incentives in place for them to reach those. So it's really generating that demand and seeing it. We think the inventory will just follow. Andrew Buscaglia : Okay. Very clear. And your two biggest markets, e-commerce and retail versus transportation and logistics, are you seeing any difference in the demand trends and dynamics driving those two areas. I guess, what is the key difference for you? Is one starter than the other, is one more likely to come back faster than the other. Yes, I guess could you parse that out? Nathan Winters : Yes, Andrew, I would say they're tied a couple pretty tightly together, especially when you consider e-commerce versus buy online and pick up in store or brick-and-mortar retail. So I'd say e-commerce and trans logistics tied together because of really parcel delivery. And I think in that case, both had built out e-commerce providers and transportation logistics built out significant network capacity across everything they did, their networks, their capacity around logistics and others to be able to meet the demands during COVID, which now kind of reset to pre-COVID levels and are going to grow from there. And I think you've seen moderating demand across e-commerce overall. So I think those two are tied together. I think brick-and-mortar retail, think of in-store, I think that's really more tied to the goods economy. So goods versus service-based economy, which is still relatively challenged. So I'd say e-commerce and translation districts tied hand-in-hand, brick-and-mortar retail, a little bit more goods economy focused. I wouldn't see much difference in those two. The recovery really is going to be driven by using up this excess capacity we talked about or and a recovery from more positive signs in from an economic perspective overall for those markets to come back. Joachim Heel : Maybe there's one area that you could see a slight additional opportunity on the retail front. And that is, of course, the one area where they don't overlap, which is the store. Retailers have been itching for some time, and we have had this vision that you can significantly improve the productivity of a retail store by having all of the workers in the store connected and collaborating. And they haven't yet realized that vision. That's been part of what's been deferred as they're going through the current phase of pausing and spending and scrutinizing their budgets. But they really do want to do that. I hear that from retailers all the time that they believe that there's a big productivity improvement to be had there, in particular, because some of their peers have done it, and they have seen those improvements. So that part of spending is still out there and it I'm convinced it will come our way, and that will create an additional demand on the part of retailers with stores that transportation companies don't have. Operator : And our next question comes from Rob Mason from Baird. Rob, please go ahead. Robert Mason : Yes, good morning all. I wanted to maybe just probe again, your thoughts as we get into '24 and not the put a stake into the ground at midyear '24. But I'm just curious, as you think about normal replacement cycles, how would your average age of your installed base look midyear next year? Would it be at an average level or below average, above average? Bill Burns : Yes, I'd say that, Rob, what we said is we're not guiding to 24% as we've talked about before. I would say, again, from a color perspective, that on average, I guess, it would be the same. What we're seeing today is our customers sweating some of their assets longer than they normally would. They can only do that so long. Devices get older, they want to use more applications requiring faster processor speeds, more memory, you see OSs moving forward, so security and others. So there's reasons for them to upgrade those devices over time. Could they sweat them for a certain amount of time, yes. But then eventually, that kind of comes our way, and they go ahead and upgrade. So I would say average life cycle of demand in second half, nothing changing there. We're working closely with our customers to make sure we understand their refresh cycles. And I think that while there's very little visibility in the second half of the year, I think the biggest thing to remember is we're going to cycle compares that are easier and this destocking moves away. So I think that's positive. But I would say average number of refreshes out their average length of the devices in service and today, customer sweating assets. Joachim Heel : Maybe I'll give you a two data points to support that. One is in Q2, the pushouts that we had in Q1 tripled. And in Q3, the pushouts were about the same as they were in Q2 which was almost the same as what we had in the entire year of 2020. So you can see that there's a lot of demand being pushed out, and those are all refreshes that should be happening now to maintain the average life of our estate out there. And so the average life of our estate is likely going up. And at some point, and that's what we said a couple of times already, sorry to repeat it, is that at some point, they will have to buy and refresh those devices. Robert Mason : Understood. That's good color. Bill, I wanted to go back to one of your earlier comments in the opening remarks. I thought I heard you mentioned a shift in go-to-market resources. And I was hoping you could put a little more color around that. And maybe just jointly, you talked about also accelerating growth in some of these underpenetrated markets, and I'm just curious if there's a connection there. And how are those underpenetrated markets performing right now relative to some of your more traditional markets? Bill Burns : Yes, I would say that manufacturing is a good example of that. It's has been less impacted, still down significantly year-on-year, but less than other markets. That is an opportunity we've talked about earlier in the call. I think there's other markets. Japan is an area that we're investing additional resources as well. And we've won a large postal opportunity there and the largest retailer in Japan most recently, and we're leveraging those wins and larger partners within Japan to do more business within Japan. Government is another area that we haven't had a lot of focus on in the past, but there remains opportunities for us to grow our business within government. I think from a product perspective, we talked a bit about RFID and machine vision as fixed industrial scanning and machine vision around inspection, but also RFID around automation and digitizing and automating customers' environments. Tablet is another good example of an area in which is closely adjacent to mobile computing and people want larger screen formats at times, and that creates an opportunity for us. So it's both a market perspective as well as a technology perspective. And tactically, we're reallocating resources across regions and areas to address these. We've started that already in Q3, and we'll continue to do that as we enter 2004. Some are short-term opportunities and others are longer-term opportunities. But we think it's important that we continue to be agile, not only in the cost side of things, but also on where we're deploying our resources to see and address the most attractive growth markets for us and stay close to our current customers, but really shift resources are the places that we see recovering the faster or that we're underpenetrated today, that's how we see it. Operator : We will now take a question from Brian Drab from William Blair. Brian, please go ahead. Brian Drab : Okay. Thanks. Most of my questions have been answered, obviously, at this point. Can you just talk about Fetch and some of the other acquisitions that you made in 2021. You spent quite a bit of money in 2021 and the assets kind of averaged like 9x to 10x sales in terms of purchase price. Is there -- can you just give an update on how Fetch and Matrox and the other business that you've acquired recently is doing? And is there any risk of impairment as you're looking at that going into year-end here potentially? Bill Burns : I think we can -- starting maybe with software is the largest segment and some of the acquisitions we did around Reflexis and Antuit prescriptive analytics in that area. We continue to focus on the retail associates and really enabling the retail associate through a suite of products and solutions portfolio around work cloud as we've announced at our recent customer user event around software, and that seems to be resonating well with our customers. This idea that taking task management, workforce management, communication, collaboration, demand planning combining that into a single application, leveraging our mobile devices in the hands of the associates in retail, and it plays into what Joe talked about earlier, this idea for a device for everyone within retail. So we see our software assets being important part of marrying with our mobile devices within retail and the idea of putting devices in the hands of more retail associates. I would say machine vision, $100-plus million market to us attractive, fragmented market overall. The focus there is manufacturing. We've talked about that earlier in the call, but also logistics and the idea of fixed industrial scanning, they continue to both look to ways to automate, to drive productivity, to improve quality across their organizations. I think the challenge to machine vision in the short term is the same as others are seeing, certainly, cyclical weakness in semiconductors where when we acquired the asset in machine vision, we knew Matrox was heavily weighted towards semiconductor and our objective there is to not only scale that business, but to diversify the offerings outside of semiconductor into new attractive markets. They could include automotive, food and beverage, inside fixed industrial scanning warehouse and distribution. So all those are represent opportunities for us, and we're excited about that market and our focus there is really diversification scale in driving share gains across machine vision. I would say Fetch and robotics automation or warehouse automation perspective, it's the smallest, still nascent in that area. I would say we're focused in two areas predominantly. First is Goods Transport. And again, we talked about that playing in line side replenishment, for instance, inside manufacturing, but also just good transport in general, of moving goods from A to B of varying sizes, that's an attractive market for us. The other market is e-commerce. So think of e-commerce picking, cobots and humans working together within that environment, where our devices today are being used by those workers to pick orders and adding additional productivity using automation and robotics is an interesting opportunity for us longer term. So it's the smallest of the segment. We don't see any impairment opportunities there or issues or concerns. We really find these three as attractive long-term growth opportunities for Zebra overall. And some are challenged in the short-term. As I said, machine vision is a good example of that with semiconductors, but we have the long-term prospects of the machine vision and fixed industrial scanning market remain very attractive to us. Operator : Ken Newman from KeyBanc Capital Markets has a question. Ken, please go ahead. I'm sorry. Let's go to Jim Ricchiuti from Needham & Company. Jim, go ahead. Unidentified Analyst : [Indiscernible] on for Jim. Most of the questions that I had have been addressed, but maybe just one for me. for the incremental $15 million of savings, is that in any one particular area or just a broad deepening across the existing targeted areas? Thank you. Nathan Winters : Not in one particular area, just broad-based, as we've worked through the plans throughout the third quarter and the fourth and scrutinized where we had to backfill certain roles with the retirement plans as well as just any open roles that have come along, just again scrutinizing that spend is really what drove it. So again, I would say fairly broad based and in line with the actions that we're driving for the company. Operator : And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. Please go ahead. Bill Burns : Thank you. I'd like to thank our customers, partners, and employees for their support and dedication to our long-term success. Have a good day, everybody. Thank you. Operator : Goodbye.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,024
| 1
|
2024Q1
|
2023Q4
|
2024-02-15
| 10.672
| 9.69
| 11.225
| 11.22
| 20.86
| 20.15
| 21.79
|
Operator : Good day, and welcome to the Fourth Quarter and Full Year 2023 Zebra Technologies' Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I'd now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's fourth quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year on a constant currency basis and exclude results from acquired businesses for the 12 months following the acquisition. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with our fourth quarter results and actions we are taking. Nathan will then provide additional detail on the financials and discuss our 2024 outlook. Bill will conclude with progress we are making on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Bill and Nathan will take your questions. Now let's turn to Slide 4 as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning, and thank you for joining us. Today, we will discuss our results, the demand environment and progress and actions we are taking to optimize our cost structure and drive sales as demand recovers. As expected, our fourth quarter performance was impacted by continued broad-based softness across our end markets and regions, which resulted in a significant decline in sales and profitability. For the quarter, we realized sales of $1 billion, a 33% decline from the prior year, and adjusted EBITDA margin of 15.4%, a seven-point decrease and non-GAAP diluted earnings per share of $1.71 a 64% decrease from the prior year. Although we experienced declines across all product categories, services and software were a bright spot in the quarter. From a sequential perspective, we realized Q4 sales growth from Q3 as demand trends stabilize. Overall profitability was primarily impacted by expense deleveraging on lower sales volumes, in a charge to renegotiate a supplier contract. However, as a result of our cost restructuring actions and inventory management initiatives, we realized a significant sequential improvement in profitability and free cash flow. Turning to Slide 5. I'd like to update you on our actions to address and mitigate the impacts of the current demand environment and position ourselves for long-term growth. As referenced in our earnings release, we have expanded the scope of our previously announced cost reduction plan and now expect $120 million of net annualized operating savings, an increase of $20 million from our last update which we expect to implement by mid-2024. Our previously announced actions were substantially completed in the fourth quarter enabled us to realize approximately $50 million of savings in 2023. On the supply front, we continue to work with our contract manufacturers to draw down component inventories, and we are substantially complete with renegotiations of long-term supply commitments. In Q4, we renegotiated 2021 agreement with a key electronic component supplier, incurring a $10 million expense. The revised agreement cancels a portion of the multiyear volume commitment and increases purchasing flexibility. We have also reallocated resources to accelerate growth in underpenetrated markets, including Japan, along with government and manufacturing sectors and to address new automation use cases with RFID and machine vision. We expect our actions to improve profitability and drive sales growth as our end markets recover. We saw double-digit declines across each of our end markets for both Q4 and full year as many customers navigate a challenging environment and absorb capacity they built out during the pandemic to address the spike in e-commerce activity. On Slide 6, we highlight secular trends that we expect to drive long-term growth including labor and resource constraints, real-time supply chain visibility, track and trace mandates and increased consumer expectations. These are all focused areas in my conversations with our customers. Entering 2024, distributor inventories are aligned with current demand. Although we are seeing some improvement in order activity, we are not yet seeing any signs of a broad market recovery and remain cautious in our planning. Consequently, we continue to take an agile approach to navigating this uncertain environment and remain disciplined with respect to our cost structure and capital allocation. I will now turn the call over to Nathan to review our Q4 financial results and discuss our 2024 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 8. In Q4, sales decreased 33% with distributor destocking accounting for more than one-quarter of the decline. We saw double-digit sales declines across our regions, major product categories and customers of all sizes. Our Asset Intelligence and Tracking segment declined 33.6%, primarily driven by printing. Enterprise Visibility & Mobility segment sales declined 32.7% led by data capture and mobile computing. On a positive note, we drove services growth with strong attach and renewal rates. From a sequential perspective, total Q4 sales were $53 million higher than Q3 despite a similar magnitude of distributor inventory destocking due to modest improvement in demand. Adjusted gross margin decreased 100 basis points to 44.6% and primarily due to expense deleveraging from lower sales volumes and the $10 million charge mentioned earlier associated with the renegotiation of a supplier agreement, all of which were partially offset by higher services and software margin and cycling premium supply chain costs in the prior year. Adjusted operating expenses delevered 670 basis points as a percent of sales. The impact was mitigated by more than $20 million of net savings in the quarter from our restructuring actions. This resulted in fourth quarter adjusted EBITDA margin of 15.4%, a 710 basis point decrease. Non-GAAP diluted earnings per share was $1.71, a 64% year-over-year decrease. Increased interest expense contributed to the decline offset by a lower tax rate from executing on a global tax strategy. Turning now to the balance sheet and cash flow on Slide 9. We ended the quarter at a 2.5x net debt to adjusted EBITDA leverage ratio which is at the top end of our target range. We generated $102 million of free cash flow in Q4 and had approximately $1.1 billion of capacity on our revolving credit facility as of year-end, providing ample flexibility. For the full year 2023, negative free cash flow of $91 million was unfavorable to the prior year, primarily due to lower operating profit, higher interest and tax payments restructuring actions and previously announced settlement payments, all of which were partially offset by lower incentive compensation payments. Let's now turn to our outlook. We entered 2024 with distributor inventory levels aligned with recent demand trends and improved backlog driven by modest year-end budget spending into January from certain retailers. For Q1, we expect a sales decrease between 17% and 20% compared to the prior year. This outlook assumes continued declines across our major product categories, particularly printing and a 50 basis point favorable impact from FX. We anticipate Q1 adjusted EBITDA margin to be approximately 18%, driven by expense deleveraging from lower sales volume, partially offset by lower premium supply chain costs. Non-GAAP diluted earnings per share are expected to be in the range of $2.30 to $2.60. Q1 sales and profitability are expected to sequentially increase from Q4 as distributor inventories and end market demand has stabilized, and we have realized incremental benefits from cost actions. For the full year 2024, we expect sales to be in the range of a 1% decline and 3% growth. Although we are beginning to see signs of improvement in order activity, we are not yet seeing signs of a broad market recovery. Consequently, we are taking a cautious approach to our guide until we have increased visibility to a sustained recovery in demand. Adjusted EBITDA for the full year 2024 is expected to be approximately 19%. We expect our restructuring actions and other profitability initiatives to drive improvement through the year delivering EBITDA margin of 20% in the second half. We remain cautious in our spending and continue to take an agile approach to navigating the environment. We expect our free cash flow in 2024 and to be at least $550 million, including the impact of our final $45 million settlement payment in Q1. We remain focused on rightsizing inventory on our balance sheet, driving 100% cash conversion over a cycle and prioritizing debt pay-down in the near term. Please reference additional modeling assumptions shown on Slide 10. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision. Bill Burns : Thank you, Nathan. As you look towards the long-term opportunity for Zebra, our future is bright. Our solutions remain essential to our customers' operations, and we are well positioned to benefit from secular trends to digitize and automate workflows. We are focused on advancing our Enterprise Asset Intelligence vision by elevating Zebra as a premier solutions provider through a comprehensive portfolio of innovative solutions that demonstrate our industry leadership. We empower workers to execute tasks more effectively by navigating constant change in near real time, utilizing insights driven by advanced software capabilities such as intelligent automation, artificial intelligence, machine learning and prescriptive analytics. By transforming workflows with our proven solutions, enterprises can improve the experience of frontline workers and customers. As you can see on Slide 13, customers leverage our technology to optimize workflows for the on-demand economy. Our solutions empower enterprises to increase collaboration and productivity and better serve their customers, shoppers and patients. I would like to highlight some recent wins by our team. A leading North American retailer selected 30,000 Zebra mobile computers and our device tracker solution for customer order fulfillment in fresh food inventory tracking. This competitive win was secured by our ability to deliver higher productivity along with superior data capture performance and network connectivity. A North American retailer refreshed 60,000 mobile printers and related accessories to enable frequent product pricing updates across various locations. This retailer has a long history with Zebra across our broad portfolio, demonstrating the value they see in our hardware and software solutions coupled with our exceptional post-sale support. A European postal service purchased more than 10,000 Zebra mobile computers to facilitate proof of delivery and package tracking. This organization's decision to replace a competitor was driven by superior product performance and enhanced cybersecurity features. A European field service organization, providing public housing repairs selected Zebra for both mobile computers and tablets to replace consumer devices that had been in place for three product generations. Zebra secured the win by demonstrating a customer-first strategy by addressing their unique facial recognition and authentication challenges. And finally, a large retailer in our Asia Pacific region selected Zebra scheduling software to be utilized on Zebra mobile computers. Zebra solution was selected over our competitors based on the capabilities of our software and our trusted partnership. Slide 14 highlights Zebra's value proposition for retailers which was showcased at the National Retail Federation trade show in January. Alongside our partners, we demonstrated how our innovative solutions help retailers solve their most pressing challenges and drive increased performance by optimizing inventory, engaging associates and elevating the customer experience. As retailers address e-commerce growth, the expansion of anywhere fulfillment and consumers' demand for hyper convenience Zebra solutions provide a performance edge for retail associates. Our demonstrations included next-generation checkout solutions with machine vision, loss detection with RFID, a mobile computing, AI assistant along with other innovative solutions. In our booth, Office Depot shared how our solutions address their workflow challenges. This includes Zebra's workforce optimization software boosting operational efficiency of associates and delivering faster buy online, pick up in store, order fulfillment. The combination of Zebra software and mobile computers is driving associate productivity and engagement along with improved customer satisfaction. In closing, our long-term conviction and our strong business fundamentals remain unchanged, and we are well positioned to benefit from trends to digitize and automate workflows. We are elevating our position with customers through our innovative portfolio of solutions, while our cost and go-to-market actions are positioning us well for profitable growth as our end markets recover. I will now hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to you as many as possible. Operator : [Operator Instructions] And today's first question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : I believe it was Bill who made the comment about the need to absorb some excess capacity in the e-commerce landscape and I'm curious, based on your discussions with end users in that ecosystem. Do you have any visibility into when most of that capacity will be absorbed? Is there any assumption in your 2024 outlook about a return to more normal levels of spending there? Bill Burns : Yes, Tommy, I think that we've clearly seen that retail IT budgets have been under pressure and the retailers overall certainly sweating assets, but also this idea of customers absorbing capacity, not just in e-commerce but also in transportation logistics as well. And they built out significant capacity during the pandemic, believing that ultimately the growth trajectory would continue off those rates. And now, we've seen kind of a reset in both e-commerce continuing to grow, obviously, but -- and parcel delivery both kind of resetting to pre-pandemic levels and growing from there. So we've seen some positive signs in the e-commerce side where some of that capacity has been used off and that we're beginning to see orders for from those e-commerce providers that need and have continued demand now. So we're seeing that coming to an end on some of the e-commerce providers. We're seeing across transportation logistics, still challenge in volumes of parcel delivery. And we're seeing the T&L providers really taking this as an opportunity to kind of restructure their businesses and think about how to be more effective and more efficient in their delivery mechanisms. We saw the same in e-commerce over the last year plus, but I think we're coming through it in e-commerce. Still P&L challenge there is we're continuing to see is the results in the -- around parcels being still remain challenged. So I would say, coming to an e-commerce but still challenging in the build-out across e-commerce -- around, sorry, trends. Tommy Moll : Yes. And one point I wanted to clarify, Nathan, I think in your comments, you talked to an improving backlog in January and that there were certain retail-related orders that drove that. But could you correct the record there, if I got it wrong and just give us any more detail there? Nathan Winters : Yes. No, Tommy, I think if you look, we did in the quarter, I'd say, back at pre-pandemic levels entering the quarter from a backlog perspective, where it was a little bit more depressed as we went into Q3 and Q4. And that was primarily driven by some of the uptick we saw in year-end spend that we were able to ship here in the early part of Q1, driving some of the sequential improvement from Q4 to Q1. So, I think again, not to the backlog levels we were at a few years ago, during maybe peak of the supply chain challenges, but definitely a sequential improvement with some of the incremental volume as well as getting our inventory in the channel right-sized. So again, we feel good about the backlog we have entering the first quarter relative to the guide. Operator : Thank you. And our next question comes from Brad Hewitt with Wolfe Research. Please go ahead. Brad Hewitt : So, the Q1 guidance midpoint looks to imply a slight uptick sequentially on the top line, excluding the Q4 destock headwind. But then your full year guide seems to imply revenue remains relatively flat sequentially as we progress throughout the year. So just curious, if you could talk about how you see underlying demand progressing through the year? And do you see the potential for orders in the pipeline conversion rate to improve as we exit '24 and into 2025. Nathan Winters : Yes. Maybe I'll start with just kind of the framework for the guidance. So yes, you're right. If you look at our Q1 guide, down 17% to 20% sequentially, that does improve from Q4 as we are not assuming any additional distributor destocking. So that drives the vast majority of the sequential improvement, again, along with the some uptick in demand that we saw particularly around year-end spend. And then if you look at the full year guide of 1% at the midpoint as you noted, if you look we expect Q2 to look similar to Q1 with the modest sequential improvement as we move through the second half. And as we talked about in the prepared remarks, I think we're cautious given the lack of visibility and the commitment to the pipeline in the second half. So if you look kind of again at the balance of the year, as you noted, really the growth is entirely driven by the 2023 destocking with the market flat, maybe down a little bit in Q2, up a little bit in the second half. And we think that's appropriate given the visibility we have around the demand environment. Brad Hewitt : Okay. That's helpful. And then you've talked in the past about how you typically tend to gain share coming out of downturns. Could you talk about how you see the opportunity for share gains as we turn the page to and kind of where you see the lowest hanging fruit in terms of potential share gains going forward? Nathan Winters : I would say that overall, talking to our customers and spending a lot of time with our customers and partners through NRF that clearly, our customers see that there's tremendous value in what we do for them each and every day to make their businesses more effective and more efficient and to literally run their businesses. So, we see the opportunities across each one of our vertical markets as we see really retail likely returning first is where continuing to work with them as they've been holding off and sweating assets within their environments and our engagements with NRF, certainly, we've seen optimism by our retail customers in the second half of the year. We marry our mobile devices there with our software solutions. And what we talk about is really resonating with them around our modern store initiative. We see that in transportation logistics, our value proposition remains really to help our customers with things like labor constraints and additional supply chain visibility across their businesses and we're excited about opportunities there within opportunities in technologies such as RFID as they look to get more to productivity across their businesses. We've got the MODEX trade show coming up in transportation logistics, Expo coming up next month here. And will showcase our solutions to across transportation logistics. We've talked about manufacturing has really been an opportunity for us is that we're less penetrated in that market, and we've got new solutions around machine vision and robotic automation and our demand planning software offering inside manufacturing. So we see that as an opportunity for us. And then lastly, health care, as we continue to see ways to automate workflows and digitally connect assets and patients and staff within the health care environment. We see home health care and telehealth being an opportunity. So, there's lots of opportunities across each one of the vertical markets. We'd probably say that retail is a place that we've seen some of the positive year-end spending first. And then I think the other vertical markets will follow. Operator : Thank you. And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. Maybe first question. Just -- you noted that the headwind from destocking was about the same in Q4 as in Q3. I think we had expected it to be slightly smaller understanding that's largely behind us. But just was that amount of destocking kind of greater than expected in Q4? And then maybe as a second question, obviously, the interest rate environment is maybe a little bit friendlier now your balance sheet, your interest rate is relatively heavy on your interest expense. Just wondering, if you've looked at any opportunities to refinance that at more attractive rates? Nathan Winters : Yes, Meta. So on the first question, you're right. So it was about $20 million, $25 million more of incremental destocking versus the original guide and the balance of that was offset by higher demand to come in above our guidance midpoint for Q4. So, I think we thought that is a -- I'll get a positive trend that again, we would take a little bit more out of the channel to set us up here as we moved into 2024. Now as it relates to interest rates, I think we feel good about actually our position. What you'll see in the cost of borrowing that includes all of our crediting and banking fees. But if you look at the overall cost of borrowing and where we trade at I think we feel good about the position, but we're always looking at opportunities given the environment to whether it makes sense to refinance and take advantage of the market. So that's something we're actively looking at. But today, we don't feel like we're at a disadvantage relative to the debt cost position. Operator : Thank you. And our next question today comes from Joe Giordano with TD Cowen. Please go ahead. Joe Giordano : I just wanted to -- last year, when we initially started to see the real weakness and you guys had to adjust your guide, there was clearly like a change in methodology, and it was very stripped down. It was kind of discounting things that weren't burden hand kind of orders and a change in how you were building up from the sales force commentary. So I'm just curious now as you look into '24 and you give that kind of qualitative guide. How would you compare your buildup methodology to how you were a full year ago versus how you were like six months ago when it got much more conservative. Bill Burns : Yes, Joe, I'd say that probably if you look back to January, we literally have met with thousands of our customers and partners across our channel partner summit in Asia Pacific and than in Europe and then North America, Latin America and then with the National Retail Federation show. And it's clear that our solutions are essential to what our customers are doing in their business every day and they're grateful to have gone honestly, Zebra is a strong partner along with them. And they're excited about the innovation that we're bringing to market and they're optimistic. So our partners and our customers are optimistic. They're happy to put 2023 behind them, quite honestly. And there's optimism for 2024, especially in second half year. However, I would say that from our perspective, and it's prudent to remain cautious and that we haven't seen a broader recovery. We've really seen some kind of green shoots here in the year-end of year-end spending across retail, mostly in North America. And we'd rather -- we'd like to see first some orders, projects, deployments really move forward before we get ahead of ourselves kind of for the full year. So, I think optimism, happy to put '23 behind us. I think we feel good about modest increases through the year as demand progresses throughout the year, but we'd like to get a little more confidence by having more orders, more projects, more deployments across our end customers move forward. And we think it's prudent and reflect in our guide to be a bit conservative at the moment. Nathan Winters : Yes, and I think if you look back historically at this point in the year, we would have always assumed we'd have several of those large mega deployments in the second half, even though we may not have identified exactly which customer, but we would -- that was something we always had. And I think that's where we've pulled back on that assumption, given the experience we've had over the last several quarters. And the fact, as Bill said, there's not a firm commitment. So until we start to see some of those firm commitments, we didn't think it was appropriate to lean in and just assume that some of those will start to come back in the second half. Joe Giordano : Okay. That's fair. And then if I look at the margin guidance for the year, the EBITDA at 19%, maybe I thought maybe a little higher at that level of revenue, particularly given an extra $20 million in costs. So can you just maybe talk through the gross margin if you're seeing any pressures anywhere? And then, if you could just touch on the working capital this year, just the free cash flow. How normalize is that going to look exiting the year? Nathan Winters : Yes. So again, if you look at our full year guide of 19% that does have us at 20% in the second half and as we head into 2025. We thought that was important for us to work through as we went through the cost actions and if you look sequentially, it's about year-on-year, I should say, about one point higher than '23 really around gross margin due to favorable pricing, some lower premium supply chain costs and a bit of volume leverage. If you think about the restructuring benefits, it's about $60 million of benefit improvement from 2024, but that's offset by incentive compensation. So getting back to fully loaded on our our incentive compensation plans for the year. So, those two negate each other for the full year. Again, if you look at our full year guide for free cash flow, one important milestone was getting back to positive free cash flow, which we did in the fourth quarter. Our guidance of at least $550 million has us above 100% free cash flow conversion, excluding our final Honeywell payment here in the first quarter, and our expectation is for modest decreases in inventory and working capital throughout the year. And there could be some opportunity to exceed, if we get back to our optimized inventory levels, but we did not include that in our guidance, just given some of the uncertainty around demand and the mix of that demand. Operator : Thank you. And our next question today comes from Damian Karas with UBS. Please go ahead. Damian Karas : Thanks for all the color on kind of the demand and what you guys are seeing on the project front. Maybe just a question on these long-term supply commitments that you've been renegotiating. Could you just maybe talk a little bit more about what's happening there? You highlighted one particular contract, a $10 million expense impacting gross margin. Is that -- could you just clarify, is that a onetime hit? Or is that going to kind of be a headwind for the next three quarters, a little bit of a structural change in your cost structure? Nathan Winters : Yes. So just as it relates to the one that was a onetime charge that's behind us in the fourth quarter, no change in our structural costs or that we did anticipate having moving forward. And we feel like we're, at this point, substantially complete, working with our suppliers around a lot of those longer-term supply agreements, and particularly the ones that we had to entered into in 2021 when we had kind of both a combination of peak demand as well as some of the extended lead times across the supply chain. And you'll actually see that if you look at we have also a 75% decrease in some of our long-term purchase commitments that we have in our 10-K. So, again, a lot of great progress by the team working through that throughout the year, and our focus really here this year is around components that we still have at our Tier 1 manufacturers. So that's a lot around just demand timing, working through that as well as a lot of the great work by the team to redesign those components into existing or new products as well as working with our manufacturing partners just around the safety stock that they hold. So I think we see a lot of progress there. And again, the charge we had in the fourth quarter was really associated with one supplier and one contract we signed back in 2021. And that was a combination of canceling as well as deferring some of the purchase commitments we had here in 2024 to mitigate some of the working capital pressure as well as it gives us a lot more flexibility around the mix of the components and again, the timing of when we expect to receive those or take -- or accept those components on our balance sheet. So again, we thought it was the right thing to do to kind of get that past us and move forward here as we move into. Damian Karas : Got it. And could you just comment on any impacts you're seeing owing to some of the overseas shipping issues like what's happening in the Red Sea and to what extent that might be factored into your guidance? Nathan Winters : Yes, obviously, there's new concerns that we're monitoring with the risk of the escalating tensions in the Red Sea. So, we're monitoring the situation, working with our partners Today, we have mitigation plans, again, pending any further escalation of the situation. I think what's important for context is this really primarily impacts our printing business into EMEA. That's where we ship via ocean through the Red Sea and the Suez Canal. So again, the vast majority of our products are still air shipped or ocean shipped from the Asia into the West Coast of the U.S. So, we think it's -- as of today, it's a modest impact on extended lead times, which we've communicated to our partners, particularly in the EMEA region and a negligible impact expected on margin here in the first quarter. Operator : Thank you. And our next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Bill and Nathan, is there any reason to believe there's a change to your long-term guidance or an annual growth rate of 5% to 7% over cycle? Bill Burns : No, Keith, I think that we would see that the current sales declines are due to a cyclical bottom, really accentuated by the pandemic overall and that our long-term conviction and the strong business fundamentals really remain unchanged. And we think we're well positioned to be -- continue to be the market leader and continue to take share as our markets recover overall. The secular trends really to digitize and automate environments within our customer operations really remain unchanged. They were intact before the pandemic, and they remain intact today. And I think that our strong competitive position we have in the marketplace, especially in our core, the exciting opportunities we have in our adjacent and expansion areas. And quite honestly, we're excited about the future. So despite the near-term headwinds, we don't see a -- see that changing. We see the 5% to 7% through cycle what we're committed to and -- remains intact. Keith Housum : Okay. I appreciate that. Just as a quick follow-up. In terms of the software and services, obviously, it's been really resilient for you guys. As you think about that growth or what it does for 2024, can you unpack, I guess, your expectations there as we separate that from the rest of the hardware business? Bill Burns : Yes. I think that we'd say software and service is clearly recurring revenue, right? Similar -- you saw a similar comment we had on supplies, right, which we've talked about as being semi-recurring, right? It's like a recurring business. So clearly, services and software outperformed our broader product portfolio overall. But I say that customers today continuing to strong attach rates on our mobile devices. Also, we're seeing -- this is the negative side of some of the services growth is really people extending service contracts at higher prices, right, that ultimately, we're working closely with them to get their refreshes done within their environment. So that's a target for us starting in kind of second half of '23 and into '24 is really working closely with those customers that are looking to extend service agreements and sweat assets is to get them to move ahead with new technologies and new advantages of our hardware, but that's helping software a bit -- I'm sorry, services a bit in the short term. From a software perspective, we're seeing really a compelling value proposition to our customers around what we really brought together is our work cloud software, which is bringing the multiple organic and acquisition assets together to really address the needs that a retail associate. And we talk about that of this modern store framework as an engaged associate. So think of it as communication collaboration, think of it as task management workforce management, demand planning, so marrying that all together into a single application or instance for our customers and be able to really enhance the productivity of the retail worker and that's resonating well with our customers. We had our trade show on our internal event with our user group of our software customers in the second half of the year and rolled out really what we're doing around work cloud and the future of that and they're pretty excited about it. I know, Nate, do you want to add -- I mean the other thing we're focused on is really profitability around those areas and not growing top line, but also profitability in our software business as we bring those together. Nathan Winters : That's right. I think the other -- yes, the bright spot on the service and software is the improved margins. So a lot of great work by the team focus on the cost structure for both of those pieces of the business. So that was a nice improvement as we move to the second half, and it will be a tailwind as we move here into 2024, along with the expectation that those businesses will continue to grow. Operator : Thank you. And our next question comes from Brian Drab with William Blair. Please go ahead. Brian Drab : I just wanted to clarify first on the cost savings. Exactly what is the incremental benefit that we'll see in terms of cost savings, OpEx savings in '24 versus '23 now that we've got these incremental savings coming on in the year, I guess? Nathan Winters : Yes. So, if you look at our the expanded cost reduction plan at $120 million of net annualized savings, $20 million higher than our prior guide with the additional actions expected to be completed here middle part -- by the middle part of the year, so we realized $50 million of savings in the second half of '23. So, we're expecting $60 million of incremental benefit into '24 and then the balance as we head into 2025. Brian Drab : Yes. Perfect, okay. Nathan Winters : And what we had in the past, they're pretty broad-based across functions. So I'd say a similar with the declines, the incremental amount was similar structure as we had with the first pass in terms of fairly broad-based. Brian Drab : Okay. Got it. And that's all in OpEx and won't affect gross margin, I guess. And my next question was just going to be on gross margin. I guess the best assumption here for gross margin as we track through the year would be modest increases in sequential increases in gross margin as we move through the quarters on leverage and anything that you would correct me on there or add to that? Nathan Winters : Yes. So, I think one thing I'd say on the $120 million. There's a small piece of that that is in gross margin. So I'd say the vast majority is OpEx. So there's a piece in gross margin just based on some of the actions the supply chain team is taking within our cost structure. So a bit of that is in the $120 million in gross margin. But I'd say for modeling purposes, I'd assume the vast majority is in OpEx. But you're absolutely right. In terms of the sequential improvement in gross margin, our EBITDA rate throughout the year is primarily going to be driven by gross margin, both as some of the actions we've taken around pricing the lower prime supply chain cost, which is, I guess, really here in the first quarter, but also a little bit of volume leverage, project timing as we move through the year. So yes, there's a that's what we'd expect through the year as a kind of modest improvement as we go through the year to get us to where we have as an exit point in the fourth quarter. Operator : Thank you. And our next question comes from Rob Mason with Baird. Please go ahead. Rob Mason : I wanted to circle back, Bill. You mentioned several times customers willing to sweat their assets more right now, which, again, we've seen that in the past during these downturn periods. It sounds like you're trying to address that some with service strategies. I'm curious if you're testing any other strategies around trying to stimulate new product demand, whether customers might be more amenable to as service or subscription or, say, leasing type arrangements in this period of time? And then maybe relatedly, is there anything as you look into, say, the 2018-2019 devices that were put into the installed base -- anything on the horizon that would more catalyze their replacement, just where they can't be upgraded any further anything of that nature? Bill Burns : Rob. So a couple of things kind of weaved into that. I would say, first, that our sales teams are working and our partners closely with those customers that we have identified that are -- have the devices in there in use longer than normal and working closely with them to understand how we can convince them to move forward with upgrades and lots of different ways to go do that. And -- but the driver really would be a couple of areas. One would be technology transitions. So I think 4G to 5G and wireless think of faster WiFi speeds like WiFi 6, OS upgrade. So as the devices become older, then there's Android releases aren't available. And then along with that, we extend the security with that OS so long, but eventually, the security patches aren't available. So from a security perspective, that's a driver as well. The other place is really around use case expansion, right? So that adding more functionality of the devices, things like authentication of facial recognition, think of Zebra Pay integrated RFID on those devices we're going to release here shortly. Over time, we'll be releasing. We showed this at the National Retail Federation Show generative AI large language models on the actual devices and an assistant. So we want this to really be about productivity and wanting more features and functionality within their environment versus just around security, right? And we're seeing that. I would say that in the area of leasing, what we're looking at is opportunities to marry our software with hardware, and we demonstrated some of this at the National Retail show as well is that Think of a wearable device that has our task management software, communication collaboration on that wearable device in retail, which would be sold as a service kind of offering to our customers, so not quite a lease. In most cases, our customers say, hey, I can -- I'd rather spend the capital than lease. But in this case, it would be an OpEx recurring revenue stream around software and hardware combined together. So sales teams have a lot of different plays they're running to try to move those customers forward with upgrades. Rob Mason : That's helpful. Just as a follow-up, could you just comment on what you're seeing in some of these underpenetrated markets where perhaps you do have more runway, and I'm thinking Japan and government specifically just what the current tone of business is there. Bill Burns : Yes, Rob, I'd say that there are opportunities for us as we look around the globe, and we have different market shares those are two good examples of really significantly lower share than we have in other places. But as we look at each vertical market as we look at each geography, we see places where we can continue to take share as a business. Japan is a great opportunity for us, as we've talked about for a while, second largest market in Asia, we won the largest postal carrier there. We've won the largest retailer we now have the attention of some of the largest integrators -- system integrators and cellular carriers in Japan to work in some new opportunities there beyond retail and postal. So those have gotten some more attention and we've changed our channel strategy there a bit to large work with larger SIs. We've just hired a new sales leader. If we look at government in the U.S., a new sales leader there is the refocus on government and building our partner community and expanding our reach inside government opportunities that includes public safety. So, we're excited about these markets because we have low share, and we know there's opportunities for our portfolio within those underserved markets. Operator : Thank you. And our next question today comes from Jim Ricchiuti with Needham & Company. Please go ahead. Chris Grenga : This is Chris Grenga on for Jim. Maybe just one for me. You had mentioned the trend of new automation use cases in RFID and machine vision could you talk about what you expect from these technologies in 2024? And what use cases are you having the most productive conversations with customers currently? Bill Burns : Chris, maybe start with RFID. We're continuing to see strong interest across many customers and verticals. We've seen the opportunity to expand beyond retail apparel really into track and trace, supply chains, parcel tracking, baggage tracking tools, work in progress in manufacturing, health care opportunities, all with RFID. Certainly, Walmart and what UPS is doing inside smart package into their environment has caused others to continue to look at of interest in RFID. The cost of the tags coming down in the has created opportunity because today, we have the broadest and deepest set of RFID solutions in the market. And that includes fixed readers, handheld readers, industrial and mobile printers, software and the label to go along with that. So we've seen strong double-digit growth over the past few years in RFID, including in 2023. And we are excited about the opportunity across everything we do in RFID. I would say in machine vision really focused in two areas : manufacturing and transportation logistics from a manufacturing perspective, automotive, food and beverage, inside logistics, it's really about warehouse and distribution. We combined our organic investment really with a few acquisitions of Matrox and Adaptive Vision. That's really given us a broad differentiated offering across those markets and creates opportunities for us to win and what we see as a fragmented multibillion-dollar market opportunity for us. Our value proposition really is around marrying software and hardware together and giving a unified software platform to our customers and easy to set up, easy to upgrade really to drive simplicity, speed, efficiency within our customers' organizations that allow them to automate in an easier way and upgrade that automation from things like fixed industrial scanning to machine vision. So, we're excited about both these opportunities. We are the leaders in RFID reading today. We're a challenger in the machine vision market, and we see both being a tremendous opportunity for Zebra. Operator : Thank you. And our next question today comes from Ken Newman at KeyBanc Capital Markets. Please go ahead. Ken Newman : First question here. Just looking at R&D expense, I know it saw that it took a sequential step down this quarter for 3Q. Just as I think about this first quarter guide in the full year, how should we think about the cadence of R&D dollars as we move through the year? And is there may be more room to take out there as we progress after the first quarter? Nathan Winters : Yes. So I think a couple of things. Just some of the sequential decline from Q3 to Q4 was related to the cost actions that we took and just the timing of those rolling into the P&L, which is, again, what we had expected coming into the quarter. You'll see it increase a bit here as we go through '24 just as we reset comp plans and things like that around incentive compensation. And typically, the first half is a little more front-end loaded just with the timing of projects and deployments. And then Q4 is always a little light just with holidays and whatnot from a project execution. So, I think I would think of similar trajectory from a sequential perspective as we move through the year, but maybe a bit of an uptick just as we kind of again reset all of our comp plans and whatnot for the year. Ken Newman : Got it. That's helpful. And then for my follow-up, with free cash flow improving this year and you being at the top and a leverage target range, what is the midpoint of guidance like here for where you think net leverage ends up relative to debt pay down? And am I right in assuming that the priority for capital deployment will be towards the debt side? Or is there other portions or avenues that you see a better return for that capital? Nathan Winters : Yes. So as you mentioned, we ended the quarter at 2.5x debt leverage, which is at the high end of our target range. We are prioritizing debt pay down of our variable rate debt here in the short term. And we would expect the debt leverage to increase a bit here through the first and second quarter really just as we lap on the profitability side, not so much debt will come down, but the ratio will increase, but then will decline through the second half as we kind of lap Q3 and Q4's lower profitability. And so that is really the priority here starting out the year as debt pay down but as always, we're going to reassess overall capital deployment and opportunities we have, whether that's share buyback or M&A as the year progresses. Operator : Thank you. And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Burns for any closing remarks. Bill Burns : Thank you. As we look towards the long term, the opportunity for Zebra is bright. I'd just like to thank our customers, our partners and employees for their support. We look forward to returning to growth in 2024. Have a good day, everyone. Operator : Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.
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ZBRA
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Zebra Technologies
| 877,212
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Information Technology
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Electronic Equipment & Instruments
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Lincolnshire, Illinois
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1969
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2019-12-23
| 2,024
| 2
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2024Q2
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2024Q1
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2024-04-30
| 9.916
| 10.132
| 11.518
| 11.823
| 21.51
| 21.94
| 24.06
|
Operator : Good day, and welcome to the First Quarter 2024 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Michael Steele : Good morning, and welcome to Zebra's first quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year and on a constant currency basis. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our first quarter results and strategic actions. Nathan will then provide additional detail on the financials and discuss our second quarter and full year outlook. Bill will conclude with progress on advancing our vision. Following the prepared remarks, Bill and Nathan will take your questions. Now let's turn to Slide 4 as I hand it over to Bill. William Burns : Thank you, Mike. Good morning, and thank you for joining us. As expected, our first quarter performance was impacted by continued broad-based softness across our end markets and regions, which we began to experience in the second quarter of last year, resulting in a double-digit decline in sales and profitability. However, we are beginning to see a modest recovery in demand as we saw sequential improvement from the fourth quarter. We are particularly encouraged by the better-than-expected large order activity, which drove the upside for the quarter. That said, we are not yet seeing a broad-based recovery. And as a result, we continue to take an agile approach to navigating the current environment. We also delivered another quarter of sequential improvement in profitability as a result of our restructuring actions and improved gross margin. Services and software were a bright spot in the quarter with improved sales and profitability, helping to offset the year-on-year sales declines across all product categories. For the quarter, we realized sales of $1.2 billion, a 16.8% decline from the prior year, and adjusted EBITDA margin of 19.9%, a 150 basis point decrease and non-GAAP diluted earnings per share of $2.84, a 28% decrease from the prior year. We are pleased with the progress we have made on our previously announced actions to improve profitability and drive sales growth as our end markets recover. Our restructuring plans to deliver $120 million of net annualized operating savings is on track to be completed midyear. On the supply front, we made substantial improvement in our working capital driven by our renegotiation of long-term supply commitments and ongoing work to drive down component inventories with our contract manufacturers. We have also driven both tactical and strategic sales initiatives, including reallocation of resources to accelerate growth. Given the progress on our actions, we are raising our full year outlook for sales, margin and free cash flow. I will now turn the call over to Nathan to review our Q1 financial results and discuss our revised 2024 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 6. In Q1, sales decreased 16.8% with declines across our regions, major product categories and customers of all sizes. Services as a Software were a bright spot in the quarter, with growth driven by increased units under support contract and retail software wins. Our Asset Intelligence & Tracking segment declined 25.3% primarily driven by printing. Enterprise Visibility & Mobility segment sales declined 11.8% with relative outperformance in mobile computing. Our Asia Pacific region saw the steepest sales declines led by continued weakness in China. From a sequential perspective, total Q1 sales were 16% higher than Q4 as distributors had completed their destocking process by year-end and we realized modest improvement in demand. Adjusted gross margin increased 60 basis points to 48.1% supported by higher services and software margins and cycling premium supply chain costs in the prior year, all of which were partially offset by expense deleveraging from lower sales volumes. Adjusted operating expenses delevered 230 basis points as a percent of sales. The impact was mitigated by approximately $25 million of incremental net savings in the quarter from our restructuring actions. This resulted in first quarter adjusted EBITDA margin of 19.9%, a 150 basis point decrease versus the prior year and a 450 basis point sequential improvement from Q4. Non-GAAP diluted earnings per share was $2.84, a 28% year-over-year decrease. Interest expense contributed to the decline, offset by a lower adjusted tax rate. Turning now to the balance sheet and cash flow on Slide 7. We generated $111 million of free cash flow as we begin to realize benefits from reducing inventory levels. We ended the quarter at 2.6x net debt to adjusted EBITDA leverage ratio, which is slightly above the top end of our target range. And we had approximately $1.3 billion of capacity on our revolving credit facility as of quarter end, providing ample flexibility. Let's now turn to our outlook. For Q2, we expect sales to decrease between 1% and 5% compared to the prior year. We entered the second quarter with a solid backlog and pipeline of opportunities, particularly for mobile computing in retail and e-commerce. This outlook assumes a modest improvement in demand trends across our major product categories, with mobile computing and the EVM segment returning to growth as we cycle easier compares. We anticipate Q2 adjusted EBITDA margin to be slightly above 19% driven by expense deleveraging from lower sales volume with the benefit from restructuring actions and lower premium supply chain costs, offset by normalized incentive compensation expense. Non-GAAP diluted earnings per share are expected to be in the range of $2.60 to $2.90. We have raised our guide for the full year, reflecting our progress on actions to drive sales and profitability as our end markets have stabilized. Although there is optimism from partners and customers regarding recovery in the second half of the year, we would like to see additional momentum in large orders before factoring in a broader recovery. We now expect sales growth between 1% and 5% for the year, with adjusted EBITDA margin now expected to be approximately 20%. Non-GAAP diluted earnings per share are expected to be in the range of $11.25 to $12.25. And we now expect our free cash flow for the year to be at least $600 million, including the impact of our final $45 million settlement payment in the quarter. We have been making progress rightsizing inventory in our balance sheet and improving cash conversion and have been prioritizing debt paydown in the near term. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill. William Burns : Thank you, Nathan. As we look longer term, we continue to be well positioned to benefit from secular trends to digitize and automate workflows for our customers. We remain focused on elevating Zebra as a premier solutions provider through a comprehensive portfolio of innovative solutions and our go-to-market ecosystem. Zebra empowers workers to execute test more effectively by navigating constant change in real time through advanced capabilities, including intelligent automation, machine learning, prescriptive analytics and artificial intelligence. As you see on Slide 11, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to increase collaboration and productivity and better serve their customers, shoppers and patients. In March, at the MODEX Manufacturing and Supply Chain trade show, Zebra, along with our partners, showcase our expanded portfolio of solutions that are modernizing workflows across the broader supply chain. Managing operations has become complex with increased consumer expectations for inventory visibility and same-day deliveries. The event provided an opportunity to demonstrate how we improve key outcomes such as production quality, supply chain agility and capacity utilization. Machine vision was one of the many solutions we featured where we have enhanced our capabilities to address emerging use cases. We continue to build our market presence with a few notable wins. A large state-owned European logistics company recently invested in thousands of Zebra machine vision cameras to enhance the speed and efficiency of inspections of government bonds and transaction documents. Additionally, an Asian manufacturer incorporate our machine vision cameras and frame grabbers, into their product sorting and quality control processes. This solution is significantly faster and more accurate than the previous manual approach. At HIMSS, the leading Global Healthcare Conference, Zebra and our partners demonstrated how our solutions improve the patient journey from check-in to bedside point-of-care as well as medical equipment track and trace. Additionally, the University of Maryland Health System shared how they are utilizing our clinical communications platform, which includes our mobile computers and work cloud software. I'd also like to call out a win with a North America hospital network, who recently implemented thousands of Zebra printers, specifically enhancing its specimen tracking and labeling processes. These printers integrate with the electronic health record system facilitating noticeable organizational improvements across departments. Zebra's reputation for ease of use helps secure this win. Recent wins in retail, demonstrate how customers are driving productivity, improving asset visibility, enhancing the experience for associates and shoppers. The European retailer selected thousands of Zebra mobile computers to replace their legacy devices from a competitor. The customer plans to pair our new mobile computers with their Zebra mobile printers to improve their price markdown, labeling and online order-picking processes. The North America-based retail department store chain enhanced thousands of Zebra mobile computers by incorporating our device tracking software. Prior deployment of this software, the retailer experienced issues with misplaced devices in stores and fulfillment centers, resulting in wasted time and resources. Additionally, a North American grocer has expanded their installed base of Zebra mobile computers with thousands of additional units and implemented our work cloud software. The solution is expected to enhance operational efficiency among associates, improve employee communication and streamline inventory management within their stores. On Slide 12, we highlight secular trends that we expect to support long-term growth for Zebra as we drive value for our customers. These include labor and resource constraints, real-time supply chain visibility, track and trace mandates and increased consumer expectations. We are hosting an innovation day on May 14 at our headquarters near Chicago where Nathan and I will be joined by other members of our leadership team to discuss how we digitize and automate workflows to drive positive business outcomes for customers across our end markets. In closing, as we look forward to a long-term opportunity for Zebra, our conviction in the business remains strong. We continue to elevate our strategic role with our customers through our innovative portfolio of solutions while our cost and go-to-market actions are positioning us well for profitable growth as our end markets recover. I will now hand it back to Mike. Michael Steele : [Operator Instructions] Operator : [Operator Instructions] The first question comes from the line of Jamie Cook with Truist Securities. Jamie Cook : Nice quarter. I guess first question, can you just call out how much freight helped the first quarter lower freight cost? And then what's implied in the guide relative to how you guided last quarter? And then I guess just my second question. The gross margins in the quarter struck me, in particular, the sorry, the EVM margins, which were up year-over-year. And so I'm just wondering if you could help us understand what drove the gross margin improvement on the sales decline there? Nathan Winters : Yes. So, Jamie, I'll take that. So if you look for the -- particularly the freight in Q1, it was about 1 point year-on-year improvement just given the cycling through, now that we fully neutralize the premium supply chain costs between the operational actions and the price increases. So year-on-year, that was about 1 point of benefit in the quarter. Yes, I'd say the other drivers for the relative strength in Q1 was both from the slightly higher volume as well as some favorable mix. Along with the service and software profitability and the strength we saw there, which is primarily in EVM, which is, I think, driving the benefit both sequentially as well as relative to our guide in the quarter. Jamie Cook : And then just a follow-up, sorry, the larger order activity that you talked about in the quarter, which obviously isn't in the guide, and I guess would reflect some conservatism in the guide? If that continues, I mean, what's preventing you from putting that in that -- in the guidance if that continues, how would we think about the sales guidance relative to your sales growth of 1% to 5% ex-FX? Nathan Winters : Yes. I think as we stated, we've seen some improvement in demand, particularly in mobile computing and retail, which drove the beat in Q1 as well as what we're expecting to see come through for the remainder of the year, driving the raise for the full year from 1% to 3%. And so the way we think about the full year was we'd expect Q3 to look very similar to Q2, which looks similar to Q1, just in terms of run rate and trajectory, which as they maintain that relative strength in some of the large orders we've seen come through in the first quarter. But I would separate that from what we have yet to see, I'd say what's still kind of waiting to look at is the larger mega deals, mega deployments, that's still not coming through. The deal sizes are still in the, let's say, $1 million to $5 million range, some of the initial phases of the deployment. So that's what you see carry through for the remainder of the year and inflected in the guide, but not that uptick in terms of the larger deployments. Operator : The next question comes from Damian Karas with UBS. Damian Karas : I was wondering if you could maybe elaborate a little bit on the large order activity, which you spoke? Could you give us a sense, right, is this sort of 1 or 2 customers that are placing rather large orders or are you kind of seeing just your larger customer base in general, start to bring back a larger quantity of project activity? If you could just maybe elaborate and provide any detail like which end markets and regions you're seeing some of these larger orders as well? William Burns : Yes. I'd say overall in Q1 and into -- as we entered '24, we've really seen demand stabilize and we've seen modest improvement in large order activity overall. And it's been particularly in mobile computing, and it's been specific to retail as they've kind of wrapped up their year. So we're certainly encouraged by the better-than-expected sales results in Q1 as a result. And we'd expect modest improvement in demand as we continue to progress throughout the year. However, H2 is -- the growth there is primarily driven by lapping through the prior destocking activity that we've seen. So overall, I think as we anticipated, mobile computing is the first place that we're seeing recovery. We're seeing it in retail. Both of those were the first to be impacted coming through the cycle with COVID. And what we'd like to see is more visibility and momentum in order activity beyond what we've seen so far. And I think we'd like to see it move from retail to T&L and manufacturing in other verticals before we'd call it kind of a broad-based recovery. Damian Karas : That's really helpful. And then a follow-up question on your guidance, just maybe ask a little bit differently. I know you guys have spoken of, right, this really large funnel, but just kind of a lack of conversion to orders. Guidance sort of has you sequentially second half sales comparable to the first half. Could you just tell us like what you're assuming for that funnel conversion, kind of a probability of some of those projects hitting in the back half? Nathan Winters : Yes, I'd say the -- as I mentioned earlier, really the second half, I would call it, grounded and based on what we see today, both in terms of the orders velocity, what we're seeing in terms of being sold out through the channel as well as the conversion rates that we've experienced now over the last 2 quarters. I'd say still lower conversion rates on our pipeline than we would have historically assumed based on what we experienced in the second half. But again, aligned with what we've experienced over the past 2 quarters. I think the big difference is, we're not assuming, we're making an assumption around a mega deployment just given that we've yet to see kind of firm commitments from our customers. There's a lot of optimism, discussions around those. But in terms of committing to move forward those projects or ensuring that they have the budget available in the year, that really remains the uncertainty and the way you look and see the second half look very similar to the first half because that's what we're experiencing and what we're seeing play out in the market. We think that's appropriate for the guide for the year. Operator : The next question comes from Keith Housum with Northcoast Research. Keith Housum : In terms of Asia Pacific region, obviously, underperformed compared to the rest of the company. And I understand China is challenged right now, but perhaps can you just expand a little bit on what you're seeing here? And expectations for us and the pressures perhaps be a little bit longer lasting versus short-lasting? And just more color about the performance in that area, please? William Burns : Yes. I mean, Keith, it's Bill. I think that overall, the Q1 performance was continued to impact by soft demand across all of the regions. So I think we start there. I think that as we've said, the relative outperformance was really in mobile computing, and we saw some bright spots in services and software clearly in the quarter. I would say the regions pretty much look the same, except Asia was, as you said, impacted probably more through the declines in China. I would say that we see Asia overall having China continued to a longer recovery for the China market. We've seen some bright spots again, in retail, again, in larger orders in Australia and New Zealand. So that was a positive for the Asia market. I think we continue to see opportunities outside of China. So Southeast Asia and India with the investments in manufacturing there. We continue to see Japan as the longer-term opportunity for us as we're making investments there, and we have lower share there than other places. But I think we expect that China continue to remain a challenging moving forward. Keith Housum : All right. And just as a follow-up, Nathan, in terms of adjusted EBITDA, a little bit decline in the guidance you've given for 2Q versus 1Q. Sequentially, how should we think about the moving parts and the reason for a little bit lower adjusted EBITDA margins in the second quarter? Nathan Winters : Keith, as you mentioned, our Q2 guide slightly above 19%, so down from the 19.9% in Q1. That's entirely driven by the seasonality of our retail software business, which you probably recall, but is seasonally higher in Q1 at accretive margins, just given the timing of retailers when they've performed their cycle counts and physical inventories, which is where that platform really focuses. So that's the adjustment from Q1 to Q2. And the way I'd characterize it is the Q2 guide is fairly in line with how we've structured the full year going into it. I think Q1 was benefited by some of the cost actions coming in earlier, giving us confidence in the remainder of the year as well as some of the benefits in just a bit of -- a little bit better mix and revenue start of the year. So -- but then Q2 in line with where we expected the year to play out and the sequential decline is entirely driven by the seasonality of our retail software business. Operator : The next question comes from Tommy Moll with Stephens. Thomas Moll : You've given us some context on the omnichannel retail and e-commerce end markets, but I wanted to ask for any other detail you could provide. In particular, on the e-commerce side, there are some anecdotes regarding finally hitting the end of this absorption phase from some of the overbuilding in years past. Are you seeing any signs of that on your side? William Burns : Yes. I would say that overall, retail relatively outperformed, as we've talked about already. And we're seeing encouraging signs, right? We saw some modest year-end retail spending across Q4 and Q1. Some customers clearly have absorbed the capacity and it begin to buy again, as you've kind of referenced, Tommy. We've also seen some of the pushouts that took place in last year and really over the last 18 months or so, begin to come back. So we've seen those projects as we expected and we talked about for a long time, those projects will come back. What we've seen mostly is initiating of really Phase 1 of those projects and the customers not quite ready to commit to the full deployment. So we've seen deployments that in the past would have been larger, even larger orders and full rollouts immediately, now a more conservative, let's start with that project, but roll it out over time and complete the deployment kind of later in the year. So we have confidence that there'll continue to be a recovery. I think we anticipated retail would recover first, followed by T&L and manufacturing and health care, and we're seeing that play out. And we also anticipated, it would be mobile computing first as well, and that's what we're seeing. So the bright spots are really mobile computing and retail, retail and e-commerce. That capacity is being used off, retailers are beginning to bring those projects back, but they're doing it in a very measured way. And I think what we want to see is, retail, T&L, manufacturing, more of the vertical markets come back and more of that order activity, even more than we're seeing today and the uptick in orders before we call a broad-based recovery. Thomas Moll : That's helpful. As a follow-up, I wanted to ask about the channel inventory levels. It sounds like there really wasn't any noise from a destocking perspective in the first quarter. But I'm curious what's your view on how many days on hand in the channel currently? And if you think historically, do we sit today below what that historic level is? And does that imply at some point there may need to be a restock? Nathan Winters : Yes, Tom, I think ending the Q1, somewhat to exit in Q4 that the global channel inventories measure that on a days-on-hand basis is normalized to support the current demand. So I'd say within the range that we'd expect on a global basis, there's puts and takes if you go by region and product families. So I think a nice improvement from where we were just 6 to 9 months ago. And as you said, I think, no meaningful impact in the quarter or assumed in the full year guide in terms of changes -- relative changes in the distribution inventory levels. Operator : The next question comes from Brad Hewitt with Wells Fargo. Brad Hewitt : So you just talked about a return of some of the project deferrals from last year. I guess, how would you describe your pipeline and sort of overall visibility versus 6 months ago? It kind of feels like visibility across the space has been generally trending in a positive direction, but just any color on how your visibility looks relative to history would be helpful. William Burns : I'd say that overall, we'd expect orders -- customer orders that continued to resume overall. I think that as I just talked about with Tommy's question, we've seen customers absorbing the capacity that's previously been built out. That's been more, again, focused on retail and e-commerce as opposed to the other verticals so far. I would say that the macroeconomy, kind of the uncertainty around that abating will certainly help as well. We're viewed as a trusted partner of our customers, and we're staying close to them across each of the verticals as we would see this order momentum picking up across other verticals as we progress through the year. We've got a large installed base, right? We're growing solutions. So we're continuing to work with our customers as well. Kind of on new solutions and new use cases. So overall, I would say that we anticipated large deployments kind of starting to come back. We anticipated in retail. We want to see more of that across manufacturing and T&L. As I said, we'd like to see more of it to in kind of different size deals, so mid-tier and run rate deals come back a bit. But I would say, overall, we're -- our engagement with customers have been encouraging. There's certainly uncertainty remains around timing of some of the projects. I think Nate covered that earlier. And I think it's reflected in our year-end outlook overall. Nathan Winters : You see it in the pipeline in terms of where the deals are at in the deal stage. So you qualify versus where we'd like to see them more in the validate secure. So earlier stages of the funnel, particularly in the second half, than where we'd like to see it at this point in the year or relative to what we've maybe seen in prior years. Brad Hewitt : Okay. That's helpful. I think you guys had some retail orders that you expected to convert to revenue at the end of Q4 that were pushed into Q1. Would you be able to quantify the magnitude of that deferral? And then when you talked about the uptick in the large order activity on the retail side, was that inclusive of some of that year-end spending? Or was that a separate bucket? William Burns : I would say that year-end spending across retailers that their years and differently, whether it's the truly year-end or into first quarter. So I think we typically see orders that bridge both on an annual basis. So I don't think there was much that move between Q4 and Q1 as much as just customers need product before they have their year-end from a retail perspective. And again, I think those are all encouraging signs, whether it was Q4 or Q1 to us, the retailer start beginning to buy again. And I think we continue to want to see more of that momentum. I would say that even those orders are measured. You know what I mean, so it's -- it was year-end spending, but it was the first phase of a project, and we want to see those continued projects moving forward, and we believe they will. So I would say nothing really in movement of Q4, Q1 as much as just normal activity around that, where some customers in retail ended the true year-end, December 31 and others in the first quarter. Operator : The next question comes from Jim Ricchiuti with Needham & Company. James Ricchiuti : Maybe I missed it. Did you comment about the activity you're seeing in the SMB market? Is that -- is the recovery you're seeing in ports to retail, also impacting that part of the business? William Burns : I would say that SMB would fall kind of in this mid-tier to run rate business. And I think we've seen, again, more recovery in large opportunities. I think we're seeing optimism clearly on the part of our partners and our distributors. That business will continue to progress and get better through the second half year. But I think at the moment, we have not seen the uptick we've seen in large orders across mid in run rate business, which really falls in this SMB category. So I'd say not yet. I would say there's optimism on the part of our partners, but I think that we want to see more of that. As large orders typically are the first to decline or the first to recover, retail was the first to pull back, and now we're seeing it first to recover. And I think that SMB, call it, mid-tier and run rate business will follow. James Ricchiuti : Got it. How would you characterize the RFID business in the quarter, level of activity you're seeing and just the trends in that business, we're starting to see more activity, it sounds like on the T&L side with the big customer moving out of the distribution center into the package delivery side of the business? How would you characterize RFID for you? William Burns : Yes. I would say RFID, clearly, we see as an opportunity in across multiple verticals now, not just retail and retail apparel, where it was originally focused and we're clearly seeing opportunities across track and trace and supply chain. You mentioned parcel tracking with the transportation logistics, airports and airlines with baggage tracking inside manufacturing work in progress in tools and over. So a whole series of different applications we're seeing, quick-serve restaurants. Clearly, the move ahead of large retailers like Walmart or UPS smart package initiatives are causing others to continue to look at what they're doing in RFID and move things along across multiple industries and verticals. Zebra has the broadest and deepest set of RFID solutions in the market today. So whether it's fixed or handheld readers, industrial and mobile printers, our software that we utilized to -- for reads and locates and then our labels printed through our printers. So we've seen strong growth across the portfolio over the past few years. We continue to see the drivers being the fact that the technologies continue to improve with greater rerate accuracy across the development of new tag types that make that more efficient in the reading of the tags. I think we're seeing more software applications being available today of serving these different markets. We're -- clearly, overall, the idea that the number of tags, I think what excites all of us is the fact that readers follow tags, right? So from our perspective, that the adoption of tags and source tagging of items at that point of manufacturing, the number of tags being sold is certainly going to allow more applications of those tags in customer environment. So we remain excited about this space overall, and I think we're going to continue to see growth across RFID. Operator : The next question is from Joe Giordano with TD Cowen. Joseph Giordano : Just -- I know people are hesitant to lay out big capital still, like you said a couple of times. But as you get into like next year, just considering the large-scale increase in your installed base that happened in the immediate aftermath of COVID. Like should we be thinking refresh cycle is kind of like in play for 2025? William Burns : I think overall that the EMC clearly, across mobile computing is really what you're talking about in kind of large refresh cycles. And as I've said a couple of times already, we're seeing that as the first signs of recovery. And really in retail to start, I think that the customers in have begun to absorb their capacity, certainly in e-commerce. We'd like to see that happen across T&L as those customers build out a lot of capacity as well during the pandemic. And we'd like to see manufacturing be a bit more healthy in the idea that moving from a services-based economy to more goods-based economy overall. I'd say that the refresh cycle, our sales teams are focused on that with our customers. And ultimately, mobile computing -- mobile computers are essential that are operation, they have worked with us across multiple generations of products. We've got a healthy pipeline of opportunities, but we'd want to see those move ahead through this year and into next year, as you described. So clearly, there is a refresh cycle out there. The embedded base is larger than it's ever been that's people that deployed more applications for mobile devices in their environment. So the installed base is larger. So those will continue to refresh and every customer is on a different cycle. So I think that whether you're talking about a postal environment in a specific country or a G&L provider or a larger retailer. What we have seen is that even in retail, these larger orders have been more measured as I talked about, so haven't been large scale, as Nate described in kind of mega deals, they've been smaller in size and rolling out over time. We'd expect probably that same thing will happen in places like T&L. So I think it will be a measured overall recovery. And I think we feel that we've got a strong base to continue to refresh, but it's going to take time. Joseph Giordano : Fair enough. And then maybe just shifting to the balance sheet quickly. With your key markets, at least we get the data magnitude of recovery, but it seems like deterioration has kind of stopped. It was good to see you pay back some debt here. Cash flow looks strong. So is there an appetite for buybacks to kind of increase your leverage on a recovery as you come out of this? Nathan Winters : Yes. As you mentioned, we finished the quarter at a little over 2.5x leverage ratio, so slightly above the target range. That begins to move back within the range, particularly as we roll through Q3 of last year. Today, we feel like we have ample flexibility with the revolver. As you mentioned, we are prioritizing debt paydown just given the debt leverage ratios and the current interest rate environment, but we do plan to reassess buybacks as the year progresses, particularly in the second half. Operator : The next question comes from Andrew Buscaglia with BNP Paribas. Andrew Buscaglia : So I just want to check on -- you commented on the guidance. You're seeing a sequential step down in margin seasonally. It seems like -- the comment on the Q3 looking more like looking similar to Q2, just to clarify, you're talking about run rate on sales? And then what about margins? Because it does seem like you're expecting some lift in Q4. I'm wondering what's behind that. Nathan Winters : Yes. No, you're absolutely right. So the comment on Q3 similar to Q2 was on -- from a revenue perspective, we do expect an uptick in margin as we go through the year. Some of that just similar to what we talked about in the last call, which is phasing of some of the incremental cost actions that will be coming through late this quarter and early part of Q3 as well as our, say just normal project timing between things, like payroll taxes and just the typical funding cycle with -- as you get into Q3, Q4, you get into holidays, so it tends to be a little bit of a downtick in terms of just seasonal spend. So I think there's no magic bullet there in terms of the actions we need to take in order to deliver that sequential improvement from Q3 -- into Q3 and Q4. Andrew Buscaglia : Okay. And then maybe along the lines of Joe's question, heading into your cash flow is improving, you raised it a bit. What about M&A now? I think the software story has been nice. It's helping you lately. So what's the environment like as you see it with deals? William Burns : Yes, I'll take that, Nate. I would say that organic growth continues to be our first priority overall. I think our M&A philosophy really hasn't changed much. We're clearly targeting assets that are clearly adjacent and synergistic to our portfolio today, as you've seen us acquiring kind of these adjacent and expansion areas. We have a strong balance sheet, obviously, that could support that over time here. I think in the short term, there's clearly a higher bar as -- given the macro environment and the debt leverage that we're at today. So I think we'll continue to be inquisitive and look what's out there. I think we see it as an opportunity to be strategic and add to our portfolio, products and solutions that we have in the marketplace. And I think that in the short term, I think it's just a higher hurdle. Operator : The next question comes from Brian Drab with William Blair. Brian Drab : So clearly, I just want to clarify one thing. So clearly, you're seeing the recovery in retail, and you said you expected that to play out this way where retail comes back before manufacturing and T&L. Are you -- does that mean that you're not seeing recovery in manufacturing and T&L yet or that the recovery in retail is just stronger at this point than those 2 categories? William Burns : Yes, I would say that we're not seeing it there yet. I would say that the T&L customers are clearly still absorbing capacity built out during the pandemic and that they're continuing to take actions to optimize their operations overall. I would say that manufacturing is impacted by the broader market trends of uncertainty. And clearly, still a services-based economy versus a goods-based economy. But I think overall, our value proposition remains strong in both markets. We've got strong relationship across T&L. And I think that we'll see them continue to buy again once the capacity is built out. I would say manufacturing is an opportunity for us. Overall, as customers continue to buy again, they are -- will invest in automation and things like traceability and resilient supply chains. Those themes haven't gone away, but we've seen just a conservative nature of spending based on the uncertainty. So that represents an opportunity for us. I would say that manufacturing unlike T&L is kind of underpenetrated for us, that there's an opportunity for us. And we've got new solutions within manufacturing, so like a machine vision, robotics automation, our demand planning strengthens our offering there as those markets recover. So -- and we've also shifted additional sales resources through this to manufacturing. So I think that we expected retail was the first to decline. It's the first to recover. T&L and manufacturing will follow. I would say we've got strong relationships across T&L, but lots of opportunities there when it does recover. And manufacturing will continue to be a focus area for us because we see it as an opportunity longer term. Brian Drab : Okay. And then I wonder if I could ask a question this way. You have that good slide that you used where you talk about the core and the adjacencies and expansion markets and growing expected longer-term mid-single, high single and low double digit, respectively. I'm just wondering, in your outlook for the next year, can you frame it in terms of those 3 categories, what you're expecting for growth in those 3 categories? William Burns : I'd say overall that it's hard to predict where each is going to end up. I would say, overall, the core and mobile computing has become -- is recovering first. I think each has a different dynamic. So I think that things like tablets and others in the expansion categories will be closely connected to things like mobile computing. RFIDs in that category, and that will continue to be an opportunity. I would say, if you think of the kind of last circle to that, software and our services business had a positive quarter in Q1 overall. So I think that's more recurring revenue-based. Machine vision has been challenged in the short term with areas like semiconductor and manufacturing being down. So I think it varies by each segment. I think there's gives and takes in each. I think the core mobile computing first, the others still down, but will recover. I think in the adjacencies, RFID and others will be bright spots. And I think software was a bright spot, but machine vision challenge in the short term, robotics still rate at its infancy. So I think kind of mixed across those, but I think that it's going to be -- all will recover over time. It's just different time frames for each. Operator : The next question comes from Meta Marshall with Morgan Stanley. Meta Marshall : I think you alluded to this in kind of the replacement cycle question earlier in the call. But just any trends between kind of mobile computing and printing as we think about kind of some of these renewal cycles coming up? And then maybe a second, you haven't touched on the health care market. That's clearly been an area of expansion for you guys. Just any investment or kind of progress that's been made on that opportunity? William Burns : Yes. I'd say that as we talked about mobile computing clearly showing the first signs of recovery as expected, and we talked through that a fair amount. I would say that in printing, we saw kind of broad-based declines, but has stabilized now in Q1. There was a difficult compare in Q1 for both printing and DCS as a year ago, first quarter '23, we saw supply chain challenges abate in both those areas. So we shipped a lot of printers and scanners in the quarter a year ago. So the compares were pretty tough. I would say that in printing specifically, clearly still challenged by the softer macroeconomic conditions and then particularly by manufacturing, but I would say stabilized overall. We'd expect that recovery in printing and scanning would follow mobile computing as we kind of talked about. Specific to health care, I would say that impacted by the same trends, the broader market overall, clearly tighter budgets in margins within health care, we would see that we continue to drive productivity solutions within health care which allows health care providers to be more efficient, which is certainly appealing to them on tight margins and clearly to enhance patient safety. We see home health care is an opportunity for us. So we're clearly seeing some of our partners address that market. So think of tablets as an example around home health care opportunities. So I think we see optimism. We were at the HIMSS trade show, which was well attended in Q1. The largest retail show as we mentioned in the script earlier. But I think that we've seen optimism on the point of our partners and our customers just like the other verticals in manufacturing and T&L, we'd like to see more of that optimism turn into real orders like we're seeing in retail. Operator : The next question comes from Rob Mason with Baird. Robert Mason : Bill, you've touched on it a couple of times, just the run rate business, you haven't necessarily seen signs of recovery there yet. I would just want to see if you could put a finer point on the expectations there for the year, just in the context of your overall guide -- sales guide up 1% to 5% relative to the -- maybe the large deal side of the business? William Burns : Yes, I would say that our thought is probably relatively flat. I think we expected large deals to recover first. We expect mid-tier in run rate to recover after as we've talked about already. I think there's been a lot of optimism on the part of our partners and our distributors in this area, and we just want to see more progression, I think, more than anything else. That's kind of where we're at. We typically -- large deals are the first to decline and then followed by mid-tier and run rate because run rate is kind of the longer tail. And I think we're going to see that same thing in recovery. We haven't seen it yet. So I think that, that's the challenge we're seeing. I wish the visibility was better through the year. And I think consequent with our guide, is that we're kind of guiding to what we see from a visibility perspective, and we just haven't seen the recovery in mid-tier or run rate yet. And the optimism is out there, the opportunities seem to be there, everybody wants to go after it. We just need to see more of it really happen and turn the worse. Nathan Winters : Yes. I think, Rob, you said that play when you say the flat, right kind of Q1 to 2 to 3 in terms of overall revenue. Flat, just because that's what we see in terms of the trajectory across all the different categories of business without seeing an inflection point of a dramatic uptick. Again, that's how we feel it. That was the appropriate guide based on what we're seeing today across all those different categories. Robert Mason : Yes. Understood. And then just as a follow-up, Nathan, could you tell us what the placeholder you have slotted into the guidance for debt reduction is for the year? Nathan Winters : I would assume that the vast majority of the cash -- the $600 million of free cash flow will either go to debt pay down, maybe a little bit in terms of held in cash at some modest interest rate, but the vast majority would go to debt pay. Operator : The next question comes from Ken Newman with KeyBanc Capital Markets. Kenneth Newman : Most of my questions have been asked, but I just wanted to ask a longer-term higher-level question. Obviously, you've got some very significant operating leverage implied for the back half, and I think that's mostly just on easier comparisons on the volume side. As we think about maybe returning more towards a normalized operating environment, how do you think about the run rate operating leverage or the run rate incremental EBITDA margins, just given all the cost-out initiatives that you've executed on? Would you think that structurally higher than what we've seen in past cycles? Or is that still too early to tell? Nathan Winters : Yes. As we mentioned, obviously, the volume leverage or the margin expansion in the second half is highly correlated with the increased volume along with -- coupled with the restructuring actions we took throughout last year. And really, for us, the target was to get back to above 20% as the baseline so that we can grow and scale from there. And I think still too early to tell in terms of what exactly that framework looks like. I'd say historically, we've going to look at 30% incremental decrementals in a normal quarter, quarter in, quarter out. Fundamentally, the business hasn't changed in terms of what you would expect. Over time, we'd expect that to be a little bit greater as we scale some of these new emerging markets like machine vision or software that have inherently higher gross margin. But I think that's probably the best way to think about it now until the dust settles and we get to some normalcy both from a year-on-year as well as a sequential perspective. Operator : Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. William Burns : Yes. I'd like to thank our employees and partners for the stronger-than-expected start to the year and positioning Zebra to return to growth in the second half of the year. We look forward to seeing analysts and investors at our Innovation Day in 2 weeks. Have a great day, everyone. Thank you. Operator : Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
|
Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,024
| 3
|
2024Q3
|
2024Q2
|
2024-07-30
| 10.503
| 10.895
| 12.632
| 13.34
| 22.7
| 23.6
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Operator : Good day, and welcome to the Second Quarter 2024 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's second quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-on-year and on a constant currency basis. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our second quarter results. Nathan will then provide additional detail on the financials and discuss our third quarter and revised full year outlook. Bill will conclude with progress on advancing our strategic priorities. Following the prepared remarks, Bill and Nathan will take your questions. Now, let's turn to Slide 4, as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning and thank you for joining us. Our teams executed well in the second quarter delivering sales and earnings results above the high end of our outlook. For the quarter, we realized sales of $1.2 billion approximately flat to the prior year. An adjusted EBITDA margin of 20.5%, a 70 basis point decrease, and non-GAAP diluted earnings per share of $3.18, a 3% decrease from the prior year. As we discussed in our last earnings call, during the first quarter, we began to see modest recovery in retail and e-commerce. In the second quarter, we saw signs of momentum across other end markets, including healthcare, where we realized double-digit growth. Mobile computing returned to growth across each of our vertical end markets led by healthcare and retail. The growth in mobile computing was offset by declines across our other major product categories where year-on-year comparisons are more challenging and we were in earlier stages of recovery. Services and software saw modest growth in the quarter. While we are encouraged by early momentum and demand, we continue to see cautious spending behavior from our customers on large deployments which have not yet returned to historical levels. Another highlight was our sequential improvement in profitability due to improved gross margin and the benefits of our restructuring actions. Our plan to deliver $120 million of net annualized operating savings is on track and substantially complete. Given our second quarter performance, progress in our cost actions, and early signs of momentum and demand, we are raising our full year outlook for sales and profitability. I will now turn the call over to Nathan to review our Q2 financial results and discuss our revised 2024 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 6. In Q2, total company sales were approximately flat, reflecting early signs of momentum demand beyond retail and e-commerce. Our Asset Intelligence & Tracking segment declined 14.4%, primarily driven by printing and RFID on challenging prior year comparisons. Enterprise Visibility & Mobility segment sales increased 8.2% with double-digit growth in mobile computing partially offset by a decline in data capture solutions. We saw modest growth in services and software. Performance was mixed across our regions. In North America, sales decreased 7% with fewer large orders in retail and transportation and logistics, partially offset by strong growth in healthcare. In EMEA, sales increased 10%, driven by mobile computing. In Asia-Pacific, sales declined 3% with continued weakness in China and challenging compares in Australia and Japan, partially offset by growth in Southeast Asia. And sales increased 7% in Latin America led by Brazil. From a sequential perspective, total Q2 sales were slightly higher than Q1, with growth in nearly all product categories as we realized modest improvement in demand throughout the quarter in manufacturing, healthcare, and transportation and logistics. Adjusted gross margin increased 60 basis points to 48.6% as we benefited from cycling premium supply chain costs in the prior year in favorable effects. Adjusted operating expenses as a percent of sales increased 110 basis points. This was driven by normalized incentive compensation expense partially offset by approximately $25 million of incremental net savings from our restructuring actions. This resulted in second quarter adjusted EBITDA margin of 20.5%, a 70 basis point decrease versus the prior year, and a 60 basis point sequential improvement from Q1. Non-GAAP diluted earnings per share was $3.18, a 3.3% year-over-year decrease. Turning now to the balance sheet and cash flow on Slide 7. In the first half of 2024, we generated $389 million of free cash flow as we drove improvements in working capital. We ended the quarter at a 2.4x net debt to adjusted EBITDA leverage ratio, which is within our target range and we had approximately $1.5 billion of capacity on a revolving credit facility as of quarter end. We diversified our capital structure during the second quarter by issuing $500 million of senior unsecured notes, while retiring a receivable financing facility that matured in May. We also terminated our remaining interest rate swap agreements for $77 million of cash proceeds. We have been prioritizing debt pay down and now have increased flexibility given our lower debt balance and improved cash flow. Let's now turn to our outlook. For Q3, we expect sales growth between 25% and 28% compared to the prior year. This outlook assumes continued stability of demand trends across our major product categories with broad-based growth as we cycle easier compares across the business, including significant destocking activity by our distributors during the second half of last year. We entered the third quarter with a solid backlog and pipeline of opportunities. That said, we are not anticipating an increase in large order activity considering the conversion rates on our pipeline remain lower than historical levels as customers continue to be cautious in what remains an uncertain environment. We would like to see additional momentum in large orders before factoring in a stronger recovery. Q3 adjusted EBITDA margin is now expected to be between 20% and 21%, driven by expense leveraging from higher sales volume with benefits from restructuring actions partially offset by normalized incentive compensation expense. Non-GAAP diluted earnings per share are expected to be in the range of $3 to $3.30. We have raised our guide for the full year, reflecting our second quarter performance and early signs of momentum and demand. We now expect sales growth between 4% and 7% for the year and adjusted EBITDA margin to be in the range of 20% to 21%. Non-GAAP diluted earnings per share are now expected to be in the range of $12.30 to $12.90. Free cash flow for the year is now expected to be at least $700 million. We have been making progress rightsizing inventory in our balance sheet and improving cash conversion. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill. Bill Burns : Thank you, Nathan. Zebra is well-positioned to benefit from secular trends that support our long-term growth. These include labor and resource constraints, track and trace mandates, increased consumer expectations, and the need for real time supply chain visibility. We help our customers digitize their environments and automate their workflows through our comprehensive portfolio of innovative solutions, including purpose-built hardware, software, and services. We empower frontline workers to execute tasks more effectively by navigating constant change in real-time through advanced capabilities including automation, prescriptive analytics, machine learning, and artificial intelligence. At our Innovation Day event in May, we demonstrated how we transform workflows across the supply chain to drive positive outcomes for enterprises across our end market. Our products and solutions are mission critical to enable visibility that consumers and enterprises now expect throughout the entire supply chain. On Slide 11, you will see Zebra solutions can touch a product 30x from its origination to the point of last mile delivery. Let's briefly walk through the journey with a few high level exams. In manufacturing, our machine vision solutions provide quality inspection and track and trace visibility throughout the process. In a warehouse, our wearable mobile computers, autonomous mobile robots and comprehensive RFID portfolio transform receiving, picking and shipping. As the product arrives at a store, associates are equipped with Zebra software running on our mobile computers to assist customers' stock inventory and fulfill online orders. And when an item is delivered to your home, you receive a notification and picture from Zebra's handheld device verifying on time quality delivery. As you'll see on Slide 12, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to drive productivity and better serve their customers, shoppers, and patients. We are seeing Zebra's competitive differentiation in mobile computing solutions drive wins across our vertical end markets. Customers value the capabilities we embed in the software layer of our devices that they leverage to transform workflows and improve outcome. For example, we secured a mobile computing win with the commercial airline utilizing our mobile package dimensioning solution enabled through AI. Also, a North American retailer will leverage Zebra's work cloud collaboration software on their new wearable mobile computers, connecting their associates to drive better outcomes in their stores. Additionally, we are able to displace consumer cell phones at a European retailer with our mobile computers and Zebra's Identity Guardian solution. It provides multifactor authentication for a shared device environment that brings security, productivity, and convenience to the front line. It is also notable that mobile computing contributed to double-digit sales growth in healthcare. Over the past year, our teams have been successfully selling the benefits of our solutions and clinical mobility that empower caregivers while delivering lower total cost of ownership for hospital systems. We have been displacing consumer cell phones with our devices and there continues to be a long runway of opportunity for equipping more clinicians with mobile computers. In closing, we expect to see broad-based growth in the second half as we cycle much easier comparisons and benefit from momentum beyond retail. We maintain strong conviction in our long-term opportunity for Zebra as we elevate our strategic role with our customers through our innovative portfolio of solutions. Our sales and cost initiatives have positioned us well for profitable growth as our end markets continue to recover. I will now hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up to give everyone a chance to participate. Operator : We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Damian Karas with UBS. Please go ahead. Damian Karas : Hey, good morning, everyone. Congrats on the quarter. Bill Burns : Good morning, Damian. Damian Karas : Bill, I wanted to get your thoughts on what you suspect it's going to take to bring some of the larger project activity back into the fold, and maybe you could just give us a sense on, it sounds like you're not expecting much this year. How much upside to your guidance do you think there would be if you do in fact start to see a return sooner rather than later? Bill Burns : Yes, Damian, I think that if we look back to Q1, we saw early signs of recovery, as we talked about last quarter in retail and e-commerce. We're certainly encouraged by the better than expected sales results in Q2, which really, we saw momentum, as we said around beyond retail really. And really, it was driven by mid-tier and run rate business. So large deal activity was pretty consistent in Q2 coming off of Q1, but still well below historic levels. So I think that we see customers overall continue to cite uncertainty to us in the market, their markets, their end markets, which really is reflecting in their purchasing behavior. I'd say that large deployments overall are being spread more to these mid-size deals or smaller deals, and being spread out over a longer period of time because of this, and I think ultimately, when they're placing small orders, they're placing those to add to their installed base or for new applications or expansion opportunities to-date. So I think that the pipeline of opportunities remains strong. I think there's optimism on the part of our partners and customers. I think we'd like to see more momentum in large orders. So we saw the first uptick in large orders in the first quarter kind of flat the second quarter. So we feel okay about that. We saw growth in mid-tier and run rate. I just think we'd like to see more large order activity to call a broader base recovery. So I think now we're seeing strength in mobile computing, strength across kind of large orders, medium and small. But we just want to see more large orders really from our customers. And I think it's just driven by their caution of what's happening in macro today. Damian Karas : Great. That makes sense. And I just want to ask you on the cost front, it seems like there's been a pick back up in shipping rates, and I know that was a little bit of a headwind for you guys in past years. To what extent have you been maybe experiencing some of that cost inflation and maybe just talk through what's kind of in your guidance for the rest of the year? Thanks. Nathan Winters : Yes. Damian, so we have seen a modest increase in rates due to whether that's some of the Red Sea issues or now with the stronger demand, particularly on the ocean rates. I'd say it's a modest impact in terms of incremental costs that we've included in our full year guide. But the team's again working several actions in terms of the different air modes, how we leverage cost off to improve transit time, as well as again working with our partners around the forecast for the remainder of year to get ahead of that, the second half demand and mitigate as much of that as possible. So there is absolutely seeing some increase, but I'd say it's pretty modest at this point and within our second half guide. Operator : The next question comes from Jamie Cook with Truist Securities. Please go ahead. Jamie Cook : Hi, good morning, and congratulations on a nice quarter. I guess, just my first question, I guess, what struck me in the quarter, your EVM margins were much better than I thought, and I think even better than your expectations. I think you were guiding to down margin sequentially. So can you just speak to the drivers behind that? I guess, that's my first question. And then I'll stop there and then I'll give you my second question after, I guess. Nathan Winters : Good morning, Jamie. So, yes, if you look at overall gross margins at 48.6%, this is our highest gross margin quarter in three years, benefiting from the level of large deals. So the strength in run rate and mid-tier is a positive for gross margin in particular within the EVM segment. We're also seeing continued strength in our service and software margins again, which is heavily less more weighted towards EVM, as well as now fully rolling over all the premium supply chain costs. So again, I think it was part of that was just the strength in the quarter and really seeing the incremental volume fall through to the bottom line, driving the sequential improvement in gross margin both within EVM particularly. Jamie Cook : Okay. And then I guess, just given the strength in the margin this quarter, and I mean, I don't think your EBITDA margin guide is now, what 20% to 21%, I think before it was about 20%. I'm just wondering why we wouldn't see better pull-through in the back half of the year, in particular with the top-line growth that you would see relative to declines or flat revenues in the second quarter. Nathan Winters : Yes. If you look at our EBITDA guide for the third quarter of 20% to 21% again year-on-year, that's up primarily due to volume leverage, nearly 9 points. And I think we expect similar deal as well as business mix Q2 to Q3 such that you get a similar margin profile from Q2 to Q3. So if you look at the Q3 guide, effectively flat to Q2 based on that assumption of kind of the underlying mix of deals as well as the business unit mix gives us that similar profile. And I'd say the other really don't expect the same level of incremental benefits sequentially as we were able to realize some of the incremental benefits in Q2 from the restructuring actions. And then you do see that modest uptick implied in the guide for the fourth quarter on the incremental volume. Operator : The next question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Good morning and thank you for taking my questions. Bill Burns : Good morning. Nathan Winters : Good morning, Tommy. Tommy Moll : First question on the large order activity. At this point where we're nearly through July, how fully baked are your customer budgets for this year? And at what point does the large deal conversation really start to become one centered around 2025, when a lot of the customer budgets are refreshed? Bill Burns : I think that, Tommy, I'd say that customers continue to scrutinize their budgets even as we're well into the year, right? And I think that some of those have to do with, in the past, we've seen kind of year-end spending from our customers, but I think that the uncertainty around the economy is still kind of weighing on them in large deployments and what will happen in kind of second half of year here. So I think that we typically not have visibility quite yet into whether there'll be year-end spending by our customers. We're talking about certainly a pipeline of opportunities that they see. And then the question is, do they move ahead with those in late 2024 or into 2025. I think that from a macro perspective, whether it's interest rates or presidential election or manufacturing production, all those shipping parcel, parcels, shipments have just started to inch up and turn to more positive volumes or growth in volume. So I think all those kind of weighing on their business, and I think there's even though they've got budgets, it's kind of the reluctance to move ahead with those, really because of the macro factors overall. And I think that we'd expect those to continue to kind of stabilize. They can get more confidence in their business and then abate as we get into kind of second half year and into 2025. But I'd say, overall, many discussions with our customers regarding projects; it's really about just taking longer to kind of move those forward still. Now, again, we saw a large order activity about flat Q1 to Q2 overall, and we saw this pickup in mid-tier run rates. So these are all positive signs. Growth outside of retail, which we really saw in first quarter into a broader segment. Mobile computing was the first to decline and the first to return to growth we expected that. So I think everything's moving in the right direction. So I think that -- I think our customers just don't know for kind of year-end 2024 and into 2025, but we're optimistic, I would say, that everything's moving in the right direction. Tommy Moll : And Bill, just from a competitive standpoint, is there anything that you've sensed having changed particularly in a large deal context where you've seen other market participants perhaps become more aggressive on price or whatever other factor? Bill Burns : Yes. No, I would say that really the competitive environment hasn't changed a lot. Overall, we're certainly continuing to maintain share in the marketplace. We feel good about our differentiation that we bring to the marketplace with the depth and breadth of our solutions, our competitive advantages, scale, technology, leadership, our partner community, our go-to-market, our relationships with our customers. So the large deal, phenomenon not coming, not returned to historic levels is not really about Zebra. It's truly about the market. And we don't really see any mark change from a competitive perspective. We're always going to have competitors out there, large and small, and then that continues to be the case. So nothing there. And we feel good about our market position and continue to win in the market. Operator : And the next question comes from Joe Giordano with TD Cowen. Please go ahead. Joe Giordano : Hey guys, good morning. Bill Burns : Good morning. Nathan Winters : Good morning, Joe. Joe Giordano : Bill, you had mentioned, I guess, it was last quarter that distributors were asking for more product than you were willing to sell because, but you were hesitant because you wanted to make sure you understood where it was going and try to prevent a future buildup of inventory that then needs to get liquidated again. Like, what's the update on that? Have you kind of started to give them what they're requesting? Nathan Winters : Yes, Joe. This is Nathan. I can take that. I'd say overall, the global channel inventory as we look at it from days on hand is still at a normalized level. I think you have pockets around the world, where there's still a little bit of rebalancing both driving down inventory in the channel as well as where there's incremental needs. And I think similar to where we were last quarter, it's working with each one of those partners across the region to ensure that they have the appropriate level of inventory for the demand they're expecting and that we see in the pipeline. So again, it remains very collaborative. I'd say similar position where we were in Q1, where there's always some that want a little bit more. And again, just trying to make sure we have the right amount in the channel to support our end users, but not getting ahead of ourselves, given some of the uncertainty that we've talked about. Joe Giordano : Fair enough. And then just if I could ask on some of your smaller businesses, can you give us an update on trends within like RFID and with Matrox and Fetch and maybe how you see those businesses in terms of like growth in size exiting this year? Bill Burns : Yes. I can take that, Joe. I'd say, RFID challenging kind of second quarter on compares from cycling large opportunities a year ago. I would say that overall would expect return to growth in second half year. We're continue to -- we move into the second half really with strong backlog and pipeline of opportunities across not just retail but transportation, logistics, manufacturing. So we're seeing continued use cases across RFID, including moving beyond apparel to general merchandise inside retail. Clearly track and trace across the supply chain, parcel tracking within T&L, baggage tracking within airlines, so lots of opportunities across RFID. I would say machine vision. We continue to be excited about the opportunity within machine vision, challenging market at the moment. And our Matrox acquisition, when we acquired that asset, we knew was heavily weighted towards semiconductor equipment manufacturing, which is still a challenge segment as well. So decline in the quarter in machine vision, but we feel good about it overall. We saw strength in our Adaptive Vision acquisition. So software -- machine vision software in the quarter that was a bright spot. I'd say that the diversification of that business, which was our focus all along with the Matrox business diversify into areas like automotive and logistics into new areas. We also had our organic investment in machine vision, which really applies more to logistics area. That diversification is going well. Ultimately, we're calling on more customers. We're seeing more opportunities. We're continuing to invest in go-to-market across the globe in just seeing more opportunities is across machine vision. So we feel good about that in a great opportunity for Zebra overall. I'd say software -- our software assets, we're seeing the combination of our mobile devices, especially in the wearable space now with some of our assets in software that we're pretty excited about. So the word cloud solutions really focus on retail and then leveraging our mobile device in the hands of retail associates. And we continue to advance and bring those solutions together and combine that with things like wearable mobile computing. We've seen some early wins there. So we feel good about the portfolio. They're a smaller segment of the market, right, or, sorry, our not market, meaning smaller segment of our business overall or piece of our business. So really mobile computing returning to growth, other segments being more challenged. These are areas that we see as driving the future growth of Zebra. Operator : The next question comes from Andrew Buscaglia with BNP. Please go ahead. Andrew Buscaglia : Hey, good morning, guys. Bill Burns : Good morning. Nathan Winters : Good morning. Andrew Buscaglia : Yes. So I want to get your thoughts on potential upgrades of devices, especially in 2025. Do you have any data you can share around the age of your installed base? Because presumably a lot of these devices were sold during COVID and we should start to see a natural need to upgrade these in the next year, I would think. Bill Burns : I'd say overall we're, from a mobile computing perspective, I'd say that our customers have really been absorbing the capacity that they've built out during the pandemic more than anything else. So I think there's clearly continued upgrade cycles across all of our customers. But from the idea that they built out so much capacity during the pandemic that they're using that capacity today, and then as the economy slowed, that created even more capacity, so they're ever using that capacity off, I think we're seeing customers move into the idea that they've absorbed some of the capacity and are beginning to buy again. But that's kind of early signs of what we're seeing. I'd say that there's a solid pipeline of opportunities for mobile computing overall, both in kind of refresh new use cases continue to add to the number of devices inside our customer base. And we continue to see competitive wins across the portfolio. So I think the upgrades are out there, the refreshers are out there, and ultimately some customers are sweating assets a bit more, others are leveraging what they have today. And I think that we're confident that as the macro environment gets better, our customers will continue to upgrade our devices and we'll see an uptick in large orders within our business, which will marry with what we're seeing as kind of medium in run rate business growing in second quarter. Andrew Buscaglia : Yes. Okay. Okay. And then you're raising your free cash flow expectations again and just kind of given where we are things looking to start to improve, and you probably have some confidence here. Where do you see capital allocation going into the year-end? Is M&A -- will see some M&A come to fruition before year-end? Or is there a focus more on share repurchase? Or how are you thinking about things? Nathan Winters : Yes. So I think on the first part, again, please raise the guide for free cash flow to over $700 million, including the final settlement, as well as the swap sale in the second quarter. So -- and the improvement overall in working capital to get us above the 100% free cash flow conversion. And as you say, the -- really the prior -- we've prioritized debt paydown as well working on our capital structure in the first half of the year. So ending the second quarter just under our below the target range of 2.5x debt leverage, and that will sequentially improve as we move through the year. I think in terms of overall priority, they remain unchanged. The first is organic growth getting the business back to the growth trajectory we need it to be and want it to be along with the right profitability levels. M&A continues to be a lever. And I think now with the improved cash flow as well as our overall capital structure, we have additional flexibility for share repurchases as we move through the year. So Bill, you want to touch on the M&A brochure? Bill Burns : Yes. I guess, I'd say that our M&A philosophy really remains unchanged. I think we continue to leverage M&A where it makes sense to advance our vision and our overall strategy. I'd say in the short-term, the bar is probably higher based on kind of macro uncertainty and then higher interest rates. But I would say that we continue to target select assets that ultimately are closely adjacent and synergistic to our business today. As Nate said, we've got a strong balance sheet and flexibility to continue to look at companies and we continue to be inquisitive. But the bar is higher at the moment. Operator : And the next question comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. Thanks. Maybe a couple of questions, just on the healthcare strength that you saw. I know that that had been a relatively they had been in a more challenged spend environment. So just wondering, how broad-based that is. Is that kind of new project based or just any detail there? And then second question, EMEA looked like a source of strength for you guys. I think we've seen that across some other companies. And so is that a matter of, they're just coming from a very depressed environment. And so we're coming off of a lower base and that's where some of the EMEA strength is. Are you -- are there any trends in EMEA that you think are worth calling out? Thanks. Bill Burns : Yes. So I'll start with healthcare and then jump to EMEA. Healthcare, I'd say overall, mobile computing drove the growth in healthcare. It really is our team's focus on clinical mobility and really total cost of ownership. We've seen in the past a significant number of consumer devices used in that space. And I think that we're seeing healthcare systems realize that the total cost of ownership of Zebra devices is well-positioned for them in an environment of tighter budgets and thinner margins overall within healthcare. And we add a lot of value, ultimately by improving productivity of healthcare workers, getting data into electronic medical record systems, and then ultimately enhancing patient safety overall. So I think the automating of workflows, the digitizing the information around assets and patients and staff is of value that our healthcare customers are seeing. I think a medium to longer-term opportunity we're now seeing is things like home healthcare that remains an opportunity for us. So things like tablets in that area, in home healthcare. So we're excited about that. Healthcare has always been a smaller piece of our business, but in one of the faster growing areas, and certainly that happened in Q2. I would say, if we move to EMEA, say overall strength in EMEA was relatively easy compare in Q2 compared to the other regions. Overall, the positive, I'd say in EMEA is that we saw some larger projects move ahead outside of retail. So this is one of the places where we've seen some growth in P&L outside of retail, and some competitive wins in EMEA. So we feel good about that. Manufacturing remains challenging in EMEA today. So I think that kind of mixed overall feel good about some P&L orders, large P&L orders, easier to compare where manufacturing makes challenging. So I think overall, I think we want to see North American EMEA, we'd expect to come out of this first, but we saw some strength in Latin America too. So I think mixed results across the region. Operator : And the next question comes from Brad Hewitt with Wells Fargo. Please go ahead. Brad Hewitt : Hey, good morning, guys. Wolfe Research, not sure what happened there. Bill Burns : Sorry, Brad. We missed the question. You broke up there during the question. Brad Hewitt : Yes, sorry. So, just curious if you could elaborate a little more on what you're assuming in the second half from the top-line perspective. So at the mid-point of your full year guidance, it implies revenue in the second half, essentially flat with the Q2 run rate. So can you help me reconcile that versus kind of the early signs of momentum in mobile computing and also given the typical positive seasonality in Q4? Nathan Winters : Yes. So if you look at our full year guide of 4 to 7 with a mid-point of 5.5, I think from a year-on-year perspective, really driven by what we see is double-digit growth in the second half demand, it's about 5 points for the year where again, if you look at the full year, a lot of moving parts where the destocking from last year accounts for about 7 points of growth. But then we had the challenging comps in the first half that offset that. So again, really the full year growth is driven by underlying strength in the business in the second half. As we said, we see modest demand increases across each of our vertical markets. That's inclusive of the Q2 beat. So I think we look at it as really the strength we saw in Q2 continuing into the third quarter. I think similar to how we structured the guide over the last several quarters of not anticipating or expecting sequential improvement. But what have we seen here in the most recent weeks and months? We see that continuing here in July in terms of that stability in the business, albeit at a bit higher level than we saw as we entered the second quarter with modest increase as we go into the fourth quarter. So as Bill highlighted before, typically a lot of the year-end spend that we see from our customers has leaned towards large orders in the past, and again, being thoughtful about how we embed those in the guide until we have more certainty and commitments from our customers on moving forward with those projects before including it for our full year guide. So I think, we think it's grounded in what we see today, given that visibility into the large deployments and appropriate. Brad Hewitt : Okay. That's helpful. And then you guys have talked in recent quarters about your expectation for seasonally lower OpEx spend in the second half of the year. Just curious if you could kind of shine some more light on that. And then if we look at the implied Q4 EBITDA margins about 21%, can you talk about some of the puts and takes there on a sequential basis? Nathan Winters : Yes. So if you look just historically, sometimes it is hard to see. But typically, as we go throughout the year, just based on when a lot of our trade shows, sales, kickoff meetings, timing of benefits, et cetera, tend to be more weighted towards the first half of the year. Then as you get into the back half of the year, you get into holiday seasons around the world, as well as some of the lower benefit costs as you go sequentially through the year. So I'd say a lot of the sequential improvement is timing-related now that we've kind of flushed through all of the restructuring benefits, or the vast majority of restructuring benefits through the P&L. And then look at the sequential improvement in profitability from Q3 to Q4 is really based on that slight improvement in OpEx, as well as the higher volume leverage flowing to the bottom line. Operator : And the next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. Question for you on the software and services. With mobile computing being up double-digits, I guess, I would have expected a little bit of that flowing through more in software and services design as people sign up for their warranty contracts and things of that nature. Can you pass a little bit of light on the connection between the two and the modest growth that you had and that's in that line item this quarter? Bill Burns : Yes. Keith, this is Bill. I would say that overall, we've seen consistent growth in software and services over the last several quarters. So we feel good about that. I'd say we continue to see strong attach rates with mobile devices. So the revenue lags that, of course, right? So ultimately, the strong attach rates continue with uptick in mobile computers. So no real change there. It's just not tied directly to revenue in the exact quarter depending on when the mobile devices are sold. So I wouldn't take anything away from that. We're continuing to see strong attach rates, really driven by things like upgrades around OS and security patches and so forth continue to be an important aspect of our customers buying service from us. I can say that we've seen in the past some customers extend their support agreements, and I think we're seeing a little bit less of that now, which is again a good sign for ultimately our customers looking to upgrade the mobile devices in the future. So maybe a little bit of less of that, if anything else. Overall, I'd say software and services, an important piece of our business, recurring revenue that we and others like. So I think all good there, nothing really to read into it, Keith. Keith Housum : Okay. I appreciate that. And then just a follow-up, in terms of like, as most people are starting with here toward the refresh cycle of all the devices bought four or five years ago. How should we think about pricing today versus where it was, say, four years ago? Are people trading down to a lower mobile computer? Or as you think about most customers, is it relatively similar? But how do you think about pricing, what people are buying today versus four years ago? Bill Burns : Yes. I think we're -- obviously, there's customers are making choices on the type of device they need in their environment. So I think that we continue to see that. So if somebody needs a more rugged device, and their experience was they had a lower tier device and they beat those devices up, they'll move to a higher tier device and you'll see the reverse. If they had a good experience with a more rugged device, could they go to a more mid-tier type device? I think that happens all the time. I think we continue to focus on value that the devices bring to our customers to keep ASPs as high as we can, and then if we can't, to make sure that we're getting the same gross margin out of each tier of the portfolio. In the past, we've tiered the portfolio kind of good, better, best, or all the way down to kind of value tier. And I think that's allowed us to keep our pricing and margins higher. So if you want a higher spec device, you pay us a higher price for it. In the early days, call it, eight, nine years ago of -- eight years ago, nine years ago on Android, we didn't have as many flavors of devices. So you're discounting higher end devices to meet value to your players. We don't do that today. We're really tearing the portfolio has allowed us to kind of have conviction around our prices at the higher end, and we feel good about our customers and working closely with them to select the right device for the right use case. Operator : And the next question comes from Brian Drab with William Blair. Please go ahead. Brian Drab : Hi, thanks. You mentioned that you're seeing sequential improvement in all the end markets, including T&L and manufacturing. There have been some signs of further softness across the manufacturing industry in recent weeks, and I'm just wondering if you are seeing any of that show up in your customers buying patterns or if it really does feel like a pretty stable sequential improvement environment now. Bill Burns : Yes. I'd say that, as we talked about before, I think in Q1 we saw kind of retail and e-commerce first, and now we've seen mobile computer -- mobile computing kind of grow across each of the vertical end markets. So retail, manufacturing, healthcare, I'd say that, we're still seeing challenges in manufacturing and overall, demand, especially in a large deal isn't back to the historical levels that it's been in the past. But in manufacturing specifically, we saw sequential improvement from Q1 and Q2. But I still think EMEA, for instance, we're clearly seeing a challenge in manufacturing where I would say overall, I wouldn't call manufacturing back to normalized levels in any way. But I think we just saw some sequential improvement, which I think was good. Manufacturing is an important segment for us. We see we've got lesser -- we're lesser penetrated in through manufacturing. Our relationship with manufacturing, many times are more in the warehouse or the finished production and moving that through the supply chain and some of our new solutions around machine vision, rugged tablets, our demand planning solutions for CPG manufacturers, all play into having a broader portfolio for manufacturing. So we ultimately see that a segment for growth for us, but I think still challenging the short-term. We would say, we're seeing probably about the same as you're seeing. Brian Drab : Okay. Thank you. And then for follow-up, are you seeing opportunities potentially to gain share when we come out of this tougher environment? I mean, you obviously have a great balance sheet. You're not letting up in terms of investment in technology and customer service. Can you comment on how you might be potentially better positioned in both AIT and EVM ultimately? Bill Burns : I'd say that overall, we feel good about where we're at in our customer relationships. We continue to stay very close to our customers as we're a trusted partner to them. And I think that as the macro environment gets better, I think we would say that they will begin to buy again, especially, and we'll see large orders improve as we continue to solve growth in medium and run rate in second quarter. The installed base continues to grow. And I think that from that perspective, I think that we're seeing increased use cases across our customer environment. So some are still sweating their assets that will shift. They can't do that forever. So I think overall, we see the momentum in demand continuing and then continue to broaden both by vertical market to your first question, and then by size of order and order activity across small, medium and large type orders. Operator : And the next question comes from Rob Mason with Baird. Please go ahead. Rob Mason : Yes. Good morning, Bill and Nathan. The strength in the gross margin, I think has already been commented on. But as you think about when large orders do come back, how should we be thinking or how are you thinking about sensitivity in the gross margin profile today versus, say, maybe 2018, 2019? Have you done anything different structurally around either your supply agreements or just as you mentioned, Bill, tiering the portfolio that would suggest the gross margin holds up better? Or does it have that kind of return to maybe 2018, 2019 levels when large orders come back? Nathan Winters : Yes. Rob, I'd say just if you look, I would say, no structural difference in terms of maybe the differential between the margin we'd expect on a large yield versus kind of the run rate business. So that hasn't structurally changed. The one thing, if you go back, I think the one aspect, particularly if you go from 2019 -- since 2019, whether that's tariffs, the supply chain, challenges the rapid growth. So it's pretty challenging to find what's the right baseline. And if you go back to 2018, right, so I'm just the lower rev -- lower base. So I think, if you look at the business today, I think the strength across the portfolio is -- we have strength across the portfolio in terms of the underlying gross margin and being able to leverage the scale and leverage our distribution network as we've grown to inherently build a higher gross margin profile company. But again, I think it will be somewhat decremental as we in gross margin once large deals recover, but still incremental, as you think about it from a EBITDA rates. So I think there's the balance of -- there's still incremental margin to the total -- to the bottom line, but slightly dilutive in gross margin. Rob Mason : I see. And just to go back on the regional discussions, my math, and maybe this is not totally right, but it did look like North America stepped down a little bit sequentially. If that is the case, just any color that you could provide on what you saw there. Bill Burns : Yes, Rob, North America was down year-on-year. I'm not sure it's sequentially -- down sequentially as well. Nate's warning to me, I would say, overall mobile computing return to growth in North America, again, just like we saw across the other regions. So that clearly was positive. The other product categories were down, as a year ago, in first and second quarter, we saw supply chain challenges abate from a print and a scanning perspective. So the compares were pretty challenging for both those businesses. They had really good Q1 and Q2s of last year. So I think that impacted North America. In North America typically has an overweight on large deals as well. So growth in North America, we really like to see kind of run rate, mid-tier and large deals because the large deals are overweight typically in North America. So we saw kind of flat sequentially, as we said before, large deal activity, Q1 to Q2. And really, North America would like to see more large deal activity come back here in kind of second half, and then hopefully some year-end spend and then growth into 2025. So that's really the story of North America. Operator : And the next question comes from Jim Ricchiuti with Needham. Please go ahead. Chris Grenga : Hi, good morning. This is Chris Grenga on for Jim. Most of my questions have been addressed, but maybe just one for me. The chart with the touchpoints is very helpful. Just wondering, as you look ahead to seeing larger projects return, are you preparing for large project activity to be in any one of these particular nodes, whether it's factory, warehouse store, or last mile, et cetera, or do large projects generally entail a broad coverage of one or many of those nodes, or just how you're thinking about that? Thank you. Bill Burns : Yes. I think we see large deals typically across the portfolio, so that it's all about kind of size and scale of customers. So in retail, it'd be larger -- the larger retailers that would refresh and have refresh cycles or upgrades or larger orders across the portfolio that we do a multiple store upgrade, refreshing to a new device for instance. In transportation logistics, you'd see things like the fleet of last mile delivery drivers as an example. Upgrade across transportation logistics, or postal workers around the globe would be examples of large opportunities. So I think we see them across each one, they're a bit different. In manufacturing, it's more location by location or plant by plant, as opposed to large deal activities, would see in retail where they do multiple stores at once, or T&L, where they do an entire fleet of drivers or postal. So it's a bit different by nodes. So manufacturing more broken down by site, retail more, multiple stores at once, T&L more larger deployments, I would say, healthcare more, more like manufacturing, not as large a hospital systems more kind of hospital at a time or multiple hospitals at a time, but not those large refreshes. So I'd say large refreshes and upgrades more tied to retail and T&L. Operator : And the next question comes from Guy Hardwick with Freedom Capital Markets. Please go ahead. Guy Hardwick : Hi, good morning. Zebra issued some -- Bill Burns : Good morning. Guy Hardwick : Good morning. Good morning, all. Zebra issued some very interesting press releases regarding working with Qualcomm to run LLMs on Zebra mobile computers, but without the requirements to kind of regular uploads to the cloud. So I was just wondering, Bill, just how close is Zebra to kind of a broad-based introduction of these kind of AI digital system products in mobile computing? Bill Burns : Yes. So we think of AI across the portfolio in several different ways. First is that just our core business really is about collecting real-time data, and that's used as kind of intelligence to feed AI models overall. So whether that's a barcode reading a printed label with the information on it back into the cloud, whether that's an RFID tag being read. So the idea of digitizing a customers' environment, getting real time data to AI models, and ultimately to generate insights in AI is a fundamental thing we do in our -- the value of our data that we collect feeds these models. So I think that's kind of the baseline of when we think about AI. Second is traditional, more traditional AI is used about probably in 50 different solutions across the portfolio today, whether that's optical character recognition or product recognition, navigation for autonomous mobile robots, package dimensioning inside our software around workforce planning and demand forecasting. So traditional AI is kind of the second piece that we think of across the portfolio. The third is what you're kind of referring to is the idea that it's AI assistant, right? Is that empowering the frontline worker through more information, leveraging a large language model on the device without connectivity to the cloud? Working closely with Qualcomm and Google, as you mentioned, to go do that. We've demonstrated that it -- at our National Retail Federation Trade Show in January. We demonstrated again at our Innovation Day. We also demonstrated at Google's Trade Show earlier this year as well. So I think we're excited about that opportunity. Today, it's not commercialized yet. We're continuing to work closely with our customers to really understand all the use cases, what's required around that. How do we best leverage which model in that case, how do we keep the model up to date? So a lot of different discussions with our customers about what that offering will look like. But we're excited to work with Google and Qualcomm on it. Our customers excited about having a digital assistant within retail or manufacturing. You think of all the use cases of making your newest worker as good as your most experienced worker, having all of your standard operating procedures at the hands of the associate or the frontline worker, being able to tie that back to what's the source of the data being restricted to the individual customer. So we think it's a driver long-term for our mobile devices and a differentiator for us. But today, still early days, more pilots and demonstrating and working with customers than commercialization. Guy Hardwick : If you don't mind just me pushing a little bit on that. I mean, in terms of commercialization, is it a 2025 timeframe or beyond that? Bill Burns : Yes, no, likely -- like we're going to have more demonstrations around it that we're planning today with some of our customers at the National Retail show as we go the next step along with it next year in 2025, and then probably commercialization in likely in 2025 as I would see it today. Guy Hardwick : Okay. Thank you. Operator : And the final question comes from Rob Jamieson with Vertical Research. Please go ahead. Rob Jamieson : Hey good morning, Bill and Nathan. Congrats on the quarter. Bill Burns : Thanks, Rob. Rob Jamieson : Just wanted to kind of ask more of a high level question around and go back and revisit M&A and add an adjacencies. I mean, you all have a great installed base and a lot of market share across your various verticals. As we think about you adding adjacencies and what you've done recently, adding things like Fetch and Matrox and other markets, given the comfort that your customers have with you, do you think that as we return to like a more normal environment that will kind of, you can leverage that and your customers be more comfortable maybe deploying a new solution, something more kind of like advanced like Fetch or Matrox in their operations. Bill Burns : I think that clearly are strategic relationships with our customer creates an opportunity for us to deploy a broader set of solutions within those customers. That, that trusted partnership allows us to go do that. I think the backdrop of the environment hasn't been all that great. So machine vision is a good example of that. It's been kind of a challenging market and then our diversification just takes time where we were centered really around more semiconductor manufacturing and moving outside of that. So -- but that is -- our customers are giving us an opportunity to sell solutions in that space because we have a relationship with them already. I think we're seeing the same thing across retail software and robotics, as you mentioned. So clearly it matters. Our breadth and depth of our current portfolio, the relationship we have with them, the fact that we're a trusted partner to them; it's not always the same persona. So it's not -- I wouldn't say it's easy. Meaning we've got to get from our current buyer of our solutions and the person who deploys our solutions today to someone else within the organization. So if we're working with somebody inside a manufacturer more on the distribution of products at the end of the manufacturing line, we now need to form a relationship with somebody on the manufacturing line for things like machine vision solutions to stick with that example. So it's not easy, but it's certainly doable. And our -- because of our trusted relationship, they're willing to make that introduction. And then we've got to earn our way in and prove our solutions into that manufacturing space. But we're given that opportunity because of those relationships. Rob Jamieson : That's helpful. And I appreciate it. And then to the extent that you're willing to share, just as you talked about adjacencies and things you're looking at in the portfolio, is there anything either high level or specific that you're looking at the moment, just especially as your leverage is getting to an attractive point here. Thank you. Bill Burns : No, I think that again, it's -- we think of assets that are closely adjacent to the portfolio overall, and really synergistic to what we do today. We'd like to do things in the similar vertical markets for the reasons we just talked about. So all that comes into play. And then ultimately, as I said before, a little bit higher hurdles at the moment, given the macro uncertainty to make sure that if we were going to acquire something, or the certainty of revenue, and then ultimately higher risk interest rates weigh down on that a little bit. So I think overall, we continue to be inquisitive. It's got to be the right asset and the right fit for Zebra. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. Bill Burns : Yes. I'd like just to wrap up by saying thank you to our employees and partners for continued support of Zebra and execution in the second quarter. We're now positioned for growth in the second half year. So have a great day everyone. Thank you. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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ZBRA
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Zebra Technologies
| 877,212
|
Information Technology
|
Electronic Equipment & Instruments
|
Lincolnshire, Illinois
|
1969
|
2019-12-23
| 2,024
| 4
|
2024Q4
|
2024Q3
|
2024-10-29
| 11.403
| 11.98
| 14.013
| 14.71
| 23.28
| 23.24
| 23.92
|
Operator : Good day, and welcome to the Third Quarter 2024 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. Mike Steele : Good morning, and welcome to Zebra's third quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed on our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-on-year and on a constant currency basis. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our third quarter results. Nathan will then provide additional detail on the financials and discuss our fourth quarter and revised full year outlook. Bill will conclude with progress on advancing our strategic priorities. Following the prepared remarks, Bill and Nathan will take your questions. Now, let's turn to Slide 4, as I hand it over to Bill. Bill Burns : Thank you, Mike. Good morning and thank you for joining us. Our teams executed well in the third quarter delivering sales and earnings results above the high end of our outlook. For the quarter, we realized sales of almost $1.3 billion, a 31% increase compared to the prior year, and adjusted EBITDA margin of 21.4%, a 980 basis point increase. Non-GAAP diluted earnings per share of $3.49, which was 4x the prior year and delivered strong free cash flow. As we discussed on our last earnings call, during the second quarter, we began to see early signs of recovery across our end markets with mobile computing returning to growth. In the third quarter, we were encouraged to see the recovery broadened with data capture and printing also returning to growth. We realized double-digit growth across all our primary end markets and broad-based growth to customers of all sizes as began to cycle significant destocking activity in the second half of last year. We are seeing indications of customer spend generally improving in the second half, including expectations for higher year-end spending in North America and EMEA across most end markets. That said the manufacturing sector is still lagging as the goods economy continues to recover. Additionally, as we look ahead to 2025, visibility remains limited regarding the timing of large deployments. Another highlight was our improved profitability, primarily due to improved gross margin driven by volume, leverage, and business mix. With the recent consolidation of our North American distribution centers into a single Chicago area facility, we have successfully completed our restructuring actions to deliver $120 million of net annualized operating savings. Given our third quarter performance, improved momentum in demand recovery, and our focus on profitable growth, we are raising our full year outlook for sales, profitability, and free cash flow. I will now turn the call over to Nathan to review our Q3 financial results and discuss our revised 2024 outlook. Nathan Winters : Thank you, Bill. Let's start with the P&L on Slide 6. In Q3, total company sales grew 30.6% reflecting continued recovery in demand across our major product categories. Our Asset Intelligence & Tracking segment grew 25.8%, primarily driven by printing and RFID. Enterprise Visibility & Mobility segment sales increased 33% with strong growth in mobile computing and data capture solutions. Our services and software recurring revenue businesses grew 4% in the quarter. We realized double-digit sales growth across our regions. In North America, sales grew 22%, led by mobile computing and printing. EMEA sales grew 47% with strength in Northern Europe. Asia-Pacific sales grew 24% led by momentum in Southeast Asia and India along with stabilization in China. And sales grew 42% in Latin America with particular strength in Mexico and Brazil. Adjusted gross margin increased 430 basis points to 49.1% due to volume leverage and favorable business mix and adjusted operating expenses as a percent of sales improved by 580 basis points. This resulted in third quarter adjusted EBITDA margin of 21.4%, a 980 basis point increase versus the prior year and a 90 basis point sequential improvement from Q2. Non-GAAP diluted earnings per share was $3.49, a greater than 300% year-over-year increase. Turning now to the balance sheet and cash flow on Slide 7. In the first nine months of 2024, we generated more than $650 million of free cash flow as EBITDA improved and we continue to drive significant improvements in working capital. We ended the quarter at a 1.6x net debt to adjusted EBITDA leverage ratio, which is within our target range. We resumed share repurchase activity in Q3 and now have increased flexibility given our improved cash flow, lower net debt, and $1.5 billion of capacity on our revolving credit facility. Let's now turn to our outlook. We entered the fourth quarter with a solid backlog and pipeline of opportunities and expect sales growth between 28% and 31%. This outlook assumes continued recovery across our major product categories with an improved level of year-end spending by our customers including several large North American retail projects. We continue to cycle easier comparisons across the business due in part to significant destocking activity by our distributors during the second half of last year. Q4 adjusted EBITDA margin is expected to be approximately 22% and non-GAAP diluted earnings per share are expected to be in the range of $3.80 to $4. Our fourth quarter outlook translates to full year sales growth of approximately 8%. Our full year adjusted EBITDA margin is expected to be approximately 21% and non-GAAP diluted earnings per share is expected to be in the range of approximately $13.30 to $13.50 based on our Q4 guide. This represents stronger profitable growth than our prior outlook supported by increased momentum and demand recovery and continued focus on our cost structure. Free cash flow for the year is now expected to be at least $850 million. We continue to drive profitable growth while improving our working capital levels including rightsizing our inventory. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill. Bill Burns : Thank you, Nathan. Turning to Slide 10. We remained well-positioned to benefit from secular trends to digitize and automate workflows with their comprehensive portfolio of innovative solutions including purpose-built hardware, software, and services. We empower frontline workers to execute tasks more effectively by navigating constant change in real time to advance capabilities including automation, prescriptive analytics, machine learning and artificial intelligence. Zebra continues to demonstrate market leadership through innovation. We have consistently reinvested approximately 10% of our revenues into research and development to advance our vibrant core and bring new innovative solutions to market. At recent customer events we hosted in North America and EMEA, we unveiled solutions that underscore our commitment to innovation. These include the latest version of our work cloud software utilizing advanced AI and machine learning and new rugged tablets for demanding environments. We also highlighted a Zebra kiosk solution offering self-checkout including tap-to-pay capabilities, which enhance the customer experience and enables frontline associates to focus on higher value tasks. This launch enables us to expand Zebra's addressable market with near adjacent technology that leverages our core software platform. Additionally, we are developing a generative AI mobile computing solution designed to assist frontline workers with sales, merchandising, and operating procedures, which we will feature at the National Retail Federation Trade Show in January. As you see on Slide 11, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to drive productivity and better serve their customers, shoppers, and patients. Our relentless focus on innovation continues to drive our competitive differentiation and secure wins. In the second half of this year, we're seeing momentum in large Zebra deployments in North America and EMEA across retail, e-commerce, and logistics. Our customers are beginning to increase investment in our solutions as they absorb the supply chain capacity they built out during the pandemic and look to drive increased productivity. Recent key wins include a technology modernization project at a large e-commerce customer, a mobile computing upgrade at a large retailer to enable the latest software applications, a grocer's initiative to replace desktop computers with our mobile devices to drive several front of store use cases and a luxury retailer will deploy work cloud software to optimize in-season pricing. Additionally, logistics customer in EMEA selected Zebra's new wearable mobile computers to replace a competitor's voice picking solution. This customer expects to improve accuracy and increase employee and customer satisfaction with our solution. Last quarter, I highlighted our success and traction in selling the benefits of enterprise grade devices in healthcare. Our ease of integration into electronic medical record systems has been a competitive differentiator and we recently secured mobile computing and printing wins at large North America hospitals. Our solutions will improve workflows and enable enhanced visibility and tracking of assets, equipment, and specimens. Now turning to Slide 12. We realize double-digit sales growth across all vertical markets as demand recovers. Our confidence in sustainable long-term growth is underpinned by several themes that we expect to drive investment in our solutions including labor and resource constraints, track and trace mandates, increased consumer expectations, and the need for real time supply chain visibility. In closing, we are seeing the broadening of demand recovery in the second half of this year with a more normalized seasonality in sales volumes as we enter the fourth quarter and into 2025. As we look longer-term, we maintain strong conviction in the opportunity for Zebra as we elevate our strategic role with our customers through our innovative portfolio of solutions. Our sales and cost initiatives have positioned us well for profitable growth as our end markets continue to recover. I will now hand it back to Mike. Mike Steele : Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up to give everyone the chance to participate. Operator : We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Andrew Buscaglia with BNP Paribas. Please go ahead. Andrew Buscaglia : So it's a, obviously demand seems to be picking up quite a bit facing some easy comps. But also you had some commentary around some larger North America retail project wins, I believe, if you could comment on that. What are you seeing in that market specifically and how do you see that playing out into next year? Bill Burns : Yes, Andrew. I would say that, certainly, we're seeing that the quarter ended where we were pretty happy with the results and ultimately the teams executed well. I would say that we saw a broadening recovery across all vertical markets, not just retail, in Q3, which certainly was encouraging. From a retail perspective, I would say retail and e-commerce outperformed across all product categories, really in Q3, and we expect that to kind of extend into Q4, as you mentioned easier compares from a year ago. But we've also been able to see some year-end spending, which injects some more -- some normalized seasonality, which we have seen in past years, certainly year-end with larger orders from e-commerce, retail and transportation logistics, specifically North America and EMEA. So this is what we'd normally see at year-end. We hadn't seen that last year, of course, and now, we're seeing that, that return to more normalized levels. So we feel good about retail customers beginning to spend again. Sure, their focus continues to be investments in e-commerce, omni-channel continue to drive that market. We've got a solid pipeline of opportunities as we enter Q4 and we continue to win in that market against competition as we've got a differentiated portfolio of hardware and software serving the retail market. So we feel good about what we're seeing across retail in Q3 and Q4 and the seasonality coming back where we see some year-end spending across North America and EMEA. So we feel pretty good about retail at the moment. It was the first to recover, right? If you think back to the beginning of the year, retail was the first to decline and the first to recover. And we're seeing that continue across retail throughout the year. Andrew Buscaglia : Yes. Okay. And then can you just comment on what you're seeing with distributors and how are they going about their decision to start to restock and what kind of trends are you seeing in with those customers? Bill Burns : Maybe I'll start and hand to Nathan. I would say overall that our distributors are seeing the uptick in business that we're seeing from our partner community. I think that we're working closely with them to make sure that they've got the right level of inventory to meet the increase in demand as we enter Q4. But that we continue to work closely with them to make sure that across all product categories that we make sure that they've got the right level of stocking across each of the regions around the globe. Nathan Winters : Yes, I think that's checks in, and again, when we look at it from an inventory perspective, they're at a good amount of days on hand in terms of where we'd like them to be entering the fourth quarter. So again, I think we feel, as Bill said, good about the overall inventory position here as we enter the quarter with the expectation for the year-end spend to come through. Operator : The next question comes from Jamie Cook with Truist. Please go ahead. Jamie Cook : Hi, good morning. Congrats on a nice quarter. I guess, just back to the large orders, can you help us understand how much of the large orders did that help the third quarter and sort of what's implied in the fourth quarter and your confidence level that this continues into 2025? And then, I guess, my second question, the margins over the past two quarters, I mean the gross margins were 49% plus, that's implied 49% or so in the fourth quarter. I'm just wondering, based on the sales volume and benefits from some of their structuring, the expectation that margins can at least be at that level in 2025, given the exit rate for 2024. Thank you. Bill Burns : Yes. So Jamie, maybe I'll start and then hand over to Nate around margin. I'd say if we kind of look back right to 2023 and kind of recap where we're at, right? I would say overall that customers in 2023 were absorbing capacity and that they built out in the pandemic. We clearly were -- they were scrutinizing budgets, sweating assets, right, and that drove significant distributor destocking in that timeframe. And in fourth quarter last year, we saw really no large deal, no larger order activity in the end of fourth quarter of 2023. So I would say that that's what's really different this year is that ultimately as we entered 2024 in the first half, we saw early signs of recovery really in mid-tier and run rate businesses we talked about in the first half and really focused on mobile, computing and retail. But larger orders really remain below historic levels in the first half. As we got into second half, what we're seeing is broader recovery across all regions. In most end markets, we're still seeing manufacturing for instance lag, but we're seeing the return of year-end spending and larger orders by retail and logistics customers in North America and EMEA. We're also seeing some probably mid-tier orders; I would call it from healthcare. So healthcare has also been a strength, which has allowed us to raise our guide. So I think more normalized seasonality that we're seeing where typically fourth quarter is an uptick in demand as our customers spend more in the fourth quarter as they move into next year. I would say the other thing we saw was that a comment on kind of large orders was probably the fact that we saw CapEx increase throughout the year. So I think as customers got more confidence in the macro environment around them and what we're seeing across their business, the increased capital spending, especially in retail throughout the year and injecting again more seasonality that we expect to happen in fourth quarter and then continue injecting seasonality back into our business in 2025. I'd say from a 2025 perspective, while we're clearly not guiding to 2025, we're optimistic that the recovery continues into 2025, certainly based on the strong second half. We'd expect again normalized seasonality to really be injected back into the business in fourth quarter just like we'd expect in 2025. So I'd say the one caution would be we're seeing a little bit of uncertainty across the customer base. And I would say that what that means is really manufacturing lagging the other segments. I would say, each customer is in a different phase of whether its refresh or new, product investment or new investment across their business and new applications. We're seeing some T&L customers' still absorbing capacity. So we've got a bit of limited visibility to large projects on when they're going to happen in 2025. So again, we'd expect the recovery to continue but a bit uneven across some of the end markets is the only thing I'd say from a caution perspective. Maybe, Nate can comment on margins. Nathan Winters : Yes. Yes. So Jamie, if you look at our gross margin in the third quarter, just over 49%, that's the highest gross margin we've had in recent history. But really benefited from lower large deal volume, obviously, there was a bit of a return, but still lower than as a percent than what we've seen historically. But good scaling on our fixed infrastructure. We completed the consolidation of our distribution centers in North America. That was the last piece of our restructuring actions midway through the quarter, so seeing that benefit flow through. The only thing I'd say is you look at what's implied in the Q4 EBITDA guide. We do expect a sequential decline in gross margin just as you know, again, based on the incremental large deal volumes coming through on the higher volume. And I'd say that's still kind of the wild card if you look into 2025 is, what that large deal mix look like as we enter the year and as we go throughout the year, as we think about the kind of the gross margin dynamics. Operator : The next question comes from Damian Karas with UBS. Please go ahead. Damian Karas : Hey, good morning, everyone. Nice work in the quarter. Bill Burns : Thanks, Damian. Good morning. Damian Karas : Yes. So you guys mentioned that you still have limited visibility around large deployments. Could you maybe just give us a sense for like why that is and when you think about going into year-end and some of these kind of late CapEx budget type decisions, is there what have you baked into your guidance? Are you only kind of factoring in COGS these larger deployments where you do have visibility? And is there potential that after we get through the election there could still be some kind of later year spend? Bill Burns : Yes. I would say, Damian, we feel good about the fourth quarter guide with a pipeline and visibility in all size orders really to support the guide. So I think we feel good about the guide for fourth quarter. I would say, overall from a limited visibility perspective, I think as we look into 2025, what we saw in 2024, was customers start off with kind of a conservative view on CapEx spending and kind of ramp that spending through the year. We'd expect that same thing to likely happen in 2025 is, look, I think overall there's lots of positive momentum from a macro environment, whether that's positive GDP, whether that's e-commerce growth, the capital spending increase, as I said throughout 2024, IT device spending is projected to be up in 2025. So that's all good news for 2025. But I think you mentioned it, right, all the other things that are kind of weighing on the macro around the globe, including U.S. elections, right, interest rates are still high. Inflation, impacting consumers and their spending overall, which then creates a bit of caution on the part of our customers, longer sales cycles, more approvals, those kind of things as they kind of second guess their CapEx. So I'd say overall, just while we see projects for 2025 at the moment, it's a -- it's just a bit early to have the visibility especially into large deployments and when they'll actually happen throughout 2025 given that we've seen kind of the slow CapEx release in 2024. So I think we feel good about 2025. We feel really good about our guide for fourth quarter, but there is still uncertainty out there with a lot of things happening from a macro environment. Damian Karas : That makes sense. And then, I was wondering if you could maybe just give us an update on the machine vision business. Is that still a drag on your financials at this point or maybe starting to see some signs of improvement there? Bill Burns : I'd say that we still feel good about machine vision overall as being closely adjacent to our scanning portfolio overall and creating opportunity for us as our customers continue to look to automate supply chain and visibility across manufacturing from an inspection perspective and transportation logistics from a visibility perspective within their environment. And I think that -- look, machine vision declined in the quarter. I think overall weakness in manufacturing has affected that market clearly. A good example of that would be electrical vehicle manufacturing kind of slowed. We saw our semiconductor, which were kind of heavily weighted to, and that's been one of our objectives all along is to diversify the business, the acquisition of Matrox beyond semiconductor. We've seen stabilization in semiconductor in the quarter. So that's a positive sign. We are pleased with the software growth to machine vision in the quarter. And we feel good that the diversification efforts we're working on to diversify outside of semiconductor into broader manufacturing, into T&L will benefit us as the markets recover. And I think that ultimately, we feel good about the opportunity for not just software but our continued investment across go-to-market and some new investments around AI and deep learning that will benefit us as that market returns. So tough market at the moment, but we feel good about the long-term prospects of machine vision. Operator : The next question comes from Tommy Moll with Stephens. Please go ahead. Tommy Moll : Good morning, and thank you for taking my questions. Bill Burns : Hey, Tommy. Nathan Winters : Hi, Tommy. Tommy Moll : I wanted to start on the large order topic. I hear you loud and clear that the visibility on next year remains limited at this point. And then, my question is, what would a typical planning cycle look like? And in a normal year, however, you want to define that for large orders, how much advance notice do you have, and when did the conversations really start to pick up where you get that kind of visibility about what's coming? Thanks. Bill Burns : Hey Tommy, I'd say typically six months. We typically have six months of visibility to larger projects from our customers. And I would say that then that planning cycle ultimately begins six months in advance as they think about what's the next-generation of device. What are the use cases they're using devices for? Are they -- the upgrades are always in the larger projects are always bigger than the last refresh, right, as they deploy more devices, they've used more use cases and typically when our customers refresh, they also look to add additional use cases along the way. So all that gets discussed six months plus in advance, and then they go through their process of selecting what product, what solution, what vendor and then move forward. And then the ultimate timing of the project and when it gets ordered and deployed, sometimes relies on other factors, like they're rolling out new software on their side, for instance, in working with outside vendors to do that or whether they've got internal developments happening or they've got a rollout schedule, they want to go meet based on their seasonality of their business. So that all depends from a rollout perspective. Sometimes they get delayed, sometimes they move faster. But typically six months of the visibility, and I think I would say -- at the moment, we saw CapEx ramp through 2024. We kind of expect that in 2025. In first quarter, we typically get more visibility to the first half projects in 2025. And then they typically move along through their process. Operator : The next question comes from Brad Hewitt with Wolfe Research. Please go ahead. Brad Hewitt : So as we think about next year, aside from the year-end retail spending, are you seeing anything in the pipeline or the conversion rates that makes you more optimistic than you were last quarter about large orders returning in a more meaningful way in 2025? And then how much of a recovery in large order rates do you think we need to see for growth in 2025 to be in line with or better than your long-term growth framework? Bill Burns : Look, I'd probably say that, again, we're trying not to guide for 2025. I'll give you a little bit of color, right? Certainly, we're optimistic is the recovery. We expect to continue into 2025 based on the strong results we've seen in the second half of the year and the continued ramp of CapEx by our customers. We've seen a bit of uneven results into the marketplace, right? Retail, first to recover, continue that recovery. T&L green shoots in the second quarter now broader T&L recovery, but a bit uneven, meaning some customers are still using the capacity that they've built out during the pandemic and still working through that, but we're seeing parcel volumes increased. Manufacturing, clearly lagging the other sectors. And then healthcare has been a positive over the last two quarters. But I'd say that while we've seen that, we also see some macro headwinds overall, which include all the challenges we've talked about already, manufacturing softness in China, limited budget visibility as we kind of get into 2025 as to when projects will happen across the business. So we'd see continued recovery into 2025 on the strength of the second half. And right now, it's just too early to have a lot of visibility into 2025 overall. We do believe that seasonality does come back into the business in 2025, though. So as we're seeing seasonal effects of large orders at fourth quarter, we would expect that seasonality to really be injected back into the business in 2025. Operator : The next question comes from Keith Housum with Northcoast Research. Please go ahead. Keith Housum : Good morning, guys. Bill, perhaps you provide a little bit of color from a geographical perspective. EMEA and Latin America were the standouts, obviously, this quarter. Was it a matter of easier compares for those geographies? Or is there something truly unique capping in those areas that perhaps we can think about as we go forward? Bill Burns : Yes, Keith, I'd say certainly double-digit growth across all major product categories, regions and end markets, right, was encouraging. But again, as you know easier compares with a weak Q3 last year. So an aggressive distributor destocking at that point in time. I'd say EMEA, clearly easier compares than the other regions. So I would say, we feel good about all regions overall. EMEA had a even easier compare than the other regions. But that said, I would say, strength in Northern Europe clearly within EMEA, some larger projects in T&L moving forward and some wins in mobile computing. I would say, across EMEA, manufacturing remains challenging, particularly Germany as an example. But I think that the story of EMEA is really easier comparison than the other regions. North America, I would say, improvement across all product categories, strength in retail, healthcare, T&L coming back, but a bit uneven as people are using the capacity, but the good news is we're seeing parcel volumes continue to recover. Manufacturing still a bit challenging overall and kind of lacking the other areas. Healthcare, two quarters in a row is our fastest-growing market. So that's returned to what we've seen in the past around healthcare, especially in North America. I'd say Asia, momentum in Southeast Asia, so Southeast Asia and India were kind of bright spots in the quarter. Stabilization in China, I'd probably say, and we're not expecting a near-term kind of recovery or growth driver from China overall at the moment. And I'd say Latin America strength in Mexico and Brazil, as you've kind of heard from us before. So I think we feel pretty good about recovery across all the regions. And I think the difference is more around vertical markets than it is the actual regions themselves. Operator : The next question comes from Meta Marshall with Morgan Stanley. Please go ahead. Meta Marshall : Great. A couple questions. Just on the healthcare strength that you guys are seeing, is this new accounts that you guys are adding or just expansion of penetration or just kind of overall health and spend in that market after kind of some post-COVID hangover within healthcare so just more in-depth on healthcare? And then, second, I know a question was asked earlier just about some of the initiatives that you guys have enacted that had improved gross margins. But just as we think about OpEx into 2025, are there initiatives that are -- are all of the initiatives around some of the moves made earlier this year fully carried out? Or just how should we think about kind of OpEx into 2025? Thanks. Bill Burns : Yes, I'll start with healthcare and then hand over gross margin to Nate. I would say that from a healthcare perspective, a combination of new customers and refreshes across the portfolio, but continued opportunities across healthcare, I would say, we saw growth across all product categories. We have specific lines for printing, scanning, mobile computing specifically towards and focused on the healthcare market. I'd say, overall, we improved productivity and healthcare providers of all sizes really enhance safety and be able to take information and put it into electronical medical record systems, which is important across healthcare, not just in North America but around the world. So I'd say overall, this idea of automating workflows, collecting digital information on patients, assets, what's happening within the medical environment creates an opportunity for us in -- across all segments of healthcare. So whether it's clinical mobility or home healthcare, virtual care, all those have been opportunities for us. So I would say healthcare is our smallest vertical market at the moment and -- but it's the fastest growing in opportunities, both new and expansion across healthcare and not just North America, but global opportunities as well. Nathan Winters : Yes, Meta, just when you look at it from an OpEx perspective, I'd say a couple of things. One, the full benefit of the restructuring is really embedded in the OpEx for the second half of the -- in the P&L. Really the incremental gross -- incremental restructuring benefits to go are primarily in gross margin and really related to the flow-through of the closure of the DC in North America. So the team is really now focused on how we scale and drive productivity across the OpEx infrastructure that we have. And there's some really exciting things that teams are working around the use of AI to drive productivity in terms of supply chain forecasting, order management or how we leverage generative AI for technology support, software code generation, again, all allowing us to scale on the -- and drive efficiency of what we have today. So I think that's really the focus is scaling on the structure that we have today with the tools and technology that are available. Operator : The next question comes from Brian Drab with William Blair. Please go ahead. Brian Drab : Good morning. Thanks for taking my questions. First one is just around the cadence of demand recovery that you saw the timing of demand recovery that you saw in the third quarter because that is just the tone is a lot different today I think in the second quarter, it's a lot different even from touching base with you during the third quarter. So I'm just wondering, did you see an incremental pickup in demand in some of the end markets even as recently as October? Nathan Winters : Hey Brian, let me start. I think, one, if you look back at our prior guide, we really assumed a similar level of demand from Q2 continuing into the second half with only really a modest increase for year-end spending. And what we wanted to see was the real commitments the POs starting to come through from our customers before embedding that in the guide. And I think that's what we saw through the second half of the third quarter and here in the early part of the fourth quarter. So really the conversion of that pipeline coming through, which is what we wanted to see to have the confidence to raise the guide as we are today. So I think that's really the difference. It's just that conversion of the pipeline really picked up in the later part of the third quarter and here in the early part of the fourth quarter where we had the confidence based on those commitments from our customers to raise the guide for the full year and see that year-end spend start to really come through here in the fourth quarter. Brian Drab : Okay. That certainly makes sense. And then second question, depending on the outcome of the election here, it could be -- there's a concern that there could be significant tariffs that start to go into place. And I know that in the past Trump administration, you've established a tariff task force. And I'm just wondering if you could describe what the activity that's happening at Zebra right now to potentially position for that environment? Nathan Winters : Well, too early to speculate on the impact on all the various scenarios that could come out of next week's election. But we have been focused on some of the new tariffs that have been planned for 2026 and how we build alternatives so we can respond accordingly. So the team is actively working on mitigation plans for some of the new tariffs that are coming into place. And we continue to work -- actively work with our supply chain partners. We've been doing this since 2019 to diversify the supply base to improve resiliency overall as well as prepare for any future tariff changes. So I'd say right now, it's various scenario planning of what the different options could be, but our primary focus has been improved overall resiliency of our supply chain, so that we can respond, whether it's tariffs, geopolitical or natural disasters, how we make sure we have that structure in place to respond accordingly, that's really been the focus of the teams. And then obviously, depending on the outcome of the election and policies coming from that will respond and pivoted accordingly. Operator : The next question comes from Rob Mason with Baird. Please go ahead. Rob Mason : Hi, good morning. The commentary around the gross margin has already been touched on and is performing really well. I'm just curious; again, we're still somewhat early in the recovery. I'm sure business is competitive. But has there been any change in Zebra's promotional practices as we've gone about the recovery? Do you need to discount less either just from your leadership position, the way you've built out the portfolio? Or anything that maybe structurally could carry forward from a promotional aspect? Bill Burns : Yes, Rob, I'll take that. I would say that overall, look, our strong customer relationships, the deep vertical market expertise we have across each of the vertical markets we serve, the breadth and depth of the solutions portfolio that's tailored to each market. I gave you an example before around healthcare, truly differentiates us from our competitors. And clearly, that our competitive advantages being the market leader around scale and investment in technology, our partner community around the world all gives us strength. And I would say that we really haven't seen really any meaningful change across the competitive landscape. I would say, we're confident that we continue to win in the market and that we'll continue to extend our industry leadership through our investments in innovation. We talked about early on in the call. And continue to strengthen our strategic relationships with customers. So we really haven't seen much different from a competitive landscape perspective around the world at the moment, pretty much of the same. Rob Mason : I see. Yes. And just as a quick follow-up. We've talked about mobile computing leaving this recovery. Can you give any perspective just on how data capture and printing may follow that, whether you're starting to see -- and then, now, we had good year-over-year growth against easier comps? But are you starting to see accelerating momentum in those products as well? Bill Burns : Yes, Rob, I think that again, as you said it, mobile computing was kind of the first major category to recover in Q2, and we're continuing to see broad-based demand for mobile computing in Q3 and into Q4 and then some of these larger deal activity really driven by mobile computing. But I'd say what we saw in Q3 was really broad-based growth across DCS, including all product categories within DCS and then across all regions. So I think that's a good sign. And we'd expect that strength to continue into 2024. Again, there's been more variation in the first half of the year on print in DCS around supply chain not being available in 2023 and then recovery in 2024, and all the variations around it. But I think we're seeing growth in DCS, same in print. So growth across most print categories -- one of the strengths has been particularly mobile print. So again, ties back to mobile computing, right, strength across that. There's no opportunities in print. I would say things like eco-friendly linerless printing, so the idea that less waste is creating new opportunities within print. So we feel good about the broad-based growth across DCS and print. I would say me the last area may be worth mentioning because it hasn't come up yet is RFID. So strong growth in Q3 across RFID as we continue to see broad-based adoption of RFID in the quarter. Operator : The next question comes from Jim Ricchiuti with Needham. Please go ahead. Chris Grenga : Hi, good morning. This is Chris Grenga on for Jim. Thank you very much for taking the questions. Just to follow-up on that RFID point. There have been reports about new applications for RFID in grocery, first use case apparently being one involving bakery departments. First question is whether you might anticipate new opportunities for your RFID printing business as a result of these developments? And second, more broadly, how do you view the RFID growth opportunities over the next year and whether grocery could be a meaningful use case to go along with what we're seeing in apparel, general merchandise, and logistics? Bill Burns : Yes. I would say that strong growth in Q3 for an RFID perspective and strong pipeline of opportunities across retail, T&L, manufacturing. As you said, Chris, broadening and retail beyond what was originally apparel into general merchandise and now an opportunity that we've seen for some time and it's been worked on across the industry as things like fresh, right, within the retail store and around the outside perimeter of the store where you see fresh goods and leveraging RFID there. So I think that clearly represents an opportunity for us, track and trace across supply chains, parcel, tracking, healthcare, all those also create an opportunity from Zebra's perspective, we've got the broadest set of RFID solutions, including fixed and handheld readers, industrial and mobile printing, our software and labels to go along with that. So we feel good about the opportunity and the broadening of the opportunities out of RFID beyond, as you said, apparel and retail. I would say the exciting piece that everybody is looking at in RFID is the tag adoption, right, and the growth of tags and those items that are source-tagged or tagged within a retail store, for instance, or a parcel inside T&L, the more items are tagged, the more readers there's more, the more applications there are and that allows more automated collection of information. So I think ultimately, we're excited about the RFID market and continues to grow, and the pipeline of opportunities and applications continues to grow as well. Operator : The next question comes from Joe Giordano with TD Cowen. Please go ahead. Joe Giordano : You touched on tariffs and what you're doing? Can you just remind us like how much -- I know you guys moved with your manufacturing partners moved a lot of stuff out of China last go around. Can you update us on like where we are and how much production is still there? Or how much can be moved, if necessary? And how much is like structurally has to be there? Nathan Winters : Yes. So we -- if you look at an aggregate in terms of dollars, it's almost close to 50% of finished goods production is outside of China, still a vast majority of the component supply chain remains within China, and that's really the trickier or more stickier part of the supply chain to move just given how embedded it is within that market. So again, we moved a significant portion of the manufacturing up really to support North America into places like Malaysia, Vietnam, back in 2019, that's continued to ramp over the last several years. But I think it's important to note, we didn't move all North American volume out of China. Some products, just given the relative volume or the return on investment still made sense to produce in China for the North American market, even with the higher tariffs. So that's, again, the inflation, and we offset that with higher pricing, the pricing actions we took back then. So that's the equation we're working through now, which is what more can be move, should be move, if and when any additional tariffs are enacted. So that's what the team is scenario planning out, but also I want to make sure we make the right business decision that gives us long-term resiliency as well as follows where the supply chain is going because we do rely on, again, components and subassemblies and making sure that we're not too far dislocated from where the those source components are coming from. So it's a pretty complex equation that the team is working through. But we're lucky that we have supply chain partners that in and around the region that we work with to work and solve that challenge. Joe Giordano : Okay. That's helpful. Thank you. And then just I want to make sure I understand the seasonality discussion around next year. And I know you mentioned you don't want to give 2025 guidance. I appreciate that. And normally, your first quarter is a step down versus the fourth quarter. But now we're in a situation where like big orders aren't hitting in the fourth quarter, so like is it unreasonable to think that you just have kind of a continued moderate increase quarterly as you go through next year? Or do you still get like a step down even without kind of the project activity in the end of this year? Nathan Winters : I think based on what we said earlier, I think the expectation is to be pretty -- Q4 is maybe not back to a full recovery, but it's still -- there's been a pretty big step-up in what we saw from Q2 to Q3 and Q3 to Q4 with year-end spend. There is several large deployments within the fourth quarter. So I would -- that's why we said we'd expect it to be more maybe like a historical seasonality as you go into next year because of the year-end demand we're seeing and some of the large deployments here in the fourth quarter. Operator : The next question comes from Guy Hardwick with Freedom Capital Markets. Please go ahead. Guy Hardwick : Congrats on the results, excellent performance. Obviously, Zebra has made great progress year-to-date in deleveraging, and I noticed that trade working capital has fallen materially as a percentage of sales. But now with the leverage ratio down at 1.6x, at what point do you return to making acquisitions? And how would you balance those up against share repurchases? I believe you return to share repurchases for the first time more than a year in Q3. Nathan Winters : Yes, Guy, I think maybe just to start because we haven't touched on it. So obviously, the free cash flow for the year-to-date, over $650 million, almost $850 million higher than from last year. So just really tremendous work by the team on working capital improvements. We've reduced inventory year-to-date by over $160 million. So it's great to see the actions that we put in place starting to flow through in the reduction in working capital and seeing that come through free cash flow. So it really puts us in a great position exiting the year and going into next year. And as you mentioned, we returned to share repurchases in slightly here in the third -- back in the third quarter. And we're continuing to take a systemic approach to share repurchases here in the quarter and as we go into next year. But with the debt leverage ratio at 1.6x, which is on the low end of the target range, overall comfortable with the net debt cash position, but puts us in a nice position to really return to either returning capital to shareholders or as you mentioned, giving us capacity for M&A opportunities as they arise. Bill Burns : Maybe just some comments on M&A. Overall, I would say that, as Nate said, returning capital to investors through share buybacks or M&A is to really good uses of capital for us. I would say that our M&A philosophy hasn't changed. It's really -- overall, it's to leverage and advance our vision and our strategy moving forward is how we think about it. We target specific opportunities that are really closely adjacent and synergistic to what we do today. Clearly, as you pointed out, the strong balance sheet gives us optionality to return capital or look at opportunities within M&A. I would say that the bar is a bit higher today even with the increase in free cash flow from the idea of doing something larger certainly would entail higher interest rates. And there's still a bit of uncertainty out there from a market perspective. So if we were going to acquire something, we'd want to be assured kind of the revenue stream coming in. So a bit higher bar at the moment. I think we're excited about our business as it exists today. And I think that disciplined M&A is how we think about it as a vector for long-term growth that we can use in addition to returning capital to shareholders through share buyback. So both are an option. I think we continue to look and be inquisitive in the marketplace from an M&A perspective, but it's got to meet our strategic vision. Guy Hardwick : And Bill, just as a quick follow-up. I think in your prepared remarks, you referenced that the AI-enabled enterprise mobile computers will be showing -- you'll be showing those at the NRF show early next year. Does that mean that you are closer to commercialization, perhaps you would have thought just a few months ago when you -- we discussed this on the Q2 call? Bill Burns : Yes. We -- I would say, yes. So we demonstrated our early version of AI companion really on mobile devices at NRF last year. This will be a continued advancement along those lines at NRF this year, working closely with our partners of Qualcomm, Google and some of our customers to continue to advance that opportunity. I think that this idea of a digital assistant on a mobile device, assisting the frontline worker that will drive productivity and really elevate the customer experiences. And we see this as being running the large language model on the device without requiring connectivities to the cloud. You can have connectivity cloud if you want or not. And a lot of our customers don't have a lot of connectivity out of their environments, think of retail stores, think of warehouses and others. So that's an advantage. And I think it's something that we're focused on and likely in 2025, what we'll see is some type of commercial offering from Zebra. We're working through what that really means from us, but I think it bodes well for us moving forward from working closely with our customers, making sure we're understanding how they're using and building large language models and their data, how do they protect that, how do they upgrade that, how do they keep it current within the mobile devices, and we're working closely with them to make that happen. So I think, yes, we're getting closer, continue our investment there and continue to move ahead with the development cycle in that area. And we're going to show a refresh demo at NRF that takes kind of the next level this year. Operator : Our last question comes from Brad Hewitt with Wolfe Research. Please go ahead. Brad Hewitt : Thanks guys for fit me back in. It looks like you bumped up the Q4 implied sequential revenue growth by about 200 basis points. But you took down the implied sequential incremental EBITDA margins a little bit. So curious if there were any mix benefits in Q3 that you do not expect to occur in Q4? And how should we think about the puts and takes of the Q4 EBITDA margin line on a sequential basis? Nathan Winters : Yes, Brad, as you mentioned, so if you look at our EBITDA guide of 22%, it's up just over 0.5 point from -- sequentially from Q3, and again, primarily driven by the volume leverage. And I think the real change is just the deal mix overall with the higher mix of large deals and some of the large deployments in North America that somewhat of a drag sequentially on gross margin, driving that down a bit. And OpEx relatively flat just based on some of the project timing. So and the majority of any incremental gross margin on a sequential basis is embedded within gross margin. So I think that's really the -- no other kind of -- I think Q3 obviously came through stronger just seeing all the different actions flow through on the higher volume. And then the real change from Q3 to Q4 is just the mix within the portfolio. Operator : This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. Bill Burns : Yes. In closing, I'd just like to say thank you to our employees and partners for their continued support and delivering strong Q3 financial results. It was about 10 years ago -- actually, 10 years ago this week, we closed the Enterprise acquisition. And I would say that our relentless focus on innovation and our continued commitment to our customers continues to drive differentiation for us in the marketplace and secure competitive wins. And I would say, we're well-positioned to advance our industry leadership as our end markets recover. So thank you. Have a great day, everyone. Operator : The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,014
| 2
|
2014Q2
|
2014Q1
|
2014-05-06
| 1.426
| 1.448
| 1.608
| 1.585
| 2.49957
| 19.27
| 18.87
|
Executives: Juan Ramon Alaix – Chief Executive Officer Glenn David – Senior Vice President of Finance Operations, Chief Financial Officer (acting) John O’Connor – Head of Investor Relations Analysts : Jessica Fye – JP Morgan Kevin Ellich – Piper Jaffray David Redford – BMO Capital Markets Wesley Nurss – ISI Group John Krieger – William Blair Erin Wilson – Bank of America Chris Caponetti – Morgan Stanley Louise Chin – Guggenheim Liav Abraham – Citi Ariel Herman – Goldman Sachs David Krempa – Morningstar Operator : Welcome to the First Quarter 2014 Financial Results conference call and webcast for Zoetis. Hosting the call today is John O’Connor, Head of Investor Relations for Zoetis. The presentation material 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 forward automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of Zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star, one on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. In the interests of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question. When posing your question, please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star, zero. It is now my pleasure to turn the floor over to John O’Connor. John, you may begin. John O’Connor: Thank you. Good morning and welcome to the Zoetis first quarter 2014 earnings call. I’m joined today by Juan Ramon Alaix, our Chief Executive Officer, and Glenn David, our Senior Vice President of Finance Operations and acting Chief Financial Officer. Juan Ramon and Glenn will provide an overview our quarterly results and then we will open the call for your questions. Before we begin, let me remind you that the earnings press release and financial tables can be found on the Investor Relations section of Zoetis.com. We are also providing a simultaneous webcast of this morning’s call which can be accessed on the website as well. A PDF version of today’s slides and a transcript of the call will be available on the website later today. 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 2013 10-K and 10-Qs. 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. These non-GAAP adjusted figures exclude the impact of purchase accounting adjustments, acquisition-related costs, and certain significant items such as the non-recurring cost of becoming a standalone public company. 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 press release and in the company’s 8-K filing dated today, May 6, 2014. We also cite operational results which exclude the impact of foreign exchange. Prior to the completion of our IPO last year, Zoetis was not an independent public company and the first quarter of 2013 includes results from periods that were derived from the consolidated financial statements and records of Pfizer, which can make comparisons difficult in certain instances. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, John. Hello everyone. Before moving into some of the details of our call today, I would first like to address a recent change in the company’s executive team. On April 22, we announced that Glenn David, Senior Vice President of Finance Operations was named the company’s acting Chief Financial Officer. I’m delighted that Glenn is here with me on today’s call and he will speak with you as we move through the details of our first quarter performance. But first, let me share some of the highlights from the quarter, beginning with our high level financials. We concluded the first quarter with revenue growth of 1% or 4% operational. Adjusted net income for the first quarter was $191 million or $0.38 per diluted shares, increases of 7% and 6% compared to the first quarter of 2013. As a result and due to our ability to successfully navigate multiple headwinds in the first quarter, we are reaffirming our guidance for revenue and adjusted net income for the full year 2014. At the species level, we delivered 6% operational growth in companion animals and 4% operational growth in livestock. The 6% growth in companion animals was driven by a strong performance in Latin American countries due to the continued increase in the medicalization rates and the positive impact of our new canine product, Apoquel, in the U.S., U.K., and Germany. Companion animal sales in the quarter were affected by the cold weather in the U.S. which reduced the number of pet owner visits to veterinarian clinics. In livestock, sales of our swine portfolio grew by 6%. This growth was tempered by the continued spread of porcine epidemic diarrhea virus, or PEDv, especially in the United States. Our poultry portfolio performed well, also growing by 6% in the U.S. Our Rotecc product which enhances our ability to deliver solutions focused on sound rotation principles for coccidiosis management, has been an important driver of this performance. Avian flu in some markets continued to impact the poultry industry. In cattle, we delivered operational growth of 13%. Performance in the U.S. and in Latin America was strong while performance in Australia and some European markets declined. I would now like to share with you some of the performance highlights for our four regions. In Asia Pacific, we delivered operational revenue growth of 4%. Revenue for the region’s emerging markets grew by 14%, offsetting a decline in the more developed markets. We remain confident that for the full year, operational growth for the region will be faster than the average of Zoetis. Despite positive performance in Japan, New Zealand and China, sales of companion animal products declined by 2%. This was mainly due to the timing and price and promotional activities in Australia, a market that represents 36% of our companion animal revenue in the Asia Pacific region. In livestock, our business grew by 7%. The strong revenue growth in countries like China and India was partially offset by the negative growth in Japan, New Zealand and Australia. In Australia, it was due to the ongoing conditions of the weather in the market. Our business in Canada-Latin America delivered operational growth of 10% with companion animals and livestock growing 15% and 9%. Companion animal growth in the region was driven by the continued increase in the medicalization rates in the majority of the Latin American countries and the positive results in Canada. In livestock, we delivered strong performance in our poultry business in Brazil, Mexico, Venezuela, and Peru. Here demand for our medicated feed additives was particularly strong. We saw positive performance of our cattle business with strong contributions from Venezuela, Mexico, Brazil, Argentina, and Uruguay. Our business in Europe-Africa-Middle East declined by 4% operationally. This performance was primarily associated with the declines of our livestock product sales, which Glenn will cover in his remarks. During the first quarter of 2014, the companion animal business in EuAfME grew by 1% thanks to the successful launch of Apoquel in the U.K., Germany and certain other markets. In addition, we saw a positive response to our promotional activity for our parasiticide portfolio in France, Italy and several emerging markets in the region. We also saw additional competition for our vaccines and (indiscernible). Livestock sales in the region declined 6% operationally. Despite this decline, we saw positive performance of the cattle business in southern Europe and in some emerging markets in the region. Now to the U.S., where the business grew by 6%. This result was driven by a number of factors. First in companion animals, the business grew by 18%. Here we saw the positive impact of the launch of Apoquel which partially offset the impact of cold weather conditions that reduced the number of visits by pet owners to veterinarian clinics. Then in livestock in the U.S., we delivered 7% growth. This was positively impacted by the performance of our cattle business which was due in part to a higher number of feed lot placements, the higher price of (indiscernible), and the cold weather that increased demand for respiratory vaccines and antibiotics. We are encouraged by signs of the U.S. cattle being rebuilt after drought conditions (indiscernible). Poultry in the U.S. continued its strong performance. Many factors have contributed to this growth. These include our Rotecc program mentioned previously and the successful introduction of our conditionally licensed Georgia 08 vaccine, and in addition we have seen growth in our (indiscernible) poultry vaccine line. Our swine business in the U.S. continued to be impacted by the ongoing spread of PEDv. As a result of the virus, the USDA forecasts a reduction in the size of the U.S. swine herd of approximately 10%. Despite this, we delivered growth due to the positive performance of the products that we introduced in 2013, such as Draxxin 25 and Engain. As in previous quarters, the business of both our producers and veterinarian customers continued to feel the impact of a number of external factors such as weather and disease outbreaks. These factors have a degree of impact on our own performance given the nature of the direct relationships that we have with our customers. On climate, customers in the markets in the southern hemisphere such as Australia and New Zealand have continued to be adversely affected by the drought conditions. These conditions negative impact our livestock business due to the pressure they place on producers to feed and maintain large herds. In the northern hemisphere, a very cold winter has negatively impacted our customers. In our livestock business, these conditions created an increased need for anti-infective vaccines. In our companion animal business, it had reduced the number of visits being made to vet clinics in the quarter. While these conditions have been particularly harsh and extreme in some markets, they are the reality that our customers face on an ongoing basis. Moving now to disease outbreaks, the spread of PEDv that we have talked about previously continues. During the last quarter, PEDv has continued to spread into the U.S. as well as in Mexico and Canada. In the U.S., 30 states have now confirmed at least one case of PEDv and reports suggest that approximately half of the U.S. sow population has been infected. In Mexico, the virus has reportedly infected nearly a third of swine herds. The virus has also continued to be active in Asia Pacific with active cases present in a range of new markets, including Japan, South Korea and Taiwan. These add to instances of the virus having been reported in China, Thailand the Philippines. Herds are being hit hard by the outbreak and fewer piglets are surviving. With higher prices being paid for swine herds when they go to the market, we believe that producers may now be investing more in keeping those still in their herds healthy. This means that they will likely turn to premium products to achieve a greater return of investment from growing pigs, especially as market prices for pork products continue to increase. At Zoetis, we have advanced our research efforts to understand the safety, efficacy and manufacturing of an effective vaccine candidate. This is in partnership with Iowa State University and we continue to make progress in pursuit of a diagnostic tool in collaboration with the University of Minnesota. We are actively monitoring the continued evolution of the PEDv outbreak on the swine industry as well as any impact in our revenues. One of the core characteristics of our business is the depth and diversity of our product portfolio. This enables us to actively minimize the challenge created by any given species, geography, therapeutic area, or product. As we have shared with you previously, our R&D effort is focused not only on the development of new products but also the life cycle development and continuous improvement of all our brand assets. During the first quarter of 2014, we continued to secure regulatory approvals for existing products that have been introduced into new geographies or that have their indications or claim extended. Furthermore, during the first quarter we launched a number of new products. This includes Bovishield Gold Oneshot, Fostera PCV, Fostera PRRS in Canada, Latin America and Thailand. Also on the topic of new products, I will provide a brief update on Apoquel. Apoquel is an historic product for Zoetis and also for the industry. It joins our portfolio of already gold standard products and industry-leading brands across species and will have a positive impact on our business moving forward. In the first quarter, we continued to see high levels of customer acceptance for this innovative new treatment. The product was launched in the U.S., U.K., Germany, and certain other markets. The strong demand we have seen for the product has exceeded our initial expectations and has been generated by customers switching faster than anticipated from existing treatment options to Apoquel. The manufacturing process for Apoquel is complex and lengthy. This means that our ability to significantly ramp up production quickly to meet the high level of demand is limited. As a result, there are some restrictions on stock availability. To ensure that dog currently on Apoquel continue to receive treatment, we are allocating current product availability to those patients. Based on current reactions, we expect the situation to be normalized by the end of the first quarter 2015 and for Apoquel to represent approximately 1% of revenue by the end of 2014. Moving now to the close of my remarks. First, let me say that I see our overall performance for the first quarter of 2014 as positive. This is because we delivered operational growth in revenue of 4% and in adjusted net income of 8% while absorbing multiple headwinds. Second, Zoetis remains committed to its full-year guidance number on revenues and EPS previously provided. Our revenue growth for the year is in line or faster than expected market growth, now that the (indiscernible) has reduced their industry outlook for 2014. They now expect growth to be at the rate of around 2% in nominal U.S. dollar terms and around 5% in constant currency terms. With that, thank you for your attention and I will now ask Glenn to walk us through the financial results. Glenn? Glenn David : Thank you, Juan Ramon. It’s a pleasure to be here today and to join you as acting Chief Financial Officer. As some of you know, I have been working with Juan Ramon since 2011 when I joined the Pfizer animal health business, and I’ve been part of the Zoetis earnings process for the last year in my role as Senior Vice President of Finance Operations. Let me start today with a review of the first quarter results and then discuss our guidance for full-year 2014. Turning to the income statement slide, for the first quarter revenue was approximately $1.1 billion, an increase of 1% year-over-year including a negative impact of 3 percentage points from foreign exchange, so operational growth excluding currency was 4%. Reported net income was $155 million or $0.31 per diluted share and adjusted net income was $191 million or $0.38 per diluted share, representing growth of 7% and 6% respectively. Adjusted net income for the quarter excludes the after-tax impact of $36 million or $0.07 per diluted share for purchase accounting adjustments, acquisition-related costs, and certain significant items. Let’s now turn to our adjusted net income statement slide, which I will discuss primarily on an operational basis. Again, operational revenue growth was 4%. Companion animal sales were 35% of sales in the quarter and grew $12 million or 3%. Livestock sales were 64% of sales in the quarter and grew $28 million or 4%. The remaining 1% of sales is attributed to client supply services which was realigned this quarter. I will explain more about that in a minute. Adjusted cost of sales declined operationally by about 2% due to the impact of unfavorable items in the prior year’s quarter. Adjusted cost of sales was 34.2% of revenue versus 36.5% in the year-ago quarter, reflecting the operational decline in cost of sales as well as a 50 basis point benefit in the current quarter from foreign exchange. We expect our cost of sales to increase as a percent of revenue in the remaining quarters, particularly in the second half of the year, and bring us in line with the full-year guidance we are reaffirming today. This reflects the recognition of additional costs from building our global manufacturing and supply organization which will be most evident in the second half of the year, as well as our expectation that foreign exchange will not have as favorable an impact on gross margin. Meanwhile, adjusted SG&A increased by 4% operationally in the first quarter. In the first two quarters of 2013, we were still building out many of the corporate functions needed to support Zoetis as an independent public company. We largely completed this process in the third quarter of last year and this unfavorable comparison is the primary driver of SG&A growth in the first quarter of 2014, accounting for approximately half of the increase in this expense. Adjusted R&D expense decreased 2% operationally. Interest expense was up $7 million in the quarter due to the completion of our debt offering at the end of January 2013. This reflects the impact of an additional month of interest expense versus the prior year which is greater than the one month of interest allocation we received from Pfizer in our carve-out financials. Overall, we did a good job on expense management in the first quarter. Our operating expenses grew at a slower pace than revenue, even when including the unfavorable comparison in SG&A that I mentioned. Adjusted other income and deductions was negatively impacted by $5 million in FX losses related to the Argentine peso. In the year-ago quarter, we reflected the impact of the currency devaluation in Venezuela. In our segment reporting, you will find the impact from the Argentine peso in our corporate line item while the impact of the devaluation in Venezuela in 2013 is reported as part of our Canada-Latin America segment. Our effective adjusted tax rate for the first quarter was approximately 31%. This rate is elevated versus prior periods due to the impact of a discrete item in the quarter, but we continue to expect an effective tax rate for the year of approximately 29%. Again, our adjusted net income was $191 million, representing reported growth of 7% and operational growth of 8%. This performance demonstrates our ability to grow adjusted earnings faster than revenue despite the challenges we have outlined. Now onto our segment results. I will discuss these on an operational basis, but it should be noted that segment earnings are pre-tax numbers and reported on an adjusted basis. I will also highlight some of the more significant foreign exchange impacts in the regional results. I want to mention that effective this quarter, we have realigned our segment reporting with respect to our client supply services organization, or CSS, which provides contract manufacturing services for third parties. The revenue and earnings associated with CSS are now reported within other business activities separate from the four reportable segments. In 2013, CSS results were reported in the EuAfME segment. First quarter results for 2014 and 2013 reflect the new segment structure. Beginning with the U.S., first quarter revenue was $479 million, an increase of 6%. As Juan Ramon discussed earlier, sales of livestock products grew 7% with contributions across cattle, poultry and swine. Sales of companion animal products grew 3%. This was driven by the introduction of Apoquel which was partially offset by the effects of cold weather conditions in the first quarter. Meanwhile, U.S. segment earnings increased 19% due to revenue growth, improvement in cost of goods, and the delayed timing of promotional investments based on the unfavorable weather impact in the quarter. Now turning to our Europe-Africa-Middle East region, or EuAfME. In EuAfME, first quarter revenue was $270 million, a decrease of 4% operationally. Sales of livestock products decreased 6% operationally. This decline was largely driven by the U.K. and is the result of two major factors : first, an unfavorable comparison to the year-ago quarter regarding rebates which should normalize throughout the year; second, in 2014 we have taken actions to more tightly monitor and manage customer inventory build-ups that normally occur in advance of price increases. These efforts negatively impacted our livestock product growth in the quarter. Meanwhile, poultry products were negatively impacted by regulatory issues which have since been resolved, and swine products were impacted by competitive pricing issues and a reduction in the use of anti-infectives. All of these items were tempered by the growth of cattle product sales in emerging markets. Meanwhile, sales of companion animal products grew 1% operationally primarily due to the introduction of Apoquel. EuAfME segment earnings decreased 2% operationally primarily due to the revenue decline which was mitigated by strong expense discipline. Turning to our Canada and Latin America segment, or CLAR, first quarter revenue was $168 million, an increase of 10% operationally. This segment saw significant negative impact on revenue of 12 percentage points due to foreign exchange. The FX impact was primarily due to shifts in Brazil as well as Argentina and Canada. Sales of livestock products grew 9% operationally driven largely by poultry in Brazil and cattle and swine product sales across other Latin American markets. Livestock sales in Canada were relatively flat. Sales in companion animal products grew 15% operationally largely due to increased sales in Brazil, Mexico and Argentina. CLAR segment earnings increased 11% on an operational basis, driven by strong revenue growth as well as gross margin and operating expense levels that stayed in line with revenues. Reported growth of 23% is higher than the operational growth, which was primarily driven by the unfavorable impact of the currency devaluation in Venezuela in the first quarter of 2013 which we discussed earlier. In Asia Pacific, or APAC, first quarter sales were $169 million, an increase of 4% operationally. Our APAC segment also felt the significant impact from foreign exchange with the Australian dollar, Japanese yen and Indian rupee all contributing to a negative 7 percentage point impact on revenue. Sales of livestock products grew 75 operationally driven primarily by sales of swine products in China and Japan, poultry products in India, and cattle products in China. This growth was slightly offset by a decline in cattle product sales in Japan, New Zealand and Australia. Sales of companion animal products declined 2% operationally largely due to declines in Australia driven by competitive pressures in parasiticides and declines in customer inventory levels related to the timing of price increases versus the prior year. APAC segment operating earnings decreased 2% operationally due to unfavorable mix as well as the timing of promotional investments. Now let me turn to guidance for the full-year 2014. We have now reported one quarter of the fiscal year and remain confident in our ability to deliver on our full-year financial guidance. As a result, we are reaffirming all aspects of our financial guidance for full-year 2014. We continue to expect reported revenue of approximately $4.65 billion to $4.75 billion for the full year. This guidance also reflects an unfavorable impact of approximately 1.5 percentage points related to the year-over-year impact from foreign exchange. You would typically expect the foreign exchange impact on the bottom line to be relatively consistent with our overall margins; however, there are mitigating items in other P&L line items this year that largely offset this impact. Please note that our guidance does not include any further currency devaluations in Venezuela. Our guidance on adjusted cost of goods sold for full-year 2014 remains approximately 35.5% of revenue, roughly flat year-over-year. This reflects the anticipated benefit of price, volume and ongoing cost saving efforts which is forecasted to be offset by the full-year impact of cost incurred to build global manufacturing and supply functions as well as unfavorable mix. The incremental costs will be reflected primarily in the second half of 2014. Adjusted SG&A expenses are expected to be between $1.43 billion and $1.48 billion for the full year. We expect between 1% to 2% of operational growth in this line item to come from the unfavorable comparison in our corporate functions. Adjusted R&D expenses are expected to be between $390 million and $405 million for the full year. We continue to expect our effective tax rate on adjusted income to be approximately 29% for the full year. This guidance does not reflect the potential extension of the U.S. R&D tax credit in 2014. Finally, we continue to expect adjusted EPS of between $1.48 and $1.54 per share. This guidance reflects our ability to achieve our profitability targets as we absorb multiple headwinds in 2014, including the incremental cost of standing up our global manufacturing and supply operations, unfavorable comparisons in corporate function expense, and an additional month of higher interest expense. Separately, we continue to estimate pre-tax charges for 2014 of between $165 million and $185 million primarily related to stand-up and acquisition-related costs which are excluded from our adjusted earnings guidance. Including the impact of these items, as well as purchase accounting adjustments, our guidance for reported diluted EPS for full-year 2014 remains between $1.15 and $1.21 per share. This annual guidance reflects our confidence in the diversity of our portfolio, the strength of our business model, and our view of the evolving market conditions for animal health products this year. Our long-term value proposition remains anchored in three objectives : to grow revenue in line with or faster than the market, to grow adjusted net income faster than revenue, and to find investment opportunities with strong returns to our business and return excess capital to shareholders. That concludes my prepared remarks, and now we will open the line for your questions. John? John O’Connor: Thank you, Glenn. Operator, first question, please. Operator : Thank you. [Operator instructions] Our first question is coming from Chris Schott with JP Morgan. Please go ahead. Jessica Fye – JP Morgan : Hey there, it’s Jessica Fye on for Chris. Two questions – one, can you just elaborate on the cattle trends in the U.S. this quarter. What inning are we in in terms of recovery from the drought, and maybe mention feed lot and positive herd size trends. And then secondly, recognizing that there are going to be some quarter-to-quarter variability in your business, are there any trends you’re seeing in the second quarter thus far that we should be aware of? Juan Ramon Alaix : Thank you, Jessica. Let me answer the comment on cattle and then also the recovery that we can see on the second quarter. So on cattle, definitely the drought impact has been already solved, and the drought mainly impacted the price of the corn. The price of the corn now, it’s at a level which is in line with what we had before the drought impact. But we have seen in the U.S. is that the cattle has been declining in 2013. According to information that we have from external sources, the cattle herd declined by 2%, which compares the number of animals at the beginning of January of 2014 compared to the same period in 2013. We expect that now that the price of beef is very high, it’s really reaching record highs in terms of price, there will be an incentive for cattle producers to rebuild the herd; but this will take some years, as we expressed previously, because it takes two to three years really to have these rebuilt. We expect that at the end of 2014, the herd will have a small increase of a little bit less than 1%. Also, because of some of the cows will be kept to rebuild the herd, there will be less placement during 2014. We saw a significant increase in the first quarter in the number of placements by 5%. We expect that in the following quarters, this will have some moderated placement and at the end of the year will be in line with 2013 or slightly below. In terms of what we expect for the following quarter, I think we have some unique items in the first quarter. In the U.K., Australia, also the cold weather in the U.S., we expect these items not affecting our performance in the quarter, and if you see our guidance, we are maintaining the guidance which means we expect higher growth in the remaining quarters. Additionally, we have a significant impact on foreign exchange in the first quarter. Based on current exchange rates, we expect that in the second quarter the impact will be much lower. John O’Connor: Operator, next question, please. Operator : We’ll go next to Kevin Ellich with Piper Jaffray. Please go ahead. Kevin Ellich – Piper Jaffray : Good morning. Two questions for you guys. First, Juan Ramon, could you give us your thoughts on the pig virus, what the impact was this quarter, and I think you guys had a new product, ractopomine Engain that was expected to launch in Q1. I’m wondering if it did and how it’s doing. And then the second question I had, had to do with the weather impact in the U.S. on the companion animal business. Could you quantify that for us, and what sort of growth have you seen coming out into the second quarter? Thanks. Juan Ramon Alaix : Thank you, Kevin. So let’s start with PEDv. The PEDv, it’s affecting significantly the swine industry. The estimate of the total impact is 50% of sows have been affected by the virus, and this is translating into something like a 10% reduction on the herd in swine. The impact on the first quarter as well as the rest of the quarters is something that we are incorporating in our guidance, and we are also managing this situation because again, the price of pork is very high and this is also incentivating producers to use products that will protect better the animal that will have more value. So we have in one side, the negative impact of PEDv affecting a number of animals, but at the same time the high value of these animals which is increasing the use of premium price, which is the space where we mostly compete. So there are two elements that are in some way balancing, although the impact on PEDv will be higher. In terms of ractopomine, we launched Engain. This product is specifically for swine. The product has been introduced already and it’s—the results are in line with our expectations, and we expect Engain to compensate partially the negative impact of PEDv. In terms of companion animals that you also asked what was the impact of the cold weather in the U.S., the impact was mainly related to two factors : one, it was a reduced number of visits to veterinarian clinics, and second there was a delay in terms of growing tics and fleas. Now the situation, it’s normalized and we expect that this temporary impact will be compensated in the second quarter. Definitely we have some revenues that will be lost because of these pet owners not visiting the clinics, but on the total year we don’t think that this will represent a significant impact. In any case, it is already incorporated in our guidance. John O’Connor: Operator, next question, please. Operator : We’ll go next to Alex Arfaei with BMO Capital Markets. Please go ahead. David Redford – BMO Capital Markets : Good morning, this is David Redford on behalf of Alex Arfaei. I was wondering if you could add a bit more color to the discrete item that increased your tax rate this quarter and whether or not you’re open to a transaction that would lower your tax rate, such as a merger or tax inversion. Juan Ramon Alaix : I will ask Glenn to answer this question, David. Glenn David : Sure, so thanks for the question, David. Related to the higher ETR in the quarter, it’s driven by a non-recurring discrete item, as we discussed, and it’s related to an intercompany inventory adjustment. While the impact is fairly significant for the quarter, over the course of the year we believe it’s very manageable within the overall tax rate that we reaffirmed today of approximately 29%. In terms of our view of entering into any further transactions, we continue to evaluate all options to increase the value of our business. At this point in time, we do not see ourselves entering into a transaction like you mentioned, and I also want to mention that we are subject to certain provisions under the Tax Matters Agreement which might limit our ability to do that. John O’Connor: Operator, next question, please. Operator : We’ll go next to Mark Schoenebaum with ISI Group. Please go ahead. Wesley Nurss – ISI Group : Hi, this (indiscernible) sitting in for Mark today. I have one quick follow-up on the gross margins. Was there any impact to the gross margin related to geographic or species mix, and could that affect kind of the trend for the remainder of the year? I also had a question about Apoquel. You mentioned that supply was outpacing demand. Can you quantify that to any extent? And then also, I believe I heard for Apoquel there were some manufacturing issues related to that product. Isn’t Apoquel just a small molecule? Can you describe a little bit further some of the challenges there and why it will take until the first quarter of ’15 to resolve those issues? Thank you. Juan Ramon Alaix : Thank you, Wes. I will answer on Apoquel and then Glenn will cover the question on the gross margin. Apoquel is still having big sales over time, reaching the status of (indiscernible), so more than $100 million, and we remain confident that this product will significantly exceed this $100 million. What we estimated for 2014 was a switch from current therapies, mainly steroids, to Apoquel at a different rate than we have seen after the introduction of the product, so this has created a higher demand than expected, and because of manufacturing it’s complex, we need to really produce all this product, which is a small molecule, but it takes something like 12 months from the raw materials through API – active pharma ingredient – and then finished good. We have the limitations of this lengthy manufacturing period to ramp up production and to meet all the demand of the market. As I said, we expect that the manufacturing will be normalized in 2015 and at that time we’ll be able really to supply all the demand for the product. And now, Glenn will answer the question on gross margin. Glenn David : Sure. So in relation to the question on gross margin and specifically to geographic mix, emerging markets did outpace revenue growth of the developed markets this quarter, so that was a negative driver on mix for the quarter; however, in terms of the favorable impacts of gross margin, we referenced the impact of foreign exchange providing about a 50 basis point benefit. That’s driven by the fact that FX at revenue had a negative impact of 3% but at adjusted cost of sales it had a favorable impact of 4%, so that drove the 50 basis point improvement. The other thing in terms of cost of sales is we do expect the cost of goods sold in the second half of the year to increase as the cost of building up our global manufacturing and supply organization will be most evident in the second half, and that will bring us in line with the 35.5% guidance we confirmed today. John O’Connor: Operator, next question, please. Operator : We’ll go next to John Krieger with William Blair. Please go ahead. John Krieger – William Blair : Hi, thanks very much. Can you talk about any changes that you might be seeing among your customers in anti-infective usage? I think you mentioned in your prepared remarks that you saw some reduction in swine. Are you seeing any signs that that might be broadening out to other regions or other species? Juan Ramon Alaix : Thank you for the question. Definitely the pressure to reduce the use of antibiotics in regions like Europe and more specifically in western Europe continues affecting industry revenues. In 2013, the use of anti-infectives in Europe declined by 7%. This was not only because of the pressure but also the introduction of some generic products into this space. If you will compare the 7% of the industry decline to our 2% decline, it indicates that we have been managing very well the challenge on antibiotics in western Europe and we have been able really, thanks to the breadth of our portfolio and the direct interaction with our customers, to maintain a strong position in antibiotics. The antibiotic pressure was mainly focused on northern Europe while in southern Europe or eastern Europe or Africa-Middle East, we don’t see a significant restriction on the use of anti-infectives. If I move to other regions, I would say that in the U.S., for instance, the focus has been on restrictions related to the use of anti-infectives in growth promotion. We agree with the FDA to remove this indication from our label to those products have this growth promotion indication, and overall we think that despite this pressure that definitely will continue in Europe, and we have seen new regulations in countries like Belgium or France. We expect the antibiotic to continue growing at a lower basis, although a lower pace than the growth of animal health. John O’Connor: Operator, next question, please. Operator : We’ll go next to Robert Willoughby with Bank of America. Please go ahead. Erin Wilson – Bank of America : Great, this is Erin Wilson in for Willoughby. On Apoquel, will there be significant incremental cost associated with normalizing supply by 2015, and can you speak to also the recent industry consolidation based on your experience following the Wyeth and Pfizer merger and other mergers as well? Could you benefit potentially from divestitures in specific product lines from some of your competitors? Does that represent an opportunity for you to benefit from sales force defections or other changes? Juan Ramon Alaix : Thank you, Erin, and I will ask Glenn to comment on this question on the cost. Glenn David : So Erin, specific to your question on Apoquel, we don’t see a significant increase in cost related to ramping up production. In general, increased volumes relate to additional efficiencies and should be a beneficial factor to cost in the long term. Juan Ramon Alaix : Okay, and you also asked about M&A and the consolidation of—the impact in terms of the consolidation. So first, I think the recent news on this consolidation, in my opinion, are positive for the animal health industry because they are showing the high value of the assets in this industry. At the same time, I don’t see that this is changing significantly the competitive landscape, so in our opinion the model that we have, which is going to the market that we have a direct force, direct sales force, also supporting our revenue with innovation in terms of R&D, and high quality manufacturing is a model that has been showing significant strength. As a reference, in 2013 the market grew by 7%--4%, sorry, and Zoetis grew by 7%. This indicates that despite the challenge or despite consolidation and even the time that we were involved in the separation from Pfizer, so we were able to grow much faster than the market. John O’Connor: Operator, next question, please. Operator : We’ll go next to David Risinger with Morgan Stanley. Please go ahead. Chris Caponetti – Morgan Stanley : Hi, thanks very much. It’s Chris Caponetti for Dave. I was hoping you could tell me what operating cash flow was during the quarter, and then separately if you could just prioritize your uses of cash given what appears to be, I guess, a more limited interest in transformative M&A, at least over the near term. Thank you. Juan Ramon Alaix : I will ask Glenn to go into the details of this cash plan, but let me have some general comments on our cash philosophy. Definitely Zoetis will generate predictable and steady cash flow. We will identify opportunities that will increase the value of our company, and one of the areas that we think that we can increase value is also accessing opportunities in terms of M&A. We will assess opportunities based on (indiscernible) and also the return on the investment, and definitely we have integrated many companies in the past. We have the knowledge and the capabilities to make these integrations successful and we will continue assessing any opportunity that the market will offer. And now, Glenn can provide some additional comments on cash. Glenn David : Sure. So in terms of the cash flow statement for the quarter, as part of our earnings release process we don’t provide balance sheet or cash flow information. That information will be available in the 10-Q to be filed next week. John O’Connor: Operator, next question, please. Operator : We’ll go next to Louise Chin with Guggenheim. Please go ahead. Louise Chin – Guggenheim: Hi, thanks for taking my question. So first question I had was on your pricing power. I know you’ve historically been able to drive a lot of pricing power, and I’m curious is that is particular to Zoetis or it’s sort of an industry-wide figure. And then secondly on cash flow, based on my modeling, it looks like you’ll be generating a lot of strong cash flow over the next several years, and I was wondering if you could comment if that is a correct assumption or not. Then lastly, we’ve gotten some pushback on your operating cost – you know, that you’re going to have to separate from Pfizer and that cost is higher than expected. I’m just curious how you’re going to meet your gross margin and operating margin expansion targets despite the near-term increase in costs. Thank you. Juan Ramon Alaix : Thank you, Louise, for the questions. Definitely we have pricing power and then we have increasing prices in most of the countries. Definitely in countries which are more developed, we have more opportunities to increase prices while in emerging markets, because of local competition, we see the opportunity in terms of volume higher than prices. In general in the industry, it’s also increasing prices, and according to external sources (indiscernible), they are indicating that on the total growth anticipated for 2014, this 5% will be balanced between price and volume. We are confident that because of our model and the strength of our portfolio, we’ll be able really to implement the price increases in most of the geographies. In terms of the question on separating costs, maybe Glenn can provide some comments on that. Glenn David : Sure. So the guidance that we reaffirmed today does include some certain significant items and acquisition-related costs primarily related to standing up the organization that we’ll experience in 2014. In terms of the operating costs, the guidance also reflects some of the dyssynergies that we may experience this year related to being an independent company, and we highlighted some of those in terms of the incremental costs related to our corporate functions and some of the incremental costs in terms of building up our global manufacturing and supply organization, but we still believe in the long-term ability to be able to grow expenses at the rate of inflation. Juan Ramon Alaix : And let me finish with your question on cash flow. Definitely this company will generate cash in a way that will be strong and also predictable and steady, and we will use the cash in a way that will maximize the value of Zoetis and also the value for the shareholders. John O’Connor: Operator, next question, please. Operator : We’ll go next to Liav Abraham with Citi. Please go ahead. Liav Abraham – Citi: Good morning. Just a follow-up question on your tax rate. I understand from your commentary that you’re not focused on a tax inversion at this point, at least not in a material way. Can you talk to the opportunities that you have for potential reduction of your tax rate on a standalone basis over the medium term? Thanks very much. Glenn David : Sure. So in reaffirming our tax rate of 29%, we also indicated that that does not include the benefit of the R&D tax credit, which could provide an additional benefit of about 50 basis points. I’ll just reaffirm what the company has said in the past, that the rate of approximately 29% is generally the long range rate in which we think we could operate. John O’Connor: Operator, next question, please. Operator : We’ll go next to Jamie Rubin with Goldman Sachs. Please go ahead. Ariel Herman – Goldman Sachs : Hi, this is Ariel Herman in for Jamie. So just a couple quick ones. Regarding Apoquel, how much did this contribute to your overall growth, so another way of asking this is what would the growth be ex-Apoquel? And then when you think about new products versus the current or base business, how should we think about the growth in each of the segments, so how fast are new products growing versus potentially the base business declining? Then separately just to follow up on the industry consolidation question, I believe you stated previously that scale is one of the strengths of Zoetis, so if competitors are getting bigger and consolidating, how could this potentially affect you? Thanks. Juan Ramon Alaix : Thank you, Ariel. On Apoquel, Apoquel will represent in 2014 approximately 1% of our total revenues, so it means that in terms of revenue growth, it will represent also about this 1%. Our model is not based on bringing new products to compensate the loss of exclusivity or the duration of the old portfolio, but our model is to continue investing in our current portfolio in a way which is a balance with the investment that we make in generating new products. So because of generic competition has a different impact in our industry, we are able really to continue supporting our product with (indiscernible) life cycle management. We can continue investing in indications, we can continue investing in the current portfolio, moving a product from different species. We can also work on combining producers to maintain these products fresh and generating growth, and also we can invest in expanding our portfolio geographically. Definitely new products will represent a portion of our growth, and if you take our total growth, a portion will come from price- we mentioned that this will be approximately 50% of our revenue growth will be coming from price, and then in terms of volume two-thirds will be coming from our current portfolio and the way that we are maintaining our current portfolio life, and one-third will be coming from new products. These are general statements that can be different depending on the years and depending on the new product introductions or the success of being in also innovation to our current portfolio. In terms of what will be the impact of the consolidation since some of our competitors will increase scale, we are already competing with large companies, companies that already generate more than $3 billion, and we have been proving that our business model is extremely effective and efficient, and we based our model, as I mentioned, in our great introductions, bringing innovation in both new products and supporting our existing portfolio, and the quality and reliable supply. The combination of all these elements and the way that we are executing our strategies is what is making our differentiation in the market, and we are convinced that despite this consolidation we remain very competitive and growing in line or slightly faster than the market, despite having a market share of 20%. And very important, also our plan is to increase our earnings faster than revenues with the right focus on expenses and also the right focus on improving gross margin. John O’Connor: Operator, we have time for one more question. Operator : We’ll take our last question from David Krempa with Morningstar. Please go ahead. David Krempa – Morningstar: Great, thanks for taking the question. If we look at the significant differences in margin compared to the international markets versus the U.S., would you say the biggest driving factor there is solely the pricing or are there still scale benefits you can realize there that should improve as you grow, or at nearly a billion dollars in these regions are you already taking advantage of all the scale opportunities there and we shouldn’t expect any significant increases in these margins going forward? Juan Ramon Alaix : Well, margins are definitely affected by the product mix and also affected by species mix and geography mix. In smaller markets, we don’t have the same economies of scale that we can generate in the U.S. As these markets are growing, we’ll see also that the margin will improve because they will increase the absorption of all the expense infrastructure that we have been building to maximize the opportunities in these markets. I’m convinced that our margin will continue growing. As I mentioned, we’ll be growing revenues in line or faster than market, but margins or earnings will be growing faster than revenues. This will increase our margin opportunities. I don’t know, Glenn, if you want to add any additional comment on that? Glenn David : No, the only thing I’ll add is to Juan Ramon’s point about the expectation to grow revenue—to grow income faster than revenue. We expect that across all of our regions, both the developed and the emerging. Operator : I’d like to turn the conference back over to Juan Ramon for any closing or additional remarks. Juan Ramon Alaix : So thank you, all of you for joining us on today’s call, and thank you for your interest in Zoetis and our first quarter performance. Thank you very much. Operator : Thank you. This does conclude today’s teleconference. A replay of today’s call will be available in two hours by dialing 1-800-677-6124 for U.S. listeners, and 402-220-0664 for international. Please disconnect your lines at this time and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,014
| 3
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2014Q3
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2014Q2
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2014-08-05
| 1.461
| 1.475
| 1.606
| 1.63
| 2.44294
| 18.76
| 20.18
|
Executives: John O'Connor - Juan Ramón Alaix - Chief Executive Officer and Director Glenn David - Acting Chief Financial Officer and Senior Vice President Analysts : Alex Arfaei - BMO Capital Markets U.S. Mark J. Schoenebaum - ISI Group Inc., Research Division Jessica M. Fye - JP Morgan Chase & Co, Research Division Kevin K. Ellich - Piper Jaffray Companies, Research Division Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division John Kreger - William Blair & Company L.L.C., Research Division Erin E. Wilson - BofA Merrill Lynch, Research Division Christopher J. Benassi - Goldman Sachs Group Inc., Research Division Ross Taylor - CL King & Associates, Inc., Research Division Operator : Welcome to the Second Quarter 2014 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is John O'Connor, acting Head 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 is now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor: Thank you, operator. Good morning, and welcome to the Zoetis Second Quarter 2014 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, our Senior Vice President of Finance Operations and Acting Chief Financial Officer. Juan Ramón and Glenn will provide an overview of our quarterly results, and then we will open the call for your questions. Before we begin, let me remind you that the earnings press release and financial tables can be found on the Investor Relations section of zoetis.com. We are also providing a simultaneous webcast of this morning's call, which can be accessed on the website as well. A PDF version of today's slides and a transcript of the call will be available on the website later today. 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 our recent 10-K and 10-Qs. 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. These non-GAAP adjusted figures exclude the impact of purchase accounting adjustments, acquisition-related costs, and certain significant items, such as the nonrecurring cost of becoming a standalone public company. 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 August 5, 2014. We also cite operational results, which exclude the impact of foreign exchange. I also want to remind you that beginning last quarter, we realigned our segment reporting with respect to our Client Supply Services organization, or CSS, which provides contract manufacturing services for third parties. The revenue and earnings associated with CSS are now reported within other business activities, separate from the 4 reportable segments. In 2013, CSS results were reported in the EuAfME segment. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix : Thank you, John, and thank you to those joining us for today's call. I would like to start by sharing high-level details of our performance for the second quarter. During this period, we delivered operational growth of 6% in revenues and 11% in adjusted net income or adjusted diluted EPS of $0.38. We also delivered operational revenue growth across each of our geographical segments in the quarter, reflecting the strength and balance of our diverse portfolio. This illustrates that our continued focus on building strong customer relationships, bringing new products to the market, while managing the product lifecycles and producing high-quality products and reliable supply, all remain fundamental strengths of our business and model. Let me now comment on the performance of our business by species. The performance of our livestock segment grew by 9%. Here, we see more favorable market conditions for many of our customers across the globe. Overall, worldwide demand for meat protein continues increasing, especially in emerging markets. In these markets, their objective is to increase their local production. But to meet their needs, they still depend on key export markets, such as the U.S. and Brazil, where we also have a significant presence. Additionally, feed costs continue to moderate for our customers. Nevertheless, conditions will remain difficult for some producers in certain markets in Asia Pacific and in Europe. And factors such as disease outbreaks and climate conditions are placing some limitations on how quickly our customers can expand protein production. These conditions reinforce the value of our medicines and technology for more efficient production. As producers work to supply greater volumes of meat protein by increasing cattle and swine slaughter weights, we expect to see continued strong demand for our products. Our global presence and breadth of portfolio positions -- so it is well to capitalize on these positive trends. Let me take a deeper dive into some of these individual species, starting with cattle, which grew 10% operationally. We delivered strong growth in all regions, most notably in the Canada/Latin American region, where we implemented new pricing strategies in a number of Latin American countries. Poultry delivered operational growth of 11%. All regions contributed to these, but particular in the U.S., where sales of our medicated feed additives and also vaccines delivered double-digit growth. In swine, PEDv has continued to spread, not only in the U.S., but also in Canada, Mexico, Japan, and a number of other countries. The virus is reducing the size of swine herds, and producers are working to offset these reductions by raising higher-weight animals. Additionally, our business has felt the impact of antibiotic regulations in Europe. In spite of these conditions, Zoetis is still the leader, based on growth of 5% in swine, thanks to introduction of new products. Moving now on to companion animal. We delivered 2% operational growth in the quarter. Sales of our canine product APOQUEL contributed to the growth in this sector, even as we continue to address our levels of supply for this product. I will talk a little bit more about APOQUEL later on this call. Overall, while growth fundamentals for companion animal remains strong in all countries, and particularly in emerging markets, we have seen an increase in competition in many of our larger developed markets. This is primarily from new product introductions in parasiticides and in vaccines. We are confident that the breadth of our portfolio, including new product launches, as well as the strength of our field force and our world-class capabilities in R&D, will enable us to stay competitive in this market. Across our business, we continue to see that the depth and the diversity of our portfolio plays a critical role in the overall performance of our company and also sustain our competitive advantage. The depth and diversity is demonstrated by our portfolio for multiple species across 5 therapeutic areas and by the 300 products marketed in 120 countries. As a result of this quarter's performance, and our forecast for the rest of the year, we are increasing the lower end of our guidance range for revenue, adjusted EPS and SG&A for the full year. Now, I would like to provide an update on our portfolio, and in particular, highlight our R&D progress and the latest for APOQUEL. Earlier, I spoke about the impact of PEDv on our business. Now, let me share with you some details of the progress that we are making on developing a vaccine for this disease, where we have 2 programs. Our most advanced program is for an inactivated or kill vaccine. On this, we are working closely with the USDA and expect to request approval for a conditional license in 2014. Following any approval, we anticipate that we will be able to supply the markets soon after. We also continued our work with Iowa State University on an additional vaccine approach. We are making good progress and will provide updates of this program as the research evolves. Finally, we continue working with the University of Minnesota for a PEDv diagnostic test and this type of test will help producers to rapidly identify potential infections in their herds. The result from these research programs will also have applicability outside of the U.S. We are exploring regulatory approaches to enhance the reach of these potential products in all the affected markets. This quarter, we secured regulatory approval and launched ACTOGAIN. This ractopamine product for the use in cattle, alone or in combination with other commonly used medicated feed additives. This in addition to our already-strong cattle portfolio. The approval of ACTOGAIN builds on the success of the launch of ENGAIN, also a ractopamine product, which was approved and recently launched for use in swine. Both ACTOGAIN and ENGAIN are performing better than expected. This performance is in part driven by the removal of a competing product from the market. And finally, to our progress with APOQUEL. As you will remember, this is an innovative medicine designed to relieve dogs from pruritus. We launched the product in the U.S. and in a number of European markets early this year and have seen significant levels of customer demand for the product. This has resulted in a supply shortage. Our priorities at this point are to ensure that dogs currently being treated with APOQUEL continue to receive their product without interruption and to normalize the product supply as soon as possible. As noted on our last call, the process to produce APOQUEL is complex. We are working to reduce the length of time it takes to manufacture the product and to add manufacturing capacity. By April, next year, we expect to significantly increase the supply of APOQUEL, and as a result, we'll be able to begin offering APOQUEL to new customers. Based on our current market demand, the introduction of the product in new markets, and our plans to increase supply, we now expect the product to generate in excess of $100 million in revenues next year. And before I ask Glenn to walk us through the financials, I would like to highlight our coming Investor Day. This will take place on November 18 at The New York Stock Exchange. We're very excited to be able to host this event and look forward to having the opportunity to share with you more details of our strategy, capabilities and value propositions, as well as the overall animal healthcare industry. And with that, Glenn? Glenn David : Thank you, Juan Ramón. Let me start today with a review of the second quarter results and then discuss our guidance for full year 2015. Turning first to the income statement slide. For the second quarter, revenue was approximately $1.2 billion, an increase of 4% year-over-year. Foreign exchange had a negative impact of 2 percentage points on revenue, primarily due to the impact of currencies in Brazil, Australia, Argentina and Canada, which were partially offset by improvements in the euro and sterling. As a result, operational growth, excluding the impact of currency, was 6%. Reported net income was $136 million or $0.27 per diluted share, and adjusted net income was $189 million or $0.38 per diluted share, representing growth of 6% on a reported basis and 11% operationally. Adjusted net income for the quarter excludes the after-tax impact of $53 million, or $0.11 per diluted share, for purchase accounting adjustments, acquisition-related costs, and certain significant items, the majority of which were related to stand-up cost. Certain significant items this quarter also include a one-time charge related to a commercial settlement with customers in Mexico. This settlement is with several of our large poultry customers in Mexico. It is associated with certain shipments from specific lots of poultry vaccine products, and we have moved ahead with a recall of these lots. No other countries or lots are impacted. We have recorded a reserve associated with this issue in the second quarter of $13 million. I will discuss the impact of this settlement on our reported guidance in a few minutes. Let's now turn to our adjusted income statement slide, which I will discuss primarily on an operational basis. Again, operational revenue growth for the second quarter was 6%. In terms of the first half of the year, we reported revenue growth of 2%, with operational growth of 5%. This reflects an impact on reported revenue of approximately $55 million due to foreign exchange. Based on current rates, we expect the impact from foreign exchange for the remaining 2 quarters will be minimal. Turning to more revenue details in the second quarter. Companion animal sales were 38% of sales in the quarter and grew $7 million or 2% operationally. Livestock sales were 61% of sales in the quarter and grew $57 million or 9% operationally. Adjusted cost of sales grew operationally by 4%, 2 points lower than operational sales growth. Adjusted cost of sales was 35% of revenue, versus 35.9% in the year ago quarter, due to the favorable impact of foreign exchange and the benefit of price increases, which were partially offset by unfavorable mix. For the first half of the year, our adjusted cost of sales grew operationally by 1% and was 34.6% of revenue. As we said last quarter, we continue to expect our cost of sales to increase as a percent of revenue in the remaining quarters and bring us in line with the full year guidance of approximately 35.5%, which we are reaffirming today. This dynamic reflects the recognition of additional costs from building a global manufacturing and supply organization, which will be most evident in the second half of the year, as well as our expectation that foreign exchange will not have as favorable an impact on gross margin as it did in the first half of the year. Meanwhile, adjusted SG&A increased by 9% operationally in the second quarter. As we have said, in the first 2 quarters of 2013, we were still building out many of the corporate functions needed to support Zoetis as an independent public company. We largely completed this process in the third quarter of last year and this unfavorable comparison is a driver of SG&A growth in the second quarter of 2014. We also saw elevated growth in operating expenses in the U.S., EuAfME, and CLAR segments in the quarter as well. As part of our normal course of business, we continue to adjust investments and promotional activities to respond to market opportunities. Year-to-date, SG&A was 30.6% of revenue, consistent with our full year guidance, which is approximately 31% at the midpoints of both SG&A and revenue. In other items, adjusted R&D expense increased 1% operationally. Interest expense declined $3 million in the quarter and adjusted other income was $3 million in the quarter, similar to last year. Our effective adjusted tax rate for the second quarter was 28.4%. And again, our adjusted net income was $189 million, representing reported growth of 6%, and operational growth of 11%. Now on to our segment results. I will discuss these on an operational basis, but it should be noted that segment earnings are pretax numbers and presented on an adjusted basis. I will also highlight some of the more significant foreign exchange impacts in the regional results. Beginning with the U.S., second quarter revenue was $459 million, an increase of 5%. Sales of livestock products grew 10%, with contributions across cattle, poultry and swine. Cattle products showed a significant increase based on improved market conditions from the year ago quarter. Cattle prices have continued to rise, with feed cost remaining low. While we have seen the number of placements declining, customers are placing younger, lighter animals into feed lots. And these cattle are more vulnerable to illness and disease and require treatment. This dynamic, along with continued growth in market share, has contributed to growth in our U.S. cattle business despite lower overall placements in the quarter. We saw poultry product growth driven by new vaccines, such as the Georgia 08 vaccine, as well as growth in medicated feed additives. And in swine products, we benefited from continued growth in new products, such as our PCV M. hyo combination vaccine, DRAXXIN 25 anti-infective and ENGAIN feed additive. This new product momentum was tempered by the effect of PEDv, which Juan Ramón addressed. Sales of companion animal products grew 1%. This was driven by sales of APOQUEL, which was partially offset by declines from an increased competition in vaccines and RIMADYL. Meanwhile, U.S. segment earnings increased by 2%, as growth in revenue was offset by higher expenses, primarily due to promotional investments. For the first half of the year in the U.S., we had revenue growth of 5% and earnings growth of 10%. This is more indicative of the leverage that we expect in the U.S. than the second quarter results. Now turning to our Europe, Africa and Middle East region, or EuAfME. In EuAfME, second quarter revenue was $284 million, an increase of 4% operationally. Reported revenue growth was 7%, reflected a positive impact of 3 percentage points in the quarter due to the strength of the euro and sterling. Sales of livestock products increased 5% operationally, as the region experienced more positive results in Germany, the U.K. and Spain than in the first quarter, but this was slightly offset by declines in France. The livestock growth was primarily driven by increased sales in cattle and poultry products, which were slightly offset by a decline in swine products for the quarter. While weather conditions across Europe were generally more favorable than the prior year, growth in livestock was limited in the U.K. and Scandinavia by severe flooding, which affected seasonal herd movements. Meanwhile, sales of companion animal products grew 2% operationally, primarily due to sales of APOQUEL in the U.K. and Germany, and growth in emerging markets. This companion animal growth was somewhat offset by declines in France and Southern Europe due to increased competition in parasiticides. EuAfME segment earnings increased 9% operationally, primarily due to the revenue increase and higher gross margins, which were partially offset by higher operating expenses. Turning to our Canada and Latin America segment, or CLAR. Second quarter revenue was $214 million, an increase of 11% operationally. Reported revenue growth was flat, reflecting a negative impact of 11 percentage points in the quarter, primarily due to depreciation of currencies in Brazil, Argentina and Canada. Overall for the segment, sales of livestock products grew 13% operationally and sales of companion animal products grew 6% operationally. The CLAR segment results were largely driven by the region's 2 largest markets, Brazil and Canada, while price growth for livestock products in high inflation markets, such as Venezuela and Argentina, also made significant contributions to growth in the quarter. In Brazil, growth was driven primarily by sales of cattle and poultry products, as well as companion animal products. Meanwhile, the company generated increased sales of cattle products in Canada, as higher prices for cattle led to increased treatments. Canada also saw an increase in sales of swine products, such as anti-infectives and vaccines, while it posted a slight decline in poultry products. CLAR segment earnings increased 16% on an operational basis, driven by revenue growing at a faster rate than operating expenses. In Asia Pacific, or APAC, second quarter sales were $185 million, an increase of 5% operationally. Our APAC segment also felt a significant impact due to depreciation from currencies in Australia, Japan, India and other countries, which led to a negative 6 percentage point impact on revenue. Sales of livestock products grew 7% operationally, driven primarily by sales of cattle products in New Zealand and Australia, growth of swine products in China and growth of poultry products in Australia and India. This growth was offset by declines in Japan and Korea. In Australia, we saw an increase in the movement of herds to feedlots, which benefited our business as treatments increased. However, climate conditions remain difficult, and we expect the higher feedlot activity to lead to reduce herd sizes in the coming quarters. Sales of companion animal products increased 1% operationally, largely due to an increase in equine products in Australia, which was offset by declines in companion animal products in Japan. APAC segment operating earnings increased 11% operationally, due to revenue growth, a decline in operating expenses and slightly favorable gross margin. Now let me turn to guidance for the full year 2014. We have now reported 1/2 of the fiscal year and remained confident in our ability to deliver on our full year financial guidance. As a result, we are narrowing our financial guidance for revenue, adjusted SG&A, and adjusted EPS for full year 2014, and making an adjustment to our reported EPS guidance. We have raised the lower end of our revenue guidance, and now expect reported revenue of approximately $4.675 billion to $4.75 billion for the full year. Our guidance on adjusted cost of goods sold for full year 2014 remains approximately 35.5% of revenue, roughly flat year-over-year. This reflects the anticipated benefit of price, volume and ongoing cost-savings efforts, which is forecasted to be offset by the full year impact of cost incurred to build our global manufacturing and supply functions, as well as unfavorable mix. The incremental cost will be reflected primarily in the second half of 2014. Adjusted SG&A expenses are now expected to be between $1.44 billion and $1.48 billion. Adjusted R&D expenses are expected to be between $390 million and $405 million. We continue to expect our effective tax rate on adjusted income to be approximately 29%. This guidance does not reflect the potential extension of the U.S. R&D tax credit. And we have raised the lower end of our adjusted EPS guidance and now expect adjusted EPS of between $1.50 and $1.54 per share for the full year. Please note that our guidance does not reflect any further currency devaluation in Venezuela. This guidance reflects our ability to achieve our profitability targets as we absorb multiple headwinds in 2014, including: The incremental costs of standing up our global manufacturing and supply operations; unfavorable comparisons in corporate function expense; and an additional month of higher interest expense. Separately, we now estimate pretax charges for 2014 of between $175 million and $195 million, primarily related to stand-up and acquisition-related cost. This range has increased due to the commercial settlement charge related to Mexico that I mentioned earlier. These charges are excluded from our adjusted earnings guidance. Including the impact of these items, as well as purchase accounting adjustments, our guidance for reported diluted EPS for full year 2014 will now be between $1.16 and $1.20 per share, a change from the $1.15 to $1.21 range we had previously set. This annual guidance reflects our confidence in the diversity of our portfolio, the strength of our business model and our view of the evolving market conditions for animal health products this year. Our long-term value proposition remains anchored in 3 objectives : to grow revenue in line with or faster than the market; to grow adjusted net income faster than revenue; and to find investment opportunities with strong returns to our business and return excess capital to our shareholders. That concludes my prepared remarks, and now we will open the line for your questions. John? John O'Connor: Thank you, Glenn. Operator, first question, please? Operator : [Operator Instructions] Our first question comes from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets U.S.: First, on your vaccine -- on your PED vaccine. Will you have a competitive advantage in getting this vaccine to the market? If you could just give us a better sense as to where the competitors are and what kind of commercial opportunity are we looking at? And a quick follow-up, if I may, I'm not sure if I understand it, Ramón, correctly on APOQUEL. Did I hear you correctly in saying that you expect to have supply to the market, increased supply to the market, later this year? Or is it still a 2015 expectation? Juan Ramón Alaix : Alex, it's Juan Ramón Alaix. So let me start confirming that for APOQUEL, we expect that to normalize supply next year in April. And at that time, I will be able to supply more product to new customers. On the first question, on the PEDv, so we have a program now that we expect to complete soon and to submit that to the FDA, a conditional -- license for conditional approval. And there is one vaccine already in the market covering this disease. And we expect that our vaccine also will cover the needs of swine producers to protect animals against this outbreak and its high significant impact on their herds. John O'Connor: Operator, next question, please? Operator : Certainly. We'll next go to Mark Schoenebaum with ISI Group. Mark J. Schoenebaum - ISI Group Inc., Research Division : My question on the business is maybe on use of cash, if I may. In your last slide, where you kind of summed up the 3 big priorities, I suppose, for the next 5 years. The last one is to find profitable investment opportunities and return excess capital to shareholders. So I was wondering, we haven't seen a lot of M&A yet at Zoetis. So I'm wondering why that is? And if we should expect the pace to pick up? And then the follow-up on that is the dividend. I don't think we've seen much of a dividend raise since you guys have spun out of Pfizer. So I was wondering if just philosophically, you could talk to us and maybe help set expectations, what we should expect about the rate of dividend increases. Juan Ramón Alaix : Mark, on the first question on M&A, so in 2013, that it was the first year of Zoetis as an independent company. We were focused on standing up our operations and then, we decided that maybe it was not the right time for us to consider on M&A activity. We are now that -- we have, in most of the cases, completed our infrastructure, with the exception of IT. We think that we can now consider M&A opportunity that the market brings to us. And we'll be active pursuing these opportunities. We know that because of our size and our market share, we may face some challenge in terms of antitrust. This will incorporate it in our analysis, but definitely, we will consider any opportunity that will match our strategic objective, and also will provide the return on the investment. Glenn David : Mark, related to your question on dividends. So today, we have increased our dividend. And subject to board approval, we do expect to grow the dividend at a rate that is equal to or faster than our growth in adjusted net income. John O'Connor: Operator, next question please? Operator : Certainly. We'll take a question now from Chris Schott with JPMorgan. Jessica M. Fye - JP Morgan Chase & Co, Research Division : It's Jessica Fye on for Chris. A question on gross margin, just as we're starting to think about next year. Can you just remind us how much of your manufacturing Pfizer still does? And how we should think about the impact of that, I think there's some manufacturing royalty kicking in for the product they supply you with next year? And then maybe also just following up on Mark's question on M&A. We're seeing a number of tax inversion transactions across the space and just would like to hear your views on whether that will be of interest to Zoetis. Juan Ramón Alaix : So in terms of M&A, also, this tax inversion opportunity, we will continue to exploring any opportunity that will provide reduction in terms of effective tax rate, something that definitely we will see the opportunities the market -- that exist in the market. And we will decide based on these opportunities. On the gross margin, I will ask Glenn to respond to your question. Glenn David : So in terms of gross margin for 2015 and specifically to the impact of the Pfizer MSA. So when we looked at the potential impact of the Pfizer MSA, that it might have in 2015. Based on 2013 costs and volumes, we expected it to have about a $30 million negative impact on cost of goods going into 2015. We've taken a lot of actions to minimize that impact, and those actions have resulted in reducing that exposure by about 1/2. However, since then, a number of those products, APOQUEL being one of them, have had growth in volume. So it will limit our ability to bring the $30 million down fully, but we have taken many actions to minimize the impact. John O'Connor: Operator, next question, please? Operator : Certainly. Our next question comes from Kevin Ellich from Piper Jaffray. Kevin K. Ellich - Piper Jaffray Companies, Research Division : First off, we've seen some pretty strong livestock trends, especially in the U.S. Just wondering if you can keep up kind of the high single-digit, low double-digit growth in the U.S.? And then second, regarding your operating cost, and you have a direct sales model, especially in the U.S. Just wondering if there's any ability for you guys to leverage the operating cost by maybe laying on distributors and using some of the national distributors more to minimize or drive some more leverage in the model. Juan Ramón Alaix : On the performance on livestock, definitely on the second quarter, we reported very strong growth. We see that the demand for animal proteins remained very strong in the worldwide market. We also see that the profitability of livestock producers -- it's now very high. They have high price of the meat, low prices for input, which increases significantly the profitability. And this is also driving the willingness of livestock producers to increase the herd, to supply all the market demand. We don't see any change in the near future, so we expect that the livestock market will continue growing in the future. In terms of our direct sales model, so we are convinced that the demand generation model that we have, which means that our own field force and also our own group of veterinarians are interacting directly with customers. And this interaction is generating very strong demand and very strong support to our portfolio. In the U.S., we combined our direct efforts with partnership with distributors, for those customers that we don't have the reach because of economical conditions. And we see that this model is working very well, and we'll continue supporting our product portfolio through this direct interaction, and also with the combination and partnership with some of our distributors that will reach these smaller customers. John O'Connor: Operator, next question, please? Operator : Certainly. Our next question comes from Louise Chen with Guggenheim. Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division : So first question I had was on SG&A leverage. What is your ideal level of SG&A leverage and when do you expect to get there after you finish this Pfizer separation? And then second question I had was, we've seen a number of development-stage, companion animal health companies starting up. I'm just curious, your thoughts on the unmet needs these companies address and if there's potential partnership opportunities here? Glenn David : So this is Glenn. I'll address the SG&A question. In terms of the SG&A leverage, so the way we think about this is, in 2014 in particular, we have indicated that we do have incremental expenses related to building up our corporate functions, and that is increasing the level of growth we expect in SG&A this year. However, over the long term, we do expect to grow SG&A in line with inflation, while being able to grow our revenue at a pace faster than the market, which will continue to improve our margins going forward. Juan Ramón Alaix : Okay, the other question was about these biopharma companies and potential partnerships. Well, I think it's -- we have already the infrastructure, also the reach to customers. And we have developed, over time, a very strong model in terms of direct sales to customers. And we are convinced that this model also can benefit smaller companies that will have maybe problems that will be covering and managing [ph] the market, but without the infrastructure to reach customers. So we will consider this kind of partnership with these companies. John O'Connor: Operator, next question, please? Operator : Our next question comes from John Kreger with William Blair. John Kreger - William Blair & Company L.L.C., Research Division : I think you mentioned on the call that your parasiticide class within companion animal saw some pressure in the quarter. Can you just expand on that a little bit? Did it actually decline? And if so, maybe you could quantify it? And do you have anything in your pipeline that might cause this trend to be able to reverse in the coming year or so? Juan Ramón Alaix : Well, our parasiticide franchise in companion animal didn't decline in the quarter, but the growth was affected by the entrance of new competitors. There have been 2 new competitors launching new parasiticides, oral parasiticides, and we have seen that the market dynamics in parasiticides are changing, and moving from the traditional parasiticides that there were topical to more attention to oral parasiticides. We also have programs in this area and we expect to launch these products, oral parasiticides for companion animals, in the future. John O'Connor: Operator, next question please? Operator : Our next question comes from Robert Willoughby with Bank of America. Erin E. Wilson - BofA Merrill Lynch, Research Division : This is Erin Wilson in for Bob. Follow up to the SG&A expense question and the leverage of that metric going forward. What can be addressed or corrected near term or can be considered one-time in nature? And outside of some of those items, can you call out where you have made progress on this line as it relates to your separation from Pfizer? And I guess the second question then, similar would be -- can you just speak to the competition in U.S. companion animal in light of the increased promotional spending that you've called out. Why is it such a light trend in companion animal? Glenn David : Sure. So in terms of the SG&A and items that might be considered one-time in nature, I think the key item is what we've been highlighting in terms of the buildup of our corporate enabling functions and the timing of which that ramped up and when those costs were most debited in the P&L. So in 2013, in the first half of the year, we were not running at our full cost base for our enabling functions and that corrected in the second half, and that's driving the difficulty in comparison year-over-year. Some of the areas that you have seen have significant improvement though year-over-year, I think when you look at the growth in our regions and our segments, you've seen very strong IBT growth or income growth in those regions, demonstrating continued focus on managing -- or on our expenses. Juan Ramón Alaix : Maybe a comment on the competition in the U.S. and also details on the promotional activities that we conducted in the second quarter. Definitely, as I said during my remarks and also the remarks of Glenn, we have seen introduction of new parasiticides, also introduction of new vaccines and the introduction of generic competition to a product which is important in our portfolio, which is RIMADYL. And in terms of the additional investment in promotional activities in the quarter, I think it's only a question of pacing. If you take year-to-date, you would see that the investment in the year has been in line with our projections of growing promotional activities below the growth in terms of revenues. John O'Connor: Operator, next question, please? Operator : Our next question comes from Jami Rubin with Goldman Sachs. Christopher J. Benassi - Goldman Sachs Group Inc., Research Division : This is Christopher Benassi on behalf of Jami Rubin with Goldman Sachs. Since the IPO, investors have believed in the story of continued improvement in Zoetis' margins. However, we are curious as to where you might see room for further margin improvement, possibly in SG&A, R&D or maybe even across the board. Glenn David : In terms of where we see continued improvement. So R&D, I think, is one item that you've highlighted. We've seen growth in R&D that's been sort of in the low-single digits, while we still continue to be very effective with our R&D productivity. From an SG&A perspective, as well as a cost of goods perspective, we do continue to see areas for improvement. So as I mentioned, SG&A, we do expect to grow in line with inflation. And cost of goods, we're clearly focused on continuing to find areas to improve our cost of goods and expect incremental improvements in COGS going forward. John O'Connor: Operator, next question, please? Operator : Our next question comes from Ross Taylor with CL King. Ross Taylor - CL King & Associates, Inc., Research Division : I just had a couple of questions related to the PEDv vaccine you have in development. But for a conditional approval, what kind of efficacy data do you have to present to the regulators to receive a conditional approval? And I also wondered how much does a conditional approval limit appeal or uptake of this product once it does reach the market? Juan Ramón Alaix : So in terms of the regulatory requirements for conditional approval for a vaccine, so we need to demonstrate safety of the vaccine and also efficacy in certain conditions. And the requirements for efficacy for a conditional license are lower than the efficacy requirements for a full license. In terms of the selling opportunities of a vaccine under conditional approval, I think it's something that, since the vaccine, in this case, will be responding to a real market need, we don't see that this will create any limitations. There will be some limitations in terms of promotional activities, but not limitations in terms of selling the product to the market. John O'Connor: Operator, next question, please? Operator : We now have a follow-up from Kevin Ellich with Piper Jaffray. Kevin K. Ellich - Piper Jaffray Companies, Research Division : Following up on the PEDv comments, I'm just wondering, Juan Ramón, in your prepared remarks, you talked about how hog farmers are growing larger animals, even though we've seen, I guess, some pressure on the herd sizes. And I'm just wondering if your new product, ENGAIN, is helping to -- if you've seen some good uptake because of this? And if you could quantify that also? And then Glenn David, the tax rate was lower on a year-over-year basis. Just wondering what we could expect? And I also wanted to clarify, did you say your tax guidance does not include the R&D tax credits? Juan Ramón Alaix : The follow-up question on PEDv, so definitely, ENGAIN, it's helping producers to have a more efficiency in terms of food. So they are reaching feed efficiencies because of this product. This product is also a product that already exists in the market, it's ractopamine. And we think that the product that are released [ph] in the market, together with ENGAIN, is helping the producers to achieve the targeted weight, with lowered cost in terms of food. Glenn David : And in terms of the tax rates. So the tax rate was lower in the quarter at 28.4%. We have reaffirmed our guidance of approximately 29% for the year, and we still believe the full year is the best view of our overall tax rate. And just to emphasize it, that does not include the R&D tax credit, which would lower our rate by approximately 50 basis points. John O'Connor: Operator, next question, please? Operator : Next we have a follow-up from Robert Willoughby with Bank of America. Erin E. Wilson - BofA Merrill Lynch, Research Division : This is Erin again. A quick follow-up. There has been some recent changes, or recently announced upcoming changes, in the companion animal diagnostics market in the U.S., with IDEXX Laboratories moving to a direct distribution model. Do you see this as an opportunity for you? What -- and just generally speaking, what is your underlying growth rate for your diagnostics business? Juan Ramón Alaix : So we remain committed to diagnostics. We see diagnostics as very complementary to our current business, in both R&D and also commercial. And we are trying to build our portfolio in terms of diagnostics. And the change on IDEXX in terms of direct model, it's something that we will not comment on the strategy of our competitors, but definitely, we'll explore any opportunity that will further penetrate our diagnostic depth into the market. John O'Connor: Operator, next question, please? Operator : [Operator Instructions] We'll now go to a follow-up from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets U.S.: Sorry if you addressed this earlier, had to hop off for a minute. But what can we expect for your November Investor Day? If you could just frame that for us. Can we look for something like a 5-year outlook? If you could just give us more color as to what we can see from you. Juan Ramón Alaix : So we're working on the details of the agenda that we will communicate to you in the near future. So one of the objectives that we have during this day is to provide much more details on our strategy. Also have the opportunity to provide this information in terms of commercial, in terms of manufacturing, in terms of R&D, from members of my leadership team, that will go into some detail that may have not been provided until now. And in terms of the outlook, we are considering what should be the details that we will provide in terms of the outlook, and we are still considering different timeframes that will be information that we'll be sharing with you at that time. The other objective is also to go into some additional details on the animal healthcare market, to have much more clarity in terms of projections of the market and also the opportunities for both livestock and companion animals. John O'Connor: Operator, are there any other questions? Operator : At this time, there are no additional phone questions. Juan Ramón Alaix : Well with that, thank you very much for joining us today. Thank you very much for your interest in Zoetis, and we -- I look forward for more interactions with you. I definitely hope to see you at our Investor Day in November 18. Thank you very much. Operator : Thank you. This does conclude today's teleconference. The replay of today's call will be available in 2 hours by dialing 1 (800) 374-1216 for U.S. listeners; and (402) 220-0681 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
|
Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
|
2013-06-21
| 2,014
| 4
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2014Q4
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2014Q3
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2014-11-04
| 1.487
| 1.495
| 1.657
| 1.685
| 2.43665
| 20.1
| 21.75
|
Executives: John O'Connor - Juan Ramón Alaix - Chief Executive Officer and Director Paul S. Herendeen - Chief Financial Officer and Executive Vice President Analysts : Christopher T. Schott - JP Morgan Chase & Co, Research Division Kevin K. Ellich - Piper Jaffray Companies, Research Division Jami Rubin - Goldman Sachs Group Inc., Research Division Alex Arfaei - BMO Capital Markets U.S. John Kreger - William Blair & Company L.L.C., Research Division Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division Douglas D. Tsao - Barclays Capital, Research Division Vlad Nikolenko David Risinger - Morgan Stanley, Research Division Jeffrey Holford - Jefferies LLC, Research Division Erin E. Wilson - BofA Merrill Lynch, Research Division Operator : Welcome to the Third Quarter 2014 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is John O'Connor, Head 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 is now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor: Thank you, operator. Good morning, and welcome to the Zoetis Third Quarter 2014 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Paul Herendeen, our Chief Financial Officer. Juan Ramón and Paul will provide an overview of our quarterly results, and then we will open the call for your questions. Before we begin, let me remind you that the earnings press release and financial tables can be found on the Investor Relations section of zoetis.com. We are also providing a simultaneous webcast of this morning's call, which can be accessed on the website as well. A PDF version of the slides used today will also be available on the website following the call. 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 statements in today's press release and our SEC filings, including, but not limited to, our 2013 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. These non-GAAP adjusted figures exclude the impact of purchase accounting adjustments, acquisition-related costs and certain significant items, such as the nonrecurring costs of becoming a standalone public company. A reconciliation of these non-GAAP financial measures to 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, November 4, 2014. We also cite operational results, which exclude the impact of foreign exchange. I also want to remind you that beginning with the first quarter, we realigned our segment reporting with respect to our Client Supply Services organization or CSS, which provides contract manufacturing services for third parties. The revenue and earnings associated with CSS are now reported within Other business activities, separate from the 4 reportable segments. In 2013, CSS results were reported in the EuAfME segment. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix : Thank you, John. And thank you to those joining today's call. Before beginning my comments on our third quarter performance, I would like to introduce Paul Herendeen. Paul joined Zoetis as our new CFO this past September to lead the company's finance and information technology organizations, in addition to being part of the Zoetis executive team. I'm delighted that Paul has joined Zoetis and is on the call today. Later, he will speak with you as we review the details of our third quarter performance. A key element of our long-term value proposition is our ability to grow in line or faster than the market. Based on most recent data, Zoetis continues to grow faster than the animal health industry. Over the trailing 12 months ending with the second quarter, the animal health market grew by 3% according to industry sources, while Zoetis grew by 5% with both percentages, including the negative impact of foreign exchange. Our ability to grow faster than the animal health market illustrates the fundamental strength of our business model. With the broadest product portfolio in the industry, the steady introduction of new products and our top-ranked field force, we are able to bring value solutions to veterinarians and livestock producers around the world. Now, let's turn to our operational performance during the most recent quarter. During the third quarter, we generated operational growth of 10% in revenue and 21% in adjusted net income, delivering adjusted diluted EPS of $0.41. Revenue growth during the quarter was strong in all regions and in both developed and emerging markets, with emerging markets delivering double-digit growth. These are result of favorable market conditions, the strength of our diverse product portfolio and the diversity of our global presence. Let me now comment on our livestock performance. In livestock, we grew 13% and growth was strong across all geographic segments. Producers are enjoying favorable market conditions in many parts of the world with high meat and milk prices, together with lower feed cost. On a global basis, the outlook for meat and daily proteins remains strong. A growing middle-class in China, India and other emerging markets continues to drive growth in worldwide demand for meat, eggs and daily proteins. Let's now take a closer look at our third quarter performance by species, starting with cattle. Cattle is our largest species and it grew 13% with all regions delivering strong growth. In the United States, we saw strong demand for our premium products, while we also generated gains gains in market share. Swine revenues grew 17% despite the challenge of porcine epidemic diarrhea virus or PEDv in a number of countries. All regions contributed to this growth and we continue to expand our swine product portfolio through the introduction of vaccines with new antigen combinations as well as registering and commercializing products in new markets. Poultry revenue grew 7% with strong contributions from the emerging markets within the European, Africa and Middle East region. Now, turning to companion animal. Companion animal grew by 5%, aided by sales of APOQUEL in the U.S. and several European countries. Strong growth of key brands in the U.S. and Europe was offset by the introduction of new products from competitors and the impact of the solution changes in Japan. While competition has affected our results in parasiticides and vaccines, we are confident in our ability to participate in this and other growing market segments as we introduce innovative products to the market. For example, we are preparing for European launch in 2015 of Versican Plus, a new line of canine vaccines. We will cover -- I will cover Versican Plus in more details when I discuss new products and milestones. We can also confirm that in April 2015, we expect to significantly increase APOQUEL supply. With greater supply, we expect to begin offering APOQUEL to new customers. We continue to receive very positive feedback from customers about this product. And based on current market conditions, we believe APOQUEL can achieve annual sales of approximately $200 million to $300 million at peak sales, which normally is 5 years after product introduction. Now, I would like to share with you several products and milestones that illustrate how our singular focus on animal health and our core capabilities allow us to put our customers first and bring our solutions to their most pressing animal health needs. Earlier in the quarter, we announced that we obtained a conditional license in the United states for our vaccine to help fight PEDv in pigs. Under a conditional license, we demonstrate safety in a field study and provide reasonable expectations of efficacy. We are now conducting additional studies to demonstrate efficacy and to obtain a full license from the USDA. The PEDv vaccine has been received very positively by swine customers and is available to them ahead of the cold weather when the virus is more likely to spread. We were able to bring this vaccine to market in only 14 months by leveraging our 3 interconnected capabilities. Our R&D capability and the expertise in biologics allow us to fast-track the development of PEDv vaccine. Manufacturing and scale-up capability enable us to produce enough of the vaccine to meet projected customer demand. And now that the product has been launched, Zoetis representatives and our field veterinarians are partnering with our customers on how to incorporate the new vaccine into their protocols and biosecurity programs. The development of these vaccine is an example of how we leverage our capabilities to bring solutions to our customers. This past quarter, Zoetis also received a full license for the first poultry vaccine targeting Georgia 08 type IBV. The full license followed the USDA conditional license that Zoetis received in late 2013. These are the first commercially vaccine to help reduce disease cause by the virus strain. In our companion animal business, we received European approval for Versican Plus. This is a combination canine vaccine that provides unmatched leptospira protection as well as a greater convenience and flexibility for veterinarians. It provides protection against obtained bacterial and viral infections in one vaccine dose. By offering multiple vaccine combinations, Versican Plus provides a comprehensive solution for European markets that accommodates a broad range of vaccination protocols. We are now preparing the launch of Versican Plus in the European Union in 2015. Also, we announced the formation of a new collaboration with Easter Bush Research Consortium that is focused on combating emerging infectious diseases in Europe. Zoetis will partner with others in this consortium to detect and identify emerging infectious diseases early and to develop medicines and vaccines to treat and control them. Zoetis is the only animal health company in this consortium. Collaboration like this one contributes to our ability to be first to know about emerging infectious diseases and aspires to be first to market with new products to diagnose and prevent diseases. And before I ask Paul to walk us through the financials and provide details on our 2014 guidance, I would like to remind you of our upcoming Investor Day. We are very pleased to be hosting an investor meeting on November 18 at the New York Stock Exchange. The goal of the meeting is to enhance understanding of the animal health industry, the key drivers of Zoetis market leadership and the strategies for future growth. I will be joined by the Zoetis executive team for a discussion of our regional businesses, R&D approach, manufacturing and supply chain operations and financial goals. And with that, Paul? Paul S. Herendeen: Thank you, Juan Ramón, and good morning. It's been a very busy and productive first 2 months and I'd like to say that the more I learn, the more confident I am that the fundamentals of our industry, our team here at Zoetis and the strengths of our capabilities provide us with the opportunity to create value for our stakeholders. I'll speak more about all this in 2 weeks at our Investor Day, but now let me dive in and review the third quarter a little more deeply and to discuss our guidance for 2014. Turning first to the interest income statement slide. For the third quarter, revenue was approximately $1.2 billion, an increase of 10% year-over-year on both a reported and operational basis. Reported net income was $166 million or $0.33 per diluted share in the third quarter, an increase of 27%. And adjusted net income was $207 million or $0.41 per diluted share, representing reported growth of 20% and 21%, respectively. Adjusted net income from the quarter excludes the after-tax impact of $41 million or $0.08 per diluted share for purchase accounting adjustments, acquisition-related costs and certain significant items, the majority of which were related to standup costs. Now, let's take a minute to discuss currencies. In the third quarter, foreign exchange did not have a material impact on our revenue or income growth. It's important to remember that our 3 international business segments have an earlier quarter close than the U.S. segment. The third quarter for the international segments closed at the end of August with the U.S. segment closing at the end of September. Looking ahead, we expect to see a negative impact on revenue growth in the range of 250 to 300 basis points in the fourth quarter based on current rates and we expect to see similar magnitude of impact in 2015. Now let's turn to our adjusted income statement slide, which I'll discuss on an operational basis. Again, because FX was not a significant factor in the third quarter, operational revenue growth was 10%, the same as reported. Livestock comprised 65% of sales in the quarter and grew $88 million or 13% operationally. Companion animal comprised 34% of sales in the quarter and grew $20 million or 5% operationally. Adjusted cost of sales was 35.5% of revenue versus 34.7% in the year-ago quarter. And that's due to the buildup of central manufacturing supply chain operations. This buildup was completed by the end of 2013 and those higher costs are now flowing through our cost of goods sold. Adjusted SG&A, meanwhile, increased by 2% operationally in the third quarter. In other items, adjusted R&D expense was flat operationally and interest expense was flat at $29 million in the quarter. Our effective adjusted tax rate for the third quarter was 28.3%. I would not read too much into our tax rate in the quarter. What's important is that we expect our rate for the full year 2014 to be consistent with our guidance, which is approximately 29%. And again, our adjusted net income was $207 million, representing a growth of 20% or 21% operationally. Now let me talk for a minute about how we're tracking year-to-date on a few elements. This was a great quarter, but we always want to keep in mind the full year and that's because of the nature of our business, the cycles in the animal health industry and fluctuations in currencies in any given year. In looking at any quarter relative to the prior year, lot of noise can creep in. The longer the time period you look at, the more that noise cancels itself out and you can see a clearer picture of the underlying trends in our business. We focus on full calendar years and do not guide or manage to quarterly results. While it feels great to put a quarter on the board with such strong revenue and profit growth, the bigger picture is that we are on track to deliver on our guidance for the full year. That said, let's take a quick look at the 9 months year-to-date and compare that back to 2013. We're tracking in line with our revenue expectations for the first 9 months, growing revenue 6% on an operational basis. Our guidance range implies full year 2014 operational growth of 5% to 6%. Our adjusted cost of sales is at 34.9% of revenue on a year-to-date basis. As I said earlier, we continue to expect our cost of sales to increase as a percent of revenue for the year, bringing us in line with the full year guidance of approximately 35.5% of revenue. And finally, adjusted net income is also performing in line with our expectations growing at 13% on an operational basis year-to-date. This year-to-date performances are in ranges that are consistent with our expectations, and I'll discuss the implications on our full year guidance in a moment. Now let's turn to our operating segment results. Again, I'll discuss these on an operational basis, but I -- but it should be noted that the segment earnings are on a pretax basis and are presented on an adjusted basis. Beginning with the U.S. Third quarter revenue was $532 million, an increase of 7%. Sales of livestock products grew 12% with cattle and swine as the main contributors. Growth in cattle products benefited from higher demand for our premium product as producers continue to see strong market conditions. With higher prices for beef and lower input costs, producers are moving lighter animals into feed lots sooner to meet the market opportunity. These cattle can be more vulnerable to illness and disease, given their age and weight, and require more use of medicines and vaccines to maintain their health. These market conditions also mean our customers place more importance on using our premium products to protect animals and investments. Meanwhile, swine products sales were driven primarily by the success of several recent new product introductions such as our Fostera PCV M. hyo combination vaccine. The DRAXXIN 25 anti-infective product for swine and our ENGAIN ractopamine product for use in feed. This growth in swine was slightly offset by the continuing impact of PEDv, which Juan Ramón mentioned. In companion animal products, we generated an operational growth of 2%, driven by APOQUEL and other key brands such as ProHeart 6, Cerenia and Convenia. This growth was offset, however, by increased competition in vaccines, pain products and parasiticides. In summary, the U.S. segment earnings increased by 10% based on the quarter's strong sales and lower expenses. Now turning to our Europe, Africa and Middle East region or EuAfME. Revenue in EuAfME was $293 million, an increase of 12% operationally compared to the third quarter of 2013. The growth was a combination of double-digit growth in both developed and emerging markets. Sales of our livestock products increased 13% operationally as the region delivered positive results in France and the U.K., as well as in emerging markets. The livestock growth was driven by increased sales across all species with particular advances coming from cattle and poultry products. In France for example, we saw an increase in the sales of the anti-infectives as customers sought to buy product ahead of more restrictive legislative changes. And in the U.K., we saw strong demand for cattle products. Meanwhile, sales of companion animal products increased 11% operationally, primarily driven by sales of APOQUEL in Germany and the U.K. as well as growth in parasiticides such as the Stronghold brand. EuAfME segment earnings increased 28% operationally, primarily due to the revenue increase, improved gross margins and lower operating expenses in the quarter. Turning to our Canada and Latin America segment or CLAR. Third quarter revenue was $194 million, an increase of 17% operationally compared to the third quarter 2013. In this region, we saw a significant growth in emerging markets such as Venezuela, Brazil and Argentina and also in Canada. Overall for the segment, sales of livestock products grew 16% operationally and sales of companion animal products grew 19% operationally. Sales in Venezuela and Argentina grew significantly across all species. In Brazil, there was significant growth driven primarily by sales of cattle products, including new product launches and growth in key companion animal brands such as Vanguard, Cerenia, Revolution and Convenia, as this market continues to expand at a high rate. Meanwhile, growth in Canada was primarily driven by sales of companion animal products. This was the result of a later spring season than last year, which had a positive impact on parasiticides sales -- the growth of parasiticides sales for this quarter as compared to last year quarter. Strong volumes in cattle and swine products also contributed to growth in Canada. CLAR segment earnings increased 19% on an operational basis, driven by revenue growth, limited growth in operating expenses and partially offset by a decline in gross margin. In Asia Pacific or APAC, third quarter sales were $179 million, an increase of 7% operationally compared to the third quarter 2013. Sales of our livestock products grew 9% operationally, driven primarily by sales of cattle products in Australia and growth in Southeast Asia from recently launched swine products. In Australia, we are seeing more cattle moving into feed lots and requiring more treatment as Australia continues see the impact of drought on its cattle businesses. In the swine, we continue to see strong sales driven primarily by an increase in sales of our vaccine portfolio. Sales of companion animal products, however, were flat operationally due to an inventory buyback related to the termination of a distributor agreement in Japan. Excluding this event, operational growth would have been 8% driven by sales of parasiticides, equine vaccines in Australia and increased sales of vaccines in China. APAC segment operating earnings increased 24% due to revenue growth, improvements in gross margin and a decline in operating expenses. That's on an operational basis. Now let me turn to guidance for the full year 2014. As I mentioned earlier, we think about and manage our business in an annual basis and not quarterly. There can be a lot of variability in any individual quarter. For example, in revenue, the variability can be to due to changes in weather patterns or seasonality be associated with certain product lines. In R&D expenses, for example, the quarter -- quarterly variability may be based on project schedules and conditions needed to complete field trials. Our R&D expense, for example, tends to be heaviest in the fourth quarter. Over a full year, that variability, which you have seen in pockets this year, historically evens out, and we are able to deliver a steady and predictable performance when measured on an annual basis. We remain confident on our ability to deliver on our full year guidance for 2014 and we are reaffirming our adjusted earnings per share for the full year and narrowing our revenue guidance towards the high end of the range. We now expect reported revenue of approximately $4.7 billion to $4.75 billion for the full year. This guidance would imply full year reported growth of 3% to 4% for revenue and includes a negative impact of 2 percentage points from foreign currency. This also implies an operational growth of 1% to 5% in the fourth quarter, and that's when compared with a strong fourth quarter in 2013. After taking into consideration the current FX environment, reported revenue growth could be 250 to 300 basis points below the operational growth rate in Q4. Our guidance on adjusted cost of goods sold for the full year 2014 remains approximately 35.5% of revenue, roughly flat year-over-year. This reflects the anticipated benefit of price, volume and ongoing cost savings efforts, which is forecast to be offset by the full year impact of costs incurred to build our central manufacturing and supply functions as well as unfavorable mix. We understand this implies our fourth quarter cost of goods sold as a percentage of revenue will be higher than what you've seen to date. However, we believe our 2014 full year guidance of approximately 35.5% of revenue is a better reflection of our underlying cost of goods sold. Adjusted SG&A expenses are now expected to be between $1.46 billion and $1.48 billion. We continue to see good OpEx discipline in the regions, which is helping to mitigate increased spending in our general and administrative functions, where we continue to build out the infrastructure to support our business on a fully standalone basis. Adjusted R&D expenses are expected to be between $385 million and $395 million. We continue to deploy resources responsibly in R&D as this investment is fundamental to the enhancement and protection of our existing portfolio through life cycle developments and the development of innovative new products to help fuel additional growth. We continue to expect our effective tax rate on adjusted income to be approximately 29%. This guidance does not reflect the potential extension of the U.S. R&D tax credit. And we continue to expect adjusted EPS of between $1.50 and $1.54 per share for the full year. This guidance would imply full year reported growth of 6% to 9% for adjusted EPS and reflects a negative impact of approximately 200 basis points coming from foreign currencies. Please note that our guidance does not reflect any further currency devaluation in Venezuela. Separately, we now estimate pretax charges for 2014 of between $180 million and $195 million, primarily related to standup costs and acquisition-related costs. These charges are excluded from our adjusted earnings guidance. Including the impact of these items as well as purchase accounting adjustments, our guidance for our reported diluted EPS for the full year 2014 remains between $1.16 and $1.20 per share. This annual guidance reflects our confidence in the diversity of our portfolio, the strength of our business model and our view of the evolving animal health market for the remainder of the year. To sum up the quarter, we had a very strong revenue and earnings growth quarter in all regions, demonstrating the strength of our business model. We demonstrated an ability to drive gross margin improvements and operating expense containment in our regional segments while continuing to absorb some of the impact of the buildup costs associated with our corporate functions. We saw no material impact from foreign currency on our growth this quarter, but anticipate more significant effects on our future results. And we are reaffirming our guidance for the year despite the expected currency headwinds in Q4. That concludes my prepared remarks. And now we will open the line for questions. John? John O'Connor: Thank you Paul. Operator, we are ready to take the first question. Operator : [Operator Instructions] We'll take our first question from Chris Schott of JPMorgan. Christopher T. Schott - JP Morgan Chase & Co, Research Division : And then, Paul, congrats on the new role. Two questions here. First, can you elaborate on the U.S. companion business and competitive dynamics there? I think last quarter you mentioned you were increasing some of your promotional investments. I guess, any sign that those investments are having any impact? Or just when should we think about that business starting to maybe turn around a little bit more? And then a question for Paul, just as you're stepping into the CFO role, can you just elaborate a little bit more on your priorities? I guess, specifically, what are the biggest opportunities you see at Zoetis when you look at the company's margins, tax rate and capital structure? Operator : It appears that the -- we're experiencing technical difficulties at this time. Please standby. [Technical Difficulty] Juan Ramón Alaix : I hope now the line is fine and I will be able to answer your questions, Chris. Operator : Sir, you may now proceed with your answer. Juan Ramón Alaix : Okay. So Chris, it's Juan Ramón and I will answer the question on U.S. companion animal dynamics. So there are different factors driving the market in the U.S. in companion animal. The introduction of new products, mainly in parasiticides. The market is moving more to oral parasiticides compared to the previous, more topical ones with the introduction of 2 main competitors in this market. And we are participating in the market in the topical, but not on the oral. The other change that we have seen is that the introduction of new vaccines in the U.S. that also they are impacting our performance. And finally, in the pain market in where we participate with RIMADYL a very strong brand, there are also new factors affecting our performance. One, it's a competitor that was out of the market in 2012. It was back in '13 and now it's full revenues and also made it part of the shares that we gained when this competitor was not participating in this market. It's now back to the more normal situation. And also, the introduction of generic competition for RIMADYL on the chewable formulation, although this have not been representing a significant impact so far. Now, I will ask Paul to answer your question. Paul S. Herendeen: Yes, thanks, Juan Ramón, and Chris, thanks for the questions. Yes, I've been here about 60 days now. I'll tell you that my -- the first thing I see is an opportunity or I say, more as a priority for me is to help us to get complete with the standup process. Until we get through that, I think that it's going to somewhat mask our company's cash flow generation capabilities because it, obviously, while it doesn't affect adjusted net income, it obviously is a cash flow item. And so in terms of priority, both getting us past those -- that standup activity and getting the G&A infrastructure built to the point where it can support this global business has kind of been very, very high on my list. Now that said, I mean walking down through the income statement, there are opportunities for us to continue to drive operating margin improvements over time, and I think these are themes that you've heard from the other members of the team as we go -- as you go back. I mean, we've got very good expense control in our commercial groups. That's been a little bit masked by the buildup of cost in G&A. And again, once we get through that, we'll get to more of a normalized run rate for our OpEx. There are opportunities in the gross profit margin when we look at ability to continually benefit from price increases. Second, from improvements in efficiency in our plant network structure. And those are things that although they will happen here in the near term, I think that it will take us some time to generate the most meaningful portion of those margin expansion opportunities. Part of your question was around the tax rate. We -- when we spun out from Pfizer, we started with a tax rate kind of -- or we could have had a tax rate sort of in the 40% range. We were able to put together a structure or put in place a structure that enables us to have that tax rate down in the neighborhood of about 29%. So good from the perspective of a structure that allows us to have a much lower tax rate. Thinking ahead, I think that our ability to manage that tax rate is based on opportunities to present themselves to us that fit within our structure. I would not expect to see revolutionary changes in our tax rate, although we will do our level best to manage that tax rate down over time. And I think your last question was around capital structure. In this company, we are -- we have expressed that we wanted to maintain a level of debt in our cap structure. I think you certainly know me from my prior employer and -- I like debt, we like debt. There's a role for debt in our capital structure. We've expressed a target of 2.5x trailing 12 months' EBITDA. That's an appropriate debt load, but I will say that's a target. It's a target, where if there were an opportunity in the call -- we were called upon to lever up a little bit, we would do that, and then we would endeavor to reduce our debt over time back towards the target. And I'll stop there. Can I get the next question please? Operator : Our next question comes from Kevin Ellich of Piper Jaffray. Kevin K. Ellich - Piper Jaffray Companies, Research Division : First one, Ramón, could you give us a little update on the competitive landscape. Sentinel Spectrum went to a competitor, wondering what your thoughts are? And also you talked about oral parasiticides, just wondering what's on the horizon for your product portfolio? And then for Paul, you've been with the company now for only a couple of months. Congratulations again. I'm sure it's been like drinking from a firehose, but just wondering if you could give us your puts and takes from when you decided to join the company until now. And also an update on the inventory issue in Japan with the distributor. Juan Ramón Alaix : Thank you, Kevin. And I will answer the questions on Sentinel and oral parasiticides. Well, definitely as a leader in this industry, we see any transaction or any potential transaction in the market and also we are active assessing any opportunity. And definitely, Sentinel was an opportunity that we explored. And what -- as you see, we decided not to participate in this transaction. And we talked about what our programs or plan on oral parasiticides. Definitely, we see oral parasiticides an important part of preventing animals, dogs and cats against ticks and fleas and also heartworm. And we -- I would like to postpone the details of my answer to the Investor Day in -- when we have the opportunity to provide, to investors and to analysts, a more comprehensive view of our R&D approach and also some of the areas in where we are investing. Paul S. Herendeen: And I'll pick -- Kevin, pick up from there. It's Paul. Your question was around puts and takes from prior to joining. So I've here, it's almost exactly 60 days, I think. As of today, it's 61 days. When I first looked at the opportunity, I think the thing that attracted me to it was, first looking at the industry, an industry that -- a global industry that grows consistently over time. So solid underlying macro trends. And then you look at the company, Zoetis. Here's the company that's a market leader with a broad portfolio, very durable revenue streams and remember, from my experience at Warner Chilcott, we sort of had the opposite of the durable revenue streams. Everybody was always concerned. And I looked at this and said, "Here's a company that has the opportunity to put consistent, revenue growth on the board by levering its broad portfolio and driving growth of those assets through application of sales force." It's very similar to what I was used to at Warner Chilcott, and also supporting those brands through productive R&D, both in terms of extending product life cycles, in terms of providing fuel to allow the sales forces to grow the overall revenue base and lastly, to add those truly innovative products that give you the opportunity to step up and accelerate your growth. So I look at this as being kind of a similar economic model to the pharma business, but with those important differences of longer duration, revenue streams, less reliance on IP. It's about the brands. Same levers to drive the business that's using your field sales resources, face-to-face with your customers to go out and drive revenue and then lastly, supporting that portfolio through productive investment in R&D. And I'd say that, that was my analysis coming in and 61 days later, I think this is a terrific company. And what I've been most impressed with is the ability of the company to execute consistently and drive revenue that exceeds the overall market growth. It's been quite an interesting couple of months here. And again, the most important thing was we've got a great team here that knows how to drive this business. I'll stop there. I'm sorry, you had a question about inventory in Japan. That was related to the termination of a distributor agreement. It's kind of a normal course. It came to the end and we were called upon to buy back some inventory, and that's what's going on there. Operator : Our next question comes from Jami Rubin of Goldman Sachs. Jami Rubin - Goldman Sachs Group Inc., Research Division : Just a couple of questions. Specifically on the outlook for gross margins. I mean, Paul, you talked about gross margins getting hit in the fourth quarter. I imagine that's largely due to FX. But in light of global pricing pressure, maybe, Juan, you can touch upon that in terms of what you are seeing across all your different geographies. But in light of that competitive dynamic, how do you see the outlook for gross margins? Do you think that gross margins can expand in 2015, in 2016? Or should we assume that pricing pressures would offset volume growth and cost cutting or slimming down the manufacturing. But if you could just talk to, number one, pricing, global pricing pressures; and number two, impact on gross margins? And the other question was -- to Paul, was there any channel loading in front of the new vaccine launches? And Paul, congratulations on what sounds like a terrific opportunity for you. Juan Ramón Alaix : Thank you, Jami. And we see -- we continue seeing opportunities of applying price increases across all geographies in where we operate. Definitely in 2014, we had been increasing prices in the U.S., also in Europe, in Canada, Latin America and Asia Pacific. We also apply quite an aggressive approach in some markets with high inflation rates, and this is something that we have seeing a positive impact in our revenues also because of these price [indiscernible]. In terms of the expansion of gross margin, definitely, we'll have the opportunity to cover that in our Investor Day and we'll provide more details on what can be our objective for the future. And maybe I would like to delay this -- well, the details until this Investor Day. And maybe -- and the last comment on the channel loading. So we're not loading the channel and this is something that -- the vaccine launches will be next year. And normally, we apply a very strict procedures to avoid -- that we are increasing inventory that is not needed to meet customer demands. Paul S. Herendeen: Jami, it's Paul. I think you had a question regarding Q4 margin and so I want to make sure I address that because it's an important point. It's an FX impact. Yes, there's FX impact in -- across all of our line items through our P&L. However, it's -- the main reason for the expected increase in cost of goods sold as a percentage of revenue in Q4 is related to the timing of increased headquarters cost, which are flowing through our cost of goods sold in the second half of 2014. And I wasn't here when the folks articulated that, but I think that they provided some guidance that you should expect the cost of goods sold as a percentage of revenue to rise as the year went on. But that the guidance range, which is -- well, actually the guidance level, which is I think the important statistic is, we do expect to be in line with our guidance for the full year, which was 35.5%. I think broadly, looking ahead without providing guidance, I think we have the opportunity to absorb those increased HQ costs in 2015 and beyond without having it have a deleterious effect on our margin. Operator : Our next question comes from Alex Arfaei of BMO Capital Markets. Alex Arfaei - BMO Capital Markets U.S.: Regarding your Investor Day, you said that we're going to see some financial targets. I just want to clarify, are we going to -- are you going to provide some sort of medium to long-range guidance or targets beyond 2015? And the follow-up, there had been a lot of reports about potential buyers for your business. Obviously, in 2015 -- after June 2015, this will become more of a factor. Just could you comment on your overall strategic view about how relevant is that for you? How would you evaluate such opportunity? And just give us an overall sense of how you would think about that. Obviously, in the second half of next year, there's going to be a lot of focus on that. So how should we think about your position on potential -- on being a target of a potential acquisition? Juan Ramón Alaix : Okay. Let me ask Paul to answer this question. Paul S. Herendeen: Sure. I'll start with the Investor Day. We will provide a look, of course, what I'll call our normal sort of guidance look at 2015. And in addition, we will provide our thoughts around 2016 and 2017, not in the same level of detail, but in a way that would enable the market in large to get their arms around what our expectations are for the next several years. With respect to the second question? Juan Ramón Alaix : And I think it's -- we cannot really respond on other company's strategy. We think we have a solid business that we can provide significant value to our shareholders. We are showing that we are meeting our objective in terms of revenues, in terms of adjusted net income and we are also, very important, growing faster than the market. So all this, in my opinion, is showing that this company is well managed. We also have a significant generation of cash over time, and then this will be additional opportunity for investors. Operator : Our next question comes from John Kreger of William Blair. John Kreger - William Blair & Company L.L.C., Research Division : Paul, I think you said your first priority was to kind of focus on the stand-up activities. Can you just elaborate on what's still left to do on that front? And second question, I believe you guys have said previously that you expect about maybe 20 basis points of manufacturing cost headwind as we move into '15. Is that still a decent expectation? Paul S. Herendeen: Sure, and it's Paul. First, the primary task that remains to be completed is the completion of the implementation of a global ERP system, where we're installing SAP. It's very important to us to have that backbone for our company to support our decision-making and the management of our business on a global basis, number one. It's also important to us because it's important that we stand on our own away from Pfizer. So that is a top priority for me now. And that it's not just the implementation, it's also the build-out of the team. We call it Business Technology, so BT, but obviously the more familiar IT acronym. We're continuing to build out that function here in headquarters to support our business. And so that is the primary area where we continue to have some work to stand alone, away and apart from Pfizer. Second, with respect to the manufacturing headwind, I mean, you'll recall that we have an agreement with -- a supply agreement with Pfizer, which has some increases in cost that we need to absorb. I think we're doing a good job of wringing efficiencies out of our manufacturing process that have enabled us to offset a solid part of those increases that are in that contract. We're not going to provide guidance today on what it looks like into 2015, but I'll just give you the factoids that you should keep in your head : We have the opportunity to pull the price lever; we have the opportunity to manage our global supply chain and drive better efficiency; and there's always a favorable mix to the extent that our higher-margin product lines provide more of our overall revenue base. So I would say, yes, we're always facing headwinds -- or we are facing some headwinds looking into '15, but those are challenges that we have a solid opportunity to overcome. Operator : Our next question comes from Louise Chen of Guggenheim. Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division : I have a few. So first question for Paul is since you've joined Zoetis, what are some new initiatives that you plan to implement at the company that could help drive earnings well above the sort of the $2 per share mark? And then secondly, as a company, do you have any interest in companion animal oncology or biologic drugs? As you know, a lot of smaller companies develop these products. I'm just wondering if that's true -- truly good opportunity or not. And then lastly just on APOQUEL, is there any way you can quantify what sales would've been in '14 had you had enough supply? And then in '15, how should we think about the sales ramp? I know you had said $200 million to $300 million in peak sales over, normally, a 5-year time frame, but could you get there faster? Paul S. Herendeen: Yes, thanks, Louise. It's Paul. I'll take the first part of that. New initiatives to drive growth. Let's say the new initiatives, I get to step behind others who are already activating those sorts of strategies in order to drive longer-term growth, but as -- just referencing back to my past life, the similar sorts of levers that you would expect me to pull, and those include focus on value-generative business development activity. That would include using our existing tax structure to manage that tax rate in a downward direction. I think the things that I focus on also are the active management of our capital structure and thinking about ways that we can deliver value to our stakeholders really across-the-board, both from operations and from the management of our cap structure. So those are the initiatives that I've had. And then the second question was in companion animal? Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division : Yes, just curious if you think the oncology or biologics opportunities that some of the smaller companies are pursuing are actually real opportunities. Because I haven't seen the larger companies go after that, so just kind of curious. Juan Ramón Alaix : I would take this question and let me say that in oncology, Zoetis was the first company launching a product that was fully developed to treat cancer for dogs. And this product was Palladia that we launched 2 or 3 years ago. So within that oncology, it's important in companion animal. It's, today, in many cases, veterinarians are still using products developed for human to treat cancer in dogs or cats. But we think that in the future, maybe there will be new products that will be better targeted for treating these kind of diseases in companion animal. And definitely, we will be assessing these opportunity and considering the internal or external opportunities to complement our portfolio. In terms of bios, I think it has been a key area for Zoetis. We have a very strong portfolio in both companion animal and livestock and we'll continue investing in bringing new products to our portfolio and also to strengthening our offer to our customers. And then finally on APOQUEL, so in 2014, we have communicated that our revenues will be around 1% of our total revenues and this has been because of the limitations in terms of product supply. Speculating how much will be the sales of APOQUEL with -- under restricted supply probably is not adding too much value. So what I think, in my opinion, it's -- important is that for 2015, we expect to generate more than $100 million in revenues and we expect definitely to generate these revenues, basically on that 9 months of full supply because we expect to have this product available to more customers from April. So you can -- that's why we are now communicating that we expect that this product has the potential of $200 million to $300 million at peak sales. Operator : We'll take our next question from Douglas Tsao of Barclays. Douglas D. Tsao - Barclays Capital, Research Division : Just to start, I think I'm trying to understand and I've got some questions trying to understand sort of the sequential guidance in terms of revenue. Obviously, they were really strong this last quarter. If I look at your historical seasonality, 4Q seems to be up a little -- to be up pretty meaningfully from 3Q. So just understanding some of those dynamics, as we move into the fourth quarter, that we should be aware of. And certainly the FX guidance seems to be a little bit more extreme than I would've expected. And then the other question is on terms of the PEDv vaccine. Just perhaps you can provide some perspective on how big an opportunity that can be for you and sort of the timing of that sort of coming -- or sort of the revenue sort of building on that product line because, obviously, very impressive how quickly you were able to get a product approved and to market. Paul S. Herendeen: Yes, it's Paul. I'll take the fourth quarter. And how do you get there? I mean, we have 3 quarters on the board. So the year-to-date number is on the board. We have guidance. You can do the math and see what it implies with respect to revenue growth in the fourth quarter that's implied by that. Midpoint of the range, it's -- from a reported basis, it's sort of flattish and we did state that there's about a 250- to 300-basis-point negative impact to our revenues in Q4 versus Q4 of 2013. So fairly significant FX headwinds. And it does give me the opportunity to say, look, we feel like, from an operational perspective, we have a very strong quarter here and very strong guidance for the full year and that's pretty good when you're facing those sorts of FX headwinds that will -- almost certainly, in fact, I would say certainly will hit us in Q4 '14 compared back to '13. And frankly, as you think ahead to 2015 v '14 you have got to take this into account. For perspective, 45% of our revenue comes from our U.S. So we're U.S. dollar denominated, we're exposed to the euro, the real, Canadian dollar, Aussie dollar, sterling, yen. From the perspective of a U.S. dollar-denominated P&L, all those currencies I mentioned, there's not a lot of good news. There's a lot of headwind there. So we feel like our guidance for the full year and our guidance for Q4 is pretty strong, given that we're facing those headwinds going into -- or going into Q4. I think I'll leave it at that and Juan Ramón? Juan Ramón Alaix : And I will answer the question on PEDv. And so just to provide a little bit of understanding of the market's potential. So first, this vaccine, it's targeting sows. And then by vaccinating the sows, it's transmitting the immunity to the piglet. So the number of sows in the U.S. is a little bit less of 6 million compared to 100 million of pigs of the total market. You see that the potential is related to the number of animals that will get this vaccine. That will be less than 6 million. The second fact that is also important is that we obtained a conditional license. Under the conditional license, we have some limitations in terms of the promotions. Actually, we can go to the customers and work with them to ensure protection for the sow, but there are some limitations in terms of promotion. What is important here is not the size of the revenues, but the confirmation that our business model is working very well. We have very strong capabilities in terms of R&D. Also, we have very strong capabilities in terms of our manufacturing to produce vaccine in a way that it's going to the market very fast. So in our opinion, we are bringing with this vaccine significant value to our customers, that they are facing a significant challenge with this disease, and we are confirming that Zoetis has all the capabilities that are needed to succeed in this industry. Paul S. Herendeen: Sorry, it's Paul. I just do want to follow up. The one thing that I didn't say in my remarks about Q4 is also take a look at the quarter you're comparing to back in 2013. Our Q4 was quite strong. If you look at Q -- if you go back to '13 and you look sequentially, Q3 of '13 like $1.1 billion, Q4 '13 $1.254 billion, I think it was -- I've got -- yes, it was a little over $1.2 billion. And so, one is comparing back to last year's Q3, that certainly helped us in putting our good quarter on the board here in Q3 of '14. But that's a tough comparison quarter, Q4 of '13. Douglas D. Tsao - Barclays Capital, Research Division : And so, Paul, just to clarify, so you don't think that necessarily that step-up of $115 million sequentially is sort of like a normal seasonal trend that we should think about? Paul S. Herendeen: From '13 -- what I'd say is, I want to make this point over and over and over again, is because of the nature of our business and seasonality and how things can shift from September to October or across the month, the best way to look at it is the longest time period that you're comfortable with whether that's a year, a half year, whatever. If you look at the second half of 2014 versus '13, it's a good, solid second half of '14. Operator : Our next question comes from Mark Schoenebaum of Evercore ISI. Vlad Nikolenko : It's actually Vlad Nikolenko sitting in for Mark Schoenebaum. And so the question -- sorry for maybe beating a dead horse. But the question about the Q4, the current full year guidance implies that from Q3 to Q4 of this year, so year -- quarter-by-quarter growth, it's probably going to be a down quarter for revenue and for EPS. So I'm wondering if you can explain that in terms of expenses, what happens in Q4. Is it just seasonal stuff or something else? And in terms of revenue, I understand there will be a huge FX impact, but also just for FX, just to understand how it works for our models, I'm wondering if you can give more color about the type of hedging Zoetis is using for -- both for revenue, for the plan, as well as for EPS. Paul S. Herendeen: Okay. Let me -- stay with me here because I want to make sure I understand your question. I think you started by asking about sequentially from Q3 of '14 into Q4 of '14. If you take the midpoint of our range, it would be up in Q4 versus Q3. Okay. So sequentially, I mean, at the midpoint of our range, you would have an increase in revenue Q3 '14 into Q4 '14. The other thing to point out is we talked about the impact in the quarter of the increased cost of goods sold as a percentage of revenue, the implied is in the -- is going to be a high percentage and we called that out even in my prepared remarks. So you've got that. Then within SG&A, we typically do spend more towards the back half of the year. That's been a historically observed phenomenon within our business. And certainly within R&D, there is seasonality in our spend there and we talk about sort of the timing of trials that we can do in the field. You need the right conditions in order to be able to do that and the timing of projects, generally, ours have seemed to cluster and have us with more expense in R&D in Q4. You put all of those things together, yes, and then looking at Q4 on a stand-alone basis, yes, you could say, "Well, gee, the -- against whatever comparator you want to have, whether it's Q3 of '14 or Q4 of '13, it's a tough comparison." Again, strong full year expectation for the company. You were looking for reported growth in the neighborhood of 3% to 4% at the top line and that's on an operating basis taking FX out of the mix. Now this is revenue, expecting 5% to 6%. Think of that reported 3% to 4% range as -- but for FX, that's 5% to 6%, which is a very solid full year revenue growth '14 v '13. And I'm sorry, the second question? Vlad Nikolenko : And the second question about the hedging. What type of hedging do you guys use to hedge top line and bottom line, if you do. Hedging instruments, if you're using specific instruments or rely on sort of natural hedging. And if there is natural hedging between regions, what is the delay between -- when the dollar moves or currencies move and the impact that we can see? Paul S. Herendeen: Yes, a couple of things. I mean, we have natural hedges built in to markets where we have a significant presence because, of course, our costs are denominated in the same currency as our revenue streams. We do not hedge our top line nor our bottom line results. Like most companies, we don't. We are subject to, what they -- the changes in exchange rates. And frankly, if you look at them, again, my favorite phrase, over a long enough period of time, you'll see that those things sort of set -- sort themselves out. Where we do hedge is our net asset exposures in our subsidiaries. So that to the extent that we have risk when those balance sheets are translated, that we can hedge that and keep those costs within a relatively narrow band. We do, do that. Those costs as well as the FX gains or losses, would show up in our other income and deductions line within our P&L. Operator : Our next question comes from David Risinger of Morgan Stanley. David Risinger - Morgan Stanley, Research Division : So I have, first, some questions for Juan Ramón and then for Paul. So Juan Ramón, first, could you just talk about animals moving into feed lots sooner in a little bit more detail on -- specifically what I'm hoping for you to address is how durable that is. So for how many quarters will that be benefiting Zoetis? Second, you've mentioned the APOQUEL revenue for '15 being over $100 million. Could you just help us benchmark that by providing a framework for what revenue you're going to be booking in 2014 for APOQUEL? And then third, for the PEDv vaccine. You mentioned 6 million sows is the opportunity. Could you just tell us the price of the vaccine? And I think it's given twice a year, but just remind us about that as well. Juan Ramón Alaix : Thank you, Dave. And you are correct, it's 2x per year, maybe the first time, it's -- it can be an opportunity of 3 vaccines, but then the following years would be 2x. And the price of the PEDv vaccine, it's $7 -- about $7. The treatment choice, 3.5 each vaccine. In terms of APOQUEL for 2014, so we communicated that will be around 1% of our revenue. Our revenue, it's $4.5 billion or $4.7 billion. So we expect that we'll be around $40 million in terms of revenues. And this is only limited because of the supply availability. And then talking about the movement of animals and how long this movement will stay? Well, it depends on the price of the grain. So if the price of the grains are low, so the incentive of moving animals and keeping these animals in the feed lot with significant gains in terms of weight, I think, it will be an opportunity for maintaining this current situation. What we saw in 2014 is even the number of animals moving to the feed lot, maybe it will be slightly lower than the 2013 because they are less animals because they are keeping animals. Also to rebuild the herd, they have been moving animals at a younger age, which are lighter, more vulnerable to infections, more needs of vaccinations. And this has been having a positive impact in our revenues. We expect this situation of younger animals move to the feed lots will stay in the future, in 2015, because the price of feeding the animals remains very low and the profitability and the value of these animals is very high. David Risinger - Morgan Stanley, Research Division : That's great. And Paul, congrats again. My couple of questions for you are, first, when do you expect to get through the standup costs? Second, what is the FX hit to EPS that you're expecting in the fourth quarter? And then third, if the R&D tax credit is passed, what will the benefit be in the fourth quarter? Paul S. Herendeen: Okay. In -- 2 out of the 3, I can answer. Thanks, David. Well, that question about when we'll be through the standup cost, I would expect to be substantially complete towards the latter part of 2015. Let's say, the end of 2015. We will continue to be flipping switches on our ERP implementation into 2016, but the lion share of the costs should be behind us after the year end 2015. The FX impact on -- at the net income line implied for Q4 is in the range of 100 to 150 basis points negative. And then the last question about the R&D credit in Q4, if it were to be passed, it will have an impact of approximately 50 basis points to the full year rate. Operator : Our next question comes from Jeff Holford of Jefferies. Jeffrey Holford - Jefferies LLC, Research Division : I've got 2 for Paul, please. Firstly just on APOQUEL, just trying to think about contribution margins of this product as it gets towards the peak of $200 million to $300 million, which you just guided. I would assume that this is a very high margin product relative to the rest of the business, something more like a pharmaceutical contribution margin, probably -- possibly 50%, 60% or higher in terms of the operating level, if you can comment around that. And then just secondly, could you tell us if Zoetis has any kind of poison pill type measures as bid defenses? And if not, is the company intending to introduce these into 2015? Juan Ramón Alaix : I couldn't get the second question. So it's... Paul S. Herendeen: I'll get the second. Juan Ramón Alaix : So let me answer the APOQUEL. So our gross margin, has risen to 65%. And we communicated that companion animal has the highest margins in our total portfolio, followed by cattle, then swine and the lowest is poultry. So even if we have not provided details of each species, you can extrapolate that with the 65% that companion animal, being the highest, it's -- APOQUEL has a good margin. And in terms of how much we need to invest to support these product launches. So what we said is that we have the infrastructure to support the promotional activities of any new products. And maybe in some cases, we need also to support this approach probably some additional advertising and promotion. But in our opinion, in the case of APOQUEL, the reaction of the market has been so positive that we don't think that we'll require any significant additional investment to support the objective that we have set for 2015 and also the long-term objective of $200 million to $300 million peak sales. And then Paul will answer the question on the poison pill. Paul S. Herendeen: Yes. Yes, I'll answer the question by saying, with respect to your specific question around poison pill, no comment on that specifically. However, what I would say is, we're a public company. We're for sale every day and to the extend that someone were to come in and be interested and think they could do a better job with our collection of assets, there's certainly the opportunity for them to express that. What I would report back though is, we think we're the team to run this company. We're driving value for our shareholders. We're doing that by pulling all of the levers at our disposal which includes being maniacal about deploying capital both inside and, hopefully, outside of our business. And at the end of the day, if we deliver value, that's what we rely on to continue to be the fellows and ladies that run this company. Operator : Our next question comes from Erin Wilson of Bank of America. Erin E. Wilson - BofA Merrill Lynch, Research Division : Livestock growth was impressive. Can you break out what was attributable to volume, price and new products, such as the beta agonists? How sustainable kind of is that growth? And also with consolidating competitors, there could also be some opportunities to potentially fill some holes in your portfolio. What are areas that you would find particularly interesting for you, any specific therapeutic category? Juan Ramón Alaix : Well, we, in my opinion -- thank you, Erin, for the question. I think, in my opinion, we have a very strong portfolio. I believe that, that is the strongest portfolio in the animal health industry. We have always opportunities to fill some gaps, but we don't have a strategic need to really cover areas, which are important for animal health, which are not part of our portfolio. We are very strong in vaccines. We are very strong in parasiticide. We are strong in also other therapeutic areas and definitely we'll be always assessing opportunities to add more products to our portfolio. But because we think that we have the infrastructure and we have the opportunity to achieve synergies in both revenues and also in terms of costs, by adding products or adding assets of our company, but not because we have a strategic need to fill any area where we feel that we are -- or represent a significant gap in our business. And in terms of the livestock growth, definitely it has been very strong growth. Volume has been the most important part of the growth. And price, we also mentioned that the price is in line with the industry. The industry in terms of price is growing around 3% and this is consistent with our growth in terms of price. So all the rest has been volume, so very strong performance in terms of volume. That is also the result of excellent portfolio and also excellent execution from our teams to bring this as well to the market. Erin E. Wilson - BofA Merrill Lynch, Research Division : Okay. And as it relates to QUEL and the competing drug for Rimadyl, are there relationships with distributors that you could establish there and -- that would potentially help to win the competition there? And how big is opportunity for Versican? And is there an opportunity for that in the U.S.? Juan Ramón Alaix : So we definitely partner with distributors that are also helping us to reach customers that we are not calling directly to our field force. And this partnership is working very well and I think it's something we are happy with the declaration that we are having with distributors. And we will continue really providing to them the products and also the kind of support that they need also to promote the products to customers that we are not directly targeting through our direct model. Operator : And there are no further questions at this time. I would like to turn the floor back over to Juan Ramón for any additional or closing remarks. Juan Ramón Alaix : So thank you very much for joining today's call. And I'm looking forward to see you on November 18 in New York at the New York Stock Exchange, in where we'll have the opportunity to go into more details of our business model and also more details on our guidance for 2015 and also for the period of '15, '17. Thank you very much. Operator : Thank you. This does conclude today's teleconference. A replay of today's call will be available in 2 hours by dialing 1 (800) 723-2156, for U.S. listeners and area code (402) 220-2660 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,015
| 1
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2015Q1
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2014Q4
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2015-02-11
| 1.511
| 1.53
| 1.684
| 1.67
| 2.45583
| 23.08
| 24.63
|
Executives: John O'Connor - Vice President of Investor Relations Juan Ramon Alaix - Chief Executive Officer Paul Herendeen - Chief Financial Officer Analysts : Louise Chen - Guggenheim Securities Alex Arfaei - BMO Capital Mark Schoenebaum - Evercore ISI Kevin Ellich - Piper Jaffray Erin Wilson - Bank of America Merrill Lynch John Kreger - William Blair Chris Schott - JP Morgan Jamie Rubin - Goldman Sachs Jeff Holford - Jefferies Liav Abraham - Citi Kathy Miner - Cowen and Company David Reisinger - Morgan Stanley Operator : Welcome to the Fourth Quarter 2014 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 two hours after the conclusion of this call via dial-in or on the Investor Relations section of Zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor: Thank you, operator. Good morning and welcome to the Zoetis fourth quarter 2014 earnings call. I am joined today by Juan Ramon Alaix, our Chief Executive Officer and Paul Herendeen, our Chief Financial Officer. Slides presented on this call are available on the Investor Relations section of our Web site. 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 2013 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 press release and the company's 8-K filing dated today, February 11, 2015. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, John. Good morning to everyone. In my remarks today, I will discuss our 2014 performance, provide an update on the Zoetis revenue growth versus industry growth, review recent sponsor from the full portfolio and then with our outlook for 2015. 2014 was a year when we made significant progress in creating value. We are growing revenue faster than the market. We improved our margins despite absorbing additional costs required to operate as a fully independent company. We continue to advance our product portfolio through internal R&D initiatives. We communicated a 15% increase in our dividend and $500 million share repurchase program. This week, we announced that we completed the acquisition of Abbott Animal Health. We also continue to build a culture that delivers results, creates a high sense of ownership from our colleagues and focuses on generating short and long-term value for customers and shareholders. For the year, we delivered operational revenue growth of 7%, adjusted net income growth of 13%, and adjusted diluted EPS growth of 11%. Both revenue and adjusted diluted EPS exceeded the high end of our guidance. Here are some details of 2014 revenue by species on an operational basis. In livestock, total revenue grew 9% to $3.1 billion. This reflects favorable market conditions for our producers and a strong performance of key Zoetis brands across affective vaccines and medicated feed additives. Livestock markets benefited from strong meat and milk prices as well as less expensive animal feed. These generated strong producer profits and in these market producers increased the medical treatment of animals to preserve their value. This has benefited many premium Zoetis brands. Cattle grew in revenues by 10% to $1.7 billion, with exceptional growth coming from beef cattle markets like the U.S., Brazil and Canada, as well as from our China business. In some key markets we see signs that the process of cattle expansion has begun. In the near-term, the high value of animals will continue to support our growth as producers have placed their premium on the health of their herds. Swine revenue grew 9% to $695 million with strong growth in many countries around the world. New and recent protein production such as ENGAIN, DRAXXIN 25, Relan N and our PCV2 franchise continue to grow in the market that experienced challenges due to disease outbreaks and trade restrictions. Poultry revenue grew 6% to $568 million with the strong growth coming from the U.S. and Latin America. Our growth portfolio in poultry, integrated coccidiosis management programs, namely ropic brought value to producers and led to increased customer penetration in key markets. Turning to companion animal, revenue grew 4% to $1.6 billion. Across all regions we saw strong growth of key brands, including APOQUEL, ProHeart 6, CONVENIA, CERENIA and feline REVOLUTION. These gains were partially offset by declines in the vaccines and RIMADYL due to increased competition. For 2014, APOQUEL achieved sales of 34 million in an environment of constrained supply. For 2015, we are on track to increase supply in [etrin] and we expect APOQUEL revenues to be between $150 million and $175 million this year. Building on several years of solid revenue performance, we continue to deliver stronger revenue growth in 2014. We are also pleased that Zoetis continues to outpace the animal health industry. According to the latest data, for the 12 months ending Q3 2014, Zoetis revenue grew 5.5% while the animal health market grew by 4.6%. This growth includes the negative impact of currency movements. The steady interaction of our new products and investment in life cycle management contributed to steady revenue growth. In 2014, Zoetis achieved more than 180 product approvals, representing new products, new indications, new formulations, new combinations and geographic expansion of our portfolio. We recorded several important product milestones in recent months. This past November Zoetis submitted to the FDA a filing for zoromandis, which is the active ingredient of our new flea and tick oral parasiticide for dogs. And last month, we completed the filing for the same product in the EU and Canada. The global market for flea and tick parasiticides is about $2.5 billion to $3.4 billion. And launching a new product in this category is an opportunity with broad bacteria potential for Zoetis. Although bacteria for the animal health industry is generally prone to generating more than $100 million a year. Now let me turn to another milestone that illustrates continued integration from our R&D investment. We are pleased to announce that Zoetis has submitted a filing to the USDA for a novel antibody therapy to treat atopic dermatitis in dogs. Based on the USDA guidance, we are expecting a conditional license this year. Our progress in this therapeutic area further reinforces our industry leadership innovation. We have been active in building a platform in monoclonal antibodies that will have a broad application across species and medical conditions. The first potential product from this platform builds on our knowledge base in the area of canine dermatology. We are excited to bring another treatment option to veterinarians. In addition to novel products, Zoetis continues to drive demand and strengthen its diverse product portfolio through investments in product life cycle development. This past November, the FDA got a new label claim for DRAXXIN 25 in the U.S. to treat smaller cats. This follows the approval of DRAXXIN 25 label claims for pigs in July 2015. We also achieved additional label claims for the FOSTERA PRRS and vaccine for swine which is now licensed in the U.S. for reproductive protection. This product was first approved for respiratory protection in 2012. Zoetis PEDv vaccine continued to expand geographically, receiving permission to import and sell in Canada. Zoetis also launched the vaccine in China which broadens our range of vaccines in the world's largest swine market. As I mentioned, we just closed the purchase of Abbott Animal Health. This business is focused on the veterinary surgical market. It will strengthen our pain and sedation product portfolio and expand our diagnostic business. This acquisition is aligned with our value creation strategy to enhance our portfolio. We are adding leading brands and we believe Zoetis is gaining industry leading field force. I know at present we’ll expand both the reach and penetration of the new portfolio. Zoetis also invests in animal health innovation through research partnerships. We recently announced that Zoetis was chosen to lead a research team to develop digital technologies for improved swine health and production efficiencies. Paul will address our 2015 guidance later in the call, but I would like to give you our perspective on the animal health industry on some factors that will drive Zoetis in 2015. The animal health industry is forecasted to grow in the 5% to 6% range operationally over the next five years, with growth in any given year above or below these rates. Looking to 2015, we expect operational revenue growth for Zoetis to keep pace with or outpace the animal health market. We also expect adjusted net income to grow faster than revenue as we leverage our business model and continue to focus on improving cost efficiencies. Now, our perspective by species; the outlook for companion animal is positive. Increased pet ownership and higher pet expense rates are driving the growth in emerging markets while specialty care is contributing to growth in more developed markets. For Zoetis, we must expect that the sales of APOQUEL will have a positive impact on growth in this segment. The outlook for livestock in 2015 is also positive. Producers will remain very profitable although at lower levels than in 2014. For Zoetis our premium products will remain an important factor to protect the health and value of livestock animals. And the line the ban for animal health products that remain strong, despite economic events such as lower growth in GDP, significant movements in the exchange rate, lower oil prices or international trade developments. We are monitoring the current business environment and all the exchange rates we don't see any significant impact on our business from these factors. As the past has shown again we'll have industry resilient to these and other microeconomic factors. Within the industry, Zoetis is highly diversify across many dimensions and this diversity has allow us to successfully manage through many market conditions in the past. The drivers of growth in animal health remain unchanged. Animal proteins and companionship from pets are basic needs, so we are confident about the future prospects and our ability to grow under volatile market conditions. So, I will now turn it over to Paul to talk about results for the fourth quarter, the year and guidance for 2015. Paul Herendeen : Thank you, Juan Ramon, and good morning, everyone. Thanks for joining us. I am going to review our performance compared with our full year 2014 guidance, provide some color on the fourth quarter results and update you on our full year guidance for 2015. I hope to do all that quickly so that we have plenty of time for Q&A, so here we go. Starting with full year 2014 results, the big stories here are revenue, revenue growth and revenue growth from a variety of sources. In 2014, we delivered 7% operational growth in revenue, the second consecutive year of 7% operational growth and second consecutive year of growth above the long-term industry trend. Pretty good, right? Even better, in the fourth quarter we delivered 9% operational growth versus Q4 of 2013, overcoming some significant FX headwinds to post 5% reported growth with positive operational trends that are heading right into 2015. Changes in FX rates reduced our Q4 reported growth rate, but we were able to overcome that and still put a solid growth number on the board. Good stuff indeed. Since mid-November FX rates have continued to move against us. I will help you think about the impact of FX rates on 2015 in a minute. Now for a look at our full-year performance versus guidance. As you can see on the Web cast slides, our revenue of 4.8 billion exceeded the high end of our expectations. The operating growth of 7% was driven by 9% growth in livestock and 4% in companion animal. On a regional basis, the U.S. accounted for almost half of our growth, up 8% compared with 2013. CLAR accounted for about third of our operational growth, up 13%. APAC was about 11% of our operational growth, up 5%, and EuAfME accounted for about 8% of our operational growth, it was up 2% versus 2013. But in going to belt, and all growth rates are on an operational basis. Continuing with 2014 performance compared with our guidance, our adjusted cost of sales as a percentage of revenue was 35.1%, a bit better than our guidance of 35.5%, and that's primarily due to the positive impact of changes in foreign exchange rates. Adjusted SG&A meanwhile, was 1.507 billion for the full year, approximately 27 million higher than the top end of our guidance range. There were a number of factors that contributed to the increase in SG&A above expectations. First, as we trended above our revenue forecast for the latter part of the quarter, we saw an increase in costs associated with higher revenue, such as sales incentive compensation and distribution expenses. We also authorized additional promotional spending in the quarter, spending that is expected to support revenue growth into 2015. Next, we accelerated some actions in Q4 that triggered additional G&A expense in the quarter, including for example, severance, software license expense and some additional business development expenses. As successful as we have been in driving our top line, we are still a young Company, just finishing up our second year on our own. We have plenty of work remaining to build and fine-tune our G&A organizations and the systems needed to support our global business model. As that process continues, there will be opportunities to move forward and towards a more efficient cost structure. In other items, adjusted R&D expense came in at 393 million, in line with our full-year guidance. This continues to be an essential investment for both developing new products and managing the life cycle of the more than 300 product lines that provide us with our durable and growing revenue streams. Our adjusted effective tax rate for the full year was almost 27%, and 18% in the fourth quarter. This reflected the full-year impact of the R&D tax credit which, you will recall, was not anticipated in our guidance. Also contributing to the lower-than-expected tax rate was a resolution of prior tax matters and changes in the mix of our earnings. It's important to know that the elements that drove the rate down below our and your expectations were not structural and we continue to expect that our tax rate in 2015 will be approximately 29%. As with our 2014 guidance, our tax rate guidance for 2015 does not include the potential benefit of an extension of the R&D tax credit. We exceeded the top end of our guidance for adjusted diluted EPS by $0.03 a share, posting $1.57 per share for the full-year. This was due to the strong revenues and the lower-than-expected tax rate, offset in part by increased spending in the fourth quarter And finally, we exceeded our range on certain significant items and acquisition-related costs for 2014. This was the result of costs associated with certain shareholder activities and some changes associated with our global manufacturing organization. As a result, our reported diluted EPS came in at $1.16, the lower end of our guidance range. Now let me switch gears and dive a bit more into the fourth quarter results. You can see our income statement and adjusted income statement slides on our Web cast. Repeating from my opening remarks, fourth quarter revenue grew 9% operationally and 5% on a reported basis. And while nine minus five equals four, there is some rounding in there so the negative impact of currency movements on our growth rate was roughly 330 basis points. Our U.S. and CLAR segments demonstrated strong double-digit sales growth, leading the way for Zoetis , while the APAC segment grew modestly and EuAfME declined 1% on an operational basis. On the last call I talked about the hazards of reading too much into any one quarter in isolation. EuAfME illustrates that clearly. In Q1 revenue was down 4% operationally and in Q2 revenue was up 4% operationally. In Q3 was up 12% operationally in Q4 it declined 1%. But for the year, operational growth for EuAfME was about 2%, broadly in line with the long-term expected growth rate for that segment. Moving to SG&A. Our adjusted SG&A expenses in the fourth quarter were up 14% operationally due to the timing of promotional spending and other items that I called out earlier in my discussion of the full-year. Our adjusted R&D expense was up 4% operationally in the quarter. R&D, as I had noted before, can vary quarter to quarter due to the timing of clinical trials and other factors. For the full year we performed in line with our guidance. And finally as I mentioned earlier, our catch rate in the quarter was 18%, due to a number of factors that got worked out in the fourth quarter. You also have a full set of regional tables and quarterly commentaries in the press release and Web cast slides. With that material available to you, let me just highlight a few takeaways on the revenue and profitability for each segment. Beginning with the U.S., fourth quarter revenue increased 14% driven by very strong livestock sales, which were up 19%, a truly stellar quarter for the largest segment of our business. The growth in livestock products, especially cattle in United States was based on higher demand for our premium products as producers continue to benefit from strong market conditions, some of which Juan Ramon just touched on. In companion animal products in the U.S., we generated growth of 7% driven by APOQUEL and other key brands, and despite continued competition for RIMADYL and competitive pressure in vaccines and parasiticides. Based on the U.S. segment strong sales and lower relative expense growth, their segment earnings increased by 20%. In Europe, Africa and Middle East, revenue decreased 1% on an operational basis compared with the fourth quarter 2013. This was the result of revenue increases in Southern Europe and Germany, driven by livestock as well as APOQUEL sales in the UK and Germany, with those increases more than offset by declines in other markets such as France and Russia. In France, we had anticipated some softness in the fourth quarter based on the fact that customers bought large amounts of anti-infectives in the third quarter ahead of more restrictive legislative changes that went into effect January 1st. The EuAfME segment earnings decreased by 4% operationally in the quarter, primarily due to declines in revenue and the timing of promotional spending. Moving to CLAR, which is our Canada and Latin American segment, we generated an increase of 16% operationally compared with the fourth quarter 2013. Brazil and Canada are the principal drivers in the CLAR region, given their relative size, and we saw growth in both livestock and companion animal products in these two countries. In Canada we saw significant cattle product sales due to strong market conditions for producers. Increased medicalization rates for companion animals in Brazil have been a driver of growth there as well. We also saw strong growth in Venezuela and other emerging markets in Central and South America. These high inflationary markets afford attractive growth opportunities that need to be carefully monitored. The CLAR segment earnings increased 20% on an operational basis, driven by the revenue growth and limited growth in operating expenses. Finally, in Asia Pacific we had an increase of 4% operationally compared to the fourth quarter of 2013. Sales of livestock products did well, particularly in Australia, Southeast Asia and across the board in emerging markets. A growing vaccine portfolio for swine and new parasiticide products continued to drive our performance there. Sales of companion animal products, however, declined 6% operationally, primarily due to the termination of a distributor agreement in Japan that we talked about last quarter. The APAC segment operating earnings increased 6% operationally due to the revenue growth and limited growth in operating expenses. Now let me turn to guidance for the full year 2015, which we first provided at our Investor Day in mid-November. We’re updating certain elements of our full year guidance today to reflect three things. First, a factor over which we have no control and that’s FX rates. We're adjusting our guidance based on the changes in foreign currency exchange rates from mid-November when we first reported our guidance for 2015 to reflect rates as of late January. In those roughly 70 days the U.S. dollar strengthened against almost all of the major currencies in which we transact. For emphasis and in round numbers, the dollar was up 9% versus the euro, 8% versus the Canadian dollar, 8% versus the Aussie dollar, 4% versus the British pound, 1% against the Japanese yen and against the Brazilian real it was flat. Those are our top six currencies. The movement in exchange rates since mid-November reduced our revenue expectations for full year 2015 by 125 million or 255 basis points, based on the midpoint of our initial guidance range. We now expect the full year impact of FX to be about 600 basis points or almost 300 million on our full year 2015 revenue as compared with our 2014 actual results. I want to repeat that for emphasis. Since mid-November the change in FX rate reduced our expectations for the full year 2015 by 255 basis points or 125 million, comparing our revised expectations for 2015 back to 2014 actual results, the changes in FX rates account for a 600 basis point reduction in our expected growth rate. So natural hedging from expenses denominated in foreign currencies reduces the dollar impact of the movements in FX at adjusted net income, where the negative impact of the change rate was roughly $30 million or roughly 360 basis points down from the midpoint of our initial guidance range. Something for you to be aware of, if the U.S. dollar continues to strengthen against our major currencies, that can put upward pressure on our effective tax rate. At this point, we are affirming our guidance for our tax rate at approximately 29%, not including the R&D tax credit. But for emphasis, I am going to repeat something I just said, continued strengthening of the U.S. dollar could cause us to have to revisit that guidance. So that's another part we can monitor but don't control. The part we can control are our operating expenses in 2015. In addition to the expense reductions driven by the change in FX rates, we revised downward our range of expectations for SG&A expenses by an additional $35 million. This reflects targeted reductions in spending intended to help offset the FX impact on 2015 adjusted net income. Additionally we completed the acquisition of the assets of Abbott Animal Health this week. With that done now, we will begin integration and expect a positive impact of approximately 75 million to revenue for our full-year 2015 results, an accretion of $0.01 per share to adjusted diluted EPS for the full-year 2015. Taking the FX rate changes and our reduction of expected SG&A into account as well as the Abbott transaction, our revised guidance calls for revenue in the range of 4.8 billion to 4.9 billion and results in our holding our guidance for adjusted diluted EPS in the range of $1.61 to $1.68 per share. The net $50 million reduction in the revenue range represents a roughly 125 million, or 2.5%, decrease driven by the change in the FX rates. Meanwhile, the combination of the natural FX hedges inherent in our business and our targeted $35 million of OpEx reductions and the overall impact of Abbott, all those things combined enabled us to maintain our earlier adjusted diluted EPS guidance for 2015. While we provided out guidance in November, we expressed growth targets based on the midpoints of our 2014 guidance ranges. With 2014 now final, it won't be freshening the growth rates implied by our guidance. The more significant revenue base that we delivered in 2014 and our guidance as revised today to include Abbott and the expected expense reductions, we are expecting revenue growth on an operational basis in the range of 6.5% to 8.5% and growth of adjusted net income in the range of 11% to 16%. All the other details of our guidance are included in the table attached to our press release. Please note that our guidance does not reflect any future currency devaluation in Venezuela. While we do not guide on a quarterly basis, I will remind you of a comment I made at our Investor Day in November about the trajectory of our overall performance in 2015. We still expect the year to start low and end high. A key driver of our growth in 2015 will be the additional supply of APOQUEL, but we will not see that supply increase until Q2. I also want to note that the revenue impact of the Abbott acquisition in Q1 is nominal, less than $5 million. And that there will be a negative impact on reported Q1 results based on the changes in FX rates since my comments in November. To sum up the quarter and the year, we continue with very strong revenue and earnings growth, demonstrating the strength of our global business model. The diversity of our business across species, product lines, geographies and therapeutic areas is one of our core strengths. Our global footprint enables us to overcome weaknesses in some regions and deliver consistent revenue and earnings growth. We demonstrated an ability to drive gross margin improvements and operating expense containment in our regional statements, while continue to absorb some of the impact and buildup of costs for our corporate functions. Foreign currency was a significant factor on our reported results in the quarter and for the year, and we have updated our full-year 2015 guidance based on the rates in effect as of late January 2015. We expect to deliver strong revenue and profit growth on an operational basis in 2015, 6.5% to 8.5% for revenue and 11% to 16% for adjusted net income. While the currency headwinds are expected to be a drag on our reported results and growth rates, we have taken steps to mitigate some of those impacts and will continue to pursue means of protecting and growing our adjusted net income throughout the year. That concludes my prepared remarks and we'll now open the line for your questions. Operator? Operator : (Operator Instructions). Our first question is coming from Louise Chen, with Guggenheim Securities. Your line is now open. Louise Chen : My question here is since it's hard to find good companies to comp Zoetis's operating margin to, could you provide us a framework for thinking about where Zoetis's operating margin could improve to over the longer-term, beyond the 30% that you had forecasted at Investor Day? Juan Ramon Alaix : Thank you, Louise, for the question. So we are convinced that now that we are finishing our work in standing up Zoetis on implementing new systems that will support our future operations, we can really identify opportunities for being more efficient in many lines of our P&L. That is something that we will continue in define business opportunities and seeing ways of improving our margins in the medium and long term. Operator : Our next question comes from Alex Arfaei, with BMO Capital. Your line is open. Alex Arfaei : Good morning and congratulations on a strong quarter. Juan Ramon, you mentioned strong market conditions and profitability in the livestock market. Clearly a key driver here, can you clarify on your outlook, when you say you expect this to continue in the near-term, what is the timeframe you put on that one-year or two-year? I want to get a sense of how long you think the cycle will last? And Paul, a follow-up if I may, you got a significant FX benefit on cost of goods sold this quarter. You lowered revenue guidance because of FX. I am just wondering why not raise gross margin guidance to reflect an FX benefit? Thank you. Juan Ramon Alaix : Thank you, Alex. In my comment I refer to the outlook was in for this year. So, we mentioned that in 2014, the conditions in livestock were very positive; the price of milk and meat was very high. Also there were low costs on feeding the animals. We expect that most of these conditions will remain in 2015, although we see maybe in some of the species like swine, maybe a lot of more attention in terms of price because of more supply of product. Since some of the rates that were affecting 2014, maybe we’ll have a lower impact in ‘15 like the PEDv outbreak. So, we expect that the conditions will remain favorable, although for some of the species, maybe less profitable than in 2014. Paul Herendeen : Thanks for the question, Alex. I'll take the question regarding the FX benefit that flowed through cost of goods sold. I want to point out that the timing of the way FX flows through our cost of goods sold is somewhat difficult to predict and also when you recognize it as we did in 2014 that does not necessarily translate into a continued benefit flowing through in 2015, point of fact that could very easily turn around on us on a reported basis. Operator : And we’ll take our next question Kevin Ellich with Piper Jaffray. Your line is open. My apologies, we actually have Mark Schoenebaum. Line is now open with Evercore ISI. Mark Schoenebaum : Also my congratulations to Paul on a great job since you've taken the reins as CFO and to John on the IR front. Just a question on, I'm intrigued by your comments around your antibody platform. I haven't heard you talk about that before. You gave a little bit of detail during your prepared remarks, but I'd be interested in knowing more if possible, like how broad this program really is. Are you pursuing antibodies outside of companion animal dermatology or should we think of this is mainly a derm program? And the impact, if any that you think this antibody program will have on your P&L once commercial. Gross margins on the human health side tend to be a bit lower on antibodies than they are for small molecules. And then also of course on a CapEx -- long-term CapEx projection, sometimes building plants capable of producing large quantities of biologics can be expensive. I am wondering if that's already something that you've got your footprint or if these products are going to be big, we should be altering our models to some degree? Thanks a lot. Juan Ramon Alaix : Thank you, Mark. The monoclonal antibody that we mentioned today, it's a product that we neutralized the canine interleukin, which is also a key cytokine which is involved in the atopic dermatitis and also involved in sending the signs of itching to the brain of the animals. We have been investing in biopharmaceuticals for now several years. And we have been also introducing the products in these categories, not only on antibodies but on biopharmaceuticals. A good example is Improvac that was launched some years ago. And we also focus our attention to platforms that we also increase, the product portfolio that also will meet the demands of the market. We are very pleased that Zoetis is not only leading in pharmaceuticals, we have many examples like APOQUEL, that we've shown very strong leadership in that category, but also in vaccines. In 2014, we had the opportunity also to bring to the market a solution for an outbreak that it was a highly significant impact in the swine industry in the U.S., I am referring to the PEDv vaccine. And now we have used monoclonal antibody, we’re also showing that also we are leading in biopharmaceuticals. We're very pleased also that our model, which is combining investment in innovation with investment in the protecting of our current portfolio is showing a high level of productivity and leading the industry in all different areas of innovation. Paul Herendeen : Mark, it's Paul. First, thank you for the kind words. Yes, I had the very good fortune to join an outstanding team here. So, while I’ll take the complement, I'd also say that it's a team game here. I also want to pile on a little bit on the R&D front, because from an investor perspective I kind of think of Zoetis is kind of like two-in-one. You have a large growing portfolio of existing business and we also have this robust R&D engine, that if it were on its own, would represent an attractive investment opportunity in its own right. So great question, thank you. Operator : We will now take a question from Kevin Ellich, with Piper Jaffray. Kevin Ellich : Given your strong operational growth, I was just wondering if you'd break out the difference between volume and what type of pricing increases you are pushing through. And then could you maybe talk about the performance of some of your new products like ACTOGAIN and ENGAIN, and if you'd noticed any significant market share. Juan Ramon Alaix : Paul will answer the first part of the question and then I will make some comments about the new product launches. Paul Herendeen : I will speak to the history because that's what we can do with respect to price and volume. Let's start with the quarter. We had total growth, as I said, operational growth 9%. Of that 9%, roughly 2% came from price and 7% came from volume. So strong in the quarter. Take that for the full-year, 7% operational growth. Again, 2% came from price and roughly 5% from volume. We got a lot more pricing leverage in emerging markets than in developed markets. I don't know if it's all that productive to go through the specifics of it, but I hope that, in general, answers your question. Juan Ramon Alaix : Then back to your question on ACTOGAIN or ENGAIN. Both products performance are doing well and exceeding our initial projections. One of the factors that has been also impacting the higher revenue than expected, it was withdrawn off of one competitor product one year ago. So very pleased, with also the acceptance of our two products from customers, and these two products, ENGAIN is for the swine producers and ACTOGAIN for cattle producers. Both performing above expectations. Operator : Our next question comes from Erin Wilson, with Bank of America Merrill Lynch. Your line is open. Erin Wilson : I was reading some of the literature on APOQUEL on the Web site and it continues to say that April's launch time frame or replenish supply. Will this be the same? Will it be fully ramped up that point? Or will there still be order limits in place over the course of the year? Is this all Incorporated into your guidance at this point? And then on new products, could you speak to the opportunity in diagnostics, any attraction you're seeing with your feline rapid assay? Is that an area you expect to build as to acquisitions? Do you anticipate any product launches in diagnostics overall? Juan Ramon Alaix : Thank you, Erin. On APOQUEL, definitely we expect that from April we'll increase significantly the production of the product, or the product availability to the veterinary market. We expect that from April we will be able to meet all the demands from the customers. And we expect also that through the year, demand will increase and then we will be able to supply all these demands with the product that will be available. As I said in my remarks, we are forecasting for 2015 revenues from $150 million to $175 million. And we are convinced that this will be a significant quality in our portfolio, and we are very pleased that all the constraints that we face in 2014 will be over in 2015 from April. In terms of diagnostics, the diagnostics has been always -- since some years ago an area and where we have been also investing. We are convinced that this very complementary to our current portfolio and we also expect that with our internal efforts and also the acquisition of Abbott Animal Health, this will enhance our portfolio and definitely we will also consider any external opportunity and even further expressing our portfolio diagnostics. Paul Herendeen : It is Paul just a follow-up a little bit area. So the modelers out there and I know there are plenty, with respect to APOQUEL, we get through the first quarter and when we have supply we would expect a stair step for sales of APOQUEL and then with growth to follow. So I hope that provides a little better color. Operator : Our next question comes from John Kreger, with William Blair. John Kreger : Juan Ramon you mentioned the new oral flea and tick product that has been filed. Do think that will be in a position to be fully launched by spring 2016 season? And then a quick second question I believe on Investor Day you talked about efforts to optimize your manufacturing. Program, which I know is big and complex around the world. Can you just give us an update on the timing for that broader effort? Juan Ramon Alaix : We expect [indiscernible] to be available sometime in 2016, which will depend on the approval from the FDA as well as the approval from EMA in Europe. And also in Canada also we expect approval. And we are working to make sure that the product will be available for the next parasitic campaign in April or around spring next year. Something that it will depend on FDA, but we expect to provide to FDA all the information needed to get this product approved on time. In terms of manufacturing, we mentioned during our Investor Day that from now until 2020, we expect an improvement in our cost by 200 basis points. And plans are moving ahead. And there is no any reason to think that we’ll not be delivering on the objective that we have. Now also we mentioned that we have three phases of our plan. We are now on Phase 1, in this Phase 1, we’ll be delivering these 200 basis points, then we’ll go into the next phase that we’ll be going to further analyze our plan network and then finally the third phase will be how we need to invest in manufacturing to achieve higher profitability or lower cost and also making sure that we have the technologies that will be needed to support our future revenues. Next question please. Operator : Our next question comes from Chris Schott with JP Morgan. Your line is open. Chris Schott : Just to two quick ones here. First following up an earlier pricing question, can you just elaborate a little more on the drivers of pricing particularly on the production side of the business? I guess specifically is there more opportunity to selectively raise or reset price when you see healthy market dynamics that we’re seeing for your customers in the current environment? And second with just a broader business development kind of question, in area I think we all have a little bit less visibility into, but when you look at these Abbott type transaction that seem to make a lot of sense for Zoetis. How broad is an opportunity effect do you see on the business development front and given some of the anti-trust issues in the space are there realistically larger targets that Zoetis could pursue or should we really think of Abbott type transactions being the real focus here? Thanks very much. Juan Ramon Alaix : In terms of pricing, the approach that we have for both like livestock and companionable is to have steady and consistent price increases. We are not trying to get the opportunity of higher prices when the conditions are more favorable to livestock producers. And at the same time, we also apply pricing increases with these conditions as less favorable. So is -- and study that has been working very well and a study that has been extended to many markets around the world including emerging markets. And we had in 2014 very positive improvement in our prices in many of these emerging markets. In terms of really definitely Abbott was a great opportunity that it was meeting all the requirements that we have in terms of business development opportunities including the strategic field, including the synergies, revenues and cost, also the financial value and the anti-trust issues. Definitely we have significant market-share, you know that we have market-share which is close to 20% and these may have some intentions in terms of a larger acquisition. We’ll consider any opportunity that is available in the market. We have a team that is aware of any kind of potential transaction that can be an opportunity for Zoetis and we will continue assessing these opportunities and as part of the evolution, we include any kind of anti-trust challenge, but we’ll limit the value of the acquisition. Next question please. Operator : Our next question comes from Jamie Rubin with Goldman Sachs. Your line is open. Jamie Rubin : Sorry about that, can you hear me? Sorry about that guys. Had a little technical difficulty on my end. Juan Ramon, can you tell you what do you think is on the agenda as a new Board member? Is the agenda more related to margin improvement or is it business development? And as a follow-up, can you remind us of the agreement with Pfizer and how it would impact a potential sale of the company, is Zoetis too large for an acquisition by a competitor or would it have to be acquired by company with essentially no animal health presence? Thanks. Juan Ramon Alaix : Thank you, Jamie and let me start saying that we have very constructive dialogue with Pershing Square, since they became the largest shareholder in the fall. And they were -- they expressed interest in having a position in our board. And given that the Mr. Doyle has a lot of operational experience and again the position of Pershing Square in our company the Board agreed to incorporate him into our Board. So, what we -- all the Board will be working including Mr. Doyle and other members of the Board, increasing the value to our shareholders. And this value can come from many different ways. Including margins, growing revenues and any kind of potential transaction. And this is something that will be part of the discussions and maybe at this point may be stipulated is not creating any additional value to the discussion. Operator : [Operator Instructions] We can take our next question from Jeff Holford with Jefferies. Your line is open. Jeff Holford : Hi thanks very much for take my question. Going back to APOQUEL. Your 2015 guidance and commentary does suggest much higher peak sales and you get to full penetration to this so one could think of this product potentially adding 5% to 10% against your current base of revenues over the next couple of years. And I'm interested also around the level of margin seem a much higher margin product than the rest of the business overall. Could the potential bottom line impact from this product be a most double what it is that the top line? Juan Ramon Alaix : Thank you, Jeff. On APOQUEL we mentioned our peak sales are predicted between 200 million of 300 million and these based on the current knowledge of the market. Definitely we will be updating these peak sales based on what will be the reaction and the consumption of the public once the product it is available. In over quantity to assess what is the full potential of this compound. In general, we are not providing gross margin by products, but as you know we have gross margin in our Company of 65% and we rank margins depending on the categories. The highest margins are coming from companion animal followed by cattle, swine, and poultry. So you can imagine that companion animal much higher than the 65% average that we have at the Zoetis . Paul do you want to add any other comments? Paul Herendeen : Sure, just one that is the increased sales of APOQUEL certainly help. Of course we do have a mix of our portfolio for example the guidance table you all saw the addition of the Abbott assets to our total 2015 expectations. The Abbott assets are gross profit dilutive. Now I know they are only updated guidance for 75 million of sales but we do have a portfolio so even when things like APOQUEL help, there are other parts of our portfolio that can help smooth or help – they tend to smooth that out back towards our expected 35.5% to 36% -ish range of revenues in for 2015. Operator : And our next question comes from Liav Abraham with Citi. Your line is open. Liav Abraham : I am just looking back to cost efficiencies you mentioned this a couple of times during the call. Can you go into little but more detail about the opportunities that you see here in which cost categories and over what time frame? Paul Herendeen : It is Paul. I will take a stab at that and Juan Ramon may want to come in as well. Louise asked a question earlier on about margin expansion and I just want to point out that so far, we've done a pretty good job over the course of the last several years if you have looked at our reported operating margins going back to 2011 and up to ’14 and it's been a nice progression from ’18 to ’21 to ’24 to ’25 and I was broadly by rolling the top line while having some expense discipline meaning holding the line on expenses. Now a wise man once said to me it’s not all that impressive to grow into an expanding margin but I would say it may not be impressive but it is a good thing. That said, that what sets the stage. Even with respect to think about our 2015 we saw some headwinds in FX and we took some actions with respect to our operating expenses in order to be able to as best we could without impacting our business model reduce our expected operating expenses for 2015. The areas where we are most likely to have long-term opportunity are those areas that are away from revenue production and R&D and manufacturing. And manufacturing would be more efficient to that process as we would hope to disclose to the market at some point in the future. In the area really is around those into recall enabling functions in G&A, we are still in the process of our standup. I know that is frustrating to a lot of people where we just really completed our second year on our own. We continue to have challenges in implementing systems and building out the infrastructure that will enable us to grow and control and manage what is a very complicated global business. As we make progress along the lines of the implementation for example of our global ERP package SAP, it will give us opportunity to be more efficient in our enabling functions. Now, we look at all types of expenses and I would say -- I do say constantly in investor meetings, we can always do better. So, we want to look at ways that we can deploy our capital within our business to the areas where we think we’ll get the most bang for our buck, and to the extent that we are successful in doing that over the next several years, we expect that we can expand our operating margin potentially beyond what you would be -- or what would be implied by our current long-term guidance. And to refresh for everybody what we said on Investor Day was, you look out to 2015, '16, and '17 based on what you have in front of you, is you have a company that can grow from now roughly 25% operating margin and add 500 basis point so that by growing revenues and being disciplined with respect to expense. We see opportunities to be more efficient, that would survey be additive to that. Next question please. Operator : (Operator Instructions) And we can take our next question from Kathy Miner with Cowen and Company. Your line is open. Kathy Miner : Just two quick follow-ups if I may. First on the stand up cost and ERP spending that you were just discussing. I believe the last time you had talked about those costs winding down the early part of 2016 can you give us an update on the timing? And second one on the oral flea and tick products, when it does come out, should we expected to be differentiated in any key ways from the products that are already out there? Thank you. Paul Herendeen : The timing on that was that we would expect to be fully up on SAP by the end of the first quarter of 2016. So 2015 is a busy year for us in that regard and we’ll still have some work in the early part of 2016, but we would expect to put that behind us in early 2016. Juan Ramon Alaix : And about Sarolaner that is our compound, the active ingredient of our new oral parasiticides for ticks and fleas, we are still working on the label. The label is not yet finalized and not approved. And we’ll see how this is hit it's from competitors. And we know that there are already several competitors in the market, but as I said in my comments, it's a market of 2.5 billion to 3 billion. So it's a plenty of opportunities for Zoetis even in phase of several competitors. The other important point is that we have the access to the customers. We have a significant presence in all the markets, but the product will be available and the opportunity will be significant. And we are convinced that the vision of the model that we have which is our direct interaction with customers also will generate good revenues out of this product even with more or less differentiation in the market. Next question please. Operator : We’ll now take a follow-up from Jamie Rubin with Goldman Sachs. Your line is open. Jamie Rubin : Hi, you may have missed my second part of my question if you could remind us of the agreement with Pfizer and how it impacted potential sales to the company? Thanks. Juan Ramon Alaix : Yes, thank you, Jamie. While this agreement it's an agreement that its part of the tax matter agreement for which there are some restrictions until June 24. After this time there will be no restrictions but even with these potential restrictions until that date, there also maybe opportunities for company's considering transactions which are not affected by this tax matter agreement. Next question please. Operator : Our next question comes from David Reisinger with Morgan Stanley. Your line is open. David Reisinger : Thanks very much and congratulations to the team on the strong quarter. My question is on SG&A and I guess there are a few sub parts to it and it really relates to the cross currents. So, in the fourth quarter SG&A was above expectations, yet for 2015 SG&A will be below expectations. So with respect to the fourth quarter, were there any one-time or unusual items in the non-GAAP SG&A, Paul that will not repeat in the fourth quarter of 2015? And then second on the 2015 SG&A outlook coming down $35 million, does that include any sales force rationalization and if not, what are the areas of cuts? Paul Herendeen : Yes sure, I’ll start with the SG&A in Q4, David. There were as I articulated in my prepared remarks there are some of those cost that were directly related to increase revenue. There were some dates when we get to a certain point in revenue, where we have released additional promotional spending that occurred in Q4 that might not be likely to complete unless we are trending well above our expectations again in Q4 of 2015. So I wouldn’t describe the items in there so much as one time. This is the ones that are within our adjusted SG&A. They were expenses that in large part were managed by us in the quarter, and reflect a robust revenue quarter for us and looking ahead to 2015. Thinking about the SG&A for 2015, full-year, we did reduce the range by some $35 million and no, it does not reflect any sort of a restructuring or anything. Evidence of that is if it had been a restructuring we probably would have called out in one-time cost and certain significant items restructuring charge. This was -- what I will call a normal course of business, looking at 2015, looking at where we are relative to where we want to be in us taking actions around categories that we do not think will influence that top line. So by definition, away from revenue generation mainly in enabling type functions. I hope that answers the question. Next question please. Operator : There are no further questions. At this time I would like to turn the program back over to Mr. Juan Ramon for any additional or closing remarks. Juan Ramon Alaix : Thank you for joining us today. On our fourth quarter results total year for 2014. And our guidance for this year. So thank you for joining us. Operator : Thank you. This does conclude today's teleconference. A replay of today’s will be available in two hours by dialing 1 (800) 695-2185, for U.S. listeners and (402) 530-9028 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,015
| 2
|
2015Q2
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2015Q1
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2015-05-05
| 1.56
| 1.592
| 1.691
| 1.717
| 2.81739
| 26.16
| 27.66
|
Executives: John O'Connor - Juan Ramón Alaix - Chief Executive Officer and Director Paul S. Herendeen - Chief Financial Officer and Executive Vice President Analysts : Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division Kevin K. Ellich - Piper Jaffray Companies, Research Division Christopher T. Schott - JP Morgan Chase & Co, Research Division Erin E. Wilson - BofA Merrill Lynch, Research Division Alex Arfaei - BMO Capital Markets Equity Research Mark J. Schoenebaum - Evercore ISI, Research Division Jami Rubin - Goldman Sachs Group Inc., Research Division John Kreger - William Blair & Company L.L.C., Research Division Kathleen M. Miner - Cowen and Company, LLC, Research Division Liav Abraham - Citigroup Inc, Research Division David Risinger - Morgan Stanley, Research Division Operator : 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. John O'Connor: 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 for 2015, '16 and '17. During the first quarter, we generated operational growth of 6% in revenue and 14% in adjusted net income, delivering adjusted diluted EPS of $0.41 per share. During the quarter, half of our operational growth or 3% was attributed to price. New products, such as ACTOGAIN an acquired product from Abbott Animal Health, accounted for 2% while in-line products contributed to 1% of revenue growth for the quarter. As a note, all the following growth rates that I will discuss are operational. In livestock, we grew 7% to $715 million with all species contributing to growth. Cattle revenue grew 7% to $397 million with favorable market conditions in the U.S. and Brazil driving growth across the portfolio, while weather and reduced herd size led to declines in Australia and New Zealand. Swine revenue, which grew 13% to $170 million, is benefiting from increased herd size in the U.S. after a winter of lower piglet mortality from PEDv plus positive industry momentum in the CLAR region. Poultry revenue grew 1% to $129 million as the U.S. reintroduction of Zoamix, a medicated feed additive, helped to offset a negative impact from the timing of product rotations in several countries. Turning to animal health -- companion animal health. Revenues grew 4% to $377 million due to the continued performance of key brands and overall strong growth in China and Latin American markets. We closed on the purchase of Abbott Animal Health assets in early February, so sales of newly acquired Abbott products also contributed to results. They were recorded primarily in the U.S. where we have seen additional competition in the pain and sedation markets. These results continue to demonstrate the strength of the business model as defined by our 3 interconnected capabilities : the largest and most capable field force in the industry with direct customer interactions, investing more innovation than any other company, and having the highest quality products and more reliable supply at a competitive cost. These 3 capabilities form an essential foundation for long-term success in animal health. Going forward, we are committed to investing in these capabilities but also see an opportunity to use them in more focused ways to enhance competitiveness and drive greater value for our customers and shareholders. Over the last 2 years, since becoming an independent company, we have delivered on our operating and financial targets, created shareholder value and continue to meet our customer needs while standing up a new global company and infrastructure. We are certainly proud of what we have achieved. And as we transition out of our stand-up phase, we are focused on driving efficiency and reducing complexity that is a barrier to productivity. The program we announced today is a comprehensive plan that is designed to simplify operations, improve our cost structure and better allocate resources. We enter this next stage building on solid business performance, and we'll emerge as a stronger, simpler and more cost-efficient organization. We expect to generate cost savings of $300 million in 2017 and see our adjusted EBIT margin improve from 25% in 2014 to approximately 34% in 2017 as we reduce complexity and achieve a greater focus on key brands and markets. We are fully aligned to achieve these goals and have the plans in place to incentivize our leaders to exceed these targets. These initiatives will allow us to derive additional value by taking full advantage of our scale. It will allow us to invest in the products, markets and infrastructure that will drive profitable growth and continued leadership in the animal health industry. There are several important reasons why we are initiating this program. First, after 2 years of separating from Pfizer, we now have full control of our operations, manufacturing and corporate systems and we have identified significant opportunities for improvement. Second, while the breadth of our portfolio and global footprint remain strength of our business, we have seen certain elements of our breadth generate complexity that is a barrier to delivering value to our customers and to generating long-term growth. Third, we are beginning to see the benefits of implementing our ERP system. The resulting standardization and potential to simplify our business through our new ERP system will allow us to increase productivity and streamline operations. And finally, we remain focused on growing revenues and finding the most productive ways to allocate resources to internal investments and business development activities. We have 3 main objectives for this operational efficiency initiative. First, we want to reduce complexity that does not add value for our customers and our business. Second, we want to optimize our resource allocation and efficiency. And third, we want to better position Zoetis for long-term profitable growth. We'll deliver our first objective to reduce complexity by enhancing our focus on products, markets and manufacturing plants that are most important to our future. We'll eliminate approximately 5,000 lower-revenue and lower-margin product SKUs out of a total of 13,000. This will drive higher focus and more reliable supply of our products and services. We'll enhance our manufacturing operations and accelerate the implementation of our supply network strategy. We plan to sell or exit about 10 manufacturing sites over the long term. Reflecting the strategic importance of manufacturing to our business model, Roman Trawicki, President of Global Manufacturing and Supply, will now report directly to me as part of the executive team. We will change our selling approach in approximately 30 markets by shifting to an indirect sales model or reducing our presence in certain countries. We reduce the number of regional reporting segments from 4 to 2 : the U.S. and International. We expect these changes to result in greater decision-making authority closer to the customers while leveraging our scale to efficiently deliver marketing and other operational support. The U.S. Region will be led by Kristin Peck and the International Region will be led by Clint Lewis. Both are current members of our executive team and will continue reporting to me. To deliver on our second objective, to optimize resource allocation and efficiency, we will take the following actions : We will leverage the efficiency and standardization of our newly implemented ERP system to significantly reduce general and administrative costs in corporate functions. In addition to the ERP benefits, another important efficiency driver will be a reduction of management layers and increased span of control through the organization. We'll improve our ability to be more dynamic and agile in responding to customer needs by shifting marketing resources closer to the customer and simplifying all areas of noncustomer-facing commercial infrastructure. And we'll enhance our R&D focus to support a smaller portfolio of products as well as better prioritize the R&D portfolio to invest in projects with the highest returns. In the past, we have demonstrated our commitment to improve our operations and be more efficient. In 2009, we achieved a successful transformation when we became the world's largest animal health business through several acquisitions. Then in 2013, we became a large, global independent company followed by 2 consecutive years of industry-leading performance. Through each of these changes we have made ourselves better, improve how we serve customers and create new and greater value to our stakeholders. I'm confident that the comprehensive plan we have announced today will allow us to transform again, building on our successful business model to deliver high-quality profitable revenue growth and becoming a more competitive company. These are significant initiatives that will drive us to be a more focused and streamlined company. As a result, we'll see a reduction in the number of positions at Zoetis of approximately 2,000 to 2,500 over the next 12 to 18 months, subject to any consultation with work councils and unions in certain markets. With the implementation of this initiative, we will better align Zoetis' resources and operating structure with our 3 interconnected capabilities; supply products, more reliable and at a competitive cost; increase capacity to invest in future business drivers; and finally, tailor the product portfolio and improve efficiency of the operating model so we can pursue the next horizon of opportunity as a world leader with a single focus on animal health. Through this process, we'll be more competitive and better positioned to achieve long-term profitable growth. Before Paul cover the financial details, I would like to thank all our colleagues who have contributed to our success through an environment of intense change. Our next transformation will be key to supporting our future success, and I know that we have the capabilities and the team to implement these significant changes. Paul? Paul S. Herendeen: 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, which was up 14%. We continue to gain share in the U.S. livestock segment, especially cattle, based on producers' confidence in the reliability of our products to protect their investment in their animals. In companion animal, which was up 3%, we anticipate even more positive results through the balance of the year as we now have increased supply for APOQUEL. CLAR also continues performing well, with revenue up 13% on an operating basis, and that's driven by Brazil and other emerging markets. Later, when I talk about our go-forward plans to streamline and adjust our global footprint, I'll speak to our plans to deemphasize our efforts in Venezuela where the business and economic climates are becoming more challenging. In APAC, where we posted 1% operating growth in revenue, we're seeing good performance in emerging markets like China but drought conditions in developed markets, including Australia and New Zealand are having an impact. In EuAfME, where revenue was flat compared with Q1 of 2014, the takeaway is that good performance on our key brands in companion animal are being offset by declines in anti-infectives, primarily due to legislative changes in France. Now let me turn to what I will call our operational efficiency initiative. This initiative is a natural next step in the evolution of our company as a stand-alone entity with a singular focus on animal health. While we enjoy an enviable position in animal health today, our current product portfolio, footprint and organization came about in ways that were, to some extent, unplanned. The makeup of our product portfolio was heavily influenced by human health acquisitions made by Pfizer that had animal health components. These were very important to building our scale and portfolio, but the animal health assets were not the focus of those deals. And while we spend a lot of time and energy standing up our own organization and building our own culture, we quite naturally carried across organizational designs, processes and practices that worked well when we were a division of Pfizer, but may not represent the best options for a pure-play animal health company. Said another way, it's doubtful that we serendipitously came upon the best possible structure and organization to maximize our opportunity in the animal health industry. Our first priority over the last few years has been to build out the functions that we need to support our business on a stand-alone basis. We had to establish our own supply chain, build our own IT infrastructure and put in place the G&A functions like finance, HR and legal to support a global public company. While we did that, we elected to leave our commercial and R&D organizations largely as is to minimize the impact of our stand-up on our customers and on our business. I think our track record of revenue and profit growth over the last 2 years, and so far into 2015, support the wisdom of that approach. But now with the completion of the stand-up activities in sight, it's time to look at the entirety of our current state and take steps to improve the design and efficiency of our company. Importantly, we are not questioning the fundamental elements of our business model. Our model relies on what we refer to as our 3 interconnected capabilities : one, face-to-face interaction with our customers to drive revenue; two, investment in product innovation to sustain our revenue base and our growth prospects; and three, the ability to meet our customers' demand with quality products. These capabilities form the basis of our competitive advantage in the global animal health industry and changes to these areas will fall into the category of continuous improvement, not major changes. The bulk of our future cost savings will not impact these areas. Our field force, the personnel in the front lines with our customers, will remain largely intact. The scope of our activities in R&D will also remain substantially the same, and we will continue to invest in programs to build and improve our supply chain. Let me separate the 2015 program into 2 parts as I see them and then add on the previously announced supply network strategy to think about 3 areas of focus. Part 1 is what I'll call rationalizing our footprint, part 2 is driving improved efficiency in our operating expenses, and part 3 is streamlining and improving the efficiency of our supply chain. Starting with rationalizing our footprint. This work included a review of the number of SKUs that make up our product portfolio, consideration of moving to indirect sales models in a number of markets where we currently have a direct presence and evaluations of markets where we might choose to reduce our efforts. The headline here is that we will be eliminating nearly 40% of our total SKUs. These SKUs create significant complexity across multiple functions within our company. Of course, this will reduce our revenue and gross profits in the near term, but it will enable us to substantially improve the efficiency of our operations, from our supply chain and sales support, to G&A expenses and the product maintenance costs that are part of our R&D. With a leaner portfolio comprised of our more profitable product assets, we will have better growth prospects. We also intend to move from direct sales models to indirect distributor models in certain countries and reduce our efforts or exit some markets. When complete, the streamlining of our portfolio and global footprint will reduce our expected 2017 sales by some $280 million and gross profit by about $100 million. For the avoidance of doubt, those numbers are based on current FX rates. The estimated revenue and gross profit impacts are reflected in our revised guidance for 2016 and 2017. Part 2 of the initiative is driving improved efficiency within our SG&A expenses and our investment in R&D. We're collapsing from 4 regions to 2 as we go forward. We're reorganizing the support for countries, including enabling functions, like finance, IT, HR and legal, but also the noncustomer-facing resources that support our field sales forces. We're taking steps to improve the focus of our R&D activities, supporting a smaller portfolio of products, identifying greater efficiency in our regulatory practices and better prioritizing our R&D spend. And yes, our expected spend for customer-facing resources will be less as well, mainly driven by the reduction in the number of markets where we'll have a direct presence, and the deemphasis of certain other markets but also through improvements in efficiency. In total, by calendar 2017, we expect our total operating expenses, that is the sum of SG&A plus R&D, to be roughly $300 million less than it would have been but for this initiative. As I said just a moment ago, we are not changing our business model here and that should be reflected in the way you should think about the sources of the $300 million of future savings. Roughly 1/3 is expected to come from reduced G&A and another 1/3 from commercial resources that are not customer-facing. That's roughly 2/3 of the expected savings coming from areas that should not impact our ability to deliver near-term and long-term revenue growth. Of the remaining cost savings, about 10% is expected to come from improvements in efficiency within our R&D organization. About 5% is expected to come from the reduction of our field resources tied to our revised global footprint and reduced emphasis in some emerging markets, and the balance of the cost savings here is expected to come from reducing complexity and increasing efficiency in other areas. The third and final piece of the initiative is the supply network strategy that Kristin Peck outlined at our Investor Day last November. Most of the benefits of that work will be realized after 2017. So for now let's set the supply network strategy aside and focus on the activities that will impact our results in the period from 2015 to 2017, but keep in mind that the supply network strategy initiative is expected to add some 200 basis points to our gross margin by 2020 on top of the improvements driven by the 2015 initiative. You've heard me say this many times in the past that when we're looking at our operating efficiency, there are opportunities for us to do better. Today we back those words up, providing you with a framework of our plans to improve the operating performance of Zoetis while preserving the key elements of our value proposition. In our to be state in calendar 2017, we'll be an even better company than we are today, more profitable on a slightly smaller revenue base, positioned to deliver better growth from a more focused product portfolio and working off of a leaner cost structure that can be leveraged to support revenue and profit growth over the long term. After completing the change we're announcing today, we'll still be the leader in animal health, and we will continue to be the biggest investor in innovation in animal health. And we will continue to have the largest direct sales network in the industry. Our improved efficiency will provide us with more flexibility to allocate resources where we can best serve our customers' needs and to further distance ourselves from the competition. The efficiency initiative adds an estimated $200 million to our expectations for pretax earnings in 2017, driven by the $300 million in operating expense savings, offset in part by the $100 million of projected decrease in gross profit attributable to the streamlining of our product portfolio and the rationalizing of our global footprint. This initiative adds roughly $0.28 to our prior estimate of 2017 adjusted net income per share. So the song remains the same, only better. We're a company that can grow its re-based revenues in line with or faster than the mid-single-digit growth of our markets while holding the growth in our leaned-out operating expenses to the inflation rate and thereby delivering long-term profit growth greater than our revenue growth. And that's off of a higher profit base, and that's a winner. Of course, the improvements in our future financial model don't come free. So I want to take a few minutes to talk about one-time costs generally and to specifically address the costs associated with the efficiency initiative. First, it's important for you to know that we have a high standard when it comes to costs that we characterize as onetime and, therefore, are excluded from adjusted net income. Our policy limits such adjustments to purchase accounting, acquisition-related costs and certain significant items that we evaluate on an individual basis. These include direct and incremental costs required to complete the stand-up of the company and those direct costs that we will incur to execute our efficiency plan. Next, we want to be transparent about the amount and nature of these costs, so our intention is to provide disclosure of our onetime costs in 3 buckets. The bucket for stand-up costs and other onetime costs that you're already familiar with; a new bucket for the efficiency initiative that we announced today; and a third bucket for the cost associated with the longer-term elements of the supply network strategy. We estimate our remaining pretax stand-up and other onetime costs at $180 million to $210 million with those costs to be recorded primarily in the remainder of 2015 and through 2017. These are primarily all-cash costs. We estimate the onetime pretax cash costs associated with the efficiency initiative to be in the range of $340 million to $400 million and to be incurred in 2015, 2016 and with some modest portion moving into 2017. We expect actual cash payouts to occur over the next few years. Note that there will also be noncash charges triggered by this initiative. We are not providing an estimate of these charges as both the amounts and timing could vary widely. As we incur these noncash charges, we'll call them out for you when recognized. Finally, the supply-network strategy. onetime-pretax cash costs are currently estimated at $60 million to $100 million and are expected to be incurred over the term of the plan. It's worth noting that we are still in the early phases of architecting the supply network strategy, and the final onetime costs for this activity could be substantially different depending on the final outcome of our ongoing analysis of our supply network and the timing or nature of any specific site exits. There will also be noncash charges triggered by the supply network strategy, and we will call those out to you when recognized. Note that the estimates of onetime pretax costs for both the efficiency initiative and the supply network strategy ignore the possible proceeds that we may receive from the sale of certain assets, which could potentially offset some of the onetime cash costs. We provided a webcast slide that summarizes our current estimates of the onetime pretax cash costs associated with each of the 3 buckets over the period from 2015 to 2017. We will refresh our view of the various buckets of onetime costs as appropriate. I want to call your attention now to an unrelated change to our go-forward outlook, and that's our decision to decrease our activities in Venezuela. The animal health industry in Venezuela features solid underlying fundamentals and our business there has performed well. However, recent economic developments necessitate an evaluation of our efforts there. While our business in Venezuela is profitable, it has become increasingly difficult to realize those profits in U.S. dollars. Unless and until that environment changes, sales and profits there will drive low quality earnings, so we're significantly paring back our activities there. To be clear, Venezuela is a solid local market and we will maintain a presence there as we believe that the environment will improve over time. However, in the interim, we believe it's prudent to reduce our activities and exposure there. The decision to reduce our activities in Venezuela impacts our revenue and profit expectations for 2015, '16 and '17. The impact on 2015 can be seen in the exhibit to our press release that bridges from our prior guidance to our revised guidance. We've also provided a slide on the webcast that shows the impact of Venezuela on 2017, which decreases our expectations for adjusted net income in 2017 by $0.07 per share. Now let me provide an update on our guidance for the full year 2015 in light of the changes in FX rates since our last guidance update, the anticipated impacts of the efficiency program and our decision to reduce our efforts in Venezuela. I also want to update you on our expectation for 2016 and '17 and to provide you with more detail about those years. We felt it was important to say more about 2016 and '17 as there are a lot of moving parts here, and we want you to have a clear picture of our expectations. First, 2015 full year guidance. In our press release and in a webcast slide, we provided a bridge from our prior guidance to our revised guidance. The headline is that despite the continued headwinds from changes in FX rates and our decision to reduce our business in Venezuela, we're holding our guidance for adjusted net income per share for 2015 in the range of $1.61 to $1.68 per share. This includes pluses and minuses. FX is a minus again. The changes in FX rates from late January, underlying our last updated guidance, to late April, decreased our revenue expectation for 2015 by some $75 million or 155 basis points, while the impact on adjusted net income was much less, only about $5 million or 60 basis points. Then our decision to pare back our efforts in Venezuela reduces our revenue expectations by $50 million, operating expenses by $5 million and decreased our expectations for adjusted net income by $25 million. Finally, the big plus, and that's the impact of the efficiency initiative, which reduced our expectations for operating expenses by $45 million compared with our prior guidance and increased our expected adjusted net income by $30 million. So when the dust settles, we expect our reported revenue to be down by $125 million from our prior guidance range and our adjusted net income to be consistent with our prior guidance, $1.61 to $1.68 per share. It's worth pointing out that we decreased our 2015 guidance for revenue growth on an operational basis by 100 basis points to the range of 5.5% to 7.5%. The reduction in the growth rate is due to the expected reduction in sales in Venezuela. We translate Venezuela revenues at the fixed official exchange rate of VEF 6.3 to the dollar, so the $50 million expected reduction in revenue shifts the operational growth rate. And the adjusted net income operational growth rate is estimated to increase 1% as a contribution from our efficiency program should more than offset the impact of Venezuela. Turning to 2016 and '17. We provided a lot of detail for you so that you can recalibrate your expectations for us through 2017. As you can see how this longer-term guidance compares with your prior expectations, I submit that you must first revise your prior expectations to reflect the changed FX rates. To help you do that, the change in FX rates from late January to late April should reduce your 2016 and 2017 revenue expectations by roughly 215 -- excuse me, 215, 2-1-5 basis points, cost of goods sold by 260, 2-6-0 basis points and operating expenses, including both SG&A and R&D by 170 basis points, with the result being a roughly 235 basis point decrease in projected adjusted net income driven by the changes in FX rates. Using that re-based forecast in comparison with our revised guidance for 2016 and '17 will enable you to isolate and evaluate the impacts of the 2015 efficiency initiative together with our decision to reduce our efforts in Venezuela. In a nutshell, and looking at 2017, when the full benefits of our efficiency initiative are expected to be realized, the efficiency initiative increases our expectations for 2017 pretax income by roughly $200 million. Meanwhile, the Venezuela action reduces our pretax expectations by $55 million. Net, we add $145 million to our pretax expectations for 2017, roughly $100 million in adjusted net income or $0.20 per share. As Juan Ramón mentioned, the steps we are taking over the next several years are expected to enable us to improve our EBIT margin by some 500 basis points in 2017 to circa 34%. Here are a few other factors for you to consider. Our guidance does not reflect any future currency devaluation in Venezuela. We expect a slightly higher effective tax rate for the remainder of the year 2015, higher than the 27% that we had in the first quarter of 2015. The operating expense benefits that we are seeking will begin to be most evident in Q4, and our guidance assumes a constant diluted share count of approximately 502 million shares outstanding. This includes share repurchases totaling an estimated $100 million in the first half of 2015, which are partially offset by actual and projected dilution relating to employees' equity-based compensation. We also assumed a comparable level of diluted weighted average shares outstanding for 2016 and '17 as we intend for our share repurchase program to at least offset projected dilution from future employee compensation programs, including the acceleration impacts of our operational efficiency initiative. All the other details of our guidance are included in the table attached to our press release. Finally, we covered a lot of ground on this call. To assist with clear communications, as John said, we will be posting copies of Juan Ramón's and my scripts to our Investor Relations website following this call. That concludes my prepared remarks and we'll now open up the line for your questions. Operator? Operator : [Operator Instructions] And we'll take our first question from Louise Chen with Guggenheim. Louise Alesandra Chen - Guggenheim Securities, LLC, Research Division : 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. Paul S. Herendeen: 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. Operator : And we can take that question from Kevin Ellich with Piper Jaffray. Kevin K. Ellich - Piper Jaffray Companies, Research Division : 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. Paul S. Herendeen: 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. Operator : 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. Operator : We'll take that question from Erin Wilson with Bank of America. Erin E. Wilson - BofA Merrill Lynch, Research Division : 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. Paul S. Herendeen: 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 repurchases. We indicated that we expect to purchase, in aggregate, $100 million worth of shares over the first half of 2015 and that we can -- expect to continue acquiring shares in the amount that will at least offset the ongoing dilution from our equity-based compensation plans. And I said in the past, I'll say it again, the share repurchase will be an ongoing part of our plans for our capital allocation. I think of it -- share purchase activity that underlies our 2017 guidance as a baseline for that activity. As we generate either free cash or debt capacity, we'll adjust our plans there as appropriate. Did I cover it all? Sorry, the deleveraging question as well. Yes, we have stated in the past that we have kind of a notional -- when we talk about our capital structure, a notional floor of gross debt to trailing 12-months EBITDA of 2.5x. So I want to reiterate there's a permanent role for debt in our capital structure, and when you think about that cap structure, we remain committed to be responsible stewards of our shareholders' capital. And our hierarchy for that capital allocation will be first and foremost inside our business; second for business development activity that is value-generative; and lastly, transactions and shareholders including both the regular dividend and the ongoing share repurchases. So again, think of that 2.5x as a floor and think of our hierarchy of capital allocation as I outlined it for you. I hope I answered the question. Operator : And we can take our next question from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets Equity Research : 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. Paul S. Herendeen: 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. Operator : 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? Mark J. Schoenebaum - Evercore ISI, Research Division : 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. Paul S. Herendeen: 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. Operator : We can take that question from Jami Rubin with Goldman Sachs. Jami Rubin - Goldman Sachs Group Inc., Research Division : 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. Operator : 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. Paul S. Herendeen: 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. Operator : Our next question comes from Kathy Miner with Cowen and Company. Kathleen M. Miner - Cowen and Company, LLC, Research Division : 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. Operator : And our next question comes from Liav Abraham with Citi. Liav Abraham - Citigroup Inc, Research Division : 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. Paul S. Herendeen: 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. Operator : We'll take our next question from David Risinger with Morgan Stanley. David Risinger - Morgan Stanley, Research Division : 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 : [Operator Instructions] And we can take our next question from Kevin Ellich with Piper Jaffray. Kevin K. Ellich - Piper Jaffray Companies, Research Division : 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. Paul S. Herendeen: 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. Operator : 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. Operator : 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. Operator : 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.
|
ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,015
| 3
|
2015Q3
|
2015Q2
|
2015-08-04
| 1.6
| 1.61
| 1.745
| 1.78
| 2.86769
| 26.94
| 28.19
|
Executives: John O'Connor - VP, IR Juan Ramon Alaix - CEO Paul Herendeen - CFO Analysts : Kevin Ellich - Piper Jaffray Louise Chen - Guggenheim Securities Erin Wilson - Bank of America Merrill Lynch John Kreger - William Blair Chris Schott - JPMorgan Kathy Miner - Cowen and Company Alex Arfaei - BMO Capital Markets Mark Schoenebaum - Evercore ISI Jeff Holford - Jefferies Operator : Welcome to the Second 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. [Operator Instructions]. It's now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor: Thank you. Good morning and welcome to the Zoetis second quarter 2015 earnings call. I am joined today by Juan Ramon Alaix, our Chief Executive Officer; and Paul Herendeen, 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 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 statements 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, August 4, 2015. We also say operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, John and good morning, everyone. Today, I will discuss our performance for the second quarter and provide updates related to the integration of Abbott Animal Health, the performance of new products and progress on our operational efficiency program. Paul will then will provide additional perspective on the quarter and comment on our guidance for 2015, 2016, 2017. All the growth rate that I'm discussing today are rational, excluding the impact of foreign currency. I am very pleased to report that this quarter, we generated very strong revenue and adjusted net income and growth based on the strength and the diversity of our business. The growth this quarter was driven by the positive performance of our portfolio, in both companion animal and livestock. The addition of Abbott Animal Health and the growth of APOQUEL and other new products and the continued discipline on operating expenses. In the quarter, we generated operational growth of 11% of revenue and 20% in adjusted net income or adjusted diluted EPS of $0.42 per share. This performance continued to demonstrate our long-term valuable position and grow adjusted earnings faster than sales. In the quarter, APOQUEL contributed 2% of revenue growth or $19 million. Abbott Animal Health accounted for 2% of the revenue growth or $25 million and another 2% came from new product launches. The remaining at 5% is related to both performance including a 2% price increase. In livestock, we view 8% even by some growth in cattle and swine. Cattle then grew 9% with continued favorable market conditions in the U.S. and Brazil, partially offset by the impact of the full reductions in poultry. Swine products also made a contribution this quarter, growing 14% based on strong sales in the U.S. and China. In the U.S., the markets for swine continued for building after the original impact of PEDv. We continue adoption of our key brands and a positive impact in terms like our better ACTOGAIN. Quarter revenue grew 1% reflecting new product launches which were partially offset by the customer rotation of medicated feed additives in certain Latin American markets. Turning to companion animal, revenue grew 15% due to additional sales from the Abbott Animal Health and the continued performance of key brands such as APOQUEL in the [indiscernible] space and some whole and production insights. We feel very good about the progress we have made on the duration of Abbott Animal Health and we expect to achieve the target we've set from the condition in terms of revenue and cost percentages. Now switching to Sarolaner operational updates, we completed the go live profile of our ERP system in the U.S. at the beginning of May as scheduled. From a systems and control point of view, the completion was successful. However, due to a large number of our customers electrically impacted by our change of systems, we've had customers experiencing a disruption in their services. The variability of these shipments and these issues have been resolved. And customers should see the level of our service improving and turning to the quality they expect and deserve from us. Foreign presentation in other countries will remain on track to complete the growing ERP product by the end of Q1 2016. As for the Abbott growth, since the beginning of the year, we've had significant increase product supply and today more than 13,000 veterinarians have access to APOQUEL in the U.S. and more in markets outside of the U.S.. We have the manufacturing capacity to meet the future demands of the public but the process of scaling up the active pharmaceutical ingredient or API, as we mentioned to you. We have now made the necessary changes to improve the process and we're continuing to ramp up the manufacturing . While the situation is improving, we're not yet meeting all our market demand and our first priority is to manage a solution of available supply to our locations and to fulfill August for our current customers. With that in mind, we have temporarily suspended taking new first-time customers' orders for APOQUEL in most markets. We remain committed to making APOQUEL available to new customers as soon as possible. Even with these change in our operating products, we now expect revenue for APOQUEL to be about $150 million in 2015 and increasing really early in 2016. The productivity of our investment in new product notion and following the product development continue to support our future growth at. The U.S. Department of Agriculture has granted a conditional license for a first trial of first-of-its-kind antibody therapy that targets interleukin-31 or IL-31, to help reduce clinical signs associated with atopic dermatitis in dogs. It represents another major breakthrough from our R&D platform based on new scientific insights into the pathway of allergic skin conditions. We continue to receive approvals for new indications and formulations of our key products and we have expanded many products into new markets. In the second quarter, for example, we seeked approval of a new label claims in the U.S. and European Union for CERENIA, an antiemetic to treat and prevent acute vomiting in dogs and cats. We continue expanding the breadth of our FOSTERA swine vaccine franchise. We have new label claims in Canada and Latin America. And DRAXXIN 25, an injectable anti-infective which will tapped an important market for swine, was launched in additional European markets, such as Spain, Italy and Portugal. Now to achieve concerns, comments and update on the operational efficiency program, we announced that last quarter. I do want to recall the program we announced it to simplify operations, improve our cost structure and better allocate the resources for future long-term growth. We expect to generate cost savings of at least $300 million in 2017 and improve our adjusted EBITDA margin from 25% in 2014 to approximately 34% in 2017, as we review complexity and achieve greater focus on key brands and markets. Our visual leader is moving ahead with elimination of approximately 5000 SKUs from our total of 13,000 and changing or solution model in about 25 markets. Approximately 45 countries will remain with our direct sales model and generate 95% of our revenue. Meanwhile, we have begun the process of selling or executing seven manufacturing sites. And another few sites will be sold or exited in a later phase as part of our supply network strategy. We've also started job reduction as we reorganize and streamline our operations. We're making very good progress on implementation of our operational efficiency program. And I'm very optimistic about delivering or exceeding the target of $300 million in savings by 2017. While we're making these changes on efficiency, we remain absolutely committed to the moment that has been driving our success. Our direct selling approach and world-class sales reinforce creating us from the competition. Our investment in relation, the drive breakthrough products and also ensure the lifecycle development of our portfolio and our high-quality manufacturing and supply. In summary, we deliver excellent second quarter operational resource; with various sources of revenue growth across our portfolio. We remain well-positioned for profitable growth based upon on our core capabilities, diverse portfolio and focus on expansion growth. And we're seeing new initial progress on the efficiency program that made us get more competitive and profitable for the long term. I will now ask Paul to provide some comments on the quarter. Paul? Paul Herendeen : Good morning. The financial highlights of the quarter are regular growth and cost discipline. Revenues were up 11% operationally compared to Q3 in 2014 with growth coming principally from the addition of acquired Abbott Animal Health products, the ramp up of APOQUEL and of those and strength in our livestock portfolio. With respect to operating expenses, we especially took ownership to reduce expense in order to preserve our 2015 profit guidance in the face of currency headwinds and animal health growth of operating expenses to 2% on an operational basis compared to the prior-year quarter and keeps us on track to deliver on the 2015 portion of the efficiency initiative that we announced back in May. Strong revenue performance in animal gross profit margins mainly due to the favorable impact of FX on cost of goods sold and expense control enabled us to report very strong adjusted net income growth of 20% operationally and 14% on a reported basis. While the year looked no mean, we know what's coming next. While good performance in the 98% window looks great in the headline, we think about our business in terms of the year or even years. We don't guide to quarters and we don't manage the quarters so please view this quarter as a strong quarter and view it as what it is, an indication that we remain solidly on track to deliver our 2015 guidance and beyond. With that as a backdrop, I want to note that we narrowed our 2015 guidance towards the upper end of the range. Good stuff indeed. Our FX rate and I want to, again, call your attention the impact of FX on our reported results. Foreign exchange rates continued to mute our reported revenue and profit growth. FX rates reduced our reported sales by some $106 million compared to Q2 of 2014 or roughly 1,000 basis points, while adjusted net income growth was reduced by $12 million or roughly 600 basis points compared with the prior-year second quarter. We measure our performance on an operational basis or on a constant currency basis and on that basis, we delivered. As part of the operational efficiency program we announced in May, we consolidated from four of the reporting segments to two, U.S. and International. From here forward, our financial reporting will reflect this new structure. A few weeks ago we issued and 8-K to provide a historical view of our 2014 and third quarter 2015 results in this new reporting structure and I hope this helps you update the financial models and prepare for today's call. The consolidation of our business into two segments will reduce the cost and complexity of our operations and also improves our decision-making and accountability at the local market level where we drive value. It's real concerns that the consolidation segment might reduce visibility into our performance. Let me say that we believe that the revised disclosure providing revenue details on most on -- excuse me, providing revenue details on our most important countries rather than a somewhat arbitrary geographic grouping, should give you better visibility into the results and how we drive our results. And to at least organize the leads, you will see revenue for the U.S. and international segments as well as additional breakdown showing revenue for our top net 11 international countries. This gives you visibility into the markets that account for nearly 80% of our sales. Approximately 20% of remaining revenue are being grouped and reported as other developed markets and other emerging markets. I will caution you that with the increased granularity of the revenue we're reporting, you will see quarter-to-quarter fluctuations and I would not read too much into that if you are looking at a single quarter in a single market in isolation. One of the strength of our business models is the geographic diversity of our revenue and profit streams, particularly in livestock. We participate in global markets and strength and weaknesses in digital markets are generally offset by performance in other markets. Finally, we also provided an important disclosure of the two segments, showing revenue, cost of sales, operating expenses and pre-tax earnings. I hope you will agree that our new financial reporting model is an improvement over the prior model. Let me call your attention to a few highlights from the quarter. Juan mentioned this earlier but it's worth repeating because it's a great way to illustrate the ways in which we can grow our top-line. Top-line as we knew. We delivered operational growth of 11% in the quarter, of which 3% was unit growth of in line products, 2% was from price, 2% was from growth of APOQUEL, 2% was from the additional acquired Abbott Animal Health products and 2% was from a range of new product introductions. I need to go second quarter, we covered all of the ways we certainly can deliver operational revenue growth. Next, looking at the U.S., very strong growth of 17% over the prior-year quarter, we delivered growth in all species, companion animal, cattle, swine, poultry and equine. In companion animals, the big drivers for the other share of the Abbott products and APOQUEL. In cattle, we had a continuation of favorable conditions to putting use of our premium products and we increased sales of the ACTOGAIN. In swine, product sizes impact from the PEDv outbreak and you had the positive impact of new products in the portfolio, the PEDv vaccine and medicine. Finally, poultry grew largely from the introduction of our ZOAMIX Project. In the international group which grew 6% operationally, the top three countries contributing to the growth for Brazil, up 9%, mainly due to the favorable conditions in the livestock segment and new product launches; China which was up 26%, with our livestock business benefiting from higher anti-infective use in some key swine accounts and growth in companion animal, driven by from momentum from [indiscernible]; and then finally in the UK which was up 12% based on strong performance of stronghold and the addition of the Abbott Animal Health products. We do have species international group; livestock was up 6%, with cattle and swine offsetting lower sales of poultry products. Companion animal group, 8% operationally, primarily from sales of APOQUEL in Spain, India and Germany. A pick-up in sales of swine products in Western Europe, Australia, Canada and China and strong vaccine sales in China. I should note that other emerging markets grew 10% operationally and that included growth in Venezuela. You will recall that we're reducing our activities in Venezuela pending an improvement in the economic environment there for multinational companies. We're slowing down on inventories in the country and we will limit our future exports to Venezuela. Accordingly, sales growth in this market will trend downward over the balance of the year and continue into 2016 at significantly lower levels. The impact of our reduced emphasis in Venezuela is reflected in our guidance for 2015, 2016 and 2017. Let me turn you to our operational efficiency initiative and I will give this from the finance guy perspective. I will start with the punch line. We're on track to deliver at least $300 million of operating expense reductions by calendar 2017. As we implement the changes needed to deliver those savings where we will intact the interconnected capabilities with [Technical Difficulty] advantage, our leading direct sales force, our highly productive R&D engine and our global supply chain. When we enter 2017, we will do so with a direct presence in all of the markets around the globe that matter. And we will be promoting a portfolio comprised of the products that matter to our customers and have the best prospects for delivering revenue and profit growth. We want to be transparent with we respect to one-time costs and I want to call your attention to targets in the second quarter and broken down into three buckets. First, the standup and other one-time costs which are mainly associated with our separation from Pfizer totaling $39 million in the quarter. The lion's share of the standup cost should be behind us at the Q2 of 2016. Next, we recorded $263 million with costs associated with operational efficiency initiative, mainly for 2017 after attributed by the changes to our organization. This included about $25 million in non-cash charges. And, finally, there's a bucket for our supply strategy which had $15 million of charges as we're still in the early stages of this initiative. You can see on our webcast line the current estimates of one-time costs expected to be recorded in 2015 to 2017. Please note the cash forecasts for these projects remains the same as our previous guidance. Next guidance to 2016, based on our strong performance in Q2, we now in a range for revenue and adjusted EPS towards the top end of our range for revenue to $4.7 billion to $4.775 billion and adjusted EPS to $1.63 to $1.68 per share. With respect operating expenses, as I said earlier, we made excellent progress comparing that of the operating expenses in the first half of 2015. It's real important to note that there are some natural seasonal trends to how we incur expenses. In 2014, we incurred 45% of our total operating expenses in the first half of the year and 55% in the second half, with Q4 being our highest expensed quarter. That's a trend that you'd expect to see continued into 2015 but we expect to have a balance between Q3 and Q4 than in the past which was more heavily loaded in Q4. Please keep that in mind as you think about the balance of this year. Turning to our longer-term guidance for 2016 and 2017, we're affirming our expectations for 2016 and 2017 and call your attention to the table that's included as part of our press release. While thinking about the longer-term, I want to point out that we assume a constant diluted share count of approximately 502 million shares outstanding. As we said on our last call, but worth repeating, we intend to use our share repurchase program to at least offset the dilution related to the equity-based compensation that we provide to our colleagues. And I want to reiterate that the efficiency initiative will trigger an acceleration of some dilution and to those plans. During second quarter we repurchased 2.1 million shares for $98 million, an average price of $46.19 per share. Next, we saw that we recently filed on shelf registration statement. While we have no immediate plans to raise capital, the shelf provides us with the financial flexibility and access to capital markets quickly and when and if appropriate. Looking now ahead over the next six quarters or so, we had a number of calls with our cash including our standup cost, the cost of implementing the efficiency initiative, our dividend, ongoing share repurchases and a $400 million debt maturity in February of next year. So it makes sense to be prepared for that, right? That concludes our prepared remarks and we will now open the line for your questions. Operator : [Operator Instructions]. And will take the first question from Kevin Ellich with Piper Jaffray. Please go ahead. Kevin Ellich : Ramon and wondering if you would give us a little bit more detail behind your comments on the APOQUEL supply and what is going on with the ERP in the implementation with the billing issues? Juan Ramon Alaix : I will answer the APOQUEL question and then I will ask Paul to provide details of the presentation of the ERP, not only in the U.S. but also in other markets where we're implementing this new system. So in terms of APOQUEL, as I said we were able to increase significantly the supply from equity but still we're facing some challenge in ramping up and the manufacturing of API. And API is explaining some order of comments and it is a very complex manufacturing process and we had some delay in terms of permitting all the needs for finished goods. Now we have a process that in our opinion will meet the demands of the market and we expect that very soon we will be able to meet all the market demands in the power expectation. In 2015, as I said, we plan to sell about $153 million, 1.50 and that significantly increase the revenues in 2016. I'm very confident that the situation is under control. We have all the capacity that we need to use API and also to use the finished books in various in the market will start getting all the needs from our customers. For now Paul will provide an update Paul Herendeen : Let me start by saying when we went live with the implementation SAP in the us in the beginning of May itself, high level and the go live was and continues to be a success and that is not to say that everything is perfect. I would say on the good side there is one reference and we have full control of our key business processes and we have full contact any of our financial information. We have work to do in addressing the ways in which our system changes and has enacted on our customers. The us segment of our business we interface with tens of thousands of customers and the overwhelming majority have been systems working well at that does not matter if you are a customer where our systems change has led to issues with respect to you and the customer so addressing all of those issues and it continues to be a top priority for us and we will continue to look at resources and about an outstanding issue and I'm sure you and others on the line including some of our customers this is something that Wanda and I think about every day. Last thing on this I hope is I've been involved in a number of SAP implementations and all of them have been successful and none of them have been without bumps in the road. We're going to call this implementation of success. Our customers are happy with the level of our customer service and we have work to do there and we're on it and we're on it every day. Operator : And we will take next question from Louise Chen with Guggenheim. Please go ahead. Louise Chen : Paul, I know you don't manage the quarters but I was curious how we should think about third quarter and fourth quarter were qualitatively in terms of EPS progression because you did announce a meaningful beat and second quarter but you did not raise your guidance as much is the be. Thanks Paul Herendeen : A couple of things let's talk about it in second half. Please keep in mind as I mentioned earlier during my prepared remarks that the net-net was down over the second half of the year and we paired our expectations to APOQUEL to the lower in communicated range. Still expected to sell more than four times last year's volume but towards the low end of our previously range for APOQUEL also bear in mind you're looking at our business in the second half of the year and our livestock business that's been chugging along quite nicely thinks some very tough comps in the second half of the year. So realistically from the revenue perspective if we're going to be making our guidance range and we think that's pretty good. We're on track for 15 and on track for 16 and on track for 17 picked out on the expense side which really has more of the question to of around income, the income and where it should be and to call out my prepared remarks and it's at 55% of our OpEx in last year came in the second half of our year. We're expecting similar phasing in the second half of this year although less pronounced than you saw last year between Q3 and Q4 so you really need to take that into account in order to think about the full-year. We tightened our guidance range. We continue to be on track and we think for a very solid 2015 with a lot of moving parts and on into '16 and '17. Operator : And we will take next question from Erin Wilson with Bank of America. Please go ahead. Erin Wilson : Can you speak to the recent acquisition of KL progress in the poultry segment and will that be a meaningful contributor going forward and how should we think about capital deployment more broadly as it relates to acquisition and how would you characterize the deal pipeline right now and are you looking at both small and large target? Thanks. Juan Ramon Alaix : The first on the KL acquisition, it was a small acquisition but it's an indication that also enforce our presence in the country and will reinforce our presence also in the revised part of our business. So we're entering into a revised business some year ago and we have reason on [indiscernible] the ability to vaccinate and it's a very efficient device vaccinating up to 60,000 eggs per hour. Whether this device we're now -- KL problems but also we have strengthened our position in this part of the business. So it's more material but at the same time we also provide some additional relations with our customers and provide some additional service to them. Paul will respond to the capital deployment Paul Herendeen : On the capital deployment I can't resist going through the whole sort of diagram of how we think about capital allocation. First and foremost we look for invest in our business and see opportunities to drive significant value for example increased investment through R&D and sales investment that, that would be our first call because we have a business that can generate organic growth in line or in the markets in which we compete with these investments and that would lead to a solid organic growth and earnings. Now next M&A is adamant to our organic growth it will be added to our organic growth, I think good example the Abbott acquisition earlier this year which is fitting in quite nicely and helping us with our results. We think we entered Q1 perhaps it might have been observed in that, we mentioned anatomy of line of sight towards completing the standup I described us as interested and ready to look at M&A opportunities that are out there in the market and we're looking for leverage in the places where we have expertise and where we can leverage our core capabilities, broad-spectrum we look at pipeline assets. We look at in-market products and technologies, we look at company acquisitions. I want to point out that we use a return date to evaluate transactions and we look for deals that add value and cash flow and retail will be value generated to our shareholders as we look to pursue those deals. We've got some capacity to do deals and we're interested in saying there are certainly areas that are adjacencies for us or areas where we currently like to do that Juan Ramon Alaix : And we continue assessing any possibility [ph] that we make a strategic sense, we will generate synergies in terms of revenues and cost. We like the financial value. Also very important also we did incorporate into this assessment any antitrust in partners that we may have. That's really where we see M&A as a way to complement our internal growth, our operational growth and internal growth and that will increase the value of Zoetis and value to our shareholders. Operator : The next question comes from John Kreger with William Blair. Please go ahead. John Kreger : My question relates to the atopic dermatitis franchise that you are building. Can you talk about how APOQUEL these additions versus the new IL-31 antibody and do you expect to do a full launch of the new antibody now or wait for more clinical data. Thanks Juan Ramon Alaix : John. APOQUEL it's an oral treatment compared to IL-31 which is injectable. APOQUEL is a pill that need to be taken on acute and also chronic conditions of the dog. While IL-31 it's more injectable so it's different and it will depend also on the [indiscernible] but definitely we see both of the problems very complementary and maybe one much more focus on the first line treatment and while IL-31can be used more for chronic conditions and for those dogs that require some additional attention from veterinarians and follow-up from veterinarians. The full launch of the product will release when we get the full license. So at the beginning we plan to do the product -- we continue to review the methodologies in the U.S. and then we will gain details on the efficacy that the data will be used to present this information to the USDA and then finally get final approval for the license in about a year. Operator : Next question comes from Chris Schott with JPMorgan. Please go ahead. Chris Schott : We have had several big presence [indiscernible] with APOQUEL and IL-31 and [indiscernible]. Can you talk about how you think about the anticipated case of additional R&D development, should we expect another large product launching every two years and every year and then just on business development you said in the past that you’re looking to upgrade from smaller and mid-sized deals and that these opportunities tend to be more therapeutic and geographically focused. Are any therapeutic or geographic areas that are particularly attractive and are you interested in continuing to build-in devices or diagnostics? Thank you. Juan Ramon Alaix : I will try to go through all of the different questions that you raised starting with the path line. We're very pleased with the productivity of our investment in our R&D. We've been able to produce APOQUEL but also control that we're very strong players in terms of vaccines and we had the opportunity to use also the vaccine [indiscernible] in record time and now we have also IL-31 and that will also complement our franchise dermatology space and we also expect in 2016 gaining approval for an oral parasiticide that is an important segment and where we're today we're under represented. We expect to enter this product in both U.S. and also the European markets. Definitely we're focused on bringing innovation and, in my opinion now we're showing that we're leading not only in terms of revenue but also in terms of innovation that we've been showing many examples of how our team is delivering this kind of innovation. At the same time, we're continuing investing in the part which is equally important which is extending the lifecycle of our portfolio. And this will present a significant part of our investment in fact most of our R&D budget is located to ensure that our problems remain competitive and we achieve that by combining products, increasing indications and also geographical expansion. So we’re very pleased with our innovation and pipeline, we definitely we like to see that these deliveries of this success continues in the future. In terms of business development, that you ask, we're now in a situation that we contemplate business development from a provisional first time. We have a significant presence in all of the therapeutic areas, we have facility presence in all geographies and also in all species but we still see opportunities some in cases between gaps that also strengthen our position. But it will be only when it makes sense from the financial point of view. In terms of other areas, we're very open to contemplate opportunities outside of our core business. We enter some into these complementary spaces, in genetics, devices and diagnostics and we will continue assessing opportunities in these areas that we will reinforce our position Paul Herendeen : Before we for a jump off I want to go back to the kind of how do you think about the productivity or the pace coming out of R&D because it is one of our competitive trends. We often talk about and this is in round numbers, everybody, we often talk about our industry growing mid-single digits over time with if you thought of it is five using as an example, five is a 5% growth industry and 2% coming from units and 2% coming from price, 1% coming from new products. Our goal is to deliver more from self-developed products to the 1% and again I don't want to focus too often on one quarter but if you look in our quarter, second quarter of this year we have 2% of our growth year-over-year from introduction, products that have been in-line less than a year. Products like [indiscernible] collection of all other products that are in line for less than a year. So there is lots of things that are included in our R&D that are not in the same categories perhaps like an APOQUEL or Sarolaner or perhaps even an IL-31 but we go along and that growth is one, meaningful and two to the extent that we can grow faster in that market and that helps us deliver on one of our valued propositions which is our ability to grow our sales at a rate faster than the market. Operator : Yes the next question is from Kathy Miner with Cowen and Company. Kathy Miner : I was wondering if you could give us a little more of an update on your outlook for the livestock by species of cattle, swine and poultry and specifically as we get through the end of '15 and into '16 and also if you could point out what are the tough comparisons are for the second half that you mentioned earlier? Thank you. Juan Ramon Alaix : Starting with livestock we see the market conditions are still favorable. If we start with cattle, the price of beef remains high. We see that also the value of the animals remain very high and this also creates an opportunity to continue providing [indiscernible] producers the problems that they need to keep the animals healthy and productivity. Swine and poultry are also two species that have been performing very well, swine in this quarter represented the growth of 14% while in the quarter poultry was showing only 1% but one of the advantages of Zoetis is that we have a presence in all species and we can really maximize opportunities despite of some temporary challenges in one species or one in geography. So in that respect we see that the prospect for livestock remain positive and we see that continually in 2016. Paul Herendeen : The other question was to talk about the tougher comparison in livestock compared to last year. You look back in the second half 2014 and we had margins or significant ramp up of [indiscernible] and things like that in the prior-year that were not present in the first half of 2014 and the compared year. So that's what leads to more difficult comparison year-over-year. in the livestock space. Operator : Next question is from Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei : Paul, can you give us your thoughts and expectations regarding potential tax reform in the U.S. which seems to be gaining traction and specifically for your company as we [indiscernible] important goal for your tax rate and follow-up if I make strong performance in Brazil driven by new product launches, are these products that are already available in other major markets or can we expect similar launches for these products? Thank you. Juan Ramon Alaix : Looking at the first tax question is, tax is on [indiscernible] going on forever but it doesn't mean it won't create some traction but it's important to our structure and the answer is it could be to the extent that we have earnings and cash that's offshore and part of our tax structure partly intend to permanently deploy that capital offshore, the rules are changing, it affect us just like any other U.S. multinational company. So we will just have to wait and see on that Paul Herendeen : Let me then answer to your question about product traction in other markets. We see in general that companion animals are more global produce and this is something we have that products in that segment [indiscernible] in all markets around the world and this has been the case of APOQUEL and also would be the case of IL-31 and some of the products in these categories. In terms of livestock, it depends. You asked about the Brazil, Brazil is a very strong market in terms of cattle but also the cattle industry we have very specific conditions and we have been introducing definitely new product but in some cases very specific to Brazil and more recent interaction has been produce for reproduction that has been produce introduce in Brazil at the end of 2014. We will continue to try to expand our portfolio as much as we can geographically and definitely this is part of our potential growth ensuring that we have all of the heavy market introducing in all of our markets. Operator : We will go next to Mark Schoenebaum with Evercore ISI. Please go ahead. Mark Schoenebaum : The growth in the third quarter I just want to continue the question about the tax. So I'm wondering how much tax optimization or tax planning are already included in the long-term guidance because it looks like the effective tax continues to be between 29% and 30% for the next two years. How much is already tax planning that was already included in the new guidance and if there is any additional potential to optimize further the tax rate in the longer term? And somewhat related to the question about M&As, what rates would be interested in introductions and for purposes whether [indiscernible] interested in merging with the company which is not truly animal health. Thank you Paul Herendeen : So first question how much is included in our long-term guidance? We’ve a structure I think we’ve articulated that we think we have a solid structure based on the hand that we're dealt here that will allow us to maintain a tax rate in the order of call it 29%-ish for the planning horizon for us at goes out at least three years that we provided guidance. We talked many times and we look for any opportunity to grind that rate down and it is a grind. It is not something that there is a magic bullet that we can put in place in the new structure and magically reduce our tax rate by 700 basis points. We do what we can and we think we have a good solid supportable structure and that’s what is included in our guidance over the long-term. With respect to an inversion, we talk about this as well. In our there are precious few companies that would make sense for us to work with and the second thing that we try to talk about at our investor day back in November of last year is based on our particular set of circumstances we feel that in an inversion transaction the benefit if you focus on the entity that’s currently called Zoetis an offshore [indiscernible] debt would be roughly reduce our tax rate by some 600 basis points market folks are suggestive that there are other ways that could be pretty dramatically beyond that and that's our point of view and that's what we said back in November and we continue to believe that. So in terms of the transaction it could be helpful and it's not something that for us would take our tax rate down into the one-time single digits Juan Ramon Alaix : So we haven't distributed any option but you have to think about this opportunity that can be justified not only because of tax but because of the strategic rational of the position and this is something that we include in the assessment. Operator : We will go next to David Risinger with Morgan Stanley. Please go ahead. Unidentified Analyst : It's [indiscernible] filling for Dave, so I have a question on pricing. Wondering whether some of this can raise prices in livestock and companion animal anymore then you have in the past? Juan Ramon Alaix : We're always trying to maximize gross profit and the opportunity to maximize gross profit is coming from including the volume, including prices and finding the right balance between volume and price. And we will find good strategy in terms of prices and definitely see opportunities to raise prices at the higher pace and we would consider that. We have been quite aggressive and price increases in some of the emerging markets and where we have high inflation and then because of that we're also applying high price increases. In developed markets what we're trying to also is make sure we remain competitive and we're not creating a negative impact in our volume that also we have impacted revenue in terms of cost of manufacturing. All of these is part of what we consider in terms of price increases. Operator : Next question comes from Jeff Holford and this will be our final question today. Jeff, go ahead. Jeff Holford : So as well as operational efficiency program being very good for helping the efficiency of the overall business, you did talk on last quarter's call about how this might make Zoetis much better platform for integrating acquisitions. Can you just give us a bit more feel of when this process would progress through to the point where less focus on drug in the process and the platform is more efficient and you might be able to consider larger size deals because I would assume at the moment with a lot of work still do on this program, that’s not something that should be in the cards right now. Thank you. Juan Ramon Alaix : On the primary it's running and in my opinion it's running at full speed. So we will be finalizing all of the necessary changes at the end of this year and there will be also a significant work done in terms of reduction of SKUs and also changing the internal markets. I don't see at this point that our operational efficiency program is any kind of restriction, or creating any kind of restriction for M&A. On the contrary now we have an operation that is a key endpoint and we can really maximize the opportunities for any position with the model that will be more profitable. So they will start running well in terms of our program. I don't see any concern or issue on delivering or exceeding the target of 600 million and at the same time considering the M&A opportunities. Paul Herendeen : The operating efficiency initiative is not a gaining factor looking at our M&A opportunities. The best time to do a deal is when there is an attractive actionable deal in front of you, what I expressed earlier was we're ready and we would be able to take advantage of the situation if we could present itself, we’re good to go. Operator : We will take that from Jami Rubin from Goldman Sachs. Please go ahead Unidentified Analyst : This is Arielle in for Jami. I just wanted to follow up on the M&A question. Can you discuss your firepower. You mentioned on many calls that you’re somewhat cash restrained with operational efficiency, so are you able to do a large scale deal and can you remind us what your max leverage ratio you are comfortable with? Are you willing to use equity and then just secondly there has been a lot of restrictions with antibiotic usage and livestock so can you just give provide color at what is the downside risk for your business. Thanks Paul Herendeen : We're thinking about M&A let's go back and start and answer the capital structure question first, we might express an upper bound of what we would put on in terms of leverage but what we have said is we're generally thinking about target for as roughly 2.5 turns of EBITDA in our cap structure and the expectation is in the normal course ranging 2.5 to 3.5 times somewhere in that vicinity. Now what we have also said is that we have the right opportunity we would be more aggressive in the use of debt capital in order to be able to complete a value generative transaction. So what does that mean? It means that we look to balance our desire to maintain a solid credit profile and access the capital with how much debt we put on and having a clear pathway to reducing the leverage over a period of time. We have the capacity to do good sized deals within our company. And as I said the best time to do deals is when there is an opportunity in front of you and we would use all available leverage in order to be able to formed and conclude the transaction that we felt was value generative for all the shareholders Juan Ramon Alaix : And then let me take the question on what is the potential risk. We have in our portfolio about 30% of our revenues coming from antibiotics. Out of this 30%, 25% is a companion animal and we see low risk and then the rest is between MSAs and also injectable products which again we see less risk than probably is provided to animals in feed. There are different levels of categories on the use of antibiotics, [indiscernible] and also the different species where the problems arise. There has been a significant rumors or comments mainly in poultry where some of the producers have decided to move away from medical important antibiotics and to use non-medical important antibiotics. We have in our portfolio both and we think we can provide to our producers, mainly poultry activity produce that will meet their demand and also meet also consumer demand. So in our opinion I think it is a risk that is manageable and the advantage that I mentioned in many occasions we have a portfolio which is extremely diverse in terms of species, in terms of geographies and in terms of specific areas and also very important in terms of specific areas when they move away from antibiotics they need to increase significantly the use of vaccines to protect this animal. So again we have a significant presence in vaccines so we can compensate any kind of impact on certain areas and have increased in others. Operator : It appears we have no further questions at this time so I will turn the floor back over to Juan Ramon for any closing remarks Juan Ramon Alaix : Thank you very much for attending this call and thank you very much for your questions and again we think that we reported this quarter very strong results and we're very confident on delivering our objective in 2015. Thank you very much. Operator : Ladies and gentlemen, this does conclude today's teleconference. A replay of today's call will be available in in two hours by dialing 800-695-0395 for U.S. listeners and 402-220-1388 for international. Please disconnect your lines at this time and have a wonderful day.
|
ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,015
| 4
|
2015Q4
|
2015Q3
|
2015-11-03
| 1.623
| 1.637
| 1.811
| 1.84
| 2.90504
| 26.22
| 24.19
|
Executives: John O'Connor - Investor Relations Officer Juan Ramón Alaix - President, Chief Executive Officer & Director Paul S. Herendeen - Chief Financial Officer & Executive Vice President Analysts : Erin E. Wilson - Bank of America Merrill Lynch Kevin K. Ellich - Piper Jaffray & Co (Broker) Louise Chen - Guggenheim Securities LLC Alex Arfaei - BMO Capital Markets (United States) John C. Kreger - William Blair & Co. LLC David R. Risinger - Morgan Stanley & Co. LLC Christopher T. Schott - JPMorgan Securities LLC Volodymyr Nikolenko - Evercore ISI Jami Rubin - Goldman Sachs & Co. Douglas D. Tsao - Barclays Capital, Inc. Operator : Good day and welcome to the Third 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 two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. It is now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor - Investor Relations Officer : Thank you, operator. Good morning and welcome to the Zoetis third 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 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 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 US GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release and in the company's 8-K filing dated today, November 3, 2015. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - President, Chief Executive Officer & Director: Thank you, John. And good morning, everyone. Today I will discuss our performance for the third quarter and make comments about the acquisition of PHARMAQ, which we announced last night. Paul will then update you on our guidance for 2015, 2016 and 2017. All of the growth rates I'm discussing today are operational, excluding the impact of foreign exchange currency. I am very pleased to report that this quarter we continued to deliver strong revenue and adjusted net income growth based on our diverse portfolio of high-quality products, excellence in execution and our continued discipline on cost and expenses. Despite some global economic challenges, the animal health industry remains resilient based on the strong fundamental drivers for improved protein production and healthier pets. Our growth strategies and resources are aligned against these drivers to expand our market leadership in the industry. The acquisition of PHARMAQ, a market-leading company in aquatic health, is an example of this growth strategy and will bring us another platform to strengthen our Livestock business. This quarter's growth was largely due to the performance of our Livestock business in the U.S., the integration of Abbott Animal Health products into our business and the growth of recent product launches, led by APOQUEL. During the third quarter, we generated operational growth of 9% revenue and 31% in adjusted net income, delivering adjusted diluted EPS of $0.50 per share. And thanks to our efficiency improvement, reported adjusted net income grew 22% despite a negative impact of foreign currency, which resulted in flat revenue growth. As we break down our third quarter revenue via species, Companion Animal grew 18% due to the additional sales from Abbott Animal Health and the continued performance of key brands, such as APOQUEL in the dermatology space, REVOLUTION in parasiticides, as well as CERENIA, PROHEART and CONVENIA. I'm very positive about the progress we have made on the integration of Abbott Animal Health and we expect to exceed the targets we set from this acquisition in terms of revenues and cost synergies. In Livestock we grew 5%, driven by strong growth in cattle, which was tempered by relatively flat sales in swine and poultry. Cattle grew 8%. We were able to capitalize on favorable market conditions in the U.S. and Brazil with our key brands and some recent product launches. This growth was partially offset by the impact of our business reduction in Venezuela and lower sales in France. As you may recall, we had increased customers' orders in France last year that came ahead of the introduction of a new anti-infective legislation. Swine products grew 1%. We delivered exceptional growth in China as a result of our strong portfolio and improving market conditions, which was offset by lower sales in Europe and Venezuela. Poultry sales were flat based on the growth in Latin America, including Brazil, which was offset by lower sales in other emerging markets and the U.S. The diversity of our portfolio across species, geographies and therapeutic areas continues to help us maximize opportunities in animal health, while mitigating the risk that can arise in certain markets. Now let me talk for a minute about our business in two markets whose economies has been getting a lot of attention and where we continue to produce strong results despite overall economic volatility. In Brazil, the animal health industry is very resilient and not being impacted by the current economic decline there. Consumers are reducing their spending in other areas, while maintaining their consumption of animal proteins. In some cases, we may see them switching from more expensive to less expensive meat, but since we are well-positioned in other species, we have been able to sustain a strong Livestock business. We are also at a very positive point in the cattle cycle in Brazil, with tight supplies of animal and high prices for meat. This place a premium on animal health and creates incentives for our customers to build their herds. In China, we are also seeing exceptional revenue growth for our business, despite some recent reports of a slowdown in their economy. Demand for proteins, especially pork, has shown stronger growth. And we are seeing higher prices for meat in the market. The long-term trend of smaller farms consolidating into larger operations will also add to our growth, as the swine population becomes increasingly medicalized and production become more efficient. While the economic challenge in China may impact other sectors, it wouldn't have a significant impact on the animal health industry and China continues to focus on improving the quality and stability of its food chain. Through the first nine months of the year, we have continued to deliver on our value proposition by growing adjusted net income faster than revenue. Our operational growth in revenue and adjusted net income were 9% and 22% year-to-date. And despite the impact of foreign currency, we have delivered 1 and 15% growth. As I have said many times, our industry-leading sales force, high-quality manufacturing and focus on new product innovation and enhancement remain key elements of our competitive advantage. Now let me turn to some other updates. Last night we announced our agreement to purchase PHARMAQ, the global leader in vaccines and innovation for aquatic health. The acquisition is a great strategic fit that brings to Zoetis an animal health leader with similar competitive advantage, an industry-leading portfolio, strong customer relationships and world-class innovation and manufacturing. PHARMAQ strengthens our Livestock business by providing a market-leading portfolio and a strong late-stage pipeline. Fish is the world's largest category of animal protein and they are leaders in the fast-growing animal health market, farm fish. The acquisition strengthens our core business in three key ways. PHARMAQ expands our customer base into the farm fish segment, it adds to our diverse portfolio a leading vaccine for farm fish and innovative parasiticide as well. PHARMAQ is the market leader in vaccine for farm fish, a market growing 10% annually. And finally, it expands our R&D program in aquatic health, with a strong late-stage pipeline expected to deliver new solutions to the market in the near-term. Zoetis has an excellent track record of identifying and integrating their businesses, and this one meets all our criteria in terms of strategic fit and value. With this acquisition expected to close on or about November 10, I'm very excited to welcome the PHARMAQ team to Zoetis. Our companies share a passion for supporting customers and keeping animals healthy and productive, and that gives us a strong foundation to build on. We also continue to see steady progress in the new product innovation and lifecycle developments coming from our internal R&D team. In September, we received a positive opinion from the European Medicines Agency for initial marketing authorization of SIMPARICA, a once-monthly chewable medication for the treatment of fleas, ticks and mange mite infestations in dogs beginning at eight weeks of age. We await for the news in Europe and the U.S. on potential approvals of SIMPARICA. I will keep you informed of future developments. In another step to maintain our global R&D leadership and to grow in critical emerging markets, just last week we strengthened our commitment to China. We announced the opening of a new research and development center near Beijing and the opening of a new global manufacturing facility near Suzhou, which replace our original plant that has been there since 1995. These investments are a strong foundation for future growth in China and the broader Asian market. Now, let me turn to another topic that I mentioned last quarter, ERP implementation and APOQUEL supply. The vast majority of the ERP implementation issues in the U.S. are being resolved and customers should be seeing the level of service improving. In the third quarter, we had continued with successful implementation in another 27 markets, which cover Europe, Asia, Latin America and the Middle East, and we remain on track to complete the global ERP program by the end of Q1 2016. As for APOQUEL, we have been able to resolve manufacturing issues related to our active pharmaceutical ingredient, or API. We are also in the process of bringing on a second source for API supply in the near future. We continue ramping up production of finished goods in the fourth quarter of 2015. Although we now expect slightly lower sales of $125 million in full year 2015 than previously anticipated, we expect to be in a stronger supply position as we head into 2016. With the strong demand we have seen, even though we have not yet fully launched this product to our customers, we are increasing our view of peak sales for the product to more than $300 million. We look forward broadening customer access to APOQUEL in markets like the U.S. and launching in additional markets around the world in 2016. In summary, we delivered excellent third quarter operational results with diverse sources of revenue growth across our portfolio. We continue to implement changes to reduce complexity and cost in our business and to strengthen our ability to execute on the market opportunities before us and we remain well positioned for profitable growth based on our core capabilities, our diverse portfolio and continuing investment in the areas that matter for our customers : high quality customer service, relevant innovation and reliable supply. I will now ask Paul to provide some comments on the quarter. Paul? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Thank you, Juan Ramón. The financial highlights of the quarter are, once again, strong operational revenue growth of 9% coming from a variety of sources and cost discipline that together were the major factors in driving significant operational growth in adjusted net income, as Juan Ramón said, up 31% from Q3 of 2014. Now, I'll sound like a broken record, but I want to emphasize that we manage our business for the long-term and, when we measure how we're doing, we look at years, not quarters. A lot of noise can creep into any one quarter in isolation. For example, we have seasonal elements to our business that impact our customers' buying patterns and those patterns are not necessarily consistent year-to-year. The high productivity that we enjoy from our R&D engine sees revenue growth, but not necessarily in a linear fashion. My point is that 9% operational growth of revenue and 31% operational growth in adjusted net income for Q3 as compared with Q3 of 2014 is good, but the year-to-date operational revenue growth of 9% and the adjusted net income growth of 22% and our revised guidance for the full years 2015, 2016 and 2017 are better indicators of our performance and prospects. And they look pretty good, right? While we believe that the best way to evaluate our performance is on an operational basis, our guidance and your financial models are focused on expectations for our reported results. I bring this up because we've been able to maintain and now improve our 2015 guidance for adjusted net income per share in the face of unrelenting FX headwinds. And we're proud of that. Before I provide some comments around our guidance, let me call your attention to a few items of note in our quarterly results. Once again, our Q3 and year-to-date results reflect the multiple ways that we can and do deliver revenue growth. Of the 9% operational growth in revenue in the quarter, 3% came from the acquisition out of the Abbott Animal Health products, 2% was driven by increased sales of APOQUEL, 3% came from the impact of increased selling prices and about 1% came from other new product introductions. We had unit growth in our other in line products other than APOQUEL of about 1%, but that growth was offset by reduced sales in Venezuela. Now, there's a real balance in how we generate revenue growth and continuing evidence that we can tap all of these sources to drive growth at or faster than the projected mid-single digit growth rates of the markets in which we compete. A few highlights. U.S. business was very strong, posting 19% growth in Q3 over Q3 of 2014. The Companion Animal business was up 27% and Livestock was up 13%. Within Companion Animal, the big drivers were the addition of the acquired Abbott Animal Health products, increased sales of APOQUEL as we continued to ramp up the supply of the product and strength across other key brands, including REVOLUTION, CERENIA, PROHEART and CONVENIA. In Livestock, strong sales of cattle products, for example, DRAXXIN and CEFTIOFUR led the way, while we had more modest gains in swine and a slight decline in poultry. Buying patterns, particularly in the Livestock segment, can fluctuate due to weather patterns and herd movements. Q3 of 2015 saw seasonal demand for Livestock products pick up earlier in the year than we observed in 2014. The outlook for the second half of 2015 remains solid, but with revenue skewed more towards Q3 than we saw in 2014. Turning to the International segment, which grew 2% operationally for the quarter, let me highlight five countries; three that contributed to growth, Japan, China and Brazil, and two countries, France and Venezuela, where we saw declines compared with the year-ago quarter. First, Japan. The significant increase in Japan, up 56%, is mainly due to the comparison with a weak Q3 of 2014 when we bought back inventory in connection with the termination of a distributor agreement in Japan. Revenue in China increased 24% operationally, as higher pork prices created favorable conditions for pork producers and supported strong demand for our vaccine products. Revenue in Brazil was up 12% operationally, fueled by price growth, new product launches and successful promotional efforts by our Brazilian colleagues in what is, despite the broader economic climate, a favorable environment for cattle producers. Growth in Japan, China, Brazil and other markets were offset mainly by declines in France, which was down 27% operationally, and Venezuela. In France, Q3 2014 revenues were substantially higher than normal as customers bought products ahead of changes to France's regulation of anti-infective sales. In Venezuela, as we reported back in May, we are reducing our efforts in the country in light of the uncertain economic situation there. Before I move on, I want to put an exclamation point on Juan Ramón's comments around Brazil and China. There's been a lot of talk recently about the challenging economic environments in Brazil and China and the impact of those economies on global companies, like ours. I won't repeat everything Juan Ramón said, but I do want to add a finance guy's perspective. The challenges in Brazil and China are real, but just how challenging they are depends on the segments in which you compete and other fundamental factors. Our business and our company tend to be less impacted by general economic conditions and Zoetis' prospects in China, Brazil and related markets remain good. Our operational growth in China of 24% in Q3 was actually faster than was posted for the first half of the year. And in Brazil, our operational growth in the quarter of 12% was the same as our operational growth through the first half of the year. I bring this up because there will continue to be hand-wringing about the impact of these economies on global businesses, and appropriately so. However, our belief is our industry and our company are far less exposed to weakness in these economies than other companies and industries, and our historical results and our results so far in 2014 support that belief. Quick update on our operational efficiency initiative. We're making excellent progress implementing the structural and organizational changes that will drive the cost reductions we outlined to you in May. We remain on track to deliver our target of at least $300 million of cost reductions entering calendar 2017. I want to repeat that we have been and continue to be thoughtful in how we achieve those cost savings with a focus on efficiency and the preservation of the core strengths of our business model : our direct sales forces, our productive R&D engine and our supply chain. In terms of one-time costs, you'll recall that I talk about these costs in three buckets : our standup and other one-time costs, the costs associated to our efficiency initiative and the costs associated with our supply network strategy. In the quarter, we incurred $28 million of stand-up and other one-time costs. The stand-up costs associated with our separation from Pfizer are largely behind us and should be complete in 2016. We recorded $21 million of one-time costs associated with the efficiency initiative in the quarter. Much of the cost of the initiative were recorded in Q2 of 2015. And finally, we recorded $3 million of costs associated with the supply network strategy. We continue to be in the early days of this initiative. We have provided a slide summarizing our current estimates of the total cash cost associated with each bucket. Now here's the payoff pitch. Updates to our guidance for 2015, 2016 and 2017, the good news here is that there is a lot of good news. Let's start with 2015. We narrowed and revised our guidance range for revenue. Let's not lose sight of the negative impact of FX rates that reduced the range by some $25 million since our last update. We reduced the top end of the range by $25 million, but held the low end of the range. Next, we have reduced the expectation for adjusted cost of sales as a percent of revenue by some 50 basis points to 100 basis points to now being approximately 35%. Of this improvement, some comes from the favorable impact of FX rates, so those benefits may be judicious, (24:44) but some of the improvement is structural in that it represents improvements in the management of the supply chain. For SG&A, we narrowed the range towards the upper boundary. For R&D, we decreased the range by $30 million to a range of $350 million to $370 million, reflecting a more rapid realization of some of the savings from the efficiency initiative. I want to point out that even though we are spending less in R&D, we continue to commit the necessary resources to support our rationalized product portfolio and to develop new innovative products to fuel our long-term growth. Finally, we revised our guidance for our tax rate on adjusted income down by about 100 basis points to approximately 28%. Part of this favorability is structural, coming from refinements and simplification of our operating model as well as several discrete items that occurred during the quarter. All of these things together enable us to raise and narrow our range for full year 2015 adjusted net income per share to $1.70 to $1.74, with the entire range of our revised guidance above the high end of our previous guidance. As I said, good news. Looking out to 2016. The negative impact of FX rates would have lowered our prior revenue guidance by some $105 million. However, a combination of factors has enabled us to increase 2016 revenue guidance by $75 million to $100 million. Supporting the increase are the acquisition of PHARMAQ, increased expectations for the acquired Abbott products and APOQUEL and the addition of new products, including IL-31 and SIMPARICA. The new revenue guidance range for 2016 implies operational growth versus 2015 in the range of 3% to 5%. As a reminder, this growth rate is suppressed by the impact of the ongoing SKU rationalization and our decision to reduce our activities in Venezuela. The increase to the range of SG&A costs is a result of several factors, including cost that's moved as a function of our now higher revenue outlook, second is the inclusion of SG&A cost for PHARMAQ and finally cost to support the launches of IL-31 and SIMPARICA. I want to point out, launch costs for Animal Health Products tend to be more modest and of shorter duration as compared with launch costs in human health. We reduced our outlook for R&D costs consistent with my comments around 2015, but then we added in costs associated with Aquatic Health R&D, which is embedded in PHARMAQ. The other significant change is the reduced expected tax rate on adjusted income from 30% to 28%, this reflects some structural benefits coming from actions to further refine and simplify our global operating model, which are expected to continue into future years. The net result of all the changes we are making to our outlook for 2016 is that we are revising upward our guidance for 2016 adjusted net income to the range of $925 million to $975 million, with implied operational growth moving from 12% to 19% to the range of 14% to 20%. The range for 2016 adjusted EPS moves up to $1.84 to $1.94. And especially in light of the FX headwinds, this is good stuff. Finally, and I'll spend less time on it, 2017 guidance. In a nutshell, the negative impact of changed FX rates on the previously provided revenue range is a reduction of about $115 million. But we are increasing 2017 revenue guidance by $175 million. The increase is driven by the acquisition of PHARMAQ, increased expectations for the acquired Abbott products and APOQUEL and the inclusion of the new products, IL-31 and SIMPARICA. Where previously we had guided to operational revenue growth in 2017 versus 2016 in the range of 3% to 7%, we are now guiding to the range of 4% to 9%. And this is truly organic growth as the acquisitions for both the Abbott products and PHARMAQ are fully reflected in our 2016 guidance. I call your attention to the tables that contain all the details of our guidance in 2017 and the changes from prior guidance and I'll just skip to the end. We're increasing our guidance for 2017 adjusted net income by $30 million to the range of $1.125 billion to $1.195 billion, implying growth on an operational basis in 2017 versus 2016 of 18% to 26%. And our guidance for adjusted EPS has been increased by $0.06 per share to the range of $2.24 to $2.38 per share. Again, strong and reflective of the team here taking all steps to drive profitable growth. Please note that for 2016 and 2017 we've assumed a constant diluted share count of approximately 502 million shares, as we expect our share repurchase program to at least offset the dilutive impact of our share-based comp plans. Speaking of our share repurchase program, in the third quarter we purchased 1.1 million shares for about $50 million, an average price of $46.92 per share. Through the third quarter and year-to-date in 2015, we repurchased 3.2 million shares for an aggregate $148.1 million, an average price of $46.45 per share. Before we move to Q&A, I want to take the opportunity to talk about the strength of our industry and our company in turbulent times. I have to say we've been a little frustrated watching our share price drift lower while at the same time knowing that we are delivering across a range of activities that we believe are building the value of our company. We ended 2014 with a share price of roughly $43, not a lot different from our closing price last night. But here's a short list of the things that we've accomplished since the beginning of the year. In January, we closed the acquisition of the Abbott Animal Health business. In February, we put a strong full-year 2014 on the board, delivering operational revenue growth of 7%, adjusted net income growth of 13%. In May, we unveiled our operational efficiency program and provided you with a road map in the form of longer-term guidance as to how we intend to increase profit levels and improve our adjusted operating margin to the mid 30%s. And we reported a strong Q1 of 2015 with operational revenue growth of 6% and adjusted net income growth of 14%. In August, we put a strong Q2 on the board, year-to-date operational revenue growth of 8% and adjusted net income growth of 17% and we announced that we received a conditional license on the innovative monoclonal antibody for Canine Atopic Dermatitis, which you call IL-31. Today we post a strong Q3 of 2015, with year-to-date operational growth of revenue of 9% and adjusted net income growth of 22%. And we announced the acquisition of PHARMAQ, providing us with a market-leading presence in aquatic health, the fastest-growing segment of the animal health industry. That's a heck of a year and we're only through Q3. Our industry has continued to prove its many positive attributes. And coming up on three years since our IPO, we believe the team here has proven the strength of Zoetis' business model and our capability to deliver to you value. That concludes my prepared remarks, and so let's open the line for questions. Keith? Operator : And we'll take our first question from Erin Wilson with Bank of America Merrill Lynch. Please go ahead. Erin E. Wilson - Bank of America Merrill Lynch : Great. Thanks for taking my questions. How would you characterize the underlying demand trends across the U.S. livestock market? How should we think about the quarterly progression here given the buying patterns you alluded to in the press release? And if you could comment on poultry dynamics as well. And then part two of my question would be, as far as the acquisition goes, can you speak to underlying profitability of the business and potential synergies and cost savings associated with the PHARMAQ deal and your capacity for future business development initiatives? Thanks. Juan Ramón Alaix - President, Chief Executive Officer & Director: Thank you, Erin. And let me answer the first question on the demand in the U.S. Definitely, there are different drivers depending on the different types of animal proteins, cattle, pork, swine. I would say that the cattle, it's still facing maybe some limited production, although the demand has been reduced slightly. Because of the limited production, it seems most of the producers are rebuilding their herd and sending less animals to the slaughterhouses. At the same time, in some markets we have seen that the demand for beef has been changing slightly, but we remain very positive in terms of the cattle business in the U.S. In terms of poultry, the demand continues very strong. And I think we expect also that not a significant impact in terms of the avian flu affecting the meat part of the poultry segment, although this is affecting the egg production. And in swine, in 2015 we have seen a significant increase in the supply because of the PDV is not affecting and the farmer have been able to increase significantly the number of animals. And this also has been making a pressure in terms of prices. But for the animal health industry, it has been positive because there are more animals and more animals to be treated and protected. In terms of PHARMAQ, I think really Paul can provide the details on this acquisition. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure. And I think your question, Erin, was around how do you think about this business in the go-forward? And firstly I want to point out a couple of things. Is this is a business that shares a lot of the characteristics of our business. These are long-duration assets participating in solid growth markets that are supported by a productive R&D engine. It's very similar to our business. There are cost synergies associated with our acquisition here, however, this is not a cost synergy deal. PHARMAQ have solid operations on the sales and marketing side, as well as in the R&D side and of course in the manufacturing arena. And so from a cost perspective, this is not like a classic cost synergy deal; this is a transaction that puts us squarely in a space that's going to grow quickly, that comes to us with a well-developed pipeline featuring near-term opportunities to continue the attractive growth that they deliver. And I'll get the start date wrong, but I believe that they've been growing at a compound rate of about, through 2014, of about 17% in that business. And so thinking about this business, this is more about supplementing our Livestock business, getting us into a space of where we're not presently represented. And we love this deal, we love the value of this deal and we think you will too once it starts to play out over the course of the next couple years. I think there was a third question there was kind of capacity for more deals to say, look, we've had a great year so far in 2015. When you look at the Abbott transaction as a classic good deal for us that came up a couple of times in our prepared remarks, we're doing better both in terms of driving revenue synergies and cost synergies on that deal. I wish there were 10 of those out there to be done every year, there just aren't. But when they come up, we would certainly look to pursue additional transactions like that. Larger more strategic transactions, like a PHARMAQ, there are a handful of opportunities out there. Do we have the capacity to do it? Well, we haven't even closed this one yet. So we'll get this one closed up and then we'll start or continue the process of looking for what that next opportunity is. M&A will continue to be an element of our strategy. Juan Ramón Alaix - President, Chief Executive Officer & Director: But we want to make sure that we remain very disciplined in terms of assessing opportunities for M&A and also we want to make sure that we maintain our ratios in terms of debt, which are a range between 2.5 to 3.5. That is something that we'll be also considering. One important element that we mentioned many times is that our market share also is creating some limitations in terms of large acquisitions in terms of antitrust. But we'll continue assessing opportunities as they come and always applying a criteria that will support any kind of acquisition. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Okay. Next question, please? Operator : We'll take our next question from Kevin Ellich with Piper Jaffray. Please go ahead. Kevin K. Ellich - Piper Jaffray & Co (Broker): Good morning. Thanks for taking the question. Juan Ramón, wondering if you could talk about the strength that you saw in some of the developing markets, like Brazil and China. I think we saw 12% operational growth and 24% in China. And then I guess just going back to the acquisition, Paul, could you talk a little bit about the profitability of PHARMAQ and I guess the justification for the valuation or how you guys think about valuation for deals like this? Thanks. Juan Ramón Alaix - President, Chief Executive Officer & Director: Thank you, Kevin, for the question. Let me start with China. China remains a market with a significant growth potential. And we mentioned that several times that the consumption there is increasing very fast because of the increase of middle class, but also very important for our industry, they are changing also the way they are raising animals. So in the past in China, there was significant part of animals, I'm talking about pigs, that they were small productions or even backyard production. We have seen that it's a significant shift from this kind of production to more sophisticated production and this is what is generating a significant opportunity for animal health industry that can provide the quality of a product that can increase the productivity in these farms. We have been also investing in China since many years. We have in China the infrastructure to maximize any new products that we are bringing to the market. We have been launching new products in China, some of them as a result of a JV that we formed a couple of years ago. And we are very pleased with the all the things that are going on in China. As I said, we don't see that this economic slowdown is affecting the animal health industry. In Brazil, the situation is different. Brazil remains a very strong market in terms of production of animal proteins for export. Brazil is one of the key markets in terms of export and they also have the benefit now of low cost in the country and also lower prices because of the real has been reducing against the dollar. So these elements are creating a very good momentum in Brazil. We have seen also Brazil that the cattle industry, it's increasing the herds. Prices of meat are also very positive. The only comment in Brazil is that we have not seen any reduction in terms of internal consumption; what we have seen is switching from more expensive meat to less expensive. If the situation remains in the future in terms of economic crisis, we need to assess if their internal consumption will be affected. But so far, we have not seen any kind of reduction of meat consumption in Brazil, so the prospects for this country remain very positive. Paul will talk about the acquisition. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, Kevin, thanks for the question. And I think you have to think about the PHARMAQ acquisition as being comprised of two pieces, one is that base business that's been growing very quickly and, by the way, has been supporting solid investment in R&D. And that leads me to the second piece of the value, which is the pipeline opportunities that come with the company and those are both near term and they're longer term. I said earlier I think in response to Erin's question, you've got to look at this business as being one that's very similar to ours in that it enjoys that long duration, long durability of the revenue streams, and that includes taking into consideration the near-term pipeline opportunities. If you look at this deal on a near-term basis and say, gee, accretion and it's neutral in the first year and then it's accretive thereafter. This is a deal that goes on and enjoys that long period of sustainable growth of profit and cash flow as added into our business and so that's how we value it. We value it on a fundamental basis, not necessarily – if you're going to look at it, a sales multiple is not appropriate here. Juan Ramón Alaix - President, Chief Executive Officer & Director: Let me add a couple of comments on PHARMAQ that, in my opinion, are important. I think first, the farmed fish market is the fastest-growing market in the animal health industry. PHARMAQ has been delivering very strong growth in the last 10 years. We mentioned that a CAGR of 17%. And, very important, PHARMAQ is focused on the area that is showing the fastest growth within aquatic health, which is vaccines. And definitely PHARMAQ is the leading company in terms of innovation in vaccines that will be a great opportunity for the future in terms of revenue growth. So we are extremely happy with this acquisition and we are convinced that this company integrated into Zoetis and having the support of our infrastructure will also maximize the opportunities in the farmed fish. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Next question, please? Operator : Our next question comes from Louise Chen with Guggenheim Partners. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my questions. So first question I had here was just on the potential for cost cuts greater than $300 million. And then a second question is just on the PHARMAQ deal again here. My understanding is that Permira had brought this company for meaningfully less two years ago. I'm just curious your thoughts here on your valuation for the company. Thanks. Juan Ramón Alaix - President, Chief Executive Officer & Director: In terms of cost cuts, I think we are on track to deliver what we announced, the $300 million by 2017. And the teams are working very hard. So we have made significant progress. And as you remember, there were some elements of this program related to SKU rationalization, also the reduction of some of the manufacturing plants and also the reduction or the change in some of the markets in where we were operating direct and we will be now operating through distributor. But still, this market is representing a small part of our portfolio because 95% of the revenues are still generated through our direct interaction with customers. So the report here is that we are doing very well and we plan to meet or exceed the $300 million. In terms of PHARMAQ, Paul will cover this question. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, sure. Permira bought the company back in 2013. A couple of interesting tidbits. We would've loved to have owned this company back in 2013 and tried to own this company back in 2013 and we were not able to acquire it back in 2013. And so what has happened since then, and I think you have to take your hat off to the team at PHARMAQ and Permira for backing that team to do what they needed to do to substantially build the value of that company over the last several years. What did they do? They advanced the pipeline, which for us is a very important factor. And while they were doing that, they continued to deliver growth in their base business and build that company. So that company is worth a heck of a lot more today than it was in 2013, number one. And number two, I would argue that it is worth more in our hands than it's worth in other people's hands because of our opportunities to drive geographic revenue for this part of our company that is not available to a stand-alone. Juan Ramón Alaix - President, Chief Executive Officer & Director: Next question, please? Operator : Our next question comes from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets (United States): Good morning. Thanks for taking the questions and congrats on the strong quarter. Paul, sorry to keep going back to this, but I think it's an important question. How profitable is PHARMAQ and what is your expected profitability for this business given increased scale as part of Zoetis? And also, gross margin was higher than we expected. How much of that was FX as opposed to product mix? Thank you. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, with respect to the profitability of PHARMAQ, the business is profitable. It is supporting and has been supporting a substantial investment in R&D and continues to be a profitable business. Not sure we want to get into providing the entire P&L for PHARMAQ and, say, oh, here's exactly what they're doing. But suffice it to say that we think that the company, as part of Zoetis, fits with our model of long-term revenue growth and driving that over an extended period of time. And clearly we see a lot of value there. I don't want to provide a P&L for PHARMAQ for 2014. I don't think it would tell you the whole story. The salient points again, and I'll keep coming back to this, is a base business that is growing very rapidly, a base business that has supported the investment of R&D and helped them develop a pipeline that we see a great deal of value in as we go forward. With respect to gross margins, one thing you've got to take into consideration, I called it out in my remarks, is that FX has a favorable impact on our reported gross margin. And that was I believe roughly 100 basis points – someone will correct me if I get that wrong, but I believe it was about 100 basis points. And that turns around if FX rates happen to go in the opposite direction, but, yeah, it's roughly 100 basis points. There are some structural things that we've done in the early stages of our supply network strategy to improve the efficiency of our supply chain and, therefore, improve margins through doing things more efficiently in the supply chain. And those are permanent and structural and that over time – this is just the early stuff with respect to the supply network strategy. We've articulated in 2020 we expect to have another couple hundred basis points of gross margin from the broader supply network strategy, which really we're just at the early stages of. Juan Ramón Alaix - President, Chief Executive Officer & Director: Yeah, maybe not to go into the details of the P&L for PHARMAQ, Alex, but maybe some information that can be interesting there for you. First, I think this business, it's mostly a vaccine business. So we are not talking here about maybe feed additives, but a vaccine business. The second is that this industry is highly consolidated. So the cost to bring the products to the customers is not as expensive as in Companion Animal. So it's fewer customers and it's also providing operating ability that is related to the cost of commercialization of all the products of PHARMAQ. So what I want to say is that it's a profitable company and definitely we see the opportunity to make this company even more profitable in the future. Next question, please? Operator : We'll go next to John Kreger with William Blair. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Switching gears to SIMPARICA, are you still comfortable that product gets on the market in the U.S. next year? And does your guidance assume a 2016 launch? And then maybe a just quick follow-up. You mentioned France had some tough comparisons, with antibiotic regulations kicking in a year ago. Are there any other regions where you're watching closely for perhaps more restrictive regs around production antibiotics? Thanks. Juan Ramón Alaix - President, Chief Executive Officer & Director: So let me start with SIMPARICA, John. We expect the U.S. launch in SIMPARICA next year. We'll always depend on FDA approval, but we are preparing for this launch in the U.S. and also the launch in the European market. In terms of France, France we reported that last year there was a change of legislation. So the change in the legislation was mainly eliminating rebates on sales of antibiotic and then customers bought in anticipation of this new legislation. Definitely we are monitoring any kind of changes in terms of restriction on the use of antibiotics. There are movements, mainly in Western Europe, and we are tracking all that and this has been incorporated in our guidance for 2015, 2016 and 2017. Still, we consider that today there are no alternatives to treat animals that are sick other than antibiotics. And in many cases, the only way to achieve the productivity that customers need, we also need to prevent diseases with antibiotics. What we have seen in many markets, including the U.S., mainly a reduction of antibiotics which are medically important for human. But again, we don't see these changing significantly our revenues in the U.S., mostly because they will be moving to other antibiotics that we also have in our portfolio. Next question, please? Operator : Our next question comes from Chris Schott with JPMorgan. Please go ahead. And we'll go to David Risinger with Morgan Stanley. Please go ahead, your line is open. David R. Risinger - Morgan Stanley & Co. LLC: Yes, thanks very much. Congrats on all the news flow. My question relates to 2017 revenue and your guidance. Could you just remind us for some of the key new product launches, what you're incorporating into your 2017 guidance for those major new product introductions and then also whether you are excluding any new product launches from the 2017 guidance? Thanks very much. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah. Hi, David. It's Paul. Thanks for the question. This is both 2016 and 2017 and following on from the last question, SIMPARICA is included in our 2016 and 2017 guidance. And we're expecting the o-U.S. launch of SIMPARICA and then anticipating the U.S. launch of SIMPARICA, so that's in both 2016 and 2017. IL-31 is also in 2016 and 2017, but point out that we're currently operating under a conditional license and expecting to have a full license in the latter part of 2016. So the impact on 2016 is pretty modest. And then you see it included in our 2017 under a full license, so it's in there as well. And with respect to the question of is there anything – well, just to be super clear. And of course this now includes PHARMAQ as part of our guidance in 2016 and 2017 as well. We only add in products to our guidance when they achieve a high probability of regulatory and technical success and these are the only new products that we have included in 2016 and 2017. Next question, please? Operator : Yes, and I will try Chris Schott with JPMorgan. Please go ahead. Christopher T. Schott - JPMorgan Securities LLC : Great. Can you guys hear me now? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yes. Christopher T. Schott - JPMorgan Securities LLC : Okay. Sorry about that. Just had two questions. First, can you just elaborate on the priorities for business development following yesterday's deal? I guess my question is, just how many more assets like PHARMAQ or Abbott are out there? Is it a large universe, or is that a fairly targeted group of companies or divisions of companies you can target? And the second question was just on APOQUEL. I appreciate the comments earlier. But when we think about 2016 growth for APOQUEL, is capacity a rate-limiting factor or is it really just how quickly you can build demand for next year? Thanks so much. Juan Ramón Alaix - President, Chief Executive Officer & Director: Let me start with the easiest answer, which is APOQUEL. In 2016, we don't expect to have any limitation in terms of capacity and it's just the time for introducing the product in more customers in those markets in where we have already introduced the product and also launching in new markets. But we don't expect to have capacity issues. We have solved the API, we have a second source of API also in 2016 and now the manufacturing group is working to produce all the tablets that will be available to customers in 2016. In terms of BD, opportunities like PHARMAQ are unique, so I don't think that we'll find so many opportunities like PHARMAQ in the market. But there may be some assets that can be attractive to us, not many, but it will be maybe in some countries maybe some companies that will be for sale in the future. But, again, so we need to understand that because of our market share, we're facing some limitations in terms of antitrust that we need to incorporate in our evaluation. But we have been demonstrating that we are understanding the opportunities in the market, Abbott Animal Health, KL, PHARMAQ, and we'll continue assessing these opportunities in the future. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, I want to continue on, on that because after the press release last night, we started getting a lot of questions about BD strategy and are there other, I'll put air quotes around this, big deals out there. And we want to be clear. If you'd asked us in June of 2014, say, gee, do you think you can do two right down the middle of the fairway business development deals in 2015? We would have had a fair degree of confidence that we could do that, but, as we all know, whether or not you can actually do those two deals is good material for a debate. We're very fortunate in that 2015 we've had two very good and two very different type of deals present themselves. One, the classic tuck-in acquisition, where I mentioned before, but it's worth mentioning again, we acquired in the beginning of the year. We are achieving greater than our targeted level of cost synergies and we're delivering revenue synergies, that's a great deal. I will do that deal 100 out of 100 times. And then secondarily, PHARMAQ, which for us from a strategic perspective and a value perspective is one of those rare deals that comes around not all that often. If you think about the aquatic health industry, it's roughly a $400 million industry and here's a company that in the very near term you would expect to have a 25% or greater share of that rapidly-growing segment. And it happens to be a business that we know a lot about. I mean if you think about us on a fundamental level, what do we do? We are excellent at developing and promoting products to producers of animal protein for human consumption. This is right in the middle of the fairway. But if you'd asked us a year ago or more than a year ago, gee, are you going to be able to do a deal like that? We would have been hopeful, but the opportunity needs to present itself. Two important points. One is we will maintain the discipline to focus on business development opportunities where we can leverage our particular competitive strengths to build and drive value for our shareholders. We think that there are other opportunities for us as we look out into 2016 and to 2017 and we will continue to pursue those opportunities, but I want to be clear, they're more likely to fall in the category of an Abbott-type deal than a PHARMAQ-type deal. That said, there's always opportunity. I'll stop there. Next question, please? Operator : Our next question is from Mark Schoenebaum with Evercore ISI. Please go ahead. Volodymyr Nikolenko - Evercore ISI : Thank you. It's actually Vlad Nikolenko on behalf of Mark Schoenebaum. Congratulations for the great quarter and smart acquisition of PHARMAQ yesterday. Actually a question more about the macro situation about what else is going on in biotech. There have been a lot of chatter and noise in present from political front about potential regulation of drug prices in the human health. And Zoetis looks like being a victim of overall selloff in biotech. So I just want to hear your perspective on animal front (1:01:30) of potential regulation or even just headline from political noise from human health on animal health and Zoetis' ability to continue increasing prices on something like 2% or 3% per year. And second question is more about long-term guidance, specifically tax rate. So whether revised guidance, additional decrease in the long-term tax rate of 100 basis points to 200 basis points, if it's sustainable or if there is additional limit to decrease tax rate even further? Thank you. Juan Ramón Alaix - President, Chief Executive Officer & Director: Thank you, Vlad. I'll start with the first question on macro environment and then Paul will answer the tax rate. So the first thing, we are not a human health company. And we try from the reading to explain how different is animal health to human health. And the most important difference is that our business is a business-to-business model. We are not dealing with a third-party payer, so our prices are defined by just the pure market dynamics. So we sell what our customers that are also paying are willing to pay for based on the value that we can demonstrate to them. So regulating prices in an industry which is just a market-driven industry will not make any sense, but it's something that we don't see happening. And in terms of what is the macro environment, we describe that our industry is very resilient to economic dynamics. We saw that in 2008 and 2009. We also saw that in 2012 at the time of the drought that our industry responded extremely well. So one of the characteristics of animal health are stability and sustainability and we think that it is one of the attributes that make our industry very attractive to investors. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : I think on the tax rate question, I'll restate one of my phrases around our tax rate is, we have the opportunity to continue to lower our tax rate, but, as I said before, it's going to be evolutionary not revolutionary. We through the process of our efficiency initiative, which we kicked off in May, have taken steps to both define and simplify our global operating model. And that's had some benefits to us in terms of our global effective tax rate and that's a tax rate on our adjusted net income, by the way, and adjusted pre-tax either way (1:04:32). And we expect that we can continue to do that, but, again, I don't want to provide anybody with the unrealistic hope that we can suddenly dramatically change our tax rate. But I think that you can see in the progression of 2015, in our guidance for 2016 and 2017 that we are continuing to take those steps that we can take in order to try to drive that tax rate down. But, again, evolutionary, not revolutionary. Next question, please? Operator : We'll go next to Jami Rubin with Goldman Sachs. Jami Rubin - Goldman Sachs & Co.: Thank you. Just a couple of follow-up questions. Most of my questions have been answered. Paul, you said in your remarks that you're surprised your stock price is so low. What is your capacity for embarking on a very large share buyback program? I would think you'd want to put your money where your mouth is and if you think the stock is so cheap, why aren't you guys announcing a big buyback program? And then secondly, Juan Ramón, I'm sorry if I missed this, I was in and out of the call, but you talked about making an aqua health acquisition for the past couple of years. What other areas, where are there holes in your overall business areas or business segments, where do you feel – is it geographical that you'd like to fill in or is it actually product-related? What are the other businesses that you would like to be beef-up in? You were very clear about aqua health for the past couple of years. So what other businesses are you seeking to add to your portfolio? Thanks very much. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure. Jami, thanks for the questions. And I'll start with the share buyback. And here's a thing. We have a share buyback program; I know it's modest. And we continue to buy back shares and have been buying them back since the beginning of the year. And this is a balance between allocating capital to those activities that we think will build the most value over the long term. And for this year it's, again, I think so far a remarkable year. Beginning of the year we allocated capital to the acquisition of the Abbott Animal Health assets. Great place to put our money. Secondarily here, hopefully on or about November 10 we'll close on the PHARMAQ acquisition. These represent deployment of capital ways that we'll continue to build value for our shareholders over the long term. While we're doing that, we continue to buy back shares. To the extent that we find ourselves in an environment where we have lots of cash flow and nowhere to deploy it in a way that we felt was value generative, yeah, we could increase the scale of our share buyback. But right now, going out and levering up the company to buy back a bunch of shares is not something that we're going to do. Juan Ramón Alaix - President, Chief Executive Officer & Director: Jami, thank you for the question. And let me describe where we're at now. So definitely before the acquisition of PHARMAQ, the only area that was significant for animal health and where we were not participating was aquaculture or this aquatic health. Now, with the acquisition of PHARMAQ, we have filled this gap. So now we are number one in cattle, we are number two in companion animal. But I think we have been taking all the actions to have a stronger position in this category with a launch of APOQUEL, the acquisition of Abbott Animal Health and also our internal efforts in terms of R&D, to bring new parasiticide that was an area where we were underrepresented. We are convinced that we have all what we need to compete in this space. We are number one in swine and we are number three in poultry. And definitely in poultry we see opportunities if they come to consider some acquisitions of products or other assets. We incorporated a small acquisition in poultry this year, mainly on devices. And we are also working internally to develop the portfolio and the pipeline that will bring us to a stronger position. In terms of geographies, we have a very strong position in all the of the markets. And very important, in those markets where we don't have yet the position that we should have is not because we don't have the portfolio, it's only a question of registering the portfolio and bringing this portfolio to the market. So I see in terms of geographies more opportunistic than need. And then moving to what will be other opportunities, definitely any area that will be complementary to our core business, which are medicines, that can enhance these core business and create additional revenues and profits will be part of our assessment. Next question, please? Operator : And we'll take our last question from Doug Tsao with Barclays. Please go ahead. Douglas D. Tsao - Barclays Capital, Inc.: Hi. Good morning and thanks for taking the questions. Just maybe clarify on APOQUEL. So will you be at a state without any supply constraints by the end of this year, or will that sort of take place in phases over next year? And just in terms of the second source of API, is that going to be a back-up source or is that going to be a source that is going to be regularly contributing towards production? Thank you very much. Juan Ramón Alaix - President, Chief Executive Officer & Director: Thank you, Doug. And in terms of APOQUEL supply, we expect to have a supply for meeting the demands of customers in the U.S. and UK markets at the end of the year. Then we'll continue introducing the product in other markets. And we don't think that supply will be an issue to deliver all customer demand in 2016. The second API source, it will be not just of a back-up, it will be a contributor. And we have the opportunity to double the capacity of the existing capacity that we have. And this is also something that will protect future revenues of future demand for the product. So we are very confident that the API will be enough to produce all the finished product that will be demanded by the customers in 2016. Operator : And it does appear we have no further questions, so I will return the floor to Juan Ramón for closing remarks. Juan Ramón Alaix - President, Chief Executive Officer & Director: So thank you very much for attending this call. And, again, we are very pleased to have the results of this third quarter. But more important, my opinion, it's how confident are we in terms of our future, in terms of revenues and in terms also of adjusted EPS. We are very confident that we'll be delivering very strong results despite of the negative impact of exchange rate. That has been compensated with the introduction of new products and also the performance of the rest of the portfolio. So with that, thank you very much for attending this call. Operator : This does conclude today's teleconference. A replay of today's call will be made available in two hours by dialing 800-283-4605 for U.S. listeners and 402-220-0874 for international. Please disconnect your lines at this time and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,016
| 1
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2016Q1
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2015Q4
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2016-02-16
| 1.678
| 1.72
| 1.88
| 1.92
| 2.79396
| 23.89
| 24.53
|
Executives: John O'Connor - Vice President, Investor Relations Juan Ramón Alaix - Chief Executive Officer & Director Paul S. Herendeen - Chief Financial Officer & Executive Vice President Analysts : Kevin K. Ellich - Piper Jaffray & Co (Broker) Louise Chen - Guggenheim Securities LLC Alex Arfaei - BMO Capital Markets (United States) Erin Wilson - Credit Suisse Securities (USA) LLC (Broker) John C. Kreger - William Blair & Co. LLC Christopher Schott - JPMorgan Securities LLC Jami Rubin - Goldman Sachs & Co. Douglas Tsao - Barclays Capital, Inc. Mark J. Schoenebaum - Evercore ISI David R. Risinger - Morgan Stanley & Co. LLC Kathy M. Miner - Cowen & Co. LLC Jeffrey Holford - Jefferies LLC Operator : Good day and welcome to the fourth quarter and full year 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 two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. It's now my pleasure to turn the floor over to John O'Connor. You may begin, sir. John O'Connor - Vice President, Investor Relations : Thank you, operator. Good morning and welcome to the Zoetis fourth quarter and full year 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 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 actual results could differ materially from those projections. For a full 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, February 16, 2016. We also cite operational results, which exclude the impact of foreign exchange. With that I will turn the call over to Juan Ramón. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, John. And good morning, everyone. In today's call I will provide perspective color based on the performance for the full year 2015 and our goals for 2016. Paul will discuss some of the fourth quarter highlights, the 2015 net results and our guidance for 2016 and 2017. In 2015, we affirm Zoetis' reputation as the global leader in the animal health industry with a strong financial performance, continued investment in our future growth and a commitment to creating a value for our customers and shareholders. For 2015 our diverse portfolio enabled us to grow our revenues by 8% operationally, with particular strength coming from R&D innovations and acquired products from Abbott Animal Health. In our three years as a public company, we have been delivering consistent operational revenue growth and we expect our 2015 to show again that we are growing faster than the industry. We grew our adjusted net income by 24% operationally, and grew our adjusted EBIT margin from 25% to 28% as we continue our focus on greater efficiency in our business. Even while we are scrutinizing our efficiency, we also continue to allocate resources for future growth. We invested $1.6 billion in 2015 across strategic acquisitions, internal research and development and capital expenditures in areas like manufacturing and supply. And finally, in 2015 we returned approximately $370 million in excess capital to our shareholders in the form of dividends and share repurchases. This performance reflects our disciplined implementation of our business plan and our colleagues' tremendous dedication to serving our customers. I am pleased to say that as a result we met our guidance for revenue and exceeded our guidance for adjusted net income in 2015. On a reported basis we had a flat revenue growth due to an 800 basis point impact from foreign currency, but we still grew our reported adjusted net income by 13% thanks to our continued focus on achieving our efficiency goals. Looking ahead to 2016, first and foremost we are focused on delivering our financial guidance for the year. We are projecting 2% to 4% operational revenue growth, which reflects the impact of our SKU realization and changes to our operations in Venezuela. Excluding those impacts, we expect to grow revenues 8% to 10% operationally with 2 percentage points coming from the addition of PHARMAQ. This means organic growth is expected to be faster than the market again. And for 2017 we expect to continue growing faster than market at the rate of 5% to 9% as we are confident in our end markets, business model, the prospects for new product launches, improved product supply and progress in our efficiency goals. We are also confident in our pricing strategy. Our prices are defined by the value that we can demonstrate to our customers who buy and pay for the products we completely independent of third-party payers. In January we updated our adjusted EPS guidance for 2016 and 2017 to reflect the impact of the European Commission decision on our tax rate. Today we are pleased to reaffirm our 2016 and 2017 guidance for adjusted earnings per share despite the negative impact of foreign currency and the change in our operations in Venezuela, which will have a negative impact of $0.06 in 2016 and $0.08 in 2017. Our second objective for 2016 is to ensure the successful launch of new products that are critical for our long-term revenue growth. We are increasing supply for APOQUEL and also launching in new markets. This growth already surpassed $100 million with a limited availability in 2015, and we see significant room to grow from this level with long-term peak sales of more than $300 million. Another important breakthrough in the area of dermatology, our canine antibody therapy against atopic dermatitis has been introduced in the U.S. to veterinarians and dermatologists, and we are preparing for global market availability later in 2016. Meanwhile SIMPARICA, a new oral parasiticide, will help us to better compete in the global market of flea and tick products, a market of approximately $3 billion. SIMPARICA was approved in the EU later last year, and we are awaiting approval in the U.S. this quarter. We expect the launch in both the U.S. and EU in the first quarter of 2016, and see sales ramp up during the year. Our third major objective this year is enhancing the supply and customer service, an area where we fell short last year. As we continue with our supply network strategy, we are making steady improvements, most notably in APOQUEL. We're also investing to build capacity in product categories that will be an important part of our future revenue base. In the near term we believe that a simplified supply chain with fewer manufacturing plants, focused on expanding the set of products will improve our performance. We also remain on track to complete the global implementation of our new Enterprise Resource Planning system, or ERP, in the first quarter. The ERP will support our overall efficiency goals and will help us better manage the processes and information to run our business. And we continue to refine these systems over the course of the year; we'll make certain we are exceeding our customers' expectations. Our fourth major objective is around capital allocation and how we maximize our cost structure, investment in R&D and business development. We are making a good progress in shaping our cost structure as part of the overall efficiency plan we announced last May. That work has been accelerated, and the additional cost savings has been included in our guidance. It is equally important to realize that while we are implementing these plans, we have remained committed to building the three interconnected capabilities that drive our success with customers : U.S. sales, innovative R&D, and high quality and reliable manufacturing and supply. The implementation has been resourced, even as we go through changes in other areas of the company. Our investment in R&D continues showing high return and support for our future growth. I am very pleased to say that our efforts to refresh our portfolio with innovative vaccines offerings, especially in companion animal are paying off. Last year, we launched a new combination vaccine for dogs across the EU called Versican Plus, and has been very well received by customers. In the fourth quarter, Zoetis was granted a conditional license from the USDA to market our canine influenza vaccine, the first conditional licensed vaccine to help control disease associated with canine influenza, the virus that is H3N2. In December, we received our U.S. license for VANGUARD crLyme, a vaccine that aids in the prevention of conditions associated with Lyme disease in dogs. And in November, we expanded our INNOVATOR horse vaccine franchise in the U.S. with the launch of our vaccine to aid in the prevention of leptospirosis. Meanwhile in aquatic health, shortly after closing our deal with PHARMAQ in the fourth quarter, one of their new vaccines for salmon received an emergency license in Chile, one of the world's largest farmed fish markets. Our focus on enhancing our portfolio resulted in recent approvals for new indications and formulation of existing products. In January, Zoetis received FDA approval for an update to the labeling for CERENIA, which allow for intravenous administration during the surgical protocols that use medication that induces vomiting. We launched a new formulation of LUTALYSE, a reproductive product for use in dairy and beef cattle, in the U.S. We are also viewed as a partner of choice, for all innovators in the industry. In January we enter into an agreement with Anatara Lifesciences, a company in Australia. We'll be evaluating their non-antibiotic, anti-infective product as an alternative to antibiotics that could treat and control infections in farm animals. And finally, in terms of business development, we'll continue to look for M&A opportunities like we did last year with Abbott Animal Health and PHARMAQ, while we continue with our internal investment in new products, lifecycle innovation and research alliances. In summary, we delivered an excellent 2015, built in our diverse and market-leading portfolio of products for animal health. We are getting significant traction in the business as we continue reducing complexity, achieving efficiencies, and freeing up resources for our most promising growth opportunities. And we remain well positioned as the industry leader based on our core capabilities and singular focus on animal health. With that, let me turn things over to Paul. Paul? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Thanks. Thank you, Juan Ramón. Let me put an exclamation point on Juan Ramón's overview of 2015. What a terrific year we had. If you think back to a year ago, we had a number of very challenging initiatives in front of us, most notably, the design and implementation of the efficiency initiative that we announced in May, and also the rollout of our enterprise-wide SAP system in our most important market, the U.S., as well as many other key locations around the world. I can tell you that both of those projects put enormous pressure on the company, on our colleagues, and in some cases impacted our customers. But we were able to stay on task, overcome many challenges, and deliver results that we're very proud of. So let's talk about our performance. We had very strong sales growth in the U.S., up 13% for the full year, driven by good livestock sales primarily in cattle, the addition of Abbott Animal Health, and increased supplies of APOQUEL. In the international business we delivered operational sales growth of 4%, which reflected good performance in major markets like Brazil and China, which grew 11% and 17% respectively, partially offset by the business changes that we are making in Venezuela. We reduced our total operating expenses by 1% on an operational basis in 2015 compared with 2014 while growing revenue 8% operationally. We kicked off our efficiency initiative in May and were able to capture meaningful savings in 2015, particularly in the second half of the year when we reduced our operating expenses by 3% on an operational basis while we were growing revenue 7% operationally. To be fair, the true test of the operating efficiency improvements that we are making will come over the long term. Anyone can cut costs and improve profits in the short term. The challenge is to improve profits and then grow that larger profit pool at an attractive rate. To do that, you need to be thoughtful about where, how, and how much you reduce costs. We continue to prioritize and spend behind activities that deliver value to our customers and therefore support our growth, namely our sales forces, our R&D engine, and our supply chain, so very good stuff for the full year 2015. Let me turn to the quarter quickly. You can read the details of our fourth quarter results in the press release and tables, but let me hit on a few highlights, focusing on themes that may be impactful on our future results, starting with revenue. Again, good operational revenue growth of 6% in the quarter coming against a very strong quarter in 2014. Next, improvement in operating efficiency; total operating expenses were down 8% operationally in the quarter, and this enabled us to grow adjusted net income by 29% operationally. Foreign currency continued to be a strong headwind for us as it is for most multi-nationals. Changes in FX rates reduced Q4 reported revenue growth compared with the prior-year quarter by some 900 basis points. There's a word for that; it's brutal. Setting aside FX, we feel very good about the underlying drivers of our operational; that is, constant currency revenue growth. For the quarter, the 6% operational revenue growth included 3% from increased APOQUEL sales due to better supply, 3% from the acquisition of the Abbott Animal Health products, 2% from price increases across the portfolio, and 1% from new products. Yet these drivers were partially offset by a 3% decline of in-line product revenues. I want to point out that's primarily related to ongoing changes to our business model in Venezuela and other countries like India, which were initiated as part of our efficiency program. As I said previously, the changes we have made and are making to our business model in certain markets impacted our second half 2015 performance and will have impact on our 2016 revenue growth. But these changes improve our prospects for longer-term revenue and profit growth. That's the prize. In the case of Venezuela, you'll recall that we are reducing our activities there due to unfavorable economic conditions for multi-national companies. We've been selling down our inventories in the country, limiting our future exports to Venezuela, and this quarter we decided to revalue our assets and liabilities there, based on the free floating SIMADI exchange rate. In the case of India, we remain committed to our business there, especially in our companion animal and poultry businesses, with a direct field force. However, we are making changes in our approach to the dairy segment. That segment has not consolidated in the way that we had expected over the last several years, and so we are eliminating our dairy field force there and pursuing a distributor partnership to serve those market needs. It's worth noting that revenue from our other emerging market geography includes Venezuela and India, and declined 3% operationally in the fourth quarter. If you want to go back and you can exclude India and Venezuela, other emerging markets would have grown by 12%. The other emerging markets segment will continue to be an area where we see some noise in 2016, as it includes the countries that will be most significantly impacted by the SKU reductions, as well as market changes that we are undertaking as part of our efficiency programs. While I'm on the subject of international markets, I know there continues to be general concerns with the outlook for countries like China and Brazil, given lots of recent media reports about their slower GDP growth and their economic outlooks. Generally, demand for animal health products is tied to more stable growth drivers, mainly the demand for animal proteins and the increased adoption and medicalization of pets, both of which move as a function of population, income, and urbanization. Fundamentals in the animal health segments of both China and Brazil remain strong, and here's the proof. For the full year 2015, we grew revenue in China and Brazil on an operational basis 17% and 11% respectively. In the fourth quarter, China and Brazil grew 14% and 10% respectively. Both markets on a constant currency basis are growing at healthy rates and the growth prospects of these markets remain solid. And so I pose the question rhetorically. Why is that? For China it's two things. One is the fact that the consumption of animal proteins in China is growing and has continued to grow even in challenging economic times. Second is the goal of the Chinese government to see an improvement in the productivity, safety, and quality of their food supply. That means moving from smaller farms producing animal proteins to a more industrialized model, and that model requires more animal health products to maintain and drive the productivity of the business. Now frankly, as I'm saying this, the second factor should be the first. It's a powerful driver, and it will last for many years. Now turning to Brazil, Brazil is a very developed livestock market, and domestic consumption of animal protein is only a part of the equation. Brazil is a significant exporter of meat. And so to the extent that the consumption falls within their borders, they have the opportunity to use exports to maintain the health of their livestock businesses. With the weakness of the real, exports are even more attractive today. So counter to what you might conclude when seeing negative headlines about conditions in Brazil, the Brazilian livestock industry and the supporting animal health industry are quite strong. Using China and Brazil as examples, the key takeaway should be that we operate in an industry that's very resilient. Now I use that word quite a bit, even in times of economic stress, and that applies to developed as well as emerging markets. Turning to restructuring charges, this quarter we had significant one-time costs that drove a decrease in our reported GAAP net income and earnings per share. Let me explain this quarter's major charges in terms of the three buckets that we use. First, the standup costs which are mainly associated with our separation from Pfizer totaled $34 million in the quarter. That work will be substantially completed by mid-2016. We recorded $4 million of costs associated with our supply network strategy, and we are still in the early days of that initiative. And we also recorded $52 million of one-time costs associated with our operational efficiency initiative which reflected the acceleration of some of those plans and the associated costs into the fourth quarter of 2015. And finally, we have taken accounting actions related to the revaluation of our bolivar-denominated assets and liabilities in Venezuela this quarter. We believe it's appropriate to change to the SIMADI rate as our exchange rate for Venezuela. And accordingly, we recorded charges of approximately $93 million in the fourth quarter. In the fourth quarter, we also announced the sale or exit of five manufacturing sites in the U.S., India and Taiwan, which we expect to generate proceeds in excess of $80 million of cash during 2016. Turning to guidance, we've provided a bridge in our tables and slides to help show the changes in our guidance for 2016 and 2017, to spotlight the impact of changes in FX rates and changes to our operations in Venezuela. We now expect for the full year 2016 revenue of between $4.65 billion to $4.775 billion, reported diluted EPS of between $1.30 and $1.48 per share, and adjusted diluted EPS between $1.71 and $1.81 per share. For full year 2017, we expect revenue between $4.95 billion and $5.15 billion, reported diluted EPS of between $1.95 and $2.13 per share, and adjusted diluted EPS between $2.18 and $2.32 per share. Our revised guidance reflects the impact of the European Commission's decision on Belgium's tax rulings and the related effect on our earnings, which we disclosed in early January. Our effective tax rate on adjusted pre-tax income is expected to be approximately 33% in 2016 and 30% in 2017. In January we communicated that the changes to our tax rates reduced our expectations for adjusted diluted EPS guidance for 2016 and 2017 by $0.13 and $0.06 per share respectively. Note that we expect to record one-time net tax charges during 2016 of approximately $55 million, of which approximately $35 million to $45 million will be recorded in Q1. These Q1 charges relate to the nullification of our Belgium tax ruling by the European Commission for the periods from 2013 through 2015. Included in the total $55 million charge is an estimate of a future impact of the revaluation of deferred tax accounts currently associated with our Belgium operation. You can see these $55 million of one-time costs footnoted in our guidance bridge for 2016. Our revised guidance today also reflects our latest views of our operations in Venezuela, updated FX rates as of the end of January, and other efficiency improvements to offset some of those impacts. Here's some really good news. Other than the impact of the change to our expected tax rate due to the EC ruling, a factor over which we had no control, we're holding our guidance range for adjusted earnings per share for both 2016 and 2017. We expect the momentum that we carried through Q4 combined with the expected pace and magnitude of the efficiency initiative should enable us to offset the unrelenting headwinds of FX rates and the change to our business model in Venezuela. Yeah, we're proud of that. And since I have the floor and I like to talk about our company, here's my summary of the year. Looking back at 2015, what you see is another year where the global animal health industry posted solid mid-single-digit growth despite many challenges in many economies around the world. And you saw our company, Zoetis, deliver strong operational growth of revenue, up 8%, by pulling on all of the levers that we have available to us : the best animal health sales forces on the planet, the most productive R&D team in the industry, value-generative M&A, and a supply chain that is a core strength of the company. And we delivered operational growth of adjusted earnings per share of 24% for the year. And I'm going to repeat that because it's awesome. Adjusted earnings per share for the full year 2015 increased 24% on a constant currency basis to $1.77 per share. I call out the $1.77 because while we always measure ourselves on a constant currency basis, at the end of the day we put an actual dollar amount on the tape. Way back in November of 2014 we put 2015 guidance on the – excuse me – 2015 guidance on the table. We guided revenue in the range of $4.85 billion to $4.95 billion and adjusted earnings per share of $1.61 to $1.68. Since that time, we, like many multinational companies, have been battered by FX that dramatically reduced our reported revenues. But here's where we're different from many of those other multinationals. Throughout 2015 we held the line on our guidance for adjusted earnings per share and in November of 2015 we actually raised the range to $1.70 to $1.74. And now we report actual results of $1.77 per share. We're able to do that because we as a management team brought forward a plan in May of last year to improve the efficiency of our cost structure and then we as a team got after it and reduced and controlled expenses to give us the best shot in delivering to you, our shareholders, the best earnings we could under the circumstances. As I love to say, pretty good. So here's my pitch. The global animal health industry is not just resilient; it has characteristics that point to an extended period of predictable mid-single-digit growth. And the number one company in the global animal health industry is Zoetis. In the three years since we've been public, we've put results on the board that support what we see as our key value drivers. First, we can grow our revenues at a rate equal to or faster than the mid-single-digit growth rate expected for our industry. Second, we can leverage our expense structure to drive increasing operating margins, delivering profit growth faster than revenue growth. And third, we can intelligently allocate our capital; actively manage our capital structure to grow adjusted earnings per share faster than operating profits. In today's dystopian financial markets where investors may be looking for shelter from the storm, I think my suggestion would be to look at companies in reverse alphabetical order and start with Z for Zoetis. That's it for my prepared remarks. Let's get to Q&A. Keith? Operator : Okay. We can take our first question from Kevin Ellich with Piper Jaffray. Please go ahead. Kevin K. Ellich - Piper Jaffray & Co (Broker): Good morning, thanks for taking the questions. I guess, Paul, could you just go back to the contributions from acquisitions in the quarter? I kind of missed those prepared remarks. And then, Juan Ramón, I wanted to get an update on SIMPARICA as well. I think in the press release it says you expect approval now in Q1. I think previously you said first half of 2016 so I guess what's the change and what should we expect heading into Western Vet? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, I'll start, Kevin. Good morning. It's Paul. I'll start with the components of the growth. We had 6% operational revenue growth in the quarter and we recognize the goal was whole percentages here so there's rounding that comes into play but it was 3% from increased APOQUEL sales, 3% from the acquisition of the Abbott Animal Health products, 2% from price increase across the portfolio, and 1% from new products. Then the offset to that was about a 3% decline of what I guess we'll call revenues of all other products. And again, that is primarily related to the change in the business model in Venezuela and countries like India and places that were affected by our efficiency initiative. I hope that answers the question. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Paul. I will take the question on the SIMPARICA. So we submitted to the FDA all the information and based on the normal timing for approval, we expect SIMPARICA to be approved in the U.S. in the first quarter. This all will be depending on final decision of the FDA. Next question, please? Operator : And our next question comes from Louise Chen with Guggenheim. Please go ahead. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my question. So I do see slide 18 in your presentation but I was wondering if you could help us better understand the underlying sales growth for the year without the impact from restructuring and SKU reductions? And then also, do you expect your sales growth to accelerate after these programs are completed? And when might we actually see that? Thanks. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure. Louise, its Paul. Let me take that, and thank you for asking the question, Louise, because if you just take the headline and say, gee, we're looking at 2% to 4% operational growth in revenue next year, people say, what's up with that? So let's start with from the 2% to 4%, the operational efficiency initiative, the effect on SKUs, and now Venezuela and other markets where we're going to change our model, reduced that by some 600 basis points. You can see that if you look at that slide 18, 600 basis points. So there's 8% to 10% if you're thinking about what our actual expectations are for normalized operational revenue growth in 2016 v. 2015. And if you want to take PHARMAQ out of the equation and go what's the organic portion of that, it's about 200 basis points. So as you look at that slide, again I'll call everyone's attention to it, we tried our level best to help you think about the strength of 2016 because this is quite a strong year by showing you this waterfall slide. So 2% to 4%, 600 basis points on the efficiency initiative, SKU reductions, Venezuela, India, et cetera, gets you to 8% to 10%, and if you want to look at that on an organic basis it would be 6% to 8% by taking PHARMAQ out of the mix. Before I concede the floor, I want to say two things before I talk about 2016, because we did change from 3% to 5% operational growth to 2% to 4%. That is predominantly because we had previously articulated that range at the midpoint of our 2015 guidance for revenue. And as you saw, we had strong revenue in Q4, and for 2015 it was about $25 million higher than that. And that accounts for the change from 3% to 5% down to 2% to 4%. We feel really good about what we put on the table in 2015. And as we think about it, we really are excited about 2016, even though it will be masked a little bit by the changes that we are making to our model. Now last before I concede the floor, you asked the question about what could we expect in 2017. We expect a return to the same kind of solid growth that you would have expected in 2016 but for the change in the efficiency initiative. We're currently forecasting on an operational basis 5% to 9%. That's pretty solid, and that's being driven mainly by new products. Next question, please. Operator : And the next question comes from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets (United States): Good morning, folks. Thank you for all the details on the slides and congratulations on a strong operational performance in 2015. Paul, cost of sales grew at a higher rate than revenues in the quarter, and as a result gross margin was lower year over year and sequentially versus 3Q. I was wondering if you could give us your thoughts there on gross margin. And just a general question for the both of you, your stock has obviously been underperforming despite this strong operational performance. I'm wondering if you could give us your thoughts on that. And is there an opportunity for a more aggressive share buyback at these levels? Thank you. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure, it's Paul. I'll take the Q4 margin. That was predominantly due to FX. Again, I would look at the full year and how we came out, and it was in line with what we were expecting. I know, Alex, we've traveled together a little bit. You look at a quarter; there can be a lot of variability that sneaks into the equation. You compare it against this, that and the other thing. Things happen in a 90-day period that smooth themselves out over the year. I would look at the 65%-odd margin that we put on the board for the full year, and that's indicative of the strength. But the one thing in the fourth quarter was FX. FX is hard to forecast when it flows through cost of sales, but it sure does. The second thing I think you asked a question about the share price. We're watching our company along with many others lose value, at least in the eyes of shareholders or people who are holding our stock. We continue to do what we can do. We're driving real fundamental value. You posed the question about our share buyback and the scale of that, et cetera. I'd point out that when we were last in the window I guess, which was in the early part of November, the stock was $43 – $44, I think, and I'm going from memory here, $43 – $44. And we elected at that point in time to increase the pace of our purchases. As everybody can do the math, we bought about $50 million a quarter through 2015. We're currently buying stock back at a pace of about $75 million a quarter. I know that's not a ton. But as I said also many times, we had a lot of calls on cash in 2016, but even so we elected to increase the pace at which we were wanting to acquire shares. So I hope that answers the questions. Juan Ramón Alaix - Chief Executive Officer & Director: I will add a comment here, Alex. I think that in many cases our company is still associated with the human pharmaceutical industry. And discussions on prices, for instance, have been affecting the human pharmaceutical industry, while this should not be having any impact in our share value. Our prices, as I mentioned in my comments, are completely dependent on third-party payers. We price based on the value that we can demonstrate to our customers, and our customers are not only buying and paying the products they buy from us. So this is something that in my opinion should be also included when different investors or analysts also define the value of Zoetis and also the value of the animal health industry in general. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Next question, please. Operator : And the next question is from Erin Wilson with Credit Suisse. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): Great, thanks for taking my questions. How should we think about the quarterly progression of the U.S. livestock business? And could you characterize the overall health of the U.S. livestock industry just more broadly? And then one on R&D on the parasiticide front, should we expect that you're ready to launch as soon as SIMPARICA gets approval in the U.S.? And then with the potential flea, tick, and heartworm combination chewable product, longer term, how long in the pipeline, or how far along in the pipeline is this product? And when should we expect it I guess to launch, and is it in the guidance? Juan Ramón Alaix - Chief Executive Officer & Director: So thank you, Erin, for your question. In terms of the launch of SIMPARICA, we are ready to launch as soon as we get approval from the FDA. We're also ready to launch not only in U.S. but also in the European markets. And the team is ready, the plans are in place, and we have a product to supply to the market. You also asked a question about the livestock progression in the U.S. And definitely we have seen that in general the livestock has been performing well in 2015. In terms of the quarters, the fourth quarter has been stronger than expected because already in the last year, we reported very strong revenue growth, and in this year also we grew significantly. And in terms of the different areas of livestock, we see also opportunities in cattle, we see opportunities in poultry, and we see opportunities also in swine. We expect also in 2016, the momentum will continue. We see positive trends in the cattle industry, mainly on beef; that we expect that the number of animals will increase by 3% or 3.5%. And this will expect, also will drive additional use of animal health products. And you also asked about... Paul S. Herendeen - Chief Financial Officer & Executive Vice President : The combination product. Juan Ramón Alaix - Chief Executive Officer & Director: The flea and tick and the heartworm. Definitely, our R&D team is working on developing this product and finalizing all the information for submitting all the dossiers to the FDA. We have not yet communicated when we plan to have this product into the market. As we get closer to the finalization of all the different filings, then we'll communicate to the market. And this has not been included in our guidance for 2017. So next question, please. Operator : We'll go next to John Kreger with William Blair. John C. Kreger - William Blair & Co. LLC: Hi, thanks very much. You mentioned that you had some issues last year with customer service. I think you said mainly around APOQUEL. Can you just expand upon that? Is that issue behind you? How comfortable are you that you will not have any residual issues as we move through 2016? And then, Paul, maybe just talk a little bit more about longer term, your tax rate thoughts? Do you think 30% is the long term right number to use, or is there an opportunity to maybe push that lower? Thanks. Juan Ramón Alaix - Chief Executive Officer & Director: So we have had supply issues for APOQUEL, and the supply issue has been resolved now. We have now the process for the production of the active pharmaceutical ingredient that had been the bottleneck of manufacturing APOQUEL. We have a process which is much more robust and much more consistent. And we are really producing all the product that will be delivered in 2016, and we'll increase significantly the supply to the market. We are also planning to expand APOQUEL to the rest of the world in where the product has been approved, and we plan to do that in 2016. So we are convinced that APOQUEL will deliver significant growth and all the issues that we faced in 2015 will be behind us. We also reported in 2015 that the implementation of the new ERP also created some issues in terms of deliveries of products into the market. We are very pleased now how the implementation of the ERP has been now performed in the U.S. We have now 90% of our orders delivered the same day, which is a significant achievement, and we are working on improving there, the rest of the functions that also are provided to the customers. We expect that also the ERP, will be supporting our operations in a very efficient way in 2016. And this is something we plan to finalize all implementation of the new system in this quarter, and then moving forward, to maximize the way that we'll be supporting our business. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : John, its Paul. I'll take the tax question. First let me just say we were very disappointed with the European Commission's kind of stating that the Belgium tax rulings like we had are illegal, and essentially nullified our arrangement there. We're disappointed because the Belgians have been very supportive; we've built a terrific operation there. I think I've said in a prior public forum, the Belgians on the contrary, have been one of the more responsible countries with respect to tax policy and how they used it to attract employment and investment into their country and it's a shame. So set that aside, we're very disappointed. It obviously was not something that we were planning on. And let's pretend that, that didn't happen for a second. We had previously articulated, we thought our tax rate in, call it 2017, would have been on the order of 28%, our adjusted ETR roughly 28%, and now it's 30%. So we lost a couple of hundred basis points there in 2017. But what I would suggest to you is, just as we had articulated with respect to our structure before this happened, we can grind that down, but we wouldn't be grinding it down. The frustrating thing for us is, we were doing pretty well, fine tuning our global operating model to be efficient and here we have to go back and we have to change course a little bit. So not something – it was not a happy day for us but we're responding the best way that we can. And I think the way we look at it is we just add 200 basis points higher ETR in 2017 and our job is to grind that down. Next question, please. Operator : And the next question comes from Chris Schott with JPMorgan. Christopher Schott - JPMorgan Securities LLC : Great. Thanks very much. Just a couple of here. First, on the 6% impact from the SKU reduction in 2016, I guess now that we're further along in that process, any surprises in terms of customer behavior, in terms of the SKU changes? And I guess is there an opportunity for that number to be lower than 6%, either through uptake of alternatives of those products, or just other initiatives you put in place? And the second question which is as we're looking out 2016, just any dynamics we should be keeping in mind for modeling this year in terms of quarterly progression? I guess are there any particularly difficult or easy comps that we should be watching as we're kind of thinking about the quarters this year? Thanks very much. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Chris. What we evaluated very carefully when we decided to reduce SKUs on how will be the impact to our customers, we made sure that none of the SKUs that we are eliminating has no alternative to our customers. These alternatives can be from our competitors or can be alternatives, in our portfolio. The 6% impact in our revenues is the net result of reduction and also the assumption that some of these reductions of SKUs will be moved to other SKUs in our portfolio. In terms of reaction from our customers, I think in some cases, well, they will like to have these products in their portfolio, but they also understand that more important than offering 13,000 SKUs is ensuring that we have a reliable supply. What we want to make sure that when they place an order, they get the order on time to treat or protect the animals. And this is one of the important strategic rationales for our SKU rationalization. It was not only to improve gross margin, but also to ensure that our supply to the market is much more consistent and we can meet all customer submissions. And then Paul will take the question on the phasing in terms of quarters. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : I think there are two things that I'd be mindful of; one is how the SKU reduction plays out with respect to our revenues. You'll recall that we announced this program in the middle part of 2015, and so we're just starting to see here in Q4 an alignment to Q1 and Q2, the impacts of the SKU rationalization. And it will be relative to the prior year, it will be a significant factor. But we will have to keep our eye on. The second part is with respect to our cost, our efficiency initiative. We continue to ramp up the amount of savings that we are seeing flow through, and of course the first half of last year we had a modest amount of cost containment or that occurred in the first half, but that steps up and we currently are tracking, as you saw, with an 8% operational reduction in operating expenses in Q4, tracking at a much lower rate, so that will be a very helpful driver on the operating expense side in the first half of the year, and then that benefit, if you will, comparing back to the prior year will moderate over the second half of the year. I think that's about all we want to cover on phasing. Just lastly, I'll say it again and again and again, we look at our business on a yearly basis. Trying to – I know you have to and that's what you do and all, and we'll try to be as helpful as we can with respect to the phasing but we run our business on an annual basis. Next question, please. Operator : Our next question is from Jami Rubin with Goldman Sachs. Jami Rubin - Goldman Sachs & Co.: Thank you. Just a couple. First, Paul, maybe you can answer this. On the 2% contribution from price, can you talk about the outlook? How did that look on a global basis U.S. versus outside of the U.S.? And what is the outlook for price increases going forward both in the U.S. and across different geographies. And then, Juan Ramón, just a question for you; as you are now, congratulations, three years as an independent company and it's been very exciting to see how Zoetis has evolved and achieved such tremendous success in a short period of time. Congratulations. But maybe you could just sort of step back and tell us – when I look at the industry, the animal health industry, it doesn't seem that a whole lot has changed. It still remains highly fragmented. We've seen a little bit of movement with Novartis swapping its business to Lilly. You've made a couple small acquisitions. But by and large, the industry hasn't changed much. Do you see more consolidation going forward? Or do you see some of your peers spinning out their animal health businesses like you have done for yourself? And what does this all mean for your future in terms of M&A? Thanks very much. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Jami. And I will try to answer both questions. So in terms of the 2%, so the 2%, as you mentioned, it's a global increase. And in terms of where we see this 2% in the different geographies, definitely we have been very consistent in the U.S. with price increases of around 2%. And in the rest of the markets, it depends. So in high inflationary markets, we increased significantly the prices to compensate for inflation and also to compensate for foreign exchange. In some markets where the economies are – the inflation is very stable or probably not having any inflation at all, so we are also trying to adjust our prices based on these situations. So in Europe or Japan and some other markets we have been increasing prices but at a lower rate than in the U.S. or some of the markets where we had the opportunity to increase the prices because of inflation. The second question was related to the consolidation of the industry and the top four or five now animal healthcare companies represent almost 70% of the total market, which has already been increased significantly from some years ago. Do I see opportunities for further consolidation? I think there are still opportunities, especially on the second tier of companies, after these four or five companies we see opportunities for the consolidation. We expect now the merger of Boehringer Ingelheim and Merial being completed, there's another round of consolidation, and maybe in the future also we'll see some additional consolidation. Definitely the consolidation would be limited because of antitrust issues, but without these antitrust issues or managing these antitrust issues, definitely consolidation can represent a good opportunity for the animal health industry. The last comment I want to add is that the top 10 companies in animal health represent something like 80% of the total market. On the 20% which is remaining we have maybe hundreds of companies that in -where I expect that this will be a significant consolidation here. And Paul will add some comments in terms of the pricing. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure. I mean Jami asked a specific question. I think Jami was trying to get to where is our pricing power. For the full year, emphasis full year, our price added approximately – a little better than 2% overall but U.S. is about 2% and international was about 3%. Again, a lot of rounding here, but more price increases outside the U.S. than in. Next question, please. Jami Rubin - Goldman Sachs & Co.: Thank you, Paul. Operator : The next question comes from Doug Tsao with Barclays. Douglas Tsao - Barclays Capital, Inc.: Hi, good morning. Thanks for taking the questions. Maybe if you could provide a little bit more of an update in terms of how you will sort of increase the availability of APOQUEL, is this what we start now in terms of broadening the number of veterinarians who will have access to the product? Or is it going to be focused more on current – expanding to new patients? Also, if you can just provide some commentary in terms of the MFA business and how it's faring right now? One of your competitors spoke about some regulatory headwinds in that business and whether you're seeing those as well? Thank you. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Doug. In terms of the increase for APOQUEL, so let me start saying that we have now two sources of the production of API and the second source that will be a company in Switzerland which is called Siegfried will double the capacity of the production of the active pharmaceutical ingredient. We plan to now offer APOQUEL to more veterinarians and also to offer more available product to existing veterinarians. At the same time, also the plan is to introduce the product in the rest of the markets where the product was put on hold because of product availability. So we are convinced that during 2016 we'll be able to meet all the demand from the market. In terms of MFAs, I think MFAs in our case continue growing very strongly and we have the advantage of – that's right this is the diversity of our portfolio. It's not only diversity in terms of therapeutic areas or in terms of different types of products, but also within the MFAs we have a lot of diversity. And for products that will be maybe facing some challenge because of changes on the approach of the use of antibiotics, and I mentioned in the medical important antibiotics in MFAs with indication of a growth promotion, this will be eliminated but in our portfolio we also have a non-medical important antibiotics in MFAs that can be a good replacement for those that will be eliminated. We have in total in MFAs $500 million in sales and we grew operationally in 2015 by 8%. So definitely we expect that those are probably the only indication of growth promotion which are medically important for human health that will have an impact in the revenues but this impact will be minimum. Next question, please. Operator : We'll go next to Mark Schoenebaum with Evercore ISI. Mark J. Schoenebaum - Evercore ISI : Hey, Paul. My email went up during your prepared remarks. I just wanted to say that it was really a brutally awesome prepared remarks section, especially the part about how we should reverse the alphabet, I love that. That's a great idea. But in all seriousness, I had a bunch of questions, but I'll limit it to 1.5 because most people have been doing it. Number one, given all the opacity that – you guys have tried to do everything you can to make it clear but this the confusion, I guess, that FX potentially creates, why not synthetically hedge against the effects on that at least in that net income line especially after the turmoil this year, although you guys have done a great job helping us understand the effect. And then number two, maybe I missed this, but I didn't hear you break out APOQUEL sales on 4Q. I was wondering if you could. I apologize if I just missed it, if you could break those out in the U.S. and also the rest of world. And if you already answered that one, then my question would be the 6% to 8% normalized organic operational growth, what are the components of that for 2016 that you see? Thanks. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure, I'll start with the FX. I think when you're looking at trying to hedge operations around the world against foreign currencies, you have two choices. You can either, in non-technical terms, let it fly, which is what we do with respect to operations like many, many other multinational companies do, or you can attempt to hedge. If you hedge, you hedge within a quarter, and the analysis that we've done has suggested that you're essentially chasing down. You limit the cost of the hedges, ultimately make it like a less than fruitful exercise. Now others will tell you that they can do it, and that's okay. That would be their point of view. I point out that a couple of the currencies that tend to be the most volatile, there are not markets for us to go out and hedge. I think they're not deep enough. They're not efficient enough. And so you wouldn't be able to fully offset that. I think I love your word there, opacity. I might have mispronounced that. We're trying our best to let the market follow along with as much of the information that we have that we can share with you so you can decide how we're performing. We do now, and we will continue to manage ourselves on an operational basis, meaning a constant currency basis. And I will hope against hope perhaps that at some point in the future here we'll see some more stability in the foreign exchange rates, and that we'll enjoy the positive upside, not from an operational perspective, but from a reported perspective of currency, FX rates going in the opposite direction. Juan, do you want to take the APOQUEL sales, or would you like me to? Juan Ramón Alaix - Chief Executive Officer & Director: The APOQUEL sales, I think we had more than $100 million in 2015. It's about $110 million. This was below initial expectations. And the only reason for that was that ensuring that we have enough product to supply to customers, and not increasing the number of customers having access until we have the certainty that the product would be available. Now we're having a situation that we increase significantly the production, and we'll be able to increase the deliveries to our customers. Globally in international markets, I think we had about $40 million, and then the rest was in the U.S. But it's important to understand that in international markets it was very limited number of countries where we have the product available in the market. You also asked about components of our organic growth, 6% to 8%, and Paul will provide the details of this. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure, I'll start. First of all, we expect to continue to be able to take consistent price across our portfolio. That's a driver. Second is there's a significant impact from new products in 2016, which frankly will be an even bigger impact on 2017, and then just performance of our portfolio. When I say new products, I'm focusing on the ones that you can see that make a difference. I'd point out that we have lots of new products that we don't talk about necessarily individually and maybe individually don't move the needle, but in the aggregate they sure do. 6% to 8% normalized operational growth in revenue next year would be terrific, and then again going into 2017 new products help even more. Juan Ramón Alaix - Chief Executive Officer & Director: And, Mark, let me correct the total revenue that we generated internationally. Internationally was $20 million and then the rest was in the U.S. And I want to insist that in the international markets we have very limited number of markets and also limited supply. So the potential in both U.S. and international is much higher. So next question, please. Operator : We'll go next to David Risinger with Morgan Stanley. David R. Risinger - Morgan Stanley & Co. LLC: Yes, thanks very much. My questions are financial. Obviously, you've covered a lot of ground on the business and the outlook. So, Paul, two questions. First, could you please discuss the outlook for 2016 cash flow, including cash flow from operations and then planned uses of cash? And then second, if you could, just comment on the quarterly progression throughout the year, just to make sure that we set up our models appropriately and we understand the different variables to consider. Thanks very much. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Sure, I'll start with the discussion around expected cash flow. Recall that we try to call them out each and every quarter. We have a large amount of expenses that we're incurring with respect to : one, the standup from Pfizer; second, the operational efficiency initiative; and now we add to the list a potential true-up of our international taxes in light of the EC's comments. If you look at our guidance tables, we call out the amount or the expected amount of the acquisition costs that we expect to incur in 2016 and then again in 2017. Those are I would call them – they're not normal and they will go away, and most of them will go away towards the latter part of 2016. But in 2016 it's a fairly significant call on our cash. Secondarily, we continue to be in a phase of investing in our supply chain. We continue to invest capital there, so our CapEx is tracking at a rate that exceeds our ongoing depreciation rate, so net-net we continue to invest there. Of course, we called out that we now have a program that everybody can do the math, where at least the current expectation is we're purchasing shares at the rate of $75 million a quarter. It's $300 million this year plus our dividend. You can do that math. And those are other than our earnings are the things that you need to take into consideration when thinking about our cash flow. I don't want to stop without speaking about efficiency of working capital. That is something that is to come. It's not something that you would see necessarily in 2015 and not in an enormous way in 2016. By the end of this quarter, we expect to have our ERP system up and running in all of our locations around the world, which is going to give us the ability to then implement tools, to much better manage primarily our investment in our inventories. Our receivables, I think we do a pretty good job there, and we certainly do the same things as everyone else with respect to payables. But we will not start to see some maybe significant cash flow from the improvement in cost of working capital really until 2017. I wasn't specific there, David. I wasn't specific for the reason we don't want to provide specific guidance with respect to free cash flow, but I believe we've provided each of the components that will enable you to look out to 2016, 2017, and then beyond. I think when you get out into the latter part of this decade, our depreciation should start to normalize at a level close to our depreciation amount. I'll stop there. Juan Ramón Alaix - Chief Executive Officer & Director: You also asked about the quarterly progression for 2016. Let me provide a couple of comments here. So first we expect that the new product launches will have no impact in the first quarter and we expect that these products ramping up during the year. Also APOQUEL, we expect that the biggest impact we'll see from the second quarter of 2016 as we also extend the product availability in the markets where the product has been already introduced, and we also launch in new markets. In terms of expenses of course, also our efficiency program, will have much more impact in the second half than in the first half, because in the second half, we plan really to complete most of the actions that we took as part of the announcements that we made in May, and this also will have a positive impact in our results in the second half of the year. Next question please. Operator : We'll go next to Kathy Miner with Cowen & Company. Kathy M. Miner - Cowen & Co. LLC: Thank you, good morning. Two questions, one first on PHARMAQ. When you acquired the company, you had stated that it was growing about 17%. Is that still a good estimate going forward, or could it be higher given their late stage pipeline that you talked about? And also do you continue to expect it to be neutral to EPS this year and then accretive thereafter, or could that accelerate? And the second question just has to do on trends outside of the U.S. in livestock. We saw the issue in France last year where they changed the legislation on antibiotics. Are there any other areas that we should look for in 2016 where there may be similar changes? Thank you. Juan Ramón Alaix - Chief Executive Officer & Director: So Thank you, Kathy, for the questions. In PHARMAQ, what we communicated is that we plan to generate that revenue for $100 million in 2016 and $125 million in 2017 and at the end of the year PHARMAQ reported revenues of close to $80 million, so we see a significant increase in terms of our revenues. What we saw during the due diligence when we acquire in terms of the pipeline, it's performing now with the launch of the product in Chile that it was under this emergency license. And we will continue progressing in the plans that we have for PHARMAQ. So we are very excited about the opportunities of PHARMAQ. We are working also in terms of integrating the two companies, but ensuring that PHARMAQ remains a leader in aquatic health with enough identity to maximize the relationship with the customers that they already built through many years. In terms of the comments that you made, in France, definitely in 2015 we saw an impact because of the change of the legislation in France. This was affecting antibiotics. We expect also that antibiotics will continue having discussions and restrictions in some of the markets. This has been incorporated in our guidance for 2016 and 2017. And we also think that the projections that external sources are making about the total animal health industry and also the growth in antibiotics are consistent with what with our projections. So the industry will be growing about 5%. Antibiotics is expected to grow at half of this rate. The advantage for Zoetis is that it will have in our portfolio, antibiotics which are injectables, which are considered as premium antibiotics that are kept by veterinarians as a resource to ensure that they are treating and in some cases protecting also animals against infections. So we are confident that the impact that it will have in antibiotics will be lower in our revenue, but in any case all these elements have been incorporated in our projections. Next question, please. Operator : We'll go next to Jeff Holford with Jefferies. Jeff, if you want to check your mute button please? Jeffrey Holford - Jefferies LLC : Hi. Can you hear me now? Juan Ramón Alaix - Chief Executive Officer & Director: Yes, we can. Jeffrey Holford - Jefferies LLC : Okay. Great. Thank you. Good morning. I just want to ask a couple of questions around Sanofi and Boehringer. First off, if you expect that business combination or that potential business combination to have any impact on the competitive environment for you as you go forward into 2017 and beyond, any specific areas of concern or opportunity there? And then second, just as you got two European companies coming together there. You've talked very briefly in the past about potential inversions, lack of opportunities, that's potentially two less opportunities now. Just any updated thoughts there is that's really looking beyond you now to potentially look at any kind of inversions or spin-versions out there. Thank you. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Jeff, for the question and definitely the Sanofi/BI merger will create a very strong competitor. It will be the second largest animal health company in our industry. But we don't think that the combination of the two companies will create additional competitive challenge to Zoetis. We have the scale, we have the diversity, and we have the business model that has been proven very successful in the past and will continue also being successful in the future. The productivity that we have in R&D is also showing very high levels. So we are confident that we'll continue growing in line, or faster than market. So we are projecting in fact in 2016 and 2017 we're growing faster than market despite of Sanofi/BI or despite of all these additional consolidations in our industry. Sanofi and BI, they are two European companies that potentially can be, maybe an opportunity for tax inversion, but also creating significant anti-trust issues to Zoetis. So we continue assessing opportunities that, to further consolidate, not with the only objective of saving on tax, but a combination of synergies that we can generate in terms of revenue, in terms of costs, opportunities on reducing our effective tax rate, and definitely creating a value to the company. Next question, please. Operator : Next we'll go for a follow-up with Kevin Ellich with Piper Jaffray. Kevin K. Ellich - Piper Jaffray & Co (Broker): Hey. I was just wondering if you could comment about the, I guess Juan Ramón, did you say you guys have – supply of SIMPARICA is ready for launch? I just wanted to make sure I had that right. Juan Ramón Alaix - Chief Executive Officer & Director: Yes. I said that SIMPARICA product is ready for launch and as soon as we have approval for FDA, we'll be launching that in the U.S. and also in Europe. So we have the product in our warehouses. Operator : And it does appear we have no further questions. I'll return the floor to you, Juan Ramón, for closing remarks. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you very much. And thank you for joining us today. As we continue through 2016, we are determined to make the most of our business model, our interconnected capabilities and the fundamental drivers of growth in animal health. We'll complete our operational changes, becoming less complex, more efficient and more agile. And we'll invest in growth opportunities to strengthen our business. I am confident that these steps will help improve our margins, better serve our customers and build shareholder value over the long term. And I look forward to reporting to you on our progress in each of these areas. Thank you very much. Operator : Okay. Ladies and gentlemen, this does conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-839-6980 for U.S. listeners and 402-220-6062 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,016
| 2
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2016Q2
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2016Q1
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2016-05-04
| 1.755
| 1.775
| 1.906
| 1.905
| 3.34554
| 22.49
| 21.24
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Executives: John O'Connor - Vice President, Investor Relations Juan Ramón Alaix - Chief Executive Officer & Director Paul S. Herendeen - Chief Financial Officer & Executive Vice President Analysts : Alex Arfaei - BMO Capital Markets (United States) Louise Chen - Guggenheim Securities LLC Erin Wilson - Credit Suisse Securities (USA) LLC (Broker) John C. Kreger - William Blair & Co. LLC Christopher Schott - JPMorgan Securities LLC Jeffrey Holford - Jefferies LLC Volodymyr Nikolenko - Evercore ISI Douglas Tsao - Barclays Capital, Inc. Divya Harikesh - Goldman Sachs International David R. Risinger - Morgan Stanley & Co. LLC Kathy M. Miner - Cowen & Co. LLC Operator : Good day and welcome to the First Quarter 2016 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 two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. It is now my pleasure to turn the floor over to John O'Connor. John, you may begin. John O'Connor - Vice President, Investor Relations : Thank you, operator. Good morning and welcome to the Zoetis first quarter 2016 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 for 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 2015 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 4, 2016. We will also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, John, and good morning, everyone. We delivered another solid quarter, demonstrating our steady and predictable growth, and confirming the strength of Zoetis as the industry leader in animal health. The diversity of our portfolio in terms of geographies, species and therapeutic areas, as well as our business model continues driving our performance. In previous years, we have seen different species leading our growth based on changes in market trends and the mix of products in our portfolio. For example, in 2013, our growth was driven largely by swine and poultry products. In 2014, it was driven by cattle and swine. And in 2015, companion animal and cattle led the way. This quarter, the most significant operational growth driver by far has been our portfolio of companion animal, a trend we expect to continue through 2016. Our companion animal business is growing, thanks to the increasing sales of APOQUEL, the addition of Abbott Animal Health products, the introduction of new vaccines in Europe and the U.S., and the overall positive performance of the rest of our portfolio. It is important as we experience softer growth in livestock. We continue to invest across our portfolio, and during the first quarter, our R&D investment continued to show many positive results, including the approval of SIMPARICA, our new oral parasiticide in the U.S., Brazil and Canada. This quarter also marked the completion of our ERP implementation. After nearly two years, all our commercial operations, manufacturing plants, and support functions are on a single platform, enabling us to achieve greater efficiency. Overall, we have been able to accelerate our operational efficiency program with a positive impact in 2016 and we expect to exceed the initial savings target of $300 million by 2017. I am pleased to say that with the positive momentum in the business and the help of improved foreign exchange rates, we are increasing our guidance for the two-year, 2016 and 2017. Coming now to more detail on our first quarter results. Operational revenue growth was 12% and you can find a slide on our webcast that break this down. These reflect six extra days in the quarter due to the accounting calendar, as well as the negative impact of changes in markets like Venezuela and India, and the product SKU rationalization that we communicated last year. Adjusting for these factors, the growth will be 10% operational and 6% excluding the additional impact of recent acquisitions. In the quarter, we grew adjusted net income by 28% operationally, once again growing faster than revenue and helped by the fact that our OpEx increased only 2% operationally compared to the 12% revenue growth. We continue to deliver our long term valuable position of growing adjusted net income faster than revenue. In looking at the overall market, we continue to see the animal health industry performing well, despite global economic challenges. We have seen good growth in most markets as greater consumption of proteins and increased medical spending on pets continues to help create customer demand for our products. As always, while I'm very pleased with the quarterly results, I also want to emphasize the need to look at our business on a full year basis to account for some of the seasonal situations and timing patterns in animal health. Let me now update you on our new product launches and R&D developments. APOQUEL is showing a steady growth. We have continued to launch APOQUEL in each of our markets such as Canada, Australia and New Zealand, and we plan in the coming months to introduce the product in the rest of the markets where it has been approved, including Japan, Brazil and Mexico. And this month, the product will be available to customers without restrictions. In the first quarter, APOQUEL sales were approximately $50 million, an increase of about $40 million from the year ago quarter. As previously communicated, we expect APOQUEL to generate peak sales of more than $300 million. As far as SIMPARICA, our new once monthly chewable tablet for the treatment of fleas and ticks, it was launched in the U.S. and in several European markets. It is early, but we are hearing a positive response from our customers and we expect performance to ramp up in the remainder of the year. We are also developing the combinations of the sarolaner molecule in SIMPARICA with other agents. This would cover a broader spectrum of parasites, including heartworm and we see sarolaner as a strong platform for future lifecycle innovations. Our canine antibody therapy that targets and neutralizes IL-31 to help treat atopic dermatitis in dogs has been introduced to veterinarian dermatologist in the U.S. under a conditional license. And we received another conditional license in Canada in the first quarter. We are hearing a very positive customer feedback and we are gaining market experience with the product. We continue to allocate our capital for investments in key commercial activities, R&D programs and business development opportunities that can generate faster revenue growth. For example, vaccines and genetics are two areas. We are expanding our portfolio as we put greater R&D emphasis around disease prevention. And in the first quarter, we had several positive developments. We received approval of RUI LAN WEN, the second vaccine resulting from our joint venture in China and the first combination vaccine in China to help protect pigs against a certain locally prevalent disease. We also gained approval in China for our poultry vaccine to help prevent Marek's disease. In the U.S., we have now received licenses from the USDA for a new VANGUARD B Oral vaccine and three new VANGUARD Rapid Resp Intranasal vaccines. Zoetis is now the first and only manufacturer to offer oral, intranasal and injectable options for vaccinating dogs against Bordetella bronchiseptica. We also granted a conditional license in the U.S. for an Avian Influenza Vaccine to help prevent diseases caused by the avian influenza virus H5N1. We are participating in a process to supply the USDA with this vaccine for the Stockpile should they decide a vaccination strategy is needed. We're also seeing progress in genetic tests, as our farm animal customers want more information about traits and conditions that can help them build a healthier and more productive herd. During the quarter, in the U.S., we launched CLARIFIDE Plus, the first commercially available genetic test that gives dairy producers a direct way to predict risk factors for costly diseases in hosting dairy cattle. And just last month in Chile, we launched the ALPHA JECT LiVac SRS vaccine for salmon, the first attenuated live vaccine against SRS. This was a significant R&D achievement by PHARMAQ, and a much needed product to help Chilean fish farmers, great news for the industry and a terrific new opportunity for Zoetis. In summary, we are off to a good start for 2016, based on the strength of our diverse portfolio and the continued benefits of our R&D investment. We have been able to accelerate our efficiency program and expect to exceed initial savings target of $300 million by 2017. And finally, with improved foreign currency rates and the positive momentum of the business, we are increasing our guidance for the full year 2016 and 2017. With that, let me turn things over to Paul. Paul? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Thank you, Juan Ramón. I'm going to hit on many of the themes covered by Juan Ramón because they're important to the financial review of the quarter. So, let's talk about our first quarter performance. I'll walk you through a number of factors that you should consider to gauge how we did in Q1. There's some helpful information on the webcast slides and, of course, included in our press release. I'll then hit on a few other highlights in the quarter results and discuss our updates to guidance. Now, before I jump in the quarter, let me say that we know that the U.S. financial markets are quarter-centric and not to naucify quarterly modelers, but in any quarter, a lot of noise can and does creep into the comparison with the prior-year period. In our discussion and our webcast slides, our objective is to try to highlight for you the major elements of the noise in our results so that you can calibrate how our reported performance might influence your thoughts about our future prospects. The most important thing about our first quarter performance is that the results for Q1 supported an improvement to our outlook for the full year 2016. So, with that background, let me cover two important points that will enable me to put our 12% operational revenue growth in perspective. First, we operate on a 4-4-5 financial week calendar, with our International operations closing one month ahead of the U.S. Now, this is a carryover from our days as part of Pfizer. Under our 4-4-5 calendar, every handful of years you'll have a quarter in a year that has as many as six extra calendar days in it. That's what we have in Q1 2016 compared with Q1 of 2015. We estimate that the additional days account for approximately 6% of the 12% operational revenue growth for Q1 2016 versus 2015. Important safety tip for those with quarterly models out there, our fourth quarter this year will have five fewer days than the prior-year quarter and the full year 2016 has one more calendar day than 2015, this being a leap year. So, that's the extra days. Second, our operating efficiency initiative was a drag on our operational revenue growth in the quarter. We estimate that the combination of the eliminated SKUs and the changes to our business models in Venezuela, India and other countries reduced operational revenue growth by some 4%. So, think about it like this. 12% operational growth for the quarter, minus 6% for the extra days, plus 4% for the impact of the efficiency initiative, equates to a normalized growth rate of approximately 10%. Of that 10%, roughly 4% came from acquisitions including Abbott, PHARMAQ and other smaller transactions. So our organic operational growth in Q1 was circa 6%, and including acquisitions, was 10%. So, not 12%, but pretty good, right? Now, highlights for the first quarter, very high level. We've now entered what I previously referred to as the golden age of our companion animal business. With full supply of APOQUEL, the launch of SIMPARICA, a refreshed companion animal vaccine line, and the conditional license for IL-31, we are positioned to deliver significant growth in our companion animal business in 2016 and beyond. On a normalized basis, organic operational revenue growth, which adjusts for the six extra days, the impact of the operational efficiency initiative and M&A, we had about 20% growth in companion animal in Q1 compared with Q1 of 2015, and the growth was reasonably consistent between the U.S. and the International segments. On the same normalized constant currency basis, livestock was up 1% with solid performance in the International segment, offset by a decline in the U.S. Q1 of 2015 was a particularly strong quarter in U.S. livestock and there were a number of other factors that I'll touch on later. Our livestock business both in the U.S. and International segments are healthy and poised to contribute to revenue growth in the remainder of the year. Stepping down the P&L, our adjusted gross margin hit an all-time high of 67.4% in the quarter, a bit above the high end of our full year guidance range. But I'll point out that from a gross margin perspective, many things fell on the favorable side of the line during the quarter – mix, level of scrap, et cetera. Our expectations for gross margin for the full year continue to be in the range of 66% to 67%. In operating expenses, total adjusted OpEx grew 2% on an operational basis, but if you remember those extra six days, they impact our expenses as well. Our progress in reducing operating cost continues and we are on track to deliver on the promises of our operational efficiency in this initiative in 2016 and expect to enter 2017 having taking more than the targeted $300 million of costs out of our company. With our gross margin expansion and active efforts to contain operating costs, our 12% reported operational revenue growth translated into 37% operational growth in adjusted operating profit and 35% operational growth in adjusted income before tax. The EC's actions last January were a key driver of the 350 basis point rise in our adjusted effective tax rate to 30.9%, which resulted in our adjusted net income in the quarter rising 28% operationally. Our purchase of shares, which began in Q1 of 2015 – started in January 2015 – helped to reduce our fully diluted share count from 503.2 million in Q1 of 2015 to 499.5 million in the current quarter, and that led to operational growth of adjusted diluted EPS of 29%. So, that was a very quick walk down our P&L for the quarter. Here are a few more contextual details that I believe will help you think about our performance. First, FX. Dare I say that we may have found the bottom of the cycle? Maybe not, but the environment has improved for sure. Foreign exchange had a negative 700 basis point impact on our revenue growth in the first quarter compared with Q1 of 2015. That's a big hit. But based on current rates, the FX impact on our growth will lessen over the remainder of the year. While we continue to measure our performance on an operational or constant currency basis, it just feels better when the gap between operational and reported results narrows. Next, the SKU reduction and the changes to our business models in countries like Venezuela and India reduced our operational revenue growth by roughly 400 basis points. You should expect the growth drag on the full year to be roughly 500 basis points, so more of a negative factor compared with the prior year for the next nine months and particularly in Q2 and in Q3. Importantly, the impact of the SKU reduction and the changes in business models are felt more in our International segments than in the U.S. and more in livestock than in companion animal. Let me step through the elements of the 12% operational revenue growth in Q1. Price accounted for 3% of the growth, APOQUEL volume another 3%, 4% from acquisitions, 6% from growth of in-line products and minus 4% from the impact of the SKU reductions and changes to business models in Venezuela, India and other countries. Companion animal was the star of the quarter. Revenue growth normalized for both the six extra days and the impact of the efficiency initiatives increased 20% operationally. APOQUEL was the major driver, but other products contributed as well including vaccines as well as the Abbott acquisition. We also expanded U.S. customers' access to a number of our companion animal products to third-party distributors and that change led to a one-time in semi-permanent buildup of their inventories during the quarter to establish their base level. In livestock, we had lots of puts and takes. The normalized organic revenue growth was 1% operationally with the International segment up 5% and the U.S. segment down 9%. First, let's talk about International. The France livestock rebounded as the anti-infective sales in the quarter were higher when compared with a very light Q1 of 2015, which was caused by new legislation last year. Australia livestock also pushed the strong quarter with better weather playing a role. In Brazil, we benefited from above average price increases and continued favorable conditions in the cattle segment, which were in part offset by the negative impact or SKU reductions. In U.S. livestock, a mild winter was a major driver of lower cattle product sales in the quarter. With milder weather, there was a less risk of disease incidents and that impacted our premium products. We also saw decline in swine products due to increased competition. In summary, after adjusting for the noise, we had a solid quarter from a revenue perspective and through the ongoing programs to improve efficiency, delivered an improved gross margin, contained operating costs, and posted strong growth and profits. Switching to restructuring charges, let me quickly review this quarter's one-time charges related to certain significant items. First, the stand-up costs, which are mainly associated with our separation from Pfizer totaled $12 million in the quarter, down about half from the prior year. That work continues to wind down and will be substantially completed later this year. In the second bucket, cost related to the efficiency initiative, we recorded $5 million of costs, which were more than offset by $33 million gain associated with the sale of four manufacturing sites in certain products as part of the efficiency initiative during the quarter. Interesting – rather than the gain, I like to think about it from a gross cash perspective. Gross pre-cash proceeds from the sale of the sites was $75 million. We have additional assets for sale including a transaction in Taiwan, which closed last Friday and any impacts from those sales would further affect cost in this second bucket. Finally, we recorded $3 million of cost associated with our ongoing supply network strategy initiative. We're still in the early days of that initiative. We also did record a one-time net tax charge of approximately $35 million in the quarter relating to the nullification of our Belgium tax ruling by the European Commission for periods from 2013 through 2015. Now, turning to guidance. There are four factors that lead us to narrow and raise our guidance for 2016. First, let me cover the easy one, FX rates. We refreshed our guidance for our current FX rates and that was certainly a help in our guidance. Second, in the first quarter, our International segment was stronger than we had expected and we're confident that strength will carry through the balance of 2016. Third, we are more confident in our expectations for APOQUEL as we put supply issues behind us and have launch plans in place in new markets and they're well underway. And fourth, we reduced our guidance for our 2016 effective tax rate on adjusted income by 100 basis points. This is due to changes in our projected mix of income by jurisdiction as a result of internal restructuring of our International operations. If you want to calibrate the various factors, at the midpoint of our guidance range for adjusted EPS, we raised guidance by approximately $0.10 a share, I'd be remiss if I didn't say it's actually $0.105, but it's $0.10 a share for this purpose. Roughly $0.03 comes from FX, roughly $0.04 comes from stronger operational performance and the reduced tax rate added roughly $0.03. I hope that helps you think about the change for the guidance. For 2017, the only change we made at this point are based on changed FX rates. So, to go through it for 2016 and 2017. For the full year 2016, we now expect revenue between $4.775 billion to $4.875 billion, reported diluted EPS of between a $1.41 and a $1.56 per share and adjusted diluted EPS of between $1.83 to a $1.90 per share. For the full year 2017, we now expect revenue between $5.075 billion to $5.275 billion, reported diluted EPS of between $2.01 to $2.19 per share and adjusted diluted EPS between $2.24 and $2.38 per share. Now, to summarize, we enjoy a diverse product portfolio, global footprint and productive R&D that together enable us to balance fluctuations across different species, therapies and markets, and deliver consistent revenue and profit growth over time. We are well down the road of improving the efficiency of our operating expense structure, leading to improved margins and we're on track to achieve an adjusted EBIT margin of 34% in 2017. With the continued focus on expense efficiency, we expect to deliver operating profit growth faster than the revenue growth. Last but certainly not least, we strive to intelligently allocate our capital and actively manage our capital structure to drive shareholder returns. That's it from my prepared remarks. Let me turn it back to Juan Ramón before we get to Q&A. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Paul. And before we begin the Q&A, I wanted to mention our personnel development. So beginning July 1, John O'Connor, will be promoted to the role of Vice President of Corporate Strategy, Business Analytics and Enterprise Risk Management for Zoetis; and Steve Frank will now lead our Investor Relations program; John will be reporting to Alejandro Bernal, Executive Vice President, President, and Group President of Corporate Strategy, Commercial and Business Development. John has done a great job as Head of Investor Relations over the last two years, and I wanted to thank him for those contributions. He will continue to be a valuable advisor to me, to Paul, and Alejandro in his new capacity. I am pleased to say that John will leave the Investor Relations program in good hands, and there is Steve Frank. Steve has a great knowledge of our industry and business, having worked in animal health for the last 15 years, and has been involved in our recent acquisition of PHARMAQ, Abbott as well as our IPO. Many of you know Steve, and he has been working with John in IR since 2014 to prepare for this opportunity. I'm sure we will have a seamless transition. With that, let me open the lines for Q&A. Operator? Operator : And we will take our first question from Alex Arfaei with BMO Capital. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Good morning folks and congratulations on the quarter, and congratulations, John, on the promotion. I'm not sure if I got the April cost sales. If you don't mind repeating what the April cost sales were by region? And could you also comment on some of the vaccines that you are developing on your livestock business, particularly the avian vaccine. Thank you very much. We'd appreciate it. Juan Ramón Alaix - Chief Executive Officer & Director: Okay. So, the first question on APOQUEL. Total revenues for APOQUEL in the quarter were $50 million, and U.S. generated $35 million, and in International markets $15 million. These, I guess, it's answering your question on APOQUEL. You also ask about new vaccines. On new vaccines, we have new vaccines for companion animal, and this has been introduced in Europe as well as in the U.S. I mentioned new vaccines that are in the U.S. covering oral injectable intranasal, and I mentioned this for a specific Bordetella bronchiseptica disease. So, this is something that definitely represents a significant upgrade on our portfolio for companion animal infections. We also launched a new vaccine in China, used for swine, and it is combination of vaccine for PRRS with a combination for swine fever in pigs. So another opportunity for increasing our presence in China, and increasing our presence in the swine market in China. That is a significant opportunity for Zoetis. Next question, please. Operator : And we'll go next to Louise Chen with Guggenheim. Please go ahead. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my question. So you guys talked about maybe exceeding your operational efficiency target of $300 million. I was wondering if you could give more color there on the potential upside, and then how this could positively impact your 2017 guidance and margin expectations? Thanks. Juan Ramón Alaix - Chief Executive Officer & Director: Well, we already incorporated in our guidance for 2017 the potential exceeding of the $300 million. At this point, we have not provided any concrete amount of this existing opportunity – is something that in the future. As we move into the programs, we'll be sharing that with you. Next set of question, please. Operator : Thank you. And we'll go next to Erin Wilson with Credit Suisse. Please go ahead. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): A follow-up to that question on the restructuring, SKU rationalization and overall cost structure initiatives. How should we think about the quarterly progression throughout the year? And then as a second question, how would you characterize the current environment in the U.S. livestock business? You mentioned weather impacting the business in the quarter, but how should we think about the dynamics now? Thanks. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yes. Erin, it's Paul. I'll take the how do you think about the OpEx roll out. As we said, we expect to enter 2017 with the cost structure trim down to its new inefficient level. We have some work to go on that and I think that if you're a quarterly modeler, I know you are, I think you got to think about it as continuing to show in positive impact through Q4. It's not like we're going to finish this in Q2, we're not going to finish in Q3, there is more to come that you will see evidenced in our cost structure in Q4. So, I don't know if that exactly answers it. But, yes, suffice to say that the improvements will continue to occur throughout 2016 and with a good chunk in Q4 2016. Do you want to take the last one? Juan Ramón Alaix - Chief Executive Officer & Director: Yeah. Let me cover the question on the U.S. livestock. Let me start with the cattle. On the cattle, there are two segments, beef and dairy. Let's talk about beef. Beef, we reported that there were probably milder winter conditions that impacted our premium net products, but the fundamentals of the beef market of the cattle are very strong. We have seen that the increase in placement in feedlot. We also expect that it will continue for the rest of the year and also we expect that at the end of the year, the number of cows in beef will be increasing by 2% to 3%. So it's something that even if we have seen some temporary impact in the first quarter, we want also to see this business on a yearly basis and we're confident that on a yearly basis the market remain very strong. In dairy, what we have seen is the global prices for milk has been going down. This is also resulting in some negative impact in dairy customers. And in some of the cases, we expect that they will be reducing the number of dairy cows. Again, so it's a cycle that we have seen also in previous years. After a cycle of low price reduction of cows, it will be another cycle where prices will go up and then they will be rebuilding the herd. So, we don't see that this is something that is concerning on medium, long-term process for the business. In swine, we reported that we are facing some additional competition for vaccines. It's a similar case that we saw in the past with companion animal. We identified this need in companion animal. We have been working to upgrade our vaccines. Now our vaccines in companion animal are very strong and we are doing the same with swine. So, we are working to upgrade our swine portfolio for vaccines and we're confident that this also will bring us the opportunity for growing in the future. We don't expect the swine to be a significant driver of growth in 2016. And finally, poultry. Poultry in the U.S., I think it's a positive segment. We expect to generate the net positive growth in 2016. Next question, please. Operator : And we'll go next to John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Can you just talk a little bit about the strategy around dermatitis in dogs now that you've got IL-31 out there as well as APOQUEL? What are you learning about the market and how best are you using those two products? Thanks. Juan Ramón Alaix - Chief Executive Officer & Director: Well, it's still very early because, first, APOQUEL has been – because of the limitations in terms of supply – has been mostly used in chronic dogs with dermatitis. We expect now that in May we are opening the market without restrictions. They will be expanding the market not only to chronic but also to acute. In the case of IL-31, IL-31 has been introduced as a conditional license. So what we are doing is to gain experience in the market by doing some activity with dermatologists, veterinarian dermatologists. This also has the objective of collecting all the data that will support full license in terms of efficacy of the product, but we are convinced that there are two products that they are very complementary and one is oral, the other one is injectable. There are some dogs which are not managing well swallowing pills. This is something that IL-31 will cover. There also, not everyone is responding the same way to treatment. So we see that APOQUEL, in some cases, is working very well; IL-31, in some of our cases, is also working very well. So the veterinarian will have the option to choose what is the best treatment there, depending on specific cases of dogs with atopic dermatitis or with any kind of skin conditions. Finally, APOQUEL will have broader indications, while IL-31 will have the indication of atopic dermatitis. Next question, please. Operator : We'll go next to Chris Schott with JPMorgan. Christopher Schott - JPMorgan Securities LLC : Great. Thanks very much for the questions and congrats, John. First, just update on SIMPARICA and how you're thinking about the rollout of the product? I guess, should we think about a slower ramp here, given entrenched competition, and what type of share do you think Zoetis can ultimately capture of this obviously very large end market? Thanks. Juan Ramón Alaix - Chief Executive Officer & Director: So, as I mentioned, it's early, the introduction of SIMPARICA. SIMPARICA has been introduced in the U.S. and in a few European markets. We just plan to introduce the product in the rest of the markets where the product has been approved. SIMPARICA has been launched with very strong publications and comparing SIMPARICA against other products, oral and topical. And we have seen that SIMPARICA, it's showing very positive comparison in terms of faster action. So it's very fast on killing ticks and fleas and also very important. So, the SIMPARICA is keeping full efficacy during the duration of the treatment, which is also very important and much better than some of our competitors. So, we are definitely convinced that SIMPARICA will have a place in the market. I think we are not yet establishing what is the target in terms of market share, but definitely we expect that we'll gain the market share that corresponds to a company that our strength, the capabilities and our operations in the market. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, it's Paul. I just want to follow-on on that. I think that the overall market size is for parasiticides is about $4 billion. The dogs' portion is about $2.5 billion; the fastest growing segment are the oral parasiticides. But if you want to think about the market, it's kind of in that $2.5 billion market and I think that we believe that there are two things. One, with our footprint and the quality of our salesforces we have the opportunity to certainly penetrate that $2.5 billion market and participate in the fastest growing part. The second thing I want to point out is, this is a self-developed product, and that means the economics of this product to us as compared with the economics of the product to Merial and to Merck that we're in license through third-parties. This is a very good product for us and we're really excited about both the prospects of penetrating their market, but also getting the fruits of our investment in R&D. So this is a great story and we'll see how it plays out. Christopher Schott - JPMorgan Securities LLC : Thank you, Paul. Juan Ramón Alaix - Chief Executive Officer & Director: Next question, please. Operator : We'll go next to Jeff Holford with Jefferies. Please go ahead. Jeffrey Holford - Jefferies LLC : Hi. Good morning, everyone. Thanks very much for taking my questions. So Elanco licensed a new canine osteoarthritis drug just in the last quarter. I wonder if you could talk about that in terms of why you didn't feel compelled to license that asset and just remind us what products do you have in that area and if you're very active in terms of R&D late-stage development there and how that might impact your franchise? Thanks very much. Juan Ramón Alaix - Chief Executive Officer & Director: Well, thank you for the question, Jeff, and we believe that we have a portfolio in pain, which is very strong. We have RIMADYL in all markets. We also have in the European market another product, which is also complementary to RIMADYL, which is called TROCOXIL and very important. So we have a lot of experience in this area, and this expertise is not only in terms of commercial, but also in terms of R&D. And in R&D, it's an area of focus and we have programs in pain that I'm convinced that will strengthen our portfolio in the future. Next question, please. Operator : We'll go next to Mark Schoenebaum with Evercore ISI. Volodymyr Nikolenko - Evercore ISI : Hello. Hi, guys. Thank you for taking my questions. It's actually Vlad Nikolenko on behalf of Mark Schoenebaum. Congrats with the strong quarter and, John, congrats on promotion. So I have two somewhat related questions. First, more about macro trends in general. So your official guidance for 2016 and 2017 implies a strong operational growth in terms of revenue like mid to high single-digits. So I'm wondering if we can think about this revenue growth over the longer term that just will continue to grow in line with the rest of the industry – animal health industry or at some point, we need to expect some slowdown of this trend. And second, somewhat related question is about segments. Do you have more color about the potential long-term growth in different segments of products, antibiotics versus vaccines versus other pharmaceuticals and other segments that you report? Thank you. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Vlad, and let me first describe what are the macro trends. So we see that the overall macro trend that maybe are is lowering down the growth in some markets. It's not affecting the same way to our industry. And one example, so we have seen that in Brazil, the GDP, it's declining, while the GDP for agriculture including their livestock is growing. So, again, so it's – in the animal health industry, I think we cannot extrapolate the macro trends which are affecting other sectors to our trends. And our trends are based on population, it's still continue growing; middle class, which is still increasing, and also they need to improve productivity because – well, the world is being challenged with the need of more food with fewer resources. And companies like us is that we can bring this type of innovation, we have a significant opportunity for our growth. And the same drivers are also impacting their companion animal. More people, more middle class is increasing the number of pet adoptions and also very important, the amount that pet owners are spending per pet in keeping these animals healthier and to live longer. So we are very confident that the macro trends remain positive for the animal health industry. And for Zoetis, we have been targeting to grow in line or faster than the market. In the first two years as independent company, we had been growing faster than the market. In 2016, because some one-time impact related to our operational efficiency, the reported growth will be lower. Adjusted by this factor, we expect that we'll be growing in line or faster than the market. The same for 2017. We have projected for 2017 a growth that, in my opinion, at the midpoint, is faster than the projection of the market and we have no reasons to believe that in the future we'll (sic) [we won't] continue growing in line or faster than the market. So one of the things that are very important is that we have already all what is needed to maximize our portfolio. And very important, our R&D investment continued delivering very strong results. And we have been continue bring into the market new products, but also very important bring into the market lifecycle innovation, which is also helping to protect our future growth. And maybe Paul can talk about trends in therapeutic areas, antibiotics, vaccines, pills that are part of our efforts to ensure that we have the right balance and the right opportunities for our growth. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah. Sure. And when you think about – when people talk about anti-infectives or antibiotics, people look at our portfolio and they say, gee, you're a market leader in anti-infectives. I hear this and I see this in the news and therefore we have a lot of revenues at risk. And to put in perspective, I think what people mostly focus on the amount of anti-infective sales that we have in livestock. They're not necessarily as concerned with the anti-infectives that's used in the treatment of companion animals. We saw about $1.3 billion of anti-infectives in the livestock segment. But importantly, Vlad, first I'm going to talk about our company and our outlook. Included in that $1.3 billion, about $1 billion of that are in the form of high value injectable products that are dosed to animals when they are sick and where the alternative is that animal could die and the animals around that animal could die. And that's why we characterize as the responsible use of anti-infectives and that is the overwhelming majority of our portfolio was products that fall into that category. And while there continues to be pressure or concern from folks generally about the use of anti-infectives and wanting to use anti-infectives, what they are mainly focused on is not treatment of sick animals, but really the use of anti-infectives in ways that would, for example, to promote growth. Within our portfolio, about $300 million balance in livestock, that is mainly anti-infectives that are used in feed and in water. Our work with our customers and our own diligence strongly suggest that those products are being used in what we would call a – what we call a responsible way, in other words, not in sub-therapeutic doses to promote growth, but to treat sick animals. Even still, if I were looking as an outsider, I would look at that $300 million as – that's a piece I got to keep my eye on and that's a piece I'd be concerned about. Now, back to the overall trends. Our anti-infectives continue to grow, but they grow slower than the balance of our portfolio. And just so, well, real quick, of course, that's baked into our 2016 expectations, our 2017 expectations, and frankly is baked into our folks who look at our industry generally about what the long-term growth prospects are for the industry. It's an important part of the industry, and so that's baked into the macro view of our industry to able to grow mid single-digits or better for the foreseeable future. I'll continue on because it's a very interesting topic. We pivoted many years ago away from the development of additional anti-infectives to a focus on vaccines because the best way to reduce the use of anti-infectives is to reduce the incidences of disease. That's the best way. And we've been very successful of pivoting our R&D portfolio and now our product portfolio to feature vaccines and will assist producers in maintaining the health of their herd so that they would have to use less anti-infectives. So that's a big area for us. And we focused – I'm focusing all of this on the livestock segment because I think that's where your question lies. So I'll stop there. Next question, please? Operator : We'll go next to Douglas Tsao with Barclays. Please go ahead. Douglas Tsao - Barclays Capital, Inc.: Hi. Good morning. Thanks for the questions. Just on the IL-31, what is your expectation in terms of timing for going from a conditional to a full approval and just obviously there's some limitations in terms of your promotion of the product right now. Just how widely is that being used in terms of veterinarians? Juan Ramón Alaix - Chief Executive Officer & Director: Thank you, Doug for the question. So we expect but there is something that will depend on the final approval from the USDA. We expect this approval by the end of the year. So now what we are doing, it's a gaining experience and also collecting the data in terms of efficacy and this will be submitted to the USDA for final approval of the product and is related to the U.S. we have similar partner in Canada and a different one in Europe. Also, we expect in Europe this product approved in the future. So today it's used under this conditional license. So the use is quite limited because we're just going to fewer customers in the U.S. mostly veterinarian dermatologist, some other customers are using the product. Now the objective is not really to generate significant revenue growth but to gain experience of the product and making sure that the product it's generating the amount of data that would support full license. We're convinced that IL-31 will be an important product in our portfolio and very important so it's – Zoetis, it's developing a franchise which is this skin conditions, itching, atopic dermatitis. And with two products in the market I think it might have been that we have very strong position with it the future opportunities. Next question please. Operator : We are going next to Jami Rubin with Goldman Sachs. Divya Harikesh - Goldman Sachs International : Good morning. This is Divya Harikesh on behalf of Jami Rubin. Just wanted to get your latest thoughts on capital allocation. Are there other assets that look more attractive at current valuation or areas that are of particular interest to you. Also how much leverage would you consider given the market's increasing concern on leverage levels for companies. Thank you. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : This is Paul. I'll take that on the capital allocation front. Of course, we continue to – I think like most companies and we focus first on what kind of capital can we allocate within our company to drive incremental revenue and profit growth that is always going to be very high return activity. So, first thing we do is try to max out programs inside that can drive revenue and that falls in the bunch of categories that's – yeah that could be incremental salesforce, it could be investment in DTC advertising to grow markets, it could be incremental investment in R&D to develop new products. It could be incremental CapEx to create a technology platform. So it's all those things. So we do that first. The second piece which is I think what you're asking about is outside. So we look outside on what sorts of opportunities do we see. We see a very consistent flow of what I'll call smaller deals that we do every single year that none of which I think on an individual basis is going to be exciting to the market at large, but in the aggregate help us one, feed our R&D effort because we can acquire technologies and things that feed R&D. Second is small add-ons that we just continually do and yeah that can be anywhere from $40 million to $75 million a year in activity and that's relatively consistent. The next bucket would be sort of the mid-sized M&A and I think last year and, I guess, I'd put PHARMAQ in that category and maybe even Abbott in that category as well. Lastly, we were fortunate enough to close two deals. I wish we could do that every year. The challenge is not our desire, would you do this deal. We will do those deals 100 out of 100 times if they present themselves. So we are – as I used to always love to say, we're tanned, rested and ready to do those deals when they present themselves and we're spring loaded to go after them when they present themselves but now predicting when they're going to be available is the challenge. On the larger scale M&A, really, I guess, what you think of it as potentially transformative, we've said many times over, our transaction with one of the top five companies is very difficult for reasons of anti-trust sort of – think of it as FTC type issues because there's a lot of concentration now amongst the top, say, five companies. So, the prospect for a transaction, I'd say, never say never; it's not zero, but it would be pretty hard. And then, next down the list, there are opportunities, there we continue to look. We are very active and I should say we're very proactive in targeting assets that we think would be interesting and valuable to add to our company, but of course, we're not going to disclose what our list of targets might be at any moment in time. And then, the last bucket is the one that I think is important – I referenced it in the tail end of my prepared remarks – and that is returning capital to shareholders. As we enter 2017, we have lots of the standup costs and the operational efficiency cost, and all those things behind us, not just from a P&L perspective, but also from paying out the accruals, et cetera, and we put that cash flow behind us, that negative cash flow behind us and we enter 2017, we still have to throw off a fair amount of cash. And the question is, well, gee, if you don't have anything to do with it, what are you going to do? Well, a couple of things. One, we have a dividend. It's a circa – a commitment this year of – call it circa $190 million or thereabouts in 2016. We have a share repurchase program. We are currently purchasing shares at the rate of 75 million a quarter under a program that we announced way back in November of 2014. And so, long-winded but, we intend to the extent that we can't deploy that capital in our business or outside our business, to return to shareholders in the form of dividends and share repurchases over time. We think that's appropriate. Cash is a non-productive asset for us to have around, but this also dovetails nicely into the discussion of capital structure, which you inquired about as well. So, we have articulated that we expect to operate in the normal course of business in the range of 2.5 to 3.5 times trailing EBITDA for a debt level for our company. Operating in that range will enable us to maintain an investment grade rating – we believe will enable us to maintain an investment-grade rating – and that's important, as you pointed out. I mean, the market is taking a different look at leverage levels today than they might have two or three years ago, and we're cognizant of that. I said – but because we get this question a lot, I'll restate it. People say would you ever do a deal that would cause you to be above that range? The answer is, yes. So, we would go above the top-end of that range to pursue what we felt was value-generative M&A. Would we go above that range to buy more stock? Probably not. In fact, I'll say definitely not. But we would in the context of making an acquisition. And so, we get below 2.5 times. We probably put some leverage on, we get above or up to the top-end of the range at 3.5, you'd expect us to manage that leverage down. The objective is to try to operate in that range and I'll stop there. I think as to the high-end of the range, I don't know what it is. Juan Ramón Alaix - Chief Executive Officer & Director: Next question please. Operator : We'll go next to David Risinger with Morgan Stanley. David R. Risinger - Morgan Stanley & Co. LLC: Right. Thank you very much. So, I was a little bit on and off the call. I just have a couple of questions on the guidance changes. So for the 2016 guidance, Paul, what percentage of the EPS guidance increase was due to operations and what percentage was due to FX? And then for 2017, obviously, you haven't updated that guidance for operating performance; you've only updated it for FX. When do you expect to update it for operating performance? Could we expect that after the second quarter results or do we have to wait until the company goes through its full-year annual planning in the fall? Any color on that would be helpful. Thank you. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah. Sure. Thanks for the question, David. It's Paul. I'll take that. I'll go through the – the factors in – the midpoint in the range $0.10 up, $0.03 from FX, $0.04 from stronger operational performance and then the tax rate was a $0.03 helper as well and that gets you to the $0.10 raise at the midpoint of our range in 2016. You're quite right. 2017, we said, we updated our 2017 guidance solely for the favorable change in FX rates. It's 2017 guidance. We're one quarter into 2016. We have a pretty broad range there. You can surmise that our outlook continues to be in that range or we would have adjusted – or adjusted that range. So there is no set time at which we would change our operational view of 2017, but to the extent that we were outside the range for 2017, we'd change it. I'll stop there. Next question, please? Operator : And we'll go next to Kathy Miner with Cowen & Company. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. First, I just had a follow-up on the sarolaner. Could you confirm that you do have full supply now so you're ready for full global launch? And was there any stocking in the first quarter of sarolaner? Second question has to just do on the SKU reduction, you've targeted 5,000 or roughly in total. Can you give us a sense of sort of where that's out right now and does that – is that something that just sort of goes away slowly as the year unfolds or is it more dramatic that they're kind of there until year-end? And also a sense of what therapeutic categories those SKU reductions are coming from. So as we sort of look at that, we can get sense of where some of those reductions will be coming. Thank you. Juan Ramón Alaix - Chief Executive Officer & Director: Okay. Let me start with sarolaner, SIMPARICA now. The name in the market is SIMPARICA and we have no restrictions for this product. We have enough of our product to introduce the product in all markets and where the regulatory authorities have approved. And this, in the U.S., all new markets and we also have operations for Canada and some other countries. So it's something that we don't see any restriction. So, at the time of the launch in the U.S. and also in Europe, there is no any significant loading of the product in the country. So, most of the product was related to samples that we provided to the veterinarians to get familiar with the product. So, we have not generated significant revenues in the first quarter, but we expect that these revenues would be ramping up during the rest of the year. So, we have very good expectations for the product. As I mentioned in some of the other comments, we have very strong publications supporting the efficacy of the product. As I said, this product is working very fast and also it's showing that during the duration of the treatment, it's having very strong efficacy. So, there is no drop in efficacy at the last day of the duration of the treatment, on the contrary is maintaining the efficacy. In terms of SKU, I think we have made significant progress on SKUs. So, most of the SKUs have been already eliminated from our portfolio, and maybe there are some few SKUs that will be eliminated from now until the third quarter, which are related to SKUs that will be replaced by other products that we are introducing in the market. But the large majority of SKUs has been already eliminated from our portfolio. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Let me continue on that because I think you asked the question about how it plays out over the course of 2016, and also important. We eliminate an SKU from the portfolio. If we sell it, like as we did, we sold some plants, as I said in my remarks, during the quarter and we sold it with the product. Obviously, the product is gone. We eliminate an SKU and we stop producing. We may still have inventory and we may still sell it. And so that's why you are seeing it play out over the course of 2016. But let me frame it. Q1, we said the impact of SKU reductions was about 4%, we said that we expected to be about 5% and this is growth versus prior year. For the full year, which it says that during the nine months, Q2, Q3, and Q4, it will be greater than 5% impact from a growth perspective versus the same period in the prior year. And I further said that it's mostly in Q2 and Q3. So the middle part of the year as we sell out these products and they are gone, and what you're going to see is a moderation of that in Q4 because we did start to see a impact in Q4 of last year. And as we enter 2017, there is still going to be a drag, because you still sold them at the beginning – some of these products at the beginning of 2016. But if you look at the kind of run rate when we enter Q1 of 2017, that will be fully reflective of all of those SKUs being gone, and again, impact versus prior year heavier in Q2, Q3 of this year, moderate in Q4, there is still an impact in Q1 next year, and Q2 next year, but it diminishes pretty substantially. The cool part is, we will have this activity behind us entering 2017. Next question, please? Operator : And we do have a follow-up from Erin Wilson with Credit Suisse. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): Great. Thanks so much. Also, I still don't see a balance sheet in the release. I guess my bigger question here is what can you accomplish in the way of working capital improvements near-term, and to address the high inventory days? And then also, how much was the distributor stocking contribution in the quarter? I assume that's related to the vaccine business. Was that material? Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Yeah, it's Paul. Let me take the balance sheet and working capital questions. Yeah, we are working very hard to shrink and then eliminate the gap between when we report our earnings and when we release the balance sheet. We are expecting to file our Q Friday of this week. So, yeah, we've shrunk it to a couple of days. It had been substantially more than that. That's just a – we could not shrink those days in the context of also changing all of our ERP systems et cetera. So we are working on that and our goal is, to be like most other companies, to have our balance sheet on the same day to report earnings. So just know that that's a priority for us and we'll get there. With respect to working capital, you pointed out to the day sales of inventory that we are on at the end of the year. We expect that we can have some pretty sizable improvements in our investment and working capital efficiency. Now with the – thank some higher power of the completion of our SAP implementation where we have every part of our company up on one instance of SAP, we now have the opportunity to activate the tools that will enable us to much more tightly manage our investment and inventory while at the same time having a high service level to our customers. That's not something that is instantaneous, that is something that we explored it and I think I've said in public forums before, we expect to make progress against that in 2016. We'd expect to make much more substantive progress on that in 2017 and that is the focus of our opportunity in being more efficient in working capital. We're pretty good in accounts receivable. I'd say pretty good, we're good in accounts receivable and we are also good on accounts payable. So it's really inventory that we are focused on, expect a modest improvement in 2016 and more significant improvements beginning in 2017 as we get the tools up that will enable us to better manage our supply chain. Your question regarding the distributor stocking, again that was in the U.S. That was with respect to some companion animal products to increase. So the amount that went in was approximately $18 million in the quarter. And so, it's something that you should take into consideration. Next question, please? Operator : And it appears we have no further questions. I'll return the floor to Juan Ramón for final comments. Paul S. Herendeen - Chief Financial Officer & Executive Vice President : Great. Juan Ramón Alaix - Chief Executive Officer & Director: Thank you very much for your attention. And looking forward for following quarters and also the interaction with all of you. Thank you. Operator : And this does conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-757-4761 for U.S. listeners and 402-220-7215 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,016
| 3
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2016Q3
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2016Q2
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2016-08-03
| 1.793
| 1.82
| 1.991
| 2.085
| 3.07648
| 23.27
| 22.65
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Paul S. Herendeen - Zoetis, Inc. Analysts: Louise Chen - Guggenheim Securities LLC John C. Kreger - William Blair & Co. LLC Jon Block - Stifel, Nicolaus & Co., Inc. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker) Alex Arfaei - BMO Capital Markets (United States) Jeffrey Holford - Jefferies LLC Volodymyr Nikolenko - Evercore Group LLC David R. Risinger - Morgan Stanley & Co. LLC Chris Schott - JPMorgan Securities LLC Douglas Tsao - Barclays Capital, Inc. Operator : Good day, and welcome to the Second Quarter 2016 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-out or dial-in on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you, operator. Good morning and welcome to the Zoetis second quarter 2016 earnings call. I am 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 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. 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 2015 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 of our earnings press release and in the company's 8-K filing dated today, August 3, 2016, and also in the slides accompanying this presentation that are available on the Investor Relations page of our website, zoetis.com. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve, and good morning everyone. Our performance this quarter once again demonstrates why we have confidence in the consistency and the predictability of our results and why we are the leader in the animal health industry. True to our diverse business model, we continue generating result from many different sources, both in the U.S. and international markets and across different species and therapeutic areas; and our portfolio help us deliver steady results over the long-term despite some economic and market challenges that exist. Our R&D investment is maintaining a high level of productivity with new products like SIMPARICA as well as lifecycle innovation and market expansions for key product lines such as DRAXXIN, VANGUARD and VERSICAN Plus. We also combine this internal investment with external partnerships and opportunities with products like SILEO, the new noise aversion medicine we are marketing for dogs in the U.S. In addition to sales and innovation, we are demonstrating our leadership in the animal health industry with the profitability and performance of our operations. We have been executing on the operational efficiency program we announced last year; and we are on track to deliver more than $300 million dollars in savings and an adjusted EBIT margin of 34% by the end of 2017. We believe this achievement in efficiency and profitability is unparallel in the animal health industry. Looking more closely at our second quarter results, operational revenue was up 6%, excluding the impact of foreign exchange. As you will recall, this year our revenue growth and focus will continue to reflect the impact from changes related to the operational efficiency program we put in place in 2015. Those SKU rationalization and business changes in countries like Venezuela and India continue to partially offset more significant gains in our core business. Excluding these impacts and the impacts of acquisitions, our normalized organic operational growth will be 9%; and on the same basis, our companion animal products grew 15% and our livestock products grew 5%. Paul will provide more details on the bridge from reported to normalized organic operational growth in his remarks. The growth in companion animal was based on the strong performance by APOQUEL, as well as our recently launched vaccines and SIMPARICA. In livestock, we saw growth coming from a recovery of cattle business in the U.S. In swine, the positive performance from the International segment was offset by a decline in the U.S. And in poultry, we declined globally due to market conditions and pressure from competition. We are improving our cost of sales and gross margin as we refine our manufacturing network, execute our efficiency plan and focus on continuous improvement. On an operational basis, our adjusted operating expenses were flat in the second quarter, even as we grew revenues significantly; thanks to the ownership and mindset of our colleagues and expense management discipline. The growth in revenues, gross margin improvement and discipline on expenses resulted in adjusted net income growth of 22% operationally; once again, supporting our long-term and value proposition to grow adjusted net income faster than revenue. We always emphasize a full year view of our business to account for some of the seasonal fluctuation and timing patterns in animal health; and we continue to see good progress through that lens. We're increasing our guidance for 2016 based on our strong performance in the first half of the year, the continued strength of our business model and the confidence in our outlook for the rest of the year. Paul will go through updated to 2016 guidance in his remarks. Now let me turn to the innovation investment that are fueling our performance this year and positioning us well for the future value creation. At the beginning of the year, I said we needed to execute flawlessly on our new product launches; and I'm very pleased with our progress. In the case of APOQUEL, it has become a very positive story. For the first half of 2016, we have exceeded $100 million in revenue; until May, we have been supplying APOQUEL with no restrictions. Recently, we have launched in additional markets such as Brazil, Japan, Mexico and Russia; and in the coming months, we plan to introduce APOQUEL in the rest of the approved markets such as Colombia, Peru, and Uruguay, as well as Singapore and Hong Kong. SIMPARICA, our new oral parasiticide for dogs is now available to customers in U.S. and most of the European countries; and we expect it to be further deployed in Canada, Brazil and New Zealand during 2016. We are pleased with the launch of SIMPARICA, despite being the most recent entrant in a very competitive oral flea and tick market for dogs. At launch, SIMPARICA was introduced with extensive published data, showing its rapid onset of action, its sustained persistence of protection against fleas and ticks and other advantages over various oral and topical parasiticides on the market. While new products have been a big lift for us recently, we continue to build on our major established product lines and focus on the lifecycle innovation that will keep our portfolio strong and sustainable. One of the strengths of our R&D organization is ability to innovate across the phases of care that veterinarians encounter; phases that includes prediction, prevention and treatment. Our R&D begins with an understanding of the biology of the diseases, their pathways and how they work. Then, we complement that with customer insights that come from our commercial teams working shoulder to shoulder with veterinarians and producers; and we apply this knowledge across the phases of healthcare. We use innovations in genetics, diagnostics and increasingly digital platforms to help predict risks or detect diseases in species. This means the ability to breed healthier and more productive animals, to detect disease earlier and to develop practices informed by bioinformatics and digital applications that capitalize on the use of big data. In the second quarter, for example, we continue to expand our business diagnostic franchise into new markets with an additional approval in Spain for livestock test kits. These point-of-care test kits deliver accurate, fast and clear results that give the customers timely and informed diagnosis without disrupting their clinical consultation. Our customers are also seeking for new solutions to get ahead and help prevent infectious diseases. We have been placing a greater emphasis on our vaccine portfolio, some of which we introduced last year and others that we continue to expand in terms of approvals and geographies. For example, in the second quarter, we expanded our VERSICAN Plus and the VANGUARD vaccine franchises with new approvals in Europe and Canada. VERSICAN Plus, a combination of vaccines that protect dogs against 10 canine diseases was first approved in European Union in 2014; and this quarter, we received additional approvals in the United Kingdom, Denmark, Sweden and the Netherlands for a smaller combination of the vaccine. Additionally, VERSICAN Plus Rabies achieved approval for a new claim in European Union three years duration of immunity. Meanwhile VANGUARD B Oral and VANGUARD crLyme vaccines were approved in Canada after having just received their U.S. approval in December 2015. And finally, across the phases of healthcare, we develop medicines to treat sick animals. DRAXXIN, one of the Zoetis' largest global product lines and was first introduced in 2015 (sic) [2005]; and this quarter, we received approval of a new label claim in Europe for DRAXXIN and DRAXXIN 25, an injectable anti-infective for treating swine respiratory disease. In addition to our internal R&D, we also look for partners that can help broaden and strengthen our product portfolio. For example, in May, Zoetis launched in the U.S. a product called SILEO under an exclusive agreement with Orion Corporation. SILEO is the first and only medication approved by the FDA for treatment of noise aversion in dogs. And if you were in the U.S. this July 4, you probably read about or heard about this exciting new product that brought hope to many dog owners. In summary, we have continued our positive momentum through the first half of the year based on the strength of our U.S. portfolio and dedicated Zoetis colleagues. We continue to reap the benefits of a productive, world-class R&D organization focused on new products and lifecycle innovation across our approximately 300 products lines. And we are executing on key product launches and our operational efficiency program to ensure our long-term growth and value creation. With that, let me turn things over to Paul. Paul? Paul S. Herendeen - Zoetis, Inc.: Thank you, Juan Ramón. Another solid quarter with lots of good things to cover, so let's get to it, starting with a quick walk down the P&L for the quarter. Then, I'll provide some commentary on a number of areas that I believe will be helpful to understanding our quarter, our first half of 2016 and what you might expect for the balance of 2016. Before I start, I want to point out that the SKU rationalization and the changes in business models we made in several international countries continue to have an impact on our revenue in 2016 and growth in revenue for 2016 compared with 2015. First, we're confident that the steps that we took and are taking to improve efficiency will put Zoetis in a position to deliver higher profits and cash flows and to better grow those profits and cash flows from here forward. Second, while we're going through this transition, we believe it's important that we and you have visibility into how to the go-forward portion of our business is performing. So we prepared analyses that strictly eliminated SKUs out of our revenue to show the underlying growth of the go-forward business. On our website, you'll see slides and you'll find a table – or tables rather that show our reported revenue growth for the second quarter and for the first half of 2016; and then walk you through the impacts of foreign currency, the operational efficiency changes related to SKUs and other business model changes, recent M&A and in the case of the year-to-date charts, the extra days in our first quarter relative to the prior year. The objective here is not to divert attention from the reported revenue growth rates; it's to provide perspective on how you might think about our future growth prospect in our to-be state. While we use the phrase operational growth, that means excluding the impact of changes in FX rate versus the same period in the prior year; when we say normalized organic growth for any period compared with the prior year period, that means excluding the impact of FX, the eliminated SKUs, the business changes outside the U.S., the extra days in the first quarter of the year and the impact of recent M&A. So with that lengthy preamble, let's talk about the quarter. Revenue grew 6% on an operational or constant currency basis. We posted an adjusted gross margin of 67.9% in the quarter, resulting in adjusted gross profit growing faster than revenue; up 11% on an operational basis. Adjusted operating expenses were flat on an operational basis, reflecting the great progress we've made on our efficiency initiative. As Juan Ramón said, we're on track to deliver more than the previously announced $300 million in savings associated with the efficiency initiative; and those savings are considered in our guidance for 2017. The combination of 11% operational growth of adjusted gross profit and the flat adjusted operating expenses enabled us to grow adjusted EBIT for the quarter by 25% on an operational basis. Below the operating line, we had higher interest expense and higher effective tax rate on adjusted income, which together reduced the operational growth rate of adjusted net income to 22%. We put adjusted earnings per share of $0.49 on the board for the quarter. And the strong performance in the first half of the year enabled us to increase our guidance for the full year 2016 by 3% – excuse me, $0.03 per share across the range; a solid quarter and a solid first half of the year for sure. So a bit deeper dive on revenue. The star of the quarter geographically was the U.S., up 10%, and by global business it was companion animal, up 13%; and both of those are on an operational basis. Of course, APOQUEL was an important driver of both. APOQUEL sales in the quarter were roughly $60 million. APOQUEL has a lot of revenue growth still ahead. And with SIMPARICA and a number of other recently introduced companion animal products, we expect our companion animal business to drive above market revenue growth through 2017. Our International segment was up 2% operationally, and the global livestock business grew about 1% operationally. Both were disproportionately impacted by our SKU reductions and the changes we made to our operating models in countries, including Venezuela and India. On the flipside, global livestock is benefiting from M&A, mostly PHARMAQ. Now let's talk about the components of our operational revenue growth of 6% in the quarter. APOQUEL accounted for 3% of that growth. New products other than APOQUEL, including our new companion animal vaccines, SIMPARICA, SYNOVEX ONE and SILEO, to name a few, added 2%. In-line products added 4%, with 3% coming from increased prices and 1% for volume; and M&A accounted for another 2%. The impact of the SKU reductions and the changes in business models reduced our growth by some 500 basis points; and that gets you to the 6% operational revenue growth for the quarter. Pretty good, right? Once again, our revenue growth came from a number of sources and reflects the strength of our diverse business model. Let's turn to our two segments, U.S. and International, starting with the U.S. Overall, the U.S. business was up 10% in the quarter. On a normalized organic basis, the U.S. grew 11% in the quarter. U.S. companion animal business was up 17% mainly due to the ramp of APOQUEL, the launch of SIMPARICA and the introduction of other new products. Half of the growth was driven by the ramp of APOQUEL. U.S. livestock grew 2% with a 4% pick up from increased selling prices that were offset in part by volume decreases related to some of the SKU reductions. On a normalized organic basis, the U.S. livestock business delivered growth of 5%, compared to a 9% decline in Q1 of this year. The business rebounded nicely in Q2 and the year-to-date normalized organic growth rate for the U.S. livestock business was negative 3%. After the first quarter, there was some concern out there about the health of our U.S. livestock business. For the avoidance of doubt, after a slow start, we expect our U.S. livestock business to deliver growth for the full year 2016 on a normalized organic basis. Within U.S. livestock, cattle, especially beef cattle, was particularly strong as the herd size and placements in feedlots were increasing and drove higher demand for our high-value injectable anti-infectives, vaccines, parasiticides and the recently launched SYNOVEX ONE implants. U.S. swine products experienced a decline due to competition for Fostera PCV vaccines, new restrictions on the use of some of our products for pork exports to China, a decline of PEDv revenue as the disease is no longer prevalent and some eliminated SKUs. U.S. poultry revenue declined in the quarter with the impact of SKU rationalization more than offsetting growth from the increased use of our health maintenance products and MFAs for antibiotic flea production; products like Zoamix, for example. On to the International segment, revenue from our International segment was up 2% operationally. On a normalized organic basis, the growth rate was 7%. On the same normalized organic basis, the international companion animal business led the way, up 10%, while international livestock was up 5% in the quarter; again, both of those are on a normalized organic basis. It's worth spotlighting a few countries for you. China was up $14 million or 49% operationally. Pork prices in China were relatively high leading to favorable conditions for pork producers and for our swine portfolio, including products like DRAXXIN, EXCEDE and our vaccines. About one-third of the growth in China was driven by products purchased by producers to stock up ahead of label changes for some of our products. Finally, we had a very successful spring promotion that drove increased sales of our REVOLUTION and DECTOMAX products in China. In Brazil, cattle and companion animal sales were strong, but partially offset by a weakness in poultry. The cattle portion of livestock in Brazil enjoyed favorable market conditions, leading to strong performance from our vaccines and parasiticides. We also saw increased adoption of IMPROVAC in the swine business. Across the portfolio, we also benefited from increased selling prices. The poultry business saw high input prices and increased restrictions on exportation to Japan that made for a challenging market for poultry producers and saw us lose a few accounts based on price. For the quarter, Brazil grew 6% operationally. Australia posted a solid 10% operational growth for the quarter, led by the launch of APOQUEL, the success of a promotional campaign for REVOLUTION and sales of anti-infectives for cattle. On the negative side of the growth ledger, in the UK, we saw our sales decline 21% operationally. The biggest factor, nearly half the decline was due to weather. A wet winter to spring delayed the cattle sheep turnout seasons; and that was a factor. The second quarter was also negatively impacted as we were in the process of shifting the acquired Abbott products to our distribution and we saw the channel accelerate purchases into Q1 and work off the inventory in Q2. Year-to-date, the UK business is up 3% operationally. Finally, the grouping in other emerging countries declined 5% operationally with the biggest drags being Venezuela and the SKU reductions. We saw growth across most of the countries in this grouping, including through the addition of PHARMAQ revenue in Chile. So on revenue, high level, the beat goes on. Growth from many sources in a diversified model that enables us to overcome softness in parts of our business with strength in other areas. Now let's shift to the rest of the P&L. We posted a high gross margin, 67.9% in the second quarter. But before we all start high-fiving each other, let's look at the factors that led to the 250 basis point improvement over the prior year quarter. Of the improvement, roughly a third came from price increases; a third from a mix shift toward the high-margin companion animal products; and a third came from other areas, mostly improvements in our supply chain efficiency. These three net positives experienced a bit of a headwind due to unfavorable foreign currency. Our gross margin has been improving, but it's not a one-way ratchet and there are some seasonal elements that we expect to come into play in the second half of 2016. For example, sales of our livestock products are greater as a percentage of total revenue in the second half of the year; and pricing promotions heading into the fall can lessen our net selling prices and thereby reduce gross margins in the period. These factors are expected to result in our reporting lower gross margins in the second half of the year as compared with the first half. And finally, there's, of course, FX. Predicting the timing and magnitude of FX changes on the cost of goods sold and on gross margin in short periods is very difficult. So that's a lot of discussion designed to caution you about assuming that our guidance for adjusted cost of goods sold as a percentage of revenue for 2016 and 2017 are conservative. There's good news here. We fully expect our gross margin to continue to improve over time based on increased selling prices, increased sales from our companion animal products versus livestock and increased efficiency on our supply chain. But the upward journey will not be linear quarter to quarter. Turning to adjusted operating expenses. There is really not a lot to say except that we're on track to take out more than our target of $300 million of operating cost by year-end, so we enter 2017 in our new leaned out state. Total adjusted operating expenses were flat on an operational basis when compared to Q2 of 2015. Note that our operating expense base is not static. We've added costs, selling, marketing and R&D to the base via the PHARMAQ acquisition and to support the launch of SIMPARICA and we may consider investing in promotion of certain key products or incremental R&D. The purpose of the efficiency initiative was to eliminate non-productive expenditures, not to ignore high-value investments we can make in our business. At this stage, our to-be operating expense structure is what you see in our 2017 guidance table. We continue to demonstrate excellent expense discipline through the second quarter, and that combined with the gross margin improvement enabled us to post operational growth of adjusted EBIT of 25% for the quarter. Below the operating line, we had increased interest expense due to the note issuance in Q4 that funded the PHARMAQ acquisition and pre-funded the $400 billion of debt that matured in the first quarter of the year. And our effective tax rate on adjusted income increased by some 100 basis points, mostly due to the change in our tax status in Belgium. Bottom line, our adjusted net income grew operationally 22% and our adjusted earnings per share grew 23% operationally, about 100 basis points faster than adjusted net income, as our fully diluted weighted average shares outstanding in Q2 2016 were almost 1% less than in Q2 of 2015. Couple of additional factors, I think, that you need to think about for the balance of 2016 and into 2017. First, as always, FX. While there has been a bit of volatility in FX rates recently, notably with the British pound and the euro, the FX impact on the balance of our year and into 2017 is little changed from our last guidance update. The overall impact on our future expectations for our International operations, based on FX rates, in late July are negligible. That said, FX rates had a negative impact on our reported revenue and profit rates, decreasing revenue growth in Q2 by some 300 basis points compared with Q2 of 2015 and adjusted net income growth by some 800 basis points. Contrast that with a 700-basis-point drag on reported revenue growth in Q1 and a 1,300-basis-point drag on adjusted net income in Q1. So as we had hoped on the last call, the impact of FX rates on our reported growth is moderating. Regardless, we continue to measure ourselves on a constant currency or operational basis. Next, the SKU reductions, including the changes we made to our business models in places like Venezuela and India. As we communicated on our last call, we expect the SKU reductions and business changes to decrease revenue growth by some 500 basis points for the full year 2016. In Q1, the impact was roughly 400 basis points; in Q2, it was roughly 500 basis points; and year-to-date, it was roughly 500 basis points. I'll point out, there's a little bit of rounding in there. You can see the impact of the SKU reductions in business model changes on the revenue growth in the charts that are on our website that I mentioned earlier; and I call your attention to those. I think they're helpful. On to one-time costs, I won't use this time to walk through the table in the press release, but want to call your attention to a contra expense item from the reversal of a portion of our severance accrual. At the time we recorded the accrual, we based it on the best information available. As it's worked out, we expect to pay out a little bit less in severance than we had thought, mainly due to a greater level of voluntary attrition than expected. From a cash out the door perspective that's a good thing for us. For the avoidance of doubt, the reversal did not increase our adjusted net income, but it did increase our reported GAAP net income in the quarter and was a factor in narrowing the gap between adjusted earnings and Generally Accepted Accounting Principle earnings. Finally, on to guidance. Today, we're updating our guidance for the full year of 2016 for a couple of things. We've increased our revenue guidance range by $25 million to reflect the strength of our business and our improved visibility now that we're through the first half of 2016. And we moved our expectations for adjusted cost of goods sold as a percent of revenue from a range of 33% to 34%, to approximately 33%, so the favorable end of the range. Adjusted EBIT projections have improved in a similar fashion, so that's been updated too. We also updated our one-time costs to reflect the lower expectations for the severance point I just talked about. All other categories remain the same and the result is that we've raised our guidance range for 2016 adjusted earnings per share by $0.03 to the range of $1.86 to $1.93 per share. Note that the operational growth rate for adjusted net income implied by our guidance increased by 100 basis points and is now a range of 10% to 14%. The majority of the increase in our guidance is operational, not FX-related. Now, we can all do the math into what our guidance implies for the second half of the year for adjusted net income per share and you may think that that outlook is anomalous, given the second half revenue is expected to exceed revenue in the first half of the year. Here are a couple of observations about the phasing of our business in 2016. First, we do expect second half revenues to exceed the first half, that's a good start. However, as I mentioned earlier, we expect to generate lower gross margins in the second half of the year than seen in the first half due to mix and promotional programs reducing net selling prices and, therefore, gross margins. Next, our major promotional spending and operating expenses in support of our various product franchises are more weighted to the back half of the year. And finally, our R&D spending also skews to the second half of the year. Generally, the benefits of the increased sales expected in the second half of the year compared with the first may be more than offset by reduced gross margins, and the phasing of spending on promotional programs and R&D. So you all know I don't like to talk about quarters, but here are a couple of tips for phasing Q3 and Q4 2016. We expect Q4 to be our highest revenue quarter. We expect gross margins in the second half to be below those in Q1 and Q2. Selling expenses are expected to be heavier in the second half of the year, particularly heavy in Q4; and R&D spending in the second half is expected to be higher than the first half and heaviest in Q4. From adjusted net income perspective, Q3 may be the low quarter for the year. What's the most important is that we raised our full year 2016 guidance at revenue by $25 million and at adjusted earnings per share by $0.03. This is all good stuff. Our guidance for 2017 is unchanged. We expect a more detailed look at 2017 at the time we report our third quarter. That's it from me. Keith, let's go ahead and queue up the Q&A. Operator : We will take our first question from Louise Chen with Guggenheim. Please go ahead. Your line is open. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my question. I was wondering if you could give us more color on why you think livestock sales should continue to improve in second half 2016, especially since some of your competitors posted disappointing livestock sales this quarter? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, livestock is a combination of many species. Let's start with cattle and let's start with cattle in the U.S. Cattle in the U.S. have two different segments, beef and dairy. In beef, we have seen that the number of animals, it's larger than the previous year by 3%. In the second quarter also we saw that the number of placement in the feedlot increased by 5%. On the total year, we expect that the number of animals will be about 3% higher than 2015; and also the placement on the feedlot during the second half will be lower than in the second quarter we expect also to grow by about 3%. With all this, we expect that the cattle business for beef in the U.S. will be positive. We have seen also improvement in Australia because of the weather conditions. We have seen also that the fundamentals of the Brazilian remains very strong with even increasing exportations. So in our opinion, the cattle business for beef will be positive for the year. Dairy, prices are having a negative impact in the profitability of farmers around the world. In the U.S., we expect that the business will not be – or revenues coming from dairy will not be a significant driver of growth; although we have seen also that so far farmers are not reducing the number of animals, so which is also a good indication that they also expect improvement in pricing in the second half or first half of 2017. Swine, and for us as we said, in the international business is doing extremely well. We expect this trend to continue in the second half. In the U.S., we are facing some competitive challenge that we also expect to start solving in the fourth (sic) [fourth quarter 2016] and first quarter of 2017. And poultry is the area in where we expect probably less positive evolution for our portfolio. But, in general, we expect that livestock at the end of the year will be showing a positive growth. Operator : Thank you. We'll take our next question from John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Juan Ramón, can you talk about longer term goals that you've got for SIMPARICA and SILEO? How do you think those products over time will end up sizing compared to APOQUEL? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, we expect SIMPARICA being a key product in our portfolio. And we think that SIMPARICA and SIMPARICA also as a platform for adding new products into the parasiticide franchise will be an important product. We mentioned that we expect this product to generate more than $100 million. Based on the current trends of the market switching more into oral and moving away from topicals will represent a higher opportunity for SIMPARICA. For SIMPARICA, we also are implementing our approach in lifecycle innovation from the very beginning. So we expect also to increase or to improve the label of SIMPARICA very soon with new ticks and also new indications and using SIMPARICA as a platform to combine the active ingredient of SIMPARICA with other active ingredients that will extend the protection of dogs for any type of parasiticide. We will be also working on how to use SIMPARICA active ingredient also to develop products for cats. So, overall, we consider that SIMPARICA as a platform will be a very strong product in our portfolio. SILEO, it's a product that – it's showing that why we are the product of choice in the animal health industry. It's also combining our internal effort with external collaborations. We obtained the license from SILEO from Orion Corporation for the U.S. And SILEO got very good support in terms of communication at the time of the launch. And it will not be a large product in our portfolio, but it's adding solutions to our customers and definitely it's increasing the relevance of Zoetis in terms of providing any type of needs to our customers. Operator : And we'll take our next question from Jon Block with Stifel. Please go ahead. Jon Block - Stifel, Nicolaus & Co., Inc.: Great, guys. Maybe I can slip in two quick ones. SIMPARICA, you just mentioned the label expansion. What about plans for a DTC similar to what we've seen from some of the competitive offerings. And then if so, on the DTC, Paul, is that embedded into some of that promotion expenses that you mentioned in the back half of the year? And then also, if I can just ask one on APOQUEL. I think you threw out $60 million versus $50 million last quarter. What do you feel like inventory looks like in the channel, people who were sort of trying to horde or stockpile that in the early days? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Let me start with SIMPARICA and then I will ask Paul to answer on the APOQUEL question. So definitely we see SIMPARICA as a strong candidate for DTC promotion. But we also we want to make sure that the product has enough penetration in the market to benefit for this type of investment. And we'll consider this opportunity when we have the product well established in the U.S. market, and we expect that to be in 2017. In terms of APOQUEL, I will ask Paul to answer the question on the inventory channel. Paul S. Herendeen - Zoetis, Inc.: Sure. And I'll come back and hit the DTC question as well. With respect to APOQUEL and the channel, I think we saw a much more normalized pull-through of APOQUEL in Q2 than we had in Q1. Anybody that wants APOQUEL can get it now. They can order what they want. And so, we're starting to see a more normalized or a matching between our revenues and the products that are moving out through the various clinics where it's been stocked. You hit it right on the head. I mean, earlier when people were not quite convinced that we've put the supply chain issues behind us, people were hording it or holding it in the office to ensure they had supply. But that is, from our perspective, less and now you're seeing normal stocking and pull-through of the product. There may be pockets where it's still there, but much more normalized; and we're excited about prospects for APOQUEL. With respect to DTC, and if you think about DTC for potentially two products, it's APOQUEL and it could be SIMPARICA, I'd just say that within our guidance or within our OpEx guidance for 2016 and 2017, there are dollars allocated for promotional programs, including DTC. I think when I talk about – and during my prepared remarks, not ignoring opportunities to invest and say, we made assumptions about the level of promotional spend against all of our product franchises. And it's currently embedded within our guidance for 2016 and 2017 to the extent that we see great returns from certain promotional activities, we may well increase them in the future. But for now, they're baked in. Juan Ramón Alaix - Zoetis, Inc.: Let me add one comment of APOQUEL. And in APOQUEL, we have seen that most of the use of the product has been in chronic conditions. Now the effort of our people, it's really to promote the product to expand also the use to acute indication. That is something that we are confident that over time the opportunity of APOQUEL will continue growing. Paul S. Herendeen - Zoetis, Inc.: Yeah. As long as you went there. Some great statistics that I think are helpful, but people think about APOQUEL and the potential for APOQUEL, whether it's in the U.S. or outside. If you take the universe of itchy dogs, over half of itchy dogs are considered acute. They have average treatment days of a couple of weeks. And so, on a percentage of the market basis, it's not great, but there is a lot of opportunity for us there. And of course the thought is the next largest group in terms of a percentage are the seasonal itchy dogs and then the smallest is the chronic. About 20% are chronic; it's a little less than 20% are chronic. And, of course, our view is that when you have an acute situation and you bring a dog is there's that opportunity where that dog can get excellent relief from using a product like APOQUEL. And to the extent that it turns out that that dog has seasonal issues, then, well, it can move into a different category. So there is a lot of opportunity here for us. We started off by really focusing on that slightly less than 20% of the market that was in the chronic category, albeit when they go on to therapy, they go on for a large number of days. I'll stop there. Operator : Thank you. We'll take our next question from Erin Wilson with Credit Suisse. Please go ahead. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): All right. Thanks. On your restructuring, SKU rationalization, overall cost structure initiatives, how should we think about the quarterly progression throughout the year? What would you – or would you say you're running ahead of plan? What were you able to accomplish in the quarter and what's left to do on that front? And then my second question is on capital deployment. Can you just sort of outline your near term and longer term priorities there, particularly as cash flow builds heading into next year? What is your guidance also assuming in the way of share repurchases? And if I can ask just a really quick housekeeping question – if you haven't broken it out yet, the U.S. sales and International sales of APOQUEL? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Okay. So I will answer the first question on – I think it was a question on APOQUEL? But let me – did you ask... Paul S. Herendeen - Zoetis, Inc.: It was the restructuring process. Juan Ramón Alaix - Zoetis, Inc.: Restructuring. Okay. So let me cover that. So we are ahead of our plans, and we mentioned that we expect that to generate more than $300 million. The initial target was $300 million. So also the good news is that we are ahead in the implementation and we'll generate in 2016 also higher savings than initially expected. In terms of the SKU rationalization, plans are in line with expectation. We have eliminated the majority of the SKUs now. There are still some few SKUs that we decided to keep until we have some other product that will be replacing these SKUs. So we'll minimize the impact of the reduction. And in terms of the plans that we included as divestment or exiting, we did almost all the work now. Countries that we changed the distribution model has been fully implemented. So we are definitely extremely pleased with all the progress that we made in this program. So, Paul, will talk about the capital deployment. Paul S. Herendeen - Zoetis, Inc.: Yeah, I will take capital deployment. I think we continue to look for ways to invest our cash flow back in our business where we could earn the highest returns. Certainly to M&A and as we said pretty consistently, to the extent that there's not a better call on our cash flow within our business for M&A, then when will distribute it back to shareholders in the form of dividends and share repurchases. We are currently purchasing shares at the rate of about 75 million a quarter. We have a program that runs through the balance of 2016; and we're obviously in the process of looking at 2017 and beyond and thinking through what we'll do there. But, Erin, you bring up a great point and it's something we talk about quite a bit. 2016, we don't really demonstrate through our quarter results the real cash-generating properties of our business. 2017 will be the first opportunity for the market to see in our reported results the ability of this company to generate significant free cash flow. And the reasons for that are the obvious ones that we're completing our standup from Pfizer, and that's been expensive and lengthy; we are completing – or generally completing the payments for implementing our efficiency initiative and we hope to put those behind us by the end of 2016. And so, when we enter 2017, you're going to see a much more normalized level of cash generation from this company. And as we generate that cash, we will stick to the model of looking for ways to deploy inside, outside in value-generative M&A. And last and certainly not least, in the form of our dividends and share repurchases. Juan Ramón Alaix - Zoetis, Inc.: Okay. So you also asked about sales for APOQUEL U.S./international. U.S. is about 75% of the total amount that we reported for the first half and 25% for international. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): Is that the first half? Juan Ramón Alaix - Zoetis, Inc.: First half, yes. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): Just so it's clear. Operator : We'll take the next question from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets (United States): Okay. Good morning, folks, and congratulations on a strong quarter; and, Paul, thank you for the great visibility. Good stuff, as we like to say. Apologies if I missed this, but the tax rate was a little bit lower than we expected. I'm wondering if you could give us your updated thoughts there and if there's any updates regarding your longer term expectations? And just a follow-up on the capital allocation strategy, given current market demand for yield and is there an opportunity to kind of reevaluate share repurchases as opposed to more aggressive increase in your dividend, particularly given that as you just mentioned, your cash flow generation and predictability should improve after 2017? Thank you. Paul S. Herendeen - Zoetis, Inc.: Sure. I'll start with the tax rate. Yeah. The tax rate was a little bit lower, but you should note we did not change our guidance for the full year 2016. Tax is a fun thing. It's like I talked about how difficult it can be to calculate or predict the impact of FX on your gross margin. Similarly, trying to forecast your tax rate by quarter or by half year, the longer the period you're forecasting, the more accurate you're going to be. It is entirely likely and possible that we'll see some discrete items in the second half of our year that would cause our tax rate to be higher in the second half than it would be in the first. Generally, what I want to report is, we've made excellent progress in managing our tax position in light of the challenge that was thrown at us by the European Commission in January of this year; and we feel good heading into 2017 that we'll be able to achieve the effective tax rate that we've guided to on adjusted pre-tax of roughly 30%. So I'll leave it at that. And I think your other question there was around dividend versus share repurchase and how do you think about that perhaps as you move into 2017 with a more normalized cash flow coming out of the company. Let me say it's something that we will more likely address in detail later in the year. As I said, as we go through the process of looking at 2017 in some detail and we'll come back to you. Just state that we intend to return to shareholder's, through dividends or share repurchases, capital that's not needed to invest productively within our business or for M&A. I know a lot of you would – we've been out in meetings to say do you have a personal preference for share repurchase versus dividend. Let's leave that discussion for the fall. Operator : The next question comes from Jeff Holford with Jefferies. Please go ahead. Jeffrey Holford - Jefferies LLC : Hi. Thanks very much for taking my question. Just wanted to get a quick comment from the management team there, just where your barometer is right now on M&A and business development? Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: So we define that the first priority in terms of capital allocation is investing internally. We have a significant return on R&D, significant return on also the commercial activities. Second would be M&A. And, M&A, we consider a scenario that we will continue assessing any opportunity in the market and bringing to our company things that will enhance our core business or will complement our portfolio. We mentioned that diagnostics was an area that we entered some years ago, and we are committed to this area. And we will continue assessing and bringing additional opportunities to our diagnostic portfolio. Genetics is another area that we are already participating. We have seen that genetic is growing very fast in terms of genetic markets and also in terms of other areas that also will support the increase of productivity in livestock. Definitely, we'll be assessing the opportunities to participate in this broader market. And actually, we will consider how we can enhance our core portfolio in livestock, companion animal or aquaculture now that we are also participating in aquaculture. We use also business development to support our R&D efforts. And we will continue partnering with universities, also with biotech companies and other partners that will also support our R&D efforts. Operator : The next question is from Mark Schoenebaum with Evercore ISI. Volodymyr Nikolenko - Evercore Group LLC : Okay. Thank you for taking my question. It's Vlad Nikolenko on behalf of Mark Schoenebaum. First of all, congratulation with the quarter's strong performance, EBIT and EPS. It's very nice and (53:20) that. So the question will be about the guidance and longer term margins. So back in November 2014, the company issued the long-term guidance for the first time given target 34% operating margin in 2017. So I'm wondering – and since that day, they just never re-issued the longer term guidance and did not expand to further years. So wondering if you're planning to provide longer term guidance in the future or it was more like one-time event in advance of restructuring a month later. And if there is no long-term guidance, how should we think about operating margins going forward? And if you can also specifically and whether there is a limit for operating margin growth and whether you can specifically quantify contribution from the product gross margin growth due to ongoing supply network rationalization initiative? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you. Let me make a short comment on the guidance that we provided back in November 2014; and then I will pass to Paul on how we see this margin evolving over time. So the first thing, almost three years ago or two years-and-a-half after we made this projection, we are confirming that in 2017 we'll be improving or reaching that 34% EBIT margin. And moving from at that time 25% that was projected for the end of 2014 to 34%, it's a significant improvement. And I think it's probably the confirmation of the predictability and the sustainability of our business. I think there are not too many companies that after three years they can maintain what I consider of course an aggressive target of improving our margin by 900 basis points. Now I will turn to Paul to provide some additional comments. Paul S. Herendeen - Zoetis, Inc.: Yeah, sure. And I want to be real clear. One, why did we provide long-term guidance? We provided that because we knew the steps that we were about to embark on would include the SKU rationalization, the change in business models outside the U.S. and a pretty substantial change in our OpEx base. And in light of that, outside parties trying to forecast what we would look like in 2016 and then in 2017, you would've had no chance to really be able to be somewhat accurate. And so, we felt compelled to provide longer term guidance to let people determine through their own models whether they were in the neighborhood of what we were thinking or they had a difference of opinion. I think that was a one-time event. We, like most other companies, are reverting to having just – will revert to having just one year worth of guidance on the Street. So we'll provide the update, as I mentioned, in my prepared remarks for 2017 later this year and then we'll have 2017 on the board. But I really want to focus on comments, Vlad, that you made around the 34% kind of operating EBIT margin – or excuse me, adjusted EBIT margin target that you referenced. Because I want to be really, really clear. We're not targeting a maximum operating margin. We're seeking to maximize our cash flow and grow it at a fast rate. If that's at a 33% margin, that's okay; if that's at a 36% margin, that's okay too, but it's not focusing solely on what is that margin and let's maximize that margin. We're looking at maximizing earnings as a proxy for cash flow and then growing it as quickly and for as long as we can at an attractive rate. Now, separately I believe you asked about is there an upper limit. One of the advantages of our company is that we have a wonderful global footprint where we have the scale to support that global footprint and generally – not completely, but generally, we have the ability to drive a lot more revenue on the infrastructure that we have deployed around the globe. So the answer is, yeah, we have the ability to continue to leverage our cost structure and thereby improve that operating margin. But what I don't want people to do is to focus on and say, a 33% or a 35% or – and look at that and say, well, gee, that's less than I thought. The goal is not to continue to drive that percentage; it's to maximize profit, cash flow, grow it and grow it fast and grow it for a long time. So I rambled a little bit there, but I hope I covered your question. Operator : The next question comes from David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Sorry. I was just coming off mute there. Thanks very much. I was just hoping for a bit of a higher level framework for where you are with the restructuring and reorganizing of Zoetis. My sense is that you're about two-thirds of the way done of rationalizing SKUs and rationalizing people and your SG&A, et cetera. But, obviously, it's different for the cost of goods sold line than the SG&A line. So I was hoping that you could just provide a little bit higher level framework for how far you are along with the rationalization and restructuring by cost line? Thank you. Juan Ramón Alaix - Zoetis, Inc.: So thank you, Dave. Let me maybe provide a little bit more details on where I see we are in terms of our progress in terms of restructuring efforts. So I would say that all the efforts in terms of commercial and R&D are mostly completed. What we are still not fully finalized is related to some areas of G&A, mainly finance and IT, because this was also dependent on the implementation of SAP and we wanted to make sure that while we were transitioning to a different model – a more efficient model, we were ensuring the compliance of any type of finance, tax or IT elements. But we have no doubt that by the end of the year, all the programs will be in place and we'll start 2017 with a new base. In terms of SKUs, I said most of the work has been completed. And there are only some SKUs that we'll be eliminating from now until the end of the year; and this will be also with the introduction of new product that also will help us to minimize a negative impact of this last SKU rationalization. The other area that is still work in progress, but also progressing in line with expectations is the manufacturing changes. We exit the seven plants that we targeted. There is one plant that is still in progress, but five have been sold, one has been exited and the other one is in process. So in that area, things are progressing very well. There are some structural changes also in manufacturing that are a work in progress. And, again, so we plan to finalize this work by the end of the year and start 2017 with a full implemented plan for the operational efficiency program that we announced in 2015. Operator : The next question is from Jami Rubin with Goldman Sachs. Please go ahead. Unknown Speaker : This is Jonathan (01:02:05) on the line for Jami. Juan Ramón, your discussion on R&D productivity is encouraging, but if possible we'd like to receive greater transparency on what that means. We're expecting 5% to 6% of operational growth for the next five years. Can you help us parse out what contribution comes from same product, same indication sales growth through price and volume? And based on your expectations for R&D productivity, what contribution is expected from new products and label expansions that come from this investment? Thank you. Juan Ramón Alaix - Zoetis, Inc.: The answer to this question in R&D is also answering how much are we allocating to new product innovation and how much we are allocating to lifecycle innovation. And we have actually buckets in our R&D expenses, one is related to regulatory expenses, about 15%; and then the other 85%, it's split between new product innovation and lifecycle innovation. So we are investing significantly to keep our current portfolio updated and competitive. So how much are we generating in terms of growth in-line compared to new products and price. So we describe that the animal health industry will be growing 5% to 6% in the next coming years. About half of these 5% to 6% will be related to price; and then in-line, we'll have half of the growth and new products have half of the remaining growth. The ability of Zoetis and other companies to grow faster than this 5% to 6% will come from new products. So, in 2016, excluding the impact of SKU rationalization, in the second quarter, this normalized operational growth is 9%. So how much came from the price? It was about 3% from price. New products also generated a significant part of this growth; and the in-line portfolio, it was growing volume by 1%. So the rest of the portfolio, APOQUEL generated 3 percentage points, other new products another 2 percentage points. So you see that the new products in the second quarter were generating about 500 basis points out of this 900 normalized organic operational growth. And that is what we also expect there for the future. For the future, we have communicated that we plan to grow in-line faster than market. In 2017, based in our guidance, we plan to grow faster than the market; and this faster growth will come from new product launches. Operator : And the next question comes from Chris Schott with JPMorgan. Chris Schott - JPMorgan Securities LLC : Great. Thanks for the questions. Just two quick ones here. First is on restructuring. To the extent that there are excess savings relative to your initial plan, should we think about those savings falling to the bottom line or are those likely to be reinvested in the business? And the second question was on China, you've had very strong growth for last couple of quarters. How much of this is near term in nature given some of the topics you described in the commentary versus sustainable step-up in growth in that part of the business? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Well, let me start with the question on how much we plan to circulate the excess of the savings into our profits and how much we plan to reinvest. And the answer will be, if we see opportunities of reinvestment, these extra savings that will generate future of growth and future profitable growth, then always we will decide to reinvestment in areas that will create future higher value for all our shareholders. And if we'll have these opportunities, then these excess savings will go to our profits. In China... Paul S. Herendeen - Zoetis, Inc.: Hold on, before you flip to China. Again, I want to make this point and it was in my prepared remarks, but it's an important point. Efficiency initiative was all about eliminating non-productive expenses. Those are expenses that don't drive value for our company. So to the extent that we eliminate those, the returns are awesome. It's the first thing anyone should do is eliminate non-productive investments in the business. That gives us the ability to consider investments that will produce outside returns back in our business. And so, it's a very important point. And, by the way, when we boarded on that efficiency initiative, we targeted the $300 million and we believe we're going to be able to deliver savings beyond that. This sort of activity is a continuous process. It doesn't start and end when we announced the program last year. This is something that we will continue on and we look for ways to eliminate those non-productive expenses; and you can have the choice of either having enhanced near term profitability or we may see opportunities to redeploy those funds in more productive areas. So I wanted to make that point. Do you want to talk about China? Juan Ramón Alaix - Zoetis, Inc.: Yeah. In China, we see China as a country that will continue offering high opportunities for growth. We describe many times China as the largest producer of pork in the world. They have more than 600 million (pigs). Some of the statistics there are also indicating that they have 800 million of pigs; and still a lot of this production is not consolidated or is not highly sophisticated. And we expect that this will represent big opportunities for companies like Zoetis that can offer products that will increase the productivity and the quality and safety of the production in China. We also have seen opportunities in other species like cattle. The objective for us in cattle is to build a stronger portfolio, especially to build a stronger portfolio in vaccines. And the way that we are doing that is first trying to get approval for a portfolio that is already available in other markets, also in China. And second, to invest in R&D locally to produce specific vaccines for cattle, for swine and also for poultry. And this is a strategy that we are following, and we are convinced that China will continue growing, not only in livestock, we have seen a significant success in our portfolio in companion animal. We have now a portfolio, which is covering vaccines and covering some other products. We still have the opportunity in China to approve APOQUEL in the future – to approve SIMPARICA. This will take some time, but we are convinced that the potential growth of China will continue. There has been in the second quarter some additional growth coming from these extra acquisitions from channel distributors in anticipation of changes on the label. This is mainly administrative changes rather than a lot of work really to update the indications updates there (01:10:23). So you have seen that we wanted to ensure that the product will be continually available in the market without any kind of a reduction. Paul S. Herendeen - Zoetis, Inc.: I want to make one – it's one point, and Juan Ramón covered this. But China, from a growth perspective, is attractive both on the companion animal front and the livestock front. And so that's an important point and I think he covered the structural elements that will lead to we believe good long-term growth opportunities. What's also interesting about China is how it affects one of our other key markets, which is Brazil. I think many of you may have seen recently an article that talked about the increase in exports of beef from Brazil to China. That's a good thing for us, because we're present in Brazil and that helps with the health of our customer base in Brazil. So China has a pretty interesting influence on our business, both for what we do there, but also on other segments of our company. Operator : We'll go next to Douglas Tsao with Barclays. Please go ahead. Douglas Tsao - Barclays Capital, Inc.: Hi. Good morning. Thanks for taking the questions. Just really quickly, in terms of APOQUEL, I think you said that you're selling without restrictions since May. Just curious what the sales would have been this quarter if you'd have been able to sell without restrictions the entire time? Juan Ramón Alaix - Zoetis, Inc.: Well, it's always difficult to respond to these hypothetical questions, so I think definitely much higher than what we reported and not only in the U.S., but also in the other markets. So imagine that we have had APOQUEL fully available and fully launched in all markets from January 1, then definitely the revenues will be much higher than the $100 million at this point. How much, I think, is difficult to assess. But we are convinced that the opportunity is not only on having the product available without restrictions to all markets, to all customers, but the opportunity also to expand the use of APOQUEL not only to chronic, but also to acute indications. And this is where we're making a lot of efforts and we are considering different ways of communicating through veterinarians and also different ways to communicate that to pet owners to increase the awareness of the product and to make sure that the pet owners are also going to the clinics asking for APOQUEL for both chronic, but also acute indications. Operator : Thank you. We'll go next to Erin Wilson with Credit Suisse. Please go ahead. Erin Wilson - Credit Suisse Securities (USA) LLC (Broker): Thanks. Just a couple of follow-ups on innovation, new products. Can you speak to the value proposition of IL-31 and monoclonal antibodies in the veterinary setting just in general? And on SIMPARICA, would the cat indication for SIMPARICA likely be a topical product and would it likely have the same sort of six-month age restriction similar to the canine chewable? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Let me start with the easiest answer on the cat. So definitely cats, in general, they don't like pills. And if you want to really to succeed in the cat market, you need to offer a topical indication; and this is what would be working in our R&D program really to bring this product into the market. So IL-31 still is a product that has been commercialized under a conditional license. It means that we still have very limited promotional activities for IL-31. So we want – or we focus during this period until full license to get the experience of using this product and also to develop all the data that will support the approval, the full license of IL-31. The feedback from the market so far is very positive. And, again, it's very complementary to APOQUEL. APOQUEL will be in both, acute and chronic. IL-31 being a product which is injectable, maybe we will position more in chronic than acute, but still will be opportunities for both indications. And as I said, in terms of efficacy, greater response from the veterinarians, mainly dermatologists and some experienced veterinarians and also great on safety. So I think all the indications are very positive to IL-31. And this will be, as I said, very complementary to our atopic dermatitis franchise (01:15:31) itching conditions. And we are very pleased with what we are doing. Last comment on SIMPARICA. So we continue to see SIMPARICA as a platform. So the active ingredient of SIMPARICA will be used for combination products, also for oral, for atopical; and we are convinced that this will be a significant product in our portfolio. And I think just to remind that in the cat business – or parasiticide, the cat market, we have REVOLUTION and REVOLUTION is performing very well. And we also expect that with the new lifecycle innovation that we are applying to SIMPARICA, the REVOLUTION penetration also will also be reinforced. Operator : And it appears we have no further questions. I'll return the floor to you, Juan Ramón, for any closing remarks. Juan Ramón Alaix - Zoetis, Inc.: Okay. Thank you very much for joining us on this call. And with that, I hope you have a very good day. Thank you. Operator : And this will conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-283-9429 for U.S. listeners and 402-220-0871 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
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2016Q4
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2016Q3
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2016-11-02
| 1.843
| 1.868
| 2.149
| 2.215
| 3.27107
| 23.32
| 22.82
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: Louise Chen - Guggenheim Securities LLC Jonathan Block - Stifel, Nicolaus & Co., Inc. Jeffrey Holford - Jefferies LLC Derik de Bruin - Bank of America Merrill Lynch John Scotti - Evercore ISI John C. Kreger - William Blair & Co. LLC Frank DiLorenzo - BMO Capital Markets Kathy M. Miner - Cowen & Co. LLC Operator : Good day, and welcome to the Third Quarter 2016 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you, operator. Good morning and welcome to the Zoetis third quarter 2016 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 statement in today's press release and our SEC filings, including but not limited to, our 2015 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, November 2, 2016. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. There's been a lot written lately about the animal health industry, livestock, in particular, and the cycles we face as a part of the global food supply chain. Let me start by saying that I'm very pleased with the positive result we have reported in the third quarter because it reaffirms that we understand the cycles of our customers' businesses. And as in the past, we continue to be resilient in our ability to adapt and steadily grow our business, despite the broader agricultural market changes. At Zoetis, we have regularly grown faster than the market, and we are very well positioned to achieve predictable growth during these cycles because of our diverse portfolio and global scope. We remain focused on the long-term full-year review of our business since quarterly results can be misleading about the cycles in our customers' markets. Our strength in all relevant geographies, species, and therapeutic areas help us offset many of the economic and business challenges that can affect part of the animal health industry in the near term. We're also making improvements in our cost structure and reallocating resources to the most important growth opportunities in animal health from a therapeutic area and geographical perspective. I'm pleased to say, we have nearly completed our operational efficiency initiative, and we can confirm that we expect to achieve the target of $300 million in cost savings by the end of 2017. We also now expect to achieve an adjusted EBIT margin of 34% to 35% in 2017, higher than our original projection, and we expect to grow our revenues faster than the market again in 2017. This quarter, we delivered strong results. We grew our revenue 4% operationally, with particular strength in our companion animal portfolio. When you exclude the impact of our operational efficiency initiative, foreign exchange, and acquisitions, or what we call normalized organic operational growth, our growth in the third quarter was 6%. On the same normalized basis, our companion animal products grew 11% and our livestock products grew 2%. The companion animal growth was driven by a full supply of APOQUEL and the introduction of other new products. And in livestock, the main driver of growth was strength in our international markets, which were able to offset the impact of product rationalization changes across the livestock portfolio. Moving forward, we expect companion animal to be the main contributor to growth in the fourth quarter and in 2017. And in terms of livestock, we expect improved growth as we get beyond the product rationalization impacts this year. Moving on to earnings, we grew adjusted earnings 6% operationally, reflecting the negative impact of higher adjusted effective tax rate. Glenn will discuss this in more detail. But, excluding tax and interest, our EBIT growth was 17%. As we finish up 2016, we are increasing our 2016 earnings guidance to reflect the strong performance we have achieved through the first nine months of the year. And based on the monthly (sic) [continued] trends we see and the confidence in our business, we are also improving our guidance for 2017, despite the recent negative evolution of currencies compared to the U.S. dollar. Let me provide additional business updates on some key products and discuss the investments we are making to support that growth. For the first nine months of 2016, we have generated approximately $180 million in revenue for APOQUEL, with about $70 million coming in the third quarter. We have here an excellent response from veterinarians and pet owners using APOQUEL, as we increase our penetration in new markets. Our research indicates that we are achieving great awareness and satisfaction among veterinarians, as well as more frequent proactive requests from pet owners. APOQUEL has now been launched with unrestricted supply in all approved markets. And we are working on further expanding its market share. In the U.S., we have seen growth of new patients since achieving full supply in May. APOQUEL has been doing very well in treating dogs with chronic allergies. And we are increasingly seeing it used for more seasonal and acute allergy causes, an important part of our expansion plans. As we look ahead with APOQUEL, we are trying additional ways to support this product growth. For example, in the U.S., we are developing and testing direct-to-consumer, or DTC, advertising and we expect to launch a national advertising campaign for APOQUEL in 2017. Also to support the growth of our companion animal business, we have also been expanding our product portfolios and field force in China and Brazil. These are great examples on how our efficiency initiative is ultimately about better allocating resources to generate sales growth. Meanwhile, Simparica, our new oral parasiticide for dogs, is available in the U.S. and most of the EU countries, and is being further deployed in markets like Canada and Brazil. In 2017, Simparica will be available for the full flea and tick season in the U.S. and EU. We are planning to support Simparica with additional promotional investment to ensure it has a positive impact in our revenue growth in 2017. We are also getting ready for the broader launch of our canine antibody therapy, targeting IL-31. This therapy is currently only available in the U.S. under conditional license. And in October, we expanded our efforts beyond dermatology specialists and made it available to all veterinarians in the U.S. We'll broaden distribution in the weeks ahead and we expect to achieve a full USDA license by the end of the year, with Europe to follow next year. We are also seeing good progress with the PHARMAQ acquisition that we made one year ago. We have posted $64 million in fish revenue through the first nine months of the year, despite the toxic algae bloom that has been impacting fish farmers in Chile. PHARMAQ has achieved rapid adoption of its ALPHA JECT LiVac SRS vaccine for farmers in Chile. Fish farmers who needed a more predictable and reliable means of protection have responded very favorably to recent information that LiVac SRS has already demonstrated protection up to 11 months after vaccination, and we continue testing for longer duration of efficacy. Fish farmers also view this vaccine as an important way to reduce the use of antibiotics in their operations. Now, let me turn to the R&D innovations that continue supporting our future growth and value creation. New product introductions like APOQUEL, the IL-31 antibody therapy, Simparica and the ALPHA JECT LiVac SRS vaccine are very important. And continuous innovation over the lifecycle of our products is also critical to our long-term success. In the third quarter, we had several approvals of new indications and formulations for key livestock products. In swine, we obtained approvals in the U.S. for new combinations of our FLUSURE XP vaccine. This now helps guard against additional flu strains that threaten swine herd health. We also expanded our FOSTERA swine vaccine with additional indications and approvals in markets like Brazil, Mexico and Korea. Our premium injectable anti-infective DRAXXIN received additional indications and approvals in Japan and Canada. We also obtained approval in Japan for BOPRIVA, a unique vaccine that temporarily reduce testosterone in bulls, providing farmers with a highly-effective way to manage aggressive behavior. We're also making investment and showing progress in our diagnostic portfolio. In August, we acquired Scandinavian Micro Biodevices or SMB. They are pioneers in developing the manufacturing microfluidic lab on a chip diagnostic products, which are used for veterinary point-of-care services. SMB's promising product line has helped our existing diagnostic business, which obtained approval for values and test kits in the third quarter in new markets such as Mexico, Japan and Korea. Lots of good news to share about our new products, lifecycle innovation and business development activities. In summary, we have continued to demonstrate the strength of our diverse portfolio across geographies and species. And this time, we see particular strength in our companion animal portfolio. We are realizing the benefits of a disciplined approach to R&D and business development, which is strengthening our business for the long term. And we expect to achieve our operational efficiency initiative target in 2017 and set ourselves on a path to increase profitability, cash generation and value creation, while maintaining our revenue growth. With that, let me turn things over to Glenn. Glenn? Glenn David - Zoetis, Inc.: Thank you, Juan Ramón. Before I get into the financials, I wanted to thank many of you for reaching out and speaking with me since I became CFO in August. I'm very excited to take on this role and work with the rest of Zoetis' leaders to continue driving the performance of our company. As CFO, I am committed to maintaining our reputation for financial integrity and transparency and continuing an ongoing dialogue with the investment community. We remain focused on achieving our updated financial guidance for 2016 and 2017, building our capacity for long-term revenue and earnings growth, and delivering the innovations and financial performance that people have come to expect from Zoetis. I am pleased to say that in my first quarter as CFO that we are making excellent progress on all those fronts, and we are raising our earnings guidance for 2016 and improving our earnings guidance for 2017, despite the negative impact of foreign currency, which was approximately $0.03. The consistent performance we've delivered over time through recent periods of major efficiency initiatives and change is a testament to the quality and commitment of our Zoetis colleagues. So, what are the key takeaways for the third quarter results? Continued strong operational revenue growth from our diverse portfolio, continued improvement in our adjusted EBIT growth and margin, a meaningful contribution from several new product launches, lifecycle innovations and targeted business development activities, and finally, an updated guidance for 2016 and 2017 that reflects our recent performance and confidence in the future. Now, let me walk you through the major pieces of our third quarter income statement and provide some color. We generally talk to operational growth, which excludes the impacts of foreign currency. You can also see, once again, in the tables on our website that we are providing additional detail on impacts related to our operational efficiency initiatives, M&A, and in the case of the year-to-date charts, the extra days in our first quarter relative to the prior year. We refer to the revenue growth excluding these items as normalized organic operational growth. For the third quarter, operational revenue growth was 4%, which excludes the 2% negative impact of foreign exchange. Now, let me take you through the key elements of our performance and bridge that to our normalized growth. First, APOQUEL and a number of other new products contributed 5% of our revenue growth. The in-line portfolio grew 1%, with price contributing 2% and volume declining 1%. Recent M&A contributed 3% to our growth, while our operational efficiency initiative reduced our growth by 5%, due to product rationalizations and changes to our business in markets like Venezuela and India. Accounting for all of these factors, we delivered normalized organic operational growth of 6% in the quarter. And for the first nine months of the year, our revenue growth on this basis was 7%, in line with our view of 7% to 8% growth for the full year. Turning now to our segment performance; in terms of the U.S., we generated 1% operational growth compared to a very strong third quarter in the previous year. Just a reminder, the U.S. grew 19% in Q3 2015, with livestock growing 13% and companion animal growing 27%. In the third quarter of 2016, U.S. companion animal products grew 5%, driven by APOQUEL, Simparica and other new product launches like our new vaccines. This growth was partially offset by a decline in surgical fluid products. In U.S. livestock, we declined by 2% against the very strong year-ago quarter when we grew 13%. The decline was primarily due to the impact of SKU eliminations, lower sales of our swine products, where we continue to see increased competition, as well as the impact of a challenging market environment, especially for our cattle and swine customers. We partially offset this decline with growth in our cattle business, where successful promotional activity drove increased volumes. Shifting back to a normalized organic operational growth basis, U.S. grew 3% with companion animal growing 6% and livestock growing 1%. Turning to International, revenue grew 6% operationally. We delivered very strong operational growth of 15% in companion animal and 2% in livestock. Our International business saw a significant impact from our operational efficiency initiatives, which reduced growth by 8%. By species group, the impact was 9% in livestock and 6% in companion animal. M&A activity, primarily PHARMAQ, contributed 5% to our International revenue growth. Based on these factors, our normalized organic operational growth for International was 9%, with companion animal growth of 21% and livestock growth of 4%. You can see the full results for our top 11 markets in the table, so let me highlight a few items. Growth in markets like Japan, Brazil, Germany and Australia was primarily from companion animal products and launches of APOQUEL. In Japan, we saw a significant benefit from the initial stocking of APOQUEL with wholesalers in the quarter. France and Canada both saw a mix of companion animal and livestock sales driving their growth, including sales of APOQUEL and a more stable environment in France around antibiotic usage and prior regulatory changes. Meanwhile, we continue to see livestock supported with growth in cattle in Brazil and swine in China, where we currently have favorable market conditions, as well as growth in companion animal in China, where we are seeing positive trends in medicalization rates for pets. Overall, we have been very pleased with the strong growth we have seen in emerging markets, particularly China and Brazil, where we have invested in expanding our field force and product portfolios to effectively capitalize on the fast-growing trends in these countries. We'll continue to deploy selling resources in these and other markets where we see significant and sustainable growth drivers, combined with high returns on our investments. Wrapping up the revenue picture, there are five key takeaways for the third quarter. Our diversified model continues to deliver steady, predictable and meaningful revenue growth, with strong product lines and geographies balancing the effect of certain market challenges and cycles. Product rationalization continues to impact revenue growth. However, we continue to deliver strong growth on a normalized basis. APOQUEL once again was a significant growth driver, with launches in new markets and continued expansion of the customer base in existing markets. Other companion animal products, like Simparica and recent additions to our vaccine portfolio, are contributing to growth. And finally, when it comes to revenue, we are improving the base business in various emerging markets by expanding our product portfolio and adding to our direct sales capability. Turning to the rest of the P&L, adjusted gross margin improved 120 basis points, primarily due to a more profitable mix of products, while foreign exchange had a negative impact of 70 basis points this quarter. Adjusted operating expense also declined, reflecting the continued realization of our operational efficiency changes and continued discipline around SG&A, which includes the addition of PHARMAQ expenses this year. Improved gross margin and a reduction in operating expenses enabled us to grow our adjusted EBIT by 17% operationally, versus the 4% operational revenue growth. Our adjusted effective tax rate in the third quarter was 31.6% versus 25.1% in the year-ago quarter. This difference was primarily driven by the impact of the European Commission tax ruling earlier this year, and the benefit of certain discrete items in the year-ago quarter. As a result, adjusted net income grew 6% operationally, reflecting the change to our adjusted tax rate and higher interest expense, which offset much of our adjusted EBIT growth. For the quarter, GAAP net income grew 26% on a reported basis, aided by a reduction in stand-up costs and restructuring charges, as well as the revaluation of deferred tax assets related to the establishment of our new International operating model. Moving to guidance for full-year 2016, we are narrowing to the high end of our revenue range, and increasing our adjusted diluted EPS to reflect our ongoing confidence in the momentum of our new products and the sustainable cost benefits of our operational efficiency initiative. As you model out the remainder of 2016, remember that we have five fewer days in Q4 2016 than Q4 2015. And this is usually our highest quarter in terms of operating expenses as a percent of revenue, and our lowest quarter for gross margin, due to the seasonal nature of our product mix. For the year, we expect to achieve operational revenue growth, including the impact from product rationalization, of 4% to 5%, and adjusted EBIT margin of approximately 32%, and operational growth and adjusted net income of 12% to 15%. The significant increase in our guidance for reported diluted EPS is due to our increased outlook for the business and the favorable tax items realized in Q3. Moving to 2017; since our last update in August, changes in FX rates have lowered our views for revenue by $50 million and adjusted diluted EPS by $0.03. However, the overall evolution in our business over the past year has been positive on balance, as our companion animal dermatology portfolio continues to grow and several livestock markets in our International business are strengthening. These changes are allowing us to increase the lower end of our revenue range and maintaining the high end, while absorbing the negative impact of foreign exchange. Cost of goods remains the same at 32% to 33% as we have been successful in our cost reduction efforts, as well as our SKU rationalization that has brought an improved mix. On SG&A, FX changes were slightly in our favor. However, we are increasing the lower end of our range and maintaining the high end as we allocate a portion of our cost savings to promising investment opportunities, such as, advertising and promotion investments in key companion animal franchises like APOQUEL and Simparica that will drive revenue starting in 2017 and over the next several years. Field force expansions in Brazil and China where we see sustainable growth drivers and opportunities for increased market share, and enhancements to our diagnostics commercial capabilities following the acquisition of SMB. We're also taking on the necessary R&D investments to develop SMB's pipeline, as well as investing additional R&D dollars to some of our key international growth markets. When you take all of these changes together, we are increasing the lower end of our adjusted EPS range, maintaining the high end of $2.38, despite the negative impact of foreign currency, while also improving our view for adjusted EBIT margin to be between 34% and 35%. While we don't provide quarterly guidance, we do want to point out that we are currently expecting the delivery of full-year 2017 adjusted diluted EPS growth to be more heavily weighted to the second half of the year for a few reasons. First, we will have some lingering effects from the operational efficiency initiative in the first two quarters as we continue to sell out remaining inventory in Q1 and Q2 of 2016. Second, a portion of our revenue growth is dependent upon the ramping up of new product launches, which we expect to build throughout the year. Finally, many of the incremental investments we are making on the SG&A line are weighted towards the first half of the year and begin to deliver results on the revenue line as the year goes on. A final point on capital allocation; we are continuing to repurchase shares at a steady rate of $75 million per quarter. At this rate, we'd exhaust our current plan at the end of this year. Share repurchases will continue to be an important element of our capital allocation framework and we will provide a more specific update later this year. So wrapping up; we've improved our outlook for revenue. We've achieved our targeted cost structure. We're prudently taking on investments in long-term growth. We've improved our outlook for adjusted EBIT margin and we've improved our view for EPS. There's been a tremendous effort to get where we are. We're proud of what we've achieved to-date and we are excited to continue to move the business to new heights. With that, I'll hand it over to the operator to open the line for your questions. Operator? Operator : And we'll take our first question from Louise Chen with Guggenheim Securities. Please go ahead. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my question. My question here is on livestock. How should we think about Zoetis' ability to grow livestock sales through pricing pressures in the U.S. for cattle? And can you provide more details on the herd size, U.S. feed lot sales, and producer profitability and the puts and takes here? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Louise. It's Juan Ramón. Well, on the question on the livestock and how we plan to grow this business in price or other volume growth, definitely, we'll continue applying the same strategy in terms of pricing that can be justified through outcome and providing the value to our customers. We continue having these prices vary constantly over the years, and we also plan to continue increasing these prices in the future. In the U.S., as we reported, livestock in this quarter grew by 1% in terms of normalized growth, so excluding the impact of SKU or currency or M&A. If we go to the sales of – in light of this growth, cattle grew by low-single digit, swine declined and poultry have double-digit growth. So, talking about the cattle and also the situation on the feed lots and all different drivers that are affecting this segment, so let me describe the factors that are impacting the cattle business in the U.S. So, one, it's more animals, which is positive. We have seen also in this quarter higher placement of animals in feed lots, another positive element. But there are other elements, which are negative and we have seen that in the quarter. So, first, the producers are losing money. Animals are entering heavier into the feed lots. And also, we have experiencing mild weather conditions in the U.S. that are driving a lower-disease incident. So, net-net, compared to one year ago, we think that the situation is less positive. But still, with this situation, we have been able to grow the business and the reason why we are growing is because of our portfolio, the ability also to increase prices and also the team, which is interacting with customers. The last comment I want to make here is that this is a business, livestock, which is affected by cycles. Cycles that have been affecting in the past, and will continue affecting in the future. Despite these cycles, the animal health industry has been very resilient and they're showing very steady growth. In the past, that's 5% to 6% and we expect also in the future despite of those cycles we will continue growing at the same rate. And definitely, we see Zoetis also growing in 2017 in livestock in line with the market. Operator : Thank you. We'll take our next question with Jon Block with Stifel. Please go ahead. Your line is open. Jonathan Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks, guys. Good morning. And maybe I'll just try to ask both questions upfront, so the first one on APOQUEL. I think it's now $280 million run rate before the DTC. So, how do you feel about that north of $300 million goal? Is that now possibly $400 million? And maybe if you can talk about what prior DTCs have done to other Zoetis products, like Rimadyl. And then just a follow-up on the U.S. livestock; you mentioned you're up 1% after the adjustments in the SKU rationalization. In the comments, I think you called out some promotions in the quarter. So just wondering, is the thought of positive U.S. livestock growth for the year still intact? Just trying to get the fluctuations between 3Q and 4Q. Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon for the question. On APOQUEL, we expect definitely to exceed that $300 million. We want to make sure that we have full understanding of the market reaction not only in the U.S., but also in all the rest of the markets in the product has been now made available that – with full availability. We also need to have a full understanding of what will be the impact not only in chronic, but also in seasonal and acute. And we said that DTC campaign, definitely, we expect to broaden the access of – or expanding the access of the product to more patients and also bring pet owners to the clinics then the veterinarians then can prescribe the product. In terms of other DTC investments, we mentioned also that we are considering also DTC for Simparica. It's something that we will consider in the U.S. when we have the right level of penetration in the market. In terms of cattle; so cattle in the U.S., we expect that at the end of the year, we'll be growing and we insisted many times that it's important not to look at our business on a quarterly basis, but on a full-year basis. And in full-year basis, we still expect the cattle business showing positive growth. And we know that some cycles that can be negative at certain point will turn into positive in the following phases or the following quarters or months. So, we are confident also that the cattle business in the U.S. will be showing growth in 2017. Glenn David - Zoetis, Inc.: And this is Glenn. And just to add on to APOQUEL in terms of the DTC. Since we don't have a lot of experience with DTC with a lot of our other products, we did run specific pilots for APOQUEL that give us strong confidence in the return that we're going to get that investment in the future. And then the other thing in terms of the peak sale, we really do want to stress to look at that from a dermatology portfolio perspective. We're very excited about IL-31 in the future that that's going to bring for us. Operator : Okay. Our next question comes from Jeff Holford with Jefferies. Please go ahead. Jeffrey Holford - Jefferies LLC : Thanks very much for taking my question. Just for Glenn, I wonder if you can just tell us around some of the inventory management you have. You have the SKU focus. You quite clearly guided for that in 2017. Could you just tell us if there could be further inventory movements from the integration of SAP and is that included in the 2017 guide? And then just quick add-on of you noticed – you mentioned an update on the share repurchase, would that be part of our Capital Markets Day later this year? Thank you. Glenn David - Zoetis, Inc.: So from an inventory perspective, we definitely still do see significant opportunity to reduce our inventory moving forward. We currently sit at 10 plus months of inventory on the balance sheet and that's definitely an area of opportunity that we see. And we'll start to see benefits from the additional visibility we have in SAP. We'll start to see those benefits in 2017 and beyond, so definitely an area of opportunity for us to increase our cash generation. The other question in terms of share repurchase, so we have a $500 million share repurchase program in place that started last year. We'll be complete with that program by the end of the year, and we'll come back to the market later in the year with our intentions for that moving forward. But share repurchase does remain a very important part of our capital allocation priorities. Operator : And the next question comes from Derik de Bruin with Bank of America. Please go ahead. Derik de Bruin - Bank of America Merrill Lynch : Hi. Good morning. Glenn David - Zoetis, Inc.: Good morning. Derik de Bruin - Bank of America Merrill Lynch : Could you talk a little bit about the swine business, and how much of a headwind has that been to organic revenue growth the last year or so? And I guess, when can we think about new product timing and concentrations of that? I mean just talk a little bit more about how you are thinking about rebuilding that business, or expanding that business. Juan Ramón Alaix - Zoetis, Inc.: Yes. And let me describe the swine business, not only in the U.S., but also International. Internationally, the swine business has been showing double-digit growth, which is very strong growth. While in the U.S., we saw in this quarter, a decline. The main reason of this decline was some challenge in terms of one important vaccine that is used in the swine industry, which is the PCV2 vaccine. We expect to update this vaccine, and having a positive impact in terms of growth in 2017. The rest of the markets outside of the U.S., the performance has been very strong, especially in China, where we continue seeing the benefits of more sophistication of the swine production (39:16). And we are very well positioned to maximize the opportunities in this (39:21) market. We also – after we explain that, we are expanding our portfolio and field force in the country, in China. And definitely, we see swine generating net growth in 2017. Operator : And our next question comes from John Scotti with Evercore ISI. Please go ahead. John Scotti - Evercore ISI : Hi. Thanks for taking my question. So I wanted to ask on operating margin, because given the increase in 2017 guidance; Glenn, in your new seat, would appreciate any thoughts on where you see operating margin growth beyond 35%? And specifically, where do you think the upper bound of operating margin expansion is? Is above 40% realistic here? And then also, can you comment specifically on the contribution of the manufacturing initiative in future years? And then really fast, sorry, just a follow-up on APOQUEL. You mentioned you plan to exceed $300 million, can you provide any detail on timelines for that? Is that a 2017 event? Thank you. Glenn David - Zoetis, Inc.: So, in terms of the $300 million, I'll take that question first, that is a 2017 event. Exceeding the $300 million is baked in to our projection for 2017. In terms of operating margin, so we're not targeting a specific operating margin going forward. We're really focused on income generation and cash generation, and that is our focus. However, when you look at what we articulate as our long-term strategy, the ability to grow revenue at a faster pace than our costs, that definitely does lead to increased margins as we move forward. And in terms of the benefit that we expect to get from the supply network strategy moving forward, so we have articulated and we're still committed to, by 2020, we do expect to achieve an extra 200 basis points improvement in our margin from that strategy. So, when you take all of those factors together, that definitely leads to improved margin. But again, our focus is on cash generation. Operator : And the next question comes from Jami Rubin with Goldman Sachs. Please go ahead. Unknown Speaker : Good morning. This is Jonathan (41:21) on the call for Jami. So, if protein prices continue to fall and are sustained at lower levels as a result of your cyclical factors, would that potentially cause you to revise your expectations, particularly in cattle and swine? And a second question, some of your competitors have cited challenges in their dairy segment, and given that you discuss cattle as a consolidated figure, I was hoping that you could comment on trends seen in that particular group? And further, can you elaborate on the progress of the SKU rationalization program and when that will begin tapering off, and whether you will see operational growth in U.S. livestock remain positive, net of these rationalizations? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you for your questions. Hi, Jonathan (42:02). Let me start with the comment on the protein pricing and how this can be affecting our business. So, we have seen that these prices are going up and down, it is part of cycles that has been affecting our industry for decades. And we have been managing that very well, this situation. We saw prices going down for poultry, and then the next cycle, going up. It always depend on the supply. The demand continue growing, and it is something that will help the industry to continue generating more revenues. We don't think that the current situation is specifically negative. It's something that we expect that there will be a reverse in the near future. And we will see that this is not having a negative impact in our projections. And, again, so this industry (43:11) has been very predictable and showing steady growth, even in situations with significant negative factors, including the drought or even including the economic crisis in 2008, the animal health industry was probably one of the few industries showing growth in this negative environment. Dairy, we have seen that the prices of dairy has been down significantly at the beginning of the year. Now these prices are recovering, and very important is that we have not seen any reduction of a herd in terms of cows, which is an indication that producers are still keeping the animals to ensure that they will be able to supply market demands in the next cycle. So, we expect also dairy having a positive trend in 2017. And then, Glenn will talk about the SKU rationalization. Glenn David - Zoetis, Inc.: In terms of the SKU rationalization, we are essentially complete with that program. However, we did have some sales of these products in Q1 and Q2 of 2016. That does pose a challenge in the comparative for 2017. We estimate that impact to be about 1% for 2017 and more disproportionately weighted to the first half of the year. Operator : The next question comes from John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Glenn, can you expand a bit more on the supply chain optimization plan? You've talked in the past about a couple hundred basis points goal, but could you maybe just lay out a little more specifically, the timeline and the strategy to get there? And then secondly can you give us an update on how the livestock antibiotic portfolio did in the quarter? Thanks. Glenn David - Zoetis, Inc.: So, in terms of the supply chain optimization, there are a number of sites that we're still in the process of divesting or changing our strategy in three sites essentially that will need to ship product from one site to another. That occurs over time. So the progression of that 200 basis points improvement that we talked about through 2020 will come over a number of years. You'll see that in 2018, 2019, and 2020. It won't be an automatic shift. It's based on the timing of shifting the products of the – from those three plants. In terms of livestock antibiotic growth year-to-date, we are seeing positive growth year-to-date in those products. There are some shifts with M&A – within MFA. But overall, our antibiotics are growing year-to-date. Operator : And we'll take the next question from Alex Arfaei with BMO Capital Markets. Please go ahead. Frank DiLorenzo - BMO Capital Markets : Good morning. This is Frank DiLorenzo on behalf of Alex. Thanks for taking my call. Regarding business development, will management continue to look towards small opportunities such as the recent Scandinavian Micro Biodevices deal, or are you willing to consider larger deals. Also along those lines, are there any particular areas of interest that you are focusing on? Thanks. Juan Ramón Alaix - Zoetis, Inc.: So, we are not limiting our target in terms of M&A to small acquisitions. What we are targeting is a business that will support our strategy and also will create value. And I think we have significant experience in integrating companies. We think that any acquisition that is supported by the strategy and the value creation will generate synergies in terms of costs and also revenues. We are also defining what are the areas of interest for M&A. We will continue assessing opportunities in our core business. But also, we will consider in diagnostics also in genetics, and in devices, as a way to complement our portfolio and maximize the already existing infrastructure that we have that we will be using these products also to deliver even higher value to our customers. Operator : We'll go next to Kathy Miner with Cowen & Company. Please go ahead. Your line is open. Kathy M. Miner - Cowen & Co. LLC: Thank you, good morning. Two questions, first on APOQUEL, I think you've talked in the past that the APOQUEL sales have been largely three-quarters U.S. and one quarter O-U.S. How has that shifted and how do you see that trending going forward? And also on APOQUEL, are you able to tell us how many dogs in the U.S. have been treated with APOQUEL so far? And then secondly just a broader question on pricing trends, as you look into 2017, can you remind us what you're pricing expectations are, both U.S. and O-U.S. and whether there's been any change from 2016? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Let me start with the comment on prices. So, on prices, we are consistent also with the animal health projections. And the animal health projections is growing prices 2% to 3%. And this has been always very consistent in the past, and we'll continue applying this 2% to 3% in our projections. And we expect that 2017 also will be in line with these percentages. Not too big difference in terms of U.S. or international. The only difference in some international markets with high inflation rates, the price increases can be higher and in line with this inflation. You also asked about the use of APOQUEL in the U.S. mainly. And well, so far, until very recently, the use of APOQUEL has been mostly focused on chronic. We have seen already in this quarter that it's already APOQUEL in the U.S., which is where we have more recent market research. The use has been also extended to seasonal and chronic and acute. And we expect also this to continue not only in the U.S., but also in the international markets. And we are very confident that the expansion of the products will be driven by the use in all the different categories; chronic, acute and seasonal. You also asked about what is the division of APOQUEL U.S.-international. Well, this quarter, on the $70 million, $40 million came from the U.S. and $30 million international. This is something that is probably not representative of the full potential of international and the U.S. What we can also show in the market through market research is that the new patients is growing constantly in the U.S., which is very positive, and we expect that this will continue. And if the results of the pilot is showing positive for the DTC that we are testing in the U.S., then we expect that this will be also accelerating the use of APOQUEL in the U.S. As you know, not in all markets that DTC is available because there are some restrictions in terms of regulatory for direct-to-consumer advertising in many markets in the world. Operator : And we'll take a follow-up from Derik de Bruin with Bank of America. Please go ahead. Unknown Speaker : Hi. Thanks. This is Mike (51:10) on for Derik just with a quick follow up. In the last couple of months there's been a lot of movements in the competitive landscape with companies moving ahead with proposed asset swaps, some divestitures. Can you talk a little bit about how have you seen any change in the competitive landscape, if you've been able to gain any share, and especially in the last quarter there was a lot of mixed results from competitors, particularly in companion animal in the U.S. Some promotional changes with flea and tick; can you just talk about if you've been able to capitalize on any of those disruptions in the market? Juan Ramón Alaix - Zoetis, Inc.: Well, let me start saying that we believe that we have the best portfolio in animal health industry in both companion animal and livestock. We have significant new products launch recently, and also very important our R&D investment in our current portfolio is also showing very positive results. So, we don't think that the consolidation of the industry that will be taking place from now until the end of the year will change that significantly the competitive landscape. We compete not on a global basis, but also on a country basis and also on species basis. And there are not too significant difference because of this consolidation. So, we are very confident that we remain very competitive, and the products that we are introducing and also this report in terms of promotional activities and R&D and even manufacturing quality and delay of supply will help us to maintain and expand our market share. Operator : And it does appear we have no further questions at this time. I will return the floor to you, Juan Ramón for any additional or closing remarks. Juan Ramón Alaix - Zoetis, Inc.: So, thank you very much for joining us today. And as we said, we reported very strong results in the quarter. We are very confident on the projections that we are making for 2016 and 2017. And we'll connect again in the next earnings release. So, thank you very much. Operator : Thank you. And this will conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-839-1320 for U.S. listeners and 402-220-0488 for international. Please disconnect your lines at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,017
| 1
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2017Q1
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2016Q4
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2017-02-16
| 1.905
| 1.94
| 2.278
| 2.34
| 3.5775
| 22.07
| 21.73
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: Louise Chen - Guggenheim Securities LLC Derik de Bruin - Bank of America Merrill Lynch Gregg Gilbert - Deutsche Bank Securities, Inc. Erin Wright - Credit Suisse Securities (USA) LLC Jonathan Block - Stifel, Nicolaus & Co., Inc. Brett W. S. Wong - Piper Jaffray & Co. John C. Kreger - William Blair & Co. LLC Jami Rubin - Goldman Sachs & Co. Alex Arfaei - BMO Capital Markets (United States) David R. Risinger - Morgan Stanley & Co. LLC Mark J. Schoenebaum - Evercore ISI Christopher Schott - JPMorgan Securities LLC Kathy M. Miner - Cowen & Co. LLC Operator : Welcome to the fourth quarter and full year 2016 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you, operator. Good morning and welcome to the Zoetis fourth quarter and full year 2016 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 in the company's 8-K filing dated today, February 16, 2017. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. I'm very pleased to say that in 2016, we delivered our fourth consecutive year of operational revenue growth and improved profitability since becoming a public company. We completed a significant initiative to shape our business for greater efficiency and cash generation. And we continue to make investments that will sustain our future growth, innovation and market leadership. Our growth in 2016 was driven by the successful launch of several new products. The strength of our diverse portfolio and a deeper commitment to the direct customer relationships, productive R&D and high quality manufacturing that are the foundation of our business model. Let me highlight some of the headlines for 2016. We delivered on our financial goal for the year despite some challenging market conditions for livestock producers, especially in the U.S. We generated 5% operational growth in revenue for the full year, and 8% growth based on a normalized organic operational view that Glenn will discuss in his remarks. As expected, our companion animal portfolio led the way with 13% operational growth, thanks to Apoquel and other new product launches. Our livestock portfolio grew 1% operationally, overcoming the negative revenue impact of our producer rationalization initiative, and business changes in Venezuela and India. We posted 17% operational growth in adjusted net income and improved our adjusted EBIT margin to 32%. These measures demonstrate the positive impact of our operational efficiency changes and the benefits of new product launches like Apoquel. We were able to deliver these strong results on innovation while implementing important changes to our business last year. For example, we completed the implementation of our ERP system, which has really given us more efficient tools and better visibility across our operations. We eliminated approximately 5,000 low revenue, low margin SKUs from our product portfolio. And we have sold or exited six manufacturing sites. During 2016, we strengthened our industry leadership with more than 200 product approvals including Cytopoint in the U.S., the first monoclonal antibody approved to help dogs suffering from atopic dermatitis; Simparica, our new oral parasiticide and several new wonder vaccines. We continue to look at this productive R&D engine as critical to our future and we spend more on R&D than any of our peers. We also continue to see the value of investing in external business development opportunities. Last year, we acquired Scandinavian Micro Biodevices in the diagnostic space for approximately $80 million. And our prior acquisition of PHARMAQ contributed $90 million in revenue in 2016, while achieving rapid adoption of its ALPHA JECT LiVac SRS vaccine for salmon. Fish farmers in Chile have responded very favorably to the interaction of this vaccine. Finally, we returned $488 million in excess capital to shareholders through dividend and share repurchases. And we announced plan for a multi-year $1.5 billion share repurchase plan, beginning in 2017. All of these investments are consistent with capital allocation priorities we have shared with you in the past. All of the work that we have done in 2016 and in previous years such as building our infrastructure, investing in new systems and becoming more efficient has positioned us for success in 2017 and beyond. In 2017, we will target operational revenue growth of 5.5% to 7.5% and continue improving our adjusted EBIT margin as we realize the full benefit of our operational efficiency initiative this year. All the major actions of the operational efficiency program that we announced in 2015, has been implemented and we expect to exceed the initial target of $300 million in savings in 2017. These additional savings will be used to support our short- and long-term growth in several ways. In 2017, we plan to initiate direct-to-consumer marketing and advertising campaigns in the U.S. for two of our companion animal products. In the case of Apoquel, we want to increase awareness of atopic dermatitis among pet owners, especially those whose dogs maybe suffering from acute conditions. And in the case of Simparica, we want to illustrate the advantages of our products and increase our share of voice in the highly competitive parasiticide market. These campaigns will include national television ads and digital promotions online. They are targeted to begin in the first half of this year. We'll also support new product launches like Cytopoint, which was approved in the U.S. last year and Stronghold Plus, which is expected to be launched this year in the European Union. Stronghold Plus is a topical parasiticide for cats that combines sarolaner, the active ingredient of Simparica with selamectin, the active ingredient in our current Stronghold and Revolution product lines. This is our first combination product for sarolaner. This is a great example of how we use an R&D focus on lifecycle innovation to expand our platform and maintain a durable and valuable product line for decades. We also will remain focused on improving the way we interact with and support our customers. Our people and technology are important parts of any customer experience and they remain critical areas of investment. For example, we'll be deploying new tools and capabilities on our ERP system and we have been expanding our field force in markets like Brazil and China where we see significant and sustainable growth opportunities. We also see R&D, manufacturing and business development as areas where we will allocate increased capital this year to support our long-term growth plans. Our internal R&D products will help discover new products as well as develop lifecycle innovation across our approximately 300 product lines. Our business development team will continue exploring acquisitions, partnerships and alliances that enable us to fill gaps in our portfolio, and expand that further in complementary spaces and geographies. And we will continue executing our long-term supply network strategy to improve the quality and reliability of key growth platforms in manufacturing. We have become the profitable business and market leader we always envisioned when we launched in 2013, and the outlook for Zoetis in 2017 is very positive. We expect to see stronger growth from our companion animal portfolio again this year, driven by our dermatology portfolio, Apoquel and Cytopoint, further penetration of Simparica, and ongoing uptake of our new vaccines. And in our livestock portfolio, we expect a recovery and improved growth across our cattle, swine, and poultry species. In the case of fish, we expect that PHARMAQ to capitalize on the success of the new ALPHA JECT LiVac SRS vaccine in Chile. And we recently received a favorable legal ruling in Norway, the world's largest farm salmon market, which will allow us to launch our vaccine for salmon pancreatic disease this year, a great result and opportunity that demonstrates the value we saw for this acquisition. In closing, we are proud of our ability to deliver better than expected results in 2016, despite the market challenges we faced and the business changes we implemented. I want to thank all our Zoetis colleagues for their commitment and personal contribution to these results. As we look ahead in 2017, we see a brighter future. We have reshaped our business for long-term profitable growth based on our diverse portfolio, customer focus, innovative R&D, high-quality manufacturing, and improved capital efficiency. I thank you, our shareholders, for your confidence in Zoetis, and look forward to reporting to you on our progress. With that, let me turn things over to Glenn. Glenn? Glenn David - Zoetis, Inc.: Thank you, Juan Ramón. Before discussing the fourth quarter and 2017 guidance, let me offer a quick perspective on the full year. We delivered revenue and adjusted EPS at the high end of our guidance ranges. Our new companion animal products, increased efficiency, and margin improvements all helped drive that performance throughout the year. Operational revenue growth for the year was 5%, but a better indicator of our underlying performance is what we refer to as our normalized organic operational growth, that was 8% for the year. It excludes the negative impact of our operational efficiency initiative and the positive impact of M&A. You can find the details of these items in the tables on our website. Of this 8% growth, 5 percentage points came from new products, including Apoquel, 3 percentage points came from the in-line portfolio, with 2 points of that from price and 1 point from volume. This will be the last quarter that we will report our normalized revenue growth metric, as our operational efficiency initiative will have only a small impact on our revenue in 2017. There will be some continued drag in our revenue growth from product rationalization, especially in the first two quarters of the year, and we will help you understand the magnitude of those items as we go through 2017. As we said in the past, we take a long-term view of our business, and prefer to assess our financial performance on an annual basis, rather than taking a quarterly focus. During the year, we saw many of the familiar seasonal fluctuations that occur in our industry. But as we progressed through the year, our expectations for outperformance steadily increased. Our team delivered on those higher expectations, with 17% operational growth in adjusted net income compared to the 6% to 12% we expected at the beginning of the year. This success demonstrates the strength of our diverse portfolio and business model, and it builds on many years of strong performance. We are especially pleased to have achieved these results during a period of significant change in how we operate our company. Turning to the quarter, we delivered double-digit operational growth in adjusted net income, overcoming the negative impact to revenue of fewer calendar days and business changes related to our operational efficiency initiative. Both reported and operational revenue growth were flat for the quarter. We saw no impact from foreign exchange to revenue, unlike many of our prior quarters. Our operational efficiency initiative reduced revenue by 3%, and fewer calendar days in the quarter had approximately a 4% impact. M&A activity, primarily PHARMAQ, contributed 2% to our revenue growth. PHARMAQ was below our revenue projections for the year, but we feel very good about the value we're getting from this acquisition. Our positive views are supported by the strong performance of our SRS vaccine in Chile and a recent legal win in Norway that opens the door to an important category in the aquaculture market. These two PHARMAQ drivers represent a meaningful portion of the value we saw in this company. While market conditions in Chile were challenging in 2016, the long-term structural drivers of growth that attracted us to the aquaculture market remain intact. Going back to our overall results, our normalized organic operational revenue growth was 5% in the fourth quarter. Again, this backs out the negative effects of our operational efficiency initiative, fewer calendar days in the quarter, and the benefit from M&A. This growth was balanced between our geographic segments on a normalized basis, with international growing 6% and the U.S. growing at 5%. In both segments, the main growth driver was new companion animal products. We continue to see strong growth of Apoquel and our vaccine franchises, and we're steadily establishing Simparica in the U.S. and other markets. In the U.S., we continued to absorb the decline in surgical fluid products. This was partially offset, however, by additional sales in the quarter as we expanded distributor relationships on other products. The U.S. companion animal grew 7% on a normalized basis. U.S. livestock grew 3% on a normalized basis, with growth in cattle and poultry offset by declines in swine. Market conditions in cattle continue to be difficult, and results were somewhat lighter than expected in the fourth quarter. However, our U.S. cattle business delivered low-to-mid single-digit growth on the same normalized basis for the quarter and year, despite very challenging market conditions for our beef and dairy customers. Again, this demonstrates the resiliency of the animal health industry and Zoetis even in challenging market conditions. International companion animal normalized growth of 16% was supported by new product contributions as well as higher levels of medicalization in emerging markets, a fundamental long-term structural driver of our business. 2% normalized growth for international livestock was supported by growth in China, Mexico and Brazil; offset by lower usage of antibiotics in Western Europe. You can see the full results of our top 11 markets in the table, but let me highlight a few items. Growth in key emerging markets, like Brazil and China, continues to be strong. Operational revenue growth in Brazil of 8% was driven by price, new companion animal products, and favorable cattle conditions. High demand for beef exports from Brazil more than offset the difficult market conditions in poultry and swine where producers saw higher input prices. Operational growth in China of 17% was driven by continued strength in the swine market and growth in companion animal vaccine due to increases in routine care. For the year, China grew 24% operationally, our fourth consecutive year of double-digit growth since becoming public. Our recent field force expansions in Brazil and China have been productive, and we'll continue to deploy selling resources in these and other markets where we see significant and sustainable growth drivers combined with high returns on our investments. Emerging market growth was not limited to Brazil and China. Our other emerging markets category grew 6% operationally. Now turning to the rest of the P&L, I'll quickly cover a few items of note in the quarter and then move to a review of guidance. Adjusted gross margin increased 110 basis points in the quarter on a reported basis, primarily due to favorable foreign exchange, which was partially offset by higher inventory charges. Adjusted other income included a $15 million charge for the devaluation of the Egyptian pound that occurred in November, after our most recent guidance update. The adjusted effective tax rate for the quarter was 25%. This rate included the effects of discrete items and the jurisdictional mix of earnings. This brought our full year adjusted tax rate to 30%, which was two points below our guidance for the year. Adjusted net income grew 13% operationally, despite the fewer selling days in the quarter. GAAP net income grew significantly on a reported basis in the quarter. This was due to the charge in the year-ago quarter related to the currency devaluation in Venezuela, as well as lower stand up and operational efficiency costs. Versus our full year guidance, our one-time costs were above the range as we settled the product dispute with poultry customers in Mexico and had higher than expected severance cost associated with our efficiency initiative. In the quarter, we also incurred a net tax charge as a result of the implementation of certain operational changes, including the revaluation of tax assets associated with the change in our operating model. All-in-all, Q4 was a good quarter wrapping up a great year. We delivered a normalized organic operational growth of 8%, adjusted gross margin improvement of almost 200 basis points, 23% operational growth in adjusted EBIT and 17% operational growth in adjusted net income. Now, let's talk about guidance for full year 2017. We are updating our previous guidance for changes in foreign exchange rates, since our last update in November. Our guidance now reflects rates as of late January, which reduced revenue guidance by approximately $50 million and adjusted EPS by $0.03. On an operational basis, our guidance is unchanged. We have however updated our growth rates to reflect the higher base of revenue, and income achieved in 2016. For the year, we expect to achieve operational revenue growth of 5.5% to 7.5%, and adjusted EBIT margin of 34% and 35%, and operational growth in adjusted net income of 15% to 20%. We continue to see companion animal driving much of our growth in 2017. We will have additional penetration of Apoquel including its expansion into more acute and seasonal cases. We will continue the launch of Cytopoint in the U.S. as we build our dermatology portfolio, and we will see additional market penetration of Simparica, as well as the launch of Stronghold Plus in Europe. All of the necessary actions to deliver our 2017 efficiency goals were largely completed by the end of 2016. We expect to deliver more than the $300 million in savings we initially targeted, some of which we will be investing back in the business. Despite the lower tax rate in the fourth quarter, our guidance for adjusted ETR is unchanged. We do not expect the favorable discrete items from Q4 to recur. Our guidance for adjusted ETR is based on current U.S. tax law, and does not take into account any potential changes being discussed in Washington. With more than half of our adjusted pre-tax income in the U.S., a lowering of the U.S. corporate tax rate would have a meaningful benefit to us. There are also other items that can impact our taxes going forward, such as border adjustability and the impact of deemed repatriation. We will be in a position to articulate the potential effect of these items as we gain more clarity. While we don't guide to quarters, I do want to reiterate my comments from last quarter that we expect to see our revenue and income growth weighted more significantly towards the second half of the year. As a reminder, in 2017, we will face approximately $50 million drag on revenue growth from the product rationalization. This will disproportionally affect the first quarter. We are expecting first quarter gross margin to be generally in line with the fourth quarter of 2016 due to the timing of recognition of cost of goods sold. We are also re-investing a portion of our additional cost savings, in investments in product launches and key brands like Apoquel, Cytopoint and Simparica early in the year. We expect to begin seeing the revenue effect of these investments in the second half of the year. The result is that we currently see limited adjusted income growth in the first half with significantly stronger growth later in the year. A final point on capital allocation. We have completed our initial share repurchase program and in December, we announced the $1.5 billion authorization. We view this repurchase plan as multi-year and flexible in nature depending on other capital allocation priorities. We have increased the pace of our repurchase from last year to $125 million per quarter. This pace is related to the improved cash flow we expect in 2017 now that we are beyond the cost of our operational efficiency initiative. Our guidance for adjusted diluted EPS assumes only that we offset dilution from equity awards. As a general rule, we view 2017 adjusted net income as a good proxy for the operating cash flow we expect to generate. We do expect to maintain CapEx in line with the last two years as we invest in manufacturing to deliver our in-line and new product growth. So let me wrap up before we go to Q&A. We achieved our 2016 revenue and adjusted EPS guidance. And we affirmed our outlook for 2017 with updates for foreign exchange. We continue to see a path to continued margin expansion, increased cash flow and greater efficiency as we achieve the full benefit of our operational efficiency program. And we're prioritizing and funding investments in long-term growth in all of our core capabilities. With that, I'll hand things over to the operator to open the lines for your questions. Operator? Operator : And the floor is now open for questions. We'll take our first question from Louise Chen with Guggenheim. Please go ahead. Your line is open. Louise Chen - Guggenheim Securities LLC : Hi. Thanks for taking my question. So, I'm just curious on your priorities for capital allocation in 2017 and if you would continue to repurchase shares even with your stock at this price? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Louise. And we'll maintain the same capital allocation philosophy that we already shared with you. So, we'll continue investing in the business. We see opportunities this year of reinforcing our presence in the market with DTC campaigns, also expanding field forces in the markets. We'll continue investing in R&D because we consider that the productivity of R&D is very high and we have been delivering very strong products and we'll continue supporting our growth with this investment. We'll also invest in manufacturing, to ensure that we have the capacity, and the capabilities that we will need to support our future growth. And we'll also continue assessing external opportunities, business and developmental opportunities that will reinforce our internal growth. And any excess capital we will return to the shareholders through dividends or the program that we already announced for buying shares back. Glenn David - Zoetis, Inc.: Yeah. And just to add to that, Louise, we're currently in the market purchasing this quarter, we expect to purchase about $125 million in shares this quarter. Operator : Thank you. Our next question comes from Derik de Bruin with Bank of America Merrill Lynch. Please go ahead. Derik de Bruin - Bank of America Merrill Lynch : Hi, good morning. So can you talk a little bit about the new product launches? I mean, we had some positive feedback on Cytopoint talking to vets at the NAVC Conference. And just wanted to get your initial thoughts on that product and how we should look at expectations on that? And I guess the other question is, it did look like you tweaked down your core growth guide by about 50 bps. I'm just sort of wondering what was behind that given that 4Q ended up exactly where we generally thought about it? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Derik. I will answer the first question and then I will ask Glenn to provide an answer to your second question. Cytopoint, definitely the feedback from the market is extremely positive. But also we want to consider not Cytopoint or Apoquel as separate. We want to consider now our dermatology portfolio, which is now even stronger than last year with Cytopoint, and we expect that the combination of these two products will cover all the needs of veterinarians when treating acute, chronic, or seasonalized atopic dermatitis or any type of skin condition. So we are very excited about our portfolio. We are considering that Apoquel will continue growing and we're supporting Apoquel this year with additional resources in terms of DTC and some additional activities in the market. And this also will have an impact in the Cytopoint because, as I said, we'll consider the combined portfolio in dermatology as the way to deliver the value to our customers and to cover the needs in terms of treating itching conditions or atopic dermatitis. Glenn David - Zoetis, Inc.: And in terms of the growth rates for 2017 on an operational basis, when we set the guidance back in November, since 2016 actuals were not final, we based the 2017 growth off the midpoint of those ranges. Now that we have final 2016 actuals and we came in towards the high-end of those ranges, the growth rates naturally declined. I do want to make it clear, the operational numbers themselves have not changed and in the core expectations for the business have not changed, except for the update to foreign exchange that we've reflected. Operator : And our next question comes from Gregg Gilbert with Deutsche Bank. Please go ahead. Gregg Gilbert - Deutsche Bank Securities, Inc.: Yes, good morning. Can you update us on your progress as you attempt to combine flea and tick and heartworm, and any possible timelines on that front? And in light of the Mars acquisition, can you provide some context on the long-term risk and opportunities associated with the consolidation of clinics? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Okay, thank you. Well, we have the first news on the products in terms of combining the flea, ticks, and heartworm because now we have topical product, which is a combination of the active ingredient of Simparica, sarolaner with the active ingredient of Revolution/Stronghold that it's selamectin. And this product has been already approved in Europe and we plan to launch this product every soon in the European market. Definitely, this is only the first step. We'll continue working internally to combine the same principle of different agents to have broader spectrum of coverage in parasiticides, including internal parasiticides, in this case for dogs. We have not yet provided the timing of the launch, but definitely our R&D team is working in this combo, but also working in future formulations that can also include injectable formulations and longer duration of protection. When we have more clarity on the timing, we'll provide an update on this information. And then in terms of the clinic consolidation, so now Banfield that has around 900 clinics in the U.S. will be a consolidated with VCA that has another 800 clinics. So this will represent 1,700 to 1,800 clinics of a total of 30,000 clinics in the U.S. market for companion animals. We have good collaboration with both companies with Banfield and VCA, and we expect also to continue this collaboration. Based on comments that we got from Banfield, it seems that they will keep these two networks independent, and we will continue working with Banfield as a group, and also with different clinics that are part of a network, to promote and to support our portfolios. Operator : And our next question is from Erin Wright with Credit Suisse. Please go ahead. Erin Wright - Credit Suisse Securities (USA) LLC: Great. Thanks for taking my questions. Can you speak to the recent shift in strategy and the rationale behind your direct versus third-party distribution strategy and how has there been – or has there been an evolution in the market that makes direct distribution less favorable to you, now that vaccines and parasiticides are opened up? And how much did those distributor shifts impact you in the current quarter, as well as in the first quarter, from a stocking perspective? How should we be thinking about the buying pattern? And then my second question is, what does your guidance assume in terms of underlying growth across livestock versus companion animal, and the underlying fundamental trends assumed in your 2017 guidance? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Erin. So let me start with your question about the distribution strategy. And these are related, as you mentioned, to companion animal. In previous year, we had the exclusivity provisions for few products and with certain distributors. So in 2016, we extended the collaboration with distributors, adding vaccines, but on a non-exclusive basis, in this case for the vaccines. So this year also, we included as part of the agreement with distributors, our parasiticide products. So Revolution, ProHeart 6, and Simparica. This will be part now of the agreement with distributors. With these extended partnership with distributors, we are confident that we'll be able to increase our share of voice and also penetration in veterinarian clinics. Also the changes with distributors, with these changes, we have considered that it's much more attractive model to have that contract with the distributors based on total volume, rather than exclusivity, for a small number of products. Having said that, also, we remain committed to our commercial model based on direct interactions with customers through highly qualified field force to generate demand for our products. And the result of all these changes is that we expect a positive impact in our business. And the outlook for generics is also something that maybe some questions in the market will remain unchanged from what we said in the past. So, in summary, we are confident that this new model will be very attractive. We'll also have better support from distributors, while we'll maintain our presence (38:05) in the market with our direct interaction with the customers. Glenn will talk about what has been the impact in terms of stock and revenues related to the change on the distribution. Glenn David - Zoetis, Inc.: Hi, Erin. In terms of the stocking impact for Q4, when you look at that and if you compare that to our total sales for the quarter, it's less than 1%, right. So if you're looking at the companion animal growth, there was a benefit of slightly less than 1% related to that. The offset to that in evaluating the companion animal growth, particularly in the U.S., is the impact of the surgical fluid business and the decline we saw there, that was slightly greater than the impact of the stocking. To your question on the underlying trends in companion animal and livestock, as we've discussed, we do expect, again, companion animal to grow stronger than livestock in 2017. I think when you look at it, for 2016 on a normalized organic basis, right, growth in livestock was 4%, growth in companion animal was 14%. I think we'd expect that difference to come closer in 2017, but again, we'd expect companion animal to grow stronger. Operator : Thank you. Our next question is from Jon Block with Stifel. Please go ahead. Jonathan Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks and good morning. Juan Ramón, maybe just qualitatively, if you could talk about how do you feel about U.S. livestock? Back in the summer when conditions did not seem overwhelmingly favorable, you put up a good 3Q number, aided by promotions. This quarter U.S. livestock, I think you said up low-single digits operationally, although an easier comp, yet conditions seem to be getting better, especially as we enter 2017. So maybe just any color on increasing momentum that you see in U.S. livestock, specifically cattle? And then quantitatively, Glenn, can you just provide Apoquel-specific numbers to the U.S. and international, and will we be getting that number going forward, or will it sort of be combined under the atopic dermatitis portfolio with Cytopoint? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon. And let me go through the different species in livestock in the U.S., starting with cattle. So we expect, in the cattle business, for the market growth that will be 2% to 3%, and we expect to grow faster than the market in 2017. We expect also a slowdown in terms of herd expansion. Still, in 2017, we expect the herd will be continue growing. But something that is new is, we expect that in 2018 and 2019 also, this herd expansion will be now stable. Beef prices continue being a challenge in the U.S. market, but still we expect a recovery in the second half of the year. And the dairy segment, in terms of profitability, is normalizing, which is also positive. So we will see also that the volume in terms of prevention and productivity will continue growing, and maybe will be a slowdown in terms of the use of anti-infective. As I said, 2% to 3% the market, and we are predicting that we'll be growing faster than the market. In poultry, we expect flat to 1% market growth, and we expect a growth in this segment for Zoetis. So we'll see continued pressure on antibiotics, but we also have a portfolio that can be alternative to the antibiotics, which are considered as medically important for human, and we can offer alternatives that will generate growth in our portfolio. And finally, pork, about 1% to 2% growth in the market, and again, we expect also to grow faster than the market, mainly driven by now the entrance of the new PCV2 vaccines in our portfolio that we expect to roll during the year. And we'll continue working on new combinations of vaccines or vaccines that will be adding antigen. That also will reinforce our position in pork. Operator : And our next question... Juan Ramón Alaix - Zoetis, Inc.: And in... Operator : Go ahead. Juan Ramón Alaix - Zoetis, Inc.: We have another question that Glenn will talk about. Glenn David - Zoetis, Inc.: So in terms of the sales for Apoquel and Revolution, so for Q4 we saw $70 million in sales of Apoquel. So in the U.S. we had $50 million of sales, which was a nice pickup sequentially from Q3 as we work through the inventory issues we discussed in the prior quarter, so a nice sequential growth in the U.S. Internationally, we had $20 million in sales, which was a drop from Q3 as we expected. In the Q3 call, we talked a lot about the fact that there was some initial stocking in Japan. So, again, for the quarter total $70 million, and for the year we have $248 million of sales in Apoquel with a $170 million of that in the U.S. and $78 million international. In terms of how we're going to disclose that moving forward, between Apoquel, Cytopoint, or the derm portfolio, we're still early on in that. We want to see how the mix evolves, and then we'll determine what's the best way to disclose the sales are moving forward. Operator : And we'll go next to Brett Wong with Piper Jaffray. Please go ahead. Brett W. S. Wong - Piper Jaffray & Co.: Great. Thanks, guys. Thanks for taking my question. Wondering if you can please talk to the expected growth in Brazil in 2017. You mentioned that it's going to continue to be strong. But should we expect the ongoing high-single digit operational growth there? And what will drive double-digit growth in that region? If you can talk to both livestock and companion that would be very helpful. Juan Ramón Alaix - Zoetis, Inc.: So thank you. So we stopped providing exactly rate of growth in Brazil. Definitely, we see Brazil market that will continue growing, growing in many different species, including companion animal. And that's why we decided also to expand our field force for companion animal in 2017, and we are also expanding our field force for cattle in 2017. So we are investing in the market because we see the opportunities that this market will continue growing. And we see that this market will also grow in terms of export. So the projections for Brazil continue being very positive. Still one of the things that is difficult to predict in exactly how much will be the impact of the different discussions in terms of trade. But we are confident that maybe Brazil can have a benefit on all these trade discussions, including the export, that has been very strong in the past. In companion animal, definitely we see the opportunity of increasing that medicalization in dogs. They will be also having the benefit of having the entire portfolio of Zoetis now approved in Brazil. We have Apoquel, we have also Simparica is something that definitely will help us to generate even faster growth in companion animal in this market. Next question. Operator : And we'll go next to John Kreger with William Blair. Please go ahead. Your line is open. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Juan Ramón, I think you said you guys exceeded your $300 million target for cost savings. Can you just maybe comment a bit on what were the lessons you learned there and what allows you to beat that goal? And remind us what your plan is to optimize the manufacturing footprint over the next couple of years? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, the lessons that we learned – and thank you for the questions, John – the lessons that we learned that we understood from the beginning that there were opportunities for being much more efficient. But at the same time, we went through a process of building the infrastructure, implementing ERP. And we considered that it was too much trying to implement everything at the same time. But when we have full control on our operations, we really focus on improving our efficiency. And the result of this operational efficiency program is that, first, now we learned that managing so many SKUs is not adding any value to our customers. In the past, we tried to meet all customer needs in terms of not only products, but we remain with significant large number of products, but meeting expectations in terms of dosages, formulations that in many cases were adding only complexity and limiting our ability to be reliable in terms of supply. So this is one of the first lessons. So it's reducing complexity in terms of SKUs, in terms of market. It's providing to us the opportunity to be much more focused and provide more value to all our customers. The second lesson is that the reaction of Zoetis team in terms of embracing all these opportunities. And really targeting all these savings, we serve the objective of not only being more efficient but also supporting our future growth in a way that that will be stronger. And I think is the last lesson that we learnt through the process is that definitely there were significant opportunities of eliminating non-added value activities. And these were related to marketing, it was related to some of the activities that we were doing in terms of meetings and travels that were not adding value to our growth and not adding value to our operations. And we are very pleased what we have achieved. Definitely, we have now mobile that is (48:37) much more efficient in commercial, also in finance, and in many other parts of the company. But definitely, we learned that it's important to focus on improving profitability, but even more important than just improving profitability is ensuring the future growth of Zoetis. So then you asked about the plan to optimize manufacturing going forward. Maybe Glenn can cover this question. Glenn David - Zoetis, Inc.: Yeah. In terms of the plan to optimize manufacturing going forward, I think there are essentially three major plants that are still set to be transitioned by 2020. And as we go through that transition and move a lot of those products, we expect to get another 200 basis points improvement in our gross margins, but those are the next major initiatives related to manufacturing. Next question. Operator : And our next question... Juan Ramón Alaix - Zoetis, Inc.: Next question. Operator : ...is from Jami Rubin with Goldman Sachs. Please go ahead. Jami Rubin - Goldman Sachs & Co.: Thank you. With this you are marking the end of the SKU rationalization program. Should we assume that the Zoetis story becomes more focused on top line growth versus margin expansion? And Glenn, can you talk about how much more room you see for margins? I think you had guided to 34%, 35% this year, it's up about 1000 basis points since 2012. How much higher can that go and what are the key drivers of that improvement. Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jami, for the questions. The focus on revenue growth has been always a part of our objective. And what we achieved with this operational efficiency program, it's having more better allocation of resources to generate future growth. So the fact that now we were able to exceed the $300 million target, it's allowing us to invest in DTC, it's allowing us to expand our field force in certain markets, and also to invest in technology that also will support the interactions with customers. We are focused on revenue growth and we know that the revenue growth will be the only way to continue generating adjusted net income faster than revenue growth. But we also want to make sure that we generate profitable revenue growth. Glenn? Glenn David - Zoetis, Inc.: In terms of continued margin expansion, so we do expect this year of 2017 to be between 34% and 35%, which is a significant improvement over where we've been historically. We do see further room for improvement, we talked about 200 basis points that we see in gross margin coming by 2020 and we also do expect to be able to grow our expenses slower than our growth in revenue moving forward. That being said, we're not targeting a margin. We're going to look at the right investment opportunities and do what makes the most financial sense and provides the highest return going forward. But those are some of the key areas that will provide some additional margin opportunities as we move forward. Steve Frank - Zoetis, Inc.: Next question. Operator : Our next question is from Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Good morning, folks and congratulations on a strong 2016. There has been some concerns about generic erosion in your base companion animal business in the U.S., excluding the new products like Apoquel, Simparica et cetera. Could you comment on that, because I think you mentioned that the growth in the segment was driven by the newer products, so should we expect the base business to decline? And also just to follow-up on Simparica, what were the sales of Simparica now and what is the potential of this product in combination form? And forgive me if you've mentioned this, when should we expect the approval in the U.S. for the combination form as well? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Alex. So we don't see any change in the outlook for generics in 2017 or 2018. So we know that the generics will capture part of the market. We have been managing very well in the past and we don't see anything that is creating a change in terms of generic penetration. So we are very confident that there is many different aspects that are also supporting our portfolio. We have very strong brand equity. We are promoting many products in our portfolio, which is also allowing us to also to offer volume discounts. We are a company that is bringing significant innovation, which is also an important part of what is our reputation in the market. And we maintain a significant presence in terms of direct interaction with customers. So all these elements are in my opinion supporting our portfolio and definitely we see that the generic will get part of the market. But no different what we have been communicated that over time, they can reach 20% to 40%, but definitely not in the first year as we have been demonstrated many times. So it's a very different market than human health, and I don't think things are changing that will increase the penetration of generics significantly. At least for companies that maintain a significant presence in the market, they promote large portfolio and they have the reputation and the interactions with customers. Simparica combo, I guess, that you referred to the product that has been recently approved in Europe, that it was a topical formulation for cats. We expect also to introduce this product in the market in the U.S. We don't have yet details or we have not provided the timing. Definitely, once we have more information, we'll provide these details. We file in the U.S., but it's FDA filing and it depend on the U.S. reviews, the timing of the approval and the launch of the product. The rest of the portfolio, combining the combo products sarolaner with other active ingredients to include internal and external parasiticide for dogs, again, so it's something that we are working and will provide more details when we are progressing in this project. Glenn David - Zoetis, Inc.: In terms of sales for Simparica that is something that we haven't disclosed. Performance this year has been in line with our expectations and we do expect peak sales for the product to be over $100 million. We expect it to be a blockbuster and we're also very focused on the platform that it provides us to have continued lifecycle enhancements related to that product. Operator : And our next question from David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Yes. Thanks very much. Juan Ramón, I was hoping that you could talk about the competitive landscape, some of your large competitors have merged in the past. My guess is that the disruption at Lilly may be normalizing now and maybe they will be a slightly stronger competitor in the next year or two, but that's just a guess on my part, I'd love to hear your perspective on that. And if you could talk about the other major consolidation, and whether that's good or bad for Zoetis? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Well, I will say that, rather than providing a general comment, maybe it's good to see what is the impact by species. First, on the consolidation of Boehringer Ingelheim with Merial. So in companion animal, the majority of the portfolio will be Merial. They will be adding some products, especially in pain, coming from BI. We don't see a significant change in the competition landscape in terms of companion animal. For cattle is where we see that the combined portfolio will strengthen the position of the new company. In swine, basically portfolio will be the portfolio that BI had in the past, so no changes in the competitive landscape, and the same for the poultry. Poultry will be mainly the Merial portfolio. So we don't expect significant changes in terms of competition, in terms of species. They will have, definitely, a bigger critical mass. This critical mass they can help them in terms of investments, and also especially in smaller markets, and definitely will be a stronger competitor than the two companies separated. At the same time, so the combined company, they will need to manage higher complexity, and I'm sure that they will manage in the future, but they will have to understand how to manage the diversity of this extended portfolio and also, they will be facing the distraction of the integration. So in 2017, probably we will see challenge and opportunities, not too big changes in terms of competition by species, and it's something that we are confident that we will be managing. You asked about Elanco. Elanco has been reinforced with recent acquisition, but this is something that, it's already part of our competitive landscape. So we don't see that Elanco in 2017 will have a different type of challenge, in terms of competition, compared to 2016. Operator : And our next question is from Mark Schoenebaum with Evercore ISI. Mark J. Schoenebaum - Evercore ISI : Hey, guys. Thanks for taking the question. And sorry if I missed this during the prepared remarks or during the Q&A, but could you break out price, the impact of price versus volume, if possible, on an organic operational revenue growth perspective, for the full year? And it does look like, on the margin, inflation starting to pick-up in the States, at least, I haven't looked at rest of world data, but given the business model of Zoetis, do you think pick-up in kind of core CPI is going to allow you to do a little bit more with price, or is that just not relevant? Thanks a lot, and good to hear your voice, Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Well, thank you, Mark. I think probably these questions will be answered by Glenn, he has all these details, and I'm sure that he can provide the answer. Glenn David - Zoetis, Inc.: Sure. In terms of the price volume growth for the year. So if we start with our normalized organic operational growth, right, of 8% for the year, about 5% of that comes from new products. So we'll classify that as volume, right. Then there is the remaining 3%. The remaining 3%, 2% of that comes from price and 1% volume. So in total, 2% price and 6% volume for the year, in terms of the impact that we have on a normalized basis. And in terms of the impact of inflation on price, that's something, as we go across geographies, not just in the U.S., inflation is definitely a factor that we consider when setting our price increases. So it definitely does have an impact on how we set those increases annually. Operator : And our next question is from Chris Schott with JPMorgan. Please go ahead. Christopher Schott - JPMorgan Securities LLC : Great. Just a couple of quick ones here. Following up on the dermatology assets, can I just get an updated view in terms of peak sales potential when we think about Cytopoint and Apoquel, how large do you think that portfolio can become over time? And the second one was on tax reform. I think you've clearly articulated the company would benefit from a lower U.S. corporate tax rate, can you just elaborate a little bit more on border adjustment, I don't have (1:01:08) details at this point, but can you just give us a little bit of color in terms of, we think about your U.S. business, how much of that is manufactured in the U.S. versus ex-U.S., so when we get more details here, how much of the franchise would be affected? Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Chris. And I think we are not changing our projection that has been provided in the past for Apoquel, so we think that Apoquel will be generating more than $300 million on peak sales. How much is something that we'll see depending on also the market that will be also captured in Cytopoint. And we also think that, now that we have Cytopoint with a full license in the U.S., but still no Cytopoint in the rest of the world. I think it's important that we understand that the full potential of Cytopoint, and then we provide guidance on the combined portfolio, when we have this information. But we see that the Cytopoint will be adding revenues to the more than $300 million that we already communicated for Apoquel. Glenn David - Zoetis, Inc.: So, Chris. Specific to your question on border adjustability, when we look at that and we look at our imports and exports, we're essentially net neutral between imports and exports in the U.S. So in terms of the impact on tax reform, it's really going to depend on what the tax rates are on imports and exports to understand the impact of that. But from an overall number perspective in terms of what we import and what we export, we're essentially net neutral. Operator : And we'll go next to Kathy Miner with Cowen & Co. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. Just one question, if you will. You mentioned the importance of R&D to the company. Can you give us an update on some of the either key areas you're looking at, or I know you've mentioned biologics as being of importance to you going forward, just any color you can provide going forward would be helpful? Thank you. Juan Ramón Alaix - Zoetis, Inc.: So, in terms of biologicals, we will continue investing there heavily to develop new vaccines, to develop combination of vaccines. We also intend to reinforce our presence in cattle vaccines in Europe. We also want to develop a larger portfolio of vaccines in China, and we'll be developing a strategy to be having stronger presence of our teams in China, mainly for swine, but also with opportunities of other species. So all areas of R&D investment, we are now using the platform of sarolaner to develop a new parasiticide. And we mentioned the approval of sarolaner with selamectin in Europe for cat topical formulation, and we'll continue investing in this platform to ensure that we're covering broader spectrum of parasiticides. We also with Cytopoint, we have quite significant knowledge in terms of monoclonal antibody, and these monoclonal antibodies also will be targeting all the different indications including pain or including other therapeutic indications. And we're also targeting in livestock opportunities of improving profitability for productivity, improving productivity in livestock. So we know that there are now products that are helping us with efficiencies. We think that there will be opportunity for adding new products that will support this additional productivity in livestock. Steve Frank - Zoetis, Inc.: And we will now open the floor for any follow-up questions. That's follow-up questions only, thank you. Operator : And we can take the first follow-up from Erin Wright with Credit Suisse. Please go ahead. Erin Wright - Credit Suisse Securities (USA) LLC: Hi, thanks. It's follow-up on biologics there. I guess, what and maybe this depends on which indications you're focused on from a monoclonal antibodies standpoint, but will that fall under this FDA or the USDA jurisdiction? And how should we think about kind of the timeline of approval and commercial launch of those products? Juan Ramón Alaix - Zoetis, Inc.: Well, Cytopoint has been under the jurisdiction of USDA. We expect that other monoclonal antibodies will depend. We expect that the indication for pain will be under the jurisdiction of FDA, but this will depend. And there is a clear definition of who should be responsible for each type of product, and also with discussions with the regulators when we start developing the programs, then we will find which will be the final regulator that will be involved in the approval. Steve Frank - Zoetis, Inc.: And it appears we have no further questions, I'll return the floor to you, Juan Ramón for any closing remarks. Juan Ramón Alaix - Zoetis, Inc.: Thank you very much for joining us today and we'll continue with providing updates to our business in a regular basis. Thank you very much. Operator : Thank you. This does conclude today's teleconference. A replay of today's call will be available in two hours by dialing 800-388-6197 for U.S. listeners and 402-220-1115 for international. You may disconnect your lines at any time and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,017
| 2
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2017Q2
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2017Q1
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2017-05-04
| 1.995
| 2.05
| 2.37
| 2.403
| 3.57719
| 22.59
| 22.59
|
Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: Kevin Ellich - Craig-Hallum Capital Group LLC Esther Rajavelu - Deutsche Bank Securities, Inc. Derik de Bruin - Bank of America Merrill Lynch Jonathan Block - Stifel, Nicolaus & Co., Inc. Jeffrey Holford - Jefferies LLC Erin Wilson Wright - Credit Suisse John C. Kreger - William Blair & Co. LLC David R. Risinger - Morgan Stanley & Co. LLC Alex Arfaei - BMO Capital Markets (United States) Brett W. S. Wong - Piper Jaffray & Co. Divya Harikesh - Goldman Sachs & Co. Christopher Schott - JPMorgan Securities LLC Kathy M. Miner - Cowen & Co. LLC Operator : Welcome to the First Quarter 2017 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of Zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in, or on the Investor Relations section of Zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Good morning, and welcome to Zoetis First Quarter 2017 Earnings Call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 for 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 filings dated today, May 4, 2017. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve, and good morning, everyone. Before I discuss our first quarter results, I want to share some of our views on the animal health industry. Our industry continues showing steady and predictable growth in the mid-single digits with about 5% to 6% growth for 2017, excluding the impact of foreign exchange. In 2017, companion animal and poultry are expected to grow faster than the industry average of 5% to 6% while cattle and swine will be growing below those rates. Companion animal growth will be driven by the increase of oral parasiticides and specialty care products in areas like dermatology, where our portfolio of Apoquel and Cytopoint is driven category growth. We should also see increased consumption of chicken driving growth in poultry. While expecting slower growth, cattle and swine will benefit from positive trends driven by additional head of cattle, higher prices of milk and an increase of global pork production, especially in China. As I have mentioned many times in the past, the relationship of the animal health industry in terms of species to particular areas and geographies is an important factor in the steady and predictable long term performance. And in this industry, Zoetis stands as the most diversified animal health company and continues delivering revenue growth above the industry average thanks to the strength of our portfolio and business model. We continue investing in our portfolio with highly productive R&D programs resulting in product launches and lifecycle innovations. In fact, we have continued to expand our canine dermatology portfolio. We've internally discovered and developed our product, Cytopoint. Last week, Cytopoint became the first monoclonal antibody approved in the European Union for veterinary use after having been previously approved in the U.S. in December and in Canada in March. Cytopoint is the first monoclonal antibody therapy approved to help reduce the clinical signs associated with atopic dermatitis, such as itching in dogs. We are very excited about the early market adoption of this product in the U.S. and the treatment choice it offers our veterinarian customers. In February, we also announced that the European Commission granted us a full license for Stronghold Plus, a topical parasiticide for cats that combines sarolaner, the active ingredient in Simparica, with selamectin, the active in our current Stronghold and REVOLUTION product lines. We continue to look at the ways to use sarolaner as a platform for other combinations and in another markets. We also continue to pursue lifecycle innovations that help ensure the availability of our revenue streams from approximately 300 Zoetis product lines. In the first quarter, we received approval for new indications, formulations and geographic expansion of key livestock brands such as Bovi-Shield and Fostera vaccine families and the Excenel RTU and Excede anti-infective. We continue to strengthen our portfolio in areas like Diagnostics with new approvals in the U.S. for our WITNESS and SERELISA lines of diagnostic test kits. You can read more about this in our press release. We also combined our internal investment in R&D with external opportunities in both our core business of medicines and vaccines and the expansion of our portfolio in complementary spaces like diagnostics, genetics and biodevices. You have heard me speak in the past about acquisitions like PHARMAQ in the fish market and SMB in the diagnostic space, and just a few weeks ago we announced another investment in our core business for treating pain in companion animals. We announced an agreement to purchase Nexvet Biopharma, which is an innovator in monoclonal antibody therapies for companion animals. This acquisition is expected to strengthen our R&D pipeline in this area and help sustain our category leadership in chronic pain for dogs while expanding the market availability in cats. Innovations like this are being supported by other investments with additional savings from our operational efficiency programs, and we have included in our guidance. For example, field force expansions in key markets like China and Brazil, direct-to-consumer marketing campaigns for Apoquel and Simparica and capital investment in our manufacturing network to ensure we have the technology, capacity and capability to support our long term revenue growth. All of these elements are working together to make sure we can capitalize on the opportunities ahead of us to continue growing revenues in line with or faster than the market and growing adjusted net income faster than spending. In the first quarter of 2017, we continued to see positive results from our diverse portfolio, innovative new companion animal products and a more efficient cost structure. Our revenue grew 6% operationally and excluding the impact of product rationalizations, which will also affect the second quarter results, our growth would have been 8% in the first quarter. We believe this growth is, again, faster than the market. The main driver of our revenue growth remained companion animal products, which grew 12% operationally, driven largely by sales of Simparica, Apoquel and Cytopoint. And our livestock portfolio grew 3% operationally with increases in swine, cattle and fish being partially offset by a decline in poultry products. Glenn will discuss that more of the market drivers and details in his remarks. We posted 10% operational growth in adjusted net income, once again faster than the revenue growth. We saw a modest 2% operational growth in operating expenses as we made investments in the promotion and support of new product launches which were partially offset by savings from our operational efficiency initiative. We continue to stay focused on ways to simplify our operations and drive efficiency, including through the ongoing implementation of our supply network strategy. In March, we announced plans to sell our manufacturing site in Guarulhos, Brazil. We expect to complete that transaction during the second half of 2017. It will be the eighth site that has been either divested or exited as part of the operational efficiency program and supply network strategy. We are pleased with the strong start to the year from a revenue and adjusted earnings perspective. And we are affirming our full-year 2017 guidance. With that, let me turn things over to Glenn, who will provide more details on our first quarter results. Glenn? Glenn David - Zoetis, Inc.: Thank you, Juan Ramon. We performed well again in the first quarter based on our newest companion animal products and strength across many of our international markets; most notably, China, Brazil, Australia, and other emerging markets. Total company revenue grew 6% operationally, including a negative 2% impact from product rationalization. We saw no net impact from foreign exchange in the quarter. However, as our financial tables show, there were some meaningful changes in some individual currencies. Of that 6% growth, 5% came from companion animal growth in Simparica, Apoquel and Cytopoint. Sales of Simparica were $29 million for the quarter, and our total dermatology sales were $77 million. Additional growth drivers for the quarter were 1% from the introduction of other new products and a 2% impact from price increases. These growth drivers were partially offset by a negative 2% impact from product rationalizations. In terms of the bottom line, we delivered 10% operational growth in adjusted net income and 10% operational growth in adjusted diluted EPS. As we realize the benefits of our operational efficiency initiative, we have stayed disciplined on expenses to drive more profitable revenue, while making the appropriate investments to grow the value of our business. Juan Ramon spoke about these in terms of commercial and manufacturing investments. Now let's discuss segment revenues. Our international segment generated operational revenue growth of 9%, while the U.S. grew 4%. In the international segment, product rationalization had a negative 4% impact on growth. China had an exceptionally strong quarter, growing 47% operationally. This growth was broad based, with contributions from both swine and companion animal, with much of the growth coming from vaccines. In swine, we continue to see strong market conditions with high pork prices for customers as well as greater adoption of animal health products that can help drive more efficient and safe protein production. In companion animal in China, our field force is capitalizing on a growing pet population and increases in medicalization rates for pets. Brazil was also a strong contributor in the quarter, growing 15% operationally, with our price increases driving growth across our portfolio there. Significant growth in livestock benefited from strong market conditions for beef producers. And new companion animal products drove higher sales, with Simparic, as it's known in Brazil, getting off to a strong start from its launch in the fourth quarter. Our growth in both China and Brazil was aided by field force expansions in these markets which we have discussed before. Mexico made a significant contribution this quarter as well, with 10% operational growth. And our other emerging markets category grew 14%, despite a significant impact from our product rationalization. Shifting to developed markets, Australia grew 10%, drawing on performance in several key brands in Cattle, Sheep and Companion Animals as well as price increases and growth in Simparica and Apoquel. Italy, Spain and Japan also contributed to growth in the quarter while France declined 15%, primarily due to the comparison to a strong Q1 2016. We are expecting France to return to growth in the second quarter. To summarize, very strong growth in our International business is coming from a number of sources including strong market trends, strategic investments and our success in bringing new value-added products to market. Turning to the U.S., revenue grew 4%. Companion Animal grew 10% in the quarter while being offset by a decline of 2% in Livestock. The Livestock decline was due to our Swine business, where the timing of customer purchases had a negative impact in the quarter, and we continue to see competitive pressure on our vaccine franchise. In the U.S., we have made some changes to our Fostera PCV and M. hyo vaccines, and based on a recent large comparative trial, we believe this product should be well received by customers and make us more competitive in this space. The decline in Swine business was partially offset by growth in Poultry where we're seeing higher sales of antibiotic alternatives such as Zoamix. Our Cattle business in the U.S. was flat for the quarter as an increase in herd size is contributing to growth in our reproductive franchises. Performance was also supported by growth in ACTOGAIN and our SYNOVEX franchise which was offset by a higher mix of low-risk cattle moving to feedlots. Our medicated feed additive sales for both cattle and swine were negatively impacted in the first quarter by livestock producers' implementation of the Veterinary Feed Directive. This impacted U.S. livestock growth by about 3% as we continue to work with our customers on the implementation of VFD. Companion animal sales grew 10%, primarily due to the launches of Simparica and Cytopoint, as well as growth in Apoquel. This growth was partially offset by initial sales into expanded distributor relationships in the prior-year quarter. We are pleased so far with the performance of Simparica in the first spring buy-in season that it was fully available in the U.S. We've initiated direct-to-consumer and additional promotional campaigns, which we believe will help build upon the success we have seen so far. In U.S. dermatology, sales were $57 million for the quarter. Cytopoint has been well received in its first full quarter with a full USDA license and Apoquel is sustaining the base it built through the second half of last year. As we are gaining more experience with a full supply of our dermatology portfolio throughout a calendar year, we do believe there will be seasonality to the revenue with the second and third quarter dermatology revenues being higher than the first and fourth quarters. Overall, we continue to hear very positive feedback from our customers about Apoquel and Cytopoint. With the launch of additional promotional campaigns and DTC advertising we expect an acceleration of sales in the coming quarter. With the continued strong performance in the U.S. and the prospect for additional growth in international markets, we believe our global dermatology portfolio can grow to between $400 million and $500 million in the next three years. Now turning to the rest of the P&L. Adjusted gross margin of 64.4% declined approximately 300 basis points in the quarter on a reported basis and was sequentially flat with the fourth quarter of 2016. Coming into 2017, we have made additional cost improvements in our manufacturing network. In the first quarter of 2017, we recognized higher costs associated with previously produced inventory which depressed our gross margin. This will also will also negatively impact Q2. As we progress into the second half of the year, our results will fully reflect more of the impact of our manufacturing cost improvements. In addition, Q1 2016 contained some favorable items and Q1 2017 gross margin was negatively impacted by unfavorable foreign exchange versus last year. The first quarter results for adjusted gross margin are in line with our expectations and we have reaffirmed our adjusted cost-of-sales guidance for the year. Adjusted SG&A grew by 2% in the quarter, with higher promotional expenses to support new product launches and higher penetration of Apoquel, offsetting expense reductions from our operational efficiency initiatives. Adjusted R&D was flat for the quarter with an increase in project spending offsetting fixed expense reductions for our operational efficiency initiative. Adjusted other income included lower foreign exchange losses compared with the prior year and the positive impact of a legal victory in Norway for our PHARMAQ business. This legal win will allow us to launch a vaccine for pancreatic disease in the world's largest farmed-salmon market this year. The adjusted effective tax rate for the quarter was approximately 28%. The tax rate in the quarter is significantly improved from the prior year due to the realization of benefits that resulted from operational changes implemented in the third quarter last year. It also reflects the effects of discrete items, including a small benefit from the vesting and exercise of employee equity awards. The year-over-year improvement in our adjusted effective tax rate was a significant driver of adjusted net income growth of 10% operationally. Of note, our one-time cash costs have come down significantly over time as we have moved beyond the efforts to stand up our company and execute on our operational efficiency initiative. Now moving to guidance for full year 2017, the year is off to a good start for us, particularly with revenue. We are reaffirming our previous guidance and expect accelerated growth in adjusted net income as we get into the second half of the year, primarily due to the cost-of-sales trends I discussed earlier. As I said in our fourth quarter call, we expect slower income growth in the first half of the year and our current expectations are consistent with that view. For the year, we continue to expect to achieve operational revenue growth of 5.5% to 7.5% and adjusted EBIT margin of 34% to 35% and operational growth in adjusted net income of 15% to 20%. Our guidance for adjusted ETR of approximately 30% is based on current U.S. tax law and does not take into account any potential changes being discussed in Washington. With more than half of our adjusted pre-tax income in the U.S., a lowering of the U.S. corporate tax rate would have a meaningful benefit to us. In the first quarter, we repurchased $125 million in shares and our guidance for reported and adjusted earnings per share reflects the share repurchase completed through Q1. Just to summarize before we go to Q&A, we're off to a good start to the year with continued momentum in the areas we expected, such as new companion animal products in markets like China and Brazil. We see a good runway for continued growth that is in line with or faster than the market based on our diverse portfolio and recently launched products. Our operational efficiency program has been fully implemented at this point and is expected to achieve more than $300 million in savings in 2017. We will continue to use some of these savings both internally and externally to support sound investments in our business and return excess capital to shareholders. And, we are reaffirming our outlook for 2017 and continue to project a stronger second-half to achieve our full-year targets. With that, I'll hand things over to the operator to open the lines for your questions. Operator? Operator : And we can take our first question from Kevin Ellich with Craig-Hallum. Kevin Ellich - Craig-Hallum Capital Group LLC : >: Good morning. Thanks for taking my questions. Congratulations on a nice quarter. First off, could you maybe give us a little bit more detail on the strength that you're seeing in Companion Animal, specifically the strong growth in China, Brazil. And also, Glenn, you actually gave us some great detail on the dermatology sales. Could you break out what type of growth, year-over-year growth, did you see in Apoquel versus new sales of Cytopoint? Juan Ramón Alaix - Zoetis, Inc.: Thank you again for the questions. So, let me take first this trend in Companion Animal in China and Brazil. We have seen that the adoptions and also the medicalization rates in both these countries are growing. We identified this opportunity and we invested to capitalize on that, so we expanded our field force in China and Companion Animal and Brazil and the results are showing a very strong revenue growth. We also benefit in China with introduction of the new vaccines and also in Brazil now we have also almost all our portfolio approved and products like Simparica has been extremely well accepted by the market and they're generating very positive growth. Glenn? Glenn David - Zoetis, Inc.: Kevin, in terms of your question related to Apoquel and Cytopoint growth, so year over year, the Dermatology portfolio grew 47%. When you look at – actually the segment grew – Apoquel grew 47%, the segment grew 66%, so really Cytopoint, this was really the first quarter of full availability with full USDA license. So, it's almost 100% growth in terms of Cytopoint. So just to break that down again, the derm portfolio is 66% growth for the quarter, Apoquel 47% growth for the quarter. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : And we can take our next question from Gregg Gilbert with Deutsche Bank. Please go ahead. Esther Rajavelu - Deutsche Bank Securities, Inc.: Hi, this is Esther Rajavelu for Gregg Gilbert. In Livestock, do you anticipate any changes in the vaccines portfolio offsetting negative impact from the feed additives going forward for the rest of the year? Juan Ramón Alaix - Zoetis, Inc.: Well, this has partly been affecting in terms of vaccines mostly in swine and we have been working with our PCV2 and M. hyo vaccine. We have been developing additional trials and the trials are showing very positive results in terms of efficacy and we are convinced that now we have a product which is very competitive and this product will gain momentum in the U.S. market. We also introduce now in the international market the PCV2 and M. hyo vaccine and also this vaccine also will generate positive growth in the international markets. Esther Rajavelu - Deutsche Bank Securities, Inc.: Thank you. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We take our next question from Derik de Bruin with Bank of America. Please go ahead. Derik de Bruin - Bank of America Merrill Lynch : Hi. Good morning. Thanks for it. Two quick questions. Was there any stocking or any outsized orders particularly OUS? And then also just on some of the dynamics in the livestock market, the data's been showing that herd size is increasing and clearly your data is reflecting that. Is there any signs at all that there could be potentially some oversupply and that they're thinking about doing some cattle herd culls? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, let me take the question on livestock and cattle. So, we see the cattle business also showing that very positive trend, we still see that the herds are growing in countries like U.S. and also in Australia. Prices are also showing a positive trend. Most recently, on the news said that the cattle futures are 18-month high, which is also a positive. Also in the U.S., their feedlots and stockers are back to profitability. So, all this is indicating that the cattle business are showing a positive sign. For the year, we expect that for Zoetis, that the cattle will be growing mid-single digits which is positive and also the positive element that we have seen that the consumption of beef is also growing. Even in some parts of because of China consumption but these also accelerating exports. This is also helping producers to capitalize on investment that they been making in the last year. So, we see that I think the cattle business, it will be showing a positive trend, in general, for the market and also positive for Zoetis. We understand that in the first quarter we had some challenge, especially in the U.S. The challenge came from mild winter. It also generated a low risk profile for animals and then this affected our premium antibiotics. The other impact that we had in the first quarter in cattle was related to the implementation of the Veterinary Feed Directive; that created some challenge. In the cattle, especially in the small customers, they were not having a veterinarian associated with these operations. We expect also that this will be corrected in the coming months. But again, positive outlook for cattle, both in the U.S. and international. And now then, Glenn, you will answer the comment on stocking in the quarter. Glenn David - Zoetis, Inc.: Yes. In terms of the question on stocking in the quarter, there was no material stocking in the quarter. Perhaps in some markets, particularly Vietnam, there was some elevated sales in the quarter that will stall it. It's probably expect to reverse to some degree in Q2. The only other thing I would point out, particularly in the U.S. with Simparica, we had very strong sales of Simparica in the quarter. I wouldn't call that a stocking issues. It's more just the season for parasiticides in the U.S. and how the veterinarians typically make their purchases. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We can take our next question from Jon Block with Stifel. Please go ahead. Jonathan Block - Stifel, Nicolaus & Co., Inc.: Thank you, and good morning. Two questions. I'll ask them both up front. Juan Ramon, maybe for you. Just some high-level commentary on the altered structure, if you would, with the distributors on the Companion Animal side where I think the contracts are more volume based, if you would, rather than exclusivity. How has that performance been? Has it been in line with your expectations? And then, Glenn, just maybe on the gross margin cadence, I know you guys don't want to guide for the quarter, but how do we ramp the 67%-plus for the year? Can we expect a modest improvement in 2Q and then much more pronounced in 2H? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon. Let me answer the question on what was shown on that. Maybe a little bit background on these questions. So, we launched many products, many new products, in Companion Animal and then with these launches we decided to review the collaboration with the distributors in the U.S. and then as a result of this review in 2016, we decided, in agreement with the distributors, also to include in their promotional portfolio our vaccine for companion animals. The results of this collaboration was very positive for them and also for Zoetis. Then in 2017 we decided to expand this collaboration not only to vaccines plus some other products that they were responsible before, also to our parasiticide portfolio, REVOLUTION, ProHeart 6, and Simparica. All indicators are very positive, and now thanks to our direct presence together with the support of distributors, we have been increasing significantly our sales force in markets that we know that are highly competitive, and this additional volume that has been generating through all these regional portfolio has been also supporting the rest of the portfolio. Those that are affected by generic competition that, thanks to these newer studies, we are still performing in line with expectations, and we have not seen significant change on the trend of general impact in 2017. So overall, very pleased with the new way that we are collaborating with distributors. And one of the impact that also we have seen that's very positive has been the evolution of Simparica, that now we have our sales force, and the sales force of distributors supporting Simparica. Glenn David - Zoetis, Inc.: And in terms of gross margin trending throughout the year. So, in Q2 we will still have somewhat of a negative drag on margin from the impact of the costs of previously produced inventory, but the impact will definitely be smaller than it was in Q1. Then as we get into Q3 and Q4, margin improves significantly as it really fully recognized the benefits of the improved costs that we were able to deliver as far as the operational efficiency initiative. So that should give you some understanding of the trending throughout the year. Juan Ramón Alaix - Zoetis, Inc.: Next question. Operator : Our next question comes from Jeffrey Holford with Jefferies. Please go ahead. Jeffrey Holford - Jefferies LLC : Hi. Thanks very much for taking my questions. So, it looks like you had a pretty strong Q1 in international. Is there anything out there through the rest of the year, just issues you may be concerned about that stops you at least raising the bottom end of your revenue guidance for the full year 2017? And then just secondly, on Nexvet, wonder if you might just give us a little bit more color on any timing and the size of opportunities within their pipeline that you might want to just highlight for us to give us some expectation of when that might start to contribute? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Let me start with the question on Nexvet, and then Glenn will provide the comments on the guidance and most of the performance being international. So on Nexvet, we just announced the acquisition, but it is an acquisition of a company which is based in Ireland, and we need to follow their regulations and the requirements of the Irish authorities. So at this point, I think we have a lot of limitations, and let's wait until this transaction is concluded, and then I will provide all details of what we expect from Nexvet; and also timing of new product introductions. Glenn David - Zoetis, Inc.: And in terms of revenue and guidance for the year. So when you look at the performance for Q1, on a global basis we delivered 6% revenue growth for the quarter. That's very much in line with our full-year guidance of 5.5% to 7.5%. So the performance in the quarter was in line with what we expect the year, which is why we believe the guidance that we have is appropriate from a revenue perspective. International performance was positive in the quarter at 9% revenue growth, but again, definitely in line with our expectations and what we would expect throughout the year. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll take our next question from Erin Wright with Credit Suisse. Please go ahead. Erin Wilson Wright - Credit Suisse : Great. Thanks. A follow up to John's question on the gross margin. You had a particularly strong quarter in companion animals, typically a higher margin business for you. Your gross margin was essentially in line with your quarterly guidance that you gave on the last call. What can you speak to as far as the moving parts in the gross margin, and particularly just following the strength in that higher margin business for you? And then I understand you can't speak to Nexvet, but how should we think about the traction you are seeing with Cytopoint and the vision on the prospects for monoclonal antibodies in general, given now you've doubled down in the space with the recent acquisition of Nexvet? Thanks. Juan Ramón Alaix - Zoetis, Inc.: So again, let me start with the comment on monoclonal antibodies and Cytopoint. That's actually what we see with the addition of Nexvet, without getting into details of products or timing of launches. So definitely the innovation that we have seen at Nexvet in terms of monoclonal antibodies combined with the expertise that we have developed with Cytopoint and the manufacturing capability that we also developed at the time of Cytopoint – this will be a significant opportunity in combining Nexvet capabilities with our capabilities. On top of that, we have based on that present knowledge on how to commercialize monoclonal antibodies, and we see a significant opportunity of bringing to the market new options in terms of pain. Still pain is a main need (38:22) in the Companion Animal market, and definitely we see another opportunity of expanding the market with introduction of monoclonal antibodies for cats. So we see that it has significant strategic rationale on this acquisition, and we see also that this will generate significant value to Zoetis over time. Glenn David - Zoetis, Inc.: And, Erin, in terms of gross margins, so as you mentioned it is in line with our expectations for the quarter. And in terms of mix, there was some up and downs. As you mentioned, Companion Animal performed very well, typically some of our higher margin products. Also though, we had a decline in performance in some of our premium antibiotics, which are also very high margins. And International also had higher growth, and International in general has lower margins than the U.S. So, overall the mix ended up being neutral to our expectations and still kept us in line with where we thought we'd be for the quarter. Juan Ramón Alaix - Zoetis, Inc.: Next question? Operator : Our next question comes from John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi. Thanks. Just wanted to follow up on your comments about Stronghold Plus. When do you expect that product or something like it to be approved and launched in the U.S. in cats? And how about for dogs, either in the U.S. or Europe? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, this combination is a topical combination, and technically it will be focused on cats. But we also discussed that we'll be using sarolaner as a platform to develop other combinations. These other combinations will be oral, and they will be focused on dogs. Your question about when do we expect to launch on the U.S., this is not yet defined. We are working with the U.S. regulators on answering and developing all the details for a demonstration, but at this point we have not provided any timing of the approval. As we progress on the discussion with the U.S., then we'll provide the details on the timing. John C. Kreger - William Blair & Co. LLC: Okay. Thanks. And then a follow up on PHARMAQ. Given your legal victory, can you just talk about where you think that business can go over the next couple of years? And maybe just even reset the longer-term strategy there? Is that a business that can start to be a more material contributor over the next few years? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Well, thank you, John, for the question. We are convinced it's an area of growing opportunity, and we know that already the farmed fish is exceeding the consumption of wild fish. Still, there is a lot of use of antibodies in these segments. We expect that these antibodies will be replaced by vaccines. PHARMAQ is a leader in terms of developing vaccines. We are very pleased with the interaction of a new vaccine in Chile for SRS, which is also helping the reduction of antibiotic use in this country. But then the next opportunity should be China, Vietnam and other countries. Already they are number one in terms of farmed fish production. And again, we are working on developing vaccines that will be targeting these countries. There was also the legal litigation in Norway. It's opening to us the opportunity of launching a new vaccine for pancreatic disease which is very important in Norway and it's also helping us really to support the rest of the portfolio in Norway. We communicated that in 2017 that we expect to generate $125 million and that will be a significant, growth. In the first quarter, also, we show very positive growth for PHARMAQ and we are expecting for the year to generate more than 30% growth in terms of PHARMAQ. So, the prospects are very positive and we'll continue investing not only in salmon in where we have most of our revenues to date, but also in tilapia and other fishes that will be important in the future. Next question, please. Operator : Our next question comes from David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Thanks very much. Well first, I wanted to congratulate you as well on the results. I just wanted to ask about the outlook on a couple of items. First of all, I think that you had mentioned 12% operational Companion Animal growth in the first quarter. Just wondering if we should expect that to accelerate or decelerate in coming quarters. Second, with respect to other expenses and the tax rate, which surprised me this quarter, the other expense item was $35 million in the first quarter. Wanted to get your guidance for how we should think about it in the second quarter and for the full-year. And then the same thing on the tax rate. The tax rate was 27.8%. Wanted to understand what you would suggest for the second quarter sequentially. And then finally, it sounds like the 2% price increase that you've seen historically and you saw this quarter is sustainable. Just wanted to confirm that, in coming quarters and for the foreseeable future, you continue to expect the 2% benefit from price for your business. Thanks so much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Dave, and I will provide the comment on the outlook for Companion Animal and then Glenn will go to the details of tax and some of the questions that you asked including price. So on the outlook, so we have at least a 12% in Companion Animals. So we expect for the year that Companion Animal will continue growing at double digits and we think that this 12% it's probably a trend that we will see for the rest of the year. We should also have the benefit of the growth of Apoquel mainly coming from also the full introduction of international markets where now they are, some of the markets, they are now at launching pace. We also expect that Apoquel in the U.S. will continue growing. But now more than Apoquel, I think it's important to discuss about the Dermatology portfolio, including Apoquel and Cytopoint, but if we talk about Apoquel in the U.S., for instance, we are very pleased with the level of penetration in clinic. It's about 94% which is very good, but we only have 47% market share in terms of patients. So we still see opportunity for continue growing and taking share from steroids that still account for 30% of patients. Cytopoint, it's definitely has been very well accepted by the market, but still a very low market share in terms of patients, only 5%, but growing also very fast in terms of penetration. So, both products will drive growth and very important also Simparica in where we have seen very positive international growth. Now we have the benefit of this year of enjoying the full season so we have the product and we have seen that this product is performing that is positive for (47:07) performing extremely well. And one of the things that we've seen that is also helping that is the cooperation with distribution and we expect also that in the next coming months we'll see the impact, also, of our DTC campaign. So in summary, we expect that this 12% growth in companion animal will be maintained for a full year. Glenn David - Zoetis, Inc.: Hey David, this is Glenn. Just to your other questions in terms of how the quarter relates to the full year. I'm not necessarily going to break down quarter by quarter, but just how Q1 relates to the full year. So, the 2% price increase that we saw for the quarter we do expect to be maintained throughout the year, and in general we expect to generate 2% to 3% price increase, so nothing has changed from that perspective. In terms of the tax rate, the guidance on the adjusted ETR for the year is 30%. We came in at about 28% in Q1, really driven by A, some discrete favorable items, and also the recognition of some of the benefits related to employee stock options and restricted documents, and the tax effect of those in the quarter. So those had a favorable impact in the quarter versus what the trending will be for the full year. And then related to other expense. So, our other income in the doc (48:25) line was favorable in the quarter really driven by two key things. A, we had lower hedging costs than we've had in the past and also we had the PHARMAQ settlement for the PD vaccine that Juan Ramon spoke about just before. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We can take our next question from Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Okay good morning, folks, and thank you for taking the questions and congratulations on a good quarter. A couple of clarifying questions for Juan Ramon first. First confirming that you do expect U.S. livestock to return to growth in the second half, just want to make sure we're clear on that. And I didn't catch the Apoquel market share you stated. And a couple for Glenn if I may. As cash conversion improved this year, are you considering a more aggressive dividend policy to better reflect the sustainability of your business? And what are your thoughts on tax reform and how could it possibly impact Zoetis as you evaluate the various policies that are being discussed? Thank you very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Alex, and the answer to the U.S. livestock. I think we expect growth in the U.S. for our livestock, but mainly it will be important to provide some details on the different species in livestock, starting with swine. We expect mid to low single digits, and we expect that the PCV2 vaccine will help also to gain momentum in terms of revenues. We also think that the swine business in the U.S. is also having the benefit of high exports. The exports are growing 18% in the U.S. and this is also helping the producers to generate profitable results, and we are now, in our opinion, having the portfolio that will be creating that growth in the rest of the year. In the case of poultry, poultry we expect that the market will be showing very little growth. But on the contrary, Zoetis will be generating positive growth and growing faster than the market in poultry in the U.S. And finally, in cattle. In cattle, we faced down that challenge in the first quarter. The challenge of a milder winter, low risk profile, that also had an impact in our premium anti-infective. Also, as I mentioned the implementation of the Veterinary Feed Directive, that also had impact on our medicated feed additives. We expect that all these challenging implementation that affected the small producers will be managed in the future, and this will help also to have the fuller use of our products in the coming months. In the cases that are positive for cattle that make us positive about this segment, prices are increasing, and as I mentioned, the future prices are hitting highest in the stock. Also, the placement of the feed lot increased by 6%. And very positive, also, the animals are now moved with medium size compared to heavy size in the future, which is also increasing the risk profile of these animals. And again, another indicator which is a positive in cattle is that as feedlots and stockers are back to profit. So all in all, we think that the cattle market are having positive prospects. And we have the portfolio in our company also to generate positive growth in the rest of the year. Glenn David - Zoetis, Inc.: So, Alex, in terms of the cash conversion as you indicate, as we get outside of the costs of the operational efficiency initiative and a lot of the stand-up costs, our cash conversion is improving significantly. In terms of how we'll prioritize those – that additional availability; A), we'll continue to look internally for areas of high growth and investment. We'll also aggressively look at business development as well as an area. In terms of dividends, we'll continue to grow our dividend pretty much at or faster than the growth in adjusted net income. And really where we'll exhibit flexibility in terms of returning capital to shareholders will be with share repurchase. We recently announced the $1.5 billion share repurchase program. We indicated that that was flexible in nature. Just for context, in Q1, we repurchased $125 million in share. And as we go throughout the year, we'll continue to evaluate the magnitude and pace of share repurchase. Juan Ramón Alaix - Zoetis, Inc.: Next question, please? Glenn David - Zoetis, Inc.: And also just in terms of – in terms of tax reform. As we've said, we do have more than half of our pre-tax income in the U.S., so a change in the U.S. rate would definitely be favorable to us. Really, the magnitude of that favorability will really depend on the totality of the legislation. And we'll understand that more as that becomes more clear. Juan Ramón Alaix - Zoetis, Inc.: Next question? Operator : Our next question comes from Brett Wong with Piper Jaffray. Brett W. S. Wong - Piper Jaffray & Co.: Yes. We're seeing some pressure in the dairy industry in the U.S. due to tariffs being put in place in Canada putting stress on trade. So granted, prices are still up year over year, but are you seeing any weakness in that market or expect to see softness in demand for your products in that sector? Juan Ramón Alaix - Zoetis, Inc.: Yes. I lost the beginning of your question, so you were talking about dairy has moved in the U.S. And what else? Brett W. S. Wong - Piper Jaffray & Co.: Yes. Sorry about that. I was just wondering if you can comment around the U.S. dairy market, and we've been seeing some pressures there due to trade impact and so – or potential trade impact. And so just wondering if you are seeing any weakness yet or if you expect to see any softness there. And I know that prices are still elevated year-over-year, which is positive, but what you're seeing, if there's any weakness so far. Juan Ramón Alaix - Zoetis, Inc.: Well, the dairy producers, maybe they are now generating lower profit than in the past, but they're still generating a profit. So, we have not seen any significant change in terms of number of animals, which is defining the animal sales revenues. So, I think it is something that is stable. And in other markets, we have seen that they are recovering very well and countries like New Zealand are now back to much more profitable situation compared to the past. So overall, the dairy business for us, it's positive. But it also – we have some challenge in Western Europe in the importations to Russia has also been limiting the opportunity for revenues for some European dairy producers. But overall, our dairy business, it's showing positive growth for the year. Next question, please? Operator : Our next question comes from Jami Rubin with Goldman Sachs. Please go ahead. Divya Harikesh - Goldman Sachs & Co.: Hi. This is Divya Harikesh on behalf of Jami Rubin. You described growth for the dermatology portfolio of $400 million to $500 million over the next three years. Can you help explain how much of that's coming from Apoquel versus Simparica and Cytopoint and just comment on your long-term expectations for these products? With Apoquel, have you already reached a stage where a lot of the growth coming forward is going to be from Simparica and Cytopoint that are in earlier stages of ramp. So, it would be great to better understand that. Juan Ramón Alaix - Zoetis, Inc.: Thank you for the question. But maybe it's important now that when we discuss about Apoquel and Cytopoint, we discuss combining this portfolio. Both our products are targeting the same type of medical conditions. It's true that Apoquel, they have more indications than Cytopoint, but it's still – it's something that the market is understanding fully, how to use these products, considering the dogs, considering pet owners' preference and also the decision of veterinarians. So, I think it's important that we are not trying now to identify how much will be coming from Apoquel, how much with Cytopoint. Definitely something that we'll be providing this information on actual, but I think the important thing is that we expect to generate $400 million to $500 million revenues in three years' time which is, in my opinion, an increase compared to previous estimations and is related to the reaction of the market. We still see significant opportunities for growing in international. In international, we have many countries where we still have on launching pace. But in the U.S., we see great opportunities, as I mentioned, if we take Apoquel and Cytopoint combined, the number of – the market share in terms of patients is about 50%, 52%. So still we have a lot of opportunities for continuing growing that in this area. We expect also that the growth also will come from increasing awareness of pet owners through our digital campaign in the U.S. So, we expect that they are still significant growing opportunities for our Dermatology portfolio in both international and the U.S. Next question, please. Operator : Our next question comes from Chris Schott with JPMorgan. Please go ahead. Christopher Schott - JPMorgan Securities LLC : Great. Thanks very much for questions. Just two here. First on the gross margin improvement as we think about the next few years. I think you've highlighted a 200-basis-point improvement by 2020 as you optimize infrastructure. Can we just get a little bit more color on how to think about that? Is that going to be a gradual improvement as we think about 2018, 2019, 2020? Or more of a step-function improvement as you do all that work and then we get more in 2020, it has a big step up? My second question was coming back to capital deployment and just like a little bit more about your longer-term leverage targets and where you'd like to see the company over time. I'm just trying to get my hands around a little bit more how much capital you're going to have to work with as you consider the various options for cash deployment going forward. Thanks so much. Glenn David - Zoetis, Inc.: So, Chris, so in terms of the 200-basis-point improvement that we expect in gross margin through 2020, we do expect it to be gradual. It's not going to be necessarily one-step change. There are activities that need to occur over those three years to generate that 200-basis-point improvement, primarily in terms of moving products from one location to another for manufacturing. So that will be a gradual improvement. In terms of capital deployment and our debt ratios, we're still targeting a gross debt ratio of 2.5 to 3 and we believe that is appropriate for our company and that will be what we'll be targeting for the next number of years. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : Our next question comes from Kathy Miner with Cowen & Co. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. Just two questions. First, and I'm not sure if I heard this before, but last quarter you had talked about having $50 million in sales still to work through the P&L from the streamlining. Could you tell us how much of that impacted Q1? And will the remainder be in the second quarter? And the second question is on antibodies in companion animals. Given your interest with both the IL 31 and your pending acquisition of Nexvet, have you also looked at antibodies in the oncology area, specifically anti-PD1s for use in cats and dogs? Thank you. Glenn David - Zoetis, Inc.: In terms of the $50 million in sales that was a challenge to growth for 2017. That was really related to the product rationalizations and the fact that we still had $50 million of sales in those earlier in 2016. So really 1% impact in terms of growth for the year is what we're anticipating for 2017. We expected to see the majority of that impact in the first half of the year, so about 2% impact from the product rationalizations in the first half of the year, which is what we saw in the first quarter. We expect a similar impact in the second quarter and then minimal to no impact in the second half of the year. Juan Ramón Alaix - Zoetis, Inc.: And the question on monoclonal antibodies. Definitely now with the expertise that we have, that we gained thanks to Cytopoint, IL-31, and also the addition of Nexvet. We see opportunities of using the monoclonal antibody as another platform to develop other products in other indications. And oncology is one of the targets, but we are also discussing other areas that monoclonal antibodies be also responding to medical conditions or opportunities for some efficiencies in livestock. Other question, please? Operator : It appears we have no further questions at this time. I will now turn the program back over to Juan Ramon for any final or closing remarks. Juan Ramón Alaix - Zoetis, Inc.: Thank you very much for joining us today. And we'll be pleased to have following – follow-up comments with our Investor Relations group that will also be pleased to interact with you. Thank you. Operator : And this does conclude today's program. Thank you for your participation. You may now disconnect, and have great day.
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ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,017
| 3
|
2017Q3
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2017Q2
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2017-08-08
| 2.097
| 2.145
| 2.45
| 2.5
| 3.61049
| 23.37
| 24.89
|
Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: Derik de Bruin - Bank of America Merrill Lynch John C. Kreger - William Blair & Co. LLC Jonathan Block - Stifel, Nicolaus & Co., Inc. Jami Rubin - Goldman Sachs & Co. LLC Louise Chen - Cantor Fitzgerald Securities Erin Wilson Wright - Credit Suisse Kevin Ellich - Craig-Hallum Capital Group LLC Kathy M. Miner - Cowen & Co. LLC Alex Arfaei - BMO Capital Markets (United States) Brett W. S. Wong - Piper Jaffray & Co. Operator : Welcome to the second quarter 2017 financial results conference call and webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in, or on the Investor Relations section of Zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you, operator. Good morning, and welcome to Zoetis' second quarter 2017 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 in the company's 8-K filing dated today, August 8, 2017. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. As in previous quarters, the innovation we bring to the market and the diversity of our portfolio across the geographies, the species, and the therapeutic areas are all supporting in the consistency of our financial results. Our innovations include the recent introduction of new products like Cytopoint, Simparica, and Stronghold Plus, and lifecycle innovations that are developed across our approximately 300 product lines. Our diverse portfolio helps us overcome economic cycles and deal with all the political situations and weather conditions that affect the markets, the species, or the product categories. We are seeing this diversity once again in the second quarter. And along with the excellent execution of our Zoetis team and our singular focus on animal health, all these factors helped deliver excellent results. In the second quarter, our revenue grew 6% operationally, and excluding the impact of product rationalizations that we have discussed before, our operational growth would have been 7%. We expect this will be the last quarter that we see any significant impact from the product rationalization, as those efforts and comparisons are largely complete. The main driver of our second quarter revenue growth remains companion animal products, which grew 10% operationally, driven largely by sales of our industry-leading dermatology portfolio consisting of Apoquel and Cytopoint and our new oral parasiticide, Simparica. In the U.S., companion animal products grew 7%, and in international markets, they grew 15% operationally. We continue to see further penetration of new products in key countries outside of the U.S. such as Japan, Brazil, and Canada. We have been supporting growth for Simparica and Apoquel with direct-to-consumer advertising that we have started in the second quarter in the U.S. We have made similar efforts in Brazil. Initial reports on DTC in the U.S. are positive, and we look forward to analyzing more data as we evaluate the full-year impact. Our total dermatology portfolio has shown significant growth, achieving our first-ever quarter of more than $100 million in sales. We continue to build disease awareness through our DTC campaign and expect to expand the market. Our latest data shows that 55% of dogs with dermatology problems in the U.S. are treated with Apoquel or Cytopoint, up from 52% in the first quarter. Cytopoint has gotten good traction in the U.S. this year. And in EU countries we are conducting an early experience program and expect to fully launch in September. We believe the early adoption and stable reaction in the U.S. is a good indication of the success we can achieve in the European markets. Although Simparica sales were lower than in the first quarter, we continue to track well with our expectation for the year in this highly competitive market. In the U.S., we have seen net sales from clinics to pet owners growing market share since the beginning of the year. Meanwhile, our livestock portfolio grew 3% operationally, with increases in cattle and poultry products being partially offset by a decline in fish products. Our swine product sales in the quarter were flat. In the cattle market, we posted 4% operational growth. Export demand for U.S. beef has been increasing due the lower average retail prices. And we continue to see positive signs in other major beef-producing markets, like Brazil, Argentina, Mexico, Australia, and Canada. In the case of poultry products, we grew 4% operationally. We are seeing strong growth in the U.S., driven mostly for our broad portfolio and expertise to help customers address a range of consumer and retailer preferences. Combining our vaccines with product such as Zoamix, Robenz, and Deccox, we are helping certain producers shift to No Antibiotics Ever production. In swine products, although we have taken actions to strengthen our vaccine portfolio in the U.S., we are still showing a decline in U.S. sales. In international, however, our swine business is growing very strongly, led by China, the world's largest pork market. In fish products in the second quarter, we have seen a decline of 5% operationally, mainly due to a slower uptake of our SRS vaccine in Chile. Nevertheless, we still expect double-digit growth for fish products this year, and we remain confident in the long-term prospects for this business. We posted 11% operational growth in adjusted net income, once again faster than revenue growth of 6% and in line with our value proposition to shareholders to grow adjusted net income faster than revenue. And the full implementation of our efficiency initiative is enabling us to invest in additional promotional activities like DTC, while showing only a modest 1% operational growth in operating expenses. With our increasing cash flow, we continue to look at other investments we can make to support our future growth. One key area is ensuring reliable, high-quality supply to drive our growth. As part of our supply network strategy, we expect to complete the sales of our Guarulhos plant in Brazil in the fourth quarter. At the same time, we are planning to expand our vaccine plant and invest in manufacturing capacity for other innovative products. We'll share more details as plans move farther along. While new products like Simparica and Cytopoint may get well-deserved headlines, we also focus on lifecycle innovation to keep established brands delivering value to customers over decades. For example, Zoetis received approval in May from the FDA for Clavamox Chewable for dogs. This leading anti-infective was first approved in the U.S. in 1984, and it provides a broad spectrum of treatment for various infections in dogs and cats. Clavamox Chewables join the original tablet and liquid drop formulations, which we'll continue to market. And our internal innovation is complemented by M&A opportunities. Last week, we completed the acquisition of Nexvet Biopharma, an innovator in monoclonal antibody therapies for companion animals in management of chronic pain and other therapeutic area. This acquisition demonstrates how we use external innovation in key technologies and therapeutic areas to support future growth. Nexvet strengthens our R&D pipeline in monoclonal antibodies to help us to sustain our leadership in chronic pain management for companion animals, an area valued at an estimated $400 million a year, and which is poised for innovation with new monoclonal antibody therapies. We are moving ahead with the work of integrating Nexvet into our existing research and manufacturing operations in order to advance with their promising product candidates. With the first half of the year now behind us, we are tracking to our expectations. We are pleased with the strong start to the year, and we are increasing our full-year 2017 guidance for revenue and net income, based on foreign currency changes and our continued confidence. With that, let me hand things over to Glenn, who will provide more details on our second quarter results and full-year guidance. Glenn? Glenn David - Zoetis, Inc.: Thank you, Juan Ramón, and good morning, everyone. We had another solid quarter based on the strong growth of our dermatology portfolio and other recently launched companion animal products, as well as growth in our global livestock portfolio, which was balanced across our U.S. and international business segments. Total company revenue grew 6% operationally, which excludes the negative 1% impact from foreign exchange. Breaking down that 6% growth, 6% came from dermatology and other new products, and 1% came from our inline portfolio, with the product rationalization having a negative 1% impact on operational growth. As Juan Ramón mentioned, our dermatology portfolio reached a considerable milestone with sales in the quarter of $102 million. As we have said in the past, Q2 and Q3 are the peak seasons for dermatitis in the U.S., with a softer Q1 and Q4. As expected, Simparica sales were lower sequentially at $20 million. This was driven primarily by the U.S. and the timing of distributor purchases in Q1, in anticipation of the flea and tick season. Internationally, we saw strong growth sequentially in Simparica, with additional penetration in most major markets. In terms of the bottom line, we delivered 11% operational growth in adjusted net income, and 12% operational growth in adjusted diluted EPS. Overall, we had another quarter of solid top line performance, and we again grew our bottom line faster than our sales. We continue to deliver steady, long-term growth in an attractive and stable industry. Our ability to bring innovative and differentiated products to market, combined with our diverse portfolio and leading commercial capabilities, gives us a stable foundation for future long-term growth. Now let's discuss segment revenues. Our International segment generated operational revenue growth of 7%, while the U.S. grew 5%. In the International segment, product rationalization had a negative 1% impact on growth. So let me highlight a few markets. China has delivered another strong quarter, growing 14% operationally, with growth coming from both our livestock and companion animal businesses. In livestock in China, we benefited from solid market dynamics in swine, including favorable pork prices through the first half of the year. We expect some softening in this trend during the second half of the year. However, the continued modernization of production will drive greater long-term growth based on the use of vaccines and medicines to ensure a safe, high-quality food supply. In companion animal, our recently expanded field force continues to partner with local veterinarians to improve medicalization rates and increase routine care for pets in China. In Brazil, we grew 8% operationally in the quarter behind the strength of our cattle and companion animal businesses. Investments in field force expansion and favorable market condition contributed to growth in cattle, despite recent industry and government headlines. And companion animal growth in Brazil was driven by new product introductions, including Simparica and Apoquel. Japan also made a significant contribution in the quarter, growing 17% operationally over the same quarter last year. Apoquel sales begin to normalize with distributors and better reflect the strong underlying demand in the local market. As a reminder, there was significant distributor stocking in Q3 of 2016, when we initially launched Apoquel. Key markets in Europe performed well in the quarter, as the U.K., Germany, France, Spain, and Italy all exhibited operational growth. The U.K. and Germany led the way at 12% and 8% operational growth respectively. Growth in the U.K. was driven primarily by Apoquel, while Germany's performance was due to strength in both Apoquel and Simparica. To summarize, very strong growth in our International business coming from a number of sources, including strong market trends, strategic investments, and our success in bringing new value-added products to market. Turning to the U.S., revenue grew 5% in the second quarter, companion animal grew 7%, and livestock grew 3%. Companion animal sales in the quarter were driven primarily by our dermatology portfolio, Simparica, and a number of other new product launches. U.S. dermatology sales were $74 million for the quarter, with Cytopoint sales reaching $15 million, exhibiting nice sequential growth as clinic penetration and dosing accelerate. As Juan Ramón said, patient share also continues to grow for Apoquel and Cytopoint. As I mentioned earlier, Simparica sales were lower this quarter than last, but still in line with expectations. Our increased selling and promotional activity will lay the groundwork for continued revenue growth in this highly competitive market. We will continue to evaluate the performance of our direct-to-consumer promotional campaign for Apoquel and Simparica, with early indications suggesting that we are on track to meet our business objectives. Additional contributions to companion animal growth came from new products including Diroban, which recently received approval for the treatment of dogs with heartworm. With the introduction of Diroban, Zoetis now offers veterinarians a full canine heartworm product portfolio, including prevention, detection, and treatment. Moving to U.S. livestock, sales grew 3% in the quarter, due primarily to our cattle and poultry businesses. Our cattle business returned to growth this quarter due to the success of products such as Actogain and Synovex, while sales of our premium injectable antibiotics continue to be impacted by healthier animals moving into the feedlots. As certain poultry producers expand their no-antibiotics-ever labels, our portfolio of medicated feed additives for these criteria are doing well and contributed to poultry growth in the U.S. We work closely with our customers to provide the necessary products and technical assistance to help them switch over when they choose. Our swine business declined again this quarter in the U.S., primarily due to competition for our Fostera PCV/M. hyo vaccine. Our updated vaccine product is seeing modest uptake with medium and smaller producers, and we will continue to work with customers to gain acceptance. Finally, both our cattle and swine businesses were impacted by the implementation of the Veterinary Feed Directive, or VFD, which negatively impacted our medicated feed additive performance, as producers are adjusting to the new regulation in how to adopt their protocols. Now turning to the rest of the P&L. Adjusted gross margin of 65.6% decreased approximately 230 basis points year over year on a reported basis and, on a sequential quarter basis, improved 120 basis points from the first quarter of this year. As I had mentioned during last quarter's earnings call, in 2017, we have made additional cost improvements in our manufacturing network. As a result, in the first quarter of 2017, we recognized higher costs associated with previously produced inventory, which depressed our gross margin. This change also had a negative impact on our second quarter margin, which we had previously indicated. The second quarter results for adjusted gross margin, while showing improvement over the first quarter, are slightly below our initial expectations. We have been working to improve our inventory management, including reductions in the level of inventory write-offs we incur. While we still expect to improve in this area for 2017, the magnitude of improvement is less than we had expected and will continue to be an area of focus in the future. Gross margin was also impacted by unfavorable foreign exchange in the quarter. Adjusted SG&A grew by 1% in the quarter, with higher investment in our DTC advertising campaign offsetting the expense reductions in other areas. Adjusted R&D declined 1% operationally for the quarter due to the timing of project spending and fixed expense reductions from our operational efficiency initiative. The adjusted effective tax rate for the quarter was approximately 29%. The tax rate in the quarter is significantly improved from the prior year, primarily due to the impact of operational changes implemented in the third quarter of last year. Taking all these factors into consideration, we generated 11% operational growth in adjusted net income for the quarter. Moving to guidance for full year 2017. This year, we continue to perform in line with our expectations, with certain upsides and downsides, particularly with tax and cost of goods sold. For the year, we still except to achieve operational revenue growth of 5.5% to 7.5% and an adjusted EBIT margin of 34% to 35%. Since our last update in May, changes in FX rates in several markets are favorable to revenue, and we are increasing both the lower end and higher end of the range as a result. We have also narrowed the range for revenue towards the high end of our guidance by $25 million to reflect our performance to date and our confidence in the remainder of the year. Our guidance for the range of cost of goods sold for the year has moved from 32% to 33% of revenue to approximately 33%. As we progress into the second half of the year, our results will more fully reflect the impact of our manufacturing cost improvements. Our updated view, however, also reflects the higher expense for inventory charges that I discussed earlier, as well as unfavorable mix and foreign exchange. For SG&A, we're increasing the low end of our range and maintaining the high end, consistent with the change in our revenue guidance. We have increased both the low end and high end of our R&D expense range to reflect additional investments, primarily as a result of the Nexvet acquisition and the impact of foreign exchange. Our guidance for an adjusted effective tax rate has been lowered to approximately 29% from our pervious guidance of 30%. The favorable change is primarily due to jurisdictional mix and certain discrete item that have been realized in the first half of the year and does not take into account any potential tax changes being discussed in Washington. With more than half of our adjusted pre-tax income in the U.S., a lowering of the U.S. corporate tax rate would have a meaningful benefit to us. As a result of the aforementioned changes, we've increased the low and high end of the range for adjusted net income for the year. In the second quarter, we also repurchased another $125 million in shares, and our guidance for reported and adjusted earnings per share reflects the share repurchases completed through Q2. We expect our operating cash flow to grow through the year, allowing us to fund incremental investment in our business, including the including the $85 million used to purchase Nexvet last week. Just to summarize before we go to Q&A, we have delivered consistent operational revenue growth of 6% in the first half of the year. We expect positive trends in the uptake of new products and growth in international livestock to continue. Our earnings growth will accelerate meaningfully in the second half of the year, and cash flow generation will continue to improve, giving us greater flexibility to invest in our business. With that, I'll hand things over to the operator to open the lines for your questions. Operator? Operator : We'll take our first question from Derik de Bruin with Bank of America Merrill Lynch. Please go ahead. Derik de Bruin - Bank of America Merrill Lynch : Hi, good morning. Juan Ramón Alaix - Zoetis, Inc.: Good morning. Glenn David - Zoetis, Inc.: Good morning. Derik de Bruin - Bank of America Merrill Lynch : Hello? Oh, great. So just a couple of questions. So the first on – now that you've closed Nexvet, could you give a little bit more timing on the pipeline? How can we think about some of the products coming through? I believe they've got one canine and one feline drug coming in the research development pipeline right now. Could you just give us some tiny update there? And also, on the gross margin, could you sort of back out what the different headwinds were this quarter and sort of what the underlying growth rate was? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Derik. And I will take the first question, and then Glenn will answer the question on the gross margin. So, Nexvet, we completed the acquisition last week, on Monday last week. Our team, R&D team, it's now interacting with the R&D team of Nexvet, getting a getting full understanding of all the programs. When we have completed this analysis, then we will define when we expect to launch the product for both dogs and cats in both the U.S. and the European end markets. So it's a little bit too early now. But, again, so one thing that we need to remember is that we are in a market in where our competitors are not providing any detail in terms of R&D products, and providing too many details, and especially in an area that we think that can be also of high interest, will have a negative impact in our programs and maybe in the opportunity to generate future revenue growth. Glenn David - Zoetis, Inc.: And in terms of gross margin, the cost of goods sold, so for Q1, our cost of goods sold was about 35.6% of revenue. In Q2 that improved to 34.4%. The key drivers of that were the costing methodology and the fact that we did recognize a disproportionate amount of the higher costs associated with previously produced inventory in the first half of the year. When you look at our guidance for the full year of approximately 33%, that definitely implies a significant improvement in the second half of the year after we're outside the costs associated with that previously produced inventory. Next question? Operator : We'll take our next question from John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Can you talk a bit more about your swine product performance? It seems like the vaccines have been under pressure for the last two or three quarter. Should we expect that to persist in the second half, or do you expect that to turn? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, John. Well, we mentioned that we have been working on our vaccine portfolio in both U.S. and international markets. We have seen good growth in international markets, but in the U.S. despite of – our portfolio now being much more competitive, we have not yet gained share as we expected. We remain confident that we have now a very strong portfolio. And very important, we also have products in our pipeline that will be reaching the market in 2018 that will bring this segment also to growth in the U.S. In the second half in the U.S. – that is also a question that you raised, I think – we'll be improving, but probably not improving as fast as we expected initially. On the other hand, in international, we expect continued growth and positive evolution of our portfolio in swine. Next question, please. Operator : Our next question comes from Jon Block with Stifel. Please go ahead. Jonathan Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks, guys. Good morning. Two questions, and I'll try to ask them both upfront. First off, the PHARMAQ number was a bit light and, Juan Ramón, curious if you think it's market or market share, and is there a revised figure for the year, which I believe stood at $125 million? And then sort of for the guidance and just looking forward, Glenn. The gross margin will obviously be better in 2H relative to 1H. So do we take that 2H 2017 and sort of use it as our runway for 2018? And then, finally, I know you don't guide quarterly, but just how do we think about the cadence behind revenue growth? Believe we should think about it greater – the revenue growth – greater in 4Q relative to 3Q just from a comp and days adjustment perspective. Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon. And – well, the PHARMAQ was the main driver of our light performance in the quarter. SRS vaccine, that – it was a significant growth driver, and it's a vaccine for salmon in Chile – it's still showing significant result in terms efficacy and safety, and it's helping fish farmers in Chile to reduce their use of antibiotics. In the second quarter, we saw a reduction of the use of the vaccine, mainly because of pricing discussions. At the end of quarter, we reached price agreement with fish customers in Chile, and we have seen already in the first two months of the third quarter, the vaccine showing very good revenues and very good growth. We remain very confident that this segment will deliver long-term growth. In the quarter, as I mentioned in my comments, we expect double-digit growth, but you mentioned the $125 million will be below this amount. But, nevertheless, we expect that in the future years, the correction will be in line with our expectations. Glenn David - Zoetis, Inc.: And, Jon, in terms of gross margin in the first half/second half, so as indicated with the guidance that we provided, we do expect a significant improvement in gross margin in the second half. Regarding the impact of that, and how you look at that for 2018, there are a numbers of factors that will impact the gross margin for 2018, including mix, foreign exchange, as well as the goals that we have in place from an inventory reduction perspective, which mainly just make some decisions that would have some impact on our ability to utilize overhead. While that would be the right impact from a cash flow perspective, it may have some negative impact from a P&L perspective. So there are a number of factors that'll impact gross margin for 2018, and when we provide guidance for 2018, you'll get better clarity on that. In terms of the guidance for the second half of the year from a revenue perspective, days has a minimal impact in the second half. We do have one more day in Q4, but other than that there's really nothing that would lead to a significant changes in growth between Q3 and Q4. Next question? Operator : The next question comes from Jami Rubin with Goldman Sachs. Please go ahead. Jami Rubin - Goldman Sachs & Co. LLC: Thank you. Just following up on the question related to gross margins, are you still comfortable with your 200 basis point improvement after the 2017 initiative by 2020? Is that still on track? And also with respect to U.S. livestock, can you update us on the impact of meat prices this quarter and your expectations for the rest of the year? Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you for the question. So we are still seeing the opportunity of improving by 200 basis points in gross margin by 2020, and plans are moving ahead as expected. In terms of comments on the cattle business in the U.S., well, there are some positive factors that are really helping the cattle business in the U.S. One is the number of cows. It's expected to grow in 2017 and 2018. We also expect that the number of placements in feedlots will be higher than in 2016. And we also saw that the feedlot producers are generating profits in 2017, and we expect also the same in the second half. The price of the beef, it's also helping exporters to increase exportations to markets like Japan, markets like Mexico, and many other markets in where the beef it's – in the U.S. it's being exported. Also the prices of milk are positive. It is not related to beef, but we have seen an increase on the price of milk. It's still below prices that we saw in 2016, but this is also helping to rise the market. And at the same time, we have seen some headwinds in the U.S. market for our cattle. One was the mild weather in the first quarter that reduced the risk profile of animals and also had a negative impact in our premium antibiotics. The implementation of the Veterinarian (sic) [Veterinary] Feed Directive also had an impact in the first quarter, and we expect also having an impact in the remaining of the year. And finally, we have seen in the first half of the year that animals moving to the feedlots were heavier, again with a lower risk profile. In the second half, we expect that these animals will be medium size; that also will increase the opportunity for the cattle business. But in general we have seen that the prices in the different parts of the chain of production has been more positive than in 2016. Next question? Operator : The next question comes from Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen - Cantor Fitzgerald Securities : Hi. Thanks for taking my questions. First question I have is, I was wondering if you could talk a little bit more about some of your near- and long-term growth drivers, that being PHARMAQ, the Nexvet acquisition, and also the triple combo product, and how we should think about the peak sales potential for these products, and when we'll see some sort of meaningful accretion to earnings from these different products? And then the second question I have was just on diagnostics. Do you want a bigger footprint in diagnostics, and will you have to make additional investments to get there? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Well, definitely we described that we expect 2017 companion animal being the main driver of growth, and the same for 2018. And this will be coming from still growth of Apoquel, growth of Cytopoint and Simparica. For Apoquel, Cytopoint, we mentioned that $400 million to $500 million is what we expect in terms of peak sales. For Simparica, as a single agent, it was to generate more than $100 million, and when we introduce this three-combo product, then we'll update on our expectations. So we have not yet provided details of what we expect for Simparica platform, that will include the single agent plus also Stronghold Plus, later also Revolution Plus in the U.S. and also the triple combo. In terms of PHARMAQ, we are convinced that this will continue generating double-digit growth. We expect double-digit growth in 2017. We have not yet provided details for 2018. We'll be providing this information in a later date. On Nexvet, it's too early to define what are the projections for the monoclonal antibody for managing pain in both dogs and cats. So, in all the pain market for dogs, it's about $400 million and we also know that cat is a real unmet need. So we see also opportunities to bring a monoclonal antibody to manage that pain for cats. In terms of diagnostics, we acquired SMB; that also complements the previous acquisition of Synbiotics. Now we have future participation in two segments. One is the rapid test at point of care, and the other one is equipment that will be coming out of the programs which have been developed by SMB. We are convinced that SMB have very interesting platforms in different areas : chemistry, immunology, molecular, also specialty. And we'll be working on developing all of these programs to bring products into the market. It will be a phasing of introduction of products, and we are confident that end of 2017 or early 2018, we'll start introducing new products into the market. Next question? Operator : Your next question is from Erin Wright with Credit Suisse. Please go ahead. Erin Wilson Wright - Credit Suisse : Great, thanks. Can you speak to some of the initiatives you alluded to in you prepared remarks in terms of the manufacturing footprint and also the potential for further rationalization? It sounds like you continue to expect the 200 basis points in gross margin expansion associated with those initiatives, I guess starting in 2018, but could that process be expedited at all? And then my second question. You mentioned building cash flow, which I think that statement is still absent from the press release disclosure. But can you speak to capital deployment priorities, how is the M&A pipeline shaping up, and is Nexvet fully incorporated into your guidance at this point from an expense perspective? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Okay, thank you, Erin. We'll mention the comments on manufacturing initiative. So, first, we are – the manufacturing is always a continuous work in design opportunities for being more efficient. Reducing cost, it's a priority, but it's not the only priority that we have in design and manufacturing. We also want to make sure that we are improving the cost, at the same time ensuring that we have reliable supply. And at the same time that we are also working on reliable supply that we'll reduce our inventory levels. So this is something that is a target for the company. We identified a target for 2017, and we'll continue targeting inventory improvements over time. In terms of the initiatives that we already communicated is the 200 basis points by 2020. And you're asking if we can accelerate that. I think it's something that – we always try to do things as fast as we can, but at this point, what we are really targeting is to ensure that, by 2020, we generate these 200 basis points. And we also need to understand that, in some cases, these savings as a result of transferring the products from one plant to another plant or different plants, is something that it takes time, because it's a complex process to move products from different plants, and we need to make sure that when the product is in the final destination, it really delivers in terms of cost and also in terms of supply to the market. We also expect that, because of all the product rationalization, all the manufacturing plant rationalization, also we have opportunity for impact in terms of volumes and improving our allocation of overheads. In terms of cash flow and the priorities for our cash, we remain committed to invest internally, investing in commercial, and we have examples this year to invest in DTC campaigns to support new product launches. We also continue committed to bring innovation to the market internally with our R&D expertise and capabilities, and we see opportunities also for further expansion of some of the areas in where we think that we can improve our operations in terms of manufacturing, with special attention on ensuring that we have the right capabilities and capacity for vaccines in developed and also in emerging markets that also will be equally important. And we also mentioned that we, as a second priority, it's identified opportunities that will complement our internal efforts and will support further revenue growth and further profitability. And it's something that we are committed to identify these opportunities and bring these opportunities – to keep these opportunities – can bring values to our operations. And finally, you also asked in terms of Nexvet guidance. At this point, we are not yet providing any guidance in terms of Nexvet. It's too early. So we need first to have full control of all the programs that Nexvet has been – developed. We have access to some of these programs, but now that our R&D colleagues are really working together with Nexvet R&D colleagues, then we'll have a full understanding of the opportunity. So, Glenn will add some comments. Glenn David - Zoetis, Inc.: Yeah, Erin, just to clarify on the Nexvet. So for 2017, you'll notice that we did raise our R&D guidance, and that was to reflect the costs the we see for 2017 for Nexvet. Juan Ramón comment was more in terms of long-term guidance for Nexvet. The other thing I just wanted to comment on was the manufacturing initiatives. There are certain investments that we are contemplating that will lead to some increased capital expenses that'll keep our capital expense as we move to 2018 probably more aligned with previous years. However, those initiatives we do believe will shore up supply for some of our newer products, some of our key products, as well as key products in key markets. And they'll also have the right return from a financial perspective, bringing our costs down on those products as well. Next question? Operator : Your next question is from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Good morning, guys. Just, Juan Ramón, could you maybe give us an update on what you're seeing in the companion animal market? You guys gave some good detail on Simparica. Wanted to see why we saw the sequential decrease in Q2 and what your outlook is for distributor increases who are purchasing in the back half of the year. And do you plan on expanding your relationship with those distributors? And then secondly, on the production animal side, you've talked about the premium line of antibiotics like Draxxin. Did you say you expect the trend to reverse in the second half, where – kind of the midsize cattle being in the feed lots, and that could lead to increased sales? Juan Ramón Alaix - Zoetis, Inc.: Well, thank you, Kevin, for the two questions. So first on the companion animals. So on companion animal, we expect that we'll continue generating very positive growth in the second half, and we expect that the differential between companion animal and the livestock will remain in the second half of the year. We have seen in the second quarter growth in the U.S. of companion animal, 7%, while international market was 15%. I think it was in line with our expectations. The U.S. in the second quarter in companion animal, we had some additional promotional activities that also had a temporary impact in terms of prices, but the growth in the different parts of the companion animal portfolio have been in line with our expectations. Simparica also had additional revenues in the U.S. in the first quarter. That had an impact in the second quarter. But we don't see any situation that is different than what we expected, very pleased with the performance of new products, Apoquel, Cytopoint, and Simparica. All indicators are showing our progression in terms of market share improvement in both – for dermatology and also for parasiticide segment. And in the other inline portfolio, again, so we have not seen any change in the generic assumption, so I think it's something that – it's in line with the plan that we have seen in previous quarters, maybe occurring on Rimadyl that's has been affected by the interaction of Galliprant. Galliprant is another product for treating pain, and we know that in this market, new products, they get significant attention and growth. And this growth is maintained depending on the results that are showing in the mid and long term in terms of efficacy and safety. But we are very pleased with our overperformance in companion animal, and definitely it's a significant driver of our growth in the first half, and we expect also a significant driver of our growth in the second half. In terms of the trends for the cattle in the U.S., you mentioned the Draxxin impact. I will say that maybe – well, definitely the mild winter and also the heavier animals into the feedlot had an impact in terms of the use of premium antibiotics. The other impact that we have seen was also the implementation of the Veterinarian (sic) [Veterinary] Feed Directive that has been affecting our cattle business, especially the medicated feed additives. We saw that it was affecting temporary to smaller producers in the U.S., and they will be adjusting how to use these products in the future. This adjustment is taking longer, and we have incorporated in our guidance a more permanent impact in our revenue. But, having said that, we expect more favorable conditions in the second half of the year for cattle, and we also have seen that in the second quarter premium antibiotics has been performing very well in the year. Next question? Operator : Your next question's from David Risinger with Morgan Stanley. Please go ahead. David, can you check the mute function on your phone? Juan Ramón Alaix - Zoetis, Inc.: Maybe we can try the next one? Operator : Yes. We'll go next to Kathy Miner with Cowen & Company. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. Just a follow-up on the dermatology sector. Can you give us a little bit more color on Cytopoint, and how you characterize its use? Is it being used more every four weeks or every eight weeks? And are you seeing it used in more Apoquel-treated dogs or non-Apoquel dogs? And also just on Apoquel, can you talk about whether you're starting to see – getting any more traction in the acute and shorter-term settings as opposed to the chronic use? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Kathy, and I will start with Cytopoint. And, first, I think Cytopoint has been – well, the indication of the label in the U.S., it's four to eight weeks. And we see that it's more used on the mid of this four to eight weeks than at four weeks. And we have seen also seen that Cytopoint in its infancy also having a 28% cannibalization to Apoquel. But combining both together, I think we are growing very nicely. And now I think we see the opportunity also to extend these experience to the European markets, in where we started the early experience program, and we expect a full launch in September in the European market. And in the European markets, the label, it will be different. It will be 1 milligram on four weeks, compared to 2 milligrams on four to eight weeks in the U.S. But still the products are very consistent in terms of efficacy and also in terms of safety. For Apoquel, we have seen now that Apoquel use has been extended or increased in terms of acute, but also in terms of seasonalized conditions for dogs, and this is the result of now full availability of the product in the market, and we believe also the effort that we are making in terms of direct-to-consumer advertising. Chronic use will remain the main generator of revenues because the use will be very prolonged, but the acute or the seasonalized use of the product also will add significant opportunity. Next question? Operator : We'll go next to Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Okay. Good morning, folks. Thank you for taking the questions. Juan Ramón, just want to clarify your comments on Rimadyl. So I guess the pain franchise was lower, because of new product competition and not cheaper generics from the distributors. And then a follow-up on Brazil. Very good performance there given everything that's going on. My understanding is that the USDA has banned fresh beef imports from Brazil because of safety concerns. Obviously we know there's other concerns there as well in Brazil. So what impact could all of this have longer term on your business? And is there an opportunity for U.S. livestock to do better as a result and gain share? Thank you very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Alex. So for the question on Rimadyl, So we are not saying that generic competition is not gaining share. It's gaining share in line with previous comments. And there – well, the message I wanted to convey was that we have not seen significant changes in the trends of the generic penetration. What we saw is that product, which is Galliprant, which is a new product that has been introduced recently, it's a product developed by Aratana and commercialized by Elanco, it has been gaining share in this pain market. We have seen also in the past that new products in this market are having rapid penetration, because it's still some level of dissatisfaction in terms of safety. And products coming into the market may have some opportunity, and definitely the opportunity will be maintained if it can really deliver on the expectations in the medium and long term. But we don't think that will be something that – we are confident that Rimadyl, with so many years in the market, with a very well-established profile in terms of efficacy and also in terms of safety, will remain a key player in terms of managing pain for dogs. At the same time, so moving into the acquisition of Nexvet, it's very strategic for us to maintain our leadership in this area. We are convinced that there is still unmet needs in this market in terms of safety and efficacy. And monoclonal antibodies can really fill this gap in terms of providing an alternative to current products in the market, and we are convinced that in both in dogs and cats, monoclonal antibodies will play a significant role. In Brazil, definitely the scandals are not helping, but we have been managing quite well. Our growth in Brazil despite of this political and scandals situation and we – the investments that we made in terms of expanding our field force are having a very positive favor. We are growing sales in Brazil very rapidly in cattle, but also in some other areas. Areas like companion animal is also driving significant growth. And Brazil in general has been a market exporting in most of the cases processed beef rather than fresh beef to some of the markets, and this is not really changing. And Brazil, they had a temporary challenge when they had the scandal in terms of the meat quality with China, but this has been already managed. And I think the prospects for Brazil are very positive, and definitely Brazil will be continue competing with the U.S., although today they are competing with a different quality of meat. U.S. is much more focused on quality, while in Brazil at this point they are much more focused on process, which has – not so important in terms of quality. So very positive in terms of future growth in Brazil, and also we see some additional opportunities in terms of export in the U.S. Next question please? Operator : And our last question will come from Brett Wong with Piper Jaffray. Please go ahead. Brett W. S. Wong - Piper Jaffray & Co.: Hey, guys. Thanks for taking my question and fitting me in here. Just wanted to see if you could talk a little more on the U.S. livestock fundamentals. You already talked about the beef cattle outlook into 2018, expecting expansion. But how long are you expecting expansion in the other species like chicken? And when we see contraction in any of those markets including cattle, what is the expected impact to the business, given that the animal health products are a lot less discretionary in nature? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Brett. And so we think that the fundamentals of the U.S. livestock are very strong. So, in terms of cattle, I described that in our opinion, cattle will continue being an important part of the production of quality meat in the U.S. and also export to many other markets. We expect also that the growth in terms of number of heads in cattle will moderate in 2018, but still growing, which is positive. And we also think that in both in poultry and swine, the production in the U.S. is very efficient. They are very competitive. The consumption of animal proteins worldwide will continue growing, and the U.S. will continue playing a significant role in terms of producing the meat that will be reaching their customers around the world. The poultry and the swine, they are two areas in where they can manage very well the additional volumes. And we expect that in 2018, poultry and swine also will remain positive. If we move – I was making comments in general to the market. If we move to our specific business, so we expect both poultry and swine in the U.S., showing positive growth in 2018. So we expect to bring new products. And also we have seen that even for producers that are moving to No Antibiotics Ever, we can offer to these producers a very good portfolio that will meet their demand. At the same time, also we generate also a very positive growth in our company. Next question? Operator : It appears we have no further questions. I'll return the floor to you, Juan Ramón, for any closing comments. Juan Ramón Alaix - Zoetis, Inc.: Thank you very much for joining us today. And we mentioned during the call, we are very pleased with the results. We are also very confident on the guidance for 2017. And, as I mentioned, companion animals will continue driving growth. But we see also positive growth in terms of livestock. We expect in the second half also maintaining the differential of growth that we have seen with the companion animal and livestock in the first half. With that, thank you very much for joining, and looking forward for meeting you again in the third quarter earnings call. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,017
| 4
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2017Q4
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2017Q3
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2017-11-02
| 2.194
| 2.245
| 2.545
| 2.595
| 3.77294
| 24.61
| 25.16
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: Michael Ryskin - Bank of America Merrill Lynch Kevin Ellich - Craig-Hallum Capital Group LLC Alex Arfaei - BMO Capital Markets (United States) Louise Chen - Cantor Fitzgerald Securities Jami Rubin - Goldman Sachs & Co. LLC Erin Wilson Wright - Credit Suisse John C. Kreger - William Blair & Co. LLC Jonathan David Block - Stifel, Nicolaus & Co., Inc. David R. Risinger - Morgan Stanley & Co. LLC Kathy M. Miner - Cowen & Co. LLC Esther Rajavelu - Deutsche Bank Securities, Inc. Operator : Welcome to the Third Quarter 2017 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and it will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial in or on the Investor Relations section of zoetis.com. At this time all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is not my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you, operator. Good morning and welcome to the Zoetis third quarter 2017 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 in the company's 8-K filing dated today, November 2, 2017. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. Our performance through the first nine months has been consistent with the guidance we provided at the beginning of the year. Companion animal has continued to drive our revenue growth in 2017, based on an innovative dermatology portfolio, our new oral parasiticide, Simparica, and other new products and lifecycle innovations. We have also accelerated our revenues and adjusted earnings and improved our margins in the third quarter, as our cost improvement have become more fully reflected in our results. We expect these to continue for the rest of the year, as reflected in our updated guidance. We are also delivering our strong performance, despite the negative impact of the implementation in the U.S. of the Veterinary Feed Directive. This has had a higher and lower impact on the U.S. cattle and swine businesses than we initially expected. Once again, the diversity of our portfolio is helping us to deliver consistent result and grow further in the market, despite these and other challenges, such as economic crisis, political instability, and regulatory changes. Our results are enhancing our financial strength. And we continue investing our capital and resources internal and external opportunities. We are executing our plans for future growth, and we are confident in our raised guidance for full year 2017. In the third quarter, our revenue grew 8% operationally. And we are at 7% operational growth for the first nine months of the year. The main driver for our third quarter revenue growth remains companion animal products, which grew an impressive 19% operationally and 13% through the first nine month. This was driven largely by sales of our industry leading dermatology portfolio consisting of Apoquel and Cytopoint, our new oral parasiticide, Simparica, and several other new companion animal products. In the U.S., companion animal products grew 21%, and in international markets, they grew 15% operationally. We continue to expand our business in dermatology. Our latest data in the U.S. shows that 59% of dogs with dermatology conditions are treated with Apoquel or Cytopoint, up from 55% in the second quarter. Cytopoint has now been fully launched in the fourth quarter in European Union, and we expect to generate further Cytopoint growth in these countries. As a result of the success in the U.S. and continued expansion in other international market, our global dermatology portfolio achieved $124 million in sales in the third quarter, up from $102 million in the second quarter. Through the first nine months of the year, our dermatology revenue is at $303 million. And now, we expect peak sales of more than $500 million. Simparica sales also increased in the third quarter. And we continue to track well with our expectations for the year in this large, but highly competitive market. We obtained approvals in new markets like Japan and Taiwan. And expect to launch in the first quarter of 2018. We remain confident in the blockbuster potential of this product. The direct-to-consumer advertising campaigns for Apoquel and Simparica, which began in the second quarter in the U.S. have had a positive impact on sales and are in line with our expectations. We have been able to support disease awareness for atopic dermatitis, and have established more brand recognition and product differentiation for Simparica, as a superior flea and tick protection. Meanwhile, our livestock portfolio grew 2% operationally, with increases in fish, poultry, and swine products, offset by a decline in cattle products. In fish products, we increased our third quarter sales 52% operationally, roughly equal to our total sales for the first half of this year. This strong performance was driven by the launch of a new vaccine in Norway to prevent pancreatic disease in salmon. And we have also worked with customers in Chile and seen a resumption of strong sales there for our SRS vaccine for salmon. We feel very positive about these new two products for farm fish, and we continue to lead the vaccine market for supporting the salmon production. Our expansion into vaccines for other fish species in other global markets will help drive future growth for our fish business. In the case of poultry products, we grew 7% operationally. We continue to generate strong growth in the U.S., where our expertise and broad product portfolio are helping customers address evolving consumer and retailer preferences. Using our Poulvac vaccine and medicated feed additive such as Zoamix, Robenz or Deccox is helping certain producers, who are choosing to shift to no-antibiotic-ever production. In the third quarter, our swine products grew 1% operationally, led by strong international sales of our Suvaxyn PCV combo product and by sales of Improvac in Brazil. The growth was offset by decline in the U.S. pork business, but our updated PCV M-Hyo vaccine in the U.S. continues to demonstrate good customer adoption. We believe our U.S. pork business is positioned to return it to at/or above market growth in 2018. Overall, our U.S. swine business and U.S. cattle business, were both impacted by ongoing implementation of the Veterinary Feed Directive, or VFD, which caused changes to some producer's protocol for use of medicated feed additive. In the cattle market, our sales declined 2% operationally. This decline was driven by the U.S., mainly due to the VFD implementation, as well as the impact of promotional activities last year and healthier animals. We continue to see positive growth in other major beef markets like Brazil, Argentina, and Australia. We also still see positive signs related to the export from the U.S. and increasing herd size in 2017 and into 2018. We expect our U.S. cattle business will return to growth in the fourth quarter. As for earnings in the third quarter, we posted 25% operational growth in adjusted net income, significantly faster than revenue growth of 8%. And year to-date, we have generated 16% operational growth in adjusted net income. Our value proposition for shareholders has always been based on growing adjusted net income faster than sales, while making the right investment in our commercial, R&D, and manufacturing capabilities to ensure long-term profitable revenue growth. In terms of innovation in the third quarter, the European Commission granted us approval for a new addition to the Suvaxyn/Fostera family of vaccines for swine. This new product is a modified live vaccine that protect pigs against their porcine respiratory and reproductive syndrome, one of the most common diseases affecting swine herds. Also in the third quarter, Zoetis extended its poultry portfolio with the approval of the new Poulvac vaccine in Korea to prevent certain local strains of infectious diseases. We are also continuing with our supply network strategy to support our new products and long-term growth. Manufacturing is critical to our past and future success. Over the last few years, we have eliminated a number of low volume products from our portfolio and reduced our manufacturing footprint to improve our overall efficiency. While we still have the imminent sale of our Guarulhos plant in Brazil to complete, we also have several opportunities to invest and position our manufacturing network to best support our portfolio; secure manufacturing control over high value products and improve their cost. For example, we plan to build a new manufacturing facility in China. This site will expand our capacity to develop and manufacture vaccine for swine, cattle, and farm fish for the Chinese market. It would also serve as a central research center in China. We anticipate breaking ground in spring of 2018. In October, we also acquired the remaining 55% ownership stake in the Jilin Zoetis Guoyuan joint venture from our partners in China. And now we have sole ownership of the JV, which was founded in 2011 to produce swine vaccines. In Ireland, we recently acquired the former MSD manufacturing site in Rathdrum. This facility will give us better control of active pharmaceutical ingredients, which are used in many of our key products. It will also make us less dependent on third parties and improve our long-term cost for these durable assets. We have also announced plans to expand manufacturing capacity at our facility in Kalamazoo, Michigan to support more products like Simparica, and we expect to complete those renovations by early 2019. And in Charles City, Iowa, we are finalizing plans to expand our site and increase capacity for new poultry vaccines in the coming years. All represent important uses of our capital to build and ensure our capacity for growth. In summary, we continue to use our direct sales presence, our diverse and innovative portfolio of our products and high quality manufacturing network to achieve our financial goals in the first nine months of the year. As we move into the fourth quarter, we are raising our full-year 2017 guidance for revenue and net income based on our continued confidence in our performance. With that, let me hand things over to Glenn, who will provide more details on our third quarter results and full-year guidance. Glenn David - Zoetis, Inc.: Thank you, Juan Ramón, and good morning, everyone. We delivered another solid quarter with top line growth coming from our dermatology portfolio and new companion animal products, and with strong performance from our international livestock portfolio in key markets, including Brazil, Australia, Japan, and Mexico. Total company revenue grew 8% operationally, excluding a favorable 1% impact from foreign exchange. Of that 8%, 4% came from dermatology products, 4% came from Simparica and other new products, and the remaining portfolio was relatively flat. Unlike recent quarters, our product rationalization has limited impact on our growth this quarter, and we expect the same for the fourth quarter. Now, a few revenue highlight. Our dermatology portfolio once again surpassed the $100 million mark with $124 million in sales in the quarter. As we've indicated in the past, Q2 and Q3 are the peak seasons for dermatitis in the U.S. Sales of Simparica were $25 million in the quarter, growing 280% over the prior year and 21% sequentially. In terms of the bottom line, we delivered 25% operational growth in both adjusted net income and adjusted diluted EPS. We were able to achieve this significant level of growth due to the full year impact of cost reductions from our operational efficiency initiative, as well as leveraging our infrastructure. Our performance in this quarter is another example of our ability to execute on our value proposition of growing adjusted earnings faster than sales over the long-term. Now on to segment revenue. Our International segment generated operational revenue growth of 11%, while the U.S. grew 6%. Our International segment displayed balanced growth across both species and markets. This growth is a testament to our diversity, not only from a product portfolio perspective, but geographically as well. Turning to some key markets in the quarter. Starting with Australia; favorable market conditions for livestock drove growth of 19% operationally. Higher sheep prices combined with greater market penetration of our vaccine contributed to growth. And the beef cattle herd in Australia continued its expansion following several years of drought. In companion animal, our growth was driven by Apoquel. In Brazil, we grew 14% operationally in the quarter, behind the strength of both our livestock and companion animal businesses. In livestock, investments we have made to expand our field force, in addition to favorable market conditions continue to contribute to growth in cattle product. In swine, increased sales of Improvac were driven by higher usage and greater penetration with larger customers. Meanwhile, higher companion animal revenue in Brazil benefited from the continued growth of Simparica, as it's known in Brazil. Switching to China. We delivered another strong quarter, growing 22% operationally with growth coming from our companion animal vaccines business. Underlying demand for our vaccines remain strong due to improving medicalization rates and a growing population, and growth in the quarter was aided by supply resumption of one of our vaccines. Revenue in Japan declined 3% operationally in the quarter, due to a difficult comparison with the third quarter of 2016, when we experienced a significant initial stocking of Apoquel with wholesalers. Inventory levels have stabilized and we see a healthy rate of sales for Apoquel in Japan, driven by strong demand. PHARMAQ, which is reflected in other developed and other emerging markets, experienced significant growth in the quarter. This was driven by our recently introduced vaccine for pancreatic disease in Norway, as well as in-line product growth across various markets, including Chile. Norway and Chile are the two largest farmed salmon markets in the world, which combined, account for approximately 80% of global farmed salmon production. To summarize, a very strong quarter for our International segment with growth across the diversified portfolio, including all of our core species and key markets. This performance was driven by a combination of favorable market conditions, strategic investments, and our ability to consistently drive commercial results. Turning to the U.S.; revenue grew 6% in the third quarter. Companion animal grew 21% in the quarter, while livestock declined by 6%. Companion animal product sales in the quarter were driven primarily by our dermatology portfolio, Simparica, and a number of other recently launched products. U.S. dermatology sales were $89 million for the quarter with Cytopoint sales reaching $20 million in the U.S., exhibiting nice growth over both the prior year, as well as on a sequential basis. In addition, as Juan Ramón previously mentioned, we continue to see increasing penetration in total patient share reaching almost 60% in the quarter. This performance also resulted in 80% revenue share of the market. With the premium nature of our dermatology products, we are significantly expanding the size of the market, as we continue to grow patient share. Simparica grew significantly over the same quarter last year as our direct-to-consumer investment, field force focus, and other promotions led to higher clinic penetration. Additional contributions to companion animal growth came from new product launches, including Diroban, a recently approved product for the treatment of heartworm, and a number of line extension for our Vanguard vaccine franchise. Moving to U.S. livestock, sales declined 6% in the quarter, due to the performance of our cattle and swine businesses that more than offset robust growth in our poultry business. Declining sales in our cattle business have been impacted by a number of factors, including the impact of promotional activities in the prior year, lower disease risk, and incidence, as well as the continued implementation of the Veterinary Feed Directive and its impact on Aureomycin sales. On a year-to-date basis, the impact of the VFD on our cattle and swine business has been approximately $30 million. Our swine business declined again this quarter in the U.S., primarily due to competition in PCV/M. Hyo vaccine market, as well as the continued implementation of VFD. On the positive side, our updated PCV/M. Hyo vaccine continues to gain traction with small and medium sized producers. Hence, in U.S. poultry, the Zoetis portfolio of alternatives to antibiotic medicated feed additive continues to be the primary driver of growth, as certain producers expand their No Antibiotics Ever label. Our portfolio is well positioned to address these evolving industry practices. Now, turning to the rest of the P&L. Adjusted gross margin of 67.9% increased approximately 40 basis points on a reported basis versus prior year, and on a sequential quarter basis improved 230 basis points in the second quarter of this year. Our cost in this quarter, reflect the impact of cost improvements in our manufacturing network, as the higher cost inventory from 2016 has largely worked its way through our P&L, as expected. Adjusted SG&A declined by 2% in the quarter, as we continue to see the full impact of the expense reductions from our operational efficiency initiatives. Adjusted R&D expense increased 6% for the quarter, due primarily to the timing of project spending and incremental R&D associated with recent acquisitions. Operating expenses, in total, were flat versus the same period last year and they reflect significant decreased spending in G&A. Those savings are being reallocated to value generating investments in commercial operations and innovation, including direct-to-consumer advertising, field force expansion, and increased R&D. The adjusted effective tax rate for the quarter was approximately 29%. It has significantly improved from the prior year, due to the impact of the favorable jurisdictional mix of earnings. The year-over-year improvement in our adjusted effective tax rate was a driver of operational adjusted net income growth and contributed 5% in operational growth to the overall 25% for the quarter. Moving to guidance, for full year 2017, our consistent top line performance through the year, success of productive investment, as well as effective discipline on costs are allowing us to improve our outlook for both revenue and adjusted diluted EPS. For the year, we are raising and narrowing our revenue guidance, and we now expect to deliver between $5.225 billion and $5.275 billion at revenue. The increase to our revenue expectation for the year is due to continued strength in our international business and the acceleration of our normal annual price increase in U.S. livestock to harmonize the timing of our price increases across our business. Our guidance for adjusted cost of sales for the full year continues to be approximately 33%, as we expect the continuation of the improvement we saw in Q3. For SG&A, we're increasing the range to reflect variable costs associated with our higher outlook at revenue. We've increased the lower end of adjusted R&D spend, as we continue to invest in future growth. Our guidance for the adjusted estimated tax rate of approximately 29% is consistent with our prior view and does not take into account any potential changes being discussed in Washington. With more than half of our adjusted pre-tax income in the U.S., a lowering of the U.S. corporate tax rate would have a meaningful benefit to us. As a result of the changes above, we have increased below and high-end for operational adjusted net income and now expect growth of 18% to 21%, corresponding with adjusted EPS expectations of $2.34 per share to $2.39 per share. In the third quarter, we also repurchased another $125 million in shares. And our guidance for reported and adjusted earnings per share reflects the share repurchases completed through Q3. In September, we announced a senior debt offering of $1.25 billion. The financing was completed as favorable long-term rate with a blended coupon of 3.38%. $750 million of these proceeds were used in October to retire debt that was scheduled to mature in the first quarter of 2018. The additional debt added to our balance sheet will align our gross debt-to-EBITDA ratio within our preferred range of between 2.5 times and 3.0 times, as well as add incremental interest expense for the remainder of the year, which we have incorporated into guidance. Again, looking forward to 2018, we will have growth in our interest expense, based both on the higher debt balances, as well as the longer-term nature of the new debt. So just to summarize before we go to Q&A, we are undertaking a number of activities that serve as an indication of our commitment to sustainable and profitable growth. In manufacturing, we are investing in additional capacity for new products, building sites in important emerging markets and bringing strategic products under our full control, while improving cost. In R&D, we continue to invest in a range of innovation, from new novel compound and extending the life of existing brand to groundbreaking platform technologies, such as monoclonal antibodies. In our commercial operation, we've invested in direct-to-consumer advertising to raise awareness and grow the market for important new products, as well as expanded our field force presence in fast growing markets like China and Brazil. We continue to look for new external business development opportunities and invest in the recently acquired businesses, including Nexvet for unmet needs in chronic pain and PHARMAQ for farm fish, which experienced significant growth in the quarter. With that, I'll hand things over to the operator to open the line for your questions. Operator? Operator : Thank you. We'll take our first question from Derik de Bruin with Bank of America Merrill Lynch. Please go ahead. Michael Ryskin - Bank of America Merrill Lynch : Hi, thanks. This is Mike Ryskin on for Derik actually. Thanks for all the color on the quarter in terms of the moving parts for the companion animal portfolio and livestock as well. I was just wondering you mentioned that you expect U.S. cattle to return to growth in the fourth quarter. In terms of the impact you saw in the current quarter, could you breakdown how much of it was the lower incidence of disease risk versus the MFA headwinds? And then a quick follow-up in terms of volume and price contribution overall in the quarter. It sounds like you didn't see any price benefit. Is there an expectation that you will return to sort of 100 bps to 200 bps in 4Q and going forward, and what were the drivers of that? Thanks again. Juan Ramón Alaix - Zoetis, Inc.: So, thank you, Mike. So definitely, we expect the U.S. cattle return to growth in the fourth quarter. You ask what were the drivers of the impact on the third quarter. Definitely, some of the impacts have been related to the Veterinary Feed Directive that had more permanent and higher impact that we initially estimated. So this has been year-to-date, as Glenn mentioned, something like $30 million. The other impact that was specific to the quarter, was some promotional activities that we did in the third quarter of last year that we didn't repeat this year. And this had a negative impact in this quarter. And finally, we have seen that the animals because of the weather condition has been showing healthier conditions, and this has been mainly affected the use of some premium antibiotics. We expect this type of things being corrected in the fourth quarter, and then, as I said in the fourth quarter showing a positive growth in U.S. cattle. Then the second question was about price volume, and Glenn will respond to that. Glenn David - Zoetis, Inc.: Yes. So Mike, in terms of price and volume, for the overall business we saw about 8% volume growth and relatively flat price. And that flat price is really driven by two things. A, we saw positive price movements in international as we were able to take advantage of inflationary markets. And then, we did slightly decline in the U.S. in price in the quarter, really just driven by certain promotions that we had in the quarter. Over the long-term, we still expect to return to positive price increasing for the business. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll take our next question from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Good morning. Thanks for taking the questions, and congrats on a nice quarter. Juan Ramón, I guess starting off with the aquaculture business, really strong growth driven by Norway. Can you talk about that new product that you launched, and is that also available in Chile and how big do you think aquaculture can be over time for you guys? Juan Ramón Alaix - Zoetis, Inc.: Well, the product that we launched in Norway is specific to Norway. It's pancreatic disease that there is a vaccine or it's a condition that is quite prevalent in some part of Norway. And we were not participating in this business. Now, we have a vaccine and this vaccine is performing extremely well, and also having a positive impact in the rest of the portfolio. We are not expecting that pancreatic disease affecting Chile, but in Chile for instance we have the SRS disease, which is not affecting Norway. So we – as in many other parts of our business some of the diseases are very specific to countries or regions that's why we need to also – to respond to these diseases. We have different products depending on countries of origin. This year, we initially forecasted $125 million in revenues for the farm fish because we had some challenge in the second quarter in Chile also related to this SRS vaccine. We had some negative impact in the quarter that has been solved in the third quarter, and we expect continue growing on the SRS in Chile. But because of the impact of the second quarter, we have adjusted our projection for the year, about $110 million, $115 million. Long term, I think we expect that this business will be growing faster than the average of the animal health industry, animal health industry growing at 5% to 6%. We expect the farm fish growing faster, especially the area of vaccines in where we are leading, and we expect that we will continue bringing innovation to the market. Next question, please. Operator : We'll take the next question from Alex Arfaei with BMO Capital Markets. Alex Arfaei - BMO Capital Markets (United States): Good morning. Thank you very much for taking the questions. First, I just want to clarify, I understood the comments on U.S. livestock correctly. So you not only expect to return to growth in 4Q, but you expect in line with the market growth in 2018, and could you tell us what your expectations for the market is? And then, just a broader question, Glenn, I think you said 4% of the growth is coming from derm, 4% of the growth is coming from Simparica, and the rest of business was flat. That clearly doesn't – that clearly implies that you need new products for growth. And the issues on the U.S. livestock aside, I just want to get a better sense as to how you think you're competitively positioned, and particularly the derm space, I'm sure this growth hasn't gone unnoticed by your competitors. So, as these launches moderate, A, how do you think, you will compete relative to the competitors? And yeah, I'll stop there. Thank you very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Alex. I will respond to the U.S. livestock question first, and then we'll discuss about the competitive landscape in dermatology. So first, as I said that we expect the fourth quarter, the U.S. cattle business returning to growth. In the U.S., the poultry business is doing very well. Pork has been challenging during the year. In both cases, cattle and pork or swine, we expect growth in 2018. I mentioned that in the swine or pork business, we expect to grow at or above market growth. In the case of cattle, what we see is that there are positive factors; export remains strong. We expect also that the number of animals will continue growing in 2018. The market is a little bit more positive now about the expansion of herd than some month ago. And the other element that we expect also will have a positive impact in our revenues will be the products affected by the Veterinary Feed Directive, has been rebased. And in terms of growth, we don't expect any significant impact in 2018. So all these elements make us confident that the livestock in general for the U.S. will be showing positive numbers. One of the things that is always important to remember is that, we have a portfolio, which is highly diverse in terms of geographies. And we know that in some cases we'll be facing challenge – one market that will be compensated with maybe acceleration of revenues in other market, which is what is happening in 2017. And we continue to expect that this will be an element that will provide more sustainable and predictable growth in our business. The second question was about competitive landscape in dermatology. Today, we are only competing with steroids, we are competing with some other products that are creating probably not significant revenues in this market. We expect that in the future, some of our competitors will bring products into the market. This is an area that we show that it's a significant opportunity. Now, we are projecting more than $500 million combining Apoquel/Cytopoint. So, it's something that definitely we can expect in the future. But just as a reference, so for us developing Apoquel took about eight years, Cytopoint seven years. So, even if competitors now are reacting based on the success that we are delivering, definitely yeah, I think we feel comfortable that in the coming years, we'll maintain our very strong position in the market. Next question, please. Operator : We'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen - Cantor Fitzgerald Securities : Hi. Thanks for taking my question here. So, now that you've optimized your operating platform, how do we or how should we think about your cash flow generation going forward, and how do you prioritize this cash? And then, the second thing here is just that you had a very robust gross margin this quarter, how sustainable is that going forward? Thank you. Juan Ramón Alaix - Zoetis, Inc.: I will ask Glenn to cover these two questions. Thank you, Louise. Glenn David - Zoetis, Inc.: So, from a cash flow generation perspective, I think when you look at 2017, we've guided that we see our operating cash flow pretty closely approximating adjusted net income and that implies significant growth in cash flow this year, as we get out of lot of the cost related to our operational efficiency initiative, the implementation of SAP and other cost. And we continue to expect to drive cash flow growth at a faster pace than adjusted net income, as we do have opportunities in working capital, particularly in inventory that we'll continue to leverage. In terms of the gross margin, so we saw nice improvement in gross margin in Q3. And just as a reminder, in the first half of the year, we had gross margin of about 65%. As we moved into Q3, our gross margin is 67.9%. As we got away from the cost of the previous years' inventory and how we worked that through our P&L, and this was exactly as we expected and it does give us greater confidence in our full-year guidance of cost of goods at approximately 33%. And in terms of how that moves forward, while we're not giving specific guidance for 2018 at this point, we still are committed to the 200 basis point improvement in gross margin by 2020, and we do expect to see some of that come forward in 2018. Juan Ramón Alaix - Zoetis, Inc.: Next question please. Operator : Next question comes from Jami Rubin with Goldman Sachs. Please go ahead. Jami Rubin - Goldman Sachs & Co. LLC: (41:34-41:44). Juan Ramón Alaix - Zoetis, Inc.: We couldn't hear you. Are you still there? So, next question please. Operator : We'll take the next question from Erin Wright with Credit Suisse. Please go ahead. Erin Wilson Wright - Credit Suisse : Thanks. A follow-up on the gross margin trend in terms of species mix and profitability. What were sort of the major components driving that gross margin trend in the quarter? And curious why, I guess, it wasn't even higher given the disproportionate exposure to presumably a higher margin business, and I think you mentioned promotional activity around that, but how much was that a contributing factor and will that continue? And then, the second part on the VFD. I guess, how do you expect to offset this, I guess near-term? As we head into 2018, do you anticipate incremental headwinds from the VFD in medicinal feed additives in the U.S. alone in 2018. And is this greater than what you've kind of experienced, I guess in 2017, and what have you sort of gleaned from (42:47) or can compare it to what has transpired in Europe in terms of those regulations? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Erin. Glenn, do you want to answer the gross margin question, please. Glenn David - Zoetis, Inc.: So, in terms of gross margin for the quarter, Erin, and what are the components that drive it, and why it couldn't necessarily be even more favorable. There are number of factors in terms of gross margin. So, A, there is the product component that you referenced. But there is also the market mix component. And when you look at the quarter in particular, we saw stronger growth in our international market versus U.S. and as our international markets generally have lower gross margin than the U.S. in total that did impact the quarter. Juan Ramón Alaix - Zoetis, Inc.: And in terms of the VFD, we think that the impact has been mostly affecting 2017, and it's pretty much now the impact or the volume of products affected by these new directive been rebased. We expect that some minor impact in 2018, but not having a significant impact in our revenue growth. Next question please. Operator : We'll go next to John Kreger with William Blair. Please go ahead. John C. Kreger - William Blair & Co. LLC: Hi, thanks very much. Could you give us an update on generics on your business. So, both in terms of what brands are seeing the most erosion from generic pressures, and then, conversely how is your generic business doing? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, John. So, in terms of generic, we have not seen an acceleration of penetration in this year, so it's in line with our expectations. We continue supporting our products that are affected by generic competition with lifecycle innovation, and an example has been the introduction of the chewable formulation for Clavamox. Clavamox is doing very well, and we are delivering the results in line with our projections. In the case of Rimadyl, it's a combination of not only generic, but the introduction of our new products. But still, what we have seen in terms of a generic penetration for Rimadyl it's in line with the trends that we already projected or already discussed in previous meetings. We still think that the impact over time, it's about 20% to 40% and will remain what we still project for this type of generic competition. Next question, please. Operator : We'll go next to Jon Block with Stifel. Please go ahead. Jonathan David Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks. Good morning. I'll ask two questions upfront. First one, Glenn, just to push you a little bit on the gross margin, is there any sort of (45:41) the cadence of gross margin? In other words, per your full year guidance, it looks like you should be exiting this year or 4Q 2017 at around 65% or even 69%. You do call out a lot of investment and manufacturing in the coming quarters, so just wondering if that weighs a bit in 2018. I know you said higher next year, but I just want to be as clear as possible, without be a little bit higher of the full year 2017 number? And then just maybe, Juan Ramón, the peak sales of $500 million plus for the derm portfolio, those numbers have been tremendous, but maybe a time line for this to be achieved? In other words, this quarter you can annualize it out to $0.5 billion-ish. I know you benefited from seasonality in the DTC, but is the thought that you can get to that sort of peak number within the next 12 to 24 months? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon, and let me answer the dermatology portfolio projection, and then Glenn will cover the gross margin question. So, we think that these peak sales of more than $500 million. We expect to generate that in the next two or three years. So, it's not talking about peak sales on five years, no, in this case, two or three years and is what we expected to achieve this more than $500 million in sales for Apoquel and Cytopoint combined. Glenn? Glenn David - Zoetis, Inc.: So Jon, just to go a little deeper into the gross margin, so your question on Q4, I mean if you look at the year-to-date gross margin, we're sitting at approximately 66%. Our guidance would imply approximately 67%, right, which would imply a better Q4. Some of the drivers of that, as Juan Ramón mentioned, we do expect the U.S. cattle to return to growth and some of the premium anti-infectives there as well generate a higher margin and that is one impact that will give us better margin as we look into Q4. In terms of 2018 and my comments there, that was referring to full year 2017 expectations on cost of goods and an improvement over that as we move in 2018. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll take the next question from David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Yes, thanks very much. So, I have two questions please. The first is, with respect to your companion animal product launch ramps, could you provide some color on where those stand ex-U.S.? And basically where you are in ramping up new companion animal products ex-U.S.? And then second, looking ahead to future innovation in R&D, will it continue to be more heavily weighted towards companion animal or should we think about the pace of livestock, new product launches accelerating? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you Dave. Glenn, will provide details of sales U.S. and ex-U.S., and then I will respond to your question on the R&D. Glenn David - Zoetis, Inc.: So, in terms of the new companion animal products U.S. and ex-U.S. the ramp is definitely ahead of the curve, in terms of the U.S., just based on the timing of launches and the availability of the products. So, for example we just recently launched Cytopoint outside of the U.S. in Europe. So, in terms of the breakout between – so for total derm, we had sales of $124 million with $89 million in the U.S. and $35 million international; for Simparica, we had sales of $25 million, $17 million of that is in the U.S. and $8 million is in international. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Glenn. In terms of where we invest in R&D, I think we have a good distribution of investment between livestock and companion animal. We have been successful in new products in companion animal, but this is not an implication that in the future we'll not be bringing products in poultry, swine or cattle, and also now including fish. One of the example, is that we expected to introduce a new poultry vaccines in the vector technology in the U.S. in 2018. And also, we expect to have new PCV vaccines for swine in the U.S. also in 2018. So, we continue investing in all the different areas of our portfolio, and we are not just targeting companion animal. On the contrary, we are trying really to diversify our investment and maintain the diversity in our portfolio. Next question, please. Operator : We'll go next to Kathy Miner with Cowen & Company. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning, Juan Ramón. Given the recent comments from a large competitor, if Elanco, Merial and Merck Animal Health all became independent companies, what would be the impact on Zoetis, and how would you size up each of these as a potential competitor? Thank you. Juan Ramón Alaix - Zoetis, Inc.: First, the decisions of other companies, definitely we cannot make any comment. But definitely having competitors that will be competing with us as a public companies, I don't see that as a negative. On the contrary, you will see that our financials are very good – are very good now, if we compare to other companies in animal health. And in my opinion, you will see that our margins are significantly higher than any other competitor. So, having this public information in my opinion will be only positive to us. Next question, please. Operator : We'll take the next question from Gregg Gilbert with Deutsche Bank. Please go ahead. Esther Rajavelu - Deutsche Bank Securities, Inc.: Hi. This is Esther Rajavelu on for Gregg Gilbert. Thank you for taking my question. On the companion portfolio, can you please discuss the trends you're seeing on the use of Cytopoint versus Apoquel? How are vets choosing between the two, and any pet owner feedback you may have on one product versus the other? Juan Ramón Alaix - Zoetis, Inc.: Well, we provide information about the two products to the veterinarians, it's up to them to decide, which one is meeting best the needs of their patients; Apoquel it's oral, Cytopoint, it's injectable. In some cases, while injectable is a preferred option for treating these type of medical condition. In the case of Cytopoint/Apoquel decisions, I think it's up to veterinarians, and in some cases that they are even combining the two products, depending on why they feel it's the best for their patients. And in terms of Cytopoint, the feedback has been extremely positive. So, we know that with Apoquel, it's now very well established in the market. Cytopoint, it was more recent, but I think feedback that we are getting from veterinarians is extremely positive; in terms of efficacy, but also in terms of side effects. So in both cases, excellent feedback from the market. Next question, please. Operator : And it appears we have no further questions at this time. I'll return the floor to Juan Ramón for any closing remarks. Juan Ramón Alaix - Zoetis, Inc.: Thank you very much for joining us. And again, so we have delivered very strong results in this quarter. We are very confident on the fourth quarter, and that's why we are also raising our guidance for 2017. So, thank you very much. Operator : Okay. Ladies and gentlemen, this will conclude today's program. We thank you for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,018
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2018Q1
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2017Q4
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2018-02-15
| 2.303
| 2.37
| 2.656
| 2.72
| 4.62814
| 25.6
| 26.61
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Operator : Good day, and welcome to the Fourth Quarter and Full Year 2017 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 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. Steven Frank : Thank you, operator. Good morning, and welcome to the Zoetis Fourth Quarter and Full Year 2017 Earnings Call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 statement 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 in the company's 8-K filing dated today, February 15, 2018. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix : Thank you, Steve. Good morning, everyone. Two weeks ago, we celebrated our fifth anniversary as a public company. And since our IPO in 2015, we have been able to improve the ways we innovate and serve our customers, grow as a profitable stand-alone business and build a track record of delivering results. Over the last 5 years, we have maintained a high level of R&D productivity and developed new and enhanced products that address the more relevant needs of our customers. New innovative products like Apoquel, Cytopoint and Simparica as well as lifecycle innovation for our existing portfolio has supported our leadership in the animal health industry. On an operational basis, Zoetis' revenue has grown an average of approximately 7% over the last 5 years compared with the 5% to 6% for the animal health industry. And our adjusted net income for the same period has grown operationally an average of approximately 21%. Over the last 5 years, we have been able to deliver on our commitment of growing our revenue in line or faster than the market and growing our adjusted net income faster than sales while also targeting value-added investment opportunities and returning excess capital to our shareholders. And for the next 5 years, we remain committed to achieving these elements of our value proposition for shareholders. In 2017, Zoetis became the first animal health company to deliver more than $5 billion in revenue as we continue to demonstrate the strength of our business model and the growth opportunities in animal health. We achieved operational revenue growth for 2017 of 8% based on the diversity of our total portfolio and balanced performance across the U.S. and major international markets. And once again, we grew our adjusted net income 5% sales at 21% operationally as we continue to realize the benefits of our operational efficiency initiatives and deliver our long-term value proposition. The strength of our diverse portfolio of approximately 300 product lines helped to absorb economic challenge in certain market and to offset all issues like the implementation of the Veterinary Feed Directive, or VFD, in the U.S. Our companion animal business led the way again in 2017. It grew 14% operationally based on the continued penetration of Apoquel and ramp-up of Cytopoint and other new products like Simparica, which has gained share in the large and highly competitive parasiticide market. We believe 2018 will be another year of above-market growth for our companion animal business. We see further opportunities for gaining share and expanding the market for dermatology products with our innovative treatment options. We expect to achieve more than $500 million in combined sales from Apoquel and Cytopoint in 2018. We'll also continue to support these products, as well as our oral parasiticide, Simparica with direct-to-consumer campaigns in the U.S. and other markets. Simparica has been able to gain market share in the U.S. in 2017, and we expect further growth there and internationally in 2018. Meanwhile, we delivered 5% operational growth in our livestock business there for the year. International markets grew faster than the U.S. where we felt the impact of the VFD implementation in our cattle and swine anti-infective products. For 2018, we see more favorable market conditions for livestock, particularly in the U.S. Glenn will discuss the details of our fourth quarter results and guidance in a minute. But I would like to say that we feel very confident about our prospect for 2018. In addition to revenue growth, we have also been focused on improving our operational efficiency and margins. And in 2017, we achieved an adjusted EBIT margin of 34.1%. This was an improvement of 900 basis points in the last 3 years. With our improved cost structure, margin expansion and revenue growth, we have been able to almost double our operating cash flow for the year in 2017 compared to the previous year. That improved cash flow, along with the long-term benefit of the recent U.S. tax reform, is providing us the flexibility to invest for long-term growth. In terms of long-term growth, we'll continue investing significantly in R&D for our core species and geographies, look to strengthen our cattle, fishing areas, livestock monoclonal antibodies, vector vaccines, genetics, diagnostics, devices and automation and define new technologies in areas like data analytics and sensors. We'll continue supporting our key products like Apoquel and Simparica with direct-to-consumer advertising and other marketing campaigns. We'll also increase our field force in diagnostics to better support the interaction of new products in the future growth expected in this area. We'll be allocating capital to support many of the manufacturing and supply improvements I have discussed recently in places like China, Ireland and the United States. And as always, we'll continue to look at external partnership and business development that could accelerate our ability to grow in our core business and in complementary spaces like genetics and data analytics. All these investments will support our goal of more integrated solution, which cover the entire life cycle of animal care that our customers need. In conclusion, as we mark our fifth anniversary as an independent company, I'm grateful for the colleagues at Zoetis who have delivered our strong performance and will support our future of profitable growth. We continue to drive innovation, believe in customer excellence, simplify our operations and increase our cash flow. And as we look to the future, we'll remain committed to strengthening our interconnected capabilities in direct sales, R&D, manufacturing and look for additional investment opportunities to enhance our growth. With that, let me hand things over to Glenn, who will provide more details on our fourth quarter results and full year guidance for 2018. Glenn David : Thank you, Juan Ramón, and good morning, everyone. Before I get into the details on our fourth quarter performance and guidance for 2018, I will provide a few comments on the results for full year 2017. This year, we delivered operational revenue growth above the market, grew adjusted net income faster than revenue and almost doubled our operating cash flow. Reported revenue for full year 2017 was $5.3 billion with operational revenue growth of 8%. Of this 8%, 3.5% came from our dermatology portfolio, 3.5% came from Simparica and other new products and the remainder of growth came from price and volume. Our product rationalization initiative had an unfavorable impact of 1% on volume for the year. Adjusted net income for full year 2017 was $1.2 billion and grew 21% operationally. Adjusted net income continues to grow faster than revenue driven by the continued impact of our operational efficiency initiative and a lower adjusted effective tax rate. Our performance this year, again, reaffirms our ability to execute on the financial targets that we said in May of 2015 when we provided long-term guidance through to 2017. With the results that we are reporting today, both our top and bottom line in 2017, beat the goal outlined nearly 3 years ago. For the full year, we've performed well across all the species and key markets where we compete. The diversity and durability of our existing portfolio, our market-leading commercial and manufacturing capabilities and the innovations we bring to the marketplace have allowed us to outpace the animal health industry market growth for the last 5 years. Our income growth and our increased discipline on the balance sheet have enabled us to almost double our operating cash flow in 2017. This was the result of lower cash outlays for termination benefits and stand-up costs, increased profitability and inventory improvements. In 2017, we reduced our months on hand of inventory by more than a month. We have more work to do in this area but are pleased with the progress in 2017. Turning now to quarterly results. Q4 2017 was an exceptional quarter, with top line growth coming from new products in our companion animal portfolio and strong livestock performance in our U.S. and International businesses. Our product rationalization initiative had no material impact on our growth this quarter and will not have an impact on our revenue growth going forward. Total company revenue in the fourth quarter grew 13% operationally, excluding the favorable 1% impact from foreign exchange. Our key dermatology products, Apoquel and Cytopoint, once again surpassed the $100 million marketing revenue with sales in the quarter reaching $125 million and $428 million for the full year 2017. Sales of Simparica were $18 million in the quarter, growing 102% over the same period in the prior year. Fish products also contributed to growth with sales of $39 million, growing 44% operationally versus the same quarter last year. Our recently introduced PD vaccine in Norway was the primary driver of growth as it continues to gain share and help increase the penetration of other related vaccines in our portfolio. Now let's discuss segment revenue. Our International revenue grew 13% operationally in the fourth quarter, with companion animal operational growth of 18% and livestock growth of 11%. The International segment continues to drive growth across multiple dimensions with growth coming from our dermatology portfolio; new products, such as Simparica, our PCV combo vaccine and our PD vaccine; and volume and price from our in-line portfolio. Turning to some key market highlights in the quarter. In Brazil, we grew 13% operationally, driven by the strength of both our livestock and companion animal businesses. In cattle, investments in our field force have led to increased penetration and coverage in key regions within the market while favorable export market conditions also continued to contribute to growth. In swine, increased sales of IMPROVAC, or Vivax as it's called in Brazil, were driven by higher usage and greater penetration with larger customers. The higher companion animal revenue in Brazil benefited from the continued growth of Simparic through the increased promotional activity and higher veterinary clinic penetration. In Japan, we experienced operational revenue growth of 27% in the quarter. Growth came from Apoquel as a result of the timing of distributor purchases last year and the additional market penetration we achieved as well as the launch of premium injectable products for livestock. France grew 23% operationally over the same period last year due to a timing impact related to our price changes and new products to both -- across both companion animal and livestock. China grew 13% operationally on a continuing strength of the companion animal business, driven by increasing medicalization of pets. Our swine business once again showed modest growth this quarter due to softening pork prices, which we have expected and discussed on recent earnings calls. Our optimistic outlook and long-term view of the market remain unchanged as we continue to invest in our local operations there. To summarize, a very strong quarter for our International segment with growth across the diversified portfolio, including all of our core species and key markets, favorable market conditions, strategic investments in our portfolio and a focus on execution, are all helping to drive consistent commercial results. Turning to the U.S. Revenue grew 13% in the fourth quarter. Companion animal grew 15% while livestock grew 11%. Companion animal sales in the quarter were driven primarily by key dermatology products, Simparica and a number of other recently launched products. U.S. dermatology sales for Apoquel and Cytopoint were $86 million for the quarter and exhibited substantial growth over the same quarter in the prior year. While we did see a small decline on a sequential quarter basis, Q1 and Q4 are impacted by seasonality with the warmer spring and summer months experiencing peak activity. Simparica grew over the same quarter last year as DTC investment and field force efforts led to higher clinic penetration in both key corporate accounts and smaller clinics. Additional contributions to companion animal growth came from a number of line extensions to our Vanguard vaccine franchise, DIROBAN, a recently launched product for the treatment of heartworm and CLAVAMOX chewable, a trusted antibiotic in a new easy-to-administer tablet. Our U.S. livestock business saw a return to growth in the fourth quarter, with sales increasing 11%, thanks to the performance of our cattle and poultry businesses. During the fourth quarter, growth in cattle products was driven by increased sales of premium products, which was supported by a greater risk of disease outbreak and incidents due to the weather as well as the timing of promotional activities in 2016. Our beef cattle business also benefited from higher numbers of animals moving through feedlots than in the comparable 2016 period. Our livestock business continued to be impacted by the Veterinary Feed Directive, or VFD, with another $10 million hit to revenue in the quarter. For the full year 2017, the VFD had about a $40 million impact on revenue. In poultry, there's a weather's portfolio of alternatives to antibiotics and medicated feed additives continue to be the primary driver of growth as certain producers expand their "No Antibiotics Ever" labels. The weather works with customers to provide the necessary product and technical assistance that can help them switch over whenever they choose. Now moving on to the rest of the P&L. I will quickly cover a few key line items and then move on to our guidance for 2018. Adjusted gross margin of 68.9% increased 450 basis points in the quarter on a reported basis and reflects the benefit of cost improvements in our manufacturing network as well as the reduction of inventory waste charges versus the same quarter last year. Operating expenses in total grew at 2% operationally versus the same period last year, which was significantly lower than the operational revenue growth of 13% as we benefited from the final stages of our operational efficiency initiatives. The adjusted effective tax rate for the quarter was approximately 27.6%. This is higher than the rate in the comparable 2016 period due to the favorable impact of certain one-time discrete items that we experienced in the same quarter last year. Our reported effective tax rate of 43.5% reflects the provisional net tax charge of $212 million in the fourth quarter, which is the result of the recently enacted tax legislation in the U.S. Adjusted net income for the quarter grew 37% operationally through a combination of strong revenue growth and margin expansion and cost improvements in manufacturing and leveraging our global scale and infrastructure. Adjusted diluted EPS grew 39% operationally in the quarter versus the same period in 2016. Turning now to guidance for the full year 2018. A table of our guidance is included in both our press release and the presentation slides provided for this earnings call. Please note that our guidance for 2018 reflects foreign exchange rates as of early February. Building off a strong 2017, we see another year of operational revenue growth above the long-term trend we see in the industry overall. Our projected reported revenue range for 2018 is $5.675 billion to $5.8 billion. This represents operational revenue growth of between 5% and 7% over our full year results in 2017. Foreign exchange is expected to add an additional 2% for this revenue growth. We continue to expect more balanced performance across companion animal and livestock in 2018. Livestock growth is expected to reflect improved conditions in the U.S. and a relatively similar performance in 2017 in our International segment. While companion animal continue to grow faster than livestock, its growth rate will moderate as our dermatology portfolio and other new products grow off a larger base in 2018. Our adjusted cost of sales as a percentage of revenue is expected to be approximately 32% in 2018, an improvement of around 100 basis points over 2017 and driven by manufacturing cost reductions, price increases and favorable product mix. We expect SG&A for the year to be between $1.37 billion and $1.42 billion. Similar to revenue, foreign exchange is expected to increase these expenses approximately 2% on a reported basis. We will continue to fund our DTC programs for Apoquel and Simparica in the U.S. These programs have been successful, and we expect they will continue to help our sales teams drive market expansion in dermatology and market share in parasiticide. As our diagnostics pipeline continues to advance, we are beginning to fund additional investments in commercial capabilities in both the U.S. and International to be prepared to offer our customers these products with the level of service and support we offer them on our other portfolios. We expect R&D expenses to be between $400 million and $420 million, a step-up in the level of spending we have had in prior year. Over the course of 2017, we made a number of decisions to either expand investments or accelerate investments where we saw the opportunity to do so in areas such as monoclonal antibodies and key emerging markets. The increase in adjusted interest expense and other income deductions reflects the incremental interest expense associated with our recent debt offering. For the full year 2018, the company expects its adjusted effective tax rate to be in the range of 21% to 22%. The decrease versus prior year is primarily the result of the tax changes enacted in the U.S. in December. The target range for adjusted net income for the full year 2018 is between $1.45 billion and $1.52 billion, representing an operational growth rate of 20% to 26%. Growth here includes the favorable impact of continued operating margin expansion and a lower adjusted effective tax rate. Our guidance for adjusted diluted EPS is between $2.96 and $3.10 for the full year. Turning to capital allocation. Our priorities remain the same, investment in our own business and internal R&D programs, then external business development opportunity and finally, returning excess capital to the shareholders. With the impact of the recent tax law changes, we'll have greater flexibility to execute on these priorities. I would also point out that given the level of investments we have discussed in manufacturing facility, you should expense capital expenditures in 2018 to be approximately $100 million higher than the $224 million we reported in 2017. In terms of returning excess capital to shareholders, we increased our dividend by 20% for Q1 2018 and had share repurchases of $500 million in 2017. It's worth mentioning that we still have $1 billion left on our current share repurchase program. To wrap up, we had strong performance in 2017 and see those fundamental business and market drivers continuing into 2018. We have the capital and cash flow generation to invest in growth opportunities across the animal health industry. And we have the talent and capabilities to maintain our market leadership in this attractive market and create more value for our customers and shareholders. With that, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We'll take our first question from Louise Chen with Cantor. Louise Chen : My question is just on R&D. We always get a lot of questions on this since you don't disclose a lot of detail. I'm just wondering, where are your greatest unmet needs in animal health? How are you addressing these? And will we hear more about these products in 2018? And also can you provide any measures by which you can measure your R&D productivity? Juan Ramón Alaix : Thank you, Louise, for the question. We still see unmet needs in our animal health industry. One of the unmet needs there is related to pain in dogs and cats and bring some of them in the solutions for the current treatments. And this is why we are focused on a number of [ current treatments ] that we'll be providing alternative to the current treatments for dogs and cats. We also see opportunities of combination of oral parasiticide for internal and external parasiticides. And definitely, we see the opportunity of enhancing productivity in livestock with the new technologies that will replace existing ones. So there are areas that definitely we have internal problems. And we mentioned many times, our competitors because they are part of pharma companies, we are not disclosing any details. For us, providing this information will create a negative impact in our ability to compete successfully in the future. In terms of how we measure productivity, I like Glenn that will provide some details. Glenn David : So in terms of measuring the productivity for R&D, a, as we prioritize the projects across the portfolio, we use [ EMPV ] and EROI to make sure that we're appropriately prioritizing across the portfolio. We'll also look retrospectively from a return on invested capital perspective to see the return that we get from our investments. And based on the productivity we've had over the last number of years, we've been very pleased with our return on our R&D spend. Operator : And we'll go to -- next question to Kevin Ellich with Craig-Hallum. Kevin Ellich : So very, very strong results this quarter, guys. And it's great to see the rapid growth in companion animal as well, the recovery at livestock that you expect. Glenn, you made a comment about more balanced growth between livestock and companion animal in 2018 and even moderating growth in dermatology. Can you just give us a little bit more detail behind what you expect in companion animal? Should we be thinking about 10% companion animal growth versus 8% livestock? Or any help on that front? Glenn David : Yes. In terms of the growth that we expect for 2018, I'm not going to give specific numbers, obviously, between livestock and companion. But I think when you look at 2017 for the full year, we had 5% growth in livestock and 14% growth in companion, so there was a big differential in the growth. As we move into 2018, with a very strong performance that we had in our companion animal portfolio in 2017, we've established a new base to grow off of, particularly in our derm portfolio as well as Simparica. So while we still expect those products to grow in 2018, the overall contribution that we'll have for the total companion animal growth will be smaller just as they're off of a much larger base. So that's going to cause our companion animal growth to decelerate as we move into 2018. Operator : And we'll take the next question from Erin Wright with Crédit Suisse. Erin Wilson : In terms of the development pipeline, a follow-up here. I guess can you speak to some of the focus areas outside of traditional therapeutics? So for instance there, you launched a new diagnostic offering at VMX, you also have SMB opportunities and you mentioned some sales force investments there. Is that going to be a focus area for you in terms of new product launches near term? Will it be a more organic or inorganic initiative? And then, just could you speak to some of the -- you mentioned data and analytics but some of the other areas or ancillary areas outside of traditional therapeutics where you see growth opportunity? Juan Ramón Alaix : Thank you, Erin on that. We see Zoetis as a much more integrated offer to our customers, including the products in medicines, the change there, but also diagnostics, genetics. What we have to describe as a -- the health care cycle of intention also prediction, prevention and treatment. And definitely, we'll continue focus on our core business. In the core business we'll continue generating the majority of our revenues and profit. But we see opportunities to accelerate our growth by investing in some of these complementary spaces. Definitely, in genetics, diagnostics, data analytics are part of these efforts. We have now in diagnostics arranged on the pipeline that definitely we'll be focused on delivering in the next coming years. We also presented in the last congress of VMX, a new Carysta, high-volume chemistry that -- it's part of our efforts really to become a key player in diagnostics. But in a way, that will be integrated -- or we'll be integrating more all these portfolio in our offer to our customers. As well, we will be investing in data analytics essentials that will complement our offer to our customers. Operator : The next question comes from Michael Ryskin with Bank of America Merrill Lynch. Michael Ryskin : A couple of questions on the quarter and then just a longer-term follow-up. Really strong results in U.S. livestock this quarter. I know it's a bit of surprise relative to what we are looking for. And particularly, U.S. cattle had a great number. You mentioned some of the disease conditions, but you also talked about feedlots and cattle herd size. I recognize that the weather and the [ days, months ] is more transient, but the feedlot data you should have pretty good visibility in. And I was just wondering if you could talk a little bit how the outlook there is sort of the first part of 2018. Is the feedlot strength sustainable? Is that something that you think it will continue for several quarters? And then broader on the '18 guide, you talked about a pretty sizable gross margin improvement, 120 bps year-over-year. Is the longer-term targets are still what you talked about, 200 bps by 2020? Or is there upside opportunity there, given how much improvement you're looking for this year? Juan Ramón Alaix : Thank you, Mike. I will respond about the U.S. livestock results. And then Glenn will provide the details of our gross margin improvement and also targets for the future. Well, in the U.S., definitely, we had a strong fourth quarter in the U.S. And this was just the result of several factors, including the weather conditions and movement of animals. Also the fact that we decided not to implement promotional activities in the third quarter and then views the -- for some more movement of sales from the third quarter to the fourth quarter of 2017. But the results are in some way, what we were expecting there and we also communicated in the previous quarter. So we saw that in the first part of the year, we have some limited growth in the U.S. cattle, but we were also expecting that at the end of the year, we will be reporting a revenue growth in the U.S. cattle. And this quarter is just confirming our projections for the year. This has been movement of animals, as I had mentioned, to the feedlots. And we are pleased with the performance of the entire portfolio in our cattle business in the U.S. Moving forward, for 2018, we see positive elements in our beef segment in the U.S. We see that the number of animals that we -- are continue growing, probably at a lower rate than what we have seen in previous year, but still growing. Placements are expected also to continue being positive. And we expect also that the weather conditions in 2018 will be more favorable for animal health than in '17. So overall, we see that the beef segment will grow and [ as prices ] will be growing in line with the market. We also see that unleashing the first half, half, the dairy segment will be facing some challenge because of the price of the milk is lower than in previous quarter, and then maybe they will have an impact on the first half of the year. We expect that the second half will be a more positive. But overall, the cattle will be showing a positive growth in 2018. And as I said, we expect that to grow in line with the market. Then Glenn, please, do you mind to cover the question from gross margin? Glenn David : Yes. Mike, in terms of the gross margin, when you look at the 2018 guidance of approximately 32%, that's more in line with the second half of 2017, which is more reflective of our underlying cost structure as we've discussed on some of the previous calls. In terms of the 200-basis-point improvement by 2020, we remain committed to that improvement. And as we've said all along, that improvement is driven by the supply network strategy efforts, to the extent that there's additional opportunity based on price, based on volume, based on mix, which can grow on either direction, that can either have an incremental impact or an incremental improvement over the margin over that time or take away a little bit. But the 200 basis points was always based on the supply network strategy, and to the extent that we have favorable movement in price and mix, that would add additional margin improvement. Operator : We'll go next to Alex Arfaei with BMO Capital Markets. Alex Arfaei : Congratulations on the product performance and all the progress during the past 5 years, it's really remarkable. On the U.S. livestock business. Clearly, much better than expected. The difference is particularly striking, given what we are hearing from some of your competitors, particularly Elanco. So I'm just wondering, if you could highlight what are some of the differences that's driving better performance for your portfolio versus what we are seeing from some of your competitors? And then on the companion animal business, could you comment on the base business, excluding dermatology and Simparica? Is that stable? Or is it under pressure as some of those franchises mature? Juan Ramón Alaix : Thank you, Alex. And well, I -- probably I should focus on the drivers of our growth and it's basically because of our portfolio. We have a portfolio, which is extremely well-balanced on many different therapeutic carriers, talking about livestock. And these are also helping us -- as I said many times, the diversity is helping us really to manage different cycles, different opportunities, different challenge and really deliver results, which are very consistent and, in some cases, we're growing as faster than our competitors. And we don't see that the livestock business in the U.S. is showing any negative fundamentals. As I said, for '18, we expect the cattle business, beef and dairy combined, showing positive growth. We also expect that the swine and poultry will continue growing. In the case of swine, we expect that Zoetis will be growing faster on the market because we are introducing new products. And also we have seen that some of the challenges that we faced in '17 related to the PCV2 vaccine now are over. And at the same time, we are introducing new PCV2 vaccines covering more strength, but also will help us structurally with the growth in 2018. Poultry, also we expect a positive growth in the U.S. and will be growing in line with the market. So overall, very pleased with our performance and also positive about the prospects for livestock in the U.S. In terms of -- you also asked about companion animal and what has been the drivers of growth in '17 and also how we see the growth moving forward. Maybe, Glenn, you can provide the details of new products, price and also volume of growth for the price of the portfolio. Glenn David : In terms of companion animals in 2017, obviously, a lot of the growth was driven by our new products, and we had new products in a number of categories. So the ones that get the most attention, obviously, are Apoquel and Cytopoint and Simparica. But we also have significant growth coming from our vaccines as well. And these products were the focus of our field force in 2017. In terms of the rest of the portfolio, what you then called the in-line portfolio, performance in those categories was relatively flat as we did experience some pressures from generic competition in line with what our expectations would have been, particularly in the U.S. And that was offset by some strong performance, though, in our emerging markets that continue to grow as increasing medicalization rates in markets, such as China and Brazil continue to benefit us. So overall, relatively flat performance of our in-line portfolio, but a really strong performance from our new products as that was the focus of our field force with the tremendous products that we had to launch and continue growth in. Operator : We'll go next to Jon Block with Stifel. Jonathan Block : Two questions. Glenn, I've OpEx as a percent of revenue, that improved by the 270 basis points in '17. It was just huge. And the guide for '18, I believe, implies about a 70 bp improvement, OpEx as a percent of revenue with a rate of revenue growth, that really isn't too dissimilar in '18 versus '17. So I want to be clear, the 70 bps is nothing to sneeze at, but maybe if you can talk to the increased investments that you guys are pursuing and when those will yield the return or they just a function of sort of moving further away from the operational efficiency program. And then just to pivot, Juan Ramón, I really don't expect specifics, but any thoughts if you believe you will have it, call, a new blockbuster companion animal product in '19 and maybe that's from the triple or something out of the pain portfolio from Nexvet. Any details you guys can give there. Glenn David : Jon, in terms of the OpEx improvement that we experienced in '17 versus what the expectation may be for 2018, it was really the latter of your comments. 2017, we continued to benefit from the remainder of our operational efficiency initiative and we were able to grow revenue significantly faster than OpEx in 2017. Now as we move into 2018, we still expect to grow revenue faster than OpEx but not to the same magnitude as we don't have the same level of improvement coming from our operational efficiency initiative. The other thing I'll point out for 2018 is there are investments that we're making in SG&A to support the continued development of our diagnostic portfolio and to make sure that we have the right commercial support behind those products as they become ready for launch. Juan Ramón Alaix : And answering about the potential opportunity of launching a future blockbuster. Definitely, we'll continue seeing opportunities of launching our products that generate significant growth. And I discussed about monoclonal antibodies for pain. I also talked about combination of products in parasiticide segment for internal and external enhancement of our productivity for livestock. At this point, commenting when these products will be launched, I think it's too premature. But we think that we can continue generating growth, which is in line [indiscernible] the market with existing portfolio and also the addition of a -- maybe a blockbuster, but also multiple products that will support our revenue growth. In our industry, as I mentioned many times, we are not dependent on bringing these blockbusters to generate consistent growth because we don't have the same impact that we see in pharma sales because of generic deceleration. So we are pleased with our pipeline. We are pleased with the return of our investment in R&D. And we'll continue our focus on generating internal value growth. And at the same time, as I see an opportunity that -- external opportunity that will enhance our opportunity to grow. Operator : The next question is from John Kreger with William Blair. John Kreger : Can you just expand a bit more on the diagnostic strategy? Not talked about it this much in the past. Should we think about that as more focused in companion animal or livestock and more sort of centralized or sort of point-of-care type of products? Juan Ramón Alaix : Thank you, John. Let me say that we see diagnostics as an area that is growing faster than the average of animal health. And we see diagnostics also as a very complementary to our offer to customers and also an opportunity to leverage our existing relationship and infrastructure in many markets. The focus today is developing our internal pipeline, to bring these products into the market. We see that it's a significant competition in companion animal, especially in the U.S., much more opportunities to offer penetration in International market in companion animals. And because also our expertise and our presence in livestock, we see this area as a significant potential opportunity for Zoetis. And this should be in areas like rapid test point of care but also equipment. So this is where we are focused today in Zoetis. These type of point-of-care diagnostic tools that will help veterinarians in companion animal and livestock to make decisions at the point of care. Operator : The next question is from David Risinger with Morgan Stanley. David Risinger : I have two questions. The first is, could you provide a little bit more color on the ramp of new products, and specifically new companion animal products ex U.S. in 2018? And then second, with respect to cash flow for 2018, could you please discuss the outlook for operating cash flow and free cash flow in 2018 relative to 2017? Juan Ramón Alaix : I will provide some comments on the companion animal products outside of the U.S. Glenn also will maybe expanding in some of the details for International markets and definitely, will be commenting on the operating free cash flow. That's the question that you raised and also the outlook for 2018. We have seen in International markets a very high growth in companion animal. International markets are combination of the new product launches, Apoquel, to a lesser extent, Cytopoint, Simparica. But also the growth that we have seen in some of the major markets in companion animal in where the rates of medicalization has been growing very fast. And we have seen in countries like Brazil, China, significant growth. And in countries like China, we started new product launches. So we still see the opportunity of growth in the future once we introduce Apoquel, Cytopoint and Simparica in the Chinese market. We still see significant opportunities for growth in International markets because the level of penetration of Apoquel, Cytopoint and Simparica compared to the U.S. is much lower. So we expect in 2018 that we'll be -- continue enjoying growth in international markets in companion animal. Maybe, Glenn, you can maybe expand some details on this question and also on the free cash flow one. Glenn David : In terms of our free cash flow and the cash flow that we expect for 2018. So our operating cash flow, we expect to grow pretty much in line with our growth in adjusted net income. As I also mentioned in my prepared remarks, with the increased expenditures we have for CapEx, free cash flow will grow slightly lower than what we expect to grow for operating cash flow. Operator : The next will be Kathy Miner with Cowen. Kathleen Miner : Just wanted to follow up on the dermatology area a little bit more. Juan Ramón, I think you -- it sounds like you increased your guidance for the Cytopoint and Apoquel franchise to $500 million in 2018. Can you tell us if this is being driven more by Apoquel and/or Cytopoint? And what the penetration is in dogs now for the -- for dermatology conditions? Juan Ramón Alaix : Thank you, Kathy. And I think definitely, we have seen that the option of Apoquel and Cytopoint has been growing in 2017 very fast. And that's why we are now projecting for 2018 already to generate $500 million of -- in sales or more. Both products are -- performance is still well. And now I think it's something that we feel that pet owners when they go to clinics and they have dermatology issues, they are leaving the clinics with either Apoquel or Cytopoint. Definitely, the direct-to-consumer advertising has been helping to accelerate their option and also to expand the market. In terms of penetration, definitely, the penetration in the U.S. and in international market is different. In the U.S., we reported last quarter that we have a penetration of -- in terms of patients of about 59%. We have seen in the fourth quarter this penetration is stable. And it's something that, in some ways, was suspected because it's a quarter in where most of the use in -- it's in acute while -- I am sorry, chronic while we have seen increase in the penetration because of the use of acute and seasonal. Seasonal and acute is mainly in the second and third quarter, and we expect in 2018 continue growing in these acute and seasonal and also helping also to -- with the increase of awareness in terms of dermatology issues with our continued DTC campaign in 2018. We have not seen too much cannibalization of Apoquel because of Cytopoint. It's about 26%, which is what we were expecting. But I think it's something that we are offering -- both solutions to the veterinarians, and we are very pleased with the performance of these 2 products. Operator : We'll go next to Liav Abraham with Citigroup. Liav Abraham : Just a quick question on the tax rate. You've guided to a tax rate of 21% to 22% for 2018. Can you comment on your outlook for tax beyond 2018 and the opportunity for this to be reduced further over time? Juan Ramón Alaix : Thank you, Liav. And we'll be -- Glenn, answering this question. Glenn David : In terms of the tax rate. As you mentioned, for 2018, we've guided to 21% to 22%. We haven't provided guidance for beyond 2018. There are additional cost of that kicking beyond 2018 for us then -- as coming into effect for 2019. We need to fully understand the impact of that. But again, the guidance for 2018, based on current understanding, we're comfortable with the 21% to 22% for 2018. Juan Ramón Alaix : Thank you, Glenn. And maybe some clarification on the dermatology penetration. I mentioned data for the U.S., International markets there, definitely, we have a lower patient share. And we still see a lot of the room for growing in terms of patient share and also in terms of expanding the market. Operator : We'll go next to Chris Schott with JPMorgan. Christopher Schott : Just two quick ones here. First, anything -- I know you don't give quarterly guidance, but anything we should be keeping in mind as we think about quarterly progression of both top line and earnings if we think about 2018 relative to '17? And a second was just maybe following up on those comments on Apoquel and Cytopoint. Just a little bit more color, just how much more room for growth is there in this franchise beyond '18? And I guess, what I'm really trying to get is there any more color of how -- what -- or could -- what could peak sales look like for this franchise? I guess, as you start getting through '18 this $500-million-plus number. Is there still significant room for growth? Or are we starting to a point where we're seeing peak sales for these assets? Juan Ramón Alaix : Thank you, Chris. And let me cover the question on dermatology portfolio, and then Glenn will discuss about the quarterly projections for 2018. We still see growth not only in 2018 but in future years for dermatology portfolio. And maybe the growth in the market that the products has been introduced [indiscernible] like in the U.S. This growth will be moderated in the future. But there's still -- in many international markets, we are just introducing Cytopoint. Apoquel, definitely have a -- still a lot of opportunity to continue growing. I mentioned China as a country where we don't have yet Apoquel, and we expect also China generating growth in the future. So we don't see that 2018 will be our peak sales in terms of Apoquel. Cytopoint, on the contrary, will continue growing. Definitely, the growth will be moderated, but we expect also continue growing. And definitely, we'll see growth coming from volume but also growth are coming from prices. Glenn David : In terms of the 2018 quarterly production, as you mentioned, we don't give 2018 guidance by quarter. But just a couple of things to think about. And we do expect more balanced growth in 2018 than we saw in 2017 and a more steady performance in terms of cost of goods as a percent of revenue than we saw in 2017, in particular. The other thing I'll point out is, we are moving from a 4-4-5 accounting calendar to a month-end accounting calendar, and that will have some small impact per quarter. The greatest impact that you'll see will probably be in Q4, where it could negatively impact our growth in Q4 2018 by almost 2%. So those are the only things that I would point out. Operator : The next question is from Gregg Gilbert with Deutsche Bank. Gregory Gilbert : Curious whether you saw any headwinds or benefits tied to the consolidation of vet clinics in the U.S. I realized there wouldn't be material effect for the whole year, for the whole company, but curious on that team as it continues to build. And my other question is about the environment overall in some of your competition. And one of the elephants in the room this year is Lilly will explore options for Elanco. And I know Juan Ramón, you've commented in the past that mergers among the larger players in the industry would be difficult from an antitrust perspective. But how would you view a spinoff of Elanco if that's what they decide to do? I'm curious on your thoughts there sort of operationally and otherwise as it relates to any effects, good or bad for Zoetis. Juan Ramón Alaix : Thank you, Gregg. And definitely, we have seen a consolidation of vet clinics in the U.S. Also, we have seen not too much consolidation of clinics outside of the U.S. but there may be buy-in groups that also are having an impact. So far, we are managing very well the relationship with these clinics. In some cases, we have been able, really, to reach exclusive agreements for Simparica on one of these larger groups that -- it's something that we see as a very positive. We understand that, in some cases, we may tap some pressure in terms of prices, which is part of also our projections in our model. But at the same time, where we see the opportunity also of expanding the health care because of better services to veterinarians. So we see also that in the case of Zoetis, we have a portfolio of specialty care. That is also providing significant benefits to this change of clinics and definitely, we are managing extremely well. It was a very positive collaboration with [ man field ] in the future -- in the past. We also have good collaboration with the VCA, and we expect that the combination of the 2 groups also will continue positive for Zoetis. In terms of the decisions of Elanco. I think it's something that -- I prefer not to comment on other companies' strategic reviews. We went through our process 5 years ago. It was the right decision for Pfizer and also for, as what you said, very pleased with our performance. And definitely, we have seen the benefits of being at Zoetis, having a single focus on animal health and a singular focus on providing value to our customers and to our shareholders. Operator : And we'll go next to Jami Rubin with Goldman Sachs. Candace Richardson : This is Candace Richardson on for Jami Rubin. I have two quick questions. Tempered growth in the U.S. companion this quarter appears to be related to tougher comps from certain products that launched last year. When should we expect this to annualize? And then secondly, your recent dividend increase of nearly 20% is among the highest in the industry. We're wondering if there's a specific payout ratio you're looking to achieve. And given that you're the only stand-alone public animal health company, what comps do you look at when you evaluate your dividend policy? Juan Ramón Alaix : Thank you for your question. Please, Glenn, do you mind answering the question? Glenn David : Yes. So in terms of U.S. companion animal growth for 2017. For the full year, we had 13% operational growth in U.S. companion animal. In the quarter, we had 15% growth. So we saw another continued quarter of very strong growth in U.S. companion animals. So not necessarily tempered growth for Q4. In terms of our dividend policy. We generally grow our dividend at or pace faster than our growth in adjusted net income. And that is our commitment moving forward is that we'll continue to grow our dividend at or faster than income and have a focus on dividend growth. We're also focused on share repurchase as another way to return excess capital to our shareholders. And we currently prefer share repurchase as a -- gives us a little more flexibility to manage the other priorities we have for capital allocation, being our internal investments as well as business development. Operator : We'll go next to Douglas Tsao with Barclays. Douglas Tsao : Just focusing on the companion business. You referenced some greater amount of competition for the in-line products. Just curious if that is a trend that you expect to continue. And then just when you think about the growth for the dermatology franchise going forward, should we -- it'd be safe to assume that a lot of the growth going forward will come from the ex U.S. And if you think about that peak potential, I know people sort of hinted at this question, but do you think that the ex U.S. opportunity could be ultimately as big as what we've seen in the United States? Juan Ramón Alaix : Thank you, Doug. We don't see that the competition has been increasing in companion animal for our in-line portfolio. Definitely, we have seen the impact of generics in line with previous years and also in line with our predictions. Definitely, vaccines, which have been growing very fast in our opinion, growing faster than the market for companion animals. So in general, we understand that there has been new problems in the pain market in 2017 that has an impact on RIMADYL. But this is not something we see as greater competition in our in-line. Maybe our in-line portfolio has been affected because of so many products, new products that have been launched in period year. And as you can imagine, the level of attention of our field force during this period has been intentionally in these new products. But we are very pleased also with the performance of our in-line. And definitely, we see that this in-line will be performing according to our projections. In terms of the dermatology portfolio opportunity outside of the U.S., so there is probably a couple of years or 18 months difference in terms of the interaction of Apoquel in international markets. Cytopoint, that it was introduced in U.S. at the end of '16 or mid-'16, has been introduced at the end of '17 in Europe, still not introduced in many international markets. I mentioned that even Apoquel is not yet approved in China, and we expect approval in the future. So definitely, it's a significant opportunity of growing our dermatology portfolio outside of the U.S. But still, we see opportunities of continue growing in the U.S. And definitely, we'll be supporting this growth with a DTC campaign in 2018 in our U.S. markets. Operator : And we'll go next to Brett Wong with Piper Jaffray. Brett Wong : You talked a bit about your positive expectations for U.S. livestock. But can you comment on kind of the International livestock business, specifically in your key markets, like cattle Brazil, hogs in China, et cetera? And if you expect the strength that you saw in 2017 to continue in '18? Juan Ramón Alaix : We see livestock in international markets also continue positive. China show companion animal, 20% growth in '17. This was the combination of companion animal and livestock. There are always, as we mentioned many times, in current cycle prices of pork in China and some of our markets there, they kind of affect temporary some of the growth drivers. But one of the advantages of Zoetis that we explained many times is the diversity of our business in all the geographies. In terms of Brazil, we don't see any change in the fundamentals of our business in Brazil. The cattle business is doing very well, swine doing very well. We have some challenge in 2017 in our poultry business in Brazil. But overall, we see also projections for livestock International as a positive for 2018. And again, so -- we may see some quarterly fluctuations in some of the markets. But these are not indicative of the fundamentals of the markets, that should be a rise on a longer period of time. And we don't see any significant or any headwind in terms of the projections for 2018 in international markets for livestock. Operator : We'll go next to David Westenberg with CL King. David Westenberg : So my question is, some of our research is suggesting that veterinarians do tend to like order in bulk and from one vendor for additional discounts. So with the derm portfolio now approaching $500 million in sales, what's the opportunity to add to the product bag of the veterinarian. There's Simparica and vaccines and -- what's the cross-selling opportunity on derm becomes a $500 million drug? Glenn David : So -- this is Glenn. We do think there are definitely opportunities to leverage our portfolio and in many of our markets, we have programs that do provide additional incentives with the more products that you buy from Zoetis. So we're definitely able to leverage the scale that we have with Apoquel, with Cytopoint, with Simparica with many other vaccines to provide additional discounts for buying our total portfolio versus just buying one of our individual products. Juan Ramón Alaix : And when we are talking about the total portfolio, so we include products looks like rapid test and diagnostics or, in the future, equipments. So that's why we see the advantage of integrating a larger portfolio and offer this portfolio to our customers. Operator : And it appears we have no further questions. I'll return the floor to you, Juan Ramón, for closing remarks. Juan Ramón Alaix : Well, thank you very much for joining us. And thank you for your questions and looking forward to have another discussion for the first quarter of 2018. Thank you very much. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,018
| 2
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2018Q2
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2018Q1
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2018-05-02
| 2.458
| 2.56
| 2.96
| 3.13
| 4.63744
| 25.89
| 26.95
|
Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn David - Zoetis, Inc. Analysts: John C. Kreger - William Blair & Co. LLC Kevin Ellich - Craig-Hallum Capital Group LLC Louise Chen - Cantor Fitzgerald Securities Michael Ryskin - Bank of America Merrill Lynch David R. Risinger - Morgan Stanley & Co. LLC Gregg Gilbert - Deutsche Bank Securities, Inc. Jonathan David Block - Stifel, Nicolaus & Co., Inc. Christopher Schott - JPMorgan Securities LLC Jami Rubin - Goldman Sachs & Co. LLC Douglas D. Tsao - Barclays Capital, Inc. Alex Arfaei - BMO Capital Markets (United States) Kathy M. Miner - Cowen & Co. LLC Liav Abraham - Citigroup Global Markets, Inc. David Westenberg - C.L. King & Associates, Inc. Operator : Good day, and welcome to the First Quarter 2018 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of Zoetis. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Good morning, everyone, and welcome to the Zoetis first quarter 2018 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer and Glenn David, 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, May 2, 2018. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. Let me start by saying that the fundamental drivers of the animal health industry remain strong. The adoption of pets and focus on their health and their wellness are leading to a steady increase in medicalization rates, as well as more interest in specialty care products. A growing world population continues to require more efficient production of meat, eggs, fish and dairy products. Our livestock customers may face economic cycles, weather conditions, as well as fluctuations in their input cost and prices. These type of cycles will always exist, but the underlying need for healthy animals to produce safe and affordable food is essential. As a leader in animal health, Zoetis has stayed well positioned to support our customers. We have been able to discover, develop and deliver valuable products and services to them, based on our best-in-class combination of direct sales, R&D and manufacturing capabilities. This has been our formula for success, and it remains that way in 2018. In the first quarter, we continued generating profitable revenue growth, thanks to the quality and the diversity of our portfolio; also the innovations we bring to the market and the value we deliver to our customers. We achieved 7% operational growth in revenue, driven by the performance of our dermatology portfolio, as well as new products including vaccines. We generated growth in the U.S. and across our major international markets, based on the sustained effort of our field force and targeted investments for the launch of new products and the support of our in-line portfolio. We also grew our adjusted net income by 34% operationally, based on revenue growth, improvement to our gross margin and the benefits from the recently enacted U.S. tax reform. In terms of more revenue return, our Companion Animal products grew 11% operationally, and we expect another year of above-market growth in this part of our business. We see further opportunities for gaining share and expanding the market for our innovative dermatology products. We are extending our derm portfolio into new markets internationally, and putting our sales and marketing efforts behind them. In the U.S. and in other select markets, we are continuing digital and direct-to-consumer campaign to expand awareness around atopic dermatitis and also to increase the overall category spend on canine itch. Our new parasiticide products based on the sarolaner molecule, Simparica, a chewable tablet for dogs, and Stronghold Plus, a topical formulation for cats, are also contributing to growth in Companion Animal products in the first quarter, along with our new canine influenza bivalent vaccine. All of this was developed internally at Zoetis and illustrates a positive return on our R&D investment. On the Livestock side of our business, we generated 6% operational growth, led by stronger performance in our poultry products and growth in cattle and swine products as well. The conditions in the livestock market are stable and we expect to grow our cattle, poultry, swine and fish products in line with or faster than the overall market. There are excellent growth opportunities in animal health across the cycle of healthcare, from prediction and prevention to protection and treatment. And we are using our stronger financial position to support investment for growth. The investment in R&D is a top priority for Zoetis, and we see opportunities to enhance our product line with new lifecycle innovation and to make new breakthrough discoveries. In the first quarter, for example, we expanded our Fostera swine vaccine franchise with the approval in the U.S. of Fostera Gold PCV and Hyo. This is the first ever vaccine to contain both genotypes of PCV2 – 2a and 2b and a study show it provide cross protection against the leading 2d genotype. It also provide the long duration for commercial PCV2 combination vaccines at 23 weeks. As I said, we'll maintain DTC advertising and other digital marketing campaigns similar to last year, and we have started increasing our field force support in diagnostics in key markets. We are also executing our plans in manufacturing investments, which I have discussed recently. In fact, last week we held a groundbreaking ceremony in Suzhou, China for a new facility that will enable us to expand our vaccine manufacturing and R&D in that country. As always, we'll identify and scrutinize external acquisitions and partnerships in areas where we have our gaps or where we can achieve more value from an existing business or asset. In closing, we remain confident in the strength of our company and the opportunities to offer customers more integrated solutions across the entire cycle of healthcare. With this approach and our proven business model, we can generate long term growth for Zoetis and value for our shareholders. With that, let me hand things over to Glenn, who will provide more details on our first quarter results and full year 2018 guidance. Glenn David - Zoetis, Inc.: Thank you, Juan Ramón, and good morning, everyone. As Juan Ramón indicated, we performed well again in the first quarter, delivering operational revenue growth above historical trends for the market and we grew adjusted net income at a faster rate than revenue. Total company revenue in the first quarter grew 7% operationally excluding a favorable 4% impact from foreign exchange. Revenue growth in the quarter was driven by our in line portfolio which includes our key dermatology products. We also saw growth in new products, price and a strong Livestock performance across both our international and U.S. segments. The breakdown of our 7% growth was 2% from price and 5% from volume. Of the 5% volume, 2% was from new products and 3% was from in line products including 2% from our key dermatology products. We experienced balanced growth again this quarter as virtually all therapeutic areas, key markets and core species contributed to revenue growth. Adjusted net income grew 34% operationally, driven by revenue growth, gross margin improvement and a lower effective tax rate. Our key dermatology portfolio, comprised of APOQUEL and CYTOPOINT, once again surpassed the $100 million mark in revenue with sales in the quarter reaching $122 million. As we indicated on our earnings call last quarter, we expect to achieve more than $500 million in combined sales from APOQUEL and CYTOPOINT for the full year 2018. Now let's discuss segment revenue. International revenue grew 11% operationally in the first quarter with Companion Animal operational growth of 19%, and Livestock operational growth of 7%. Companion Animal growth was largely driven by our key dermatology products APOQUEL and CYTOPOINT, new products such as Simparica and Stronghold Plus and increased medicalization rates in key emerging markets such as China and Brazil. Livestock benefited from growing demand for animal protein, new product introductions and the success of our field force. Turning to some notable market performances in the quarter. In China, we grew 14% operationally, largely due to strength in Companion Animal, which increasingly represents a larger portion of our business there. An increasing companion animal population and medicalization of pets contributed to this growth. And our Fel-O-Vax vaccine continues to perform well as the only registered vaccine available for cats on the market. In Brazil, sales grew 7% operationally with contributions from both the Companion Animal and Livestock businesses. Higher Companion Animal revenue in Brazil benefited from the continued growth of Simparic due to a strong return on the direct to consumer investment, co-promotion with key in line products such as Revolution and higher vet clinic penetration. In cattle, investments in our field force have led to increased penetration and coverage in key regions within the market and we continue to see favorable export market conditions. In swine, increased sales of Vivax, or Improvac as it's known elsewhere, were driven by higher usage and greater penetration with larger customers. These increases were tempered by a decline in poultry. Other markets also contributed to growth. Japan experienced operational revenue growth of 17% in the quarter with positive performance across all species. Growth came from APOQUEL as a result of the timing of distributor purchases last year and the additional market penetration we achieved in the first quarter. Australia grew 14% operationally with strength across all species, particularly poultry and cattle. In poultry, the growth was driven by an installation of hatchery devices related to KL Products, which was acquired in 2015. In cattle, our vaccine business grew due to strong beef prices and the rebuilding of the herd and the market. Other emerging markets, particularly Russia and Poland, performed well. Russia had increased sales of medicated feed additives in poultry. And in Poland, we had the benefit of milk price stabilization and a cattle sector recovery based on producer consolidation. To summarize, a very strong quarter for our international segment with growth across a diversified portfolio. Favorable market conditions, a return on strategic investments in our portfolio and field force and a focus on execution are all helping to consistently drive commercial results. Turning to the U.S., revenue grew 5% in the first quarter with all species contributing to growth. Companion Animal grew 6% while Livestock grew 4%. Companion Animal sales in the quarter were driven primarily by our dermatology portfolio and a number of recently launched products. These gains were partially offset by decreases in certain in line products and Simparica. U.S. dermatology sales were $83 million for the quarter with both APOQUEL and CYTOPOINT exhibiting strong growth over the same quarter in the prior year. As anticipated, Q1 revenue was in line with Q4 and we expect higher sales in Q2 and Q3 with the warmer weather driving seasonal activity. Simparica declined over the same quarter of 2017 due to the timing of customer purchases in Q1 and Q2 of last year. We expect this product to grow in Q2 as we continue to gain clinic penetration and market share and realize the benefit of our direct to consumer investments which we are maintaining in 2018. Additional contributions to Companion Animal growth came from new product launches including our VANGUARD canine bivalent flu vaccine and DIROBAN for the treatment of heartworm. Partially offsetting growth in our Companion Animal business was the continued impact of expected competition on REVOLUTION, RIMADYL and CLAVAMOX. Our U.S. Livestock business continued to grow in the first quarter, building off a strong fourth quarter with sales increasing 4%, thanks to the positive performance across all species. Colder and more volatile weather conditions across parts of the continental U.S. led to a greater risk of disease outbreak and incidence and this supported the sales of premium products. Our beef cattle business also benefited from higher numbers of animals moving through feedlots than in the comparable period in 2017. The positive performance in beef was partially offset by dairy where reduction in herds due to lower dairy prices led to declines in sales of our anti-infectives and intramammaries. In poultry, the Zoetis portfolio of alternatives to antibiotics in medicated feed additives continues to be the primary driver of growth. Swine returned to growth in the first quarter. We are starting to see the benefits of our investments in our Fostera vaccine line including the launch of Fostera Gold PCV M. hyo and we expect further contribution in future quarters. Now moving on to the rest of the P&L. I will cover a few key line items and then discuss guidance for 2018. Adjusted gross margin of 67.5% increased approximately 300 basis points in the quarter on a reported basis and reflects the benefit of continued cost improvements and efficiencies in our manufacturing network. Operating expenses in total grew 6% operationally versus the same period last year. This reflects an increased investment in R&D in areas such as diagnostics and monoclonal antibodies for chronic pain. We also realized higher spend in SG&A, primarily due to increased compensation related costs. The adjusted effective tax rate for the quarter was 18.2%. The tax rate in the quarter is significantly lower than the rate from the comparable 2017 period due to the favorable impact of recently enacted U.S. tax reform and the benefit of certain discrete items such as the vesting of employee equity awards. We do, however, anticipate a higher effective tax rate for the remainder of the year in line with our guidance. Adjusted net income for the quarter grew 34% operationally through a combination of strong revenue growth, cost improvements in manufacturing and a lower effective tax rate. Adjusted diluted EPS grew 36% operationally in the quarter versus the same period in 2017. Now moving to guidance for full year 2018. The year is off to a solid start, as expected. We are therefore reaffirming our 2018 guidance provided during our February earnings call. Please note that this is shown representing foreign exchange rates as of mid-April. For the year, we continue to expect to achieve operational revenue growth of 5% to 7% and operational growth in adjusted net income of 20% to 26%. In the fourth quarter, we will have comparisons to a strong U.S. Livestock performance and less calendar days due to a change in our accounting calendar. Finally, we repurchased nearly $200 million of our shares in the first quarter and our guidance for reported and adjusted earnings per share reflects the shares repurchased through Q1. Just to summarize, before we go to Q&A. We're off to a good start with balanced growth across our portfolio including markets, therapeutic areas and species. We're seeing a balance contribution to growth across our in line portfolio, price and new products from our pipeline of novel innovation and lifecycle management. Our diversity, geographic presence and ability to innovate will continue to provide a platform for growth that is in line with or faster than the market. And we will continue to invest both internally and externally to support sound investments in our business and return excess capital to shareholders. With that, I'll hand things over to the operator to open the line for your questions. Operator? Operator : Thank you. We'll take our first question from John Kreger with William Blair. Please go ahead. Your line is open. John C. Kreger - William Blair & Co. LLC: Hi. Thanks very much. Juan Ramón, can you talk a little bit about all the discussion about tariffs in recent months? Have you seen that impact your Livestock business at all? And maybe related to that, if we see changes in NAFTA, do you see any exposure to your U.S. Livestock business? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, John. We have not seen any impact on price in our Livestock business. Definitely, yeah, that is something that can have an impact on some of the U.S. producers. Same time, because of our international presence and because the consumption of animal proteins will remain the same, we expect that anything which is not produced in the U.S. because of the implementation of a tariff will be supplied by other markets where we also have activity. But maybe talking to two areas that represent the biggest concerns, one is China and the tariff on the importation of pork. Our swine business in the U.S. represent 3% of our total revenue. 80% of the production in the U.S. is for local consumption and about 20% is for export. But in the case of exports, China only represent about 10% of these 20% of exports. So for our total revenues, this is something that would not have any impact. Definitely, we want to support our U.S. customers and I think it's something that we'll continue working to ensure that they manage any impact. What percent of bigger impact is the NAFTA discussions. Definitely the export to Canada, the export to Mexico are significant and hopefully the U.S. government will achieve a good agreement with these two countries and they will continue supporting agriculture and livestock in the U.S. So next question, please. Operator : We'll take our next question from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Good morning. Thanks for taking the questions. I guess Juan Ramón and Glenn, could you give us a little bit more detail on your capital allocation priorities and capital structure? You increased the dividend 20%. You bought back more stock this quarter than you had in the past. I guess, how do you prioritize things and what's your outlook for strategic M&A? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Kevin. And our capital allocation priorities remain the same. So we'll continue investing internally. We have been showing that these investments are having a high return. This year we are increasing our capital expenditure in manufacturing to ensure that we have the capacity and the capabilities that will be needed to support future growth. We'll continue investing in DTC to support key programs and we are expanding our field force to support diagnostic portfolio in the future. We'll continue also assessing external opportunities at divisions. We'll remain focused on anything that will meet the criterias of a strategic asset, and also value creation, and it is something that we are regulating the cash really to contemplate this type of acquisition, but at the same time will remain very disciplined on ensuring that the return generated is through any type of external position. And we'll continue paying dividends and also buying share backs in line with what we have been communicated in previous discussions. Glenn David - Zoetis, Inc.: Yeah, and the only thing I'll add, Kevin, as Juan Ramón said, our priorities haven't changed. However, we continue to have additional capacity and flexibility to execute on those priorities. And as we mentioned, our cash flow generation continues to increase also with tax reform. We have more flexibility and access to that cash and as you indicated in terms of your question around dividends versus share repurchase, we continue to prefer share repurchase as it does give us flexibility to execute on our other capital allocation priorities. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : And we'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen - Cantor Fitzgerald Securities : Hi. Thanks for taking my question. I'll try to ask Kevin's question a little bit differently. Maybe in terms of the acceleration in your cash flow generation, could you just give us a little more color, metric behind how we should think about that? Maybe the magnitude of increase? And then also the earnings potential of that cash, that's not really reflected in your earnings per share as it is today. So how should we think about how that magnitude could improve over the next several years? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Okay. So then, since you are asking a similar question, I will ask Glenn this time to answer to provide a different type of comments. Glenn David - Zoetis, Inc.: In terms of the magnitude of the cash generation and how we expect that to increase particularly for 2018, I think as we look at that, while we don't provide specific guidance on cash generation, for 2018, you could pretty much expect it to increase at the pace of our adjusted net income. So again we'll see continued expense in cash generation, continued flexibility to execute on our capital allocation priorities. Right? Our current guidance for 2018 includes the investments that we have internally. We've also referenced that we expect capital investments to be up in 2018 and then we'll continue to look for business development opportunities that have both the strategic and right financial rationale. To the extent that those materialize, we'll adjust our share repurchases either up or down depending on the magnitude of business development. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : And we'll go next to Erin Wright with Credit Suisse. Please go ahead. Unknown Speaker : Hi. This is actually (27:37) on for Erin today. Thanks for taking our question. We would like to ask a question about, how do you think about the quarterly progression of growth in product metrics and where do you think there are potential elements of conservatism in your guide relative to sort of the profit metrics? Thanks. Glenn David - Zoetis, Inc.: So as we indicated, we don't provide necessarily quarterly guidance. A couple things though that we will point out related to the quarter, as we referenced on the call, a change in our accounting calendar. That does provide a slight benefit to growth in revenue, particularly in Q1 and Q3 to the tune of about a half point to a point of growth. That reverses in Q4 where we'll see negative impact to growth from a number of calendar days by about 1% to 2%. The other thing, just to point out from a growth perspective, obviously we face tough comparison in Q4, particularly based on the strength of the U.S. Livestock performance in Q4 2017. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll go next to Derik de Bruin with Bank of America. Please go ahead. Michael Ryskin - Bank of America Merrill Lynch : Thanks. This is Mike Ryskin on for Derik. You talked about the competition in the U.S. on the in line products, the REVOLUTION, RIMADYL and then you also mentioned the strength in price for the portfolio overall. In the areas where you're seeing competition, is it more – specifically with those products, is it more in terms of volume? Or are you having a cut price there to sort of adjust for the market? And can you talk about what your expectations are for those products going forward, what levers you can pull to sort of strengthen that? And then also, if actually I can squeeze one more in, on the diagnostics products, you mentioned it's been a few months since you launched that and you talked on it briefly in the prepared remarks. Can you talk about, give us an update on the build-out there with the sales force? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you for the questions, Mike. So we reported this quarter in Companion Animal U.S. 6% growth. When we say that we expect that, you say, growth in Companion Animal U.S. will be higher for the total year, we saw some impacts in the first quarter that Glenn will describe, but as I said many times, one of the advantages of Zoetis is the diversity of our portfolio and this diversity in terms of species, in terms of therapeutic areas, geographies. It's helping us to be consistent in terms of generating revenue growth. But maybe Glenn will talk about the impact or some of the problems in line portfolio in the U.S. volume, price and what are expectations that we have moving forward. Glenn David - Zoetis, Inc.: Yeah, in terms of the impact of competition in the U.S., there were three products that especially faced the competition. It was CLAVAMOX, RIMADYL and REVOLUTION. CLAVAMOX, competition was really coming from generic sellers, primarily volume, but some price expense as well. And with CLAVAMOX, we have launched CLAVAMOX Chewables which we do expect will minimize this impact as we move forward. RIMADYL was really impacted by Galliprant and continued penetration of Galliprant and it's really a factor of the comparison year-over-year as the growth in the competition expanded throughout last year. So, we're in the toughest quarter in terms of comparison growth year-over-year. And then REVOLUTION, really Bravecto for cats was the biggest challenge from a competition perspective. And again, more volume competition there. Juan Ramón Alaix - Zoetis, Inc.: And maybe adding that also the parasiticide portfolio including REVOLUTION was affected by a cold March. This is something that we have seen also affecting the overall parasiticide portfolio not only for Zoetis, but also from our competitor. So you also asked about diagnostics. Well, in diagnostics, we continue investing internally to develop our portfolio and we are making progress in this area. We already have products that we are offering to veterinarians, mainly Companion Animal, and what we started it's building our field support and the field support in (32:03) is field forces in all locations (32:06) that will be supporting our current and future portfolio. We started in the U.S. We are now also expanding in key international markets and we'll continue until we complete what we think will be the needs of field support for our diagnostic portfolio. Next question, please. Operator : We'll go next to David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Thanks very much. I have two questions, please. First with respect to U.S. Companion Animal, the growth of 6% was marginally below what we had expected, but I wanted to ask about the outlook. I know that the comps may be getting a little bit tougher over the course of the year. I just don't have a sense for how to think about U.S. Companion Animal growth prospects in coming quarters. And then second, you're obviously reinvesting in R&D, which has paid off in the past, and the R&D year-over-year growth is accelerating as you invest in, I guess, more expensive R&D projects and you're now past your cost efficiency initiatives in R&D. Could you just talk about the outlook for year-over-year spending growth in R&D as well? Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Dave. And we expect higher growth for Companion Animal in the U.S. for the total year. And we expect that the higher growth will be coming from, well, the strong season on parasiticides that is now starting. Also the investment in DTC that has started in the month of April, so no impact in the first quarter. We'll be increasing our campaigns for DTC for increasing awareness on dermatology conditions and also we'll be also investing in DTC for Simparica. So all this should generate expansion of the market in dermatology and also continue grow in terms of a market share for Simparica. So we are optimistic about generating a higher growth in Companion Animal in the U.S. for a total 2018. In terms of the R&D investment, we are increasing our allocation for R&D. We have a strategic program that we are supporting. We also added some additional products with the acquisition of Nexvet that now we are supporting. We are also increasing our allocation for diagnostic R&D as well as increasing also investment in fish. So all this it's really increasing the level of allocation that we are – we are reallocating (35:05) that to R&D, and we are very confident that we'll maintain the same level of total activity that we show in the past. Glenn, if you want to add some additional comments either on the U.S. or R&D, please... Glenn David - Zoetis, Inc.: Yeah. Just to add to the U. S. Companion Animal growth comment. Just one thing to consider particularly for the quarter, the quarter was negatively impacted by Simparica growth in the quarter and that was really driven by a tough comparator to Q1 of 2017. So if you go back to 2017, we had strong sales in Q1 and then a sharp decline in sales in Q2. We're not going to see that same pattern in 2018. So while Simparica was a decliner in growth in Q1, we expect that to drive growth in Q2 to Q4 as well, which will then help accelerate growth in Companion Animal throughout the year. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Glenn. Next question, please. Operator : And we'll go next to Gregg Gilbert with Deutsche Bank. Please go ahead. Gregg Gilbert - Deutsche Bank Securities, Inc.: Thank you. I'm sorry if I missed this, Glenn, but could you give us the U.S. rest of world breakdown for APOQUEL, CYTOPOINT, and my more strategic question is about the fish business. Obviously a nice grower but small numbers overall. I'm curious conceptually how large can that business become for you relative to the other categories and species over the very long term? And clearly there's an organic story with R&D spend that, is this an area ripe for acquisitions as well? Again just looking at how large could this business be relative to others longer term. Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Gregg. Glenn you want to provide the details of the derm portfolio? Glenn David - Zoetis, Inc.: Yeah. In terms of the derm portfolio, so for the quarter, we had $122 million in sales and derm growing nicely, over 50% growth. Of that, $83 million was U.S., $39 million was international. The break out of $122 million between APOQUEL and CYTOPOINT, there was $99 million in APOQUEL, $22 million in CYTOPOINT and obviously there's just a little bit rounding in the numbers between the two. Juan Ramón Alaix - Zoetis, Inc.: And I will provide some comments about fish. It is difficult to estimate what will be the long-term opportunities for fish. Today most of the revenues generated in fish are coming from salmon, and in our case we are focused on salmon. We have 70% market share in salmon for vaccines. But the growth that will be generated in the future will be also for expanding the portfolio of vaccines for other fish species, mainly fresh fish, in where today the mortality rates are very high and most of the products that are used are antibiotics which are dropped into the water. So we expect that in the same way that many years ago the salmon industry moved from antibiotics to vaccines and today we are not using almost antibiotics in the production of fish. We expect the same for other species in the future. We see fish in some way similar to protein many years ago. In where there was very small revenue generated in poultry and now poultry, well, it's $16 billion revenues. So in the total animal health – no sorry – $5 billion. $6 billion (38:50), $5 billion total revenues for poultry. So we expect that maybe not reaching this level of revenues for fish, but over time moving from an industry that today is about $600 million, $700 million to an industry that will generate more than $1 billion in terms of revenue, and we think that the greatest asset, already the expertise and also the infrastructure to generate the future products that will be delivered to the fish producers. So next question, please? Operator : And we'll go next to Jon Block with Stifel. Please go ahead. Jonathan David Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks. Good morning, guys. I'm actually going to try to squeeze two or three into one. And just to roll through, maybe first, last quarter you had conviction that dairy would pick up in the back half of 2018. Just curious if that's still intact as pricing seemingly remains difficult. I guess part B would be fish up modestly year-over-year, but a big step down from the run rate that we did see in the back half of 2017. So how do we think about the contribution from PHARMAQ this year? And then lastly, sorry, but just Simparica, is there an update in the goal? And by that I mean out of the gate I think you guys pointed to a $100 million annual product. We've seen APOQUEL and CYTOPOINT have the positive revisions. What's the latest on Simparica? Is there a sort of an update positive or negative to the initial $100 million? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon. Let me start with the question on dairy and look for 2018. In general, Livestock, it's stable in terms of the previous conversations that we had in February. Maybe realistic (40:37) exception, it's dairy, in where we have seen that prices have been declining and we expect that in 2018 dairy farmers will face the challenge of profitability because of these prices. We expect that as in many other occasions there are cycles that always are happening and the next cycle they will be adjusting the volume and the supply and then prices will recover and we expect that in 2019, so the dairy industry will be back to profits. But even if the dairy, it's more negative, we'll see in some cases more positive in other species in Livestock that will compensate. So we remain confident that the total livestock will be in line with the projections that we made at the beginning of the year. In terms of fish, this quarter the fish portfolio was flat. We are comparing with a quarter in where our vaccine for SRS in Chile was priced at much higher level. We adjusted the prices in following process and we are comparing something which is probably in terms of our volume. We have continue increasing the penetration. Price is having a negative impact in the total revenue growth, but we expect that the growth for our fish will be growing in line of what's on the market but will be faster than the overall growth for animal health. And maybe Glenn, you want to talk about Simparica? Glenn David - Zoetis, Inc.: Yeah. The only other thing I'll mention on fish in terms of sequential quarters versus Q4 is the PD season, as we've indicated, really is in the second half of the year. So that's part of the step down between Q4 and Q1 performance as well. In terms of Simparica, we have indicated that we expect that product to be a blockbuster with sales of greater than $100 million and that still is our expectation for Simparica. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : And we'll go next to Chris Schott with JPMorgan. Please go ahead. Christopher Schott - JPMorgan Securities LLC : Great. Thanks very much. Just two questions here. First on the incremental investments you're making in R&D, how much of that is focused on lifecycle management versus breakthrough investments? And when we think about areas that you're focused on on the breakthrough side, what are you most excited about as you think about the R&D portfolio? My second question was just a quick one on tax. You obviously had a lower rate in the quarter. I know you expect that to rebound the rest of the year. But we have seen a number of companies lower their tax expectations as they've had more time to digest the new rules. So as you think about Zoetis beyond 2018, could we see improvement to the tax rate as the business trends over time? Or is 21%, 22% rate a good one to think about going forward? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Chris. And we are investing in lifecycle or new product innovation about the same. So we are very much balance how much these investments in our current portfolio compare to the products that will be new into the market and creating some additional growth. And in terms of what are we most excited about R&D. Definitely, we are very excited about monoclonal antibody. We have now one monoclonal antibody which is working extremely well and generating a very positive growth and missing the demand of our customers which is CYTOPOINT which is complementing APOQUEL. But we see monoclonal antibody as platform for many other indications including pain for dogs and cats and we see that, especially for cats, it's a significant unmet need. There's nothing specific for cats today. We state that monoclonal antibodies will cover this need and will generate very positive feedback from the market. We are also excited and will continue investing in sarolaner which is the molecule of Simparica and combining this with other active ingredients to extend the protection of dogs and cats to other parasiticides including internal and external. And we continue also excited about finding ways of integrating more the different aspects of healthcare, not just vaccination or treatment but also prediction with the genetic market, genetic information, and also detection with our diagnostic investment to build our portfolio also to cover from prediction, detection, prevention and treatment. And all across that ensuring that we use digital data analytics to really increase the value of our R&D investment. So definitely we are working on all these aspects and we think that they are great opportunities in both the Companion Animal and Livestock. And we see that integrating all these elements of healthcare will also have an impact on R&D but also an impact in our value that we'll be delivering to our customers. And let me ask Glenn to talk about tax rate for 2018 and 2019. Glenn David - Zoetis, Inc.: Yeah. In terms of the tax rate, the guidance that we had provided in February, we had spent a lot of time trying to understand the new law and providing that guidance. And we really haven't learned anything new to date that changes our expectations for the approximate 21% to 22% that we have for 2018. Over time, we'll continue to look for ways to grind down the rate but we don't see it changing substantially from the 21% to 22%. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Glenn. Next question, please. Operator : And we'll go next to Jami Rubin with Goldman Sachs. Please go ahead. Jami Rubin - Goldman Sachs & Co. LLC: Thank you. Just trying to – going back to the U.S. Companion Animal business that was up 6%, can you tell us, Glenn, what is a normalized growth rate if you exclude APOQUEL and CYTOPOINT? Those have been such strong drivers of growth to that business and I know there were a lot of moving pieces with Simparica this quarter. But is that business growing excluding APOQUEL and CYTOPOINT? And then secondly, what sort of competitive intelligence have you guys done around future competition, specifically for APOQUEL? Elanco certainly has the JAK inhibitor technology. What have you seen out there, and when do you expect competition to materialize for either of those two products? Thanks very much. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jami and I will answer first about the competition that we may expect for APOQUEL, CYTOPOINT and then Glenn will talk about the U.S. growth and also in line and also the rest of the portfolio. So as you know there is very little information about R&D in our industry. Most of our competitors are part of big pharma companies and they don't have the need of disclosing the details about R&D like in human health to support the future growth. It's something that is much more complicated. We should expect that in the future we'll have competition for APOQUEL and CYTOPOINT. There are some indications that the company was offering the monoclonal antibody that maybe have some activity in allergy, but it is information that they provided. They're still far from reaching the market because it was very early stage of development so it will take several years to reach and market. Apart from that, maybe some competitors are also working on developing this type of portfolio. We are very confident that first we have very strong asset protection for APOQUEL, that that will go through 2029 and for CYTOPOINT it will be even longer. And we have two products that has been demonstrated efficacy and also safety and that has been extremely well accepted by the market. So definitely competition one day will come but we're still very confident that we have very strong portfolio and very strong way to support our portfolio. And Glenn will talk about the U.S. Companion Animal growth and the breakdown between key problems and in line portfolio. Glenn David - Zoetis, Inc.: For U.S. Companion Animal growth, when you back out the impact of derm, you especially get to flat growth for the rest of the portfolio. And that was driven by a number of factors. A, we talked about the competition that we experienced on the three products that we described. We also had the negative impact of some of the quarterly variation with Simparica that we do expect to reverse as we move throughout the year. Offsetting that was growth in some other new product as well that contributed nicely and growth from some other in line portfolio as well. So overall, we were flat when you take out the impact of dermatology. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll go next to Doug Tsao with Barclays. Please go ahead. Douglas D. Tsao - Barclays Capital, Inc.: Hi. Good morning. Thanks for the taking questions. Just curious when you think about the Companion business, if you could provide some perspective on just sort of the consolidation we've seen on the customer side in terms of the vet clinics. And does that have any impact positive or negative in terms of your business there, in the Companion business in the U.S.? Juan Ramón Alaix - Zoetis, Inc.: Well, the consolidation on vet clinics, it's something that is happening and we expect that that will continue in the future. We have now Banfield and VCA, they're consolidating and representing, it's about 2,000 clinics in total. And it's a significant customer. We have excellent relationship with both VCA and also with Banfield. There are other group that are now consolidating and we'll see that many individual clinics will be also forming and buying groups or other sorts of networks. This definitely will have pressure in terms of pricing. But at the same time, we are very confident that the portfolio that we have which includes products which are highly differentiated also will help us to manage this situation or to manage volume and price discussions. And this is also something that we are incorporating in our projections. It's something that will happen in the U.S. We'll see also some type of buying groups in countries like the UK or France. It's part of what we should be expect in the future, but at the same time, with this consolidation, it's also increasing the opportunity to integrate more many of the things that we can offer to these clinics. So next question, please. Operator : And we'll go next to Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Hey, good morning, folks. Thank you for taking the questions. Can we get your Simparica sales by U.S. and ex U.S. please? You provided some helpful comments about the U.S. performance. Would appreciate your thoughts about expectations for ex U.S. And then Glenn, stepping back and looking at your margins, you've obviously made great progress. Just wondering what kind of operating margin is possible for your business in an optimal scenario. I appreciate the earlier comments about gross margin getting better with mix and efficiency but as competition increases invariably in dermatology, as you recently just pointed out, I would imagine that you also need to – there's going to be some need for SG&A spend. So if you were to look at your business optimally on an operating margin, help us figure out how much more room you have left there. Thank you very much. Juan Ramón Alaix - Zoetis, Inc.: I will start with a comment on Simparica. Glenn will provide more detail. But we have seen that the interaction of Simparica in international markets continue growing and continue growing there very nicely. And we see that the opportunities of growth in international markets are in line or even higher than our expectation and we are both very confident that Simparica will reach a significant part of the revenues in the future in international markets. But maybe, Glenn, you can go into more detail. Glenn David - Zoetis, Inc.: Yeah. Just to add to that point, so Simparica internationally grew 100%, over 100% in the quarter, so very strong growth internationally. To break out, there was $31 million in sales for Simparica for the quarter; $18 million of that was in the U.S., $13 million was international. In terms of operating margin, so as we've said in the past, we're not focused purely on generating higher operating margins. We're (55:30) both driving profitable revenue growth and improving on our overall cash flow. And that's going to continue to be our focus moving forward. That being said, we believe our long term value proposition is very much in place in terms of our ability to grow revenue at a faster pace than OpEx and therefore drive adjusted net income growth at a faster pace than revenue. You reference in terms of competition and global scale, we believe in the majority of the markets that we operate, we currently have the scale and infrastructure to support the anticipated revenue growth that we have moving forward. To the extent that there are some changes needed, they'll probably be more in the incremental house (56:05) to support additional revenue growth and would not change our cost structure materially. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll go next to Kathy Miner with Cowen and Company. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. Two questions. First on canine pain. Given that we've seen Galliprant making some inroads, does Zoetis have an interest in small molecule canine pain meds or is your focus on monoclonals? And can you give us any update on the timing of the next monoclonals that you have in development? And the second question is on antibiotic-free proteins. Do you see the demand for antibiotic free proteins in the U.S. increasing or do you think it's stabilized? And what are the types of products or services that Zoetis is providing to offset some of the loss of the antibiotic sales? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you for the questions, Kathy, and let me start saying that, well, we are focused on for pain for dogs mostly on monoclonal antibodies. We think that the current treatment that exists in the market related to NSAIDs or other type of solutions are well covered, but we see the opportunity of bringing monoclonal antibodies that will provide excellent efficacy to treat the symptoms of pain and also excellent safety profile. We have seen that, well, Galliprant had a good increase in 2017. Maybe they are reaching some level of plateau in terms of growth. And we are convinced that the portfolio we have today with RIMADYL, RIMADYL, it's a product that has been in the market for many years. It's extremely well accepted there based on brand equity, and we'll continue supporting RIMADYL in terms of oral formulations and developing these injectable formulation with monoclonal antibodies. In terms of demand for non-antibiotic or antibiotic-free proteins, we have seen that in poultry. It has been increasing there, the production of antibiotic-free, and the advantage of (58:39) is that we can also offer alternative to antibiotics and protein have been growing very nicely with this alternative and we have not seen the negative impact of the reduction of antibiotics in poultry. In other species, it's much more complicated to move to antibiotic-free production because they're much more exposed to external pathogens and with this exposure, so the infections are much more complicated to achieve with biosecurity and other healthcare protocols. In any case, we'll continue working internally to identify alternative to antibiotics that will protect the animals. One of these alternatives is where we are investing and will continue investing is vaccination. But we know that despite of all healthcare protocols and vaccinations there, animals get sick and when they get sick, they need to use antibiotics. Otherwise the impact in animals, in the productivity, but also the potential impact to humans will be extremely negative. So we'll work on alternative, but I don't – we don't see that antibiotics can be replaced in some of the species like beef or even pork. Next question, please. Operator : We'll go next to Liav Abraham with Citi. Please go ahead. Your line is open. Liav Abraham - Citigroup Global Markets, Inc.: Good morning. Thanks for squeezing me in. Just a quick follow-up question on the pipeline. Thank you for some of the color you provided. Can you call out any specific pipeline catalysts over the next couple of years, let's say? Just want to get a sense of when some of the opportunities that you've talked about qualitatively can come to fruition and translate into revenues. Thank you. Juan Ramón Alaix - Zoetis, Inc.: More than providing specific timing for the launch of the product, but in some cases, as you know, first, we don't want to provide information to our competitor. That will be a negative to us, and we want to make sure that when we launch a product that we maximize revenues and profits as fast as we can. And providing details probably will reduce the opportunity to maximize our new product launches. But definitely we'll see that we'll be launching in the next coming years combination of sarolaner with other active ingredients to cover internal and external parasiticides, as I mentioned. You will see that we are introducing also monoclonal antibodies for pain in dogs and cats. We'll continue bringing new innovation in terms of vaccines. In 2018 we introduce an expansion of our Fostera line with the first vaccination for PCV2, combining 2a and 2b, and also providing cross protection against 2d. So we are very pleased with the way that we are investing in our portfolio. And there will be many other things that we'll continue discussing in the future. But we prefer at this point not to provide too many details of specific programs or time, because I said this is something that we are – we want to protect our future launches and not to provide too much information to our competitors. Next question, please. Operator : And we'll go next to David Westenberg with C.L. King. Please go ahead. David Westenberg - C.L. King & Associates, Inc.: All right. Thank you for squeezing me in. So the merger or the upcoming merger of Henry Schein and Vets First Choice, a lot of that's on the paradigm they believe they can increase compliance. Now, for Zoetis, what opportunity do you see in encouraged compliance in your own kind of products? Is there a real potential to kind of grow the market in the companion animal market? And as a follow-up to that and the merger, what are the opportunities that you see to work with a Henry Schein, Vets First Choice combined company? Juan Ramón Alaix - Zoetis, Inc.: Well, we have excellent collaboration with both and we expect that this collaboration will be maintained in the future with the combination of Henry Schein and Vets First Choice. We see also that this JV will increase compliance, mainly on the chronic treatment and this an area that we will have a benefit for pet owners, a benefit for veterinarians and also benefits for manufacturers. We think that this type of JV also will increase the support to veterinarians and it's an area that we are 100% aligned in terms of keeping veterinarians at the center of any healthcare decision. And we think that this type of JV will expand also the presence in international markets. Vets First Choice is mainly focused on the U.S. today, but with their JV they maybe expand to other markets and definitely we expect to have a good collaboration with them. Next question, please. Operator : And we'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : My question's been asked and answered. Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you. Operator : And we will go next to Derik De Bruin with Bank of America. Please go ahead. Michael Ryskin - Bank of America Merrill Lynch : Thanks. Just one quick small one to squeeze in. I know it's not core business but the contract manufacturing slipped a decent amount in the quarter and by our estimates was a 25 bps to 50 bps headwind to the top line. Can you talk about that business? It's a little lumpy but is this something that you expect to continue going forward or was this just in timing of orders? Glenn David - Zoetis, Inc.: Yeah. That one really is just timing of orders. That business, it varies by quarter so I wouldn't read anything into the first quarter performance. Juan Ramón Alaix - Zoetis, Inc.: And this a business which is, as you said, is not core. It's helping us to increase the volume in some of our facilities and the absorption of overhead. But definitely is not an area that we are promoting or we are trying to increase the business through these third-party contact with in manufacturing. So our next question, please. Operator : And it appears we have no further questions. I'll return the floor to you, Juan Ramón, for any closing remarks. Juan Ramón Alaix - Zoetis, Inc.: Thank you very much for joining us today. And as we said in our comments, our results in the quarter were very strong. We are very confident on the projections for the year and we'll continue having interactions with you to provide future results. So thank you very much. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,018
| 3
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2018Q3
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2018Q2
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2018-08-02
| 2.643
| 2.73
| 3.186
| 3.24
| 4.53802
| 26.66
| 26.96
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn C. David - Zoetis, Inc. Analysts: Erin Wilson Wright - Credit Suisse Securities (USA) LLC Kevin Ellich - Craig-Hallum Capital Group LLC Jon Kaufman - William Blair & Co. LLC Louise Chen - Cantor Fitzgerald Securities Michael Ryskin - Bank of America Merrill Lynch David R. Risinger - Morgan Stanley & Co. LLC Gregg Gilbert - Deutsche Bank Securities, Inc. Divya Harikesh - Goldman Sachs & Co. LLC David Westenberg - C.L. King & Associates, Inc. Alex Arfaei - BMO Capital Markets (United States) Kathy M. Miner - Cowen & Co. LLC Christopher Schott - JPMorgan Securities LLC Operator : Good day, and welcome to the second quarter of 2018 financial results conference call and webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It's now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you. Good morning, everyone, and welcome to Zoetis second quarter 2018 earnings call. I'm joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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 in the company's 8-K filing dated today, August 2, 2018. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. Let me share three brief headlines for our call today. First, we continued to perform very well through the first half of 2018 with a strong second quarter results. Based on the latest external estimate, we have continued to gain market share through the last 12 months ending in March 2018. Second, we are very excited about the Abaxis acquisition that closed this week, well ahead of our expectations. And this should allow us to move quickly into the integration phase. And finally, we remain very confident in our ability to achieve our full year guidance. When you look at our historical performance and the recent revenue growth, much of our success comes from our diverse portfolio, a portfolio that has been compiled through the long-term investments in R&D and the careful selection of external partnerships and acquisitions. We are very confident in the long-term return of this investment. And in 2018, we have had an increase in R&D expense as we continue to accelerate certain projects in key growth areas such as monoclonal antibodies that will address pain associated with osteoarthritis and other indications. We're also progressing with the development of combination products based on the sarolaner compound, which is used in new products like Simparica, an oral parasiticide for dogs, and Stronghold Plus, a topical combination parasiticide for cats. We have filed for approval a new three-way combination parasiticide, which if approved will be known by trade name Simparica Trio. It will combine sarolaner with two other active ingredients to focus on ectoparasiticides such as fleas, ticks and mites as well as internal parasites and the prevention of heartworm disease. We remain very confident in the technical package that we have completed for this product. We are taking a phased filing approach in various markets around the world and subject to regulatory reviews and approvals, we would anticipate it coming to the market in 2020. We are also proud of recent launches of new swine vaccines, which includes Fostera Gold in the U.S. as well as PRRS, PCV2, PCV and M Hyo combination vaccine that are performing well in other markets. All demonstrate our continued expertise in vaccines and have us well-positioned for continued growth. External partnerships and acquisitions are also important for innovation and providing us new capabilities to predict, prevent, detect, and treat disease in animals. We have always seen diagnostics as an important high growth space for Zoetis, an important piece of comprehensive solutions we can bring to veterinarians. We wanted to find the right opportunity and partner. And this week, we completed our acquisition of Abaxis, a leading provider of veterinary point-of-care diagnostic instruments for approximately $2 billion. With our growing scale and direct customer relationships in approximately 45 countries, we can help accelerate the growth of Abaxis portfolio in the U.S. and International markets. We can also combine the expertise in diagnostics with our diverse portfolio and provide customers with integrated solutions that can work across the continuum of care. We are now moving ahead with the integration plans. While there will be cost efficiencies, the real value of this transaction is in the revenue growth opportunities, especially, International. Another area of external investment has been in monoclonal antibodies. In addition, to our internal expertise, this June we announced a five-year agreement with Regeneron Pharmaceuticals to collaborate on additional research in antibody therapies. As part of this agreement, Zoetis will be using Regeneron technology to develop monoclonal antibodies for use in companion animals and livestock animals. Regeneron will also work with Zoetis to evaluate select Regeneron antibodies in diseases of dogs and cats. Together we'll generate data that could be used in later human trials and for proof of concept in veterinary species. This collaboration demonstrates our access to multiple sources of innovation and reinforces our reputation as the animal health partner of choice in R&D. Finally, we are also expanding into sensors, digital platform and data analytics tools that help our customers predict and detect diseases in their animals. We recently acquired a small company based in Austria called Smartbow. They are an innovative partner. We have been working with them for more than a year on precision dairy farming technology. Smartbow has developed a cow monitoring system that helps dairy farmers use active electronic ear tags to collect data and analytics from individual animals. This includes monitoring for reproductive data, animal locations, detecting signs of stress, behavior change and disease and paving the way for early intervention and treatment. Moving on the second quarter results. We achieved 9% operational growth in revenue, driven by the performance of new parasiticides and new vaccines, our dermatology portfolio as well as contributions from the rest of our in-line portfolio. Our key dermatology products, Apoquel and Cytopoint, generated $143 million in sales in the second quarter. This included our first ever quarter of $100 million in the U.S. where we continued to use direct-to-consumer advertising to bring both, disease and brand awareness. We have continued to grow patient share in both the U.S. and International segments. And over the last 12 months we have generated more than $500 million in sales for our key dermatology portfolio. Our new parasiticide products, Simparica and Stronghold Plus, saw solid growth in the second quarter, with more than $50 million in sales for Simparica, putting it well on its way to blockbuster status this year. We continue to use our digital marketing and direct-to-consumer campaigns to support these products, and we are seeing good results in the U.S. and in other markets like Brazil. As we said last quarter, we expect to grow our cattle, poultry, swine, and fish products in line or faster than the overall market, and we expect to see positive growth in the livestock market in 2018. We have also sustained profitable performance in the second quarter. We grew our adjusted net income by 37% operationally, based on revenue growth, improvements to our gross margin, and continued benefits from U.S. tax reform. In closing, I'm confident that we are taking the right actions and making the right investments to deliver on our objectives for 2018 and ensure our future growth. With that, let me hand things over to Glenn, who will provide more details on our second quarter results, the Abaxis acquisition, and full-year 2018 guidance. Glenn C. David - Zoetis, Inc.: Thank you, Juan Ramón, and good morning everyone. We've had an exciting and busy second quarter, but first I would like to lay out what I will cover today. I will discuss the Zoetis Q2 results, which do not include Abaxis performance. I will mention the most recent Abaxis quarterly revenue results separately just for your reference and context going forward. And I will then review changes to our 2018 guidance, which do reflect the acquisition of Abaxis this week as well as changes to foreign exchange rates. Beginning with Q2 performance, we had another strong quarter with 9% operational revenue growth, balanced across our U.S. and International business segments, and we continued to grow adjusted net income at a rate significantly faster than revenue. Our performance was positive across all key markets and all core species. Total company reported revenue growth was 12% in the second quarter, including a favorable 3% impact from foreign exchange. Revenue growth in the quarter was driven by strong companion animal performance across both our International and U.S. segments. Our in-line portfolio, including key dermatology products, continued to demonstrate solid growth, with new products also contributing strong growth across both companion animal and livestock. Operational revenue growth of 9% was driven by 1% price and 8% volume. Of the 8% volume, 5% was from our in-line products, of which 2% came from our dermatology products and 3% from the rest of the in-line portfolio. The remaining 3% growth came from new products. Adjusted net income grew 37% operationally, driven by revenue growth, gross margin improvements, and a lower effective tax rate. As Juan Ramón mentioned, our key dermatology portfolio, comprised of Apoquel and Cytopoint, had their best quarter yet with sales of $143 million. We are well on our way to achieving more than $500 million combined sales target we previously communicated for these products in 2018. We're also very pleased with the uptake of Cytopoint and expect it to achieve blockbuster status this year, which is greater than $100 million of sales. We also recognized record sales from Simparica in the quarter, generating $51 million worldwide. We continue to be very pleased with both the U. S. and international performance of this product. Now before moving into Zoetis segment results, I would like to recognize a strong first fiscal quarter for Abaxis, which as I mentioned, is not included in Zoetis Q2 results. As a reminder, fiscal Q1 for Abaxis represents the months April to June for both U.S. and International. Abaxis Q1 revenue was $68 million and represents 17% growth over the same period in the prior year. These results were provided to us by the Abaxis team, are unaudited, and were recognized under Abaxis accounting policies while they were an independent public company. Now let's discuss segment revenues for Q2. International revenue grew 10% operationally in the second quarter, with positive contributions across all key markets, with companion animal operational growth of 17% and livestock operational growth of 6%. Companion animal product growth was largely driven by our key dermatology products Apoquel and Cytopoint, new products such as Simparica and Stronghold Plus, and increased medicalization rates in key international markets such as China and Brazil. Livestock products benefited from growing demand for animal protein, new product introductions, and the success of our field force. Highlighting some key markets for the quarter, in China we grew 23% operationally, largely due to strength in companion animals, which increasingly represents a larger portion of our business there. A growing companion animal population and medicalization of pets contributed to this growth, with Q2 benefiting from increased usage of our parasiticide Revolution and vaccines. In Brazil, sales were flat operationally. However, this is primarily a result of a national truck driver strike that occurred at the end of the international quarter, impacting recognition of livestock revenue within the quarter. We expect to recover these sales in Q3, as shipping resumed early in the quarter. We anticipate stronger than normal results in Q3. Excluding the impact of the strike, both livestock and companion animal products performed very well in Brazil in Q2. For cattle in Brazil, investments in our field force, including local commercial campaign efforts, have led to increased penetration and coverage in key regions within the market. We also continue to see favorable export conditions that will contribute to our growth. Companion animal revenue in Brazil benefited from the continued growth of Simparic due to a strong return on the direct-to-consumer investments. Australia grew 16% operationally, primarily driven by cattle, companion animal, and sheep. In cattle, our vaccine business grew due to strong beef prices and the rebuilding of the herd in the market. Companion animal benefited from growth in Apoquel due to the return on our direct-to-consumer investments as well as strength of our in-line portfolio. Sheep products benefited from continued strength in local market conditions. The UK contributed 23% operational growth with companion animal and cattle driving the largest increases. New products in companion animal generated strong growth with wholesale purchasing patterns in the prior year also contributing to growth for both companion animal and cattle. Mexico grew 22% operationally, delivering growth in excess of 20% for the third consecutive quarter. And the growth was generated across all species. New products, including the recent launch of Simparica and strong demand generation by the field force is driving the positive performance. Other emerging markets, particularly India, Poland and Turkey, performed well. India and Turkey had increased livestock product sales due to field force penetration and key account management. While Poland benefited from growth across both companion animal and livestock. Overall, a very strong quarter for our International segment with growth across all key markets. New products, favorable market conditions and a return on strategic investments in our portfolio and field force are all helping to consistently drive positive results. Turning to the U.S., revenue grew 9% in the second quarter, companion animal grew 15%, while livestock grew 1%. Companion animal sales in the quarter were driven by our dermatology portfolio and new products, primarily Simparica. These gains were partially offset by decreases in certain in-line products due to competitive pressure. U.S. key dermatology sales reached a new milestone of $100 million for the quarter with both Apoquel and Cytopoint exhibiting strong growth over the same quarter in the prior year. Both products also increased sales over Q1, consistent with expectations and the warmer summer months. I mentioned Simparica also had a strong quarter with the U.S. being a large contributor to the growth this quarter with more than 200% growth. As communicated in the first quarter, we had anticipated Simparica returning to growth this quarter due to the timing of customer purchases in Q1 and Q2 of last year. Year-to-date growth of 46% also demonstrates our ability to gain clinic penetration and market share and realize the benefits of our DTC investments, which we are maintaining in 2018. Partially offsetting growth in our companion animal business was the continued impact of anticipated competition for Clavamox and Revolution. With Clavamox also impacted by the timing of promotional activities in the prior year. The U.S. livestock business continued its strong growth in poultry and swine in the second quarter, partially offset by a decline in cattle. In poultry, there's the latest portfolio of alternatives to antibiotics and medicated feed additives continues to be the primary driver of growth. Swine continued growing in the second quarter, primarily from extended usage of Fostera Gold PCV MH, which we launched in the first quarter of this year. We expect to see continued adoption among our customers through the second of this year as it is the first and only vaccine to include two genotypes of PCV2, both 2a and 2b. In the beef cattle business, sales of cattle products declined due to increased competition of certain medicated feed additives. As anticipated, the dairy cattle business continued to experience pressure with lower dairy prices and limited producer profitability. This led to a decline in sales of our MFAs and intramammaries. Now moving on to the rest of the P&L, I will cover a few key line items and then discuss guidance for 2018. Adjusted gross margin of 68.7% increased approximately 300 basis points in the quarter on a reported basis and reflects favorable pricing, mix, reduced inventory waste and a benefit of continued cost improvements and efficiencies in our manufacturing network. Operating expenses in total grew 7% operationally versus the same period last year. The growth in operating expenses this quarter is primarily impacted by R&D growth of 16% and reflects increased investments in areas such as monoclonal antibodies, for chronic pain, and other pipeline programs. We also realized higher spend in SG&A primarily due to increased compensation related costs. The adjusted effective tax rate for the quarter was 20.1%. The tax rate in the quarter is significantly lower than the rate from a comparable 2017 period due to the favorable impact of U.S. tax reform. Adjusted net income for the quarter grew 37% operationally through a combination of strong revenue growth, cost improvements to manufacturing and a lower effective tax rate. As previously communicated, we were able to create strong operating leverage while investing in strategic areas of future growth for Zoetis. Now moving to guidance for the full year 2018. We continue to perform in line with our expectations. However, we are making certain adjustments to reflect the unfavorable changes in foreign exchange rates that have occurred since our last update as well as to include the partial year impact of the Abaxis acquisition based upon our preliminary estimates. Starting with revenue, foreign exchange rates negatively impacted revenue versus prior guidance by approximately $125 million. With the addition of Abaxis as well as other operational drivers we are maintaining the high end of the range at $5.8 billion and increasing the lower end of the range to $5.7 billion. We still expect to achieve operational growth of 5% to 7% excluding any impact from Abaxis. Including Abaxis partial year revenue, which consist of five months of domestics activity and four months of International, our operational revenue growth increases to a range of 7% to 9%. Implicit in our updated full year guidance are certain impacts in Q4 that I want to remind you as you think about the remainder of the year. Our business in Q4 2017 was very strong, so growth off its higher base will moderate. U. S. livestock is one area where we experienced an exceptionally strong Q4. In addition, the fourth quarter of this year will also include four fewer International selling days compared to last year, resulting from the change in our accounting calendar implemented this year. Please note that from an EPS growth perspective, the second half of 2018 will be impacted by the timing of cost of sales, which were higher in the first half of 2017 when compared to the second half of 2017. For SG&A and R&D, we're increasing both the low and high ends of the range primarily due to the impact of the Abaxis acquisition. Adjusted interest expense is increasing to approximately $200 million to reflect the financing of the Abaxis acquisition. Our guidance for the adjusted effective tax rate has been lowered to approximately 20% from our previous range of 21% to 22%, primarily due to the impact of favorable discrete, non-recurring items, resulting from the implementation of U.S. tax reform. For adjusted diluted EPS even with the negative foreign exchange impact of $0.07 and the slightly diluted impact of the Abaxis acquisition this year, we're maintaining the high end of the range at $3.10 and increasing the low end of the range to $3. Please note that our range for reported diluted EPS includes preliminary estimates for certain significant items and purchase accounting for the Abaxis acquisition. Finally, we repurchased nearly $400 million of our shares in the first half of the year and our guidance grew reported and adjusted earnings per share, reflects the shares repurchased through the end of Q2. Now to summarize before we move to Q&A. We've delivered consistent operational revenue growth in the first half of the year with balanced contributions across all key markets and all four species. We are well positioned to meet our guidance for the year and anticipate continued positive trends in our key products and markets. Our diversity, geographical presence and ability to innovate, will continue to provide a platform for growth that is in line with or faster than the market. The Abaxis integration is well underway and will allow us to unlock the value of the revenue growth opportunities in the diagnostic market and further support our customers across the full continuum of care. We will also continue to invest both internally and externally to support sound investments in our business and return excess capital to shareholders. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : We will take our first question from Erin Wright with Credit Suisse. Please go ahead. Your line is open. Erin Wilson Wright - Credit Suisse Securities (USA) LLC: Hi, thanks. On U.S. livestock, can you speak to the quarterly progression and your visibility there on in the second half? I guess, particularly across the cattle segment in particular, and how confident you are in sort of a better trend there? And then also maybe some of the seasonal aspect on the U.S. companion animal business? And how we should be thinking about the quarterly progression there as well? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Erin. And, well, we see the U.S. livestock has not changed compared to previous projections. Despite of the trade situation, we expect that the U.S. livestock will be showing positive growth in 2018. We also mentioned at the beginning of the year that on this market growth, we expect cattle and poultry product is already growing in line with the market, and swine growing faster than the market and our forecast remain the same. The only change compared to what we estimated at the beginning of the year was the dairy segment, where the performance is below expectations for the market, and we also expected a recovery in the second half. And now our estimate is it will be taking longer and will not be until 2019. Just to summarize our performance in the first half. So livestock grew in the U.S. by 2%. And for total Zoetis the growth was 5%. And this confirms again that our geographical diversity is helping us to manage our economic cycles, regulatory changes or now even trade war. The fundamentals of livestock remain the same and the consumption of animal proteins to continue growing, and the needed to keep animals healthy and productive is the same as we have been communicating before. So with all these, we expect that at end of the year, livestock in the U.S. and also the livestock worldwide will be growing and we'll be growing in line or faster than the market. Maybe also Glenn can add to my comments on the second half of the year. Glenn C. David - Zoetis, Inc.: Erin, just one thing to consider as you look at the quarterly progression of livestock in the second half, just a reminder that in Q4 of 2017 in the U.S. in particular, we had a particularly strong U.S. livestock performance in growth across all of its species. So that will be a challenge to growth in Q4 in particular. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Glenn. Next question please. Operator : And we'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Good morning. Thanks for taking the questions. Two questions for me, Juan Ramón and Glenn. First off, clearly you guys have laid out a roadmap and strategy for your monoclonal antibodies with Nexvet, Cytopoint and now the collaboration with Regeneron. Could you talk more about, I guess how that's going to develop beyond osteoarthritis and pain? What are other indications you could look for both in companion and maybe even livestock? And then for the second half of the year, organic growth has been really strong the first half. What factors have you considered in the guidance for the back half besides the tough comps? Have you input anything there for the potential impacts on the tariffs and other livestock headwinds that you just talked about? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Kevin. I will cover the monoclonal antibody question and then Glenn will respond on the organic growth in the second quarter. Definitely, monoclonal antibodies is an area of significant investment for Zoetis. We have seen first opportunities for Cytopoint and this has been something that is developing extremely well. So the reaction of the market has been exceeding the initial expectations. And we also saw opportunities on developing products, as you said, for osteoarthritis, pain, and also very important attacks (32:39). These programs are progressing very well. We are combining many different programs that came from Nexvet, but also internal programs as they were part of our R&D activity. And beyond pain, we also see opportunities in renal, we see opportunities on oncology, and we are also developing programs for livestock. These programs are not as advanced as companion animal, but we remain confident that also monoclonal antibodies will provide opportunities in livestock, especially in feed enhancement. That is an area that also we'll be replacing existing technologies with new technologies that will be more acceptable for consumers for retailers. Glenn? Glenn C. David - Zoetis, Inc.: And, Kevin, in terms of your question in terms of the applied slower organic growth in the second half of the year, it is really mainly driven by the tough comps that we have, particularly in Q4, and again related to U.S. livestock. Just a couple of other things to point out, as I mentioned in the prepared remarks, we do have four fewer calendar days in the International business in Q4 of 2018 versus Q4 2017, which also provides a tougher comp. And then there are just, as you look at some of our growth portfolio, particularly derm, the growth comes off of a higher base as we mature through the year. So those are some of the factors that would indicate slightly slower growth in the second half of the year versus the first half. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll take the next question from John Kreger with William Blair. Please go ahead. Jon Kaufman - William Blair & Co. LLC: Hi, good morning. This is Jon Kaufman on for Kreger. So a question on poultry for you. One of the major producers recently remarked that chicken demand was a little bit sluggish, and that's end market chicken demand. I believe they cited other meats being cheaper than normal as the cause. Do you see any impact to your poultry business in the near and medium term as a result of these dynamics? Juan Ramón Alaix - Zoetis, Inc.: We have seen that – for us, the poultry business has been performing very well in this first half. We continue creating growth in the second half. So as we explained many times, maybe some market they will be facing some challenge. But the consumption of chicken is growing, and we have seen growth in many international markets. Maybe the only area where we saw some negative evolution was Brazil, and this was a result of also the strike, where the transportation strike was limiting the transportation of food to some of the poultry farms, and this created somewhat challenging situation for producers. But Brazil is where we had probably the lesser penetration in terms of poultry. Overall, we remained positive about poultry. And in poultry, we have not only vaccines and pharmaceuticals, but we're also providing devices for vaccination, in-ovo vaccination. And also we have to be adding also automation with (36:08). So overall we remain positive about poultry. Next question please. Operator : And we'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen - Cantor Fitzgerald Securities : Hi, thanks for taking my question. I just wanted to clarify some of the points of your guidance raise. We've been getting questions on that this morning. So first thing is just on the Abaxis portion. Can you clarify if that was actually accretive or dilutive from a model line perspective, and how that's changed or has that stayed the same to what you've previously said? And then maybe a little bit more color on the tax element of the change in the guidance? And then was this upside for organic growth in the second half of 2018? Thanks. Glenn C. David - Zoetis, Inc.: So in terms of Abaxis and its impact to EPS, so similar to what we've indicated prior, in 2018 we do expect Abaxis to be slightly dilutive to earnings when you include the funding of the acquisition. We do expect that our first full year of operations when we're able to generate both the revenue upside and some of the expense savings that we expect to generate that it will be slightly accretive to earnings. So we do expect it to be accretive to earnings in 2019. But in 2018, it is slightly dilutive. In terms of the tax change and the guidance, we have previously guided to an adjusted effective tax rate of 21% to 22%. Because of some favorable discrete items that we've experienced year to date and some of that we may experience in the following quarters as well, we've updated that guidance to approximately 20%. But again, those are just certain discrete items that don't necessarily carry forward into 2019 and beyond. In terms of the organic growth for the second half of the year, again similar, I think, to some of the comments that we've made. We do have certain challenges, particularly in Q4 of 2017 (sic) [2018] from a prior-year comp perspective that will negatively impact our growth. And also we do have a four fewer calendar days in the International segment in Q4. Juan Ramón Alaix - Zoetis, Inc.: Next question please. Operator : The next question comes from Derik De Bruin with Bank of America Merrill Lynch. Please go ahead. Michael Ryskin - Bank of America Merrill Lynch : Hi. This is Mike Ryskin on for Derik. Congrats on another strong quarter guys. A couple of quick questions. One on the Simparica Trio that you announced, just a little bit more clarity into the timing and the expectations forward and the market, any expectation for U.S. versus Europe? And I recognize, a lot of that's up to the regulatory agencies. And then on the 2020 timing is it more about – should we think about it the same way as we do all the flea and tick drugs where you want to launch 1Q to sort of be fully ramped by the mid-year summer and therefore that's why you're a little cautious with the regulatory pathways? And then on the SG&A really quick, you've highlighted earlier throughout the year that the increased OpEx both SG&A and R&D sort of just reinvest back in the business? And then with the updated guidance today, I just want to be clear. Is the guide update for SG&A and R&D entirely just rolling Abaxis into the model, or is there any incremental spend? And you talk about the spend you're doing in the diagnostics sales force that you talked about earlier? Juan Ramón Alaix - Zoetis, Inc.: Thank you, Mike. On Simparica Trio, as you said, it depends on regulatory approvals. But as I said, we feel confident that the registration packets of these products is strong and we'll be able really to gain approval to launch the product in 2020. Definitely we'll be launching the product in the first quarter. But we don't know at this point it will be in the first quarter or midyear. So definitely we'll be working to accelerate as much as possible all the approval. But it depends on third-parties approval and we don't know exactly when we'll be able to bring this product into the market. And Glenn will cover the question on OpEx. Glenn C. David - Zoetis, Inc.: So, Mike, in terms of SG&A and R&D, as you did mention a big part of the raise in the guidance there is related to Abaxis. But there are other operational factors driving some incremental R&D and SG&A. We mentioned the acquisition of Smartbow, while not material from upfront investment perspective. There are certain ongoing costs to developing those products and they hit both the SG&A and the R&D line. So that's another key area of growth in SG&A and R&D. Juan Ramón Alaix - Zoetis, Inc.: And, Mike, I don't think I responded about the timing for the U.S. and Europe. In both big market we expect approval in 2020. So, next question please. Operator : We'll go next to David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Yes. Thanks very much. I joined the call late, so I apologize if any of these questions were asked. But could you please comment on the key considerations for the third quarter, sequentially, relative to the second quarter of 2018 that you just reported? And then, if you could provide any updates on the triple combo? Once again I joined late, so if you're already addressed you could ignore that? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Dave. And that's all right. I just answered the question on the Simparica Trio. I mentioned that we expect this product to reach the market in 2020 in both U.S. and International. International will be European Union. And Glenn, do you want to answer the question on the sequential? Glenn C. David - Zoetis, Inc.: Sure. In terms of any sequential guidance. So, obviously, we don't necessarily guide to any particular quarter. But in terms of any major changes to growth, it really is the Q4 2018 drivers that we referenced are the things to note. In our Q3, no major changes versus the first half of the year. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : The next question is from Gregg Gilbert with Deutsche Bank. Please go ahead. Gregg Gilbert - Deutsche Bank Securities, Inc.: Just I have a couple longer term questions. One, it seems inevitable that there will be more competition in atopic dermatitis space. My question is whether you think those new (42:44) launches can come on fast enough and be large enough and profitable enough so that you can continue companion growth in revenue and profits continuously over the next three to five years? And secondly, I realize it's very early on Abaxis. But I was hoping you could talk, at least preliminarily, about the longer term opportunity to leverage that new capability across the food animal setting? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Gregg. Well, we mentioned usually that we expect competition for our derm portfolio. We expect competition in the future for Apoquel and also for Cytopoint. We have now very strong position in the market. We also have a product that has demonstrated very strong, safety and efficacy profile. And we are very confident that we will be able to continue defending our franchise successfully in the future. Definitely we have been growing very fast. We expect that at some point we will be reaching a level of penetration that will be difficult to continue growing. But we still have a lot of opportunities in International markets where we far off reaching this level of penetration in terms of patients. And in some countries like China the product is not available and we expect Apoquel reaching China and also generating very positive growth. So in summary we are confident that we have very strong position, we have great two products, and definitely we expect that we will be able to protect and defend this franchise that has been created by Zoetis. In terms of Abaxis, we see both short-term and long-term opportunities. We mentioned that the short-term will be for International markets where the level of use of diagnostic tools is extremely lower than in the U.S. And now with our presence and the combination of our portfolio with diagnostics and adding the field force that we have in International market we expect to generate short-term growth. In longer term definitely we see two opportunities. One is to continue bring innovation and we are confident that with Abaxis together with SMB and also our internal groups, we'll be able to continue bring the innovation in companion animals, but also very important now with Abaxis, we have the opportunity to reassign resources to develop a portfolio for livestock. And in livestock we see a significant opportunity in where there is no any existing diagnostic company having any penetration in this market. This market is served mainly from reference lab, farmers or veterinarians in livestock sending samples to reference labs, getting the information back in one to three days. We see the opportunities of bringing point-of-care diagnostic tools into the farms and creating an information that will be very important to protect the animals and also may be with the opportunity also to expand the use and the compliance in livestock. Next question, please? Operator : We'll go next to Jami Rubin with Goldman Sachs. Please go ahead. Divya Harikesh - Goldman Sachs & Co. LLC: Good morning, this is Divya Harikesh on behalf of Jami Rubin. I have two questions. One with the Abaxis deal now closed, can you provide more color on the cost efficiencies and where we can expect that to come from? You have mentioned that you continue to expect the 200 basis points improvement in gross margins, but can you help us think about how we should think about the operating margins with respect to your accretion in 2019 and longer term as well? The second question following-up on an earlier question on the dermatology franchise, given the momentum – and you said that the U.S. will reach a level of penetration soon – can you help frame expectations of what do you think that franchise could look like in terms of peak sales or at what level of sales do you think that they would get to maturity? Thank you so much. Juan Ramón Alaix - Zoetis, Inc.: So, thank you. And maybe a clarification on the level of penetration in the U.S. In the U.S. in the second quarter, we have reached 61% patient share, so we still see opportunities to continue to growing in this franchise. What I'm saying is that, well, we will be reaching in the future a level of penetration that that will be difficult to continue growing but not at this point. At this point, we still see two opportunities in the U.S. One is increasing the awareness and increasing the demand for treating dermatology issues and also increasing the penetration on patient share. Then moving to the cost efficiency in Abaxis, Glenn, do you want to cover this question? Glenn C. David - Zoetis, Inc.: Yeah. So, in terms of the impact of Abaxis on our margins moving forward, so from a gross margin perspective, cost of goods for Abaxis are a little higher than what we have for the remaining portfolio of Zoetis. So it will be somewhat of a negative impact but we still do expect to achieve the 200 basis points of improvement from 2017 to 2020 within our gross margins. When you think about more to an operating margin level because of our ability to leverage our existing infrastructure, we do believe that over the next coming years we'll achieve the same operating margins that we would have without Abaxis. So we expect to be able to continue to grow our operating margin but, again, the focus continues to be on growing cash and profitable income growth. Juan Ramón Alaix - Zoetis, Inc.: And maybe one comment on the cost efficiencies in Abaxis. So the Abaxis acquisition is not driven by cost efficiency. We will be generating short-term cost efficiencies but the cost efficiency will be fully realized in the 2019. You also ask about this 200 basis points of improvement in cost. Maybe, Glenn, you can cover that. Many of these costs has been already generated in 2018, so it's not that we are still targeting 200 basis points of improvement from now, so some of this has been also coming in this quarter. Glenn C. David - Zoetis, Inc.: So, the 200 basis point improvement, as we mentioned, was off the 2017 base where our cost of goods was approximately 33% at that period of time. We've guided for 2018 approximately 32%, so we'd expect about 100 basis point improvement year-over-year, which would then lead to about another 100 basis point improvement by the year 2020. So we're well on our way to achieving that goal and expect to be able to deliver that. Juan Ramón Alaix - Zoetis, Inc.: Thank you. Next question, please. Operator : We'll go next to David Westenberg with C.L. King. Please go ahead. David Westenberg - C.L. King & Associates, Inc.: Hi. Thanks for taking the questions. Some quick ones on Abaxis. Do you anticipate any product repositioning with Abaxis, particularly in context with how you're going to sell the products SMB products and CARYSTA? And then as a follow-up to that, just on – the 10-Q hasn't dropped yet, so just where in the product segmentation are you going to be putting Abaxis? Thank you very much. Juan Ramón Alaix - Zoetis, Inc.: Well, now we have a combined portfolio with Abaxis/SMB, but we don't think that at this point there are products which are in conflict or in competition. They are products that can be managed very well. And now we have the opportunity to combine the field force of Abaxis that has been increasing in 2018. And with our field force and the plan now – from now to the next coming months is to ensure that both field forces are fully aligned and both field forces they have their level of technical information that will be supporting this new portfolio. So we are very confident that we'll be defending Abaxis in international markets as well as in the U.S. with now stronger presence in the market. Glenn C. David - Zoetis, Inc.: And in terms of Abaxis reporting, Abaxis is going to be fully integrated into our operating structure, so therefore it will not be reported as a standalone segment. We will, however, provide transparency to the revenue performance of the diagnostics business moving forward. Just one point, you mentioned this quarter's 10-Q. since we did not own the business in Q2, we'll not be reporting on Abaxis revenues within the 10-Q. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : The next question is from Alex Arfaei with BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Great, thank you and good morning. Could you please comment on the recent announcement from the FDA about a new five-year blueprint regarding antimicrobial stewardship? How is this incrementally different relative to the prior initiatives and directives and what the impact could be for you? And I apologize if I missed this but could you provide Apoquel and Cytopoint sales by U.S. and ex-U.S. as well as for Simparica? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you for the questions, Alex. I think that the FDA five-year blueprint, in our opinion, is consistent with previous approaches in terms of anti-infectives or antibiotics. We don't think that this will have a significant negative impact to Zoetis. We already mentioned that in antibiotics we expect that they will be growing maybe half of the growth rate of the animal health industry. This is part of our model. This is part of our prediction. We continue also working on having a portfolio that is much more balanced and less dependent on antibiotics. If you compare the portfolio of antibiotics or the weight of our revenues in 2013 through the weight of antibiotics in 2018, this has been decreased significantly. But we are still very confident that we have a very strong portfolio of antibiotics – injectables and antibiotics that can be used by veterinarians in a way that is protecting animals and not creating additional resistance in human health. So we are confident that we'll be able really to maintain our position and support our portfolio of antibiotics. You also asked about the breakdown between dermatology sales U.S.-International as well as Simparica. Glenn? Glenn C. David - Zoetis, Inc.: In terms of total derm sales for the quarter, we had $143 million in total. Of that, $100 million was the U.S., $42 million was International, so obviously some rounding there. In terms of Apoquel for the quarter, we had total sales of $110 million, with $73 million being the U.S. and $37 million being International. And with that, you could calculate Cytopoint. From a Simparica perspective, we had total sales of $51 million, with $30 million being U.S. and $21 million International. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : The next question is from Kathy Miner with Cowen & Company. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you, good morning. I have two questions. First, on your first quarter call you provided a nice update on the potential impact of tariffs or lack thereof on your U.S. pork business – swine business. Could you give us an update as things have progressed since then, and maybe also comment whether the increased tariffs in Mexico are having any impact to your outlook? And the second question is on aquaculture. I don't think we've talked about that today. Just give us an update. I know the second half of the year is usually stronger. Do you expect that to continue, and what kind of growth can we look for later this year and into 2019? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Kathy. The impact from tariffs is something that is evolving every day, because it can be a – maybe some additional tariff applied to China. But our estimate for 2018 is that there definitely will be some small impact on swine because of the exportations to China. But to put things into perspective, so the total swine in the U.S. represent about 3% of our total revenues. 80% of the production in the U.S. is for local consumption and 20% is for export. On this 20%, 10% to 12% is exportations to China. So even if there may be some impact, the total revenues exported to China or as royalty, represent less than 0.1%. So definitely it's an area that we are concerned because it's affecting our customers in the U.S. But at the same time, as I mentioned, before our global presence it's also protecting us for this type of economic cycles or regulatory situations or even trade wars. And we know that the consumption would remain strong, and we have a significant presence of swine activity in many other parts of the world. You had also asked about Pharmaq performance in the second quarter. Glenn, do you want to comment on that? Glenn C. David - Zoetis, Inc.: Yes, so Pharmaq had sales of $24 million in Q2, which was growth of about 13% operationally, which is really driven by the increased adoption of our LiVac SRS vaccine in Chile. As we did indicate previously, 2018 we don't expect to achieve the same level of growth as we saw in 2017, as in 2017 we saw very rapid adoption of the PD vaccine in Norway, as we displaced a competitor following a legal victory. That being said there, we still expect Pharmaq to grow at a faster pace than the overall Zoetis business in 2018. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : The next question is from Chris Schott with JPMorgan. Please go ahead. Christopher Schott - JPMorgan Securities LLC : Great, thanks very much for the questions. Just a couple on Abaxis and the International opportunity. I think you mentioned that as a shorter-term growth opportunity, but when we think about the ramp of that business and taking advantage of your larger footprint, is that something where we just expect a significant step up in 2019, or is that a multiyear process? And when you think longer term about the Abaxis mix, I think Zoetis right now is about 50% U.S., 50% ex-U.S. by revenue. Is it reasonable to think about Abaxis getting into that type of split over time? And then my final question was just a quick update on capital deployment priorities post the transaction. Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Chris. Well, first, we're penetrating International markets with the new portfolio of diagnostic equipment; we are now building the presence in this International market. When I say building the presence, we need to have the technical people that will be in charge of selling and also installing and the plan is use our existing field force to complement this effort. This was already planned even before the acquisition of Abaxis, because when we acquired SMB, we saw the opportunity of building this infrastructure to support the future portfolio. Now with Abaxis, we are accelerating even more these plans to have the presence that we think is needed to support the growth in International markets. But it's something that we've planned to generate – well, most of this impact will be coming in 2019 and the following years. You were asking about the long-term. It could be reaching 50%-50%. I think it's too early to say. And we still need to have a better understanding of what will be the level adoption of equipment in International markets. Again, so International markets is a combination of developed market with developing markets. And – well, definitely it will be part of our analysis – full analysis and also we'll be really targeting to maximize opportunities. But at this point, it's difficult to predict it will be 50%-50%. In terms of capital allocation, Glenn will cover, but there is no change and we remain committed with the principles that we communicated before. Glenn? Glenn C. David - Zoetis, Inc.: Yes, Chris, as Juan Ramón indicated, there really is no change to our capital allocation and priorities moving forward. When you look at the current level of operating cash flow that we have and the strength of our balance sheet, we're able to fund almost the full consideration and still stay within our targeted gross debt to adjusted EBITDA range of 2.5 to 3. So that still leaves us the financial flexibility to fund future strategic investments and also return cash to shareholders through dividends and share repurchases. So really no change to our capital allocation priorities post-Abaxis. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : We'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Actually all my follow up questions have been answered. Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you. Next please. Operator : And it appears we have no further questions. I'll return the floor to Juan Ramón for any closing comments. Juan Ramón Alaix - Zoetis, Inc.: Thank you for joining us today and thank you for your questions. And as a conclusion, we remain very positive about our performance and not the performance in the quarter but also our future performance. And we are very much on track to deliver our objectives for 2018 and we continue investing in ensuring that we'll be generating a future growth through our core portfolio but now also through the extended portfolio with diagnostics and other areas in where we are also investing. So thank you very much for your attention today. Operator : This will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,018
| 4
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2018Q4
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2018Q3
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2018-11-01
| 2.811
| 2.91
| 3.294
| 3.358
| 4.78008
| 26.85
| 26.53
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Executives: Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc. Glenn C. David - Zoetis, Inc. Analysts: Jonathan David Block - Stifel, Nicolaus & Co., Inc. Alex Arfaei - BMO Capital Markets (United States) Louise Chen - Cantor Fitzgerald Securities Kevin Ellich - Craig-Hallum Capital Group LLC Erin Wright - Credit Suisse Michael Ryskin - Bank of America Merrill Lynch Jon Kaufman - William Blair & Co. LLC Chris Schott - JPMorgan Securities LLC Kathy M. Miner - Cowen & Co. LLC David R. Risinger - Morgan Stanley & Co. LLC Operator : Good day, and welcome to the Third Quarter 2018 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation It's now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank - Zoetis, Inc.: Thank you. Good morning, everyone, and welcome to the Zoetis Third Quarter 2018 Earnings Call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer, and Glenn David, 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, 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 in the company's 8-K filing dated today, November 1, 2018. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Steve. Good morning, everyone. In 2018, we have been making significant effort to support future growth with investment in the business. We are allocating more resources to critical R&D projects, updating and expanding many of our manufacturing capabilities and investing in key areas such as diagnostics with the recent acquisition of Abaxis. We are making good progress integrating Abaxis. Our sales teams have been cross-trained on Zoetis' and Abaxis' product lines in the U.S. and Canada, and they're already collaborating on customer accounts. Outside of the U.S. we are focused on building a more robust diagnostic team and using the existing Zoetis infrastructure to expand our diagnostics sales. The initial feedback on the acquisition has been very good. Our field force has been very positive about the potential of this combination and the more comprehensive solutions they can now bring to our veterinary customers. Early customer response has been very encouraging. Our core business and investment strategy has Zoetis well-positioned for the future with a diverse portfolio addressing needs across the continuum of care and a promising pipeline of new products and lifecycle innovations. As I mentioned last quarter, we have taken a phased filing approach for a new three-way combination parasiticide, and we continue making that progress. The product will be known by the trade name Simparica Trio, and it will combine sarolaner and two other active ingredients to focus on ectoparasites such as fleas, ticks and mites as well as internal parasites and the prevention of heartworm disease. Our phased regulatory filings are progressing in the U.S. The safety, efficacy and chemistry manufacturing and control technical sections are under FDA review. In addition, we have submitted the dossier with the European Medicines Agency and subject to regulatory reviews and approval, we would anticipate Simparica Trio coming to market in 2020. We are also progressing well with our monoclonal antibodies program, targeting pain treatment for dogs and cats. This will strengthen our leadership position for pain in dogs and allow us to expand into cats. I will provide further updates as we move through the regulatory process. Our R&D team also continues to enhance our internal portfolio with lifecycle innovations and additional product indication such as the recent expansion of Cytopoint to cover allergic as well as atopic dermatitis in the U.S., also introducing of leading product brands into new geographies and new combinations. Now turning to a few highlights of our third quarter results. Zoetis continued delivering strong revenue growth with 12% operational growth this quarter. Our diverse portfolio remains the foundation of Zoetis' steady and reliable performance with growth across our major species, markets and therapeutic areas. Our companion animal products performed very well in the third quarter based on continued growth in our key dermatology brands, new parasiticides and, for the first time, the addition of Abaxis diagnostic portfolio. We see further growth opportunities for our key dermatology products in 2019. In the U.S., we expect that portfolio to continue growing although at a lower rate than 2018. We expect to continue expanding the addressable market in the U.S. and building awareness of dermatologic conditions through ongoing direct-to-consumer campaigns. Internationally, we expect higher growth than in the U.S. driven by the expansion of the dermatology market, increasing the patient share and the potential introduction of Apoquel in China, pending final regulatory approval. Meanwhile, in livestock products, our swine, poultry and fish portfolios each delivered double-digit growth, with more modest growth in our cattle business. We expect all our species categories to show growth for the full year 2018 and also for 2019. For 2019, analysts expect the companion animal and poultry markets to outperform the overall industry growth of approximately 5%, excluding the currency impact. Swine is expected to be in line with the market growth, and cattle market growth is expected to be more limited. Turning to profitability, in the third quarter we achieved 32% operational growth in adjusted net income, thanks to our increased revenue, improved cost structure, and tax reform. In closing, in 2018 we are confident in achieving our improved annual guidance, continuing to grow revenue faster than market, and growing adjusted net income faster than revenue. And with that, let me hand things over to Glenn, who will provide more details on our third quarter results and guidance. Glenn C. David - Zoetis, Inc.: Thank you, Juan Ramón, and good morning everyone. Let me start by highlighting our continued strong performance in both revenue and adjusted net income in the third quarter. As Juan Ramón mentioned, we delivered operational revenue growth of 12%, driven by the performance of our dermatology portfolio, new products and the addition of Abaxis' diagnostics portfolio. Our organic operational revenue growth for the third quarter was 9%, which excludes Abaxis. Operational adjusted net income growth was 32%. We are confident in delivering our improved financial guidance for 2018 where we are narrowing our revenue guidance at the high end of the range and increasing our adjusted net income and adjusted diluted EPS guidance. While I will not provide formal guidance on 2019 until early next year, I believe our diverse portfolio, core capabilities and investment strategy will enable us to continue delivering on our value proposition of organically growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Now, let's talk about the drivers of our Q3 performance, which continued the momentum from the first half of the year. Reported revenue growth was 10% in the third quarter, which includes a negative 2% impact from foreign exchange. Currency depreciation in Brazil was the largest driver of the unfavourability in the quarter. We generated 12% operational revenue growth balanced across our segments with the U.S. growing 11% and International growing 12% operationally. Looking at growth by species, Companion Animal grew 19% operationally and Livestock grew 6% operationally. Included in our operational revenue growth of 12% is 3% from Abaxis. Of the 9% organic operational revenue growth, price contributed 4% and volume contributed 5%. New products drove 2% line, with the remaining 3% driven by our key dermatology portfolio. Price contributions of 4% in the quarter are higher than usual and relate to the timing of promotional activities in the third quarter compared to the same period in the prior year. Price contributed 2% over the first nine months of the year, which is more consistent with our expectations. Adjusted net income grew 32% operationally, driven by revenue growth, gross margin improvements and a lower effective tax rate. As I already mentioned, our key dermatology portfolio comprised of Apoquel and Cytopoint continued to be a significant driver of growth this quarter with sales of $172 million, a 39% increase over the prior year. In the first nine months of the year, we have recognized revenue of $436 million in our key dermatology portfolio with both Apoquel and Cytopoint contributing to the continued success. Consistent with our expectations for these products, Q2 and Q3 are the peak seasons for dermatitis, so we do anticipate moderated performance in Q4, particularly in the U.S. We continue to expect sales for this portfolio to exceed $500 million in 2018, and as Juan Ramón discussed, we see continued growth as we move into 2019. New products also continued to drive growth for Zoetis with Simparica as the primary driver. Simparica generated $43 million of sales this quarter, representing operational growth of 80% over the same period last year. We expect some moderation in Q4 as we move out of the flea and tick season in the U.S. Overall, we continue to be very pleased with the performance of this product in the highly competitive parasiticide market, and we expect continued growth both domestically and internationally. Now before moving into the segment results, I would like to provide more visibility into the Abaxis numbers. Included in Zoetis' reported results this quarter are sales of $42 million from legacy Abaxis products since our July 31 acquisition. These sales represent two months of sales in the U.S., Canada and Latin America and one month of sales for all other international markets based on our international reporting calendar. Please note that Q3 revenue for Abaxis also includes a destocking of wholesaler inventories that we expect to continue in Q4 as we normalize wholesaler inventories consistent with Zoetis levels. With the acquisition of Abaxis, we are adding a new major product category in our financial statements and our 10-Q filings within the revenue by major product category section called Animal Health Diagnostics. This product category will include the animal health products acquired from Abaxis as well as our legacy diagnostics products previously classified within other non-pharmaceuticals. The human health diagnostic products acquired from Abaxis will be classified within a new category called Contract Manufacturing & Human Health Diagnostics. Now let's discuss Zoetis' segment revenues for Q3. Beginning with the U.S., revenue grew 11% in the third quarter, including Abaxis which contributed 4%. Including the impact of Abaxis, Companion Animal grew 20% while Livestock grew 1%. Companion Animal sales in the quarter were driven by our key dermatology portfolio, new products, as well as the addition of Abaxis. Certain in-line product decline due to competitive pressure partially offset these increases. Excluding the impact of Abaxis, Companion Animal growth was 12%. U.S. dermatology sales were $121 million for the quarter with both Apoquel and Cytopoint exhibiting significant growth over the same quarter in the prior year. Simparica also had another positive quarter with U.S. sales in the quarter growing 53% over the same period last year. Revenue growth was due to increased in-clinic penetration and market share and returns on our direct-to-consumer investments. Partially offsetting growth in our Companion Animal business were declines in Revolution and Clavamox due to competition. The U.S. Livestock business continued with strong growth in poultry and swine in the third quarter, partially offset by a decline in cattle. In poultry, the Zoetis portfolio of alternatives to antibiotics and medicated feed additives continues to be the primary driver of growth. Favorable market conditions in the layer market also contributed to growth in vaccines. Swine also had consistent growth in the third quarter, primarily in EXCEDE related to promotional effort. We also continued to increase market share of Fostera Gold PCV MH which launched in the first quarter this year. In the cattle business, we saw challenges in both the beef and dairy segments related to competition and unfavorable market dynamics. We do expect the cattle market to recover sometime in 2019, however, the impact of weather, herd movements and producer profitability all play a role in the timing. Overall, the U.S. continues to be a significant growth driver for Zoetis, particularly due to our product diversity and strategic investments, despite some temporary unfavorable market conditions in the cattle business. Turning now to our International segment, revenue grew 12% operationally in the third quarter with operational growth in Companion Animal of 18% and operational growth in Livestock of 10%. Companion Animal product growth was largely driven by our key dermatology products Apoquel and Cytopoint, new products such as Simparica and Stronghold Plus, increased medicalization rates in key international markets and the addition of Abaxis. Livestock products benefited from favorable market conditions, including increasing demand for animal protein, new products and the impact of our field force. Our fish business also performed very well this quarter, with operational growth of 21%. This strong growth was driven by increased market share of our pancreatic disease or PD vaccine as well as customer adoption of our SRS vaccine in Chile. Highlighting some key markets for the quarter, in Brazil sales grew 31% operationally with Companion Animal growing 48% and Livestock growing 26%. Companion Animal revenue in Brazil benefited from strong growth in parasiticides with Simparic as the primary driver and a positive return on the direct to consumer investment. Livestock benefited from the recovery of sales that were delayed at the end of Q2 due to the national truck drivers' strike. Strong underlying demand, favorable export conditions and local promotional activities also contributed to growth in the quarter. In the UK, sales grew 30% operationally. Both Companion Animal and Livestock contributed to this performance, with new products primarily driving growth on the Companion Animal side and fish driving increases in Livestock. Key dermatology products and new parasiticides both performed well in the quarter, resulting from field force focus and marketing promotions, which increased pet owner awareness of the brand. In fish, vaccines were the primary driver of growth, due to increased market share in our PD vaccine as well as our multivalent vaccine, ALPHA JECT micro 6. Moving on to China, we had another great quarter, growing revenue 15% operationally, largely due to the timing of distributor purchases of our swine product. Companion Animal products also continued demonstrating growth, primarily in parasiticides and vaccines. Australia grew 9% operationally, primarily driven by Companion Animal and sheep. In Companion Animal, Simparica and Apoquel increased sales due to the return on our direct-to-consumer investments, as well as strength of our in-line portfolio and promotional efforts in the quarter. Sheep products also benefited from continued strength in local market conditions. Other emerging markets, particularly Vietnam, Argentina, Turkey and India, performed well. Vietnam performed well on Livestock, particularly in swine, due to increased market prices for pork. Argentina and Turkey had broad-based growth across Companion Animal and Livestock, while growth in India was largely due to strength in poultry. Summarizing International performance, we saw new products, favorable market conditions and diversity across our portfolio all contributing to another very strong quarter for our International segment. Now, moving on to the rest of the P&L, I want to cover a few key line items and then discuss guidance for 2018. Adjusted gross margin of 68.7% increased approximately 80 basis points in the quarter on a reported basis. This improvement reflects favorable pricing and the benefit of continued cost improvements and efficiencies in our manufacturing network, which were partially offset by the impact of Abaxis. Total adjusted operating expenses including Abaxis grew 11% operationally versus the same period last year. Adjusted SG&A operational growth was 10%, primarily due to the addition of Abaxis and increased compensation-related costs. Adjusted R&D operational growth of 13% reflects increased investments in areas such as monoclonal antibodies for chronic pain and other pipeline programs, as well as Abaxis. The adjusted effective tax rate for the quarter was 19.2%. The tax rate in the quarter is significantly lower than the rate from the comparable 2017 period due to the favorable impact of U.S. tax reform and discrete items recognized during the quarter. Adjusted net income for the quarter grew 32% operationally through a combination of strong revenue growth, improvements in gross margin, and a lower effective tax rate. These increases are partially diluted by the impact of Abaxis, which we expect to become mildly accretive in 2019 on an adjusted basis. As previously communicated, we are creating strong operating leverage, while investing in strategic areas of future growth for Zoetis including acquisitions such as Abaxis. Adjusted diluted EPS grew 34% operationally in the quarter versus the same period in 2017. Now, moving to guidance for the full year 2018, our consistent revenue growth, gross margin improvement and returns on strategic investments are allowing us to narrow our revenue guidance towards the high end of the range and raise and narrow our outlook on adjusted diluted EPS. Starting with revenue, we are narrowing the range of our revenue guidance and expect to deliver between $5.75 billion and $5.8 billion in revenue, representing operational revenue growth of 8% to 9%. Excluding Abaxis' partial-year revenue which consists of five months of domestic activity and four months of International, the organic operational revenue growth range is 6% to 7%. Consistent with what I communicated the last quarter, our full year guidance includes headwinds in Q4 that I want to remind you of as you think about the remainder of the year. Our business in Q4 2017 was very strong, so the growth off this higher base will moderate. U.S. livestock is one area where we experienced an exceptionally strong Q4. In addition, the fourth quarter of this year will also include four fewer international calendar days compared to last year, resulting from the change in our accounting calendar implemented this year. Please note that from an EPS growth perspective, Q4 will be impacted by the timing of cost of sales which were higher in the first half of 2017 when compared to the second half of 2017 as well as the timing of operating expenses. For SG&A and R&D, we're narrowing guidance towards the high end of both ranges, consistent with our revenue performance and to support investments for future growth. Our guidance for the adjusted effective tax rate has been lowered to approximately 19% from our previous guidance of approximately 20%. This is primarily due to the impact of favorable discrete non-recurring items resulting from the implementation of U.S. tax reform. We continue to anticipate our effective tax rate going forward to be higher due to certain provisions of U.S. tax reform which will go into effect in 2019. For adjusted diluted EPS, we are raising and narrowing the guidance and now expect to deliver between $3.08 and $3.13. Our range for reported diluted EPS of $2.81 to $2.90 includes preliminary estimates for certain significant items and purchase accounting for the Abaxis acquisition as well as gaining on the sale of our plant health business, which was completed in our international Q4 period. Finally, we repurchased nearly $550 million of Zoetis shares in the first nine months of the year. We have approximately $450 million remaining under the current multiyear share repurchase plan and remain committed to our capital allocation priorities of internal investment, M&A and returning excess cash to shareholders. Our guidance for reported and adjusted earnings per share reflects the shares repurchased through the end of Q3. Now, to summarize before we move to Q&A, we have delivered consistent operational top and bottom line growth in the first nine months of the year, with contributions across all core species, therapeutic areas and geographies. We are narrowing our range of revenue guidance to the high end of the range and increasing and narrowing our guidance for adjusted net income and adjusted diluted EPS. Our diversity, strategic internal and external investments, and ability to innovate, will continue to provide a platform for revenue growth that is in line with or faster than the market. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : We'll take our first question from Jon Block with Stifel. Please go ahead. Your line is open. Jonathan David Block - Stifel, Nicolaus & Co., Inc.: Great. Thanks, guys. Congrats on the quarter. I might try to jam three questions into one. So the first, on the big three therapeutics, I have that up over 40% year-over-year. At a high level, how should we think about the rate of growth from these three blockbusters in 2019 and 2020? I think you said very healthy but maybe at a diminished rate. So, anything more that you can provide there. Second would be just early feedback from the Abaxis acquisition. How should we think about sales force retention? And then have you kicked off any bundling in terms of price? And lastly, Glenn, just the price of 4% in the quarter, I just want to be clear there, we should think of that more as onetime due to the year ago comp? Thanks, guys. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Jon. Glenn will answer the first question. I will cover the Abaxis question and then Glenn also will provide the comments on the 4% price increase in the quarter. Glenn C. David - Zoetis, Inc.: So, Jon, when you look at the big three, and I assume you're mentioning Apoquel, Cytopoint and Simparica, we've had very strong growth in the quarter and year-to-date. As we look forward into 2019 and 2020, we do still see opportunities for growth for all those products. So, particularly, with our dermatology portfolio we see continued growth in U.S. albeit at a slower rate as we have significant penetration in terms of patient share there. We're up to 63% already. We do see further opportunity continue to grow the market there as well. We should also see a very strong opportunity internationally where the penetration isn't quite at that level yet, so we do see continued growth internationally in Apoquel and Cytopoint as well. In Simparica we continue to see very strong performance, continued adoption, and we think that growth will continue into the 2019 and 2020 as well, but again probably at a slower rate and also the impact of competition and new products that may come into that category may also impact growth going forward. Juan Ramón Alaix - Zoetis, Inc.: Okay. Thank you, Glenn. In terms of the Abaxis integration, well, the retention of the field force I think is not – I can describe as 100% retention. And not only it's about retention, it's about the feedback that we are getting from the field force from Abaxis, which is extremely positive. They are expressing the excitement of the opportunity now to be supported by a larger company, by much more presence in our field. And the combination of the two portfolios is something that can create significant opportunities. I think it's too early to discuss about bundling. Definitely we see the opportunity of combining the diagnostic portfolio of Abaxis, the diagnostic portfolio of Zoetis, and also the rest of the portfolio of medicines, and it's something that it's a work in progress. We see that diagnostic medicines, vaccines, are very much integrated in the clinics, so we expect that this will present a significant opportunity in the future. Glenn C. David - Zoetis, Inc.: And, Jon, in terms of the price for the quarter, so like you say, the 4% is more of a onetime impact for the quarter. The year-to-date number of 2% is much more in line with what we typically expect to be able to generate from price. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : And we'll take the next question from Alex Arfaei from BMO Capital Markets. Please go ahead. Alex Arfaei - BMO Capital Markets (United States): Great. Thank you very much for taking the question and congratulations on all the progress. First, just a follow-up on atopic dermatitis, I think one of your competitors reported data with their IL-31 recently. I'm referring to Kindred. Just wondering if you had any thoughts there whether it's on that product or just, in general how you see the competitive landscape evolving here. I'm sure your success hasn't gone unnoticed. Second, could you please break out Apoquel, Cytopoint, and Simparica by U.S. and ex-U.S.? And finally, if I may, Juan Ramón, I missed your comments about 2019 expectations for livestock species. Could you please clarify that? And any additional color would be appreciated. Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Alex. Good morning. So, let me discuss about the potential competition of our dermatology portfolio. Definitely this is something that we already communicated in previous calls that over time we expect competitors coming into this attractive market. It's a market that has been basically created by Zoetis. In the same way that many years ago, we also created the pain market for dogs, and even after many years and many new entrants, still Rimadyl remains the leading brand in terms of pain for dogs. So, we are expecting competition but we also expect that we have a very strong position with the combination of Apoquel and Cytopoint and products that has been responding extremely well to the needs of veterinarians and also the needs of dogs, and we are very confident that these products will continue growing. And new competition also will expand the market and we also benefit of this market expansion from a leadership position. Glenn will discuss about the breakdown between dermatology products, Simparica, U.S., International and also I will be covering the expectations for Livestock in 2019. Glenn C. David - Zoetis, Inc.: So, just to break out the numbers. So, for derm for Q3, we had total sales of $172 million. $121 million of that came from the U.S., with $51 coming from International. Breaking out Apoquel, we had total sales of $134 million, the U.S. at $88 million, International at $45 million. You can then do the math for Cytopoint, the difference between the two. For Simparica, we had total sales of $43 million in the quarter, with the U.S. at $26 million and International at $17 million. Juan Ramón Alaix - Zoetis, Inc.: So, the comments I provided for 2019 in terms of livestock were related to the market and not specific to our projection for 2019 Livestock Zoetis. What I said is that the market expect that poultry will be growing faster than this 5% which is expected growth for the overall animal health industry. Swine will be in line with the market and cattle will be much more modest growth. And this is something that, at this point, we are not yet providing the specifics of our growth in 2019, but we expect that we'll be more or less in line with the market expectations. Next question? Operator : The next question comes from Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen - Cantor Fitzgerald Securities : Hi. Thanks for taking my questions. So, my first question here was just back onto the cattle here. Can you just give more specifics as to what is going to actually drive the recovery in cattle in 2019? And then the second question is just on opportunities for growth and operating margin expansion in 2019 and beyond, if you still see anything beyond what you've already said and if so, where these could come from. Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Louise. We expect, as I said, in 2019 modest growth in cattle for the animal health industry. We see that prices for dairy are improving. We expect that this improve to be seen in the second half of 2018. It's taking longer. But now there are indications that these prices are recovering in the U.S. and also recovering in International market. So, we are more optimistic about dairy in 2019. In 2019, we also expect small growth, very little growth in terms of number of heads in the beef section of cattle. And combining all these elements, we expect some recovery of cattle in 2019. But as I said, cattle is expected to grow at modest growth. Glenn C. David - Zoetis, Inc.: And, Louse, in terms of margin expansion, first I'll just continue to say that we're really not managing to any particular margin, but really we are managing for long-term cash flow growth and value. But when you look forward in terms of 2019 and 2020, we've previously articulated that we expect to get gross margin expansion of about 200 basis points by 2020 with 2017 being the starting point for that. So, our cost of goods as a percent of sales at that point was about 33%. We've guided 2018 to be approximately 32%, and we do expect continued improvement in both 2019 and 2020. As we move forward, we also do expect to be able to get some leverage from operating expenses. But in 2019, in particular, as we continue to integrate Abaxis and build to make sure that we're supporting that business, that expansion may not be as strong as it may be moving forward in 2020 and beyond. But between the combination of the gross margin expansion and being able to grow expenses at a slower rate than revenue, we do expect to be able to get margin expansion moving forward. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Glenn. Next question, please. Operator : Our next question's from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich - Craig-Hallum Capital Group LLC : Good morning. Thanks for taking my questions. I guess could we start off with capital allocation? You guys have – now that you're done with the Abaxis acquisition, wondering what else we should be thinking about in terms of how you plan to use the capital aside from the share repurchases. And then can you also comment on the pipeline, Juan Ramón? Appreciate the comments on Simparica Trio and when you expect it. What about Europe? Are we going to see it approved in Europe before the U.S.? And then congrats on winning the Deming Cup for Operational Excellence Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Kevin. In terms of our capital allocation, we are not changing the previous capital allocation communication. So, definitely, we see and we continue seeing opportunities in terms of investing internally. We are increasing our allocation to R&D. We communicated that also we are expanding and increasing the capabilities in manufacturing. And we see opportunities in commercial, and in 2018, 2019, the opportunities there definitely will be in diagnostics and will be an expansion of our presence in International markets. So, we'll continue investing internally. And the result of this investment has been extremely positive and we'll continue making sure that we have the resources to generate long-term growth. In terms of BD, the second priority in terms of capital allocation, we just completed the acquisition of Abaxis. We also had some other minor acquisitions, Smartbow, that it also a company that will be providing sensors and also the opportunity for more data analytics, digital in the dairy farms. And it's an area that we are also very interested ensuring that we are developing the internal capabilities in terms of digital data analytics there to provide this value to our customers. And we'll continue with returning the excess capital to our shareholders. It will be through dividends. It will be through buying shares back. Nothing has changed, and definitely we still see opportunities of, as I said, continue investing internally, identifying external opportunities and returning this excess capital. In terms of the pipeline, well, Simparica Trio has been filed in both the U.S. and also Europe. When this will be coming to the market, it's to be seen because it's depending on the regulators. But definitely, we expect that Simparica Trio will be in the market sometime in 2020. Who will be first, it's to be seen. There are some other products that also we'll see even earlier than 2019. For example, we are also expecting that in the U.S. we'll have lifecycle innovation with Revolution Plus and combining Revolution Plus active ingredient with a combination of other agents that we will expand the protection not only to fleas and ticks but making it stronger for ticks. And this is something that we expect this Revolution Plus coming into the market in 2019. And we'll continue also bringing in some other products in 2019 in the U.S. and also international markets, especially lifecycle innovation. I also mentioned that we are expecting the approval of Apoquel in China. Again, it's subject to regulatory approvals, but it can be sometime in 2019 and this will also help us to continue growing Apoquel or the dermatologico for Zoetis. And China now is one of our top markets for companion animal within Zoetis. So, it's probably a good opportunity that we see the introduction of Apoquel in this market. Next question? Operator : Our next question is from Erin Wright with Credit Suisse. Please go ahead. Erin Wright - Credit Suisse : Great. Thanks. A couple of questions here, you mentioned some de-stocking as it relates to Abaxis, but can you provide any sort of metrics on the integration process there and traction you're seeing in terms of in-customer instrument placement trends or consumables growth, and as we think about modeling out the diagnostics segment that you'll be breaking out, should we consider that a double-digit grower when studying your own diagnostics portfolio? And then the second part of my question is how you think about a potentially kind of evolving supply chain in pet medications and do you think that it is rapidly evolving or evolving to some extent that consumers have more choice and veterinarians have more choice? And what do you think about broader implications, newer concepts such as Vets First Choice and your ability to realize price thereon? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Okay. Thank you, Erin. So, in terms of Abaxis performance (42:06) I think it's – well, the integration of the closing of Abaxis has been at the mid of this quarter. I think it's probably a little bit too early to provide the full details of the different elements of the diagnostics implementation in the clinics. This is something that we'll discuss what will be the level of information that we'll be providing in the future. And maybe we can have this discussion in the fourth quarter when we have the full quarter already reporting and having all the elements that are under control by Zoetis. Glenn will be talking about the de-stocking question that you raised. Glenn C. David - Zoetis, Inc.: Yes. So, just to give a little more color into the Abaxis numbers. So, we referenced that we had $42 million of sales in Q3. Just a reminder, that includes two months of U.S. and one month International, so it's a partial quarter. Of that $42 million is also $7 million related to human health diagnostics, so the animal health diagnostics piece of that $42 million was $35 million. To get to your question on growth for the quarter a little bit, Erin, if you take some of the pro forma information and then put that together with what I just referenced in terms of the $35 million, again it's not 100% audited or accurate because we're piecing together different pieces of information. But you would get to mid-single digit growth for the quarter for the legacy Abaxis business. Now, that does also include the de-stocking that I referenced which we do expect to continue into Q4. But if you were to adjust for that de-stocking, we get to double-digit growth in the Abaxis portfolio which we do expect to continue moving forward at double-digit growth rate. Juan Ramón Alaix - Zoetis, Inc.: And Erin, what we expect from animal health diagnostics growth trend long-term is that we'll be growing faster than the animal health core business medicines, and I think it has been, in the past, growing at 7%, 8%. We also expect that in the future we'll be growing higher than the 5%. And where we see significant opportunities for growth is in International markets. And we are now expanding our presence and we are convinced that we have a significant opportunity to penetrate in this market. You also asked about the U.S., changes in the distribution retail channel, talking about Vets First Choice or internet pharmacy (44:42), well, definitely, it's a lot of changes in this segment, companion animal in the U.S. We see some of these changes also having the positive impact of expanding the market, having much more access there for pet owners, at the same time the opportunity also to increase compliance. But at the same time, we are convinced that veterinarians will remain at the center of healthcare decision especially in areas that will require prescription and intervention of veterinarians with injectables or vaccination or acute treatment in the Companion Animal. And we'll continue supporting the veterinarians really to deliver value to our pet owners. Next question? Operator : Our next question is from Michael Ryskin with Bank of America Merrill Lynch. Please go ahead. Michael Ryskin - Bank of America Merrill Lynch : Thanks. Congrats on the quarter, guys. I have a couple questions I'm going to roll into one but it's going to be focused on some of the innovation of the portfolio. You talked about the additional indications for Cytopoint, the allergic dermatitis. Can you give any sense of how much that expands the potential for that product, near-term in both as we go into 2019 and 2020? And then regarding some of the other innovation, the lifecycle extensions in Draxxin and Vanguard, some of the work you mentioned, the focus on the pain monoclonal antibody. Just to get a sense of how big of a contributor this could be in 2019, 2020 as some of these new products come in. And then along that line, one last one is we saw some news reports that the USDA was potentially granting you a license for an African swine fever vaccine that's in an open comment period. Can you talk about the potential for that market? Obviously, there's a lot of talk in the swine markets about the disease outbreaks there, so, any sense of timing or potential impact? Thanks. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Mike. So, let me cover the question on additional label indications for Cytopoint. So, in allergies there are four main reasons for this condition. So, one is related to fleas, the other one is food, and the third one is the environment. Anything which is not in these three areas is described as atopic. Now, Cytopoint also have the indication of allergy, not only atopic indication, and this will help us really to promote what all the indications of Cytopoint. We are not expecting significant revenues because of that, but definitely it's an area that in our opinion veterinarians has been using Cytopoint based on their own understanding of the needs. But the fact that we'll be now promoting a broader label, we will always help, but we don't expect a significant incremental revenue. We expect that the market in the U.S. still has a potential for expansion and also we expect that our patient share also can increase with the right interactions with the veterinarians and the right communication with the pet owner. And this is applicable to the U.S. and also International. In terms of pipeline contribution in the near-term – well in the near term, we discussed about near-term 2019, so the pipeline will be mainly related to lifecycle innovation. We'll always be introducing some new vaccines, new product, but we expect significant introduction of new products in 2020. And we'll have the opportunity to discuss in February the details of our guidance for 2019 and also how we see 2019 in terms of the different sources of growth, our current portfolio, new product introduction and also price. You also asked about the African swine fever and the collaboration with the USDA. This is something that will take several years to see a vaccine in the market to protect pigs against the African swine fever. But definitely, it's an area that has significant impact and we have seen the impact now in China and also in some other markets. It's affecting the production of pork. But what I think is even more important that what is the short-term opportunity for developing a vaccine to protect pigs against the African swine fever is the confirmation that Zoetis is the banner of choice with the USDA and many other institutions when we need to bring new vaccines into the market. And this is, in my opinion, what is important at this moment in the collaboration that we are establishing between us and the USDA. Next question? Operator : The next question is from John Kreger with William Blair. Please go ahead. Jon Kaufman - William Blair & Co. LLC: Hi. Good morning. This is Jon Kaufman on for John Kreger. So, a question on the monoclonal antibody products, is there anything more you can tell us? What stage of the development process are they in and when do you expect them to come to market? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Well, I think it's too early to indicate when the product will be in the market. So, what I can tell you is that we are making a very good progress. So, we have several products for both dogs and cats. We are very optimistic about these products reaching the market. And as I said, I will provide to you more updates as we start the process of filing the dossier into the FDA and also the European agencies. And then when we have that information, then I will be providing more details of when we plan to have the product into the market. Next question? Operator : The next question is from Chris Schott with JPMorgan. Please go ahead. Chris Schott - JPMorgan Securities LLC : Great. Thanks very much for the questions, just one coming back to some of the earlier comments on OpEx going forward and expense growth. You've obviously stepped up spend this year supporting the pipeline and the new launches, sounds like 2019 might be another year of investment with Abaxis. I guess my question is once we get beyond that spend, should we think about OpEx growth slowing back down to more inflation-type growth that we've seen historically for the company? Or are we in a sustained period here where we should think about OpEx growth kind of above inflation, maybe closer to topline just given the variety of new products that you seem to have targeted for the next few years? My second question was just on the Simparica Trio and maybe just taking a step back. Maybe just put in context how much larger of an opportunity do you see for that product relative to Simparica today as we just think about that 2020 and beyond opportunity. Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Chris. Well, I would probably share my general comments about OpEx, and then also Glenn will provide more details. So, we have seen 2018, maybe also 2019 as a years in where we are building some additional capabilities in our commercial infrastructure, has been also two years where we see additional opportunities to invest in R&D, and this is driving that higher growth in terms of operating expenses than in previous years. In the long-term, I think we'll remain in line with previous communications that operating expenses will be growing in line with inflation. But it's also true that we have seen significant changes in our business, the inclusion or addition of Abaxis. We also included some other areas where we need some additional capabilities. And there are now new opportunities that we have seen also in digital and also in terms of data analytics. All these it's, well, creating the need of further investment but as I said, it's something that we see as temporary, and then over time, moving into the long-term growth in line with inflation. Glenn, do you want to add some additional comments here? Glenn C. David - Zoetis, Inc.: Yeah. The only thing I'd add particularly for 2019 as you look at it, I mean, one of the key drivers of the expense growth for 2019 will be the fact that we'll have a full 12 months of the Abaxis portfolio and expenses supporting that portfolio in 2019 versus only a partial year this year. And we'll also still be in the build phase for some of the diagnostics field force that we're building in both the U.S. and International. As Juan Ramón said, once we move forward into 2020, we would expect particularly the G&A line to then trend much more in line with inflation, and selling in particular, we would expect expenses to be slower than revenue growth from a selling perspective as well. R&D, we'll continue to look at the opportunity and to the extent that there are opportunities to drive future short-, medium- and long-term growth, we'll make the right investments from an R&D perspective. Juan Ramón Alaix - Zoetis, Inc.: So, in terms of Simparica Trio and the incremental opportunity compared to Simparica, we are very pleased with the performance of Simparica. So, we are now on the nine month close to $150 million, $144 million (sic) [$125 million]. But still we are significantly underrepresented in the oral parasiticide market and where NexGard or Bravecto are generating much more significant sales. And one of the reasons were that we were several years behind competitors in terms of introducing these products. We are confident that with the Simparica Trio we'll be bringing a product that would be highly competitive and also we'll have the opportunity to capture part of the revenues which are today on internal parasiticides and also heartworm provided by other products. So, the opportunity in Simparica Trio, it's to capture higher share in terms of the overall market of oral parasiticides and expanding to internal parasiticides. So, we'll provide in the future when we have probably closer to the launch what can be the expectations of Simparica Trio. Next question? Operator : The next question is from Kathy Miner with Cowen and Company. Please go ahead. Kathy M. Miner - Cowen & Co. LLC: Thank you. Good morning. Just two quick questions on Companion Animal. First is, in the past you've estimated the U.S. market penetration of your derm products is around 59%. Is that good or has that increased? And the second question is also on companion animals, derm and Simparica trends have been very strong, but how should we be thinking about the underlying, the base business? Is that flattish or growing slightly going forward? Thank you. Juan Ramón Alaix - Zoetis, Inc.: So, thank you, Kathy. So, you're correct, so the 59% share, it was related to patient share for Apoquel, Cytopoint. This was in previous quarters. Now we have increased to 63% in the U.S., and we are significantly lower in International markets. And again, so, International markets is where we see the opportunity of first expanding the dermatology market and also increasing our penetration with the market share. You also asked about the base business excluding I guess Apoquel, Cytopoint, Simparica, I guess this is the question. Maybe, Glenn, you can answer that. Glenn C. David - Zoetis, Inc.: Yes. So, when you look at the base business in the U.S., if you exclude the derm products, volume growth is declining. That is partially offset by some positive increase in price. But overall, volume growth is declining, and that is driven by some competitive pressures that we're seeing on some of our more established products such as Revolution and Clavamox as they face competition, A, from other new products but also from generic competition. But the impact that we're seeing there is very much in line with what we expect from a long-term perspective once we lose exclusivity in terms of the 20% to 40% over an extended period of time. Juan Ramón Alaix - Zoetis, Inc.: Next question, please. Operator : The next question is from David Risinger with Morgan Stanley. Please go ahead. David R. Risinger - Morgan Stanley & Co. LLC: Yes, thanks very much, and congrats on the performance. I have a couple questions related to the Trio opportunity. The first is have you filed all of the components of the application with the FDA? Second, I believe that, Juan Ramón, you said 2020, which I believe is a delay from the prior comments of second half of 2019 approval and launch. Could you comment on that? And third, do you have 100% heartworm protection in the product? Thank you. Juan Ramón Alaix - Zoetis, Inc.: Thank you, Dave. Let me confirm that Simparica Trio has been filed with all the different sections in the FDA. And I thought that in previous communications we were saying that we are expecting the Simparica Trio to be in the market in 2020, and we can maybe check if there was any confusion here, but I want to confirm that we expect this product in 2020. And let me – I think we are very confident that the product, Simparica Trio, will have full protection for heartworm. But let me confirm with our scientists what will be the level of protection in terms of percentage. But we are very confident that the efficacy of the product for internal and external will be excellent. So, this is one of the reasons why we are confident that the product will have a significant opportunity once it's launched into the U.S. and also in International markets. Let me say that in International markets, maybe the opportunity is lower than the U.S. because heartworm outside of the U.S. is less prevalent. So, the biggest opportunity for Simparica Trio will be in the U.S. Next question? Operator : And it does appear we have no further questions. I'll return the floor to Juan Ramón Alaix for closing comments. Juan Ramón Alaix - Zoetis, Inc.: Thank you for your attention. We are very pleased with the results of the third quarter, and as I said, extremely confident in our guidance for total year 2018 that has been growing over time, and now we have provided an increase in terms of adjusted net income for the total year . Thank you for your attention. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,019
| 1
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2019Q1
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2018Q4
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2019-02-14
| 3.002
| 3.11
| 3.404
| 3.46
| 5.24514
| 26.68
| 24.12
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Operator : Welcome to the Fourth Quarter and Full-year 2018 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, it will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Good morning, everyone, and welcome to the Zoetis fourth quarter and full-year 2018 earnings call. I am joined today by Juan Ramón Alaix, our Chief Executive Officer; and Glenn David, 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, 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 in the Company's 8-K filing dated today, February 14, 2019. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramón. Juan Ramón Alaix : Thank you, Steve. Good morning, everyone. Our 2018 results once again confirm the strength of our business and our leadership in the animal health industry. We delivered another year of strong performance and executed on investment plans to continue to strengthen our portfolio across the continuum of care. Our successful innovations, the high quality of our manufacturing, our best-in-class field force and the diversity of our portfolio has been driving our steady revenue growth over the years. Since we became a public company in 2013, we have consistently grown revenue faster than the market and this revenue performance has been achieved, while significantly improving our profitability, with our adjusted EBIT margin, increasing from 24% in 2013 to 35% in 2018. In 2018, we delivered our sixth consecutive year of operational revenue growth, 10% overall, with organic operational growth of 8%, which excludes the revenue related to our Abaxis acquisition. In terms of organic revenue drivers, we achieved our strongest growth in our dermatology portfolio, vaccines and parasiticides. Meanwhile, our anti-infective and medicated feed additives show modest growth and this was because of regulatory changes around the use of antibiotics in animal products. For the second year in a row, our broad base of about 300 product lines generated operational revenue growth across all our core species and major markets. We expect our 2018 organic growth to once again outperform the market and deliver our value proposition of growing in line with or faster than the animal health market. We also increased profitability faster than revenue growth for the full-year, growing adjusted net income by 31% on operational basis, consistent with our value proposition. This improvement was driven by higher revenue, improved cost structure and tax reform. In 2018, we achieved other important milestones that will support our future growth and success. Apoquel, our largest product by revenue, achieved $464 million in sales in 2018, an increase of 28% from 2017. We added two new blockbusters to our portfolio in 2018, bringing our total number of products with more than $100 million in annual sales to 12. Our oral parasiticide Simparica and our monoclonal antibody or dermatology Cytopoint, each exceeded $100 million in sales for the first time, with $158 million and $129 million in annual sales, respectively. We also introduced critical new lifecycle innovations that keep our portfolio updated and competitive and support the durability of our major global franchises. For example, Fostera Gold PCV MH, our latest swine vaccine was introduced in the U.S. and Canada to provide greater options and flexibility in protecting pigs from diseases. We also built on the sarolaner compound in Simparica to develop Revolution Plus, a topical parasiticide for cats that was recently approved in the U.S., Japan and Canada, combines two ingredients, sarolaner and selamectin, and it’s already marketed in the European Union as Stronghold Plus. All these new products and lifecycle innovations demonstrate the actual return on our investments in R&D. We also took important steps to expand our manufacturing capacity. In the U.S., we enlarged our production facility for poultry vaccines in Charles City, Iowa and our expansion in Kalamazoo, Michigan is progressing ahead of schedule. With the first commercial batches of oral solid dose medicines expected to be delivered to customers by the middle of 2019. Outside the U.S., we expect to complete the construction of our vaccine manufacturing facility in Suzhou, China by the end of 2019. And we acquired a facility in Tallaght, Ireland, to help increase the supply of our market leading bovine sealants that help protect cows from mastitis infections. During the year, we made our largest acquisition to date purchasing Abaxis for $2 billion in the fast growing point-of-care diagnostics space. We see diagnostics as an important area to growing our portfolio and with a tremendous growth opportunity ahead, especially in international markets. We also acquired Smartbow, where it's sensor technology and monitoring systems, which will be essential to our expansion in precision livestock farming, and other digital and data analytic solutions that are emerging in animal health. And we returned excess capital to our shareholders. In December, we announced a $2 billion multi-year share repurchase program and the increase of our quarterly dividend by 30%. Looking ahead in 2019, we will continue investing to generate short and long-term growth. We'll support our key dermatology and parasiticide products with direct-to-consumer advertising and promotional campaigns, through advanced penetration and launches in new markets. In the U.S., we'll be launching two new products in our companion animal business. Revolution Plus, the topical parasiticide for cats that I mentioned before, has launched this quarter, and pending FDA approval this year, we would expect to launch a new injectable formulation to protect dogs against heartworms for up to 12 months. In terms of R&D, our pipeline remains very strong and we expect to see more progress in 2019. Potential filings for new products and continued market expansions of major products like Cytopoint, Simparica, and Apoquel, which is expected to launch in China this year. In 2019, we'll continue our work on new monoclonal antibodies to manage pain in dogs and cats, as well as for dermatology in cats. We are making good progress with our research products and we feel very positive about the potential these type of treatments offer for greater compliance, convenience and efficacy for different species. This remain an area to watch as we invest further internally and we build on our partnership with Regeneron in this space. As I have mentioned in previous communications, the application for our new three-way combination parasiticides, composed of Simparica and two other active ingredients, has been filed in the U.S. and with European Medicines Agency, and if approved, we still anticipate coming to market in 2020. Additionally, we'll be investing more in research for diagnostics, devices, digital and data analytics technologies that can be integrated with our core portfolio of medicines and vaccines. Diagnostics for livestock has a promising long-term opportunity, and areas such as sensor technology, monitoring systems and other digital application for animal health will be receiving more investment. In terms of our deeper commitment to diagnostics, we look forward to a full-year of selling a more robust portfolio of point-of-care diagnostic instruments, consumables and test kits. We are seeing a great progress with integration of the legacy Abaxis that's imposed in the U.S. And outside the U.S., we are building the infrastructure, sales and technical teams needed to support our diagnostic portfolio. Moving to market creation for 2019. We expect the overall industry to grow approximately 5%, excluding the impact of foreign currency. The swine market, companion animal market and poultry are all expected to be somewhat in line with the market growth. The cattle market growth is expected to be more limited based on the challenging market conditions for beef and dairy customers. For Zoetis, we expect to grow faster in the market for companion animal and swine based on our new products and to grow in line with the poultry and cattle market. We announced our full-year 2019 guidance today and we are expecting organic operational revenue growth of 4.5% to 6.5%, excluding a three percentage point contribution from Abaxis. Operational growth for adjusted net income is expected to be in the range of 8% to 11%. In 2019, we are committed to invest in net profits to generate short and long-term growth while returning excess capital to shareholders. In conclusion, our strong performance in 2018 is based on our diverse portfolio, our leadership innovation and customer experience across the entire cycle of care. In 2018, we have invested to support the growth of our core business as well as evolve in spaces like diagnostics, devices, digital and data analytics. We expect to build on this strategic approach to our growth in 2019 while delivering on the full-year guidance. With that, let me hand things over to Glenn, who will provide more details on our 2018 fourth quarter results and full-year 2019 guidance. Glenn David : Thank you, Juan Ramón, and good morning, everyone. As Juan Ramón noted, we had another exceptional year in 2018 with strong performance in both revenue and adjusted net income. Revenue exceeded our guidance and adjusted net income was in line with the high-end of our range. We expect our 2018 organic growth to again outperform the market once industry figures are finalized, delivering on our value proposition of organically growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Revenue for the full-year 2018 was $5.8 billion with both reported and operational revenue growth for the year at 10%. Excluding the impact of the Abaxis acquisition, operational growth for 2018 was 8%. Of this 8%, 3% comes from price and 5% from volume. Included in the volume growth are contributions from our key dermatology portfolio of 2%, new products, including Simparica of 2% and in line products of 1%. Adjusted net income for the full-year was $1.5 billion, representing reported growth of 29% and operational growth of 31%, driven by revenue growth, gross margin improvement and a lower effective tax rate. In 2018, we grew our business operationally, across all core species, therapeutic areas and major markets. Our key dermatology portfolio and Simparica continued to grow and gained additional market share, both in the U.S. and international. For the full-year, we recognized combined revenue of $593 million for Apoquel and Cytopoint. This portfolio continued to grow rapidly in 2018 and is well positioned for future growth heading into 2019. For livestock, our diverse portfolio of products drove growth across both developed and emerging markets capitalizing on industry trends of higher protein consumption and improved productivity. Turning to the fourth quarter, reported revenue growth was 7%, which includes a negative 4% impact from foreign exchange. Currency depreciation in Brazil continued to be the largest driver of the unfavorable foreign exchange impact in the quarter. Operational revenue growth in the quarter was 11%. Excluding the impact of Abaxis acquisition, operational revenue growth was 7%. Of this 7%, 3% comes from price and 4% from volume. Included in the volume growth are contributions from our key dermatology portfolio of 2% and new products including Simparica of 2%. Q4 represents the first full quarter of Abaxis-related revenue being included in Zoetis results. We recognized $65 million from legacy Abaxis products contributing 4% growth to overall Zoetis in Q4. These results included destocking of wholesaler inventories in U.S. as we normalized wholesaler inventory levels to be consistent with the rest of our business. New products, including Simparica, Stronghold Plus and PCV combo vaccine were also growth drivers in the quarter. Simparica generated $32 million in global sales this quarter representing operational growth of 90% over last year. Equine's CORE EQ Innovator, the first and only vaccine to contain all five core equine disease antigen also launched in 2018 and it helped to drive operational revenue growth of 12% in equine for the quarter. Our key dermatology portfolio, comprised of Apoquel and Cytopoint, also continued strong performance this quarter with sales of $156 million, a 25% increase over the prior year. Adjusted net income for the quarter grew 21% operationally driven by revenue growth, discrete other income items and a lower effective tax rate. Now let's discuss Zoetis segment revenues for Q4. Beginning with the U.S., revenue grew 14% in the fourth quarter, including 6% growth due to legacy Abaxis products. Including the impact of the Abaxis acquisition, companion animal grew 26%, while livestock grew 3%. Companion animal sales in the quarter were driven by sales of legacy Abaxis products, our key dermatology portfolio and new products, including Simparica. Certain in-line products decline due to competitive pressure partially offset these increases. Excluding the impact from the Abaxis acquisition, companion animal growth was 14%. Key dermatology sales were $110 million for the quarter with both Apoquel and Cytopoint exhibiting significant growth over the prior year. Simparica also had another positive quarter with U.S. sales in the quarter, nearly doubling over the last year. Revenue growth continued due to increased clinic penetration and market share resulting from our field force selling efforts. Partially offsetting growth in our companion animal business were declines in RIMADYL and CLAVAMOX due to anticipated competition. The U.S. livestock business delivered growth across all species in the fourth quarter. As a reminder, this growth comes off a strong fourth quarter in 2017. In the cattle business, we continued to see challenges in both the beef and dairy segments. However, growth was primarily due to higher sales of premium products as well as competitive supply constraints in the quarter. In poultry, the Zoetis portfolio of alternatives to antibiotics in medicated feed additives, continued to be a solid contributor to growth as we saw additional market expansion of no antibiotics ever production. Overall, the U.S. demonstrated another strong quarter with growth across all species. Turning now to our International segment. Revenue grew 5% operationally in the fourth quarter, including 1% growth due to Abaxis legacy products. Including the impact of the Abaxis acquisition, companion animal operational growth was 14% and operational growth in livestock was 2%. As a reminder, international markets faced a headwind of four fewer calendar days this quarter resulting from the change in our accounting calendar implemented this year. Full-year operational revenue growth of 9% was not impacted by calendar days and provides a more accurate indicator of international performance. Companion animal product growth was driven by the addition of legacy Abaxis products, new products such as Simparica and Stronghold Plus, our key dermatology products and increased medicalization rates in key international markets. Livestock growth was driven by poultry, swine and fish, while cattle was relatively flat in the quarter. The complete quarter and annual results of our top 11 international markets are provided in the table included in our earnings release, but I would like to highlight a few items for the quarter. In Brazil, sales grew 8% operationally with companion animal growing 22% and livestock growing 4%. Companion animal revenue in Brazil benefited from growth in vaccines due to improved supply and key products primarily Simparica and Apoquel. Livestock benefited from damp weather condition, which increased the use of cattle parasiticides as well as expanded usage plan on vaccines, which helped drive premium pricing. Moving onto China, we had another great quarter growing revenue 16% operationally, largely due to continued growth of companion animal products, primarily vaccines and parasiticides. Canada grew 10% operationally with balanced growth between companion animal and livestock. Companion animal growth was driven by the inclusion of Abaxis legacy products as well as growth in Apoquel. Livestock benefited from sales of new products and swine and strong performance of key brands and cattle. Other emerging markets also performed well in the quarter. Summarizing International performance. The addition of Abaxis legacy product, continued growth of new products and diversity across our portfolio, all contributed to another solid quarter for our International segment, despite the impact of fewer calendar days. Now moving onto the rest of the P&L. Adjusted gross margin of 66.4% decreased approximately 250 basis points in the quarter on a reported basis versus the prior year. The decline this quarter is primarily due to the unfavorable impact of foreign exchange, a full quarter of Abaxis related revenue included in our results and increased inventory charges. The declines are partially offset by strong revenue growth and continued cost improvements and efficiencies in our manufacturing network. The Q4 margin is not indicative of the gross margin we anticipate going forward. Total adjusted operating expenses, including the impact of the Abaxis acquisition, grew 15% operationally. The increase is primarily related to the acquisition of Abaxis and additional spend in R&D, including investments in monoclonal antibody for chronic pain and other pipeline programs. The adjusted effective tax rate for the quarter was 17.3%. This tax rate is significantly lower than the rate from the comparable 2017 period due to the favorable impact of U.S., tax reform and discrete items recognized during the quarter. Adjusted net income for the quarter grew 21% operationally through a combination of strong revenue growth, favorability in other income and a lower effective tax rate. Adjusted diluted EPS grew 25% operationally in the quarter versus the same period of 2017. Our income growth and balance sheet discipline have enabled us to continue increasing operating cash flow. Inventory improvements are one area I'm particularly pleased with, having decreased months on hand since 2016 by more than two months. The current level of less than nine months on hand is consistent with industry standards and we expect we will continue around this level going forward. The significant improvement in inventory has released approximately $300 million of cash from our balance sheet since 2016. Now moving to guidance for 2019. We are committed to our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Before I get into the specific numbers, please note that you can find our guidance table included in the press release as well as the investor slides. Also note that all foreign exchange impact is based upon exchange rates as of late January. In 2019, we are projecting revenue between $6.175 billion and $6.3 billion, reflecting operational revenue growth of 7.5% to 9.5% over 2018. Foreign exchange is expected to reduce revenue growth by approximately 1.5%. Our organic operational revenue growth, which excludes the impact of the Abaxis acquisition, is projected to be between 4.5% to 6.5%. In addition to Abaxis legacy products, our key dermatology portfolio and new products will be strong contributors to growth in 2019. From a species perspective, we expect companion animal to grow to faster rate than livestock, driven by the Abaxis acquisition, continued growth in our key dermatology and parasiticide portfolios, increased medicalization rates in emerging markets and market dynamics, including growth in per pet spending. From a geographic perspective, U.S. and International markets will contribute balanced growth. Adjusted cost of sales as a percent of revenue is expected to be in the range of 31% to 32%. The expected improvement over 2018 is driven by price increases and manufacturing cost reductions, partially offset by the impact of the Abaxis acquisition and currency movements. We expect adjusted SG&A for the year to be between $1.47 billion and $1.52 billion. We anticipate foreign exchange to reduce growth by approximately 1% on a reported basis. Operational growth in SG&A reflects a full-year impact of the Abaxis acquisition as well as investments in our diagnostics international field force and technical service teams. We'll also continue to fund strategic investments that has demonstrated a strong return including direct-to-consumer advertising for Apoquel and Simparica. Moving on to R&D. We expect 2019 expenses to be between $445 million and $465 million. Consistent with 2018, we have committed to an increase over 2018 in R&D spending to ensure we're well positioned to capture future short, medium and long-term growth opportunities in critical spaces. These spaces includes a new combination of parasiticides, monoclonal antibody therapies for pain in cats and dogs and new vaccines for poultry. We'll also continue to invest in the next wave of diagnostic innovations, building on our existing Zoetis and newly acquired diagnostic platforms to ensure we're delivering best-in-class point-of-care diagnostic solution. The increase in adjusted net interest expense and other income deductions is related to our 2018 debt offering primarily used to fund the Abaxis acquisition. Our adjusted effective tax rate for 2019 is expected to be within the range of 20% to 21%. The increase over 2018 is related to the impact of favorable discrete non-recurring items in 2018 and the impact of the GILTI tax which is effective for us in 2019. We project adjusted net income in the range of $1.65 billion to $1.7 billion representing 8% to 11% operational growth. While we do not provide specific guidance on cash flow, we anticipate that in 2019, operating cash flow will decline compared to 2018. As mentioned previously, we have significantly decreased our inventory months on hand to be in line with industry norms, which has provided a significant cash flow benefit in the last two years. In 2019, we expect to continue in our current levels of months on hand, and as a result, we will not have the benefit of a working capital release in our cash flow. In 2019, we also expect an incremental increase of approximately $100 million in capital expenditures for information technology and manufacturing to support our recent acquisition, improved cost efficiencies and increased capacity. In terms of our capital allocation priorities, we continue to focus first on internal, commercial, manufacturing and R&D investments, then business development opportunities, and finally returning excess capital to shareholders. We recently announced an increase to our dividend for Q1 2019 of 30% in line with our 2018 earnings growth and we also announced a new $2 billion multi-year share repurchase program resulting our consistent performance, financial discipline and the strength of our business model. Finally, we expect adjusted diluted EPS will be in the range of $3.42 to $3.52. Our range for reported diluted EPS of $2.83 to $2.99 includes purchase accounting, Abaxis acquisition related costs and certain significant items. I'd also like to remind you that while we take a long-term view of our business and prefer to focus on annual rather quarterly results, there are some considerations, I want to point out for 2019 within the quarter. The full-year impact of the Abaxis acquisition will have a disproportionate impact on growth across the P&L in the first half of 2019 and partially in Q3. In addition, foreign exchange will negatively impact growth in the first half of the year by approximately 400 basis points in Q1 and 300 basis points in Q2 in revenue. Now to summarize, before we move to Q&A. 2018 was another strong year delivering topline operational growth of 10% and bottom line growth of 31%, demonstrating once again that Zoetis is committed to delivering on its value proposition. We also remain committed to creating shareholder value, returning more than $900 million to shareholders in 2018, through dividends and share repurchases. We expect to continue delivering on our value proposition in 2019, driven by solid growth in our core business and increased contribution from the legacy Abaxis portfolio of diagnostics products. Finally in 2019, we will continue to invest internally and externally to grow profitably in the short, medium and long-term. Now, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We’ll take today's first question from Michael Ryskin with Bank of America Merrill Lynch. Please go ahead. Your line is open. Michael Ryskin : Thanks guys. Appreciate taking the call. Congrats on the quarter. A couple of quick questions. First one, you talked about 5% market growth for the overall industry in 2019. I just wanted to go into that a little bit deeper, because in the past, we've seen something more in the 5% to 6% range. So I'm wondering what you're seeing there, if you could give a little more color on the dairy markets, cattle markets in the U.S., some of the swine issues we're hearing about internationally? And what I'm getting at with this is, what should be our expectation for the in-line portfolio in 2019? You know, if you exclude Abaxis, if you exclude the dermatology portfolio, Simparica, what's the base portfolio doing in terms of volume and price? And then I've got a quick follow-up questions on the margin expansion for 2019. Juan Ramón Alaix : Okay. Thank you, Mike. I will try to cover some of the questions, and also, I will ask Glenn to provide some additional details on how we can see the growth, the in-line growth in 2019. So I agree that in previous communication, I mentioned that we expect in the market, a growth of 5% to 6%. Then we have seen that the cattle market, especially in the U.S., both beef and dairy has been showing some weakness and we expect that rather than 5% to 6%, now, we are projecting the total market growth of 5%. We still expect that the cattle business worldwide will be showing growth, but definitely growth that will be below this 5%. The rest of the species, as I mentioned in my comments, companion animal, and also swine and poultry will be growing in line or slightly above the market and the only species that we see some market growth below the market will be cattle. Then, moving into the details of the organic growth, as part of our guidance, it's 4.5 to 6.5. And then if Glenn can provide a little bit more details of how much will be price growth and also volume growth and new products? Glenn David : Sure. So in terms of just the overall breakdown, it's really consistent with our long-term expectations. So price, we would to expect to generate around 2% price this year, we're particularly strong with price at 3% for 2018. Going into 2019, probably more in line with our long-term proposition of around 2%. New products, again consistent, probably 1% to 2% and then the remainder comes from the in-line portfolio. We do consider derm part of the in-line portfolio as it has matured and has been on the market for a number of years at this point. Also in terms of your question on margin expansion, when you look at where we closed 2018, cost of goods sold, as a percent of revenue, was a little over 32%. Our guidance for 2019 is 31% to 32%. And we made significant progress in cost of goods in 2018, improving our cost of goods, as a percent of revenue by over 100 basis points. So that leaves about another 100 basis points to deliver our commitment of improving cost of goods sold as a percent of revenue by 200 basis points by 2020. You'll probably see that spread between 2019 and 2020 that attainment. Juan Ramón Alaix : Thank you. Next question please. Operator : And we'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich : Good morning. Thanks for taking the questions. So I just wanted to start off on the cost structure. I mean, it looks like some expenses this quarter came a little bit higher than we expected. And then Glenn you made comments about where you think things will line up in 2019 with increased investments in R&D. Can you just talk about some of the moving parts and given how good the year was for you in 2018? Did you pull-forward any expenses or how should we be thinking about that? Glenn David : So Kevin, in terms of cost of goods, I'll start again. We had significant improvement this year of 100 basis points improvement in cost of goods. For Q4, we did see elevated cost of goods and that was really related to the impact of FX, also Abaxis and higher inventory write-offs in the quarter. Really the Q4 should not be viewed as a run rate for 2019. We have good visibility into our cost of goods, and we're confident in the guidance of 31% to 32% for 2019. As we look into 2019, from an expense perspective, consistent with what we've said, we are making investments in R&D and R&D is growing more in line or closer to revenue. As we do have many projects that we're very excited about in our pipeline that we want to make sure that we fully fund. SG&A, when you look at the operational growth is growing below revenue even with the investments that we're making in Abaxis. Juan Ramón Alaix : Thank you. Next question please. Operator : We'll go next to Erin Wright with Credit Suisse. Please go ahead. Erin Wright : Great, thanks. Can you speak to the underlying performance at Abaxis and how the integration is progressing in the longer term cross-selling opportunity with diagnostic portfolio? And then my second question is on Simparica Trio. Do you think there is a possibility that you're first to market there in that category? And how should we think about your competitive positioning there? And do you still feel confident in the 2020 timeline and do you anticipate one or two review cycles from FDA. Thanks. Juan Ramón Alaix : Thank you very much, Erin. I will probably start with the comments on the Abaxis integration. Glenn, will also provide some details of Abaxis performance, and then I will also talk about the Simparica Trio. In terms of Abaxis integration, things are progressing in line or even in some cases faster than initially planned. In the U.S., both teams, Abaxis legacy team in the field force and also our teams are already working together. And as we communicated initially, the Zoetis team is already identifying the opportunities and also helping the other team also to identify customers to complete the sales. They will be also engaging, ensuring that we increase the use of consumables and this will be an opportunity for future growth. We are working definitely that in the future we will be, not only the teams that are working together, but also the portfolio will be fully integrated, and this also, it's depending in some of the work that we are doing in terms of the SAP implementation for Abaxis operations that we plan to do it in 2019. In international markets, we're also progressing pretty well. We have almost completed the hiring process of field force and also technical support, but still some positions that will be completed in the next coming months. But this team is already working together with the field force team of Zoetis, generating the demand. In most of the markets, the supply to customers will be still done through third-party distributors. And in 2020, we'll be deciding if we keep distribution or we go direct in some of the markets. But definitely, all the integration opportunities or integration plans are progressing pretty well. We are also working on continue identifying opportunities in terms of R&D and the scenario that also we are integrating the teams of – sitting in Kalamazoo, also in Denmark and Union City. Altogether are defining the future portfolio of Zoetis in both companion animal and livestock. Glenn, do you want to give details of Abaxis performance? Glenn David : In terms of performance for the quarter for Abaxis, as we mentioned, we had $65 million in sales for the quarter. I want to remind you that Abaxis was on a different accounting calendar. But however, if you do normalize the accounting calendar, that would translate to approximately 8% growth. Again, within the quarter, we did have some destocking to bring Abaxis more in line with our overall levels of inventory with wholesalers. If you adjust for that destocking, the growth for the quarter is double-digit. Also for the year, again if you try to look at it on an apples-to-apples basis, the growth is double-digits for the year with and without the destocking. Juan Ramón Alaix : Thank you, Glenn. And then moving to triple combo. So let me maybe provide a little bit of a context. So when we launched Simparica as a single agent, we were two or three years behind competitors, Nexgard and Bravecto. Now with the triple combo, it will be first – second to market. But what we did is significantly reduced this gap of two or three years and then we expect that if FDA approval is coming in line with our filings and expectation is to introduce this product in 2020. So given we are second to market, we will be only second with few more different with competitor. We see a significant improvement compared to the situation that we had with Simparica. And with Simparica, we have been able to continue growing that patient share. In 2018, we increased patient share from 13.1 at the beginning of the year to 15.6 at the end of the year. So we are confident that with the efficacy and also the safety profile of Simparica and the future efficacy and safety profile of triple combo, we'll have the opportunity to have significant market share. Next question please. Operator : And we'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : Hi, thanks for taking my question. So my question here is, can you talk more about your pipeline as it pertains to the mAbs, livestock diagnostic and aquaculture? When will some of these new products hit the market? Do they have the potential to be blockbusters or an aggregate to be blockbusters? And then just a quick follow-up on the triple combo, is that expected to be a blockbuster product for you as well? Thank you. Juan Ramón Alaix : I'll start with the easiest question. Thank you, Louise. It's definitely, triple combo is expected to be a blockbuster. Definitely Simparica is already a blockbuster, but we expect also that the triple combo will reach this status. In terms of the rest of the pipeline, definitely there are products for livestock. These products – there are a lot of product that maybe in aggregate basis will represent a significant growth opportunity. But I will not describe these products as probably in livestock as a blockbuster potential. But definitely, it will help us, first to protect the current portfolio, and second, to bring innovation in livestock into the market. In terms of monoclonal antibodies for chronic pain, we expect that this will have the opportunity of being a blockbuster and we are convinced that the monoclonal antibodies for dogs and cats will represent significant opportunity for treating dogs and cats in a different way that is today with NSAID, especially for cats, that there is nothing especially developed for these animals in terms of pain. But we also are excited about the opportunity of developing monoclonal antibody for dermatology in cats. Again, it's an opportunity that we expect that will be coming in the next year and this will strengthen our derm portfolio, also moving another species with monoclonal antibody. Next question please. Operator : We'll go next to John Kreger with William Blair. Please go ahead. Jonathan Kaufman : Hi, good morning. This is Jon Kaufman on for John Kreger. So a couple of questions on cattle here, you mentioned premium product sales in the U.S. Is that a trend that you foresee continuing in spite of market weakness? And then internationally, where are we in the cycle and some of the key markets? Looking out beyond 2019, can international growth more than offset U.S. weakness? And what are your expectations for long-term growth in this market? Thank you. Juan Ramón Alaix : Definitely, the U.S. market for cattle has been driven by our premium products. But some of our products, they face competition during the year, especially when the situation of the animal was of lower risk profile. But we also have seen that in risk situation, our premium products are the best products that we need to protect or to treat animals. So we are confident that our premium products also will remain generating growth in the future. In the U.S., definitely we see the cattle business growing below market and maybe also growing below what we expected some months ago. Because we also projected dairy recovery in the second half of 2018, then we think that it will take even longer to see a recovery on the dairy business. In the case of beef, I think, it will be always cycles, animals moving into the big lot sooner or later, but we don't see a significant change on beef. We're still projecting that beef will be slightly increased in the number of animals only by 1%. But we think that beef will be probably in line with what we expected some months ago. We expect that the overall cattle business of Zoetis will be growing in 2019 and maybe growing faster in international markets than in the U.S. And as we said many times, the diversity of our portfolio in species and geographies is helping us to manage these cycles. These are cycles that we have been facing forever. And one of the things that, not only our industry, but also Zoetis has been very consistent even in the phase of change cycles, regulatory situations, very consistently delivering growth inline with the market or even higher in the last six years of Zoetis as a public independent company. Next question please. Operator : We'll go next to Jon Block with Stifel. Please go ahead. Jonathan Block : Great. Thanks guys. Good morning. Maybe a couple of questions and I'll try to rope into one long one. So Glenn, 150 FX basis point headwind, I thought you messaged maybe 200 basis points to 300 basis points recently at JPMorgan. So I just want to see if I'm correct, and what if anything has changed there? And then on that same question, does the midpoint of the 2019 EPS of $3.47 imply any sort of a share repo? I think just trying to flow through your numbers. I get towards the lower end of the EPS, if I use the 4Q share count. And then just to pivot over to Abaxis, when you guys bought Abaxis, Juan Ramón, they had a bunch of new products in their pipeline and your own sentiment, blood gas, rapid assay, so just any more color you can give us, in your control now for four or five months, how is the uptake been on some of these new products within that portfolio? Thanks for your time guys. Glenn David : So Jon, so I'll address the FX question. So you're correct, when we're at JPMorgan, we did see a bigger impact of foreign exchange based on the rates that were applicable at that time. In terms of the guidance that we have today, we based the guidance based on FX rates as of the end of January. And as I mentioned based on that, there is 150 basis point impact to revenue. However, if you look the last few weeks, the dollar has continued to strengthen and based on the rates that we see actually as of yesterday, our revenues would be negatively impacted by about another $50 million and EPS by a few pennies. So this is currently not reflected in our guidance and something that we'll continue to monitor. The other question you had was, in terms of the midpoint and share repo, when we set our guidance range, we really only assume that will offset dilution from compensation in terms of setting our guidance, but nothing additional. Juan Ramón Alaix : Jon, then on the Abaxis question, so the focus that we have been there in the last [indiscernible] has been to ensure that all the portfolio, existing portfolio were really meeting the needs and the quality that is expected from our customers. And one of the efforts that we have been doing significantly is to make sure that our equipments are connected to the practice management system and that's really helping veterinarians to have a full integration of information from different equipments in the clinic. We have also been working on defining the priorities in terms of R&D focus and we are progressing well. In terms of, you were asking also about new products, well, definitely FLEX4 is working very well. We also are planning to introduce FLEX4 in the international market within Canada and some other markets. And we will provide a little bit more details on the future launches as we are making progress in terms of defining all the priorities and all the products that will be coming in the next coming year. So next question. Operator : We'll go next to David Risinger with Morgan Stanley. Please go ahead. David Risinger : Thanks very much. Well, first of all, congrats on the performance. I have two high level questions. The first is with respect to Abaxis, we spoke with a consultant who suggested that it will be difficult for Abaxis to displace IDEXX at many U.S. customers. Could you speak to that, your ability to knock IDEXX out of U.S. customers and drive placements of Abaxis going forward? And then with respect to the FDA's assessment of heartworm drug efficacy and potential resistance concerns, could you just speak to where the FDA is in that process and whether the heartworm coverage that you're able to demonstrate to the FDA for TRIO will be at the 100% level or whatever level the FDA will require? Thank you. Juan Ramón Alaix : Thank you, Dave. Well, starting with the question on heartworm, definitely we have presented to the FDA all the support of 100% efficacy in terms of protection against heartworm. So what is the process of the FDA is something that probably we cannot comment. But we are confident that we have submitted all the data to support our efficacy and safety profile. We will continue working with the FDA. It's a process. It's the process of submitting the different dossiers information and also responding to questions. We are confident that the process will be able to introduce the product in 2020. About the question on, can we gain share in the U.S.? Well, the answer is, yes. And we are convinced now that Zoetis is competing with any competitor in the market on equal or even stronger conditions. In the past, Abaxis was limited in terms of access to customers and I mentioned that maybe they were meeting or visiting customers once per quarter compared to the other competitors having even more frequency than once a month. Now we have the opportunity to really be in front of our customers even more than once a month for few customers. And also very important, we have the opportunity also to combine all the diagnostics portfolio with our strong portfolio of vaccines, parasiticides, derm and so on and so forth. And also create a value proposition to the customers that it was not available at the time of Abaxis. So I understand that it maybe people that need to be convinced, but I hope and we are working hard to make them wrong in terms of the assessment that we cannot compete against IDEXX. Next question please. Operator : We'll go next to Chris Schott with JPMorgan. Please go ahead. Christopher Schott : Great. Thanks very much for the questions. I guess, first one was on Apoquel. I'm just trying to get a sense of where we are in the growth cycle here. So specifically how much more growth potential do you see for the product in the U.S. market? And when we think about the ex-U.S. opportunity, can you just give us little bit more color about how uptick has trended relative to the U.S. in the markets you've launched and what are the biggest ex-U.S. opportunities that you're watching? My second question was on margin expansion over time. So beyond 2019, I know you've highlighted 2019 to be of an investment year with Abaxis coming on Board and the R&D investments. But when we look beyond 2019, can we think about OpEx growth returning back down to low single-digit levels or should we think about Zoetis in a period of kind of multi-year period of OpEx investment as you have become as growth drivers [indiscernible] just beyond 2019 as we think about the longer-term model? Thanks very much. Juan Ramón Alaix : Thank you, Chris. Well, on Apoquel, I'm going to comment for the U.S. and also comment for international. In the U.S., we started the year with a patient share of 59% and we ended 63%. We still think that there are opportunities for growing patient share. Second, we still see opportunities for expanding the market. I will continue expanding the market or hoping to expand the market with DTC campaigns, that will be the third year that we are investing to create this market demand. And third, we still see opportunities for pricing. So these three elements are probably supporting the growth in the U.S. for Apoquel. Definitely, lower growth than what we have seen in previous year. So the growth has been in the market now for four years, it would be five years in 2019. So we should expect that there will be some reduction on the growth in the U.S. In international market, well, the situation is slightly different, and I'm not talking about only Apoquel, I'm talking the full derm portfolio, including Cytopoint. Cytopoint has been introduced in the market recently in some of the international markets. We expect growth in the introduction of Cytopoint. We still expect growth for Apoquel definitely in terms of patient share, it's below the patient share that we have achieved in the U.S. and we expect that over time reaching similar level of patient share. Although the number of medicalized drugs outside of the U.S. is lower than in the U.S. And finally, we expect in 2019, to introduce the product in China. And again, China has been a market that has been surprisingly positive in terms of growth in companion animal. Now, if I remember well and Glenn you can correct me if I'm not, now China in terms of companion animal is the second largest after the U.S. and maybe some other market, but second or third. It's in companion animal growing very fast and we expect also that Apoquel will be successfully introduced in this market. Talking about margin expansion, you wanted to cover this question. Glenn David : Of course, Chris, there are number of opportunities for us in terms of margin expansion beyond 2019, just starting with cost of goods and beyond 2020 and delivering on the proposition of delivering a 200 basis point improvement in 2017. As we look past that, we should be able to continue to get improvements in our cost of goods as a percent of revenue. Really, the cost of goods efficiency coming from a lot of the capital investments that we're making today, which we expect to payoff in longer-term in terms of improved cost of goods and we'll continue to also get margin expansion from price. Looking at the OpEx line, from a G&A perspective, we do expect general administrative expenses to grow more in line with inflation as we already have the infrastructure established in most of our markets. Selling will probably be more between the overall inflation rate and the growth in revenue, and depending on the level of revenue growth that we have and new product introductions that we'll need to support. And then from an R&D perspective that will really depend on the opportunities that we have, but that will probably grow more in line with revenue than others. Juan Ramón Alaix : Thank you, Glenn. And then maybe adding that to the question on Apoquel or derm, I did mention that one-day we should be also facing competition. It's an area that Zoetis has created. It's not the first time that we are creating the market. We did it for pain and now with derm. But we are convinced that we have developed a significant portfolio in derm, portfolio, which is showing high level of efficacy, excellent safety profile and we'll be also adding in the future monoclonal antibodies for dermatology issues for cat. So we are confident that we have the opportunity of continue growing. Always we need to consider future competition in this respect. Next question please. Operator : And we'll take today's final question from Kathy Miner with Cowen. Please go ahead. Your line is open. Kathleen Miner : Great, thank you for taking the question. One, just a brief follow-up on the dermatology area, and I apologize if I missed it, but did you give an update for your expectations for 2019 for dermatology, particularly as you've met or exceeded the $500 million-plus for 2018? And the second question just on M&A, does your 2019 guidance assume any small bolt-on acquisitions? And given that Abaxis is now on board, what would be the key areas we should watch for that? There might be some interest in adding? Thank you. Juan Ramón Alaix : Thank you, Kathy. And well, in terms of the sales, big sales for our derm portfolio, so in 2018, we almost reached $600 million, it was $593 million. We are projecting growth in 2019, but definitely we are not now updating in terms of big sales. We know that in the future, we'll have competition in this space, so it's a little bit complicated now, what is the full potential. We are convinced that we still have opportunities to continue growing. And as I mentioned before, we also expect to add new products to our portfolio, monoclonal antibodies for cats and maybe also working to ensure that we also apply lifecycle innovation to Apoquel to protect this franchise. And this can be in terms of formulations, in terms of expansion to other species, so it's something that will continue working on lifecycle innovation. And then you also ask if we are including any acquisitions for in 2019 guidance and the answer is no, so it's just our current portfolio including Abaxis portfolio and what we described now as organic growth including Abaxis, and that we will continue assessing opportunities in the market. We are convinced that we have the infrastructure, we have the expertise to integrate and also we have the reach to the customers and we will continue assessing opportunities available in the market and if these opportunities are meeting the criteria of strategic value creation and supported by financials. We think that we have the cash flexibility to go and acquire other companies. Juan Ramón Alaix : And I think with that, we conclude this session. So thank you very much for attending the earnings call. Thank you for your questions. And with that, we close this call. Thank you. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
|
ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,019
| 2
|
2019Q2
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2019Q1
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2019-05-02
| 3.161
| 3.213
| 3.505
| 3.565
| 5.25487
| 24.93
| 27.19
|
Operator : Welcome to the First Quarter 2019 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, it will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you. Good morning, everyone, and welcome to the Zoetis first quarter 2019 earnings call. I’m joined today by Juan Ramon Alaix, our Chief Executive Officer; and Glenn David, 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, 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 in the company's 8-K filing dated today, May 2, 2019. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, Steve, and good morning, everyone. I will start today by describing some of the dynamics in the animal health industry that are on Investors minds. First, is a positive strength for spending an innovation in companion animal medicines and treatments. Pet owners spending in the U.S. continued to rise in terms of our revenue per visit and number of patient medicines. And we also see positive trends for our pet care in the rest of the world. Pet owners are willing to spend their income on medicines, vaccines, and other treatment to ensure a longer and better quality of life for their pets. We believe Zoetis is well-positioned to continue success in the companion animal space as our portfolio of dermatology products, parasiticides, and vaccines continue to drive our growth. Second, we see economic pressure, and other challenges continue to impact dairy and cattle producers in the U.S. We still, however, expect to see the U.S. cattle and dairy market growing for a full-year, driven by stronger domestic demand for beef and increasingly optimistic outlook for beef and dairy export and a modest improvement in milk prices. Finally, African Swine Fever has made headlines about significant concerns for the pork market. It is impacting producer in China with some reports saying that as many as 150 million to 200 million pigs or up to 30% of their annual food supply will be lost due to the outbreak. For context, that is more than the U.S. annual core production. This situation has far-reaching implications for the global pork supply chain. The reduction in supply in China is making the pigs more valuable, creating opportunities for greater export from other countries, and increasing consumption of other products. The situation will evolve through the year, clearly monitoring any effect on the overall market and our business, which show an impact in the first quarter. This type of outbreaks, unfortunately are part of doing business in animal health. This year, we are facing issues with African swine fever. A few years ago, we built with PEDV with avian flu, and before with Bruton disease. These challenges are why Zoetis has built a diverse portfolio of best-in-class products across all relevant species and geographies. A more aggressive opportunities and manage through economic cycles, these things outbreak and integral weather conditions. We congregated in February that we expected the overall industry to grow approximately 5% for the year, excluding the impact of foreign currency. Now, because of African swine fever, we think the animal health industry will have a lower growth rate in 2019 and will continue to assess the broader impact of African swine fever as the year progresses. Despite some of these temporary challenges, we are maintaining our guidance for operational revenue growth. Excluding Abaxis, 4.5% to 6.5% for the full-year, which we expect to refractor than the growth of the animal health market. Turning now to our first quarter results. We are off to a solid start for the year with 11% operational revenue growth being driven by our companion animal business. Revenue from the Abaxis acquisition accounted for 5 percentage points of the overall 11% growth. Our sales in companion animal products are once again leading the way with 27% operational growth based on the addition of sales from Abaxis, as well as our parasiticides and key dermatology portfolio. Our livestock products sales declined [3%] operationally due to challenge in certain cattle and swine markets. For the first quarter, we grew our adjusted net income by 18% operationally, and adjusted diluted EPS by 19% as we benefitted from a strong revenue growth and a significant increase in gross margin, due to pricing, our favorable product mix and cost improvements. Glenn will provide more details on our first quarter performance in his remarks. Our results once again confirm the importance and value for growth and innovative portfolio in the animal health industry, and we remain confident in our performance and outlook for the full-year. Looking ahead, we continue to invest in advancing our pipeline, ensuring careful market launches of new products and furthering the integration of Abaxis this year. Since our last quarterly earnings announcement, we have seen key companion animal products, including Cytopoint and Simparica for dogs, and Revolution Plus for cats continue to gain approvals in markets outside the U.S. Our Core EQ Innovator, the first and only combination vaccine to offer protection against five core equine diseases, was also approved in Canada. Last week, Zoetis received approval for Apoquel in China, one of Zoetis’ largest companion animal markets and we expect to launch the product there within the next three months. On the livestock side, we launched Clarifide Plus for Jersey cattle in the U.S., this is the first genomic test for this breed that provides a direct indication about the genetic risk factors for seven of the most common and costly adult cow diseases. In terms of our R&D pipeline, we still anticipate launching this year a new injectable parasiticide formulation to protect dogs against heartworm for up to 12 months pending FDA approval. Our new three-way combination parasiticides, composed of Simparica and two other active ingredients still in regulatory review in the U.S. and with European Medicines Agency. Reviews are also underway in Canada and Brazil with further vision expected in Japan, China, and Australia this year. If approved, we anticipate this product will come into market in 2020. We also continue working on new monoclonal antibodies to manage pain in dogs and cats and dermatology for cats. Those programs are progressing and we’ll keep investors informed of future finding in this area. We feel very positive about the benefits, this treatment can provide to greater compliance, convenience, and efficacy for different species. In the case of other research or livestock, I would point to our programs in vector vaccine technology for our poultry. Research into promising new classes of antibiotics and our growing investment in diagnostics, genetics, devices, digital and data analytics technology that can be used in applications like precision livestock farming. Additionally, we have vaccine programs to address current and future emerging diseases, which has been a growth driver for our industry in the past. We also maintain a comprehensive portfolio of approximately 300 product lines for Zoetis and we invest significantly each year on life cycle innovation that keep those products competitive and growing. Finally, we are making good progress on the integration of Abaxis. We remain positive on the point-of-care diagnostic market. Given this strong global growth prospect as well as the critical growth, these diagnostics play in the vet clinic. We are excited about the strength of the Abaxis portfolio and the way our field force is representing it to customers around the world. Our U.S. imports has been working to drive greater growth through new lead generation for diagnostics. In international markets, we have nearly completed staffing and training of our expanding diagnostic team, implemented a new customer service model across these markets and view this as a greenfield opportunity for future growth. We are pleased with our progress to-date and we continue to view 2019 as an important year for the integration and platform setting, enhancing certain product and customer experiences and developing more progress essentially for customer solutions that leverage our new diagnostic assets. Including our first quarter results, once again, demonstrate the stability and the diversed strength of our portfolio in a dynamic animal health industry. We are executing on our strategies for growth across the continuum of care with new products and solutions that help our customers, predict, prevent, detect and treat diseases in animals while navigating the evolving trends in animal health. And we are investing and making important progress in key areas such as dermatology, but I think besides diagnostic, digital and data analytics, where we see both near and long-term growth opportunities. Thank you for joining us today, and I will now hand the call over to Glenn. Glenn? Glenn David : Thank you, Juan Ramon and good morning. As Juan Ramon noted, 2019 is off to a solid start. Operational revenue growth was 11% and operational adjusted net income growth was 18%. Reported revenue growth for the first quarter was 7% with a 4% unfavorable impact in foreign exchange, driven primarily by currency depreciation of the Euro and Brazilian Real. Excluding the impact of the Abaxis acquisition, operational growth for the quarter was 6%. Included in the 6% growth is, 4% price, and 2% volume. Volume growth includes contributions from key dermatology of 2% and new products of 1%, which were partially offset by declines in other in-line products of 1%. Companion animal demonstrated continued strength this quarter with legacy Abaxis products, parasiticides and key dermatology products leading the growth with positive contributions from all key markets. Meanwhile, livestock declined in the quarter based upon declines in sales of Medicaid feed additives and challenges like the African swine fever outbreak in China. Our overall results in the first quarter continued to demonstrate the value of the diversified portfolio with double-digit operational growth despite the declines in swine and cattle. Legacy Abaxis products contributed 5% to total Zoetis' operational revenue growth in the quarter with sales of $61 million. As a reminder, the acquisition of Abaxis was completed in the third quarter of 2018, so sales from legacy Abaxis products are incremental in the first half of 2019. The revenue this quarter represented a decline over the pro forma revenue from the prior year. This decline is primarily driven by new product launches and initial distributor stocking in the first quarter last year. We continue to expect full-year growth in diagnostics products as we focus on improving customer experience, connectivity to practice management software and international expansion. Our key dermatology portfolio comprised of APOQUEL and CYTOPOINT, also continued to contribute to growth this quarter with sales of $155 million, a 30% operational increase over the prior year. New products, including Revolution Plus and Stronghold Plus as it's called internationally. PCV combo vaccines in swine and Core EQ Innovator in equine were also growth drivers in the quarter. Revolution Plus, a topical parasiticide for cats builds upon the sarolaner compound that is found in Simparica. The product launched in the US this quarter and in 2017 internationally and is off to a great start supporting strong growth in the Revolution-Stronghold line in the first quarter. The decline in other in-line product volume was related to the timing of cattle product purchases in the U.S., African swine fever in China, the divestiture of certain agribusiness products in Japan, which occurred in the fourth quarter of 2018 and the implementation of stricter commercial and pricing policies in Brazil. The agribusiness is historically seasonal with a disproportionate sales in the first quarter. These declines were partially offset by the continued strength of Simparica now captured in the in-line product category, which generated $48 million in global sales this quarter, representing operational growth of 61% over last year. Now, let's discuss the revenue growth by segment for Q1. U.S. revenue grew 13% in the first quarter. Companion animal grew 30% and was partially offset by a 7% decline in livestock. Excluding the impact of Abaxis acquisition, U.S. revenue grew 8%. Companion animal sales in the quarter were driven by sales of legacy Abaxis products, in-line products, including our key dermatology portfolio and Simparica and new products, including Revolutions Plus. Excluding the impact of the Abaxis acquisition, companion animal growth was 20%. U.S. dermatology sales were $104 million for the quarter, growing 26%, driven by market share gains, price, and investments in direct-to-consumer advertising, which continue to expand the market. Simparica sales in the quarter was $25 million, growing 40% over the prior year. U.S. livestock declined 7% driven by cattle and swine. Cattle was impacted by the timing of Medicaid feed additive purchases and they are continuing to face headwinds while producer profitability remained low. Swine was impacted by the discontinuation of a promotional program for our premium products and the timing of medicated feed additive purchases. The declines in cattle and swine were partially offset by another strong quarter for poultry, driven by growth of alternatives to antibiotics in medicated feed additives. Despite the decline this quarter, we continue to anticipate U.S. livestock will grow for the full-year. Turning now to our International segment. Revenue grew 7% operationally in the first quarter. Companion animal operational growth was 23%, while livestock declined 1% operationally. Excluding the impact of the Abaxis acquisition, International revenue grew 5%. Companion animal product growth was driven by continued expansion and uptake of key dermatology products, the addition of legacy Abaxis products, strong Simparica sales, and growth in China. Excluding the impact of the Abaxis acquisition, companion animal growth was 18%. Livestock declines were driven by the impact of African swine fever in China and the divestiture of certain agribusiness products in Japan, which were partially offset by growth in poultry, fish, and sheep. The complete quarterly results of our top 11 international markets are provided in the tables included in our earnings release, but I would like to highlight a few items for the quarter. The UK had operational revenue growth of 16% in the quarter with companion animal growing 21% and livestock growing 11%. Companion animal growth was primarily related to legacy Abaxis products and increased sales of key dermatology products and Simparica. Livestock benefited from increased market share in agricultural vaccine in the quarter. In Australia, sales grew 10% operationally driven by companion animal growth of 15%, and livestock growth of 6%. This market benefited from key dermatology, legacy Abaxis products and Simparica and companion animal, while livestock growth was related to key brand performance in cattle. In Brazil, sales grew 1% operationally, driven by companion animal growth of 43%, partially offset by livestock declines of 13%. Companion animal revenue growth in Brazil was driven by parasiticides, primarily Simparica and continued strength of Apoquel. Livestock declines in cattle for Brazil related to the strengthening of our commercial and pricing policies, which impacted short-term results. We anticipate these policy updates will strengthen our long-term opportunity in this market. Overall market dynamics remain positive as does our full-year outlook. Moving on to China, we had a challenging quarter with revenue declining 2% operationally. Livestock declined 28%, driven by challenges in swine. African swine fever is having a greater than expected impact as the outbreak has worsened in China, reducing the size of the swine herd. We continue to expect other regions, primarily the EU, Brazil and the U.S., to increase exports of pork to China to meet domestic consumer demand. We also anticipate growth in other proteins, although to a lesser degree. Companion animal remain strong, partially offsetting the livestock decline with operational growth of 38% driven by continued growth of vaccines, parasiticides and an expansion of the field force in China, allowing us to capitalize on this fast-growing market. As Juan Ramon mentioned, we're also very excited about the launch of Apoquel into this important market. Other emerging and developed markets also continued to perform well this quarter, particularly in companion animal. Summarizing international performance, continued growth of key dermatology products, the addition of legacy Abaxis products, and diversity across our portfolio, all contributed to a solid quarter despite challenges in livestock. Now, moving on to the rest of the P&L. Adjusted gross margin of 70.2% increased approximately 270 basis points in the quarter on a reported basis, compared to the prior year. The improvement this quarter is primarily related to price, favorable product mix, foreign exchange and unit cost improvements, partially offset by the inclusion of the lower margin legacy Abaxis portfolio. We do anticipate a more normalized gross margin in the second quarter as both price and mix impact will moderate. Total adjusted operating expenses, including the impact of the Abaxis acquisition grew 8% operationally. The increase is primarily related to the acquisition of Abaxis and an increase of certain compensation-related expenses. We are anticipating higher expenses in the second quarter, primarily related to the timing of promotional investments for our key products, the timing of R&D project spend, and the Abaxis integration. We are continuing with direct-to-consumer advertising and promotional campaigns in the U.S. that support our key dermatology and parasiticide products with our highest expenses occurring in Q2 and Q3. The adjusted effective tax rate for the quarter was 18.8%. The increase from the comparable 2018 period is predominantly related to the impact of the global intangible low taxed income or GILTI tax, which is a provision of the U.S. tax reform, that’s effective for Zoetis in 2019. Our expectation for the full-year adjusted effective tax rate is consistent with initial guidance, which is between 20% and 21%. The favorability in the first quarter is primarily driven by the tax benefits from stock-based compensation. Adjusted net income for the quarter grew 18% operationally through a combination of strong revenue growth, favorability in gross margin, and moderated growth in operating expenses. Adjusted diluted EPS grew 19% operationally in the quarter versus the same period of 2018. Now, moving on to guidance for the full-year. Beginning with revenue, we are decreasing both the low end and high end of the range by $75 million to reflect the impact of foreign exchange. As I noted on the fourth quarter call, U.S. dollar strengthening was something we will be monitoring, and additional USD strengthening has occurred since we set guidance. We’re now projecting revenue between $6.1 billion and $6.225 billion, while maintaining operational revenue growth of 7.5% to 9.5% over 2018. Our organic operational revenue growth, which excludes the impact of the Abaxis acquisition, is projected to be between 4.5% and 6.5%, consistent with the guidance provided in February. Adjusted cost of sales as a percent of revenue is still expected to be in the range of 31% to 32%. As I noted earlier, there were some favorable drivers in the first quarter that we expect to moderate through the remainder of the year. We are decreasing the low and high-ends of the range for adjusted SG&A for the year to be between $1.45 billion and $1.5 billion, due to the impact of foreign exchange. Moving on to R&D. We expect 2019 expenses to be between $445 million and $465 million, consistent with the guidance provided in February. Full year adjusted interest and other income deductions is now expected to be approximately $200 million compared to the previous estimate of $220 million. The favorability is largely driven by a reduction in interest expense. Our adjusted effective tax rate for 2019 is expected to be within the range of 20% to 21%, consistent with previous guidance, and we are still projecting adjusted net income in the range of $1.65 billion to $1.7 billion, maintaining 8% to 11% operational growth. With a more limited foreign exchange impact on the bottom line, as well as the benefits of the actions we've taken to reduce interest expense, we continue to expect adjusted diluted EPS to be in the range of $3.42 to $3.52, consistent with previous guidance. Our range for reported diluted EPS of $2.79 -- $2.93, however, is a reduction of both the low and high-ends of the range based upon increased certain significant items, primarily due to a change in estimate related to inventory costing impacting the first quarter. Finally, I'd like to remind you that our quarterly results may fluctuate and our focus continues to be on the full-year. As I've already noted, we anticipate lower gross margin and higher operating expense in the second quarter, which will impact adjusted EPS. The full-year impact of the Abaxis acquisition will also continue to have a disproportionate impact on the P&L until we pass the acquisition date in the middle of the third quarter. Finally, foreign exchange will continue to negatively impact the P&L in the second quarter with an impact of approximately 300 basis points to revenue growth. Now, to summarize before we move to Q&A. Our first quarter results continue to demonstrate the value of our geographic and product diversity with operational revenue growth of 11% and operational adjusted net income growth of 18%. We continue to see strength in our companion animal portfolio to drive the year's results and expect growth in livestock for the full-year. And we remain committed to delivering on our full-year operational growth rate for revenue and adjusted net income, demonstrating the durability and consistency of our business. Now, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We'll take our first question from Erin Wright with Credit Suisse. Please go ahead. Your line is open. Erin Wright : Hi, thank you. Can you discuss a little bit how the Abaxis integration is progressing here relative to your internal expectations? It was a little lighter than what we thought in our Abaxis model and is that just the distributor dynamic, and I noticed that the GAAP acquisition related cost takes a little bit higher, is that all attributable to Abaxis and where we stand with it as the key implementation? And then the second question is on international livestock, just given some of the dynamics around African swine fever and what you called out in Brazil, can you speak to how we should think about that quarterly progression over the course of the year? Thanks. Juan Ramon Alaix : Thank you, Erin. Let me answer the question on Abaxis, and let me first say that we are pleased with the progress that we're making with the integration of Abaxis. The team in the U.S. is already working well, maybe not fully integrating the two portfolios because we mentioned that these have full integration, we need also to work with the integration of SAP. And related to the implementation of SAP for Abaxis, we have decided to move the implementation from August-September to February, because we want our IT team to focus on working on the connectivity of all equipment of Abaxis. We think that this connectivity that we expect to penalize by the end of the year will help us really to have that much more support to diagnostics and offer full integration or full connectivity of the diagnostic equipment to the practice management system. We’re also pleased with the progress that we are making in International markets. We have now almost completed all the hiring process for reps and also for technical support. We have also said the customer service that would help in really to provide the support to diagnostic customers. So, in general, we are progressing very well. We continue – very excited about the quality of the portfolio of Abaxis, and we are very confident that Abaxis will represent a significant growth opportunity, especially from 2020. Now we see 2020 – 2019 as a year where we are integrating, we are fixing some of the things that we have to identify from the previews Abaxis model, and we are very confident that the projections that we have for this portfolio will be very positive. In terms of the international livestock, let me provide a comment on Brazil and then I will ask Glenn to go into more details on what we expect for the rest of the year in the total livestock performance. In Brazil, we see that the market that continue growing very fast. It's a very strong growth for Zoetis. So, the growth in companion animal is above market growth, so we are growing very fast. In cattle, we decided to change some of our commercial policies, including prices, and we saw as expected some negative reaction from distribution. This had an impact in the first quarter for Brazil, especially in cattle, but we are convinced that these changes will help us in generating better future growth and improve the profitability of our cattle operations in Brazil. So, we remain very convinced that Brazil will be a growth driver for Zoetis, and we are investing to support this growth on that. Glenn, do you mind to provide more details on the International livestock? Glenn David : Absolutely. Erin, just also to your question on Abaxis and the Q1 performance you referenced, distributor stocking. So far, we talked about the performance in Q1 2019 to Q1 2018. In Q1 2018, there was stocking with the introduction of the new products in terms your settlement analyzer and Apoquel rapid test, that did pose a challenging comp between Q1 2019 and Q1 2018. In terms of the international livestock performance, as Juan Ramon said, for livestock internationally we declined about 1% this quarter, driven by the factors that we discussed in terms of African swine fever, as well as the impact in Brazil. We would expect to return to growth in Q2, and that growth to accelerate in Q3 and Q4. Juan Ramon Alaix : Thank you, Glenn. Next question, please. Operator : We'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : Hi. Thanks for taking my question here. So, I wanted to ask you about your temporary weakness in livestock and when do you expect that to subside this year and then return to growth, and how much of that is macro versus company specific? And then maybe just if you could talk a little bit more about this MSA buyer pattern? Thank you. Juan Ramon Alaix : Well, as we said that in the first quarter, we faced two impacts in terms of the temporary weakness in livestock. One was the cattle business in the U.S. was affected by different factors. And talking about the market, the market declined. We saw that the movement of animals was below expectations. In many cases, driven by weather conditions, but we are optimistic about the cattle business in the U.S. moving forward, the demand for beef is positive, and also the exports are increasing. Additionally, we expect also in the second half of the year a small increase on the price of the milk also that will help the total cattle business in the U.S. As many times we mentioned, I think it is difficult to analyze our business in a quarterly basis. There are fluctuations based on buying patterns and promotional activities weather conditions that maybe it's important to understand the business on a yearly basis. We remain confident that the livestock market will be growing at the end of the year. What we are expecting is that the poultry will be growing in line or slightly ahead of the market. In terms of swine, we expect going lower than the market, and mainly because of the African swine fever. But we expect having a temporary impact, but maybe from a third or fourth quarter and definitely in 2020, we expect a significant recovery because many markets outside of China will expand the production that will generate a significant growth. And finally, with the cattle, we also expect that for the year overall growing – we expect growing in the U.S., we expect also growing international markets, but growing below expected market growth. Glenn David : And in terms of the timing of the MSA purchases in the U.S., that's really related to the timing of our annual price increases. So, in 2019, we align the timing of our MSA price increases to be in sync with the rest of our portfolio, which is in January, that led to some additional sales in Q4 of 2018 that then destocked in Q1 of 2019. So that is not an impact that we would expect to see as we move forward through the rest of the year. Juan Ramon Alaix : Next question, please. Operator : We'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich : Good morning. Hi, Juan Ramon. Just have a couple of questions here. Companion animal continues to be really strong. You're seeing really good growth out of obviously the dermatology portfolio, but also Revolution Plus for cats compared to the dogs, could you talk about what areas you're focused with the product development, maybe more on the feline side in the areas that are being medicalized. Also timing for the monoclonal antibody products. And then Glenn, on the SG&A and operating expenses, clearly there were some favorability this quarter. And you talked about increased spending, DTC campaign in Q2. Could you give us a little bit more color on that? Thank you. Juan Ramon Alaix : Kevin, we see the current portfolio still showing opportunities for growth. We see opportunities for growing the parasiticides now with Revolution Plus. We still see that Simparica continues gaining momentum in the U.S. and also international markets. Apoquel and CYTOPOINT are growing and we expect to continue growing. We expect to continue growing in the U.S. and also expect to continue growing in international markets. And now, we have the addition of Apoquel in China, that also will support this growth. We are also very confident that this growth is steady for the long-term, because as we said, the current portfolio continue growing, but we expect also to introduce Simparica or a combination of products – three-way products in 2020, that also we expect that to continue generating growth. In the future, we are not at this point providing any details of when we expect that monoclonal antibodies to be in the market. But definitely we see opportunities in reline with pain. We see opportunities also in feline with dermatology, again with monoclonal antibodies, and always with monoclonal antibodies in dogs for pain. And we are very confident that the R&D machine will continue bringing innovation to the market in companion animals, but also in livestock. We have products for both companion animal and livestock that will support growth in 2020, 2021, also 2022. So, we are very confident that we have a pipeline that will maintain growth that will be in line or faster than the market. And Glenn will respond the question on G&A. Glenn David : Kevin, in terms of the operating expenses. So, just for the quarter, our operating expenses grew about 8%. If you back out Abaxis, operating expenses grew around 3%, compared to our revenue growth of 6%. So, pretty much in line with our overall expectations over an extended period of time. That being said, we did have some favorability in R&D expenses in terms of the timing as well. So, as we move through into Q2 and Q3, we'd expect elevated expenses in Q2 and Q3 as that is the time frame in which our DTC promotions, particularly in the U.S. around our dermatology portfolio and Simparica to kick in at a higher level. And we'd also expect some elevated expenses in terms of our R&D as well. Juan Ramon Alaix : Next question, please. Operator : We'll go next to Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Hi, guys. Thanks for taking the question. A couple – I want to dig deeper on some of the moving pieces in the quarter both on the livestock markets in the U.S. and internationally. If I sort of go through some of the items you called out African swine fever, the spend, divestment, looking at your revenues by geography, I think I can estimate that ASF may have had a $5 million to $10 million hit in the quarter. The Japan divestment is somewhere in the same ballpark as well. So, I want to get a sense of if that's the right way to think about it? And then is that the similar run rate you would expect for ASF going forward? And then the other one would on the U.S. livestock business. You talked a little bit about the distributor relationship in the stocking in 4Q, but just trying to get a sense of the magnitude of that impact in the first quarter versus the rest of the feedlot pressures as well, so we could plan the phase through the course of the year? Thanks. Juan Ramon Alaix : Thank you, Mike. I will make a general comment on the African swine fever. Then Glenn will go to the details of your questions. So, first, the African swine fever definitely is having a significant impact in China, and we also have an impact in our results. We mentioned that probably up to 30% of pigs would be lost on 150 million to 200 million. And as a reference, in the U.S., production is 120 million per year. But it's also true that in China, the market share of multinational company is only 10%, 90% is products sold by local companies. We definitely see a significant issue in China, mainly for the business in China cattle, so we see that the other countries, the U.S., Brazil, European markets will increase significantly the production of pork to meet all the demands of the Chinese consumers that are definitely for a significant period of time. There will be seen a shortfall for producing in China. And it seems outside of China, we have a significant market share in swine. In the medium and long-term, we see that as an opportunity to generate growth in swine and also maybe an impact in poultry and to a minor extent also to beef. Because in the end, the consumption of animal products in China will remain and export markets will supply products to meet that demand in the markets. And then Glenn will go through the details of the impact on African swine fever in the quarter and also the Japan agro business and also the U.S. impact of the value. Glenn David : So, Mike, specific to your questions, for ASF and Japan, you mentioned the range of $5 million to $10 million. So, what I'd say, ASF is probably at the high end of the range for the quarter and Japan is probably at the low end of that range for the quarter. In terms of U.S. livestock, obviously we did have the impact in Q1. It's a little above that $5 million to $10 million range that you referenced with the bigger portion of that being cattle. Juan Ramon Alaix : Thank you, Glenn. Next question, please. Operator : The next question is from Jon Block with Stifel. Please go ahead. Jon Block : Pardon me. Thanks guys, good morning. I've got two long ones. Maybe I'll try to break it up if it's okay with you. The first one is triple or Simparica Trio, any updates on how the filing or interaction with the agency is proceeding? and I'm just curious in your ability to fulfill demand in the early days, obviously with Apoquel there were challenges post launch although, I know some of that was sort of the reliance on a third-party manufacturer. So, any color would be helpful. And then I'll ask a quicker follow up. Thanks. Juan Ramon Alaix : Thank you, Jon. And we have provision with the discussions with the FDA. We have completed out all the sections of the filing and it's just now the normal process of question and answers. We are confident that this year it's strong and it will be approved by the FDA, but always something that is not depending on us but on the regulators. But one of the challenges that we discussed in the past is that we needed to demonstrate 100% efficacy on how we have to provide these data. And we are confident that – probably that will be approved and ready to be launched in 2020. And definitely we try to learn from previous challenge or issues or mistakes, and definitely in the case of the three-way products, we secured enough active ingredients to be ready for launch the product, as soon as the product is approved. So, we are not expecting any challenge in terms of supplying the market or the demand. Next question. Operator : We'll go next to David Risinger with Morgan Stanley. Please go ahead. David Risinger : Thank you very much. So, I have three questions, please. First, with respect to U.S. companion growth this quarter, could you just give us the figure, the percentage ex-Abaxis? Second, how should we model livestock sequentially in the second quarter? I just don't have a good feel for how we should think – thinking about the livestock business sequentially in 2Q in the U.S. and ex-U.S. And then, one little tidbit, with respect to the revenue guidance reduction of 1%, was that solely related to FX or was there also some modest impact elsewhere? Thank you. Juan Ramon Alaix : Thank you, Dave. And Glenn will cover these three questions. Glenn David : Sure. So, just in those questions. In terms of our revenue growth excluding Abaxis focused on companion animal, so globally our companion animal business grew 27%. Without Abaxis we still grew extremely strong at 19% globally. In the U.S., the number was – with Abaxis we grew 30%, excluding Abaxis we grew 20%, and internationally companion animal grew 23%. Without Abaxis, we grew 18%. So, really strong organic growth within our U.S. companion business. As we mentioned earlier, in terms of the livestock growth sequentially, when you look at it globally, we did decline 3% this quarter in terms of livestock business on an operational basis. We do expect to return to growth in Q2, and we expect that growth to accelerate throughout the year. In terms of the guidance, we reduced the guidance for both the low and high end of the range by $75 million, that was purely due to FX. There were significant movements at the time from when we set guidance. When we set guidance back in February, we were using rates as of late January, and when we set guidance now, we're using rates as of the end of – towards the end of April, and that had a significant movement, so the movement was purely due to FX. Juan Ramon Alaix : Thank you. Next question please. Operator : And we'll take the next question from John Kreger with William Blair. Please go ahead. Unidentified Analyst : Hi. This is [indiscernible] on for John Kreger. So, just a quick question surrounding the dermatology portfolio. When you just think about like the penetration rates specifically in the U.S. right now, where do you guys kind of think that is? And then when you think about the international growth in the dermatology portfolio for the rest in 2019 and beyond, where do you guys foresee that going? And then just when you think about them individually, so Apoquel and CYTOPOINT, have they trended – have they trended well, compared to your expectations and are you seeing that's having like a strong preference for one or the other products? Thanks. Juan Ramon Alaix : In terms of penetration for dermatology portfolio, I think it's – it's about – in terms of patient, about 59% and it's something that probably – 63%, sorry, it's the total patient share, which is based on and we still see opportunities first to continue expanding the market and we will be starting now in the second quarter campaign – detectable tumor campaign. We set two objectives, one it's expanded market. And also, second is set to continue building brand equity for Apoquel. We see also that these investments are also having a positive impact on CYTOPOINT. We expect dermatology portfolio to continue growing. We expect also to grow faster in international markets than in the U.S., but in the U.S., we still see a positive momentum, and how much is the preferential CYTOPOINT or Apoquel? In that respect, I think we leave veterinarians to decide what is the best for their patients, the pets. And we are not trying that to promote Apoquel in favor of CYTOPOINT, and CYTOPOINT in favor of Apoquel. We are covering all the spectrum of needs in terms of treating dermatology issues, itching in dogs, and that we see that there is [indiscernible] cannibalization, but also CYTOPOINT has been growing the market and helping us increase this franchise. Next question please. Operator : We'll go next to with Kathy Miner with Cowen & Company. Please go ahead. Kathy Miner : Thank you. Good morning. I've two questions. First, could you just provide a little more clarification on your comments about the impacts of the African swine fever on Zoetis, and I appreciate that over time there is going to be a greater demand for the proteins or will see other regions pick-up some of the supply? Can you just help us understand why that's medium to long-term and why shouldn't we see some of those dynamics sooner, particularly as supply needs to pick-up in some other countries? And my second question is on Apoquel. First, could you give us the breakdown between CYTOPOINT and Apoquel sales of 155 million you gave us before? And also, in Apoquel in China, could you give us a sense of the market size, is it similar to the EU5 or U.S. and is CYTOPOINT also under review in China? Thank you. Juan Ramon Alaix : Thank you for all the questions, Kathy. So, let's go back to the African swine fever and the potential impact. We mentioned that we expect that up to 30% of pigs can be blocked because of the African swine fever in China. So, if we translate this 30% to our revenues in – so we can also estimate that it will be about 30% of our revenues. Although we expect a little bit lower impact because of maybe sophisticated farms are less affected by the African swine fever, then the production of small farms. We expect that that it will be an immediate impact in terms of the value of the pigs. As a reference, in the last quarter, in the fourth quarter of 2018, producers in the U.S., they were losing $20 per pig, now they making $30 profit per pig. So, the value of the pigs has increasing significantly, and then their willingness to spend and to keep these pigs healthy and productive also will increase. So, we expect that that will be a positive impact, an immediate positive impact. Then, we expect also that the farmers or producers in U.S., Brazil, European Union will increase production. The cycle of the production is six months. But probably we will need to wait six months to see some impact because it will increase the production. And even that if it takes six months from birth to slaughter, I think we can start using products at earlier stage of the animal. So, we expect in the third and the fourth quarters of this year having a positive impact in the swine business in Brazil, U.S., and U.S. market. And moving into the details of Apoquel breakout, Glenn, do you mind answering that? And also, probably those projections in China and providing some context. Glenn David : Sure. So, in terms of the total derm revenue, we had $155 million in total sales for the quarter with growth of 30%. To the earlier question, in terms of penetration, U.S. had $104 million in sales and international had around $52 million. So, as the similar amount of medicalized dogs in the U.S. is international, we would expect more rapid growth from international greater penetration over time internationally. The breakout of $155 million between Apoquel and CYTOPOINT. We had $119 million of sales of Apoquel with 22% operational growth, and we had $36 million of sales in CYTOPOINT with 65% operational growth. In terms of Apoquel in China, we’re very excited about the launch of Apoquel in China, China is one of our largest and fastest growing companion animal markets. Just to put in context though, the overall potential market size. So, in 2018, Apoquel globally in all of our international markets, including the U.S., have less than $160 million in sales with our top market internationally generating sales of just below $30 million. So that should give some overall context in terms of the potential of Apoquel in any given international large companion animal market. Juan Ramon Alaix : Thank you. Next question please. Operator : And we'll go next to Chris Schott with JPMorgan. Please go ahead. Chris Schott : Great. Thanks very much. Just two questions, maybe first on Simparica Trio. Just a little bit more color about how were thinking about the launch of these new triples, how quickly they'll be adopted. Should we be thinking about these as products that could have significant year one uptake or is this a more gradual kind of three to five-year process as these roll out? The second question, I know it's been touched on a little bit, but your companion business, particularly in the U.S. companion business were particularly strong in the quarter and above recent trend, just elaborate a little bit more on what you're seeing here, and if there's anything with either one-time related or either kind of year-over-year timing related in terms of the strength we saw this quarter. Just trying to get a sense of how much of this is just really healthy organic kind of underlying growth versus timing issues? Thanks so much. JUAN RAMON ALAIX : First, starting with the combination of product for parasiticides. Well, their options, I think we expect their options would be fast and also will depend. If we are number three, number two or number one in the market, but definitely we see a need for the market to combine internal and parasiticides mainly in dogs. And we are confident that we have significant opportunity to generate growth in 2020, 2021 and also 2022, because we think that that is – this probably will have a long run, and definitely the opportunity is really to generate our growth in companion animal. And Glenn will talk about the U.S. companion animal growth in the quarter and the trends for the future. Glenn David : Yes. So, what I would say Chris is, the overall global compatible growth was very strong. When you take out the impact of Abaxis, we grew 19%, 20% in the U.S., 18% internationally. So, both segments growing very rapidly in companion animal, and those are driven just by strong underlying dynamics and trends, particularly around the derm portfolio around Simparica and also really strong performance of Revolution Plus. Q1 of 2019 was the launch of Revolution Plus in the U.S., it's off to a very successful start. There is some stocking in Q1 of 2019, particularly in the U.S., but still the start that we're seeing in Revolution Plus is very, very encouraging. Juan Ramon Alaix : Thank you, Glenn. Net question please. Operator : And we'll go next to Greg Fraser with SunTrust. Please go ahead. Greg Fraser : Great. Thanks for taking the questions. This is Greg Fraser on for Gregg Gilbert. As [indiscernible] that as livestock business was impacted by destocking related consolidation in the distributor space, that's something that you've observed, I wasn't sure of your comment on distributor purchasing patterns, which related to what they described, and just a quick follow-up on the livestock commentary, are you anticipating growth for international for the full year? Thank you. Juan Ramon Alaix : Probably we still have some challenge with distribution in Brazil, but not in the U.S. In Brazil, I mentioned that we have these changes in the commercial policies that reviews sales to distribution during the quarter. But as I mentioned, we expect that this will support more quality growth in the future, but no changes in the distribution in the U.S. So, Glenn, do you want to add comments here? Glenn David : No, just to your question on livestock growth for the full year. We still are expecting livestock to grow globally in the U.S. and internationally. Juan Ramon Alaix : Thank you. Next question please. Operator : We will take today's final question from Navin Jacob with UBS. Please go ahead. Prakhar Agrawal : Hi. This is Prakhar Agrawal on behalf of many Navin Jacob. Two questions, please. First, on poultry, your growth in poultry products was quite strong. So, could you give more color on what is driving that in terms of the near-term trends and anything specific from your product portfolio? And secondly, one of your competitors recently made an acquisition that included some oncology products, so is Zoetis making an R&D investment in oncology and do you think this market is commercially attractive? Thank you. Juan Ramon Alaix : I will ask Glenn to answer the question on poultry and then I will cover the oncology part of the question. Glenn David : So, from a poultry perspective, we continue to perform very well in poultry. Overall, very solid growth, higher than the rest of our portfolio livestock, and really that's driven by our portfolio of alternative to antibiotics in poultry that we continue to perform very well within the MSA sector. So that's something that's been consistent for us over the last number of quarters and trend that we expect to continue. Juan Ramon Alaix : And on oncology, we have already a product in oncology. She is working well, which is a [indiscernible]. We launched this product some years ago. We continue assessing the oncology market, then definitely we have some programs – internal programs related to monoclonal antibody and some of the products such that still oncology is very limited by market although maybe in the future it will be a potential attractive market. But today, it's a quietly with that opportunity. And I think, that concludes the questions, and thank you very much for joining us today. And as we said, we remain very confident about the outlook for 2019 and we are maintaining our operational growth, and we are also maintaining our target in terms of adjusted net income. Thank you very much for your attendance. Operator : And this will conclude today's program. Thank for your participation. You may now disconnect.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,019
| 3
|
2019Q3
|
2019Q2
|
2019-08-06
| 3.257
| 3.31
| 3.619
| 3.675
| 5.35146
| 27.9
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Operator : Welcome to the Second Quarter 2019 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, it will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions]. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow ups. Your line will be muted when you complete your question. [Operator Instructions]. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, Keith. Good morning, everyone, and welcome to the Zoetis second quarter 2019 earnings call. I am joined today by Juan Ramon Alaix, our Chief Executive Officer; and Glenn David, 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 then the company's 8-K filing dated today, August 6, 2019. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, Steve and good morning everyone. Our second quarter results demonstrate that many of the competitive advantages that have made Zoetis the world leader in animal health. We have been able to deliver steady and reliable financial results for our investors since 2013, consistently growing our revenue factor in the market and growing our adjusted net income faster than revenue each year. It is our track record driven by lead innovation, a diverse and durable portfolio and a clear strategy that begins and ends with our customers, their success and the health of their animals. Over the last few years, we have consistently brought new innovation to market from our R&D labs, most notably, in dermatology, parasiticides and vaccines, with products like APOQUEL and CYTOPOINT, Simparica, REVOLUTION PLUS and Stronghold Plus and values new vaccines in our Fostera, Suvaxyn, and Vanguard product lines. We invest significantly in our productive R&D and rely on the support of our commercial manufacturing and supply chain initiatives to maximize the growth of our products and services. We also invest internally and externally to maintain the most diverse and durable portfolio in the animal health industry. This approach has helped us perform well even in the face of shifting weather patterns, changing market conditions, and the impact that emerging businesses have on our customers. Recent external investment in diagnostic nutritionals and digital solutions keep us evolving in line with market trends, while enhancing the integrated solutions we offer to our customers, at the same time, better supporting our medicines and vaccine portfolio. This consistent performance made possible by the outstanding talented and dedicated Zoetis colleagues that execute our plans and growth strategies. Turning now to our financials, we continued our strong performance through the first half of the year, with 14% operational revenue growth in the second quarter. Diagnostic sales from the Abaxis acquisition accounted for 5 percentage points of that overall growth. Our companion animal portfolio is continuing its positive momentum with 22% of operational revenue growth based on diagnostic sales from the Abaxis acquisition, strong sales of our key dermatology drugs and parasiticides. As we anticipated, livestock product sales returned to growth in the second quarter up 3% operationally, with increases across all species. Poultry products led the way growing 15% operationally and this was partially offset by more modest growth in the fish, cattle and swine which was impacted by African Swine Fever in China. As we indicated last quarter, African Swine Fever remains a major factor for the overall industry growth in 2019. An industry forecast expects the animal health industry to grow around 4% compared to 5.6% in 2018. We believe our diverse portfolio across species, geographies and therapeutic areas will help us once again to grow revenues faster than the market in 2019. In terms of profitability, we grew our adjusted net income by 17% operationally in the second quarter and generated our highest gross margin ever. Looking at the rest of the year, we are confident in our latest innovation and core business to generate the growth. And we have increased our full year guidance for 2019 based on the positive momentum of our companion animal portfolio, and to a lesser extent, the favorable impact of portfolio exchange rates. As we look ahead, we are making good progress with innovation and investment that will generate our future growth. In July, Zoetis received a positive opinion from the European Medicines Agency for our three-way combination parasiticide for dogs. This addition brings Zoetis and veterinarians one step closer to offering pet owners a new choice in the prevention of heartworm disease and lungworm, while also treating fleas and ticks and gastrointestinal worms. We look forward to a final decision from the European Commission later this year. Regulatory reviews for the three-way combination are also underway in the U.S., Canada, Australia, Brazil and Japan with further submissions expected in China and Mexico this year. If approved, Zoetis anticipates this product coming to market in the first quarter of 2020. Once we have our final label approved, we’ll be able to share more insight on our market expectation for this triple combination product. It is fair to say that we expect this product to be a significant entrant in the more than $4 billion global parasiticide market. In all parasiticide use, in July, we gained U.S. Food and Drug Administration approval of ProHeart 12, the industry’s only one-year injection to prevent heartworm disease in dogs from one year of age and older. We are steadily building an innovative and fresh portfolio of parasiticides that will give the veterinarians a range of choices for dogs and cats, Simparica, REVOLUTION PLUS, ProHeart 12 and 6 and the anticipated triple combination products once approved will make us even more competitive, enable to challenge today's market leaders in parasiticides. We are sustaining and expanding our portfolio in an area where Zoetis was underrepresented historically. In the area of monoclonal antibodies, we are the industry leader in innovation with our groundbreaking dermatology product, CYTOPOINT. And we continue to advance our pipeline in other areas like pain. I am pleased to announce that we have filed in the U.S. and EU for a new monoclonal antibody candidate to control pain associated with osteoarthritis in cats and we expect approval in 2021. To support this new companion animal products coming to our pipeline and to maximize sales of our current portfolio, including diagnostics, we have already added additional sales force resources in international markets and we are beginning to expand our sales force in the U.S. In the second quarter, on the livestock side, we have expanded our Fostera swine vaccine franchise with approvals of different formulations in new geographies. For example, Fostera Gold PCV MH was approved in Brazil. This vaccine which is now commercially available in the U.S., Canada and several other markets, provides the livestock farmers with greater options and flexibility in protecting pigs from PCV2 and M. hyo. And Fostera PCV, a single dose vaccine that aids in the prevention of PCV2 was approved in China. We also combined our internal innovation approach with external collaborations. In that regard, we've recently signed an important R&D agreement with the Colorado State University to establish a research lab there. Our teams will explore the livestock immune system and target the discovery of new immunotherapies that could pave the way for alternatives to antibiotics in food production animals. We also continue to support future growth through business developmental activities. In July, we announced plans to acquire Platinum Performance, a privately held nutrition-focused animal health company that is highly regarded in the equine community. Platinum features premium nutritional product formulas and a unique approach to the field of scientific wellness for horses as well as dogs and cats. The expansion in nutritions will further strengthen our portfolio in the equine and pet care markets, and it aligns well with Zoetis, increasing focus on health and wellness as part of the continuum of animal care. We expect the acquisition to be completed in the third quarter of this year after meeting customary closing conditions. Our plan is to expand the Platinum Performance equine business through our U.S. field force, accelerate the growth in its pet care formulas with veterinarians and pet owners through our digital marketing capabilities and evaluate international expansion opportunities over the long-term. Finally, in closing, we remain on track for a strong year based on our diverse portfolio. And we are making important progress in key areas such as parasiticides, vaccines, monoclonal antibodies, diagnostics and digital and data analytics, areas where we see both near and long-term growth opportunities. I will now hand the call over to Glenn. Glenn? Glenn David : Thank you, Juan Ramon, and good morning. As Juan Ramon said, we delivered another strong quarter growing revenue 14% operationally and adjusted net income 17% operationally. Based on our positive performance in the first half of 2019, we are increasing our revenue and adjusted diluted EPS outlook for the year. I’ll review updated guidance in more detail after discussing Q2 performance. Reported revenue growth for the second quarter was 9% including a 5% negative impact from foreign exchange primarily driven by the continued strengthening of the dollar against the euro and Brazilian real. Excluding the impact of the Abaxis acquisition, operational revenue growth for the quarter was 9% with price contributing 4% and volume contributing 5%. Key dermatology products contributed 2%, other in-line products 2% and new products 1%. All species contributed to growth this quarter with companion animal growth continuing to outpace livestock. Companion animal operational revenue growth of 22% was driven by legacy Abaxis products, key dermatology product and paracitisides. Excluding the impact of Abaxis acquisition, companion animal grew 14% operationally. Livestock operational revenue growth of 3% is driven by all species including swine despite the impact of African Swine Fever in China. Poultry was the primary contributor to livestock growth internationally and in the U.S. and international sales of cattle also contributed. Legacy Abaxis products contributed 5% to total Zoetis operational revenue growth in the quarter with sales of $65 million. This represents a decline over the pro forma revenue from the prior year primarily driven by product launches and initial distributor stocking which occurred in the first half of 2018. We expect improved results in the second half of 2019 with double-digit revenue growth driving full year pro forma growth in diagnostics products. Our focus continues to be on the integration of the legacy Abaxis products into our portfolio allowing us to leverage our innovative offering of diagnostic and therapeutic products and international expansion. Our key dermatology portfolio continued solid growth this quarter with sales of a $182 million, a 30% operational increase over the prior year. Growth in this portfolio was driven by the ongoing expansion of the addressable market increasing market share, price and additional launches of both APOQUEL and CYTOPOINT into new markets. We expect to exceed $700 million in revenue for this portfolio in 2019. Other in-line products also contributed strong growth in the quarter including Simparica with $69 million in revenue and 40% operational growth. This growth was partially offset by the ongoing impact of African Swine Fever. New products, including our topical parasiticide for cats REVOLUTION PLUS and Stronghold Plus, our swine combination vaccines and Core EQ Innovator in equine also contributed to drive growth this quarter. Now, let's discuss the revenue growth by segments for the quarter. U.S. revenue grew 15% in the second quarter, companion animal grew 23% while livestock grew 3%. Excluding the impact of the Abaxis acquisition, U.S. revenue grew 9%. Companion animal sales in the quarter were driven by sales of legacy Abaxis products, our key dermatology portfolio, and number of our in-line products, including Simparica, Clavamox, Cerenia and ProHeart 6. Excluding the impact of the Abaxis acquisition, companion animal growth was 13%. U.S. dermatology sales were $127 million for the quarter growing 27% driven by market expansion, increasing market share and price. Simparica sales in the quarter were $40 million, growing 33% over the prior year. Simparica benefited from promotional investments, leading to increased clinic penetration and market share gains. U.S. livestock sales returned to growth this quarter increasing 3%. Poultry was the primary driver of U.S. livestock growth due to the strong performance of our portfolio of alternatives to antibiotics in medicated feed additives in this fast growing market. Lack of efficacy and supply constraints of competitor products also contributed to growth of our products. Our swine portfolio contributed modestly to growth driven by promotional programs in the quarter. Our cattle products declined modestly this quarter negatively impacted by ongoing dairy market challenges as well as wet weather impacting the movement of beef cattle to feedlots. These market challenges were partially offset by price. Overall, a strong quarter for our U.S. business. Innovation, diversity and consistent field force execution are all helping to deliver positive performance. Turning now to our international segment. Revenue grew 10% operationally in the second quarter. Companion animal operational revenue growth was 21%, while livestock operational revenue growth was 4%. Excluding the impact of the Abaxis acquisition, international revenue grew 8% operationally. Companion animal product growth was driven by key dermatology products, parasiticides, namely Simparica and Stronghold Plus and the additional legacy Abaxis products. Excluding the impact of the Abaxis acquisition, companion animal growth was 16%. International livestock also returned to growth this quarter, driven primarily by strong performance of our poultry portfolio, primarily vaccines and medicated feed additives. Our cattle portfolio also contributed to growth resulting from a favorable comparison to the prior year, which was negatively impacted by national trucking industry strike that occurred in Brazil. Our swine portfolio was flat compared to the prior year with growth in vaccines, including new products, offset by the impacts of African Swine Fever in China. Now, I would like to highlight a few markets in the quarter. Beginning with China, revenue declined 1% operationally, which is strong performance considering the negative impact of African Swine Fever. Our livestock portfolio in China declined 18% operationally. The outbreak of African Swine Fever continues challenging the supply of pork. Latest estimates assume a range of 30% to 70% of the swine herd will be impacted. We now anticipate that full year impact to our swine revenue to be approximately $50 million. We continue to anticipate other regions, primarily Brazil and the EU to increase exports of pork to China. However, the timing and magnitude remains uncertain as it takes time and investment in infrastructure to increase production. Our companion animal products continued to perform well growing 22% operationally in the quarter. Sales from paracitisides, newly launched APOQUEL and vaccines were the primary drivers of growth. Moving on to Brazil, sales grew 24% operationally driven by companion animal growth of 36% and livestock growth of 19%. Companion animal revenue growth in Brazil was driven by paracitisides, primarily Simparica and our key dermatology portfolio. We recently launched CYTOPOINT into this growing companion animal market and are pleased with its performance so far. Livestock growth in Brazil was primarily driven by favorable comparison to the prior year when the national truck driver strike negatively impacted the results. We anticipate an unfavorable impact in Q3 2019 results for Brazil related to the positive impact at the end that the strike had in Q3 2018. The UK also performed well this quarter with operational revenue growth of 24% with companion animal growing 38% and livestock growing 7%. Companion animal growth was primarily related to our key dermatology portfolio and the addition of legacy Abaxis products. The livestock growth was attributable to increased sales of cattle products. In Mexico, sales grew 20% operationally driven by companion animal growth of 25% and livestock growth of 18%. This market benefited from key dermatology sales including launch of CYTOPOINT and legacy Abaxis products in companion animal, while livestock growth was related to market conditions driving growth across the product portfolio. Other emerging and developed markets also continued to perform well this quarter particularly in companion animal and poultry. Summarizing international performance, we demonstrated continued strength across all species in almost all international markets despite the impact of African Swine Fever. Now moving on to the rest of the P&L, adjusted gross margin of 70.5% increased approximately 180 basis points in the quarter on a reported basis compared to the prior year. The improvement this quarter is primarily related to foreign exchange, price, product mix and unit cost improvements, partially offset by an inclusion of the lower margin legacy Abaxis portfolio. Total adjusted operating expenses, including the impact of the Abaxis acquisition, grew 12% operationally. The increase is primarily related to the acquisition of Abaxis and increase in certain compensation-related expenses and investments to support future growth of the business. The adjusted effective tax rate for the quarter was 19%. The decrease in the comparable 2018 period is primarily related to discrete tax benefits recorded in the second quarter, partially offset by the impact of the global intangible low taxed income or GILTI tax which is effective for Zoetis in 2019. Adjusted net income for the quarter grew 17% operationally through a combination of revenue growth, improving gross margins and a lower effective tax rate. Adjusted diluted EPS grew 18% operationally in the quarter versus the same period in 2018. Now moving on to guidance for the full year. As a result of our strong growth in revenue and adjusting net income in the first half of the year, we are raising and narrowing our revenue and adjusted diluted EPS guidance. Please note, that guidance reflects foreign exchange rates as of late July. I'll now walk you through each of the individual line items beginning with revenue. We're now expecting to deliver revenue between $6.175 billion and $6.275 billion representing 8.5% to 10% operational growth as compared to our previous estimated range of 7.5% to 9.5%. Our organic operational revenue growth, which excludes the impact of Abaxis, is now projected to be between 5.5% and 7%. The increase in revenue guidance is related to the positive performance in our companion animal portfolio, and to a lesser extent, favorable foreign exchange. We're now projecting adjusted cost of sales as a percentage of revenue to be between 30% and 31% compared to our previous estimate of 31% to 32%. Favorability reflects the improvements in the first half of the year, which are expected to moderate in the second half of the year. We're increasing the low and high end of the range for adjusted SG&A for the year to be between $1.505 billion and $1.545 billion due to increased revenue estimates and promotional investments on key products, primarily in the companion animal portfolio. As Juan Ramon mentioned, this includes an expansion of our U.S. companion animal field force to support current and future product launches, such as ProHeart 12, our three-way combination parasiticides for dogs and monoclonal antibodies for chronic pain. We're narrowing the range for R&D expense, now expected to be between $450 million and $465 million. Full year adjusted interest and other income deductions is now expected to be approximately $190 million compared to the previous estimate for $200 million. The additional favorability is primarily driven by the reduction of interest expense, and favorable foreign exchange. Our expectation for the full year adjusted effective tax rate is approximately 20% compared to our initial guidance of 20% to 21%, primarily driven by the incremental tax benefits from stock-based compensation and other discrete tax benefits recorded in the first half of 2019. Adjusted net income is now expected to be in the range of $1.7 billion to $1.735 billion, representing an increase of $35 million at the high end of the range reflecting operational increases, as well as favorable foreign exchange. Based upon our strong performance in revenue and adjusted net income, we're increasing our adjusted diluted EPS to be in the range of $3.53 to $3.60, compared to our previous guidance, of $3.42 to $3.52. Our range for reported diluted EPS is also increasing, now expected to be in the range of $2.93 to $3.04 based upon operational increases and lower certain significant items. As I've indicated in the past, we focus on full year performance as quarterly results may fluctuate. To that end, we expect Q3 operational revenue growth to be lower than what we've seen in the first half of the year, due to Abaxis having less of an impact on growth as we lap the acquisition date. Q3 2018 included one month of revenue for international and two months for the U.S., Canada and Latin America. In addition, we will continue to see market challenges due to African Swine Fever and the weakness in the U.S. dairy and beef sectors. Growth will also be impacted by moderated price increases in the U.S. as well as the recovery of the Brazil truck driver strike and increased revenue in Q3 2018. Adjusted net income operational growth in Q3 will also reflect higher operating expenses as reflected in the full year guidance to support our current and future products, resulting in moderated income growth. We previously communicated that we expect approximately $100 million in incremental capital expenditure this year to information technology and manufacturing to support our Abaxis acquisition, improve cost efficiencies and increase capacity. We anticipate continuing at this elevated level for the next three years as we invest in manufacturing and infrastructure to support future growth and product launches. We’ve also repurchased approximately $300 million of Zoetis shares in the first half of the year. We have $2 billion remaining under the multi-year share repurchase plan that was approved last year and remain committed to our capital allocation priorities of internal investments, M&A and returning excess cash to shareholders. Our guidance for reported and adjusted earnings per share reflects the shares repurchased through the end of Q2. Now to summarize before we move to Q&A, our strong performance in the first half of 2019 continues to underscore the value of our diversity, innovation and durable business model. We’re confident in our revised full year guidance, where we’re increasing operational growth rate for revenue and adjusted net income. And we continue to focus on long-term sustainable growth by investing in our pipeline, including infrastructure to support current and future product launches. Now, I’ll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions]. Our first question comes from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich : Juan Ramon wanted to start off with African Swine Fever, I appreciate the update that Glenn gave on the full year impact of $50 million. How much do you think Brazil and the EU and other markets can help to offset the headwinds you’re seeing in China? And then my second question is on Simparica Trio. With the submissions in Canada, Australia, Brazil and Japan, can you give us an update on timing for those markets as well as kind of what you’re feeling about in the EU? Thanks. Juan Ramon Alaix : Thank you Kevin and let me go through the different questions that you have asked. In terms of the African Swine Fever, we expect minimal impact in terms of additional revenue generated in Europe and other markets this year. As we have explained, it will take some time to build the infrastructure to increase the number of pigs, our potential export to China. We see Europe, Brazil as the main markets for this type of exportation to China but we are not expecting a significant impact of that expansion in 2019. Definitely in 2020, 2021, it will be time for producers to expand their operations and then potentially export to China. In terms of the submission on Simparica Trio in other markets like Brazil, Canada, Japan, well it's a work in progress. In Canada, we have already filed all the submission. In some other markets, we are now progressing the submission. And we expect also Simparica Trio to be approved in Europe, around September, October. What we got now is favorable opinion from the European Medicines Agency. Now the European Commission is expected to approve the product in September and October. And then we expect that to bring this product into the market in the first half of -- in the first quarter of 2020. Operator : Our next question comes from Jon Block with Stifel. Jon Block : I'm not going to put them all upfront. So first, on the implied OpEx growth in the back half of '19 is about 3.5%. I think that’s what -- you largely lap Abaxis and the increased investments you referenced. So is that a good growth rate to extrapolate going forward? I guess just to push you a little bit on gross margin, your guidance applies a step down in the back part of the year. But why is that the case considering higher margin companions growing faster than livestock? And I think that's unlikely to wind -- unwind, pardon me in the near term. And then quickly, one, Ramon, the filing for pain, and I just want to make sure, I think that was specific to fee line, is that correct? And where would canine be in the process? Thanks, guys. Juan Ramon Alaix : Jon. So we have filed for cats and we are in the process of filing also for dogs. We expect the product for cats, the monoclonal antibody for cats to be approved earlier than for dogs. And we expect that approval in 2021. And Glenn will cover the questions on OpEx and the growth rate moving forward. Glenn David : Yes, so Jon just to start with gross margin and the step down that's implied for the second half of the year. A, first of all, in the first half, there were some items that were particularly favorable in terms of foreign exchange, as well as the 4% price increase that we experienced in the first half. Also, as you look to the second half, you're correct that we would still expect the growth rate for companion animal to be higher in the second half of the year than livestock, the absolute sales though for livestock are higher in the second half of the year, just based on normal seasonality, where in the first half of 2019 we had higher sales of companion animal in terms of absolute sales. So those are the drivers for gross margin. In terms of the OpEx growth, you are correct that in the second half it would apply a deceleration in operating expense growth because of the impact of Abaxis. I'd also point that we do expect a slight change in seasonalization as well between Q2 and Q4 versus what we might have anticipated last year with a little more expense in Q3. As I sort of implied in the prepared remarks, I would not necessarily take that as guidance for 2020, the second half OpEx rate. Obviously we'll provide that as appropriate once we finish our 2020. Juan Ramon Alaix : Thank you. Next question, please. Operator : And we'll go next to Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : First question I had was with respect to the Nexvet portfolio. Can you give an update on the development and commercialization timelines for those products? And then second question was on ProHeart 12. Do you still see a place in the market where there’s opportunity despite the launch of the triple combo and why or why not? Thank you. Juan Ramon Alaix : Thank you, Louise. The Nexvet portfolio, the monoclonal antibody that we mentioned that we have filed for cats, it’s coming from the Nexvet portfolio, while for dogs we have [multi-dollar] programs and we’ll be really submitting or filing the best of what we think would be meeting the requirements of the market. And in terms of ProHeart 12, definitely we see opportunities to expand the market with ProHeart 12. Part of the sales will be categorized in ProHeart 6 but also at the same time gaining the share in the heartworm market. And also we need to consider the opportunities of ProHeart 12, also with the future launch of the three-way combination that will be included also in the same indications of ProHeart 12 plus the protection for pigs and fish. Next question please. Operator : Next question is from Erin Wright with Credit Suisse. Please go ahead. Erin Wright : A couple of questions here. So to support some of the new upcoming product launches you mentioned stepped up hiring activity. I guess where do you currently stand in terms of that effort and how should we think about some of the timing related to that as well as how quickly some of those sales reps can ramp up? And will this hiring continue into 2020? And then my second question relates to more of the companion animal side. I guess can you speak to the opportunity to leverage the relationships with Chewy and other alternative e-commerce channels, did this meaningfully contribute to growth in the quarter? And more broadly will this become a more significant portion of total sales that go through that channel over time and what sort of pricing mechanisms can you deploy whether it be price forwards or otherwise? Thanks. Juan Ramon Alaix : Let me start with the question on Chewy and also some alternative channels. So definitely pet owners are also now buying animal health medicines through these new channels, mainly for medicines for chronic treatment and paracitisides. All products are available in these new channels but always with regarded prescription every time when it’s a prescription product. We definitely see these new channels expand in the market and recent time the opportunity also to increase compliance. So we think that this can be definitely a positive for the animal health industry. And we think that at the same time also we’ll be continuing working with veterinarians to ensure that they remain at the center of any healthcare decisions. In terms of the field for expansion, I will provide some rational for this expansion and then I will ask Glenn to go into some product details. So just to remember that in recent years we added to our portfolio APOQUEL, CYTOPOINT, Simparica, and all these products are reaching blockbuster sales and without any significant modification in most of the markets in terms of the field force. Last year with the acquisition of Abaxis we expanded our portfolio to diagnostics. We incorporated the Abaxis field force into U.S. and in 2019 we have been also expanding diagnostic field force in international markets. In 2019 we have continued adding new products in companion animal, REVOLUTION PLUS during the year that, then ProHeart 12 in July and we've expected the launch of the three-way combination in 2020 and in 2021 monoclonal antibodies to manage the payment in cats and in future also in dogs. We have decided that it was needed to expand our field force in the U.S., not only in phase of these new product launches, but also to maximize the current portfolio that now also includes diagnostics. And we expect to adding these additional resources in 2019 and 2020, at the same time, we’re also adding additional expertise, and investment in new distribution channels, and also in direct-to-consumer programs. Now, I would like now, Glenn, to provide some details of these investments. Glenn David : Yes, Erin, in terms of the timing for the expansion, really there are two main field force expansions that are undergoing in 2019. One is related to Abaxis and international expansion of diagnostic specialists. And we're largely complete with that hiring as of today. So that investment has already been made. People are in place and we expect to get increased revenue penetration in international markets with that field force now being fully operational. The other key investments that we’ve discussed with the increase of the companion animal field force in the U.S. We respect those colleagues to be largely hired by the end of 2019. And then to be fully in their new position starting in 2020. So a majority of that investment would also be complete by the end of 2019. Juan Ramon Alaix : Next question, please. Operator : We'll go next to Michael Ryskin with Bank of America Merrill Lynch. Please go ahead. Michael Ryskin : I got a couple really quick ones. One is, you had another quarter of really fantastic price increases, 4%, repeat of 1Q, coming in sort of well above historical trends. I just want to get a sense of this going forward and what's driving it? Is it tied to higher mix of revenues, tied to innovative products like the derm portfolio and Simparica? Or are you taking up price on some of the older generation products as well? And then also, I was hoping for a little bit more color on Abaxis. You've had some comments down the field force expansion, you talked about how the portfolio is doing. Anything on competitive share shifts or anything new in the pipeline in terms of innovation there? Thanks. Juan Ramon Alaix : I will answer Abaxis, and then Glenn will lead to details of the Q2 and also the pricing and also he will provide some comments on the Abaxis performance in Q1, Q2 and what we expect for the future. Let me start saying that we consider 2019 for Abaxis as a year in we are setting ourselves for future growth. We are expanding the field force in international markets. We feel that we have the resources to generate future revenues. We are also integrating the field force in the U.S. with our core field force. And it's something that is already done. And we’re also working to make sure that we have the connectivity with all the equipments with effective management system that we expect to finalize at the end of 2019. We are also -- we have planned that in the first quarter of 2020 we have also integrated all the systems and this will facilitate the integration of the portfolio and offering a much more integrated offer to our customers. So we are convinced that we are now stepping all the elements for our future success and this will be something that will be generating growth in the future as well as the growth in 2019. Glenn, you mind covering the additional comments on Abaxis performance and also the comments on price? Glenn David : Sure as I mentioned in the prepared remarks in the first half of the year Abaxis on a pro forma basis did decline versus the same period last year. That was really driven by the fact that Abaxis had two significant product launches last year that resulted in some additional distributor stocking for both the urine sediment analyzer and the Flex4 Rapid Test. That being said in second half of the year we expect to see double-digit growth for the Abaxis portfolio as we’ve seen very positive leading indicators that would support those projections for the second half of the year. We’re seeing less accretion in the U.S. in terms of instrument placements, also stronger instrument sales and we believe that will lead to increased sales of consumables. Also the fact that the international field force is now in place, we’re seeing good momentum to start beginning within our international markets. So we’re expecting double-digit growth in Abaxis revenues for the second half of the year. In regards to price in the first half versus the full year, so we typically expect to get price increases of around 2% to 3% in any given year. In the first half of this year we’ve seen price increase of 4%, part of that outsized price is really driven by the fact in Q1 and Q2 of 2018 we had some promotional programs in our U.S. companion animal business that we do not repeat in the first half of 2019. That led to additional price. All that being said we still expect 2019 to be in the range of 2% to 3% but probably towards the higher end to that range. Juan Ramon Alaix : Next question please. Operator : And we’ll go next to John Kreger with William Blair. Please go ahead. John Kreger : Juan Ramon, another question on African Swine Fever. If you think about all the puts and takes that, that outbreak is causing for the worldwide livestock market, what is your early view on how ‘20 might look relative to that 4% global number that you mentioned for this year? Thank you. Juan Ramon Alaix : Well we expect 2020 go back to normal growth rates even if the situation in China because of the African Swine Fever will be not resolved. We expect still 2020 China continue suffering because of this outbreak. But we see other markets expanding production. And then in terms of comparison through 2019 we expect higher growth in livestock and also continue with the growth for companion animal. So definitely we expect 2020 back to normal growth rate of 5% to 6%. Next question please? Operator : Going next to David Risinger with Morgan Stanley. Please go ahead. Unidentified Analyst : This is [Thomas Chi] on behalf of Dave. So first question is, can you please discuss the triple combo on NexGard Spectra in Europe including its level of success and the differentiation of Simparica Trio? Second question is if you can comment on other new launch opportunities over the next one to two years? And then finally are there any key U.S. products set the stage for new generic competition over the next one to two years? Thank you. Juan Ramon Alaix : Well as you said, we expect the new combination product in Europe competing with NexGard Spectra. Mainly the incidents of heartworm in Europe is much lower than in the U.S. So the resistances are completely different and the real opportunity for the three-way combination product is in the U.S. and where we expect now to be first to the market, because NexGard Spectra or other competitors are not announcing a launch soon. So, definitely we see a significant opportunity to gain share in the U.S. Also we expect that our portfolio will be even stronger in Europe and this also will have the opportunity to generate growth. In terms of other opportunities in the pipeline, well, I think that we are very pleased with all the products that we are now announcing, the three-way combo, Europe, the U.S. or in other markets, also Canada, Japan, Brazil. We also expect monoclonal antibodies for cats in Europe and the U.S. coming in 2021. And following that we expect also monoclonal antibodies for dogs and definitely we will continue working on bringing new vaccines into the market. So we are convinced that we have a very robust pipeline that will ensure our future growth in line for us in the market. Next question, please. Operator : And we'll go next to David Westenberg with Guggenheim Securities. Please go ahead. David Westenberg : So I just want to talk about the cat market. There's potential for cat APOQUEL and of course pain in cat. The cat is obviously under medicalized compared to dog market. What does it make major education efforts? Can you maybe make what might that look like when that investment might be taking place and just overall how do you how do you expect to increase that medicalization market in education not just in terms of the products that they're in education? And I’ve got a second question on ProHeart 12. We had great feedback at AVMA. Basically, they talked about compliance one-year injections much better than I actually anticipated with ProHeart reception. Is there any fear in kind of cannibalization with 6? I understand the ProHeart -- just ProHeart and the triple is going to have worms but just kind of think about the dynamics for potential cannibalization there? Thank you very much. Juan Ramon Alaix : Thank you for the question Dave. So, definitely the cat market is a market that we need to develop. But pain exists in cats and is something that today there are not valid solutions to manage the pain in cats. We know that there are two elements that we need to consider. First, the number of cats is lower than dogs. And also the number of medicalized cats is lower than the number of medicalized dogs. But having said that, we expect the monoclonal antibodies for cats becoming a blockbuster for Zoetis. It will take maybe some years to fully develop the market. But we are convinced that we will be bringing unmet need and opportunity will be a significant. We expect in terms of the ProHear 12 cannibalization from ProHeart 6, but what we see is that now Zoetis will be offering to veterinarians all range of solutions for pigs, fleas and internal paracitisides and will be for the veterinarians also to decide what is best for their dogs to use ProHeart 12 in combination with Simparica to use the three-way combination product or what they think is the best for protecting the animals. So even if there will be cannibalization, I think here what we need to consider is what will be the opportunity of this complete portfolio in terms of parasiticides. Next question please. Operator : We’ll go next to Chris Schott with JP Morgan. Please go ahead. Chris Schott : Just two here. Maybe first just coming back to margin trends and the SG&A investment you’re making. Should we think about OpEx growth below sales growth in 2020 and beyond? Or with some of these initiatives that you’re investing in, could we see a year in 2020 where spend looks a little bit more in line with sales growth as we think about kind of just the progression over the next few years? And my second question was on Simparica Trio, I guess at this point, how much of a lead do you expect you will have in the U.S. market before you see additional competition? And how much of a lead do you think you need to really impact share as we think about the -- probably different players line up in the market? Thanks very much. Juan Ramon Alaix : I will respond to the Trio question and then Glenn will cover the margin trends and also the expenses that we’ll be seeing in future years. And in terms of Trio as you know Chris in our industry there is not too much visibility in terms of the products that our competitors are making in their pipeline. We know that in the U.S. FDA it’s requiring 100% protection against heartworm. We know that so far it seems that the three-way combination of Zoetis is the only one showing this type of efficacy. Other competitors, maybe they will be also facing some challenge because they have products protecting against ticks and fleas for two or three months and then heartworm with one month and then combining a product with different timing also can be challenging. The timing of competition is unknown to us but we are confident that being first to market will present an opportunity to gain share in the parasiticides segment. Glenn? Glenn David : In terms of the investments that we’re making in the field force, first, I just want to say that these are very positive investments that have a very strong return. So we’re investing in field force to support the existing products that are exceeding our expectations and a significant number of new products that are coming out in the future, those are very high return investments. So we would expect those to be margin accretive over time as we move into 2020. Juan Ramon Alaix : Next question please. Operator : Next is Liav Abraham with Citi. Please go ahead. Liav Abraham : Just a follow on question on your three-way combination parasiticide. Juan Ramon, any preliminary thoughts on what the launch curve could look like particularly in the U.S. of this product and how quickly uptick could be? And then secondly, interested in some additional comments on the poultry market, you cited that this has contributed to growth in your livestock segment in the quarter. Interested in your longer term outlook for poultry and some of the drivers behind this? Thank you. Juan Ramon Alaix : Liav, so on the three-way combination product, it's probably a little bit too early to define the uptake efforts. We need to ensure that we have clarity on the labels, and it is something that is still work in progress. One, we have the label. And then we also have the exact timing of the launch. We will provide that maybe how much we expect adoption of this new product into the market and is it going to be launching in January and February or March. So it is something that still we don't have a certainty of the timing of the launch. And also, we need to still get the approval of the final label. Poultry, it's an area that has been performing too well for Zoetis. We expect that poultry will continue -- for market segment will be continue growing faster than the average of the animal health industry and will be growing in line with this growth. For us, poultry, it's an area in where we are investing also in R&D. And we expect to bring new products into the market starting in 2020. That will be new vaccines with vector-operated technology that initially will be released in the U.S. and then later in European markets and all international countries. And definitely, it will be a surface of four categories in the world. And as we see the consumption of animal proteins continue growing, consumers will need to move maybe two more chicken, even more beef, and maybe at least in some countries like China, some limitations in terms of pork consumption. But definitely pork is an area of investment. We have very strong portfolio of vaccines. And again, so we will be planning to launch vector vaccines in 2020 or 2021. And finally, we are also combining our presence with medicated feed additives with vaccines, also with a very strong portfolio in terms of devices. We have the Inovoject, which is something that has highly significant value in the hatchery and other another segments of poultry and we also introduced products for automation in 2018 and 2019. Next question. Operator : Next is Kathy Miner with Cowen & Company. Please go ahead. Kathy Miner : A couple questions. Glenn, could you give us some APOQUEL sales for the U.S. versus OUS this quarter? And on African Swine Fever, could you also tell us what the second quarter impact was? And if there's any update on the vaccines that you're working on for the swine fever? And then finally just a bigger picture question. I wonder if we could get your thoughts on some of the U.S.-China trade discussions. Understand it’s very volatile but what are some of the possible impacts or situations you're looking for that could be impacting Zoetis? Thank you. Juan Ramon Alaix : So let's answer the question on APOQUEL. And then we'll move to African Swine Fever and … Glenn David : Yes, so just for the numbers for APOQUEL. I'll start with total derm just to give you overall total derm breakout between U.S. and international. So total derm globally we had a $182 million, a $127 million within the U.S., $55 million in international. At APOQUEL we had total global sales of a $133 million, in the U.S. $87 million and international $45 million. Obviously there’s some rounding there. Juan Ramon Alaix : And the impact of African Swine Fever? Glenn David : The impact of African Swine Fever in the quarter was a little over $10 million for the quarter. Juan Ramon Alaix : Okay so then in terms of the update of the African Swine Fever. We expect that there’ll be some opportunities for other markets as to supply to China. We also expect that -- we’re not expecting a new vaccine for African Swine Fever soon but we are working on developing this vaccine in collaboration with the U.S. and other international centers. And in terms of trade, we see trade impacting agriculture in the U.S. We have seen also that China would not be buying pork from the U.S. But it’s also true that they will be buying from other markets and maybe other markets also will be buying from the U.S. So we are not at this point too much concerned about the impact of the trade in the pork industry. The pork industry has been very limited in terms of exportation to China. I think it’s something that is less than 20% of the total exportation of pork to international markets and to China. So definitely it’s an impact but it’s an impact which is manageable. But we expect and we hope that finally the U.S. and China will sign an agreement that will eliminate all these tensions. Next question please? Operator : Next is Mavin Jacob with UBS. Please go ahead. Prakhar Agrawal : This is Prakhar Agrawal on behalf of Mavin Jacob. My first question is on gross margin. So you’d previously guided on gross margin expansion of 200 basis points from 2017 to 2020 and you’re obviously tracking significantly ahead of that guidance already despite of Abaxis. So just wondering if there is an update to that guidance and is it possible to get greater than 70% gross margin over the next three to five years? And secondly on the macro trends in the U.S. cattle. Could you provide more color on some other trends that you’re seeing? You had that continued weakness in dairy and beef cattle. But when do you expect recovery in these segments? Thank you. Juan Ramon Alaix : So let’s start with the gross margin. Glenn? Glenn David : In terms of gross margin, the 200 basis points improvement that we referenced from 2017, that was driven by the operational efficiency initiatives and some changes in our supply network that we were initiating. We are on track for that and expect to deliver the 200 basis point. At that time we said there’d be other factors that either positively or negatively impact gross margin over that same period. Those factors being price, mix, foreign exchange. Many of those have moved favorable for us particularly this year and those factors will vary year-over-year. So I would necessarily take some of the benefits that we’ve gotten this year from price mix and foreign exchange necessarily to carry over into the future years. So we’re well on track for the 200 basis point improvement that we targeted as far as the operational efficiency initiative and some of the other factors have been beneficial for us in 2019. Juan Ramon Alaix : When I look at the macro trends in the U.S. for cattle, we're expecting dairy prices to increase in the second half. It will probably take a longer, so we continue seeing weaknesses in the dairy business coming forward. It will be something that over time will be adjusted. Now they will be adjusting production and then in the next cycle prices will be increasing and then the opportunity for again the expansion. In terms of beef in the U.S., there are two elements that have been impacting the performance. And first has been the weather, very cold winter. And then second, very wet spring. And this has been delaying the movement of animals from pasture to the feedlot. And there are moving animals which are heavier, heavier animals also are stronger in terms of protection against diseases. And we see that with the cattle market in their efforts been slower than expected. We expect some recovery in the second half. Although we expect that in the U.S., the cattle will be showing a very modest growth. And Zoetis will be growing in line with this growth. Next question? Operator : Today's last question is a follow up from Kevin Ellich with Craig Hallum. Please go ahead. Kevin Ellich : Juan Ramon, wanted to get your thoughts on the alternative protein market, the plant-based market. Do you think that'll have any impact on the livestock production market over the next three, five, 10 years? Juan Ramon Alaix : I don’t' believe that this will have an impact. The growth of population, the increase on the middle class, it’s increasing so much at the demand that it will be needed many different sources of feeding the population to meet that demand. And this will be as we have seen in other cases an alternative for people that prefer not to eat animal proteins, but still the demand for the consumption of poultry, chicken, beef, eggs, dairy will remain very strong. And I will also add fish to this list. So I don't expect that the animal health industry will be impacted because of this alternative. But this will -- definitely will offer to consumers options for their diet, which in my opinion is always that positive. Juan Ramon Alaix : So thank you very much for joining us today. Well as I said, we had very strong quarter. We have also increased our guidance, which is showing the confidence that we have in the performance of our portfolio. And additionally, we also share with you the good news of our pipeline and how this pipeline will be reaching to market in the next coming years. Thank you very much for your attention. Operator : And this does conclude the Zoetis second quarter 2019 earnings call. You may now disconnect.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,019
| 4
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2019Q4
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2019Q3
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2019-11-07
| 3.378
| 3.46
| 3.765
| 3.87
| 5.38816
| 31.34
| 31.84
|
Operator : Welcome to the Third Quarter 2019 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you the viewer and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section at zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions] In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted, when you complete your question. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Good morning everyone and welcome to the Zoetis third quarter 2019 earnings call. I'm joined today by Juan Ramon Alaix, our Chief Executive Officer; Glenn David, our Chief Financial Officer and also by Kristin Peck, our CEO-elect. 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. For 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, November 7, 2019. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Juan Ramon. Juan Ramon Alaix : Thank you, Steve. Good morning everyone. Today, you will hear commentary on the market dynamics and quarterly result from me and Glenn. I am also pleased to have a Kristin Peck our next CEO joining us to share some remarks with her appointment in the future of Zoetis. As we near the end of the year, let me provide some context around recent market dynamics. The animal health industry in 2019 as we may facing a challenging year for swine and cut off while we have seen a very good performance in companion animal and poultry. We have seen growing an appetite in the companion animal market for a spending on innovation and pet care and we once again expect to grow much faster than the market in companion animals for 2019. We are excited by the new products and lifecycle innovations giving them more advance ways to assist pet owners, weakened skin conditions and parasites. The pathology treatment continues to be a critical need. And Zoetis has been rewarded for the innovation we have developed in this space, we have continued market penetration and our goal expansion of our key dermatology products Apoquel and CYTOPOINT, they are on track to achieve more than $700 million in sales for 2019. In recent years Zoetis has also been a strengthening its position in parasiticides. This year we added two new products to our parasiticide portfolio, Revolution Plus to protect cats against ticks, fleas and internal parasites and ProHeart 12 once yearly injection to prevent heartworm disease in dogs. Additionally, we are planning to launch Simparica Trio in the European countries and Canada in the first quarter. In the U.S. we expect the FDA to complete the review of Simparica Trio at the end of the first quarter. If approved, we will launch shortly after. Based on these assumptions, we project to generate incremental global sales of Simparica Trio in 2020 at around $150 million. In other areas like pain, alternative to existing treatment for dogs and cats we've spent a significant opportunity. And in the case of GILTI tax, it is a largely unmet need today. We are excited by the potential for our researcher programs we have monoclonal antibodies in this area. As I mentioned in the last quarter, we initiated the filing process in the EU and U.S. for a new fee line monoclonal antibody candidate to treat osteoarthritis, pain in cats and we have recently also initiated the filing process in the EU and U.S. for a canine monoclonal antibody candidate to treat osteoarthritis pain in dogs. If approved, we would anticipate this product coming to market in 2021. Meanwhile, African swine fever trade uncertainties and weather conditions affecting mainly U.S. cattle, having a significant negative impact on the livestock market. As a result of this negative impact, we expect the overall animal shelter market to grow rationally between 3% to 4% in 2019 compared to 5.6% in 2018. And as note in our guidance, we expect to outpace the market with operational growth in revenue over 6% to 7% and this excluding the positive impact of Abaxis. Turning now to our third quarter results. We continue our strong performance with 9% operational revenue growth in the third quarter driven by sales of our companion animal and poultry products. Our companion animal portfolio continues leading the way, we had 23% operational growth based on strong sales of our parasiticides, our key dermatology products and diagnostic portfolio. Diagnostic revenue from the Abaxis acquisition accounted for 2% of the overall growth. In terms of the livestock, we saw an operational decline of 4%. Growth in poultry was 5% but it was offset by declines in cattle mainly due to lower feedlot placements in the U.S. and the impact of African Swine fever in China. Our third quarter result demonstrate how our diverse portfolio and focus on meaningful innovations are driving our success. These trends remain the condition of our consistent and long-term performance. In the third quarter, we grew our adjusted net income by 10% operationally. And we continue to benefited from increase in revenue, improved gross margins and moderate growth in operating expenses. We remain confident in our latest innovation, future pipeline and core business before future growth and deliver our 2019 guidance which Glenn will discuss later. As we look ahead, we are making good progress with innovations and investment that will generate our future growth. As I said, we are preparing for the launch of Simparica Trio in European markets and Canada at the beginning of next year with the product currently in production. All regulatory reviews remain underway in Australia, Brazil, and Japan with a further submission expected in China and Mexico. In the U.S., we have been expanding our field force to better support our growing companion animal portfolio including the diagnostic products and in preparation for the launch of Simparica Trio next year once approved. We also continue to enhance our vaccine portfolios for livestock. In October Zoetis received USDA approval for Poulvac, Procerta, HVT-ND, the companies first vector vaccine for poultry. It will help to protect against both Mareks disease and Newcastle disease, highly contagious and infection for poultry. The product complements our market leading innovative vaccine delivery system for poultry producers and it is the first in what is expected to become an important new global vaccine franchise for Zoetis over the next several years, especially in international markets. We are also taking important first steps to address African Swine Fever having reached a non-exclusive license agreement with the U.S. Department of Agriculture in late September. This agreement gives us access to three patents and materials related to African swine fever vaccines strengths that will be incorporated into our research. While it could take several years to complete the development our licensing of our vaccine, our work with the USDA another partner provides a comprehensive approach to addressing these three infectious diseases. In addition to new products approval and lifecycle innovations, Zoetis continues to support future growth through business development activities. Last week we announced the acquisition of Phoenix Lab, Seattle based reference laboratory that is highly valued by veterinarians for quality assurance and customer care. The Zoetis has first entry to the veterinary reference laboratory space and it is expected to further strengthen our overall diagnostic portfolio, building of our 2018 purchase of Abaxis, a leading provider of a point-of-care diagnostic instruments. We view reference labs as another important part of our comprehensive diagnostic offering and we plan to build our presence in reference lab over time to organic expansions and other small acquisitions in this space. Now I would like to say a few words regarding our leadership transition. As we announced in October, I am retiring at the end of the year. This has been an amazing opportunity to be in a company like Zoetis over the last seven years. And I feel very positive about the Zoetis future based on our proven strategy, hard and track record of execution, the diverse and innovative portfolio that underlies our success with customers and the growth investment we are making for the long-term. I am confident our talented colleagues and management team led by our next CEO Kristin Peck will continue to capitalize growth opportunities ahead of Zoetis and create significant value for our company, customers and our shareholders. Kristin has been with the company since the beginning of Zoetis and currently serve as Zoetis Executive Vice President and Group President of U.S. Operations Business Development and Strategy. I worked with Kristin for many years, I note that she is the right leader for Zoetis next phase of our growth and industry leadership. She's a strong advocate for our customer needs, a champion offers Zoetis culture and values professional and collaborative leader for our people and industry. The track record of a strong performance through her tenure at Zoetis as well as her operational experience, innovative strategies and deep customer knowledge positions her well to drive Zoetis continued growth. She will build on our long-term study which she felt to develop alongside with the rest of the Zoetis management team and bringing her own vision leading the next stage of Zoetis journey. I will remain an advisor to Zoetis during the course of 2020 and Kristin and I are already working closely to ensure a smoother transition and maintain the momentum of our business growth. Before Glenn to discuss our third quarter results, I have asked Kristin to say a few words. Kristin? Kristin Peck : Thank you, Juan Ramon. I'm honored to be named the next CEO of Zoetis and I look forward to leading our Company into its next phase of industry leadership and value creation. I want to thank Juan Ramon for establishing Zoetis as the world's leading animal health company. I have deep respect for Juan Ramon and its track record of creating value for our customers and for delivering strong returns for our shareholders. His innovative mindset has kept Zoetis at the forefront of the industry and Juan Ramon confidence in our Company's solid foundation and prospects for continued growth. So when it has a diverse and innovative portfolio, deep expertise in animal health and a winning culture shared by our talented colleagues around the world. We know how to partner with our customers to address their evolving needs across the continuum of care from prediction and prevention to detection and the treatment of disease. We have a promising pipeline of new products and lifecycle innovations and we are focused on making investments in digital technology, data and analytics that will fuel our future growth. As CEO, I will continue to drive forward with our successful long-term strategy. I will look for opportunities to accelerate our progress in the most meaningful areas for our veterinary and producer customers and I'm committed to building on the strategies, diverse portfolio and financial discipline that have been critical to our success. To that end, I've been working with Juan Ramon, Glenn and the rest of the Zoetis team as well as the Board over the last few weeks to ensure a seamless transition. As we look ahead, I continue to view animal health as a very valuable sector for investors. With steady growth prospects as the fundamental macroeconomic drivers of global population growth of innovation and a growing middle class in emerging markets, we'll drive growth in both companion animal and livestock. The long-term history of animal health and Zoetis is the testament to the resiliency of our business. The drivers in pet care and animal agriculture are fundamental to the world economy. And Core to people's connections with animals for both companionship and nutrition. I'm excited by the new opportunities for raising the standard of care with innovative new medicines, biologics and integrations across the continuum of care. As I prepare for my new role, a key priority for me has been directly connecting with our stakeholders around the world to better understand their perspective and how we can build on our Company's success. I look forward to engaging with many of you as part of this process and sharing more on our outlook for the market and plans for 2020 early next year. And now Glenn will cover the financials. Glenn David : Thank you, Kristin and good morning. Before discussing our Q3 financial results, I first like to congratulate Juan Ramon on his upcoming retirement and welcome Kristi as the next CEO of Zoetis. In his role as CEO Juan Ramon has led our business to a remarkable transformation from a business unit advisor to an independent and publicly traded industry leader in animal health. Indeed Revenue and adjusted net income growth, well above the market during that period while managing acquisitions and a significant restructuring and from a personal perspective, he supported me to my own transition to CFO during that time as well. I'm very thankful to have worked with him over the past decade and appreciate that we will continue to benefit from his insight and knowledge as he remains an advisor & Director on the Board. I'm also very excited to work with Christian as he transitions to her new role, building upon Zoetis a strong foundation and delivering the next phase of growth. Christian and I have worked together at Zoetis for many years and we share our commitment to customers, colleague and value creation which is driven our company's success. Now let's review the financial results. We delivered another healthy quarter with operational revenue growth of 9% and adjusted net income growth of 10%, these quarterly results which built upon our strong performance for the first half of the year give me confidence in delivering on our full-year improved earnings outlook. For the full-year we are narrowing operational revenue growth at the high end of the range increasing operational growth for adjusted net income and increasing and narrowing adjusted diluted EPS. Reported revenue growth for the third quarter was 7% including a negative 2% impact from foreign exchange. Foreign exchange was primarily driven by the strengthening of the dollar against the Euro, Argentinian peso and the Australian dollar. Operational revenue growth of 9% for the quarter is driven by 1% price and 8% volume. The volume contribution of 8% includes 3% from key dermatology products, 2% from new products, 2% from legacy Abaxis products and 1% from other in-line products. Breaking down our operational revenue growth by species, companion animal grew 23% partially offset by livestock declines of 4%. Companion animal revenue growth was driven by our parasiticides portfolio including new products Revolution Plus and ProHeart 12 key dermatology products. the impact of the Abaxis acquisition and growth in emerging markets such as China. Excluding the impact of the Abaxis acquisition, companion animal products grew 20% operationally. Equine also had strong growth in the quarter benefiting from the acquisition of Platinum Performance, a nutrition focused animal health company. Livestock products declined in the quarter were primarily driven by market weakness in U.S. beef and dairy sectors. The ongoing impact of African Swine Fever and the revenue recovery of the Brazil truck driver strike that increased revenue in Q3 2018. These headwinds were partially offset by growth in poultry. Our key dermatology portfolio demonstrated continued strength this quarter with sales of $217 million representing 27% operational growth. This is our first quarter with revenue, greater than $200 million. Positive performance in this portfolio was driven by the ongoing expansion of the addressable market, increasing market share and continued uptake of both Apoquel and CYTOPOINT until recently launched markets. As Juan Ramon mentioned we are clearly on pace to exceed a combined $700 million in revenue this year. New products, especially Revolution Plus and Stronghold Plus as it's known internationally, ProHeart 12 swine combination vaccines 2% to overall growth in the quarter. This growth is net of cannibalization of the original formulations and highlights the success of our investments and lifecycle innovation. Sales from legacy Abaxis products for $68 million in the quarter represent 10% operational growth over the prior year pro-forma revenue. Other in-line products contributed 1% growth in the quarter including Simparica with $55 million in revenue and 28% operational growth. This growth was partially offset by declines in U.S. cattle and the ongoing impact of African Swine Fever. Now let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 11% with companion animal growing 26% and livestock declining 9%. Excluding the impact of the Abaxis acquisition, U.S. revenue grew 10%. Strong companion animal products performance in the quarter were driven by growth of our parasiticide portfolio, key dermatology products and the impact of the Abaxis acquisition. Excluding the impact of legacy Abaxis products, companion animal growth was 25%. Our parasiticide portfolio including in-line products such as Simparica and ProHeart 6 and new products such as Revolution Plus and ProHeart 12 which launched in the quarter contributed the strong companion animal growth. U.S. dermatology sales were $154 million for the quarter, growing 28%. Growth this quarter was driven by market expansion, increasing market share, returns on direct to consumer investments and price. Positive companion animal performance was partially offset by U.S. livestock declines in the quarter driven by cattle and to a lesser extent swine. Sales of our cattle products were negatively impacted by unfavorable market conditions in the beef and dairy sectors, while feedlot placements in the quarter impacted sales of our products as well as pricing pressure driven by competition. While we continue to see good adoption and growth of the Fostera Gold swine vaccine declines in other product sales while it's the lowest swine revenue this quarter primarily due to the timing of promotional activities. These challenges in cattle and swine were partially offset by continued growth in poultry, primarily due to sales of our portfolio of alternatives to antibiotics in medicated feed additives. In addition, we were able to capitalize on competitive challenges, including lack of efficacy and supply constraints. To summarize, the U.S. business had a very positive quarter with diversity and innovation driving results despite challenging market conditions in the cattle sector. Our International segment also contributed to growth this quarter with operational revenue growth of 5%. Companion animal operational revenue growth was 16% while livestock declined 1% operationally. Excluding the impact of the Abaxis acquisition, international revenue grew 4% operationally, companion animal product growth was driven by key dermatology products, the addition of legacy Abaxis products and growth in emerging markets such as China excluding the impact of the Abaxis acquisition companion animal operational growth was 13%. International livestock declined modestly primarily due to the impact of African Swine Fever as well as an unfavorable comparison to the prior year which included the revenue recovery from the Brazil truck driver strike. Growth in cattle and poultry, partially offset the declines in swine driven by favorable market conditions in key markets including Mexico, the U.K. and Canada while poultry benefited from increased sales in China, Australia and Brazil. Now, I would like to review in more detail a few markets in the quarter. Beginning with China, revenue declined 9% operationally driven by the ongoing impact of African Swine Fever which was partially offset by continued double-digit growth in companion animal. Our livestock portfolio declined 40% operational in China driven by swine declines that were partially offset by growth in poultry and cattle. As we indicated in last quarter, we expect the full-year impact of African Swine Fever to our revenue to be approximately $50 million. While the outbreak has continued to spread to other markets in Southeast Asia, our full-year estimate remains consistent. In the medium to long term, we continue to anticipate that other regions will increase exports of pork and other proteins however, we have not seen increases in productions to any significant extent. Our companion animal products continue to grow significantly in China increasing 43% operationally. Sales from parasiticides, vaccines and Apoquel were the primary drivers of growth aided by field force expansion and effectiveness. Moving on to Brazil, sales grew 1% operationally driven by companion animal growth of 17%, partially offset by our livestock decline of 5%. Companion animal revenue growth in Brazil was driven by our key dermatology portfolio including CYTOPOINT which launched in the second quarter as well as growth in Simparica. Livestock declines in Brazil this quarter were driven by an unfavorable comparison to the prior year when sales were recovered due to the resolution of a national truck drivers' strike that occurred in Q2 of the prior year. In Mexico, sales grew 22% operationally driven by livestock growth of 15% and companion animal growth of 46%. Livestock benefited from sales of our premium products for cattle while strong companion animal performance was driven by growth in legacy Abaxis products, parasiticides and vaccines. Other emerging and developed markets also contributed to international growth this quarter, particularly in companion animal driven by parasiticides and key dermatology products. Overall, our International segment continued to perform well, demonstrating the importance of our global diversity and helping to offset the impact of African Swine Fever. Now moving on to the rest of the P&L. Adjusted gross margin of 70.1% increased approximately 140 basis points in the quarter on a reported basis compared to the prior year. The increase is driven by foreign exchange, product mix and price partially offset by tariffs on certain products and the inclusion of the lower margin legacy Abaxis portfolio. Total adjusted operating expenses including the impact of the Abaxis acquisition through 6% operationally. The increase is primarily related to compensation-related expenses and investments to support future growth of the business. The adjusted effective tax rate for the quarter was 20.5%. The increase from the comparable 2018 period is primarily related to the impact of the global intangible low tax income or GILTI tax which is effective for Zoetis in 2019. Adjusted net income for the fourth quarter grew 10% operationally and adjusted diluted EPS grew 11% operationally, again, outpacing revenue growth. The combination of revenue growth, improving gross margins and disciplined operating expense growth enabled us to deliver strong bottom line results while still investing strategically for long-term sustainable growth. Now moving on to guidance for the full-year. As a result of our strong performance in the first nine months of the year, we are narrowing operational revenue growth at the high end of the range, raising operational growth for adjusted net income and raising and narrowing the range for adjusted diluted EPS. Please note that guidance reflects foreign exchange rates as of late October. I'll now walk you through each of the individual line items, beginning with revenue. We are now expecting to deliver revenue between $6.2 billion and $6.25 billion as compared to our previous range of $6.175 billion to $6.275 billion. The dollar decrease in revenue guidance at the high-end of the range is related to unfavorable foreign exchange. Operational revenue growth is now expected to be between 9% and 10% as compared to our previous estimate of 8.5% to 10% reflecting the continued momentum of our companion animal portfolio. Our organic operational revenue growth which excludes the impact of Abaxis is now expected to be between 6% and 7%. We are now projecting adjusted cost of sales as a percentage of revenue to be approximately 30% compared to our previous range of 30% to 31%. Adjusted SG&A for the year is expected to be between $1.525 billion and $1.55 billion compared to our previous range of $1.505 billion to $1.545 billion. The increase in narrowing at the high-end of the range reflects our focus on critical investments to support revenue growth including promotional activity on key companion animal products. Adjusted R&D expense for 2019 is now expected to be between $445 million and $455 million for the year compared to our previous estimate of $450 million to $465 million. The decrease was related to the timing of project spend. Our full-year adjusted interest and other income deductions is expected to be approximately $190 million and our full-year adjusted tax rate is expected to be approximately 20% which are both consistent with previous estimates. Adjusted net income is now expected to be in the range of $1.72 billion to $1.745 billion representing an increase of $10 million at the high end of the range. The updated adjusted net income range represents operational growth of 11% to 14% compared to previous range of 9% to 12%. The improved outlook for adjusted net income is primarily driven by gross margin favorability. We are also increasing our adjusted diluted EPS to a range of $3.57 to $3.62 compared to our previous guidance of $3.53 to $3.60. Our range for reported diluted EPS is increasing and narrowing now expected to be between $2.99 to $3.08 based upon operational increases. Our previously estimated range was $2.93 to $3.04. We expect approximately $450 million to $475 million in capital expenditures this year with increased investment in information technology and manufacturing to support our Abaxis acquisition, improve cost efficiencies and increased capacity. We anticipate continuing an elevated level for the next few years as we invest in manufacturing and infrastructure to support future growth and product launches. We also repurchased approximately $450 million of Zoetis shares in the first nine months of the year. We have $1.9 billion remaining under the multi-year share repurchase plan that was approved last year and we remain committed to our capital allocation priorities of internal investment, M&A and returning excess cash to shareholders. Our guidance for reported and adjusted earnings per share reflects the shares repurchased through the end of Q3. While we not provide guidance for 2020 until February, we view next year as a continuation of strategic investment to support recent and future product launches, our recent acquisitions including Phoenix Lab and Platinum Performance and other strategic priorities. Now to summarize before we move to Q&A. We have consistently delivered strong top and bottom line growth in the first nine months of the year despite market challenges in cattle and swine. We are narrowing our outlook the operational revenue growth at the high end of the range and we are increasing and narrowing our outlook for adjusted net income and adjusted diluted EPS reflecting the strong performance year-to-date. And our investments in R&D, diagnostics integration, manufacturing capabilities and field force expansion will provide a solid platform for continued growth in 2020 and beyond. Now, I'll hand things over to the operator to open the line for your questions, operator? Operator : [Operator Instructions] We'll take our first question from Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich : Good morning. Juan Ramon, it's been great working with you and I hope you enjoy your retirement and get the play a lot of golf. Juan Ramon Alaix : Thank you. Kevin Ellich : Congratulations. We all know you're going to do a terrific job succeeding Juan Ramon. The questions I have first, I think you guys talked about some Simparica Trio saying that your assumption is if it's approved in the U.S. by the end of Q1, revenue would be about $150 million in 2020 did I get that right? Glenn David : Yes. The incremental sales that we expect for Trio over our existing portfolio is $150 million. Kevin Ellich : And what is the underlying assumptions there Glenn in terms of pricing, how much will come from the U.S. versus international and how much cannibalization? Glenn David : So in terms of the breakout between U.S. international like we've set all along, we expect the majority of the sales for this product to be in the U.S. I really want to go into details on price from a competitive perspective at this point but like we said we do expect it to be priced significant premium to Simparica and the cannibalization impact obviously there'll be some cannibalization to Simparica but we also expect to take significant share from competition. Operator : We'll take our next question from Louise Chen with Cantor Fitzgerald. Louise Chen : So Juan Ramon, we will miss you and Kristin and congratulations on the new role. My first question is for you, Kristin, as the new CEO of Zoetis what will you do differently from Juan Ramon? And then also just on 2020, I know you're not giving guidance till February but how should we think about the pushes and pulls as we look into next year? Thank you. Kristin Peck : Sure. Thanks so much Louise. I'm going to be focused on really continuing the strong path of value creation. If you look at the strategy that we've had over which I feel actually is delivered significant results both for our customers and for our shareholders. It is been a dynamic strategy that has always been predicated on continuous innovation and disruption which I think is really would have helped us stand out. It's also been characterized by a great diversity of our portfolio and my goal is to maintain that strong momentum to stay ahead of competitors. I think if I look into 2020 and 2021 and beyond, I'm really going to be focused on innovation, making sure we continue to bring to market products that really solve both our customers and animals’ challenges. I will continue to relentless focus on our customer making sure that we're finding ways to make their job easier to do and to make them more productive. And I'll be looking for better leverage our digital and data both to make us more efficiently internally as well as to drive better productivity and greater growth in some of our data and digital revenue products both in diagnostics and precision livestock farming. So that will be my focus as we look into 2020 and some of the sources of where I think you'll see our continued growth. Glenn David : And in terms of the pushes and pulls for 2020, starting with the revenue line, where we continue to see good momentum in our companion animal business and particularly with the expected launch of Simparica Trio subject to approval, we expect to see very strong performance there as well as the continued growth in some of the new products that we launched this year such as ProHeart 12 and Revolution Plus. Also, when you take into account the impact of African Swine Fever that we had this year, we would expect that to stabilize this year and not to be a negative detractor to growth in 2020 so that should benefit us as well. When we look at the expenses, obviously there'll be some investments to support our new product launches. We want to make sure that we get those products off to a strong start and also some investments to support the recent acquisitions that we have in place. So overall, we would expect revenue to grow faster than the market again in 2020 and we would expect that we able to grow our income faster than revenue. Operator : We'll take our next question from Erin Wright with Credit Suisse. Please go ahead. Erin Wright : Great, thanks and Kristin congrats, Juan Ramon as well. It's obviously been very, very nice working with you. I had a quick question on Simparica Trio - $150 million in 2020, it's a little bit higher I guess than what we were contemplating on a net basis, I just want to confirm some of the assumptions that you're making, does it assume that you launch ahead of ZeoMAX and does it assume that you'll be the only player in the U.S. and does it also assume of puppy indication or other label caveats from a safety perspective. A separate question here, but can you also speak to the diagnostic strategy in the reference laboratory market. I guess how quickly can you scale up the U.S. lab footprint and what are some of your plans internationally from a reference lab perspective as well? Thanks. Juan Ramon Alaix : So, Kristin will answer all this question, so please Kristin. Kristin Peck : Sure, so starting with Trio. We do not expect to be launching ahead of ZeoMAX and Western vet but we do expect to be launching ahead, a very important Q2, Q3 parasiticides season. So I think we will not be there but I do think if you look at the $150 million to your point, we still expect to deliver a very strong year there. We do expect to get puppy claim that is part of the assumptions that is in there that's obviously subject to back to approval but that is our going in assumption as we look at that. So as I move towards the reference lab, we continue to believe that diagnostics is an important part of our go-forward portfolio. It is critical to that and as a part of their business that will stay there, we think it enhances as Zoetis is currently value proposition and is a great complement to our existing portfolio, it's a large and very fast growing market. As the market has been growing at 10% plus, we strongly believe that we can accommodate a third player. We've also known the customers that we're looking for a third-party alternative and if you look and different MSAs shares of third-parties have actually been significant as our acquisition of Phoenix demonstrates, they had over 50% share in the MSA they operated in. Our plan in this space is to invest both organically and inorganically over the next few years and we remain committed to the space. Operator : We'll take our next question from Christopher Schott with JPMorgan. Please go ahead. Christopher Schott : Great, thanks very much for the question. I guess my first one was on Apoquel and CYTOPOINT ex-U.S., can you just provide any additional color in terms of where penetration rate stand in some of the bigger markets in terms of Europe, Brazil, et cetera and where do you think those penetration rates can go over the next several years? And my second question is, sorry I keep going back to $150 number but I'm still not quite clear, can you help me understand again how much of that 150 is incremental revenue on top of what you're parasiticide business is already doing as compared to erosion from I guess legacy Simparica and some of your heart products et cetera. I'm trying to understand the magnitude of overall growth I should be thinking about for parasiticides next year. Thank you. Juan Ramon Alaix : Glenn will provide some data related to the penetration range and also details of the 150, how much is [indiscernible] revenues. Glenn David : So when you look at Apoquel and CYTOPOINT particularly in the U.S., we see that we are plus 60% share in that market. The data internationally is not as clear in terms of, we don't get the same level of data but we know we're not at that penetration rate. Also we've launched Cytopoint later international than we do in the U.S. so we do think we have continued uptake there. So we do see significant opportunities in international if you continue to gain share as we move up to similar levels that we have in the U.S. We also see continued opportunities in the U.S. as we continue to expand that market and raise disease awareness of dermatology and atopic dermatitis. So we see continued opportunity in the U.S. as well. In terms of $150 million revenue for Simparica Trio, I want to be clear that is incremental sales overall what we see for Simparica alone and that does include the cannibalization effect. So we would expect greater sales of Trio then $150 million as a stand-alone product. Operator : We'll go next to Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : And I want to mirror the earlier comments, congrats Juan Ramon. It's been great working with you and Kristin look forward to working with you going forward. Two quick questions from me, one on some of the moving pieces in the quarter and sort of looking forward, I would say one of the bigger surprises this year has been in the entire market not just very specifically but some of the challenges in U.S. livestock, particularly given the negative tone of ASF internationally, there is an expectation that you will see some stabilization in U.S. livestock in the market in cattle and swine. And it's been a little bit slow probably slower expected this year, if you look back in the line months earlier. How do you see some of these dynamics playing out? We talked about ASF internationally but if you think about the cattle herd in the U.S., some of the feedlot pressures that we've seen this year in terms of placements, if you could talk automatically sort of over that six months to 12-months. And then a quick follow-up on the seasonality question, you talked about the Simparica Trio approval likely end of 1Q early 2Q launch, could you talk about the timing that you think about the vet purchasing a lot of the ordering by that's happens relatively early in the year. So how much wiggle room do you have built-in and how quickly can you ramp up manufacturing to make sure that you don't miss a fleas season if there is a month or two movement either way there. Juan Ramon Alaix : Let me answer the question on Simparica Trio and then Kristin will cover the trends and also the challenge that we have seen in the U.S. livestock and we also talked about the African Swine Fever. We expected approval in late first quarter from FDA and then shortly after we launched the product in the market. We are thinking already they are prepared to step to ensure ample supply of the product as soon as we obtain approval in the U.S. So we don't think that the supply will be efficient in terms of capturing the opportunities of the high season that it's mainly in the Q2 following the Q3. We are confident that we told earlier we are making now it is probably is approved by the FDA, we will be able to generate a significant opportunity for Simparica as we are in 2020. So moving into the U.S. livestock, Kristin? Kristin Peck : Sure. As you saw our numbers both dairy and beef in the U.S. continue to be weak. As we said in previous conversations in previous quarters, we expect this to continue for the rest of the year. From a dairy perspective and we've seen depressed milk prices versus historical trends which has limited producer profitability income and in the last few months there has been a small improvement in pricing but it's not yet sustained enough we believe for producers to believe recovery M&A and to start investing significantly. On the beef side, we're at the end of what's been a very long expansion period. So we are expecting a little bit of contraction or flattening out over the medium term. As you look at beef, there has also been a lack of innovation that has driven significant pricing and competitive pressures. We had a wet spring which had good past through this year which is kept cattle out longer and as you've seen there's been a significant increase in some of those prices and live cattle prices, which has encouraged them to wait of their animals were heavier and older to put them in the feedlot. So as we look at U.S. cattle, I think we'll continue to see challenges of there as we look into next year. And as we look at ASF as we've spoken about previously, we believe with China specifically, we see about a $50 million impact across the Zoetis primarily based out of China. As we look into next year, we are hoping for that to stabilize and we are hoping to see some recovery moderate but obviously that remains to be seen based on how that goes. But we do see offsets were the Chinese swine. We are expecting imports from EU, Brazil and the U.S. both in swine as well as across other proteins to help compensate that we've seen significant price increases in pork globally. We see Brazil and EU probably best positioned to take some of this, but I think overall, it seems certainly enough in the U.S., the U.S. will also go after trying to get a greater share of. So we remain quite committed but I think what we believe that the impact of ASF should flatten out as we look into next year. So hopefully that explains. Operator : We will go next to John Kreger with William Blair. Please go ahead. Jon Kaufman : This is Jon Kaufman on for Kreger. Juan Ramon, we wish you well and Kristin congrats on the new role. One of your competitors has talked a lot recently about the importance of alternative channels. Can you guys talk a little bit about that? How important are the online and the mass market retail channels for you today? How has your strategy evolved here over the past year or so and as you think about the future outlook for the company, how much of the growth, do you think will come from these alternative channels? Thank you. Juan Ramon Alaix : We have seen Jon the changes on the how vet owners are getting that product from different channels, we have seen that mainly the U.S., but also in some other markets there are changes but really having an impact into the veterinary space but Kristin will provide much more color on how things are changing in the U.S. as these affecting the market, affecting manufacturers, affecting alternative channels, so Kristin do you want to provide some comments please? Kristin Peck : Sure. I would certainly. If you look at our portfolio is the contrast of other is the majority of what we sell requires a prescription. So our goal is to work with vet to make our product available to pet owners in a way that works best for them. And what we've seen is in the areas such as parasiticides and chronic medications, many pet owners have looked more to buy their products from e-commerce and retail and as such we've evolved our own strategy to work more directly with e-commerce and retail. We implemented as we discussed on previous calls the minimum advertised price or Matt pricing which is an agreement with all e-commerce and retailers to ensure that they cannot advertise our products beyond a certain price. This has allowed us to legitimately sell our product, eliminate some of the great market and provide veterinarians and pet owners the convenience to fill their prescriptions where and how they want. This I think is an evolving thing so just to give you context still 50% of what we sell we'll have to remain no matter what in the clinic. It's definitely expanding quickly but still on a relative basis is still a small part of our business today, but something we're monitoring closely and we're making sure that we continue to develop and enhance our capabilities to best serve this new channel as we move forward. Operator : We'll go next to Jon Block with Stifel. Please go ahead. Jon Block : And maybe just a handful of small questions most of is clarification. So first clarification for companion animal, did you guys see both canine and theme line labs both targeting U.S. approval in 2021 one, a clarification for ASF I was a little mixed up there is the thought that the drag for 2020 will be less than the $50 million incremental hit in '19 but you still think there could be additional incremental headwinds for 2020? And then lastly, Glenn, not going into 2020 guidance on you but just only we think about that COGS in sort of hitting that 70% bogey for 2019 which is certainly impressive. I would think you still going to have a favorable mix shift in 2020 is companion grows faster than livestock based on all the commentary but do somebody investments in manufacturing offset that. Thanks guys. Juan Ramon Alaix : Thank you, John. Let me confirm that we have to file both antibodies for cats and dogs in EU and the U.S. and we expect to launch in 2021 of these two products in the U.S. Moving into the African Swine Fever, the assumption that we are making on the comments that we provided today is we are assuming that there will not be a further spreading of African Swine Fever outside of China. We have seen that cases in the Southeast Asia, Korea, the Philippines to a lesser extent also in Eastern European markets. But we expect that customers now are improving that vital security and they are protecting better against the African Swine Fever. We are not expecting that China to continue growing in terms of cases may be an opportunity to slight increase in production in China and definitely we see the opportunity in other markets to compensate the gap that have in terms of supply of meat into the Chinese population with more production from Brazil, European markets, Spain, Germany and some other markets, Canada and the U.S. and this is something that in our opinion will help also to generate that growth in livestock in 2020. So moving into the third question, in terms of gross profit Glenn, you want to cover that? Glenn David : Yes, so John your thoughts on gross margin. When you look into 2020 there should definitely be a favorable mix impact as we would still expect companion animal to grow faster than livestock in 2020. Just one thing to note on that Trio being the first year of product launch will not be as favorable to gross margin as the rest of the companion animal portfolio we typically be. Over time we do expect that product to have very favorable margin. But with the first year of launch there is always learnings and efficiencies that will be delivered over time. The other thing to take into account is that FX had a very positive impact in 2019 our overall gross margin. We would not expect it to be positive in 2019 probably be somewhat of a detractor in 2012. Operator : We'll go next to David Westenberg with Guggenheim Securities. Please go ahead. David Westenberg : I echo the congratulations. So just in terms of market sizing up, can you help us size the market for the cat opportunity given that there is no existing market? just any sort of framework so that we can think about in terms of there would be population age, et cetera. And then secondly, a competitor called out the ASA-African Swine Fever vaccine market is a multi-billion dollar market. Can you maybe give us a framework on the size of that as well? Do you agree with that assessment? What are the puts and takes there? Thank you. Juan Ramon Alaix : Okay, so let's me provide some comments on the market size for cat and local antibodies. So first, there is no any specific product today in the market developed specifically for cat. We know that the number of cats, it's lower than the number of dogs and even more the number of medicalized cats it's even lower than the number of medicalized dogs in the U.S. and also worldwide. If I compare the market of dogs in terms of managing their pain it's about $400 million to $500 million worldwide. So with the comments I made in terms of medicalization rates and the number of cats, you should expect that the market potential for cat in pain is lower than these $400 million to $500 million. But the advantage is that we will be entering into a space that there is no any clear product addressing that pain in dogs and that we think that we can generate a significant growth opportunity in these areas. Then how big is the African Swine Fever market? Well, I don't know if the question is related of how much has been the impact on the African Swine Fever and the vaccine. Well, I think it's something that it is reaching because definitely we see a significant opportunity in China, developing this vaccine but also not only in China that we have already the disease but also, they need to protect African Swine Fever in other markets. We are convinced that this can be one of the top vaccine products worldwide, more than FMB or even more than PCV2. So the opportunity for developing a vaccine in this area is significant. Operator : We'll go next to David Risinger with Morgan Stanley. Please go ahead. David Risinger : And me please add my congrats to you both Juan Ramon and Kristin. So my two questions are first, with respect to U.S. tick, could you help us understand what percentage of the U.S. dog market needs tick coverage. Obviously, there are no ticks in the south, I just don't know what percentage of dogs reside in tick infested areas in the country? And then second, could you comment on livestock pipeline launch opportunities in the next year or so? Thank you. Juan Ramon Alaix : Thank you, David, Kristin? Kristin Peck : Sure. If you look at, U.S. tick average, very significant tick coverage across the United States. There are different ticks. In the South, you might see more of a Gulf Coast tick which is actually a very difficult tick to treat [indiscernible] tick in the North. So we do believe that most pets in the United States needs a comprehensive tick protection. There may be some geography where there's not a lot but I think there may varies a tick but insect protection is critical we move across the U.S. As we think about our livestock population opportunity, as you saw in the press release, we are quite focused on driving innovation across livestock. We announced a partnership with Colorado State. So look at antibiotic alternative to the livestock space. We're also really focused on immuno therapies in livestock as alternatives to antibiotics and are excited about some projects there as well. We're also looking at precision livestock farming can make producers more productive and to better predict animal looking sick. We are also excited in the area of genetics where we can breed healthier animals that are also more productive. And as we've talked about in previous calls looking through diagnostics to bring more shoot side farm side diagnostics across that. Operator : We'll go next to Mavin Jacobs with UBS. Please go ahead. Prakhar Agarwal : This is Prakhar on for Mavin. I had two questions. First on Simparica Trio, one thing we are hoping to get more clarity on is around duration of therapy, so tick free products are more seasonal which is not typically the case with hard one product. So how are you thinking about the duration of therapy for Simparica Trio? Do you expect this to be predominantly used in the tick season or good duration of therapy, be more? And secondly on Abaxis you've talked about expansion into OES markets are the key opportunity so could you provide an update on the expansion plan and have you identified target markets or regions that might be ideal and longer term could Abaxis reach similar size in international markets and the U.S. market. Thank you. Juan Ramon Alaix : Thank you very much for the two questions. So let me answer the duration of therapy. One thing is that what should be the duration of therapy that we believe that it should be in many of the markets are 12 months. And what is the actual duration of therapy that is probably three or less month. So a significant opportunity in terms of compliance and we may see some high season for ticks and fleas depending on the warmer weather but they need to protect animals goes going across the year and definitely in the case of a high warm, it's a 12-month the need of protecting against these type of disease. And I like Kristin to talk about our budgeted rate expansion plans both U.S. and international. Kristin Peck : Sure. When we announced back since there, we talked a lot about the fact that we think we can continue to operate the business in the U.S. much better and drive more efficiencies and drive growth but acknowledged that the competition in the U.S. is a little steeper. As we look into international, we strongly believe in international, there are significant growth opportunities. It's more of a blue ocean with a much more fragmented base. The use of diagnostics also varies dramatically by market. We're very focused on and building our own direct demand generation field force which is really being lacking across most companies, the operator international we looked at 2019, as we've talked about for Abaxis as a platform year to really establish ourselves there and we plan to move to direct distribution from some of our existing distributors across most markets as we look into 2020. So we do think there is a significant opportunity in Abaxis to reach us by a similar if not higher share than we have in the U.S. just given it is a less mature market with much more fragmentation but it will require a market by market approach. Operator : We'll go next to Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Thanks for the questions and let me also offer my congratulations. On the triple combo, have you guys gotten feedback from the FDA just on where they are in their review process and kind of what is driving your expectations for maybe a little bit later of an approval than you originally expected. And then can you also talk about the timing for a submission. And when you would expect approval for the triple combo in China and some of the other geographies that you mentioned like Mexico? Juan Ramon Alaix : Let me make some comments about the process of approval in the U.S. There is something which is part of the normal process of questions and answers. We get there some additional requests for information from FDA, not related to safety or efficacy and we already answered these questions and now we are waiting for the feedback and we expect the final decision on Simparica Trio by late first quarter next year. But there is something that is part of a regulatory discussion with many of the regulatory authorities across the globe. We said before that we were expecting approval and launch in the first quarter. We have already obtained approval in Europe and Canada and we have the first quarter in these markets. And we'll be ready for launching shortly after approval in the U.S. And as I said, we are already taking the steps to have ample supply to meet the market needs in the 2020 always base with the assumption that we provided that today of these 150 additional revenues in Simparica sale. And then you also ask about approval time in China. These unfortunately something that at this point, it's difficult to answer. We are preparing the filing in China and then after the filing probably we will get a little bit more clarity on the timing and we expect that to launching in this market. So first we intend to launch Simparica as a single item in China and then also CYTOPOINT that is another important product that we plan also to launch in China and then later we'll be launching Simparica Trio. So even if it will take maybe some years, we have products that are coming into the market in China that will generate very positive growth momentum in this market. Next question please. Operator : Our next question is from Kathy Miner with Cowen & Company. Please go ahead. Kathy Miner : First again Juan Ramon and Kristin congratulations to you both. Just a couple of questions, first on the canine pain map that you filed. Can you tell us if that is the compound that you acquired from Nexvet a couple of years ago? Second, I noticed that fish sales were down 9% this quarter and that's somewhat unusual that's been a growing market. Is that something temporary or is there a change in the outlook? And last question when we look at African Swine Fever, I think it took everyone by surprise, are there any other diseases that you're monitoring that could impact your business over the next three to five years? Thank you. Juan Ramon Alaix : Thank you for the question. So let me start with answering the question about the monoclonal antibody for dogs. So we have multiple programs in our R&D activity. The product that we are now planning to launch it's an internal product for dogs. The one that we are planning to launch for cat is coming from Nexvet. You also asked about the decline in the quarter related to fish. We have been growing very fast in previous years in fish. This year we had some challenge related to the PD vaccine in Norway. We expect that it is a temporary adjustment and we expect fish to continue growing faster than the overall animal health market. The long-term opportunities in fish is related to adding new vaccines to protect all species different than salmon. Today, we have most of our revenues concentrated in salmon in Norway and Chile. But we expect to continue developing new vaccines to protect animals different than the salmon and to review the use of antibiotic which is today the only treatment or the only protection against infections for species like the gases or tilapia or other fish. Definitely, we continue investing in fish and we are confident that fish will be a growing opportunity in the future. Next question please. Operator : We'll go next to Gregg Gilbert with SunTrust. Please go ahead. Gregg Gilbert : A couple longer term ones for Kristin and clearly Zoetis is the leader overall industry but is there an area or areas we'd like to see is they want us be more of a leader than it is today. And secondly on the companion side do you think pet owners they are anywhere close the maxing out and what they can afford or where they chose to afford in carrying for their pets, I realize flees, ticks heart worm is not in this category. But thinking the three to five years plus on the line we spent biotech products, et cetera. Maybe this comment on that longer term. Thank you. Juan Ramon Alaix : So let me answer the first question and then Kristin will cover the second. So when we see that we can improve our market share and becoming the leader and becoming leader and, in this call, we announced that we obtain approval of new vaccine for both which is related to vector technology it's an area that we believe that will be a growing opportunity. So I think we are starting that with one vaccine but the objective is to develop a complete set of vector vaccine to cover multiple diseases in totally and this will help us and also to maximize the opportunities with our leadership in lower vaccination which is the machine that is used in country to protect chicken before hatchery. So we are injecting X and we see an area in where we are less share that the overall share that this area has. The second area in where we think that we have been improving significantly is the launch of Simparica followed by the launch of Revolution Plus, ProHeart 12 it's parasiticides and we expect also with the launch of Simparica Trio to become much stronger leader in parasiticides than today. Kristin? Kristin Peck : Sure, on you second question. We've seen as increases over the last few years and the spend per pet, I think a lot of that has to do with the demographic shifts in developed markets where people are having fewer children, spending more time with their pets, Millennials in particular are much more engaged with their pets. And we've spoken about the increase in pet spending start when they move from the backyard to your house and then ultimately to your bed. So we don't see any end in this market. It's been a very resilient business even in times of economic challenges people have continue to spend on their pets. So we don't see right now any indicators that that spending per pet will be going down. So I think it remains a strong market as we look to the future and if you look at the urbanization and the emerging middle class and emerging market, we see significant growth there as you add more markets that keep more pets and medicalized like that. Operator : And we'll go next to Kevin Ellich with Craig-Hallum. Please go ahead. Kevin Ellich : So one quick one, thinking about African Swine Fever in a different way, down the road when it's time to re-populate the herd, just wondering how much benefit that could bring to Zoetis especially given your presence in genomics and genetics? Kristin Peck : Sure. If you look at repopulation I mean essentially in China and some of these other geographies will repopulate. We believe when they do more move more to industrialized production and more away from the small backyard farms. We think that does play to the strength of innovative companies like Zoetis so we do see the future of African Swine Fever as it goes down meeting, more technologically based production which we think it will be an increase for us and certainly if we're able to create a vaccine for African Swine Fever that will be even more in picture. Operator : And there appears to be no further questions, I'll return the floor to Juan Ramon for closing remarks. Juan Ramon Alaix : Thank you very much and since this will be my last earnings call, I want to thank you all of you for the support you have given to me and Zoetis over the last seven years. It has been an amazing journey and I'm very proud of the value that we have been created. I know that you will enjoy the same ongoing commitment to our valuable provision from Kristin, Glenn and the rest of our leadership team and the data as I think into the next phase of growth. In closing, I remain confident in a brighter future of Zoetis. This company and its people have the capabilities, experience and customer focus to continue delivering a world-class for our customers and our shareholders. Thank you very much. Operator : And this will conclude today's program. Thank for your participation. You may now disconnect.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,020
| 1
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2020Q1
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2019Q4
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2020-02-13
| 3.53
| 3.61
| 3.94
| 4.02
| 5.75613
| 31.13
| 31.59
|
Operator : Good day. And welcome to the Fourth Quarter and Fiscal Year 2019 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you the viewer and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section at zoetis.com. At this time, all participants are placed in a listen-only mode, and the floor will be opened for your questions following the presentation [Operator Instructions]. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question [Operator Instructions]. It’s now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, Keith. Good morning, everyone. And welcome to the Zoetis fourth quarter and full-year 2019 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer and Glenn David, 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 Web site 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 in the Company's 8-K filing dated today, February 13, 2020. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. Good morning, everyone. By now, you read our press release and financial tables on the Zoetis Web site, so I’ll take just a few minutes to recap the full year, talk about outlook for 2020 and outline some of the long term investment plans and growth opportunities we see for our Zoetis. Our CFO, Glenn David, will then cover the fourth quarter and our full year guidance for 2020, before we open the lines up for your questions. So let's get started. Zoetis delivered another year of strong growth and market leadership in 2019. Thanks to our diverse and durable portfolio and our commitment to continuous innovation. We grew revenue 10% operationally, which includes about 2% of growth from the Abaxis acquisition. This is once again above the market growth for animal health. We just expect it to be about 3% to 4% for 2019, reflecting the negative impact of African swine fever. We grew our adjusted net income faster than revenue at 14% operationally, continuing to achieve our goal of growing from profitability faster than revenue over the long term. In terms of other elements of our value proposition, we achieved several new approvals in areas that will strengthen our traditional portfolio of parasiticides and vaccine and we invested in critical acquisitions and partnerships that will accelerate our growth in areas where we are expanding, such as diagnostics. For example, we received approval for new parasiticides, such as ProHeart 12 in the U. S. and Simparica Trio in the EU and Canada. We are enhancing our vaccine portfolio with new products like Versican Plus Bb Oral, the first oral vaccine for dogs in Europe, and Poulvac Procerta HVT-ND, our first venture vaccines for poultry. We also continued to invest in building our overall diagnostics capabilities with acquisitions in the reference lab space, which will be give us a more holistic offering to veterinarians. And we expanded our equine and pet care portfolio into nutritional formulas with the acquisition of Platinum Performance, a premier leader in this market. Finally, in terms of our commitment to returning excess capital to shareholders, we generated a 2019 quarterly dividend of $0.16 per share, an increase of 30% from the 2018 dividend rate. And we completed approximately $625 million in share repurchases. We have built a strong record of delivering on this value proposition for shareholders over the last seven years. And I'm very confident we can continue on this path of long term growth and value creation, based on the capabilities, colleagues and customer focus we bring to every market opportunity. Looking ahead now to the rest of 2020, animal health remains a steady and reliable market based on people's increasing commitment to their pets’ health and based on the steady demand for safe and affordable animal proteins. For 2020, we currently expect the overall industry to return to growth of approximately 4% to 5%, excluding the impact of foreign currency. The market showed a dramatic shift in 2019 from African swine fever in China with at least 50% reduction in herd size according to reports. While this disease had a significant impact on our business in China last year, we see early signs of stabilization and the opportunity for the industry in terms of firms consolidating investments being made in better infrastructure and biosecurity and the frozen pork supplies being reduced. As the global pork market and trade picture sorts that more in 2020 and with increased export opportunities for many markets, we could see the overall animal health market return to slightly better growth rates. In terms of species, the swine market should be below the overall market growth for 2020. The companion animal and poultry markets are expected to be somewhat above the market growth and cattle is expected to be a little more limited than the market, based on the continuing challenges faced by beef and dairy customers. For Zoetis, we expect to grow faster than the markets for companion animal and poultry and in line with the cattle market. For the soy market, we would expect to be in line or faster than the market depending on the pace of recovery from African swine fever and its impact on additional markets this year. In terms of our guidance for 2020, Zoetis expects to grow revenue significantly faster than the industry in a range of 7% to 9.5% operationally. And in terms of adjusted net income, we expect operational growth in the range of 8% to 11%. To meet our goals for 2020, we will continue supporting our latest product launches in lifecycle innovations with direct-to-consumer advertising and the recently expanded pet care field force in the U.S. And in international markets, we're focused on supporting new products with field force expansions in certain markets and differentiating ourselves with a focus on direct field forces’ effectiveness and technical expertise. We will also continue investing in other accelerated growth areas, such as diagnostics, genetics, precision livestock farming and digital and data analytics. This will be an important year in diagnostics as we complete the integration of our systems and look to accelerate sales growth with more integrated offerings of medicines and diagnostics and importantly, we can deliver more value to our customers. And we'll continue advancing our pipeline with investments in parasiticides, vaccines, monoclonal antibodies and other therapeutic areas. The launch of Simparica Trio, our triple combination parasiticide is highly anticipated for 2020, and we remain confident in the U.S. approval in the fourth quarter with a loss shortly thereafter. As we have said recently, we completed the technical sections of the Simparica Trio package for the U.S., and are currently in the administrative review awaiting a final approval. We've already received approvals for Simparica Trio in the EU and Canada, and we expect the Simparica Trio launch in Europe to begin in certain markets this month as we take a phased approach to the launch there. Based on these assumptions, we continue to expect to generate incremental global sales of Simparica Trio in 2020 at approximately $150 million. I am energized by the opportunities ahead of us in 2020. We have a vibrant and growing companion animal portfolio, driven by internal innovation and more to come with Simparica Trio. We are delivering steady performance across our livestock products despite the market challenges some of our customers face from economic conditions, emerging infectious diseases and natural disasters. We're partnering with our customers in innovative ways to help them stay ahead of the curve on evolving technology, new commercial opportunities and shift in consumer trends. We are building out our capabilities in digital and data analytics to bring meaningful solutions to the challenges facing their farms and clinics, and we are executing on a strategy for growth with internal and external investments that have us well positioned for long term growth. I look forward to carrying on the company's successful formula of customer focus, innovation, and execution as we continue to deliver on our long-term value proposition to shareholders. Now, I’ll hand things over to Glenn. Glenn David : Thank you, Kristin, and good morning. As Kristin indicated, we had another exceptional year with revenue of $6.3 billion and adjusted net income of $1.8 million, with both top and bottom line exceeding the high end of our guidance ranges for the year. Reported revenue growth was 7% for the year, including 3% unfavorable impact from foreign exchange, which was driven primarily by strengthening of the dollar against the Euro, Brazilian Real and Argentinian peso. Operational revenue growth of 10% was driven by 2% price contribution and an 8% volume contribution. Volume growth included 2% from the addition of legacy Abaxis products, 2% from our key dermatology portfolio, 2% from new products and 2% from our other in-line portfolio. Revenue growth for the year was broad based with the U.S growing 11% and international growing 9% operationally. Companion animal led the way in terms of species growth, outpacing livestock for the year. Revenue from our key dermatology portfolio, our diverse parasiticide portfolio with several new launches this year and legacy of Abaxis product, drove companion animal operational performance up 23%. Livestock declined 1% operationally for the year impacted by the outbreak of African swine fever in China and challenging beef and dairy cattle market conditions in the U.S. Our poultry and fish product portfolios continue to grow, partially offsetting the cattle and swine headwinds. Operational growth and adjusted net income of 14% was driven by strong revenue growth and gross margin favorability. Now moving on to our Q4 financial results. We had solid performance again this quarter with revenue of $1.7 billion, representing an increase of 7% on a reported basis and 9% operationally. Adjusted net income of $440 million increased 15% on a reported basis and 13% operationally. Foreign exchange in the quarter drove an unfavorable 2% impact on revenue, primarily driven by the strengthening of the dollar against the Euro, Brazilian Real and Argentinian peso. Operational revenue growth of 9% for the quarter was driven by 1% price and 80% volume. The volume contribution of 80% includes 3% from new products, 3% from other inline products and 2% from key dermatology products. Contributions from legacy Abaxis products were not a material driver of growth in the quarter globally since this is our first full quarter lapping the impact of the prior year acquisition. Breaking down our operational revenue growth by species, companion animal grew 19% and livestock grew 2%. Companion animal revenue growth was driven by continued strength of our key dermatology products and our parasiticide portfolio, including new products, Revolution Plus and ProHeart 12 and the continued adoption of Simparica. Equine also contributed to growth in the quarter with a full quarter revenue from the acquisition of Platinum Performance and its nutritional products, as well as continued growth of our CORE EQ Innovator vaccine. Livestock growth in the quarter was primarily driven by strong poultry and fish performance, partially offset by declines in cattle and the impact of African swine fever. Swine increased 1% operationally in the quarter despite the impact of African swine fever. New products contributed 3% to overall growth in the quarter, driven by parasiticides Revolution Plus and Stronghold Plus as is known internationally, ProHeart 12 and the recently launched Alpha Flux parasiticide in Chile. Other inline products contributed 3% to growth in the quarter. This was primarily driven by revenue from recent acquisitions and commercial agreements, including Platinum Performance, our reference lab acquisitions, the statement lab diagnostic test for equine and companion animal parasiticides, including Simparica. This growth was partially offset by declines in U.S. cattle and the ongoing impact of African swine fever. Simparica contributed strong growth in the quarter with revenue of $42 million and 34% operational growth. For the full year, Simparica sales were $214 million dollars growing 40% operationally. Our key dermatology portfolio continued to grow globally this quarter, contributing 2% growth. Global sales were $200 million in the quarter, representing 29% operational growth. Full-year revenue for this portfolio was $754 million, growing 29% operationally. The positive performance in this portfolio was driven by increasing market share, price and expand the usage of both APOQUEL and CYTOPOINT into recently launched market. Sales in legacy Abaxis products was $68 million in the quarter, representing 5% operational growth over the prior year. Now let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 6% with companion animal growing 15% and livestock defining 3%. Companion annual growth in the quarter was driven by increased sales of our two dermatology products, the impact of recent acquisitions, our parasiticides portfolio and a number of other inline products, including Cerenia and RIMADYL. U.S. dermatology sales were $133 million for the quarter growing 21%. Growth this quarter was driven by price and benefits from the direct to consumer advertising driving increased market share. Our parasiticides portfolio, including new products, such as Revolution Plus and ProHeart 12 and inline products, such as Simparica, contributed to strong companion animal growth. Positive companion animalperformance was partially offset by U.S. livestock declines in the quarters driven by cattle. Cattle product sales continued to be negatively impacted by unfavorable market conditions, driven by heavier and healthier animals coming in from pasture with a lower risk profile and pricing pressure driven by competition. Partially offsetting challenges in cattle was continued poultry growth, primarily from our portfolio of alternatives to antibiotics in medicated feed additives. We also benefited from new customer adoption and competitors having product efficacy and supply challenges. Swine also had a strong quarter returning to growth due to increase sales in medicated feed additives and vaccines. To summarize U.S. performance, innovation and returns on our investments drove positive results despite challenging market conditions impacting growth in cattle. Our international segment also contributed strong growth this quarter with operational revenue growth of 12%. Companion animal operational revenue growth was 26% and livestock operational growth was 5%. Companion animal growth was driven key dermatology products, growth in our parasiticides portfolio, including Simparica and our Stronghold franchise and legacy Abaxis products. International livestock also performed well, driven by growth in cattle, fish and poultry. This growth was partially offset by modest declines in swine due to the ongoing impact of African swine fever. Growth in cattle was due to favorable pricing, as well as increased feedlot placements in Australia, new customers in other developed and emerging markets and favorable conditions in key markets such as Mexico. The fish portfolio benefited from the continued uptake of the Alpha Flux parasiticide in Chile, while poultry growth was driven by price and increased sales of vaccines. As expected, swine remain challenged this quarter by the ongoing impact of African swine fever. We do see some positive signs, however, partially offsetting these declines with new markets launching our combination swine vaccines and growth in key accounts in China. Our outlook 2020 remains neutral to slightly positive for swine in China. In the near term, however, we remain confident that other regions and proteins will increase production to help mitigate the pork shortage and long-term industrialization of pork production in China will be a tailwind. Overall, our international segment continues to be a significant driver of growth supported by innovation and the diverse portfolio across products and geographies despite the impact of African swine fever. Now moving on to the rest of the P&L. Adjusted gross margin of 68.5% increased approximately 210 basis points in the quarter on a reported basis compared to the prior year. The increase was driven by foreign exchange, manufacturing cost efficiencies, product mix and price, partially offset by increased inventory charges. Total adjusted operating expenses grew 13% operationally. The increase was primarily related to compensation related expenses, the impact of recent acquisitions, direct-to-consumer advertising and investments to support future growth of the business. The adjusted effective tax rate for the quarter was 14.2%. The decrease from the comparable 2018 period is primarily related to non-recurring discrete tax benefits recorded in the fourth quarter of 2019, partially offset by the impact of the global intangible low tax income or GILTI tax, which is effective for Zoetis in 2019. Adjusted net income for the quarter grew 13% operationally, driven by strong revenue growth, favorability in gross margin and a lower effective tax rate. Adjusted diluted EPS grew 14% operationally compares to the same quarter in the prior year. Now moving onto guidance for 2020. Please note that guidance reflects foreign exchange rates as of late January. In 2020, we were projecting revenue between $6.65 billion and $6.8 billion, representing 7% to 9.5% operational growth. Foreign exchange is expected to be a headwind again next year of approximately 100 basis points. Innovation will be a key driver of growth next year, particularly in companion animal. Companion animal overall is expected to again outpace livestock, benefiting from our diverse parasiticide portfolio, key dermatology, diagnostics and strong market dynamics, including continued growth in emerging markets. And as Kristin mentioned, our guidance assumes an incremental $150 million in revenue related to Simparica Trio. This estimate represents revenue for roughly three quarters of the year. And in 2020, as Kristin indicated, we anticipate all livestock species returning to global growth. From a geographic perspective, we anticipate balanced growth between our U.S. and international segments. Adjusted cost of sales as a percentage of revenue is expected to be in the range of 30% to 31%, neutral to slightly increasing from 2019 due to unfavorable foreign exchange and mildly dilutive acquisitions, partially offset by price and positive mix. Adjusted SG&A expenses for the year are expected to be between $1.59 billion and $1.64 billion with an increase over 2019, focused on critical areas of revenue growth, including recent and future product launches, recent acquisitions and expansion into reference lab diagnostic, as well as the annualization of our U.S. field force expansion and direct-to-consumer advertising. Adjusted R&D expenses for 2020 are expected to be between $455 million and $475 million consistent with our commitment to invest in pipeline opportunities, both lifecycle and novel new therapies. Going into 2020, investment will be focused on delivering the next wave of high value innovation, including monoclonal antibody therapies for osteoarthritis pain in cats and dogs and new vaccines for poultry. We're also investing in strategic areas of focus, such as diagnostics, biodevices and precision livestock farming and strategies to maximize the value of the continual of care through integrated offerings. Adjusted interest and other income deductions is expected to be approximately $215 million with the increase over 2019, driven by reduced royalty income, as well as lower interest income. Our adjusted effective tax rate for 2020 is expected to be in the range of 20% to 21%. The increase in 2020 is related to the impact of favorable nonrecurring discrete items that occurred in 2019. Adjusted net income is expected to be in the range of $1.865 billion to $1.915 billion, representing operational growth of 8% to 11%. We remain committed to our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. However, as I highlighted growth in adjusted net income in 2020 will be negatively impacted by the higher effective tax rate, the limited gross margin expansion and strategic investments. For context, the higher effective tax rate in 2020 will negatively impact our adjusted net income growth by approximately 300 basis points. Consistent with 2019, we are anticipating elevated capital expenditures in 2020 to support investments in manufacturing focused on [technical difficulty] capacity increases and facilities to support pipeline opportunities. We're also investing in information technology to support our recent acquisitions, as well as digital capabilities and data analytics. We're also committed to our capital allocation priority of returning excess cash to shareholders that isn't deployed internally or for business development opportunities. To that end, we recently announced 22% increase in our dividend and we have approximately $1.7 billion remaining under our multi-year share repurchase program after repurchasing approximately $625 million in Zoetis shares in 2019. Finally, we expect adjusted diluted EPS to be in the range of $3.90 to $4 and reported diluted EPS to be in the range of $3.53 to $3.65. While our guidance represents full year expectations, we do anticipate Q1 to be slightly weaker in terms of revenue with limited growth in adjusted net income due to the timing of the Simparica Trio launch and the investment required to support the launch and recent acquisitions. Now to summarize before we move to Q&A. 2019 was another exceptional year in which we delivered 10% operational revenue growth and 14% operational growth and adjusted net income. Our guidance for 2020 underscores our ability to grow revenue organically, well above the market and grow adjusted net income faster than revenue. And our focus remains on delivering long term shareholder value through disciplined internal and external investments and returning excess cash to shareholders. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We’ll take our first question from Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : My question for you is, if you could provide more color on the headwinds and tailwinds and the macro outlook for animal health in 2020? Thank you. Kristin Peck : As we talked about, the overall market for 2020 in animal health is projected to grow at 4% to 5%, probably faster than that will be companion animal as we've seen in previous years. As we think about where Zoetis is coming in, we believe we’ll grow faster than that market, really driven by our innovation. Obviously, we've given guidance around the excitement around Simparica Trio, our paras and our derm portfolio. We see poultry growing faster than the market as well and Zoetis is growing faster than the market as well. We have some launches there, as well as the portfolio we have in poultry to help raise no antibiotics ever. We see cattle returning to growth in 2020, albeit slower than the overall market and we see Zoetis probably growing in line with the market overall and swine, we see returning to growth as well in 2020 and Zoetis is growing in line or faster. So as we see some of the headwinds though remain innovation overall as well as sort of a return to growth for livestock in general. Operator : And we'll take our next Jon Block wit Stifel. Please go ahead. Jon Block : You mentioned launching the Trio in Europe later this month. I guess anything you're willing to share on price of Trio, positioning in the market? In other words, what you guys can do to try to get the incremental revenue from the top two oral flea and tick products versus call it just partially cannibalizing Simparica? And then Glenn, one for you, when I look at that 2020 guide, it seems like revenue certainly ahead. The adjusted interest expense was above expectations. I think you alluded to less royalty income, what about just from a cash flow perspective? In other words in the guide, is there any assumed buyback or paydown of debt in there? Thanks for your time guys. Kristin Peck : I'll take the first and I'll let Glenn take the second question. We are expecting to be launching commercial launch in Europe in a few markets. This month, we will do phase one. So Italy, Spain, and UK, are launching this month in Europe. We are not first to market as many of in Europe. There are other products in the market. So to your point, it is a competitive position. We will be pricing, as we've spoken about before, at a premium to Simparica overall and really, as we look back the competitive side, it actually varies dramatically in Europe by market, with the different competitive products on the market overall. We remain excited for approval in Q1 in the U.S., and plan to launch shortly thereafter as is customer and as we spoken about another product launches, probably six to eight weeks after that. And in the U. S. as we spoken about, we should be first to market. Again, we'll plan to launch at a price premium to Simparica but at a discount probably, overall, if you look at it from the two products there. We’re focused very hard in the U.S. in gaining share. So we haven't gotten specific on overall pricing but it should be at a significant premium to Simparica today. But we haven't fully launched in the U.S., our pricing is not public yet in the U. S. So I'll let Glenn take the second question. Glenn David : From a revenue perspective, very excited about the expectations for revenue growth this year with growth of 7 to 9.5% and obviously, very excited about Simparica Trio as well. In terms of the bottom line growth of 8% to 11%, a little less of a differential from revenue that we typically expect, a lot of that being driven by the impact of the tax rate change year-over-year. Accounting for that impact, we have about another 300 basis point impact of growth at the bottom line and also, foreign exchange was negatively impacting us in terms of adjusted net income absolute number and that was about 200 basis point negative impact from foreign exchange. Specifically to your questions, there is no assumed payback or pay down of debt. And in terms of share repurchase, the number of shares that we assume in our EPS are the shares ending as of the end of December 2019. Operator : We'll take our next question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Just sticking on the Trio to round out those set of questions. You've been talking about it for a while, obviously, on the conference calls and early this year at VMX, we saw a pretty significant presence from you on the Trio. Have you seen any response from your competitors ahead of the launch in terms of either stuffing channel or giving any promotions with the Spectra product in Europe or even with standalone products in the U.S., taking any price actions or any combo or bundling actions in the U.S. to try to get ahead of the March launch as that stock up in the first quarter? And then just on the same line follow-up. What's your expectation for Trio impact on gross margins, Kristin just following up on your comments and how it's priced? And obviously, you have the API component of two different drugs in there. So net-net, what's going to be the impact on gross margins in 2020? And then even in the out years as volume ramps from the Trio products? Kristin Peck : This is the single biggest category in animal health or companion animal parasiticides. So it is a highly competitive space to exactly your point, it’s a $4 billion market in the U.S. alone, its $2.5 billion. So we are expecting a significant competitive response. This is a category that a lot of people will defend. We would expect normal CapEx, obviously, trying to stuff the channels or fill in and fill up the shelves as best they can. We're certainly expecting some of them to look at pricing programs, but we think there's significant excitement around the opportunity for a triple in the U.S. We’ve certainly heard it. We did not, as you saw at VMX, we didn’t have approval on this product. So we were not promoting this product at VMX. But there's a definite understanding that a triple is coming from us. I think customers are anticipating that and are very excited to have something new and innovative to share with their customers. So I think we're expecting whatever you normally see in a competitive response, but this is a major category. So our plans for launch, our revenue guidance we provided, was anticipating a significant competitive response in this area overall. So I'll turn it over to Glenn to take the gross margin implications on Trio. Glenn David : Yes, in terms of the impact on gross margin. For 2020, we expect it to be mildly beneficial to our overall gross margin. Obviously, as time goes on and we become more efficient in the production or operating at full capacity, we do expect this to be a higher margin product for us, and it will benefit our gross margin over time as we move beyond 2020. Operator : Our next question is from Erin Wright with Credit Suisse. Please go ahead. Erin Wright : Can you give us an update on the diagnostic strategy at this point? Do you expect continued inorganic activity in reference labs, both U.S. and globally, or is it more of an organic build at this point? And can you speak to some of the success you've seen already in the bundling across the portfolio between therapeutics and diagnostics? And then separate question on stocking. Were there any stocking dynamics worth noting in the quarter? And should we anticipate distributor stocking in the first or the second quarter for Simparica Trio? I guess I just want to make sure we're thinking about the quarterly progression appropriately there? Thanks. Kristin Peck : Sure, I'll take trio first. In Europe, we obviously did begin shipping in Europe to customers there. So you will see some stocking in Q1 there. In Q2, it will depend on exact timing, but there could be some shipments obviously in Q1 until we have an approval. As we said before, we won't be able to get very specific. But we're discussing weeks here and it just happens to be the timing in Q1. So it's hard to give you an exact guidance. But if you look at the $150 million guidance we gave you, it’s assuming we're selling for three quarters of the year, so there could be stocking obviously. But back to the diagnostic strategy overall, we remain very excited at diagnostics. For starter, it's a market growing at around 10% per year, so it's quite attractive. It continues to also drive use of our therapeutics and preventative. So it's exciting. So we look -- as we look into 2020, we're looking for double digit growth overall and Zoetis’ diagnostics portfolio, both in the U.S and abroad. We’ve spoken a lot about our point of care strategy. We're really focused there and increasing placements, as well as driving consumable use. As you look at the reference lab strategy, we have made a number of BD deals over the last three or four months in the U. S specifically. These are small deals as you've seen but we're looking to build a network. This will be in the U.S. a lot of organic builds from there, scaling the sites we have today, looking at some spoke sites as well. But I think you will see some BD as we look to grow into international. So this will continue to be a mix of organic and inorganic but again, very focused on ROI. We don’t see these as significant deals right now. We're looking at continuing to grow this over time, but great excitement. If you look at sort of some of our excitement ending 2019 and moving into 2020, we've been leveraging our FREEDOM FLEX program, which combines and offers opportunities across our core portfolio in diagnostics, and are very excited to add in reference lab into that opportunity as we look into 2020. Glenn David : And Erin just to add to the comments on the quarterly seasonalization and progression for Trio. As I mentioned in the prepared remarks, we would expect significantly more sales in Q2 for Trio and really you know that growing throughout the year. So we look at the overall progression of revenue for the company. We would expect Q1 to be slightly lower in terms of overall growth and then because of the investments that we're making in Q1 to support the launch of Trio, as well as some other strategic investments, we’d expect income to be relatively flat or to low single digits. Operator : Our next question comes from John Kreger with William Blair. Please go ahead. John Kreger : Kristin, can you just give us an update on the monoclonal products that you're talking about in cats and dogs. Where does that stand from a regulatory standpoint? And do you think they could be notable contributors in '21? Or is that more of kind of the late year launch of that? Thank you. Kristin Peck : In our Q2 2019 guidance, we indicated we have filed in both the EU and U.S., and we're expecting approval in 2021. It is obviously too early for us to be terribly specific as these regulatory views we wish we could predict with that level of precision. So it's probably a little early to be able to say whether or not we have failed in ‘21 or ’22. But you know these would be the first match reviewed by the FDA. So you know we want to make sure we give them that over time, and we have less understanding of exactly how fast that will be by file. We continue to be very excited, as we spoken about before, pain in cats is you know really there are no products today that adequately serve that market. So there's a lot of excitement as well as for the canine. So when we have more information there, we're happy to provide it but we remain excited. Operator : Our next question is from Chris Schott with JP Morgan. Please go ahead. Chris schott : Just two here, first on the reference lab and organic build in the U. S. from here. Just give us some sense of how long you envision that taking to fully build out your network and portfolio in terms of when this becomes, I guess a bigger piece of the offering? My second question was just on the gross margin dynamics in 2020. It seems like we have kind of mix going in your favor with the growth in companion. I think the guidance is suggesting flat to slightly declining gross margins? So a bit more color of what's happening there. And longer term, is it fair to still think about gross margin improvements as we see that companion pipeline continuing to ramp over time? Thanks very much. Kristin Peck : I'll take your first question and Glenn can take the second. If you look at reference lab build in the U. S., we think this is multiple years. We looked at scale in geographic as we've talked about, reference lab given the importance of logistics in reference lab, it is an MSA by MSA market and we're very focused on doing this and making sure we scale the sites that we opened. So we do believe this will take a number of years before we'll have a significant presence in the U. S. I would say the same for international. It'll be a buy and build. So to your point, I don't think this is something you're going to see really be a significant player within the next 12 months. But we're very excited about the long term growth in scaling in the markets we've entered and then adding folks there. But I'll turn it over to Glenn to take the gross margin in 2020 and beyond question. Chris schott : So in terms of the gross margins so stepping back to 2019, we benefited significantly from foreign exchange in 2019 to the tune of about 120 basis points. As we move into 2020 impact of that turns the other direction. We have approximately about a negative 50 basis point impact from foreign exchange on gross margin in 2020; so that all said, some of the favorability that we're seeing, A, from price but also from mix from a companion animal perspective. The other thing that you need to take into account is some of the acquisitions that we have completed, reference labs in particular and diagnostics, they do come in into slower or lower gross margin; so that all said, some of the mix favorability that we see companion animal. One more time, we do anticipate that we'll continue to see gross margin improvements, driven by the completion of our supply network strategy, as well as some continued improvements in price and to the extent that companion animal continues to grow faster than livestock that will benefit our margins. Operator : Your next question is from Kathy Miner with Cowen and Company. Please go ahead. Kathy Miner : Just one question. Could you comment on your China business, little more specifically give us color for the fourth quarter and also how do you see the corona virus impacting both business and your outlook for African swine fever? Thank you. Kristin Peck : Sure, I'll start on corona and then I'll let Glenn get more into specifics of performance and 2019 expectations. As everyone is watching, the corona virus is obviously emerging very quickly in the sense of certainly the news overnight. As we look at our business right now, it's probably too early to tell exactly what the impact will be, but let me talk a little bit about some of the risks that we're watching. First is just an overall economic slowdown, which is already driving some reduced overall consumption in animal proteins. As we’ve seen some of the hardest hit markets are hospitality and travel. So without that, there's a number of people obviously not eating protein. So it should affect consumption a little bit. How long this lap will really impact whether or not that's a significant driver or not. There's obviously some commercial risks, many of our fields are not able to get after veterinarians and many pet owners are not currently bringing their pets to veterinarians, giving some of the quarantine. But if quarantines lift or as that emerges, we'll watch that. We're obviously watching our supply chain. We do have a number of MFA -- APIs or active pharmaceutical ingredients that are produced in China for the world. We're very confident with most of them that we have adequate supply multiple months. So even if the ports did shut down, we should be fine unless that was extended. The ports are still open and they are still shipping. So we don't see right now at the moment any impacts or overall supply chain. We'll continue to monitor this. Obviously, last year the big impact was AFS, which we did see either flattening or returning to growth in China but obviously, that will be subject to the ability to continue to move both feed around China, as well as animal protein. So it's a little earlier to tell but hopefully that gives you a sense of some of the issues that we're tracking to get a sense. But it remains a significant market. I'll let Glenn sort of talk about performance and expectations for China overall. Glenn David : Yes, so when you look at China overall, I’ll start with full year and then talk a little bit about Q4. China for full year 2019 was about $200 million in revenue, which was essentially flat for the prior year, which is pretty impressive performance considering the impact of African swine fever, which we estimate to be greater than $50 million in 2019, and was really driven by rapid growth in companion animal. Companion animal now represents more than 50% of the overall revenue in China and is growing very rapidly. So the market performed very well even in the challenges of African swine fever. And I think you saw some of that, particularly in Q4 where we saw 10% growth in China in Q4 in operational perspective even with a negative $11 million impact from African swine fever. Operator : The next question is from David Westenberg with Guggenheim Securities. David Westenberg : So you're a competitor, one of the largest competitors in diagnostics has historically 3 three or 4 times the amount on R&D versus Abaxis. In order to close the competitive gap, do you think it simply requires scaling or do you think that you need to actually close the R&D gap longer term? And then to sticking with diagnostics with the acquisitions in reference lab, what kind of safeguards in place do you have to make sure that your sales force remains focused on selling your products with such a wide product bag? Thank you. Kristin Peck : So with your first question, I'm not sure, I know that there's a number of reports out on R&D, versus IDEXX, versus Zoetis. We have significant investments in R&D in our diagnostics portfolio. So I don't think we're looking at any incremental spending to close any perceived innovation or R&D gap there. You remember part of diagnostics has always been a core part of how we even develop the products we develop today, making sure that we can diagnose the diseases that we create treatments for. So we remain very confident in our R&D spend and the percentage dedicated to diagnostics and see significant synergy from an R&D perspective between our core portfolio of medicines, vaccines, et cetera with diagnostics. So no, we don't see that. As we look at the field force, we actually, again, we like to be solution selling as we've spoken about. So we go in and talk about a wellness visit of which diagnostic is a role. If we need to -- if we're looking to place new instruments or sign up somebody on a new reference lab offering, we bring in specialists, diagnostic specialists to do that. And then we have diagnostics, technical specialists who come in and maintain that equipment. So we do not believe it's distracting at all. We do believe once you played that equipment that our core representatives and strategic account managers can really help drive consumable use as they talk about a wellness visit and how they can combine and looking at vaccines, preventative and doing wellness screening in diagnostics. So we think it's actually quite synergistic. And we have experts that come into sort of help, focus sales and replacement of new equipment as well as in reference labs. So no, we don't see that as a big challenge. Operator : We'll take our next question from David Risinger with Morgan Stanley. Please go ahead. David Risinger : Thank you very much, and congrats, Kristin, to a very nice start to your new role as CEO. I wanted to just get a little bit better understanding of the finalization of the Simparica Trio approval. So what needs to be done at this point? I know that you're highly confident that it's imminent, but what steps need to take place? And then, I believe that you mentioned that you'll wait six to eight weeks after the approval to launch. And could you just explain that? I would have expected the launch to come much more quickly after the approval, given that it's highly anticipated. Thank you. Kristin Peck : Sure. I'll let Glenn take some of the specific details there. Glenn David : So in terms of Simparica Trio approval, as we said, we're in an administrative review period. All the technical sections are complete. So we're just awaiting final response from the regulators at this point in time. In terms of time frame of six to eight weeks from approval to launch, that's pretty typical within the industry. There are a number of things that need to occur. You need to find a label, you need to complete packaging of the product, you need to make sure you're building up the appropriate launch quantities. Obviously, we're doing that every day and we're looking to minimize that time of six to eight week period, but that is very typical within the industry in terms of approval the launch based on the activities that need to occur post-approval. Operator : The next question is from Gregg Gilbert with SunTrust. Please go ahead. Gregg Gilbert : Kristin, back to ASF. Kristin, has your thinking changed at all in terms of the overall impact of ASF and when that impact will begin to abate? And then, Glenn, can you talk about how much growth you're factoring for the derm portfolio in 2020 and maybe comment bigger picture on what inning you think we're in, in terms of realizing global peak sales for that portfolio? Thanks. Kristin Peck : I'll start with ASF. We do think it's the overall impact based on what we know today is leveling out in China. The real question is how fast will they rebuild the herds in China and how will China overall meet its animal consumption demand. So, as we sort of see it as we talked a little bit, we do think in China, specifically, you'll see flat- to low-single digit growth in our pork business there. I think you'll slowly see some of the more innovative technologically advanced industrialized production start with very strong biosecurity. You're starting to see some signs of this, but it's in fits and starts and it's a little hard right now with corona to understand how fast that will really evolve. But I think if you look at the broader impact of African Swine Fever, they are going to need to feed their people even if consumption is a little bit down. So I think you're going to see the impact of African Swine Fever in countries like the Brazil, the U.S. and EU as they look to meet that demand. There has been little volatility, obviously, given corona in pork prices more recently, but overall, they've been trending up. This will encourage producers to raise more pigs, raise heavier pigs. We are seeing significant increases in export at least in the U.S. already and Brazil into China. So I think you'll see that, which is one of the, we believe, the drivers of why we said we think livestock overall across species will return to growth in 2020, because China will either have to feed their population, some will come from internal, but they will need significant imports into China and that will continue to come from Brazil, the U.S. and the EU, both in pork, but we're also seeing potential opportunities in both poultry and beef. I'll let Glenn take the second question. Glenn David : So in terms of derm growth, so, A, just looking back at 2019, a really strong year for the derm portfolio in 2019. We grew 29% operationally, U.S. growing 25% and international growing 38%. We'd expect to have continued growth in 2020, not to that level as we're working off of a higher base, but the areas that we expect to exceed growth, A, international. We expect international continue to outpace the U.S. in terms of growth, just because currently, the mix of the revenue between U.S. and international is about two-third U.S., one-third international, although the number of medicalized dogs is pretty much equivalent between the two. So we would expect to gain market share in international as vets get more and more comfortable with the products internationally. And the U.S. has had the advantage of direct-to-consumer advertising, which is not available on all international markets. From the U.S. perspective, we continue to see opportunity in terms of continuing to expand the market, continuing to expand the usage into acute patients. And we still expect continue to get price in the U.S. as well. So we see 2020 has been another year of growth for the derm portfolio. But as the portfolio continues to mature, the pace of growth will slow. Operator : The next question is from Navin Jacob with UBS. Please go ahead. Prakhar Agarwal : Hi, this is Prakhar Agarwal on behalf of Navin. So, thanks for taking our questions. My first question is on the long-term opportunity for Simparica Trio. In the parasiticide space, the switch from topicals to orals was quite significant at greater than 70%. So, do you think the switch is a good analog for how much share could be switched over from the doublet to the triplet class or are we missing any dynamic? And secondly, on your Alpha Flux vaccine, do you have plans to launch this vaccine in Norway as well? And could you frame the market opportunity for this vaccine. Thank you. Kristin Peck : Sure, I'll start with the first one, and I'll let Glenn take the second one. So, as you look at the long-term opportunity for Trio, it's obviously significant, as we talked about, it is the single largest category in companion animal and certainly overall. It's a highly competitive category as well. So, we're very excited. We think that we will gain share as we think about the $150 million incremental for 2020. The assumption in that overall is we do not have competition in the U.S. in that year, it is already obviously competitive space in many markets outside the U.S. We think we'll get a movement obviously from -- some from OTC. We think we'll certainly see some cannibalization. We've spoken about from Simparica, but we also think it will take some of the other orals in the market overall. So from capital to oral is necessarily the best overall proxy and part of the long-term opportunity for Trio will also depend on our label versus the label of potential other competitors to come to the market as well as the distance between our launch and their launch. I know the favorite question is what are we expecting at competitor. As you know in our fleet, there is very little information available. One of those is a private company, the other one does not disclose. So, at the moment, we believe we'll be the only product on in the U.S. in 2020 and that is part of the assumption on the $150 million, but the longer we are, the greater the opportunity to gain share overall. We continue to see this as a significant innovation for both the pet owner and the vet and a lot of excitement around it. So, we'll be investing significantly in that. I'll turn it over to Glenn a little bit on Alpha Flux. Glenn David : So in terms of the fish portfolio for Q4, we saw very strong growth at 17% and Alpha Flux was a key contributor to that growth in the quarter, particularly in Chile. There is already a similar product on the market in Norway. So that would not be an incremental opportunity in terms of launching a new product in Norway. As we look into 2020, we continue to see the fish portfolio growing. There may be some limitation in terms of the number of salmon available to treat based on certain regulations, but we still see fish as a rapidly growing species for us in 2020. Operator : The next question is from Elliot Wilbur with Raymond James. Please go ahead. Elliot Wilbur : First question for Kristin, just want to ask you about longer-term R&D investment. At the midpoint of the guide for 2020 on a percentage basis, guidance would have you coming in below 7% and that number has trended down. On a relative basis, last couple of years, obviously, you've enjoyed strong growth. But as you think about driving -- or the need to invest to really drive more innovation, is a sub-7% R&D ratio sustainable? Or should we expect that to increase, perhaps as we start to see the top line decelerate a little bit in the next couple of years? Just a quick follow-up for Glenn. You mentioned the lower gross margin profile of the diagnostic businesses, but as we think about modeling segment margins, I would also presume that on an operating income basis, those businesses also have lower margins, but I want to confirm that. Thanks. Kristin Peck : On long-term R&D investment, we look every year as the portfolio of opportunities and innovation that we have ahead of us and invest based on where we see those opportunities. It does fluctuate a little bit year-to-year. It's been growing, I think, faster than our overall SG&A, not necessarily always at revenue growth. We are -- we've, I think, made very strong investments. As we see opportunities, we're more than happy to increase that R&D investment and have done so certainly quarter-to-quarter and year-to-year, but we are confident that the spend around where we are again, you should expect fluctuations year-to-year based on opportunities. Some of these studies can, especially in livestock, when you move them, they can drive significant costs year-to-year, but we are very confident that we have the right level of spend to drive our value proposition, significant top line growth at or faster than the market long-term in what we've provided overall. I'll see if Glenn wants to add anything to that and he can take the second question. Glenn David : So in terms of the question on operating margins for diagnostics, so gross margins will be lower over the long period of time for diagnostics. However, when you look at operating margin, obviously, right now we're in the build phase. So it's a little lower than our overall business. But as we're progressing over the next number of years, with the ability to leverage our commercial infrastructure, we do see the operating margins for diagnostics coming very close to our core portfolio as well. Operator : The next question is from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : So a couple of questions on the poultry side. One, Kristin, you spoke about your competitors add efficacy and supply challenges in the quarter. What -- can you throw some more light on what were these challenges and how prolong do you think this could be? And for 2020, would you still have been able to grow faster than market if these dislocations did not exist? Secondly, could you also throw some light on the market opportunity for vector vaccines and how should we think about the portfolio on revenue ramp from the segment? Kristin Peck : Sure. I'll let Glenn take these. Glenn David : So in terms of the poultry outlook, A, this year, we had very strong performance in poultry. We grew 10% for the year globally in poultry. And we see 2020 as being another very positive year for poultry growing much faster than the overall market and with our portfolio continuing to outpace the market. In terms of the vector vaccine, in 2019, we launched our first vector vaccine that really set the stage for us from an R&D perspective to continue to develop more and more vaccines over the next number of years for those to become a bigger section of our portfolio and we do see poultry continuing to be a rapidly growing market and we'll continue to invest in our R&D for that market. Operator : The next question is from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Just two quick ones on diagnostics. You talked about double-digit revenue growth in 2020, could you just maybe help us think about how much of the contribution you expect from the three reference lab deals that you've done and what you're kind of expecting for organic growth kind of ex those deals? And then, Glenn, I think you mentioned reference lab being a drag on margins -- gross margins in 2020. Could you maybe just give us some sense of magnitude and help us kind of get a better picture of what you're expecting for margins for the underlying business? Thank you. Kristin Peck : Sure. I'll take the first. Obviously, if you look at diagnostics overall, to be clear, we are expecting double-digit growth in our core point of care Zoetis diagnostics. That's not being driven by reference labs. Reference labs would be incremental to that. It's, again, I want to emphasize, still a pretty small part of our overall portfolio in the U.S., but we are expecting double-digit growth in both the U.S. and in international in the point of care space. But I'll let Glenn talk a little bit more about gross margin overall. Glenn David : From a gross margin perspective, again, overall on diagnostics, as we are expecting rapid growth in that area, it will be a negative driver of our overall gross margin as those products tend to be of a lower gross margin profile. When you look at the overall EPS impact, particularly to your question on reference labs, reference labs in 2020 is about a negative $0.03 to $0.04 impact on our overall EPS based on the investments we're making to grow that business for the future. Operator : The next question is from Kevin Ellich with Ace Research. Please go ahead. Kevin Ellich : So a lot of my questions have been asked, but just wanted to see if you could provide a little bit more in detail on what you're doing in the digital and data analytics and when we could see some material impact from those initiatives. Thanks. Kristin Peck : Digital and data analytics, obviously, is an important strategy of the Company. It's one of our five priorities as we move into 2020. I would say there's two components of that. One is, leveraging digital and data to drive greater sales of our core business. So, that's really focused around better targeting our customers, providing more personalized and customized solutions for them. So leveraging the data we have to better understand how they operate their business, what products will be most attractive, what offers will be most attractive to them. So, I think that will -- that's already in place and I think we're doing a very strong job both in the U.S. and international of leveraging some of those capabilities to drive our core business. We also see that opportunity in both pet care and livestock to create new revenue-generating solutions. Some of that in the pet care side will be around overall diagnostics opportunities and linking those opportunities to our core portfolio and providing incremental insights to our customers. In livestock, that remains as well around both our genetics portfolio as well as our precision livestock farming, which we see as a significant growth driver for us in the medium- to long-term. I think if you look at both the consumer preferences and where the industry is moving, it's moving more to individualized animal care. So, solutions such as what we have a Smartbow, which is ear tags for dairy cattle and better understanding the health and the productivity aspect of animals, individual animals and helping producers and veterinarians make better decisions in the short term is an opportunity, and as we link that to both our genetics business, which is you can also predict which animals will be born healthier and will have a better productivity. And then we see in the medium term the opportunity to link that as well to our diagnostics and really provide both veterinarians, producers, and consumers with better understanding and better health for animals. So, we think this will help drive our business. As we see some of those that you saw are more short-term opportunities, some are more medium term. And when I think about the connection between all three genetics, precision livestock, data in our core portfolio in diagnostics, that's probably more in the medium to long term. Operator : Next question is a follow-up from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Just had a quick one that keeps coming up. So I appreciate you squeezing me in. I've had a lot of questions on products coming off IP or potential generic competition or others. You talked a little bit about no expectation for a competitor, Simparica Trio, for example, but I was wondering if you have anything -- any expectations, any thoughts about a competing product in the derm portfolio in the U.S.? And also products like Draxxin, haven't had questions on IP rolling off there for a while. So, I'm just curious if you're seeing anything there or sort of what your expectations for that for 2020? Kristin Peck : As we look, I'll just start with derm. We obviously have very significant market for dermatology. We have been expecting competition will enter at some point. Based again in our industry, there's not great data, so I can't tell you exactly when competitor will launch. We are obviously planning for our competitor to launch in the next one to three years. Exactly when that will be, will be difficult for us to fully assess, but we do expect a potential small or large molecule entrant. We don't know exactly when that will be, but we have put plans in place to prepare for that overall as a key focus for us. And for Draxxin, we still have patent protection through 2021. This is a significant market. So, we again here expect we will see competition when does hit and when patent exclusivity runs out. That's a significant market. But as we said, what's different about animal health and human health is, even though we'll see obvious competition, we still think in our business that normally has an impact between 20% and 40% both in sort of market share and price over a number of years. So we do expect obviously a challenge in 2021 or 2022 on Draxxin. Operator : And it appears we have no further questions, I'll return the floor to you, Kristin, for closing remarks. Kristin Peck : Well, thanks very much for -- I appreciate all the great questions today and if you got any further questions please do ask them. Thanks so much. Operator : And this will conclude today’s program. Thank you for your participation. You may now disconnect and have a great day.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,020
| 2
|
2020Q2
|
2020Q1
|
2020-05-06
| 3.665
| 3.723
| 4.061
| 4.1
| 5.28669
| 32.95
| 25.81
|
Operator : Welcome to the First Quarter 2020 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you. Good morning, everyone. I hope you are all doing well. Welcome to the Zoetis first quarter 2020 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, 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 statement 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 in the company's 8-K filing dated today, May 6, 2020. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. Good morning, everyone. I hope you and your families are staying healthy and safe. I think it's fair to say the past few months have been unlike any we've ever experienced in business or that any of us could have imagined for our families, friends and communities. The global COVID-19 pandemic has had such an incredible impact on our world and for many of us personally. It has given me a chance to reflect, not just on the financial numbers we reported today, but on the true value our business provides society, the role we play in public health, the support we deliver for our customers in crisis and the safety and security we provide to our colleagues. For Zoetis, we're privileged to play an essential role in sustaining and protecting animal and human life during the outbreak. Our products and services play a critical part in animal health, helping support pet care and the food supply, and we've continued to manufacture products and serve customers even in places that have imposed stringent limits on businesses in the wake of the coronavirus. Our colleagues are more committed than ever to supporting the nutrition and comfort that animals provide the world and that purpose has motivated us to continue serving our customers and communities in these extraordinary times. I'm especially proud of the efforts of Zoetis colleagues in supporting our local communities, healthcare workers and businesses during the outbreak. We've been contributing surplus personal protective equipment from our operations. We've been increasing production of human health diagnostics and answering requests from local hospitals for a variety of assistance. As far as the direct impact of COVID-19 on our colleagues, we've been fortunate to see only a small number of COVID-19 cases in our workforce of more than 10,000 colleagues. Thanks to increased safety measures, hygiene protocols and adjustments to our operations. About 70% of our colleagues today are working remotely. They are being productive as they adjust to new arrangements, juggle new home and family responsibilities and benefit from the use of technology infrastructure that we've invested in and continue to enhance at this time. The other 30% of our colleagues are working at our sites supporting essential operations such as manufacturing, distribution and logistics, clinical trials and research and technical services and support for customers. Our teams in Zoetis sites are adhering to strict health and hygiene protocols recommended by the WHO and CDC. They're practicing social distancing, operating in staggered shifts and participating in health monitoring, all as part of the adjustments we've made at each plant to limit potential exposure. Our 30 manufacturing sites remain open around the globe today and we've been able to maintain supply of critical product inventories. We've also shown excellent agility to deal with the local market changes in terms of border controls, regulatory changes and freight operations. I'm also pleased to say that even under these difficult circumstances, we were able to meet our launch timing for Simparica Trio, our highly anticipated triple combination parasiticide. We launched Simparica Trio in the UK, Spain, and Italy in February. Made initial shipments for distribution in the U.S. in March and initiated the full launch in the U.S. and Canada in April, with more markets to follow. We've seen significant interest in Trio and we've been supporting its introduction with consumer ads in the U.S. this spring. While we're excited by the introduction and the receptiveness of customers and pet owners, we've had to revisit full year projections for Simparica Trio, given the expected impact of COVID-19 and the recession. Glenn will speak more to this in his remarks. We are grateful, we've been able to keep our major R&D programs on track. We continue to advance our research in key areas such as monoclonal antibodies for osteoarthritis pain in cats and dogs and vector vaccines for poultry. We're continuing with regulatory reviews, commissions are going in and we're maintaining momentum at our most critical projects for the future, all while keeping colleagues safe. From a P&L perspective, in the first quarter, the pandemic had a limited impact on our results given the February quarter-end for international markets and the timing of shelter in place across the U.S. We generated 7% operational growth in revenue and 10% operational growth in adjusted net income, thanks to the strength of our diverse portfolio and global scope of our business. We expect a more significant revenue impact from COVID-19 in Q2 and for the year as the lockdowns and recession have a continued impact on our business, especially in terms of traffic at companion animal clinics and reduction in demand for protein from their restaurant and dine out sectors. We will need to watch carefully how the reopening of various markets in the coming weeks impact veterinary services for companion animals as well as livestock. Glenn will discuss 2020 guidance in more detail in a few minutes, but I'm pleased to share that Zoetis remains a resilient company at times like these, given the essential nature of our business and our diverse portfolio. In most markets, our sales teams are working virtually to respect local government guidance and limit potential exposure of COVID-19 for colleagues and customers. We've been keeping in regular contact with our customers through phone calls, video conferences, webinars and surveys. And we're responding as best we can to anticipate and address their most important needs. We're here to help them maintain critical care and supply for their customers at this time and adapt to a new normal for the future of animal care. For example, we've been advising customers on increasing digital content for their use of pet owners, offering telemedicine solutions through new partnerships, discussing their liquidity concerns, offering continuing education for veterinary staff and providing technical support services to deal with adjustments being made to food production. We are seeing many of the trends you are in terms of animal health and food supply as well as decreased traffic to veterinary practices, but history tells us that animal health medicines, vaccines and other products remain essential even in a challenging economy. On the livestock side of the business, the need for food hasn't gone away, but with restaurants and hotels closed, consumer demand has shifted to supermarkets. There's less demand for beef and dairy products while poultry remains strong as people choose less expensive proteins. As with every front-line business today, the biggest challenge our livestock customers are having is maintaining their operations with enough healthy workers to handle processing, packing, and delivering food. On the pet side of the business, veterinary traffic is down in places where containment measures are in place. Now, many vets are leveraging curbside check-ins, home visits, telemedicine and online pharmacy distribution to take the place of in-clinic visits. As you look ahead, our business continuity plans are working well and we continue to show great agility and responsiveness to this crisis. We are carefully managing our expenses and doing scenario planning for the medium and long-term, including hiring freezes and rejections to discretionary spending such as travel, entertainment and consulting. We have not had to engage in furloughs or salary reductions for our colleagues. Thanks to the resiliency and diversification of our business and our strong balance sheet. We continue to regularly assess any long-term needs depending on the duration of the pandemic and the resulting recession. Like all companies, we begun planning for the days when more of our colleagues will return to the workplace. Over the last few months, we have safely maintained operations in our manufacturing distribution and R&D facilities to ensure continuous supply to our customers while maintaining strict quality standards and keeping our colleagues safe. We plan to leverage these enhanced policies and procedures for a phased return to work that helps ensure the safety of not just our colleagues, but the customers they interact within the field. I am proud of our teams for their resourcefulness, flexibility and commitment to colleagues and customers. Their efforts are helping us to envision an even better way to work over the long-term. When we began this year, my first as CEO, I laid out five priorities for Zoetis and those are as relevant today as they were then. Our priorities remain driving innovative growth, enhancing customer experience, leading in digital and data analytics, cultivating a high performing organization and championing a healthier, more sustainable future. As we managed through the crisis to this new normal, we will find relevant new ways to adapt our strategies and tactics for the future. Even in the midst of COVID-19, we continue to act on opportunities to advance these priorities. Since February, we received approval of Simparica Trio in the U.S. and Australia and have launched it in several markets with the support of direct-to-consumer advertising and digital marketing where applicable. We acquired Performance Livestock Analytics, a company which brings us proven cloud-based management systems and data analytics for beef producers. And we announced Pumpkin, a new pet health startup is offering pet insurance and preventative care in the U.S. Once again, I'm very proud of the results we've been able to deliver this quarter and I look forward to your questions. Now, let me hand over to Glenn for more detail on the first quarter results and our updated view for the rest of 2020. Glenn? Glenn David : Thank you, Kristin and good morning. Echoing Kristin’s comments, we find ourselves in a world we never imagined. I’m grateful for our colleagues as they balance new working arrangements, caring for their families, and keeping our essential business running during this crisis. Today I'll provide commentary on our Q1 results, provide clarity on our liquidity position and review our updated guidance for 2020. Historically, we know that Zoetis has remained a resilient company, given the essential nature of our business and our diverse portfolio. But no one yet knows the full extent, duration or implications that this pandemic will have. Our updated guidance reflects our best estimates based on what we know today. Beginning with the first quarter results, we generated revenue of $1.5 billion, representing an increase of 5% on a reported basis and 7% operationally. Adjusted net income of $455 million, increased 7% on a reported basis and 10% operationally. Foreign exchange in the quarter drove an unfavorable 2% impact on revenue, driven by the strengthening of the U.S. dollar. Operational revenue growth of 7% was driven by 3% price and 4% volume. Volume growth of 4% includes 2% from key dermatology products, 2% from new products, 1% from acquisitions, and a decline of 1% in other inline products. The first quarter was not materially impacted by the outbreak of COVID-19, given the February quarter end for our international markets and the timing of quarantine guidelines in the U.S. However, as indicated in our updated guidance ranges, we anticipate a more significant impact for the full year as the lockdowns and recessions have a continued impact on our business. Companion animal products led the way in terms of species growth, growing 10% operationally while livestock grew 3% operationally. Companion animal performance was driven by continued strength of our key dermatology products and parasiticide portfolio, which includes initial sales of Simparica Trio in both the U.S. and certain European markets. Revenue from the acquisition of Platinum Performance, which was acquired in the second half of 2019 and its nutritional products also contributed to strong equine growth. Livestock growth in the quarter was primarily driven by strong poultry, swine and fish performance partially offset by declines in cattle. New products contributed 2% to overall growth in the quarter, driven by some Simparica Trio and ProHeart 12 and our Alpha Flux parasiticide for fish in Chile. We remain very excited and confident in our ability to successfully launch Simparica Trio beginning with key markets in Europe and the U.S. However, we are now anticipating the incremental revenue for the full year to be in the range of $100 million to $125 million. The initial response from veterinarians has been extremely encouraging. However, due to the current COVID-19 situation, clinic penetration and adoption will be more gradual than initially expected. Global sales of our key dermatology portfolio were $194 million in the quarter, growing 25% operationally and contributing 2% to overall revenue growth. The ongoing strength of this portfolio was driven by expanded usage of APOQUEL, resulting from promotional investments, increased adoption of CYTOPOINT, as well as entry into new markets and price. Recent acquisitions and commercial agreements contributed 1% growth this quarter, which includes Platinum Performance, our reference lab acquisitions and the stable lab diagnostic test for equine. Other in-line products declined this quarter, primarily driven by declines in U.S. cattle related to ongoing beef and dairy market challenges. Now, let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 9% with companion animal products growing 12% and livestock products growing 5%. Companion animal growth in the quarter was driven by increased sales of our key dermatology products, growth of the Simparica franchise and the impact of recent acquisitions. This growth was partially offset by declines in point-of-care diagnostics. U.S. key dermatology sales were $136 million for the quarter, growing, 31%. Growth this quarter was driven by ongoing promotional investments and expanded usage of CYTOPOINT in the clinic. Simparica Trio revenue in the quarter included initial sales, the distribution channels with product becoming available to veterinarians for prescribing in mid-April. We're supporting the launch with strong field force engagement and direct-to-consumer advertising. We remain confident in the long-term success of this product, despite launching within the current environment. Diagnostic sales in the quarter were primarily impacted by distributor purchasing patterns and slower demands in March related to COVID-19. U.S. livestock returned to growth this quarter, supported by positive performance in poultry and swine, partially offset by cattle declines. Poultry continues to benefit from our portfolio of alternatives to antibiotics and medicated feed additives, driven by new customer adoption and efficacy challenges for a competitive product. Swine also had a strong quarter, driven by increased sales of any effectives and the one-time replenishment of a classical swine fever vaccine stockpile by the USDA. Cattle product sales continued to be negatively impacted by unfavorable beef market conditions driven by feedlot placements of heavier and healthier animals with a lower risk profile and dairy continue to face headwinds from negative producer profitability and oversupply. To summarize, U.S. performance was strong, despite ongoing challenges in U.S. and dairy cattle markets. Our International segment had operational revenue growth of 4% in the quarter. Companion animal operational revenue growth was 8% and livestock operational growth was 2%. Companion animal product growth resulted from increased sales of our Simparica franchise, including the launch of Simparica Trio in certain EU markets and growth in our key dermatology portfolio. New diagnostic customer accounts and strong performance in China also contributed to growth in the quarter, despite the impact of social distancing measures in China. International livestock growth in the quarter was driven primarily by swine, fish and poultry. Swine returned to growth in the quarter, due to expanding herd production and key account penetration across emerging markets including China. Our short-term outlook for China remains neutral to slightly positive as they rebuild due to lower incidents of African Swine Fever. However, certain smaller markets in Asia continue to experiences challenges related to ASF. The fish portfolio benefited from the continued uptake of the Alpha Flux parasiticide in Chile, while poultry growth was driven primarily by price. Overall, our International segment continued to be a positive contributor to revenue growth with all species flat to growing, including swine returning to growth even in the current challenging environment. Now moving on to the rest of the P&L. Adjusted gross margin of 70.3% increased slightly on a reported basis compared to the prior year, due to price partially offset by the mildly deluded impact of recent acquisitions. Total adjusted operating expenses grew 7% operationally. The increase was primarily related to the impact of recent acquisitions, investments to support future growth of the business and direct-to-consumer advertising. The adjusted effective tax rate for the quarter was 16.8%, the decrease from the comparable 2019 period is primarily driven by the tax benefits from share-based compensation. Adjusted net income for the quarter grew 10% operationally driven by revenue growth and a lower effective tax rate and adjusted diluted EPS grew 10% operationally. Next I'd like to cover our liquidity position and our capital allocation priorities. We ended the first quarter with approximately $2 billion in cash and cash equivalents, as well as access to $1 billion revolving credit facility and a coinciding commercial paper program, both of which are undrawn. Given a strong cash flow and balance sheet, we remain committed to our capital allocation priorities of internal investment, M&A and returning excess cash to shareholders. Consistent with what I mentioned last quarter, we are anticipating elevated capital expenditures this year to support investments in manufacturing, information technology to support our recent acquisitions and capabilities in digital and data analytics. However, we are delaying expenditures that will not materially impact our medium and long-term growth strategy. Our strong liquidity also allows us to be opportunistic and continue executing on our M&A strategy. In consistent with what I've said before, our focus is on strategic acquisitions, not large scale transformational M&A. Our recent acquisitions of Performance Livestock Analytics is a good example. With regards to returning excess cash to shareholders, we remain committed to our 2020 dividend, which represents a 22% increase over 2019. In Q1, we also repurchased $250 million in Zoetis shares and we have approximately $1.4 billion remaining under our multi-year share repurchase program. However, in light of the current situation, we have decided to temporarily suspend our share repurchases and conserve cash. Now moving on to our updated guidance assumptions for 2020. As I noted earlier, we cannot know the full extent of the COVID-19 pandemic, as the situation continues to evolve daily. Our updated guidance reflects our current assumptions and may change materially as the situation progresses. Our guidance assumes that the economy begins to open up in the second half of the year with pet care visits returning to more normalized levels as the year progresses and our livestock customers being able to maintain their operations. It also assumes a continued recession this year. We have increased the width of our ranges, as the timing of returning to normal operations and the depth of the recession is still uncertain. Please note that guidance reflects foreign exchange rates as of late April and movement in foreign exchange rate has had a significant impact on our revenue and adjusted net income, since prior guidance, given our global footprint. Our current guidance includes unstable foreign exchange revenue of approximately $150 million and approximately $50 million at adjusted net income, primarily driven by the Brazilian real, Mexican peso and the euro. We are now projecting revenue between $5.95 billion and $6.25 billion, representing a 2% operational decline to 3% operational growth. Adjusted cost of sales as a percentage of revenue is now expected to be in the range of 30.5% to 31.5%, increasing slightly from February guidance due to increased manufacturing and freight costs related to COVID-19. Adjusted SG&A expenses for the year are now expected to be between $1.455 billion and $1.545 billion with the decrease from the February guidance, driven by savings and compensation due to hiring freezes and reductions to discretionary spending, such as travel and entertainment and professional service spent. As Kristin indicated, our key R&D programs are progressing and so adjusted R&D expenses are now expected to be between $440 million and $465 million, consistent with our commitment to invest in pipeline opportunities. We're also continuing to invest in strategic areas of focus such as diagnostics, biodevices, and precision livestock farming and strategies to maximize the value of the continuum of care through integrated offerings. While we were taking measures to reduce expenses this year, we also remain committed to bring medium and long-term growth and value to our shareholders. Adjusted interest and other income deductions is now expected to be approximately $215 million with the increase over February guidance driven by lower interest income and other factors. Our adjusted effective tax rate for 2020 is expected to be in the range of 20% to 21%, consistent with February guidance. Adjusted net income is expected to be in a range of $1.52 billion to $1.64 billion representing an operational decline of 2% to 9%. Adjusted diluted EPS is expected to be in the range of $3.17 to $3.42 and reported diluted EPS is expected to be in the range of $2.80 to $3.07. While our guidance represents full year expectations, we do anticipate revenue and adjusted net income to be most significantly impacted in Q2, based upon quarantine and shelter in place guidelines that have been put in place in most major markets around the world and the economic impact of recession. We anticipate the second half of the year will be impacted, but to a lesser extent. Now to summarize, before we move to Q&A. Pre COVID-19, 2020 was off to a strong start and inline with our expectations, with 7% operational revenue growth and 10% operational growth and adjusted net income. The essential nature of our business, the diversity of our portfolio and the durability of our business will allow us to continue executing on our strategy during this period of uncertainty. We're confident, we'll be able to maintain strong liquidity and manage effectively through this challenging environment, given our strong cash flow and balance sheet, and despite managing our spend in the short-term as we navigate through the impact of the COVID-19 pandemic, we remain committed to medium and long-term profitable growth through responsible investment. Now, I have things over to the operator to open the line for your questions. Operator. Operator : [Operator Instructions] We'll go first to Michael Ryskin with Bank of America. Please go ahead, your line is open. Michael Ryskin : Thanks for taking the questions. I'll ask sort of a big picture one to get the ball wrong. Steve, Glenn, Kristin, you’ve all alluded to various expense on the economic impacts of the recession, both about the press release and in your prepared remarks. Could you just help us walk through the nuance of there and how you think about that affecting both the livestock markets and the companion animal market? Because as we think through it, all the other impacts through the livestock, slaughterhouse closures, the food service shift, the vet visits, that's still for the most part transient expected to bounce back later this year. But the recessionary impact on the guide, that's something that could very well persistent 2021 and 2022. So how do you think about that affecting the business, if you could offer any pointers related to 2008, 2009 that'd be really helpful as we walk through it. Thanks. Kristin Peck : Sure. Thanks, Mike. I'll talk a little bit about some of the broader trends and then I'll let Glenn talk a little bit about what that means overall and guidance and how that translates. If we start at the vet clinic side and the pet care side. Q1, there really was limited impact just given the timing of the quarantine decisions across the world, and China tended to rebound a little bit. As we moved into early April, we did see significant impacts about – to about 20% to 30% reduction in the U.S., and in Europe, 30% to 50%. The very good news right now is that those are turning around quite quickly. We're seeing a significant improvement both in the U.S. and Europe in overall clinic visits. And so our expectation is obviously, overall a week Q2, but that will improve in Q3 and Q4, also because we strongly believe that that's our – being very thoughtful about how they increase their business, leveraging telemedicine, curbside, drop off, lots of different strategies there. As you look at the livestock sector, I mean, there are two big trends impacting this. The first is the shift out of dine-out and into grocery stores. Historically that was about a 50-50 split. And now about 80% to 90% of consumption is coming out of grocery stores. Historically those supply chains were quite different. So the channel migration there has been a little challenging as you've seen. And the second trend there has been an exacerbated in the U.S. specifically around the reduction and the battery, and at this point about a 15% reduction of processing capacity, given some of the outbreaks at some of those sites, which continues to be obviously in the news every day. Again, the good news is that's a U.S. trend and that trend is not relevant internationally. But what we do see sort of in the medium term as we look into Q2, Q3, Q4, as this will put a pressure on our customers, on livestock producers, it is decreasing price and therefore their profitability. It's likely going to decrease their herd size and also put pressure on their import costs and potentially have them trade down. The question is, how fast that works through? It’s quick to work through that in poultry, a little more challenging in swine and in catalyst we’ve seen – that really is just exacerbating as Glenn mentioned in his remarks, a trend we've been seeing for awhile. We strongly believe the long-term fundamentals remain strong in all these sectors. So the animal protein consumption will continue to grow. So I think a lot of this is a more of an impact as we work through some of these dynamics this year and the humanization of pets has never been more important than it is now, as you’ve seeing on adoptions of animals, and in previous recessions it’s pretty resilient. But I'll let Glenn sort of talk through how he thinks about those trends as we did our guidance. Glenn David : Absolutely. Mike, to your question on the economic impacts of the recession, as we saw back in 2008, 2009, the animal health industry was essentially flat, showing strong resiliency. And then it had a pretty rapid bounce back in the next year growing around 7%. So in terms of the recessionary impacts, as Kristin said, the companion animal business, just due to a recession, we expect to be very resilient. We saw that back in 2008 and 2009, and the trends of pets becoming more part of the family has only continued even stronger there. In terms of the livestock area of the business, though, that's where the recession may have a larger impact. A, as people trade down to lower cost proteins, but also our livestock producers tend to go to cheaper products as their profitability is challenged, and we do provide premium products. So there will be some pricing challenges and just some overall challenges in the livestock industry more so than companion animal from a recession. Operator : We'll take our next question from Erin Wright with Credit Suisse. Please go ahead. Erin Wright : Great. Thanks. A couple of questions here on the companion animal side. How much did Simparica Trio stocking contribute in the quarter? And how should we be thinking about that quarterly cadence in light of some of the COVID dynamics for Simparica Trio? Is the $150 million target for Simparica Trio still intact? And can you speak to also some of the traction you're seeing across the alternative online channel in the companion animal segment just amidst COVID and some of the dynamics there? How big is that segment for you now? Thanks. Kristin Peck : Thanks, Erin. I'll start off and let Glenn build on it. We've been very excited at the very strong awareness and anticipation for the launch of the really innovative Simparica Trio. We did see stocking, as I think we mentioned in Q1, of around $15 million. That was really just the distribution. We did the full launch to vets and to customers in April, and we followed that shortly thereafter with a very strong direct-to-consumer advertising push, which has been very well received. We remain very excited about this product. However, we are cognizant that with the pandemic, social distancing as well as the recession, the outlook for 2020 will be adjusted. I'll let Glenn talk a little bit about that guidance. But outside the U.S., we launched in February in the U.K., Italy and Spain. We also recently launched in Canada. So we've remain very excited about the potential for this product, and we think we'll have a very good 2020, and we're pleased given – at the launch so far, and given what we're facing with the pandemic. But I'll let Glenn talk a little bit about the updated guidance. Glenn David : Yes. In term of the updated guidance for Simparica Trio, we've now brought our estimate down from $150 million in incremental sales to $100 million to $125 million, and that's really based on launching in the face of the COVID-19 pandemic. In terms of how we see the quarterly progression, we're not necessarily going to give quarterly forecast, but we did about $15 million in the quarter, and we do expect that to grow gradually over the year and to reflect more underlying demand throughout the year. To your question on the alternative channels, Erin, we are definitely seeing a ramp-up in alternative channels as a way for our customers to get their prescriptions filled. However, it's important to remember that, that is off of a relatively lower base still today. And also about 50% of our products do need to be administered within the clinic. So while we are seeing a rapid increase, it is off of a relatively small base. Operator : We’ll take our next question from Louise Chen with Cantor. Please go ahead. Louise Chen : Hi, thanks for taking my question. So we're seeing a lot of headlines around protein supply chain. Are these headlines mostly noise? Or do they concern you in any way? And could you give more color on your producer supply chain assumptions in your guidance? Thank you. Kristin Peck : Sure. Thanks, Louise. Unfortunately, I do not think they are noise, but they're indeed , very real to our customers. It is taking a large part of our field force and technical services supporting our customers through this. Shedding some of these packing plants and having 15% of the capacity of the U.S. packing taken offline, backs up significantly to our producers. They have nowhere to put animals. We are an economy in the livestock space that was just in time, and they were – trying to make sure they were as efficient as possible. So it is a quite serious issue for our producers, and it does have impact that will be important in 2020. It is decreasing the price that they're willing to pay. They don't need the animals. So they're paying less for them. That significantly hurts the profitability of our customers and certainly would courage them at this point to reduce herd sizes. So it does have an impact. As I was trying to express before, some of that impact, as you look at it, it can be turned around quite quickly in poultry, where 43 days, you can make some new decisions there to expand production. There's a little more time in pork. The effects took a lot longer to work through in the beef side. So we do think they will have an impact in 2020 significantly on the livestock side that was baked into the guidance we provided. But I'll let Glenn talk a little bit more to that. Glenn David : Yes, to Kristin's point, we did bake this into the guidance. Now when you look at our guidance, we do expect that Q2 will be more severely impacted. So the challenges that we're seeing now in livestock with the plant closures are baked in, and we do expect that Q2 will be more severely impacted for livestock and also for companion animal as well as this is when we see the clinic visit probably at their lowest in Q2. When we look toward the full year guidance range, the higher end of our ranges do assume that our producer customers are able to return to more normal operations throughout the second half of the year. Operator : We'll take our next question from John Kreger with William Blair. Please go ahead. Jon Kaufman : Hi, good morning. This is Jon Kaufman on for Kreger. Thank you for taking the question. So one on the Pumpkin insurance launch. Can you talk about your pricing strategy here? How do your prices and coverage compare to others in the market? And on the preventive aspect of this, the direct-to-pet owner shipping. Is there a chance that you risk anchoring veterinarians because you're taking parasiticide sales out of the clinic? Or will there be some sort of reimbursement of that's related to these scripts? And then just another quick one here. I don't think I heard the dermatology sales breakout between U.S. and international. Can you provide those? Thank you. Kristin Peck : Sure. I’ll start on Pumpkin, and then Glenn can follow-up on the derm question, John. We're very excited about the launch of Pumpkin. I think it's actually never been more relevant than it is as we enter a recession. The focus of the Pumpkin insurance and preventative plans is really increasing access to care. It's one of the biggest issues that pet owners have and their vet struggle with is, what's the price? Can they get a pet and can they afford care? And really the new value proposition that we were trying to offer vets and pet owners is a real focus on preventative. So our plan is unique and it really helps cover it completely two to three core vaccines for dogs and for cats, parasiticides for the year and that wellness visit, which is an important part. Many pet owners didn't want to get pet insurance in the U.S. because they felt like it only paid "if their animal got sick". And under the new wave that we have combined the insurance and the preventative care plan, we think pet owners will see the value at day one. And so although there are some changes to where that goes for a vet clinic, ensuring that those animals will be coming in regularly because that is a visit that's paid for, for the vaccines and the wellness visits and the parasiticides, we think, really does help the veterinarian. So as we sat down, I think there was a lot of – I think, from some of our competitors, noise around that when it first launched. But as we sat down to explain the vet, what we're paying for overall in a wellness visit, how we'll be encouraging that, how we'll be covering vaccines. I think veterinarians are quite excited at the opportunity as many new people have adopted pets. And the opportunity in the space overall, in the U.S., with penetration levels of pet insurance very low at 2%, 3% versus the rest of the world at 20%, 30%, 40%, is significant And we think, especially going into recession, this is an important part of ensuring that pets get the care and that they go to the vet to get that care. So I'll turn it over to Glenn to comment on the derm. Glenn David : Yes. So in terms of the total derm sales breakout. So for the year, total was – for the quarter, total was $194 million with 25% growth, U.S. was $136 million with 31% growth and international was $28 million with 14% growth. Operator : Thank you. We’ll go next to Jon Block with Stifel. Please go ahead. Jon Block : Thanks, guys. Good morning. I'll ask both upfront. Kristin, maybe the first one for you. I may have missed it, but I don't think I heard a revised market growth figure versus the previous 4% to 5%, is there one there? And then if so, is your 0.5% operational midpoint, call it, still above market expectations? And then the second one, Glenn, just the flowdown in EPS was a little bit more – was little bit bigger than what we were expecting. So any color on the decremental margins as we think on how it impacted the P&L? I'm guessing maybe part of that is FX, but any color you can provide would be helpful. Thanks guys. Kristin Peck : Sure, John. Great question. No, you did not miss the what is the new market projection to be. The groups that project the market growth, obviously, has not been able to do that yet, and this is a fast emerging. So there is no general sense. As we look at it, we continue to see that pet care will probably have the strongest growth globally overall, followed by poultry. As we look at the swine growth overall, although that we're seeing significant impacts in the U.S. right now, given ASF in China and really the strong demand that China is going to continue to have to import swine, we think swine will likely be okay. It will probably have some impact but will do better. And we see the greatest impact overall in cattle. As you look at our business, we're about 50% companion animal, 50% livestock. So it really – we haven't seen updated market growth numbers to how we compare to that. But we think we will be doing better than the market. And I think it might be helpful. Glenn can talk a little bit about you use the midpoint of the range, but we'll talk a little bit what the assumptions are for us at the high end of the range and what the assumptions are at the lower end of the range to help you better navigate that. So I'll let Glenn take that question as well as the EPS. Glenn David : Yes. So John, when you look at the flow down to EPS, there are a couple of things that I want to point out. A, cost of goods is up since the last guidance, right, by about 50 basis points at the midpoint. Big part of that is driven by COVID-19 and some incremental freight costs. Those incremental costs, we expect to have to pay our suppliers for some of our key ingredients for the product. So that's one area that impacts the flow down to the bottom line. We did take cuts in SG&A about $100 million at the midpoint, as we've discussed. Well, we also do have additional interest expense. The previous guidance was $215 million. Current guidance is approximately $250 million, and that does take into account the fact that we will earn less interest income on our cash. And it also does contemplate that we may incur some additional debt throughout the year. So it's really the cost of goods and the interest expense that offsets some of the benefits that we were seeing in the other expense line that are impacting the EPS. Operator : We'll go next to Chris Schott with JPMorgan. Please go ahead. Chris Schott : Hi, great. Thanks so much for the questions. Maybe just the first one, just a clarification on the top line guidance update. I know you've touched on this on a high level, but can you just quantify how much of the sales revision are these kind of near-term COVID disruptions? Are people just not able to get to production sites and not able to see the vets versus how much is longer-term recession-related headwind? And maybe in the same vein, how much of the reduction is livestock versus companion? Is it 50-50? Is it 60-40? Any color there? My second kind of bigger picture question was on the companion side of the business and how sensitive that part of the portfolio is to a recession. Is that should we think about that business being more insulated than livestock? Or is there also some potential sensitivity we have to think about on that portion of the portfolio? Thanks so much. Kristin Peck : Sure. I'll take pet care, and then Glenn can take overall guidance. With regards to pet care, in previous recessions, it has been a very resilient industry, and we think it will continue to be. I think if you look at the hit in Q2, it really obviously, recession impacts it, but less than most other sectors. But Q2 with people not going to the vet, which is not necessarily right now in Q2 recession, it was more related to the pandemic and the quarantine situation. And as you look at it, we still have a very strong portfolio that doesn't even require you to go to the vet. So even vet visit isn't always a great proxy for our business, since a lot of our products can be bought online. But there are a percentage of our business that's more in clinic. We're seeing much greater impact, for example, in diagnostics. But for us, diagnostics is only 5% of our business. So we do think pet care will be quite resilient in the medium to long-term and will bounce back. And it has historically, as Glenn mentioned, been quite resilient historically. But I think Glenn can do a good job of putting in context our assumptions as if we trend through the year at the high end of the guidance versus the low end of the guidance for both pet care and livestock. Glenn David : Yes. So Chris, I'll just address your first question, and then we'll get into a little more of the details on the guidance. So in terms of COVID versus the recession, obviously, we think Q2 will be the most severely impacted, and COVID will be a big driver of that in both livestock and companion animal. In terms of then going forward, we do expect an impact from the recession, and we do expect that the recessionary impact will be more impactful on livestock than companion animal based on the reasons that Kristin just shared. However, I think when you look at the overall guidance, right, we did do a bottoms-up analysis to inform the guidance range because we do believe that the people in the markets are closest to this and have the best information. And what we got back was pretty clear that Q2 will be the hardest hit due to the impact of social distancing and the recession and the fact that the companion animal visits will be lowest in Q2, and livestock plant closures will also impact the livestock side of the business. When you look at the second half of the year, the high end of the guidance range assumes that the recessionary impacts continue, but that companion animal visits return to more normalized levels and that our livestock producers return to full operations. If you look at the lower end of the revenue range, that really assumes a very deep recession and also contemplates a potential second wave of the virus with social distancing measures negatively impacting both companion animal and livestock further in the second half of the year. So we're really just trying to be very transparent with investors as we always do, which is why we chose to provide the guidance with a broader range. However, as we look to the long-term future of both the industry and our business, we do expect that we will return to more normalized growth rates that we see in terms of revenue. Operator : Our next question comes from David Westenberg with Guggenheim Securities. Please go ahead. David Westenberg : Hi. Thanks for taking the question. So I know you mentioned that, the online alternative channels is a little bit more of a low base, but we have seen a speed up in the adoption curve of online pharmacies. Now as we look to compliance in maybe the back half of the year, I mean, do you think – could we see maybe some upside from reorders that we not – would normally not see? And then my second question is a little bit more continued granularity on the guidance. So when we're looking at – in the last week, I think I've seen some data and talking to clinics about normalization almost in the last week. So when we're looking at Q2, I mean, should we assume the last couple of weeks is something that could happen in Q2? And I know that your crystal ball might not necessarily be perfect here. But just as we're modeling that, it's moving so fast, and it does seem like there's some positive bounce back in the last week. I just want to be fairly accurate in the way we're modeling that, so, thank you. Kristin Peck : Thanks, David. I'll start with the online channels, and I'll let Glenn pick up your question on the more detailed guidance and what you're seeing as the trends right now in vet visits. The online channels have been a significant trend. I'd say from a few different places. And if they continue, I do think there is an upside with regards to compliance. We've seen a significant uptick in vets signing up for Covetrus as vet's first choice and vet source to make sure that their pet owners get their products, if they – even if they feel uncomfortable coming into the vet. We have seen – and they publish as well studies that once you get a customer on to your online home delivery that their compliance goes up, because it ships once a month and there's less of the stress. So we do think that's a potential upside. And again, it really just accelerated a trend that we thought would happen, but we have seen significant growth in that channel for us. And I think that's why, as I said before, our portfolio has been more resilient in some other companies, as many of our products you can get from home delivery. The other big channel that's been quite – growing quite quickly for us remains e-commerce. So Chewy has also increased its sales dramatically with us. Again, I want to go back to Glenn's earlier point. This is off a very low base. This was historically a very small percentage. It is growing very quickly and we do think, especially now consumers would like to get more shipped directly to them. So I think this is a trend that we're going to continue to see. And we do think it does have the upside over the medium term to improve compliance overall with pet owners. So that is a potential upside. I'll let Glenn take the rest of your questions with regards to guidance. Glenn David : Yes. So in terms of guidance and for Q2 in particular, in some of the trends that we're seeing in the more current weeks, I think it's important, a, to break it out between the U.S. and international. So again, reminding because of our international close, Q2 for us will be the month of March, April and May. So recovery in terms of visits, we'll have a smaller benefit in international because it only applies to the end of April and early May. When you look at the U.S. however, in early April we were seeing visits down 20% to 30%. But to your point, we have seen those numbers begin to rise pretty significantly. And to the extent that that continues, that could limit the impact that we would expect to see in Q2, particularly on the companion animal side of the business. So those are positive trends and we hope that those trends do continue. Operator : Our next question is from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi, good morning. Thanks for taking the questions. So Kristin could I – we're discussed much about the near-term impact in with what we're likely to see in Q2 and Q3. Can I take a step back here and ask you about the longer term implications of COVID-19 on both livestock and companion animal side? How do you think about the change in industry dynamics here with user behavior, veterinary practices, meat producers and what it means more importantly for the long-term industry growth numbers that were discussed in both the companion animal and livestock side? Thanks. Kristin Peck : Thanks. Absolutely, we very much still believe the longer term trends for this industry are very strong. If you look at the trend of the humanization of pets, I actually think has been accelerated. So as you look at the next few years of people likely spending more time at home, less travel, maybe potentially working from home more. They're around their pets longer, they tend to therefore want to take better care of them. They also tend to notice issues before they might have noticed them historically. So we think really the long-term trend here is very positive. And we'll continue the humanization of pets. And the only thing that will temper that is obviously a recession. But again, as we said in previous recessions, there has been quite a resilient space. I think as you look at the longer term trend in livestock, I think for the next, say as we've talked about this year, there's some significant impacts to many of our producers. But over the medium to long-term, feeding the world is an important secular trend that is not going to change. So supply chains will realign themselves so that it's more – it goes to the grocery store, we'll be better aligned to do that. They'll change it in the sense of dine-in, dine-out. They'll also evolve across species. So it may be that you will see poultry and pork do better over the short to medium-term. But in the end of the day, as we've seen over and over again in other crises and recessions, feeding the world is a strong secular trend. So we remain quite optimistic for the industry and specifically for our portfolio. If you look at our portfolio, it's very diversified and that has been very good for us over the years with about half in the U.S., half outside the U.S. with a 50/50 split between livestock and companion animals and watching that evolve. So we're very optimistic, continue to believe that the industry and more importantly, Zoetis will be resilient. Operator : Next question is from David Risinger with Morgan Stanley. Please go ahead. David Risinger : Thanks very much. Sorry about that. So congrats on the Pumpkin innovative and compelling offering, it certainly differentiated. Could you help us understand the insurance element of the promotional offering including acute illness coverage and exactly what Zoetis is pitching to pet owners with respect to the insurance aspect? And then just a side comment with respect to the second wave that you're modeling, you're assuming that second wave in the fourth quarter, not this summer. Correct? Kristin Peck : Okay. So I'll start with the insurance. I'll let Glenn take the question on the second wave. We're very excited about Pumpkin. What we think truly differentiates it is a preventative wellness plan. The insurance, again, we are not taking underwriting risk in this that is taken by Crum & Forster. I can't get into comparing individual plans. Obviously, it would depend on your pet, its age, as always all insurance does. I would say the insurance is a very strong insurance plans, but there's many comparable ones on the insurance. The unique part of the offering is the real focus on the additional preventative wellness plans or I think we have a very unique offering there and it's quite differentiated. But from an insurance perspective, it's quite competitive with other things out there. I wouldn't say the insurance alone is as differentiated. I would say how we work with our customers, the customer experience is quite differentiated. If you've checked it out and gone to the website, we're trying to make it easier for pet owners, simpler to understand, simpler to file claims. So we're really looking to innovate on user experience with regards to the insurance part of it. But the plan itself is comparable. What's really different is the additional preventative wellness plan, which I think is quite different. But I'll let Glenn take the question on the second wave. Glenn David : Yes. And in terms of the second wave, again, that's one of the assumptions within the lower end of our guidance range. We would anticipate that that would occur later in the year. Not necessarily in the coming months. Operator : We'll go next to Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Good morning. Just two quick questions for me. First, Kristin, just going back to your comment on Simparica Trio, could you maybe share some of the initial feedback that you've gotten from that? And how receptive do you think they might need to kind of using this product as the year-round treatment and potentially kind of switching has midyear. And then have you seen any change in your response from competitors that’s factored into your outlook? That's kind of the first question. The second question for Glenn, I think the companion animal growth rate internationally I think slowed a little bit from what the recent trend has been. Could you maybe just go into more details on what you saw there on the quarter? Kristin Peck : Sure. Thanks Nathan. If you look at Trio, we think our customers have been quite receptive. They've been excited. This has been a highly anticipated product and the reception from many of our vets having something exciting and new to discuss with their pet owners to make sure that they can take care of a deadly disease like heartworm. And combine that with one of the best flea and tick products. It's been quite positive. We've been seeing a pickup even more in the last few weeks as vets have had more time to engage. So, honestly, from the market – the vets have been very excited. We've seen great receptivity to our direct-to-consumer advertising. As we saw from some of our competitors, they did exactly what we expected. They definitely build the channel with as much product as they could in Q1 before our launch, as we had talked about at our Q4 call that was anticipated. And obviously, they will come after us, as they should. This is the single largest sector as you know in animal health and in the U.S. alone it’s a $2.5 billion market. So we're really excited. We continue to see, as you saw our guidance that this will drive significant growth for us overall as a company and certainly in the U.S. And we have been very pleased with the receptivity of both vets and pet owners to this new innovation. So Glenn, do you want to take this companion animal question? Glenn David : Yes. So in terms of a companion animal in the international market, so we did see good growth of 8% in companion animal in the international markets. There were a couple of things that did factor into limiting that growth to some degree. So a, China grew 8%, which was actually a little below our expectations because of the impact of COVID-19 and the timing of COVID-19 within that market. We also did see declines in markets such as Italy and Canada. Italy was changed – was impacted by some changes in prescribing laws that we think again will recover it through the rest of the year. Whereas Canada was impacted somewhat by the timing of the launch of Simparica Trio, there was a hold on some of the sales for Simparica Trio from our customers in anticipation of Simparica Trio being provided shortly thereafter. Operator : The next question is from Kathy Miner with Cowen and Company. Please go ahead. Kathy Miner : Thank you for taking the question. Just going to follow up a little bit more on the dermatology business, specifically, was there any stocking of Apoquel in the first quarter? And second of all, can you comment on Cytopoint, you've indicated that there was growth in the quarter and since this is a vet visit kind of product, just talk about those dynamics and how you see that as we get into Q2 and later in the year? And if there's any difference in this U.S. versus O-U.S. also. Thank you. Glenn David : Sure. So from Apoquel perspective and just from a broader companion animal perspective, we did not see stocking within the quarter. This is something that we monitor and manage very closely and we prefer ourselves to mirror our underlying demand. So we did not see significant stocking in the quarter of any extent. And when you look at the breakout between Apoquel and Cytopoint, they both perform very well in the quarter, but Cytopoint did actually grow more rapidly as we think the convenience and the compliance and the fact that it is administered in the clinic certainly does help Cytopoint. We also saw very rapid growth in Cytopoint in international, growing approximately 71% as it was introduced in new markets as well so very strong performance across the entire portfolio of both Cytopoint and Apoquel. Operator : Our next question is from Elliot Wilbur with Raymond James. Please go ahead. Elliot Wilbur : Thanks. Good morning. Question on return to baseline or normalcy trends in terms of vet visits on the companion animal side. Assuming that, in effect, does happen near year-end or sometime in the second half of 2020 at least, how are you thinking about and how should we think about revenue per visit? Is there a possibility of a trade-down effect? Is that something that you've incorporated into expectations? And maybe any color from – experienced during the Great recession with respect to that aspect of vet visits would be helpful. And just real quickly, if you could – could you just remind us of the relative margins within the livestock business between cattle versus swine and poultry? Thanks. Glenn David : Sure. So in terms of the relative margins across the livestock business, they actually are starting to converge across them. But in general, cattle is a higher margin, then comes swine and then comes poultry, but they're all relatively close. And then in terms of the revenue per visit. So, a, in the first quarter, we did see very positive trends in terms of revenue per visit in companion animal. We get most of that data honestly within the U.S. So we haven't seen anything telling us that revenue per visit is declining significantly, but that is something that we will track throughout the year, but we have no data that indicates that, that is a trend that should reverse at any time soon. Operator : Thank you. We'll go next to Greg Gilbert with SunTrust. Please go ahead. Greg Gilbert : Thank you. I know that you and others are offering telehealth to vet customers. Can you talk about how that's being embraced and how that could affect the business longer term? And then secondly, what are you seeing in Asia? I realize it's early days, but what are you seeing in terms of a return to normal or an attempt to return to normal both from your own employee base as well as the customer base. In the U.S., we see a lot of companies guiding to some return to normal for their business by year-end, but those companies that are guiding have employees who are terrified to go back to work anytime soon. So just trying to – maybe that's a very U.S. sort of New York centric way of thinking. But I'm hoping you can offer some color from a more global perspective. Thanks. Kristin Peck : Sure. Thanks so much, Greg. I'll start with looking at China. China really has come back. They have about 80% to 90% of vet clinics are now open. And they are seeing pet owners return, but they do – the pet owners do remain cautious. So I wouldn't say it's at exactly the same level. But if you look at – and we have significant operations in China. We are continuing to operate our manufacturing sites and other sites there. And our experience there is the measures that the government has put in place to control the virus and to do staggered shifts, et cetera and track and trace are not measures that so far, most of Europe and the U.S. are willing or are able to implement anyway. The ability to look at that as a proxy, we don't think that is a good proxy for what a return to the workplace looks like in the U.S. and in Europe. They're just – what they've done there is quite different. We did see a strong growth in China. As you look at Q1, they grew 13%, with 19% in livestock and 9% in companion animal. But we caution that looking at China and extrapolating to the rest of the world is probably not the best strategy. We do see and we've put a lot of focus in what a return to work looks like. We are leveraging our experience in our manufacturing sites, distribution and R&D sites that have been operational as an essential business throughout. And our plan is to leverage those learnings, where we looked at implementing health and hygiene measures such as social distancing, increased sanitization, temp checks and staggered shifts, and that is certainly the way we're looking to do that in the U.S. I think we talk a lot about office-based colleagues but field-based colleagues is another big category for us. And so we think it's going to take a little longer, and we'll obviously be leveraging other opportunities such as telehealth with – and webinars and things like that with our customers. We need to make sure that as our colleagues return, the customers are comfortable too. It's got to be two-sided. And with regards to your question, specifically on telehealth, we did see a quick uptick initially. It is a process change for clinics. So whether or not and at what level that really continues to take off, it's still early days. I've actually been doing a telehealth visit. I'd say it does help the vet do really simple checkups on a procedure to just make sure the pet’s okay. Remotely, it is actually more efficient and to get them paid for something that sometimes they call a customer and they were never paid for. So I do think it will take off, but it is a big process flow change for the vet and even integration to the system. So I think it will take a little time to see how fast that picks up. But we've heard a positive reception for most of our customers who've started to adopt it, but it does take a little time. Operator : We'll take the next question from Navin Jacob with UBS. Please go ahead. Navin, check the mute button on your phone. Your line is open. We’ll go to the next one. We'll go next to Michael Ryskin with a follow-up. Please go ahead. Michael Ryskin : On channel and your opportunity to move over there. Could you just given us an overview of the companion animal product portfolio you have now between vaccines and other injectables like Cytopoint? There's a large part of the product that simply cannot be moved on. And then on the other hand, you have parasiticides, growing presence there, Apoquel, other products that with a prescription, you can get it from Chewy and from other sites. Could you just discuss how Zoetis is positioned here in the online channel? And sort of big picture, do you anticipate COVID could drive a longer-term shift to more online pharmacy purchases, as opposed to people going to the vet. If people are trying to continue to practice some social distancing longer term? Kristin Peck : Sure. As we look at our portfolio, the first thing I'd start with is almost all of our portfolio does require a prescription. So the vet will remain at the center of anything that happens. But to your question of sort of where they get products over whether it's in the clinic, through home delivery, via the clinic website or through Chewy, is really a focus. As you look about our portfolio, about 50% of our portfolio generally would be given in clinic. That would be a vaccine, an injectable, a surgical, something for urgent care, et cetera, and about 50% of our portfolio could eventually go to home delivery or online. And I think you're seeing the acceleration of that as we look at the sort of the pandemic impact overall in Q1. And I think that will continue to accelerate. But if you look at a lot of this, it still requires a wellness visit, it still requires a prescription. So the vet will stay center. But I do think you're seeing a real acceleration in home delivery and in places like Chewy. It has the upside of driving compliance, as we've talked about before and we do believe it will. We'll see how fast it continues to go. But I think once you get a customer in the habit of a monthly home delivery, it certainly makes their lives easier. And it will drive compliance overall. Operator : And it appears we have no further questions. I'll return the floor to you, Kristin, for closing remarks. Kristin Peck : Thanks so much. These are certainly unprecedented times. But the one thing, as I started out with, Zoetis as an essential business has also been a quite resilient company, and I'm quite proud of what our colleagues across the world have done to ensure that they've taken care of each other and supported our customers. Medicines, vaccines, diagnostics and many of our solutions will remain essential in the months and years to come. We think Zoetis has a diverse portfolio that addresses a broad spectrum of needs, and given the diversification of our portfolio and our very strong balance sheet, we believe that Zoetis is strongly positioned to manage certainly over this year and in the years to come. We're driven by two very important secular trends, both the humanization of pets and ensuring we feed the world. So we remain quite optimistic as we look to the end of 2020 and 2021 that Zoetis and our industry will continue to be essential and resilient. Thanks so much for joining us today. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,020
| 3
|
2020Q3
|
2020Q2
|
2020-08-06
| 3.612
| 3.495
| 3.849
| 3.67
| 5.53446
| 31.9
| 37.27
|
Operator : Welcome to the Second Quarter 2020 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer and will not be forwarded automatically. In addition, a replay of this call will be made available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time all participants have been placed in a listen-only mode and the floor will be opened for questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steven Frank : Good morning, everyone and welcome to the Zoetis’ second quarter 2020 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, 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 statement 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 in the company's 8-K filing dated today, August 6, 2020. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. Good morning, everyone. I hope you and your loved ones remain safe and healthy as the COVID-19 pandemic continues to affect all of our professional and personal lives. On the call today, we will provide additional context around the impact of COVID-19 is having on our business, summarize the quarterly financial results, update you on our outlook and leave plenty of time to address your questions. In the second quarter, we delivered better than expected results given uncertainty around the COVID-19 pandemic. And I want to thank all of our Zoetis colleagues, who have shown amazing resiliency, customer focus and perseverance throughout the year and our response to these challenging times. In terms of numbers, our revenue grew 4% operationally with the U.S. segment up 6% and international up 3%. Our companion animal products continue to drive our business performance with 13% operational growth, livestock products declined 5%. Our adjusted net income increased 4% operationally in the second quarter. We have built a very strong companion animal portfolio over the last several years based on our internal innovation. And these products have helped offset some of the deeper market challenges in the livestock market today. Our recently launched parasiticide compared to Trio, ProHeart 12 and Revolution Plus as well as our key dermatology portfolio of Apoquel and CytoPoint provides us solid foundation that has continued to form well this year. We continue to be very pleased with the performance of our new triple combination parasiticide for dogs Simparica Trio, as well as the strength of the overall Simparica franchise. Glenn will share more details in his remarks. Our continued focus on meaningful innovations and the diversity of our portfolio across PCs, products and geographies remain core advantages for Zoetis during times of economic uncertainty and we've also seen the essential nature of animal health playing an important role in the resiliency of our business and our industry at this time. In terms of COVID-19, our veterinary and producer customers are under increased pressure to deliver critical animal care and maintain a reliable global food supply and we are fortunate to be able to support them in this mission. We continue to put the safety of our colleagues and customers first during this pandemic. And we're very pleased with our team's ability to maintain productivity, even with safety and social distancing adjustments at our facilities, as well as the ongoing use of remote work arrangements for the majority of our colleagues. Our field force has returned to meeting with customers in many geographies based on local guidance and practices. We monitor and adapt these plans on a daily basis based on local feedback and adjustments in markets that may be experiencing increased COVID-19 cases. Our teams are excited to be back out with our customers, but we're also preserving the lessons we have learned from effective online interactions, webinars, and e-commerce to evolve our sales and support. In terms of supply chain, Zoetis has maintained a reliable inventory of critical medicines, vaccines and diagnostics to our customers and distributors in more than a hundred markets around the world. And our research development programs remain on track in terms of filings clinical trials and interactions with regulatory agencies. We remain confident in the progress of regulatory reviews of our monoclonal antibody candidates for pain in cats and dogs. Our submissions are proceeding as expected. This year continues to be uncharted territory due to COVID-19 and the related trends affecting our customers. However, the underlying demand for healthy pets and a reliable source of protein remains fundamental to the global economy. In the second quarter, we benefited from the veterinary clinics in the U.S. recovering much more quickly from the COVID-19 impact than we anticipated. Veterinary practices in the U.S. adapted quickly the Cribb site visits and mobile clinics to deliver critical care and maintain relationships with our customers. We also saw an acceleration of companion animal product sales through e-commerce channels as a result of the lockdowns in many States. Veterinarians and pet owners are adapting more quickly to these online options as a way to fill prescriptions for parasiticides and other medicines. We also know people are spending more time at home with their pets. They may be observing conditions such as itchiness or pain, which has previously gone unnoticed. And so, we're actually seeing an increase in spend per visit in U.S. clinics. Meanwhile, outside the U.S., companion animal veterinary clinic performance has been in line with expectations despite wide market by market variations based on local dynamics. For Zoetis, we expect our overall revenue growth for the remainder of the year to be driven largely by companion animal products, especially our parasiticide and key dermatology portfolio. We plan to continue investing in direct to consumer advertising and digital marketing to support these products. Livestock is a very different picture and remains very challenged by the pandemic, especially in the U.S. Producers are adjusting to new market demands and distribution needs from food service and restaurant channels to more grocery and retail channels while also managing ongoing labor, safety and trade issues. As expected, U.S. livestock in the second quarter saw a significant downturn as we expect that to remain a challenge for the rest of the year. The pace of return to more food service and restaurant demand along with increased export opportunities will be the most significant factors in the recovery of livestock producers in the U.S. Internationally, livestock grew and performed in line with expectations across a diverse set of markets. We saw very positive results in places like China, where they're further along in their COVID-19 recovery, but we will be sensitive to see how Latin America and markets like Brazil perform in the remainder of the year due to COVID. As you look ahead, we remain focused on advancing our five key priorities to ensure our long- term success : driving innovative growth, enhancing customer experience, leading in digital and data analytics, cultivating a high performing organization and championing a healthier, more sustainable future. We've continued to make important investments in products and innovations across the continuum of care from prediction and prevention to detection and treatment of disease. Supporting successful launches as well as new life cycle innovations and expansions of major products into new markets continue to be the cornerstones of our durable and steady performance. In the second quarter, we expanded major vaccine franchises with the approval of our Vanguard B Oral for dogs in Brazil and our Fostera Gold PCV MH and Fostera Gold PCV Metastim for vaccines for pigs in Australia. We also continue to strengthen our diagnostic and digital capabilities building on recent acquisitions in point-of-care and reference labs along with additional investment. We plan to launch a new diagnostic platform for pet care in the third quarter called VETSCAN IMAGYST. We are very excited about the potential for this disruptive innovation, which will be the first systems to bring clinical pathology right to the point-of-care. This new multi-purpose platform uses a combination of image recognition technology, algorithms and cloud-based artificial intelligence to deliver rapid testing results to the clinic. Its first indication will be for testing fecal samples for parasites, making it quick and easy to test and treat pets in the same visit. We will have more to say in the coming weeks as we prepare for a global launch. We also view diagnostics is playing an important role in the continuum of care for fish. In the second quarter, we acquired Fish Vet Group to add more diagnostic tools to our aquaculture portfolio, including environmental testing, which is critical to fish farming. Finally, at Zoetis our key priority around high performing teams is tied to creating a culture where all colleagues feel valued and included and is reflected in our commitment to promoting inclusion, diversity and equity across our organization. Our leadership and board are dedicated to being a force for positive change across the globe to drive greater equity and inclusion. And we have dedicated financial and people resources to do so. As part of this plan, we have made commitments to publish our diversity statistics and to increase our representation of black colleagues and people of color overall in the U.S. As the world leader in animal health, we are committed to demonstrating our leadership on this important business and social issue. Now let me hand off to Glenn, who will speak more about our second quarter results and updated guidance for the full year. Glenn? Glenn David : Thank you, Kristin, and good morning. I hope everyone is safe, healthy, and adapting to what is certainly an unprecedented time for all of us. Today, we'll provide additional commentary on our Q2 financial results, provide an update on our liquidity position and review our improved full year 2020 guidance. Beginning with the second quarter results, we generated revenue of $1.5 billion, which was flat on a reported basis and 4% growth operationally. Adjusted net income of $427 million, decreased 2% on a reported basis and increased 4% operationally. Foreign exchange in the quarter had an unfavorable impact of 4% on revenue. This was driven primarily by the U.S. dollar strengthening against the Brazilian real, Australian dollar, Mexican peso, and euro. Operational revenue growth at 4% was driven by 2% price and 2% volume. Volume growth. 2% includes 3% from new products, 3% from key dermatology products, 1% from acquisitions and a decline of 5% in other inline products. Companion animal products led the way in terms of species growth, growing 13% operationally, while livestock declined 5% operationally. Companion animal performance was driven by a parasiticide portfolio, which includes sales of Simparica Trio in the U.S., Canada and certain European markets and our key dermatology products, Apoquel and Cytopoint. Revenue from the acquisition of Platinum Performance, and its nutritional products acquired in the second half of 2019, drove the growth in equine. Livestock declines in the quarter were driven by challenges to our U.S. livestock portfolio. Supply chain disruptions caused by reduced animal processing capacity and shifting consumer demand from restaurant and food service to grocery stores effected our customers' purchasing decisions. This decline was partially offset by strong performance internationally with growth in swine, fish and poultry. New products contributed 3% to overall growth in the quarter driven by Simparica Trio, ProHeart 12, Revolution Plus and our Alpha Flux parasiticides for salmon in Chile. We remain excited by the launch of Simparica Trio and are reaffirming the range of a $100 million to $125 million for full year incremental revenue. While vet clinic penetration is occurring at a more moderate pace as a result of the COVID-19 pandemic, prescriptions in those clinics that have adopted Trio have been more robust and cannibalization of Simparica has been less than we anticipated. Global sales of our key dermatology portfolio were $224 million in the quarter, growing 24% operationally and contributing 3% overall revenue growth. Recent acquisitions contributed 1% growth this quarter, which includes Platinum Performance and our reference lab expansion strategy. Now, let's discuss the revenue growth by segments for the quarter. U.S. revenue grew 6% with companion animal products growing 19% and livestock products declining by 18%. Companion animal growth in the quarter were driven by sales of Simparica franchise, our key dermatology products and the impact of recent acquisitions. U.S. key dermatology sales were $160 million for the quarter, growing 26%. The continued strength of this portfolio was driven by expanded usage of both CytoPoint and Apoquel benefiting from our direct-to-consumer campaign, uptick in e-commerce channels and pet owners spending more time with their pets as a result of COVID-19. Simparica Trio performed well in the U.S. with sales of $36 million, despite challenging market conditions in Q2. We’re observing several positive trends, included rapid uptake in clinic that have adopted Trio smaller than expected cannibalization of Simparica. Sales coming from new patients for the category and taking share from current oral flea and tick competitors. Diagnostic sales increased 18% in the quarter, largely driven by our reference lab acquisitions. In addition, previous instrument placements created a solid foundation for consumables growth in the second quarter. U.S. livestock declined 18% in the quarter driven by lower sales across all species. In the second quarter, we faced challenges with significant declines in feedlot placements, reduced demand from the food service industry and the effects that had throughout the food supply chain and our customers, in addition to increased competition. To summarize, U.S. performance was strong in a difficult market environment. And the diversity of our portfolio, again, proved beneficial as growth in companion animal offset the challenges faced in the U.S. by our livestock portfolio. Our international segment had operational revenue growth of 3% in the second quarter with more balanced performance across our companion animal and livestock portfolios. Companion animal operational revenue growth was 2% and livestock operational growth was 4%. Increase sales in companion animal products with a result of growth in our key dermatology portfolio and our Simparica franchise, including the launch of Simparica Trio in Canada. While European markets were impacted significantly by COVID-19, the decline was offset by significant growth in other markets, including Japan and China. Diagnostics had a difficult quarter as wide-scale clinic closures resulting from COVID-19, limited the ability to place the instruments and negatively impacted consumable usage. International livestock growth in the quarter was driven by swine, fish and poultry. Swine grew double digits in the quarter, primarily driven by China, which grew 25% as key accounts continue to expand their herds and production shifts from smaller farms to larger scale operations. Our fish portfolio delivered another strong quarter. We saw favorable conditions in Chile and Norway that resulted in vaccinations being accelerated into Q2. In addition, we continue to see an uptake of the Alpha Flux parasiticide in Chile. Overall, our international segment was again, a positive contributor to revenue growth with performance in swine, companion animal, fish, and poultry, more than offsetting declining cattle resulting from the COVID-19 pandemic. Now, moving on to the rest of the P&L. Adjusted gross margin of 71.1%, increased slightly on a reported basis compared to the prior year due to price, favorable manufacturing costs and product mix, which were partially offset by foreign exchange, recent acquisitions and higher inventory charges. Adjusted operating expenses were flat operationally. The incremental advertising and promotion expense is related to Simparica Trio, recent acquisitions and R&D increases were largely offset by reductions to T&E and compensated related costs as a result of COVID-19. The adjusted effective tax rate for the quarter was 22.3%. The increase versus prior year is driven by the jurisdictional mix of earnings and the impact of discrete tax benefits recorded in Q2 2019. Adjusted net income for the quarter grew 4% operationally, primarily driven by revenue growth and adjusted diluted EPS grew 6% operationally. Next, I'd like to cover our liquidity position and our capital allocation priorities. We ended the second quarter with approximately $3.4 billion in cash and cash equivalents, including the proceeds from our $1.25 billion long-term debt issuance in May, of which $500 million is earmarked for repayment of our November 2020 maturity. We have access to a $1 billion revolving credit facility and a coinciding commercial paper program, both of which remain undrawn. Given our strong cash flow and balance sheet, we remain committed to our capital allocation priorities for internal investment, M&A and returning excess cash to shareholders. Consistent with what I mentioned last quarter, we still anticipate elevated capital expenditures this year to support investments in manufacturing, information technology to support our recent acquisitions and capabilities in digital and data analytics. With regard to returning excess cash to shareholders, we remain committed to our 2020 dividend, which represents a 22% increase over 2019. In Q1, we repurchased $250 million in Zoetis shares before suspending the program in the second quarter in order to conserve cash. We have approximately $1.4 billion remaining under our multi-year share repurchase program. Now moving on to our updated guidance assumptions for 2020. Our cash performance has always given us confidence that the essential nature of our business, a diverse portfolio and the innovation we consistently bring to our customers would position us well during difficult market conditions. After assessing recent trends and our performance in the second quarter, we're further refining and raising our full year 2020 guidance. We expect recent positive companion animal trends in the U.S. will continue. Although vet clinic revenue may moderate somewhat as pent-up demand works its way through the system. Alternatively, we believe social distancing measures are negatively impacting the food service recovery and will continue to present challenges to our livestock business in the U.S. The more recent resurgence of COVID-19 cases in parts of the U.S. and expanding rates of infection in international markets continues to create uncertainty around the duration, scope and economic impact of the pandemic. Please note that our guidance reflects foreign exchange rates as of mid-July and given our global footprint, movement in foreign exchange has had an impact on revenue and adjusted net income since we issued our prior guidance in May. Our current guidance includes favorable foreign exchange at revenue of approximately $50 million and approximately $10 million at adjusted net income versus May guidance. For revenue, we're raising and narrowing our guidance range with projected revenue now between $6.3 billion and $6.475 billion and operational revenue growth of between 3% and 6% for the full year versus the negative 2% to positive 3% we had in our May guidance. Adjusted net income is now expected to be in the range of between $1.685 billion and $1.765 billion, representing operational growth, a positive 1% to positive 5% compared to our prior guidance of negative 9% to negative 3%. Adjusted diluted EPS is now expected to be in the range of $3.52 to $3.68 and reported diluted EPS to be in the range of $3.14 to $3.32. In closing, while the COVID-19 pandemic has certainly presented a set of challenges we have not seen in the past. We're extremely proud of our colleagues and the commitment they have shown toward our customers, our company, and animal healthcare. During this time, we have demonstrated the diversity and durability of our portfolio, the resiliency of our industry, and we have confidence in our ability to continue to execute on our strategy during these uncertain times. Now, I'll hand things over to the operator to open the line for your questions. Operator? Q - Jon Block : Great. Thanks guys. I guess, I'll try to just load everything upfront. Glenn, I think op margins were at an all-time high in the midst of a global pandemic, so congrats. But some of that was likely eaten by mix. Yet, it seems like that mix may remain, as you mentioned, intact or favorable for the next couple of quarters. So as we think about margins into the back part of the year, is there anything to call out overall? And what about the cadence of 3Q versus 4Q? Kristin, for you, just to shift over there, maybe if you can just talk to what you're seeing for a competitive response on Trio. And just a clarification, the new platform for diagnostics of the new offering is that in a new VetScan analyzer that displaces the old one? Or is it a different unit specific for pathology? A lot there. But thanks for your time. Glenn David : So Jon, I'll address the first part of your question with operating margins and mix. So as you say, we have very favorable gross margin in this quarter as well as the first half of the year. As we look into the second half of the year, we do expect there to be some deterioration in gross margin. And that does come from product mix, right? The separation that we've seen in performance in the quarter, livestock declined 5% operationally. Companion animal growth grew 13%. We expect that to narrow in the second half of the year, the differential in performance between companion animal and livestock. So that will negatively impact mix. The other component is that we generally have a larger portion of livestock sales in the second half of the year than we do have in the first half of the year. The other component to consider is OpEx. As we move into the second half of the year and our field returns more and more to visiting clinics, T&E expenses, which has been very favorable, particularly in Q2, will rise as we go into Q3 and Q4. In terms of the dynamics between Q3 and Q4, don't really see any big differential in terms of the dynamics between Q3 and Q4. Kristin Peck : Okay. Hey Jon. With regards to your question on competitive response to Trio. It's been the response that we largely expected. Obviously, this is an innovative product. They were very aware it was coming. They're obviously running promotions. You probably saw some stock-ins as we probably saw as you move from Q1 to Q2, but we're really not seeing anything that we weren't expecting overall. And to address your other question with regards to images, it's a completely separate product. It is actually a scanner and a microscope that then uploads to the cloud for analysis. So it is completely separate than VetScan. And it's a platform. And the first product, as we mentioned, will be around fecal, but it is not a replacement at all of the VetScan machine. It's a separate one that is both a scanner and a microscope. Operator : And our next question comes from John Kreger with William Blair. Please go ahead. Jon Kaufman : Hi, good morning. This is Jon Kaufman on for Kreger. I'd like to focus a little bit on livestock here. It'd be great to get a sense of your expectation for what the outlook looks like, not just in the coming quarter or two, but really into 2021 and over the medium term. So I guess a couple of questions within that. First, how much of a residual impact will the processing capacity issues have? And then second, on the lower foodservice demand, let's just say, hypothetically, the U.S. consumer really isn't ready to go out to restaurants until spring or summer of 2021, do you expect producers to exit and then you're serving a smaller end market? Or is it more of producers realize this is a period of limited profitability, but they don't adjust herd sizes and they stay in the market? Thank you. Kristin Peck : Sure. Thanks, Jon. A few things on that. I think the two big trends you're seeing in U.S. livestock – and I’d say you have to look at livestock. 50% of our livestock business is actually outside the U.S. and it grew at 4%. So again, this speaks to the diversity of our portfolio. But if you look at the sort of global trends you're talking about with regards to the movement from eating out to eating in, we do expect that to continue. And the guidance we've given for the rest of the year is that, that largely doesn't change too dramatically. It's obviously too early to tell in 2021 how that ultimately adjusts. The second factor to consider in the livestock overall is the packing plants, which have been an issue in the U.S. Packing plant capacity in the U.S. still looks to be about 95% to 97%. And in some businesses, that may be good, but that does continue to back up animals. But again, this is mostly a U.S. trend, although we have seen a few isolated issues outside of the U.S. and Europe, Australia and some other markets. But again, I think what producers are doing are doing their best to actually alter where they can the flow of animals. This is much easier for poultry to do, given they only have to make decisions on 45 days. Pigs can do it over six months. So I think you will see a slight reduction in the U.S. in pork. It is much harder for cattle producers. Most of those animals are already here. So we do see cattle probably continuing to struggle probably through the first half of next year. But I think the third factor besides the dine in, dine out and packing plants to consider is actually the export market. What has really helped maintain a lot of the lot of the U.S. livestock flows has been the export market, with the largest player there clearly being China. And given ASF, they are still in need of a tremendous amount of pork. So those are the three factors that we're considering that gives us confidence that, to your question, in the short to medium term. In general, livestock has grown around 5%. Obviously, it's been a little lower in the last few years. And I think, again, International was 4%. We were negative in the U.S. We do think in the medium term it goes back to normal levels, but we do think livestock will continue to be challenged certainly this year and likely at least to the first half of next year. Thanks, Jon. Operator : Our next question comes from Michael Ryskin with Bank of America. Michael Ryskin : Hi. Thanks for taking the question. Just two sort of quick ones for me. First, on the guide, for revenues and guidance of 3% to 6% core growth. I just want to make sure I'm not missing anything. Because you did 4% in the second quarter, you're over 5% year-to-date. Over end of the range actually impose pretty meaningful deceleration from the second quarter, and yet most trends are pointing upwards. So I'm just wondering if you could go into that sort of what points you to 3%, what points you to 6%. When you guided in the first quarter you talked about a second wave in the fall and winter. Is something like that in your assumptions now? Or is there anything underlying going on there? And then the second question, again, on the digital VetScan pathology instrument you talked about. Just a little bit of a follow-up. Is it an instrument-only product? Will there be consumables attached to it. And are you planning any different rollout in U.S. versus international? Thanks. Glenn David : So Mike, just in terms of your first question in terms of the guidance in revenue of the 34% to 6% growth. So to your point, in the first half, we grew 5% with a limited impact from COVID-19 in Q1. That would imply a second half of 2% to 7% growth essentially. I think, a, it's first important to understand that, in the first half, that 5% growth did have a contribution from acquisitions of about 1%, which we won't have that same contribution in the second half of the year because of when the timing of those acquisitions occurred last year. So that really brings you to organic growth of about 4% in the first half of the year, which is the real comparator for that implied 2% to 7% growth in the second half of the year. So really pretty balanced between first half and second half organically with the first quarter not really having a significant impact from COVID-19. To your question about what brings you to the low end of the range, that would be a more would be a more severe impact of COVID-19 than we're seeing today across our markets. What takes you to the higher end of that range is things sort of stabilizing as they are for the rest of the year without a more rapid or more significant impact of COVID-19. Kristin Peck : Sure. And to take the second half of your question, Mike, on images, we will be launching the U.S. and a few markets outside of the U.S. as we move into the end of Q3 to Q4. And there are consumables, but the consumable – the consumables, obviously, reagents there, but there's also a read. So obviously, with every test that's done, the read that's done in the cloud is also a fee. So there are both – some products to use to prepare the specimen. But there's also – more importantly, the read of each test in the cloud. So it's a consumable, I suppose, but it's almost like a different way of looking at it, which is a cost per read. I hope that answers it. Thanks, Mike. Operator : Our next question comes from Chris Schott with JPMorgan. Please go ahead. Unidentified Analyst : [Indiscernible] for Chris. Thank you for taking the questions. The first one is on African Swine Fever. You've touched upon this in your prepared remarks, but talk about where we are in terms of the recovery in China. How much of the herd has been rebuilt? And would you expect this to represent a tailwind in the second half of the year? And then another one on livestock. It seems a part of the dynamic that COVID is creating is producers switching to lower-cost alternatives. To what extent is this happening? And how sticky do you think this dynamic is as we think about recovery in 2021 and beyond. Thank you. Kristin Peck : Sure. So Sure. So we'll start with your question with regard to African Swine Fever in China. What we've been seeing in China overall is that the larger, more sophisticated integrated producers are starting to rebuild their herd. As you saw, very strong growth in our China business of 24%. What you're seeing underlying this is the beginning of the rebuild of these herds. This is more isolated to sophisticated producers who can ensure biosecurity. Because to be clear, there's still African Swine Fever present in China. So I think what you're seeing is some of the smaller backyard producers are not rebuilding there, but we are seeing some of the more sophisticated ones doing so. And that is a positive trend for us because they would be more likely to use our products overall. But if you look at African Swine Fever, we are still predicting that China will have to continue to import pork a significant amount for the next few years. So this rebuild is slow because, as I said, there is still African Swine Fever in China in a few isolated markets as well outside of China. So I suppose, if you look at that, for China, it will continue to be a tailwind for us, continuing to drive the China business as that herd rebuild. And with regard to your second question on livestock and whether we're – some people are switching to lower-cost alternatives. Historically, that has been the case. So people will trade down. What's slightly different is that this is a pandemic with a recession. And I say that because, as long as there's more protein than people need, the price goes down. So hamburger meat right now is actually still pretty cheap. So historically, we would've seen a recession. People trade down from beef to pork to chicken’s egg. So we think that's still a longer-term trend. But with the disruption right now and the overcapacity, you are still seeing some other proteins still in certain markets on a relative basis not be that expensive. So I think it's – I would say your overall hypothesis over the medium to long term is true, although in certain markets, given overcapacity, the difference in price is not as dramatic as it normally is. Operator : And we'll take our – next question comes from Louise Chen with Cantor. Please go ahead. Louise Chen : Hi, thanks for taking my question. So I wanted to ask you how COVID-19 has changed the way you do business on both the livestock and companion animal side? What efficiencies have emerged? And what could be here to stay? Thank you. Kristin Peck : Sure. Thanks, Louise. I think, similar to all businesses, we are – we've had to adjust the way we operate, and I've been incredibly impressed as the resilience of our colleagues and our customers and their creativity. So the first trend is we've obviously moved a lot more to doing virtual seminars or webinars to handling orders and things like that by phone. Our customers have adapted to more telemedicine in certain markets around the world. And if you look at more broadly in the U.S. and in certain markets outside the U.S. to e-commerce. So that is obviously for us, it's supporting our producers, our veterinarians and pet owners to make sure they can access our products wherever they our products wherever they need. But I think some of the skills that our field force is now learning will be one that will help us in the future, obviously reduces some of the travel that some of them had to do. But our field force across the world, where businesses are allowing, are actually back seeing customers. Now it's not as many customers as they saw before in a day, and that has to be both a customer and a colleague feeling comfortable in a given market. But it also has to flex, obviously, given some of the flare-ups in the U.S. geographically and across the world, a lot more flexibility there. So I think it's both our customers getting creative and flexible and our field force and some of our capabilities overall as the company to be able to meet our customers where they are. So I think I'm quite impressed at how our colleagues and our customers have adopted. Operator : Our next question comes from David Westenberg from Guggenheim. Please go ahead. David Westenberg : Hi, thanks for taking the questions and congrats on a great quarter. So for my first question, are you anticipating any kind of competitive launch in the derm in the next year, say, 2021? I know we've heard about potential competitive launches for five – probably five years now, but this time it kind of feels a little bit different. And then for my second question is on the diagnostic platform. Is there any limitation to the sample type, say blood fecal, urine even maybe physical tissue, et cetera? And is there a component that might have a reagent to it? Thank you. Kristin Peck : Sure. Sure, so I'll start David with your first question on the Durham portfolio. We were obviously quite pleased with its performance in the quarter, growing 24%. This is now obviously a blockbuster products as well as category. And to your point, we have expected competition for a while given the attractiveness of the sector. At this point in time, as you know – we have very intelligence, as you know, in our industry with regards to competitive launches, but based on what we know today, we are not expecting a competitive launch in the rest of 2020 and likely the first half of 2021. Obviously that's always subject to change since we don't know exactly what our competitors are doing, but we continue to believe that we will have competition in the space, but we, at this point, do not believe it's in the next 6 to 12 months. So our focus right now on our Durham portfolio is building those brands as big as we can. And if you saw in the quarter, our focus on direct-to-consumer advertising in the U.S. to continue to grow our share and to build the market itself. So your second question with regards to the platform, the images platform, what we're saying is it's the first fecal will be the first. Obviously, it could look at lots of others. I mean that's still – product that is still in our research and development to look at other types such as obviously blood and other types. But those are not things we are prepared at this point to discuss, but obviously the platform lends itself to be able to do multiple different tissue types. Thanks so much. Operator : Our next question comes from Balaji Prasad from Barclays. Please go ahead. Balaji Prasad : Hi, good morning and thanks for taking my question. So two parts. Firstly, Kristin, there's a material change in the competitive landscape with a new number two company. So I would like to understand your thoughts on what the Elanco and Bayer merger means for the industry and for Zoetis specifically as the number one company. Secondly, you've been championing technology adoption of the firm. So I want to explore one of the priority areas, you mentioned, digital and data analytics. And what does that mean in actual terms is the revenue driver is an operational efficiency measure or a mix of both? Thank you. Kristin Peck : Sure. Thanks, Balaji. For starters on the combination of Elanco and Bayer, as we said previously, we don't really see this as changing the competitive landscape in any dramatic way. We've competed against both of them many times before. Obviously, the acquisition of Bayer by Elanco will increase their business in the OTC space, where we honestly don't really operate. We do in the direct-to-consumer side, but not in the over-the-counter. So it's not a space that's important to us, especially with our focus on the veterinarian where that's more of a retail market there. So we don't foresee that changing it. They're both been well-capitalized competitors historically, so we don't see that as a major change. With regards to digital and data analytics, I think, it's an - and it is both a revenue driver as we announced today with IMAGYST certainly looking at products that drive revenues, such as platforms, such as vet. We've also spoken about precision livestock farming. So there's a numbers of ways in both companion animal and livestock that this continues to help us drive revenue in, but it's also an area where we can also be much more efficient, better targeting our customers, looking at new ways through e-commerce and other channels. We've done some quite exciting things. In China, for example, launching our own revolution page there and leveraging different tools in digital and data to just also make us more efficient, so to drive revenue and just increase our efficiency. So I think it is a – it's both. Thanks, Balaji. Operator : Our next question comes from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Good morning. Thanks for the questions. I wanted to start with Simparica Trio. You mentioned the clinic penetration is occurring, I think, at a more moderate pace than what you initially anticipated. Kristin, it'd just be great to get your view on kind of what you've seen so far and maybe what factors have had the biggest impact on pace of uptake? And do you think that we'll see the typical seasonality that you usually see in the parasiticide business, obviously a lot different about this year than maybe past year? And then the second question, if I could just ask it upfront. On the vet channel overall, how much of the strength do you think kind of might be backlog or pent-up demand versus what might be, excuse me, more sustainable as we think about trends in that part of your business over the balance of the year? Kristin Peck : Thanks, Nathan. So as we look at Trio, we started shipping the distribution in late March and launched the product in April, right and probably the height of the pandemic at least in the U.S. What we've seen to date is that – that was more difficult for clinics to take on new products. That's often something that requires an in-person meeting and training of staff, et cetera. So we saw a slight – versus what we expected fewer penetration of clinics, but what we've been incredibly pleased about and why we've given the guidance of $100 million to 125 million, is that for the – we've been quite successful in corporate accounts ones that we engage quite early on this larger clinics and the ones we penetrated, our share in those clinics has grown faster than we expected. So I think that's been a positive. So I – again, we're continuing to grow our penetration of clinics, but we're quite pleased with the share. And what we're also pleased about is it's had less of an impact certainly in cannibalizing Simparica, which has been great. So we've certainly taken share from others, but our data also suggests we're also bringing new people back to the category of oral parasiticides, which we think is pretty exciting there. So, I think – whether this will be a typical season, if you look at some of the data with regards to vet visits Q2 year-over-year, they're still down, I think, about 3%, but it's a significant improvement from the negative 20 to negative 30 you saw it in the U.S. in the beginning of the quarter. But what's really interesting and what might affect your second – your question there is that the spend per visit, however, is up dramatically. So, latest data, we'll say it's maybe up about 7%. We do think that's going to moderate over time. This is probably people buying more of the products so they don't have to return to the vet in case there's something. So we do expect that to moderate some in the coming quarters, but that might mean that people may versus the normal – historical six months, six or so – six or seven months of buying the parasiticides, maybe they bought more. So we'll see that that goes, but we are expecting that to moderate. So I think, overall, we're looking for continued positive trends in companion animal, but I think it will be dependent on geography by geography. Operator : And our next question comes from Kathy Miner with Cowen and Company. Please go ahead. Kathy Miner : Thank you. Good morning. I have two questions. First, just going back to the dermatology business given that you talked about the trends were good and people are staying home with their pets more. Could we anticipate greater near-term sales for both Apoquel and Cytopoint? And would this be true in both the U.S. and OUS? Second question, just on companion animal vaccines, when you talk about the vet visits and the greater revenue per visit, have you seen a ketchup in vaccines? And is this still working its way through the system? Or do you think we're already there? And just a clarification on the share repurchase, I just want to clarify that is in fact still on hold. Thank you. Glenn David : Yes, so – Kathy, I'll take the questions on dermatology on and on share repurchase. So in terms of the derm portfolio, if you look back to last year, we had over $750 million in sales and we grew 29%, right. Obviously, with a bigger base of revenue, we were expecting that growth rate to slow down. When you look at year-to-date, however, we've grown 25%, and that has exceeded our expectations and there's been a number of drivers in that. We've continued to invest behind the portfolio, it should drive growth and we've seen a very positive return on that. So we do expect to see better than expected performance in the derm portfolio than we would have when we started out the year, which is really pretty impressive considering the impact of COVID-19 as well. And it's a franchise that we will continue to make sure that we invest behind the growth in. In terms of share repurchase, we did mention on the last call that we were suspending our share repurchase for Q2, we are also suspending for Q3, and we'll continue to evaluate that throughout the year. Operator : Our next question comes from Gregg Gilbert with Truist Securities. Please go ahead. Gregg Gilbert : Thanks. Kristin, I have a question. I'm sorry if this came up, I don't think it's a bit about insurance, both the company’s involvement and then a broader industry question. So first question is what have you learned about pet insurance? And what went well? And what did not go so well in your launch in that space? And separate from Zoetis’ involvement in that space, longer-term do you see broader based interest in pet owners buying insurance? It seems like everyone with pet sort of gripes about their out-of-pocket yet utilization of insurance is quite low. Do you think that's an employer mediate – employer mediated phenomenon that needs to be jump started or what are your thoughts on increasing penetration of insurance in the pet space over time? Thanks. Kristin Peck : Sure, thanks, Gregg. When we entered the space, it was really about assisting the pet owner and getting the care and increasing access to care and supporting the vet and providing the best care they can. And oftentimes, one of the challenges there is the sort of unexpected expense. So our focus really has been in this to get like a product that's more attractive to the consumer or to your point, the U.S. versus the rest of the world is underpenetrated in pet insurance. But we think the primary reason there is not because of employers or anything other than we think, you know, some of the products have not been as attractive to pet owners. So we really felt that the way we launched this, the focus on the pet owner would be attractive. We are pleased with our performance to date of our product with regards to Pumpkin, which is our pet insurance. And we look at that what's going to drive that and what feedback, we did get some feedback from veterinarians and they had concerns with regard to the inclusion of parasiticide. So we did change the – that program a little bit to look – focus more on diagnostics. And this is part of continuing to launch a new product and really iterate with our customers both with pet owners and vets to make it as attractive as we can. This is still a very, very small business relative to the rest of our business to be perfectly honest with you. It's not terribly material, but we are very pleased with how the company has been doing to date and most specifically in the number of new policies they continue to attract. And our goal is that we can make insurance grow the overall market, which is not hard to do since in the U.S., I think it’s only 2% to 3% versus the other markets outside the U.S. Operator : We will take our next question from Navin Jacob with UBS. Please go ahead. Prakhar Agrawal : Hi, this is Prakhar Agrawal on behalf of Navin Jacob. My first question is on your antibodies. How do you see these products being differentiated versus some of your competitors, such as Elanco’s Galliprant, and how are you thinking about the market opportunity here? And second question is did you increase in alternative channels have a material impact on your margins this quarter and a longer-term with continued increase in alternative channels, how should we think about the impact on your margin profile? Thank you. Kristin Peck : Sure. I'll start with the first question on the monoclonal antibodies and I'll let Glenn take the second question with regards to the alternative channels. Obviously, we don't have an approved product, so it's hard to say exactly how it would stack-up. But the focus on monoclonal antibodies is really a focus on a product with strong efficacy, with a strong safety profile. And these are large markets for example in the K9 space. We think that have gotten really comfortable with monoclonal antibodies as is evidenced by our performance on Cytopoint. It really also addresses a strong compliance issue, which is you remember to give the product to your dog every day. But it would say if you think about the feline or the cat monoclonal antibodies, there really aren't any products out there today in the cat space. So we think this is quite innovative in the cat monoclonal antibody space with really very little existing products that cat owners or vets can use. So we're quite excited, but until we have a profile it would be hard to say very specifically, but certainly from a compliance and safety perspective and efficacy, we think these will be very strong products that we think both vets and pet owners will be quite excited about. So, Glenn, do you want to take the second question? Glenn David : Sure. So in terms of the impact of alternative channels on our margins, it did not have a material impact, and that's just based on the overall size of our sales in those channels, right. It really is limited to our U.S. companion animal business. So while the channel has expanded significantly in the quarter, it still represents less than 3% of our sales. So it's still not a big impact on the overall margin, but just to give a sense of the growth that we have seen. In 2019, in our U.S. companion animal business, the alternative channels represented about $100 million of sales for the year. In this quarter alone in Q2 that number was about $50 million. So that gives you a sense of the rapid increase we're seeing in these channels, but it's still small over an overall portion of our business to really impact our overall margins. Operator : And there does appear to be no further questions at this time. And I'll turn the call back over to your speakers for any additional remarks. Kristin Peck : Okay, well, thanks everybody. I want to thank you for your questions and for your continued interest in Zoetis. While there's still many uncertainties around the impact and the resolution of COVID-19, the fundamental strength of our business and industry, we believe are proven and unchanged, and we remain very confident what Zoetis can achieve this year based on the diversity of our portfolio, the resiliency of our business, and certainly the spirit of our colleagues. So thanks for joining us today. Operator : Thank you. And this does conclude today’s program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,020
| 4
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2020Q4
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2020Q3
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2020-11-06
| 3.543
| 3.625
| 3.829
| 4.025
| 5.70881
| 38.99
| 40.06
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Operator : Welcome to the Third quarter 2020 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 2 hours after the conclusion of this call via dial-in or on the Investor Relations section of Zoetis.com. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, Keith. Good morning, everyone, and welcome to the Zoetis third quarter 2020 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, 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 statement 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 in the company’s 8-K filing dated today, November 5, 2020. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. Good morning, everyone. Once again, I hope you and your loved ones are safe and healthy as this pandemic continues to be pervasive and unpredictable, with COVID cases spiking again in several regions of the U.S. and around the world. We are all facing the uncertainty and fatigue that has come with this pandemic. But I’m also grateful and pleased today to share results that reflect the resilience of the animal health industry, the outstanding performance of our colleagues at Zoetis and the essential value we are providing our customers. At Zoetis, we stayed very responsive to the needs of our colleagues and customers throughout the year. We’ve prioritized – our global supply chain and manufacturing operations are running well with safety and quality as our top priority. And we’ve maintained operations at normal capacity and with no loss output. As we look ahead, we’re fortifying our network of suppliers and building inventory level. We’re also planning further contingencies for supply and distribution in the month ahead. Our R&D programs also remain on track despite the pandemic challenges, and our field force has been very adaptive to the changing protocols, lockdowns, and customer needs in various markets. Thankfully, our purpose, caring for healthier animals and a healthier world has never been more important, apparent and appreciated. Thanks to the resilience of our customers and the commitment of our colleagues, we were able to generate better-than-expected results in the third quarter. Our diverse and innovative portfolio has been driving growth this quarter with companion animal products up 20% operationally and livestock product sales up 9% operationally. Our newest parasiticides, including Simparica Trio, Revolution Plus and ProHeart 12 led the way again, along with vaccines, key dermatology products and our diagnostics portfolio, including reference labs. The third quarter also benefited from sales growth in the U.S. cattle market and China’s swine market. As a result of the sales growth and target investments, we delivered adjusted net income growth of 20% operationally for the third quarter, reflecting on our 9 month performance and despite expectations for a more modest fourth quarter, we are increasing our revenue and adjusted net income guidance for the full year. Glenn will provide more details around guidance updates in his remarks. This year has shown once again that animal health is a steady and reliable sector, even in times of economic hardship. The world’s fundamental need for nutrition, comfort and companionship provided by animals has proven durable and enduring over time. In the U.S., veterinary clinic revenues for pets are increasing at double-digit rates. Pet owners are focusing again on wellness and chronic ailments, not just emergency visits and acute care. While spending more time with their pets, pet owners are much more attuned to their dogs and cats health, observing conditions like itchiness, dermatitis, and pain. While clinic visits are relatively flat in the U.S., they’re actually seeing an increase in average spend per visit. We expect to continue to see our strength coming from companion animal products, especially our parasiticide and key dermatology portfolios across global markets. Simparica Trio’s launch and penetration into new clinics in the U.S. and elsewhere is going well, despite the headwinds of COVID-19. And we’re seeing a good return to our direct-to-consumer advertising and digital campaign for Simparica and Apoquel. Meanwhile, in the livestock sector, producers are adapting to the changes in our end-markets for protein. And our third quarter growth was driven by increased sales in cattle, swine and fish. The spikes in COVID cases, limitations on dining out and shifts in production capacities will continue to make livestock a longer-term recovery story that may vary by region and species, another reason our diverse portfolio and global footprint is such an advantage. Looking ahead, we have stayed focused on advancing our 5 key priorities, drive innovative growth, enhance customer experience, lead in digital and data analytics, cultivate a high-performing organization, and champion a healthier and more sustainable future. Throughout the year, we’ve stayed on track with our execution and investments in these areas, supported by a strong cash position and clear strategy. In the third quarter, we achieved an important milestone for our pipeline for pain management and pests. As you know, there’s been limited innovation in this area over the last 20 years. And we’re excited by the potential of monoclonal antibodies or mAbs to be the next breakthrough in long-term pain management. We’ve been building on our research and leadership in monoclonal antibodies for several years, and gained valuable experience in the development and launch of our dermatology product Cytopoint in 2016. In September, Zoetis received a positive opinion on our latest mAb, Librela, from the Committee for Veterinary Medicinal Products in Europe. Upon full approval by the European Commission, Librela will be the first injectable monoclonal antibody licensed for alleviation of pain associated with osteoarthritis in dogs. The European Commission approval is anticipated later this year, with the potential launch in the first half of 2021. We have additional regulatory submissions for Librela under review by health authorities in the United States, Latin America and Asia Pacific. And we are progressing with similar regulatory reviews for monoclonal antibody therapy that can help manage osteoarthritis pain in cats, a condition that is vastly under-diagnosed or treated in cats today. We also continue to bring our leading product into new markets. On the companion animal side, Simparica was recently approved in China, and Cytopoint and Revolution Plus gained approvals in additional markets in Asia and Latin America respectively; and in livestock received approval in Japan for 2 of our leading swine vaccine, Fostera Gold PCV MH and Fostera Gold PCV; all great examples of how we build and expand our innovation-based franchises. Last quarter, I previewed our latest diagnostic innovation Vetscan Imagyst, which features a cloud-based artificial intelligence platform. Since then, we have launched it in Australia, Ireland, New Zealand, the UK and the U.S. And customers have been enthusiastic about its potential to simplify point-of-care workloads and improve the consistency of results. And finally, we remain committed to creating a healthier and more sustainable world through our work as a leader in animal health. We’ve been formalizing our strategy this year and look forward to sharing baseline metrics that are aligned with leading ESG reporting standards before the end of this month. Now, let me hand it off to Glenn, who will speak more about our third quarter results and updated guidance for the full year. Glenn David : Thank you, Kristin, and good morning, everyone. I hope you and your families are remaining safe and healthy during these difficult times, and I thank you for joining us today. We delivered another solid quarter with significant growth in both our companion animal and livestock portfolios. And we continue to be encouraged by the strength and resiliency of our business, despite the challenging environment due to the pandemic. Today, I will provide commentary on our Q3 results, update you on our improved full year 2020 guidance and discuss our expectations for Q4. In the third quarter, we generated revenue of $1.8 billion, growing 13% on a reported basis and 15% operationally. Adjusted net income of $524 million was an increase of 15% on a reported basis and 20% operationally. Foreign exchange negatively impacted revenue in the quarter by 2%, driven primarily by the strengthening of the U.S. dollar. Operational revenue growth was 15% with contributions of 2% from price and 13% from volume. Volume growth of 13% includes 5% from other in-line products, 4% from new products, 3% from key dermatology products and 1% from acquisitions. Companion animal products led the way in terms of species growth, growing 20% operationally with livestock growing 9% operationally in the quarter. Performance in companion animal was driven by our parasiticides portfolio, which includes sales of Simparica Trio in the U.S., certain European markets, Canada and Australia. We also saw growth in our small animal vaccine portfolio and our key dermatology products, Cytopoint and Apoquel. The positive momentum for Simparica Trio continued in the third quarter, and we expect full year incremental revenue of between $125 million to $150 million. As we’ve previously mentioned, the COVID-19 pandemic has limited our ability to visit and penetrate clinics at the rate we had originally expected. However, we are finding that once the clinic has converted to Simparica Trio, the adoption level within the clinic is resulting in meaningful incremental market share. We’re also extremely pleased with the performance of our broader parasiticide portfolio, which in the U.S., gained an additional 6% market share in the flea, tick and heartworm segment for the third quarter versus the same period in the prior year. Global sales of our key dermatology portfolio were $251 million in the quarter, growing 16% operationally and contributing 3% to overall revenue growth. Our diagnostics portfolio also contributed to growth due to the continued recovery of wellness visits following a slowdown from social distancing restrictions earlier in the year. Livestock growth in the quarter was primarily driven by our U.S. cattle business seeing a return to historical distributor buying patterns following the impact of COVID-19 in the second quarter. In addition, the fall cattle run occurred earlier in the year, causing a portion of fourth quarter sales to be pulled forward into the third quarter. And as a result, we expect a significantly weaker fourth quarter in cattle than we typically deliver. For the remaining livestock species, swine returned to growth in the quarter, resulting from expanding herd production in key accounts and increased biosecurity measures in the wake of African Swine Fever in China. We also remain encouraged by the strength of our aquaculture business, which posted a 4th consecutive quarter of double-digit growth. Poultry declined modestly in the quarter, which partially offset the growth in cattle, swine and fish. New products contributed 4% growth in the quarter, driven by companion animal parasiticides, Simparica Trio, Revolution Plus and ProHeart 12. Recent acquisitions contributed 1% of growth this quarter, including our expansion to reference labs and the Platinum Performance nutritionals business. Now let’s discuss the revenue growth by segment for the quarter. U.S. revenue grew 18% with companion animal products growing 21% and livestock sales increasing by 13%. For companion animal, we continued to be encouraged by vet clinic trends with revenue per clinic up 12% in the quarter and demand for our products remaining robust. Companion animal growth in the quarter were driven by sales of our Simparica franchise as well as key dermatology products. We continued to invest in direct-to-consumer advertising in both therapeutic areas, and we have seen a good return on that investment. Simparica Trio continued to perform well in the U.S. with sales of $44 million, despite difficult market conditions for a new product launch. Key dermatology sales were $180 million for the quarter, growing 17%, with significant growth for Cytopoint and Apoquel, resulting from additional patient share and an expanding addressable market. Diagnostic sales increased 28% in the quarter as a result of our reference lab acquisitions and increased point-of-care consumable usage. U.S. livestock grew 13% in the quarter, driven primarily by cattle. As I mentioned, purchasing patterns returned to historical levels, and we saw earlier movement from pasture to feedlot both contributing to a significant volume increase for our products. To summarize, U.S. performance was once again strong in what remains a difficult market environment. We remain enthusiastic about the recovery and trends we’re observing in companion animal products. While livestock delivered an exceptional third quarter, as we’ve indicated in the past, we do not expect a sustainable recovery until the middle of 2021. Revenue in our International segment grew 11% operationally in the quarter with growth across all species with the exception of poultry, which was flat in the quarter. Companion animal revenue grew 20% operationally and livestock revenue grew 6% operationally. Increased sales in companion animal products resulted from growth in our parasiticide portfolio, vaccines and our key dermatology products. Parasiticide growth in the quarter was driven by the Simparica franchise, including the continued adoption of Simparica Trio, as well as increased promotional activity for Revolution. In the EU, limited access to veterinary clinics due to COVID-19 restrictions presented challenges for companion animal product sales in the second quarter, but in the third quarter we saw pent-up demand begin to work its way through the system, particularly for small animal vaccines. Companion animal diagnostics grew 17% in the quarter led by an increase in point-of-care consumable usage. International livestock growth in the quarter was driven by swine, fish and cattle. Swine delivered another strong quarter with 16% operational revenue growth, primarily driven by China, which grew 159%. While a significant portion of China’s growth reflects the impact of African swine fever in the prior year, we’re continuing to see expansion in our key accounts as production shifts from smaller forms to large scale operations. Our fish portfolio delivered another strong quarter, growing 10% operationally, driven by an increase in market share in vaccines and the acquisition of Fish Vet Group. Overall, our International segment delivered strong results and was a key contributor to revenue growth with significant growth in companion animal, swine and fish. We are also encouraged to see cattle return to growth in what are still difficult market conditions as a result of the COVID-19 pandemic. Now moving on to the rest of the P&L. Adjusted gross margin of 69.6% fell 50 basis points on a reported basis compared to the prior year as a result of negative FX, the manufacturing costs and recent acquisitions. This was partially offset by favorable product mix and price increases. Adjusted operating expenses increased 9% operationally, resulting from increased advertising and promotion expense for Simparica Trio and Apoquel. We have strategically reallocated savings, mainly from T&E costs into these high return promotional programs, which have been successful in increasing sales. The adjusted effective tax rate for the quarter was 20%, a decrease of 50 basis points, driven by the impact of net discrete tax benefits. Adjusted net income for the quarter grew 20% operationally primarily driven by revenue growth, and adjusted diluted EPS grew 21% operationally. The strength of our balance sheet, along with the significant free cash flow we generate, has enabled us to execute on our investment priorities including direct-to-consumer advertising, internal R&D and external business development. While we suspended our share repurchase program for the last 2 quarters to preserve cash during the pandemic, we remain committed to our 2020 dividend. In addition, share repurchases are a critical component of our shareholder distribution strategy and we’ll continue to evaluate the appropriate time to resume the program. Now moving on to our updated guidance for 2020. We are raising guidance for a second consecutive quarter as a result of our third quarter performance and the improving companion animal market environment. While the COVID-19 pandemic presents challenges and risks, we remain confident in the resiliency and durability of our diverse portfolio. Please note that our guidance reflects foreign exchange rates as of late October. For revenue, we are raising and narrowing our guidance range with projected revenue now between $6.55 billion and $6.625 billion and operational revenue growth of between 7% and 8% for the full year versus the 3% to 6% in our August guidance. Adjusted net income is now expected to be in the range of $1.79 billion to $1.825 billion representing operational growth of 6% to 8% compared to our prior guidance of 1% to 5%. Adjusted diluted EPS is now expected to be in the range of $3.76 to $3.81 and reported diluted EPS to be in the range of $3.38 to $3.45. We are anticipating a deceleration of revenue growth in the fourth quarter, resulting from weaker performance in our livestock business. The impact will filter down to adjusted net income, which will also be affected by increased expense as we invest in future revenue growth. In addition, adjusted net income has a difficult comparative period as a result of nonrecurring discrete tax benefits recorded in Q4 2019. In closing, we delivered another strong quarter, demonstrating the resiliency of our business, even in these challenging market conditions. I’d like to once again express how extremely proud we are of our colleagues, and the commitment they have demonstrated towards our customers and our company. Now, I’ll hand things over to the operator to open the line for your questions. Operator? Operator : Thank you. [Operator Instructions] And we will take our first question from Erin Wright with Credit Suisse. Your line is open. Erin Wright : Great, thanks. So I have a couple of questions here. One is on the guidance, the step-down in organic growth trajectory in the fourth quarter. I assume that has to do with the underlying conduct, in the end you were speaking to. But is there any other dynamics we should be thinking about in the fourth quarter? And how that month-to-month trend has progressed here? And then, lastly on mix dynamics in the gross margin, what were some of the key drivers of the gross margin trend in the quarter? Has anything changed in terms of the underlying profit profile of the companion animal business? Just given the strength there, maybe we thought that would be a little bit higher. Thanks. Glenn David : Sure. So I’ll take both of those questions, Erin, thank you. In terms – I’ll address the mix dynamics first. Nothing has changed really in terms of the underlying dynamics. A couple of factors related to the gross margin. A, foreign exchange was particularly unfavorable in this quarter, so that led to a step-up, a little bit in cost of goods, so that lowered the overall gross margin percentage. Also, we continued to invest in some of the new areas for growth, such as reference labs and some of the acquisitions, which also has a lower gross margin profile than our core business. But in terms of the underlying dynamics for companion animal and continued growth there being – continue to be an overall benefit for gross margin. But the FX as well as some of the investments we’re making in newer businesses such as reference labs did have a negative impact. In terms of the guidance for Q4 and the implied step-down in revenue, a couple of key factors there. A, U.S. cattle being one of the larger ones. We had a very strong quarter in U.S. cattle in Q3, really driven by 2 factors. A, the acceleration of the fall cattle run bringing some sales from Q4 into Q3. As well as a normalization of buying patterns in Q3 that resulted in some incremental sales that we did not expect to repeat in Q4. The other thing to consider for U.S. cattle in Q4 is the impact of DRAXXIN LOE in 2021. We do anticipate that some of our customers may change their buying patterns for Q4, which could result in less sales. As I mentioned, there are impacts beyond just revenue for Q4. Really, the adjusted effective tax rate is a big driver from an income growth perspective. We had a very favorable tax rate in Q4 of last year that will not repeat this year and will have a negative impact on our overall income growth. Operator : And we’ll move to our next question. It comes from Jon Block with Stifel Jon Block : Great. Thanks, guys. Good morning. Glenn, maybe just to start with you, and I’ll actually just pick up where you left off on DRAXXIN. I know you’re not going to go down the road of overall 2021 guidance. But obviously, we all sort of want to sharpen our pencils, if you would. And so, as we think about DRAXXIN in generic next year, should we just be cognizant of call it maybe a $300-million-plus top-line item with a year 1 20%-headwind-ish? If you could, comment on that. And then, Kristin, for you, congrats on moving the pain mAbs forward. Any commentary on the revenue ramp that we might see there? And if you feel like you’ve got a good runway with these offerings in front of any large molecule competition? Thanks, guys. Glenn David : Sure, Jon. So, I’ll take the DRAXXIN question. So as you mentioned, DRAXXIN is a very large product in animal health, over $300 million, a large product for us as well. Because of that, we do expect to see significant generic competition and a number of manufacturers being prepared with a generic product. So we do typically see a 20% to 40% impact over time, once a product faces generic competition. Because of the size of DRAXXIN, we do expect that, that will occur over a little more rapid period than we’ve seen in the past with some smaller products Kristin Peck : Sure. I’ll build on the profile for the mAbs. As we talked about, we did get the positive CVMP opinion on Librela. We are expecting an approval later this year with the hope of launching that in the first half of 2021. I know we’ll probably get a question why first half. It really depends, is it February, March, it will be around that timeframe. Remember, International has an earlier quarter. So we will start to see a ramp on that product in 2021. We are still expecting approval of the cat pain product, [Cylenthia] [ph], in 2021 as well. We’ll probably see approval of those in the U.S. in the later end of next year. So just to give you a sense of just where we see those revenues ramping, both cat and dog in the U.S. and EU. Operator : And our next question comes from Mike Ryskin with Bank of America. Michael Ryskin : Hey, thanks, guys. I’ll start with a quick one on sort of the rebound from COVID and the recovery in the quarter. I’m just wondering if you could parse into a little bit. You had a comment in some of your prepared remarks about potentially some pent-up demand in Europe. And I’m just trying to get a sense broader across the U.S. as well, how much you think the true underlying growth could have been versus what really is a little bit of pent-up demand? So I realize there’s a lot of moving parts in terms of vets, vet re-openings and new pet adoption, things like that, but just curious how to think about that going forward. And then, Glenn, got a quick follow-up for you. Another comment you made on increased spending, reinvesting in the business. As we look out to 4Q, clearly, there’s a big SG&A ramp in the guidance if you sort of bridge your revenue gap to your EPS target. I’m just thinking how should we think about 2021? What’s the appropriate base for that, because there’s obviously some spend that you pulled back this year. So how much of that comes back, how much extra do you need to invest for things like Librela and Trio next year? I’m just trying to get the moving pieces down. Thanks. Kristin Peck : Thanks, Mike. I’ll start on the COVID recovery question. I think what you clearly saw in Q3 was a significant rebound in companion animal to people going back to vet business. But really, the big growth driver there wasn’t really an increase in vet visits from 2019. Maybe there’s an increase from Q2 to Q3. It was really an increased spend per visit, which we think is a trend that will continue as long as people spend more time at home with their pets, they are noticing more and more things are getting diagnosed, as well as increased use of diagnostics. And that is really we believe definitely U.S. trend, but we also believe a global trend there. So we think companion animal will continue to do well. I think in the remarks, what we had alluded to was that specifically U.S. cattle where, we saw real – in Q2 a significant dip, people not wanting to hold too many inventories. In Q3, it was just more of a return to – normalizing that. But the other trend was really the move, I mean, it wasn’t COVID related, just weather-related, moving of the fall run. So overall from a COVID recovery, I don’t think there’s any pent-up demand that we’re processing anymore. I think things have largely stabilized. Obviously, when you see the number of cases increasing in the U.S. and globally, that’s right now baked into the guidance we’ve given you, assuming that things don’t get remarkably worse or remarkably better. But I think all that’s sort of baked in. And as we look into next year, I think it’s a little too early for us to really tell exactly what that’s going to look like. But I think the key message for us, as you look at our performance and our guidance for the year, is that we’ve been an incredibly resilient and essential business. And that has really been great for our customers, for our colleagues and for our shareholders. Glenn David : Yeah, Mike, in terms of the increased spending in the quarter, so as you mentioned, we did increase spending in Q3 with total OpEx up about 9%, and SG&A up 11%. And really, what we did there is we took a lot of the savings that we saw from T&E and made incremental investments behind some of our key growth brands, particularly Simparica Trio and Apoquel in the tune of DTC advertising, which was even greater than the savings that we saw from a T&E perspective, because we believe those are the right investments, and we’re seeing a very strong return on those, to support the future growth of the brands. In terms of what you mentioned for Q4 that the EPS gap between revenue and EPS, the gap there being driven by OpEx, obviously, the bigger driver there actually is more related to what I mentioned in terms of the change in the tax rate quarter-over-quarter and the incremental interest expense. It’s really not that OpEx. It’s disproportionate to revenues. The changes that we’re seeing year-over-year, just based on some quarterly fluctuations in the tax rate as well as the incremental interest expense that we’re going to see in Q4 based on the funding that we did earlier this year. Operator : And our next question comes from David Westenberg with Guggenheim Securities. David Westenberg : Hi, thanks for taking the questions. Congrats on a good quarter. So on Trio, at least from our research, we’re not seeing any competitive entrants yet and spring is a half year way, VMX is coming up in 2 months. Is there any – can you help us think about the difference in your – in the Trio peak sales expectation in the event the competitor doesn’t launch until after the spring? And then as a follow-up to Trio, how had a full season of it? Are you seeing more adoption from heartworm customers or maybe legacy tick and flea prescribers only? And kind of what I’m trying to get at that is, essentially there is regional differences in prescribing behavior and I’m just trying to figure out, again, market size question on Trio. Thank you. Kristin Peck : Thanks, David. I’ll start with we’re not anticipating any combination competition in the U.S. this year or in the first half of next year. As we’ve talked about many times, we don’t have phenomenal intelligence the same way human health does, but we continue to believe that. And to build up on Glenn’s comments, as a result, we are investing heavily behind this product in DTC to gain market share as quickly as we can. As we look at sort of the growth, Glenn also mentioned in his remarks that the penetration of clinic is improving, but probably not as great as we would have wanted, given the difficulty in detailing the product in person. However, where we have penetrated, the sales have been much higher. And honestly, we’ve been cannibalizing Simparica much less than we expected. And we’re really seeing is an overall bringing more people in. If you look at flea, tick, heartworm, really only 10% of people who are even taking it are 100% compliant. So we think that remains a significant opportunity for us. And again, we have a strong franchise here across parasiticides and flea, tick, heartworm. And as Glenn also mentioned, we had a 6% share gain in the overall category, which I think is really impressive. So whether that’s Simparica, Simparica Trio or ProHeart 6 or ProHeart 12, we believe we have the portfolio for our customers no matter where they are in the country, how they practice or what their pet owners’ needs are. So we continue to believe there’ll be strong growth there, and we’re going to invest behind this brand next year, while we remain the only triple combination in the U.S. Operator : And we’ll take our next question from Louise Chen with Cantor. Your line is open. Louise Chen : Hi, thanks for taking my question here. So I wanted to ask you, broadly speaking, how should we think about 2021 sales and margins? And if you can’t give any specifics, could you talk about some likely scenarios that could play out given a lot of moving parts we see in the year to come? Thank you. Glenn David : Yeah. So in terms of 2021, Louise, obviously, we will be providing guidance for 2021 in February as we typically do. A couple of things to think about, right, the long-term fundamentals of the industry remain very strong with increasing pet ownership and also animal protein consumption continuing to grow. I think the other thing to think about for 2021, I think COVID has proven that this industry remains extremely resilient and we’re still able to grow very rapidly, operate very profitably even during these times. Looking into 2021, there are some things that we’re very excited about. Obviously, the continued growth that we expect to see in Trio, continued growth of our derm portfolio, and obviously, the approval of our mAb portfolio and the launch within the EU coming in the first half of the year that Kristin mentioned. Some of the things that may be a headwind, obviously, are the DRAXXIN LOE. But again, with the growth that we expect to see in some of the other brands that we’ve mentioned, we do expect that for 2021 we’ll be able to continue to deliver on our long-term value proposition of growing faster than the overall market. Operator : And our next question comes from Nathan Rich with Goldman Sachs. Nathan Rich : Good morning. Thanks for the questions. Kristin, maybe to start, could you comment on the longer-term kind of market opportunity for the monoclonal antibody products in pain? How should we think about the market for osteoarthritis? And then beyond that, is there a potential to kind of expand to additional indications? And then I had a follow-up on diagnostics. Could you kind of comment on underlying growth excluding the reference lab acquisitions? And can you update us on your progress with getting customers to kind of utilize the platform across both the in-clinic and reference labs solutions that you have? Kristin Peck : Sure. So thanks, Nathan. I’ll start on just looking at the overall market for pain, starting with Librela since it will probably be our first approval there at least in Europe. Pain right now in dogs is around a $400 million market, but there hasn’t been significant innovation in that space. And although we do not yet have a label for our product, we believe that a monoclonal antibody will have a strong efficacy as well as safety profile. And we think that we’ve demonstrated, certainly in derm, our ability to grow the market to really raise awareness, bringing innovation in, brings new customers in and new options. So we do really believe we can continue to do that. If you look at it today, there’s about 165 million dogs across the EU and the U.S., and about 40% of them will get OA. And right now, depending on whether in the U.S. or Europe, really diagnosis is somewhere between 25% and 40%. So we do believe there’s a significant opportunity to both grow the market as well as bring people in and better diagnose that to really help that. That’s really where we see our – the market on dog. If you focus on cat, we think there’s an even bigger market here mostly because many cats are not medicalized today. There are 160 million cats about 40% of them as well have OA. But here, you’re really seeing, whether you’re in the U.S. or the EU, only about 14% of them being diagnosed. And in the U.S., there really is not an alternative. There really is no pain product for cats. There are a few options in Europe. But we really see this as a significant opportunity and ability to grow the medicalization of cats and really to diagnose pain and to treat it. So we’ve demonstrated certainly in dermatology our ability to create and to grow markets. And we very much believe across both Librela and [Cylenthia] [ph] in dog and cat that we will have the opportunity to do that. We are not expecting competition at this point, certainly in 2021 from what we understand in this market. So we do believe it’s our ability to continue to drive growth and really provide new opportunities for both vets and pet owners to treat pain. Glenn David : And in terms of the diagnostic growth. So if you look at companion animal diagnostic growth for the quarter, we grew about 24%. Backing out the impact of reference labs, that growth was around 13%. So we saw very strong growth in our consumable usage. Obviously, our instrument revenue was down as it’s been a little more challenging to get into the clinics took place new instruments, but very strong performance in our overall consumable revenue growth. In terms of the benefit that we’ve seen in the usage of both the reference labs and the point-of-care together, we are very early in our reference labs strategy. We are looking to build out a network across the U.S., but that will take some time. So we’re still early on in that build-out. Operator : We will take our next question from Chris Schott with JPMorgan. Ekaterina Knyazkova : Hey, this is actually Ekaterina on for Chris. Thank you for taking my questions. In the first question is you’ve touched upon this, but should we be thinking about the durability of some of the COVID-19 tailwinds that we’ve seen in U.S. companion like rising pet adoptions and increasing standard of care per visit? Do you think that this is something that reverses as those people come back into the office and don’t spend as much time with their pets? Or is this something that can be more durable as you think about 2021 and beyond? And then the second question is on the International companion business. So with some of the recent lockdown orders across Europe, what are you seeing on the ground in terms of any initial data points on clinic visits and foot traffic and things like that? How should we be thinking about the trajectory of the International companion business relative to what we saw with the first wave of COVID-19 lockdowns? Thank you. Kristin Peck : Thanks, Ekaterina. What I think we’ve demonstrated is that overall animal health, and more specifically, pet care is a very resilient industry. And I think what we – what’s probably been a little bit different in COVID, in a pandemic and certainly an economic challenges, people are adopting more pets. And more importantly, they’re spending more time at home with those pets. So in a typical year, in the U.S., you’ll see about 3.2 million adoptions. We don’t have great data yet on what the increase is, but I think anecdotally, no matter where you sit, everyone has a new dog or cat in your neighborhood. So we’re definitely seeing, as you look at our vaccine sales, certainly an increase in some of these areas. But I really think what’s changing is dogs are becoming a greater part of the family. People are spending more time at home. I don’t think that’s going to change overnight. And therefore, they’re noticing more conditions with their dogs. They’re also spending more time at home, seeing our ads and realizing that they’re – if they have a dog who’s sick, there is a product for that. So I don’t think that trend – maybe it was more accelerated this year, but I think those dogs and cats are here to stay. I think people will change their behaviors, and some of them, I think, around spending more time with the comfort, be it emotional or otherwise, of pets will continue. And as you look at Europe, your question with regards to COVID in Europe, the data in Europe, as you know, is not as reliable and – as in the U.S., there’s not as many comprehensive data sources. But what we’re hearing anecdotally is our customers figured out in Q2 how to continue to see pets through curbside check-ins, and that really hasn’t changed. They figured out how to operate, given they’re an essential business and we really don’t – we have not seen so far any significant changes. Obviously, there’s incremental lockdowns being announced, obviously, in the last 24 to 48 hours in Italy and other places. But as you look at our guidance for the year, unless it gets significantly worse, we think that’s baked in. And I think if you look at what we’ve learned between Q2 and Q3, we think that our customers will be able to manage well as we move into 2021, certainly on the pet care side, to manage continuing to see pets and to diagnose them either through telemedicine or through curbside check-in. So we do believe the trends there are resilient. Operator : Our next question comes from John Kreger with William Blair. Jonathan Kaufman : Hi, good morning. This is Jon Kaufman on for Kreger. First, I would like to go back to diagnostics. I know your reps aren’t able to visit the clinics as much as usual, but can you talk about the initial reaction to the IMAGYST product? When your field teams are discussing this with clients, understanding that right now it’s only being used for fecal samples, how are they describing the potential for broadening out the potential use? I guess is there an expectation that there’s going to be a consistent introduction of new applications? And then I would also just like to ask about poultry. Can you just provide more details around what’s going on there? It’s typically one of your faster-growing areas in livestock. So just trying to get a sense of what changed this quarter. Is it part of a typical rotation of product usage? Or is it some sort of competitive dynamics there? Thank you. Kristin Peck : Sure. I’ll start on the diagnostic, on IMAGYST. We are very pleased with how that’s going. As you know, the first indication for the IMAGYST, which is an AI-driven diagnostic, is in fecal. That’s about a $500 million market, growing about 7%. People are excited at the opportunity for this technology and certainly for additional indications. So we are on track there, and I think we’re very pleased with this progress. And given the positive receptivity to it, we are accelerating our investments to bring new indications overall there. And as you look at poultry, certainly in the U.S., there is definitely a rotation, which we always talk about, that was definitely a driver in the quarter, and I think you’ll see again moving into Q4. It’s also potentially one of the reasons we guided where we did on livestock overall in Q4. Obviously, there’s the overall impact to all of the livestock sectors of COVID and less consumption and more dine-in versus dine-out. But poultry specifically, it was more around the rotation there. Operator : And our next question comes from Balaji Prasad with Barclays. Balaji Prasad : Hi, good morning, and thanks for taking the question. So I want to get to China and discuss both the companion animal side and the livestock side of the business. So you had a 63% growth in China. And I thought I heard you say that you had 140% growth in livestock. So could you, a, quantify any kind of sort swine re-herding happening in China and how the effects you’re seeing on the business? And if the 140% number is correct? And secondly, on companion animal, could you speak about your expectations on Simparica? And also give us a sense of the time lag before you introduce Trio? And what are the gating factors to introduce that? Is it more regulatory or your own life cycle planning? Thanks. Kristin Peck : Sure. I’ll start and I’ll let Glenn build on this. We were very pleased, obviously, with the growth in China and really the balance between companion animal and livestock there. Certainly, on the livestock side, we are seeing a faster-than-we-expected growth coming back from ASF. But really with the large integrated producers, there’s still a significant ASF challenge there. But given the biosecurity of some of them, we are seeing significant growth there. And in companion animal, similar to some trends at other places, is just great growth across the portfolio and strong performance there, certainly on Revolution, launching RIMADYL, just now getting the approval on Simparica. It’s more a timing of regulatory on Trio there, but I’ll let Glenn get into some specifics on the numbers and the growth. Glenn David : Yeah. So just, again, to the details of the number. As you mentioned, overall, China for the quarter grew 63%. We saw 52% growth in companion animal and we saw 81% growth in livestock. And that 81% growth in livestock was driven by swine. So as I mentioned in the prepared remarks, swine grew 159% in China for the quarter. As we’ve continued to see the recovery in some of our key accounts and the larger producers, we’ve seen very strong performance of our products within those accounts. Operator : And our next question comes from Navin Jacob with UBS. And we will actually move on to Kathy Miner with Cowen and Company. Kathleen Miner : Thank you. Good morning. Just 2 questions, please. First, I’d just like to go back to the canine market, where you sized it up at about $400 million. Can you give us a sense of how much of that might be outside of the United States? And does the treatment of canine OA pain differ from the U.S. such that a launch or uptake may be different? And second question on Apoquel and Cytopoint. It looks like trends for those products continue to be very strong. So as you go forward, is this strength more sustainable than you may have initially thought pre-COVID just because there’s more pets that have been adopted and owners are at home more, so perhaps you see more use of these products? Thank you. Kristin Peck : Sure. So digging in a – first of all, Kathy, great to hear from you. As we look at the pain market for dogs, it’s $400 million. If you look at the number of dogs, the EU has 90 million and the U.S. has 75 million. And as you look at, the 40% prevalence of OA is the same across. But in the U.S., really it’s only diagnosed about 28% versus 50% in the EU. The only thing we’ve learned with new technologies is that given we can do direct-to-consumer advertising in the U.S., we tend to be able to ramp faster to peak sales when we’re launching new technologies in the U.S. than we are able to do in Europe just given we can’t do direct-to-consumer advertising that’s brand-specific. So I do think we look at how fast can you ramp up that market in Europe. It will be slower than the U.S., what we have in U.S., just given the history. And ultimately, I think we’ll do well there. But I think it is a little slower, I would say, overall there. And your second question was around, what was it? Glenn David : Around derm. So in terms of the opportunity for derm, so we continue to see really strong performance in the derm portfolio. We grew 16% this quarter with 21% growth year-to-date. In terms of the continued opportunity for growth, we see opportunities for growth in both the U.S. and International. So looking at the U.S., currently, there are about 75 million dogs in the U.S. and about 14 million dogs have itchiness. Of those 14 million dogs, today about 60% are treated. So there is still 40% of the dogs with itchiness that are not treated. So we do think there is an opportunity to continue to raise awareness of the disease state and get those itchy dogs continue to take Apoquel or Cytopoint. When you look outside of the U.S., we also see a big opportunity for growth. In terms of the breakout of our sales today, about two-thirds of our sales are U.S. and one-third is International. However, the number of itchy dogs is similar between those segments. So to the extent that we’re able to continue to drive that adoption and awareness, we do believe that there is continued growth expected in the International markets as well. Kristin Peck : And the other thing I’ll say, we’re still looking at not having competition, so at the earliest the second half of next year. So we’re going to, obviously, continue to try to grow those as fast as we can and gain market share. Operator : And our next question comes from Navin Jacob with UBS. Sriker Nadipuram : Hi, everyone. This is Sriker Nadipuram on for Navin Jacob. Apologies for getting cut off before. But I just have a couple of questions. So in anticipation for the DRAXXIN generic coming next year, what level of destocking can we expect to see? And then, maybe just on the medicalization rate in osteoarthritis, what’s a good analog for how high you think it can get in dogs and cats in the U.S.? Thanks very much. Kristin Peck : Sure. Starting on DRAXXIN, I mean, it’s a little bit hard to tell you exactly what we think the destocking will be. I think given the expectation for many of our customers that they will see significant new generic entrants, I’m sure they will think differently about building inventories ahead of normally what is our price increases in Q1, and that was sort of what Glenn was alluding to earlier. Obviously, we have a robust defense plan for DRAXXIN. It’s an important product. We still have – given its high margin – significant pricing leverage here. But obviously, we anticipate that some of our customers who would normally stock up at the end of the year ahead of the price increase will not be doing so there. And how high can medicalization rates get for OA? I mean you’d love to believe that all those dogs would be diagnosed. I don’t think you’re going to really ever get to that exact number. But we try to look at our ability, for example, in derm to try to do that. So we do think there’s a significant opportunity, both because they’re bringing innovation and we also believe that the anticipated potential safety profile of a mAb will bring more people out that are struggling certainly on the dog side, but definitely on the cat side as well. So I think it’s a little too early to say exactly where you can go, but there’s a significant opportunity. And we’ve demonstrated before that we’ve been able to grow markets as we’ve entered them with new innovative technologies. Operator : Our next question comes from Elliot Wilbur with Raymond James Unidentified Analyst : Hi, guys. This is actually [Michael Paralary] [ph] on for Elliot Wilbur. Thanks for taking my question. Most of my questions have actually been answered already, so I just have one for you on the topic of share repurchases. I know that you said that you’re continuing to evaluate the resumption of the program. But given the strong recovery in the business, I was just wondering if you guys had any timeline specifically on when you’re looking to resume the program, and if you’re looking for anything specifically on deciding whether or not to resume the program? Thank you. Glenn David : Yeah, thanks, Michael. So in terms of share repurchase, we don’t have any specific timeline. Obviously, it’s something that we’ll continue to evaluate. There’s still a lot of uncertainty in the marketplace, particularly around COVID-19 and the timing that we expect to see a full recovery. So that’s one of the factors that we’ll continue to evaluate. One thing I’ll say though is our capital allocation priorities have not changed, right, in terms of investing in the business as our first priority. And I think you see us doing a lot of that this year, even in light of COVID, particularly with the investments that we’re making in DTC, the investments that we’re making in R&D to continue to support the medium, short and long term growth of this company, also significant investments that we’re making in manufacturing to ensure continuity of supply, and also investments that we’re making from an inventory perspective, again, to ensure continuity of supply. So we are really focusing on some of those internal investments. We’ve also been able to execute on some business development deals throughout this year as well even with the limitations that may be provided by COVID, but really good use of our capital across all areas. Operator : [Operator Instructions] Our next question is a follow-up from Balaji Prasad with Barclays. Balaji Prasad : Hi, thanks for taking the question again. So I was just trying to check on your comment on the market share in the flea and tick and heartworm segment, 6% gain. I just wanted to clarify if that was based on a market size of $2.5 billion, $2.6 billion, or could you clarify that? Thanks. And secondly also, what was the actual number for Trio this quarter? Glenn David : Yeah, so just to clarify, that was based on the U.S. market size of around $2.5 billion. And the second question was around Apoquel for the quarter – for Trio, I’m sorry. So, the Trio for the quarter, we did $50 million in sales for Trio for the quarter. Operator : And at this time, there are no additional questions. I’d like to turn the program back over to Kristin Peck for any closing remarks. Kristin Peck : Okay. Well, thank you all for your questions and continued interest in Zoetis. We look forward to keeping you updated on our business and continuing to deliver the results and innovations, that you and our customers expect for us. Stay well. Thanks so much. Operator : Thank you for your participation. This does conclude today’s program. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,021
| 1
|
2021Q1
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2020Q4
|
2021-02-16
| 3.706
| 3.8
| 4.146
| 4.27
| 6.56942
| 39.27
| 37.62
|
Operator : Welcome to the Fourth Quarter and Full Year 2020 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in information or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode. The floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you. Good morning, everyone, and welcome to the Zoetis fourth quarter and full year 2020 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, 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 statement 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 in the company's 8-K filing dated today, February 16, 2021. We also cite operational results which exclude the impact of foreign exchange. And with that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. Good morning, everyone. I hope you and your loved ones are all staying healthy. As we all know, we're still experiencing hard times in many regions, as COVID cases continue and new variants of the virus emerge. But I hope you share my optimism that with progress in vaccinations and continued adherence to safety protocols, better days are ahead. The year 2020 will be remembered for COVID-19, but for Zoetis it also reaffirms the resilience of our business, the essential nature of animal health and the agility and dedication of our colleagues in the face of industry and personal challenges. Throughout the year, we successfully ensured colleagues' safety and maintained reliable supply for our customers. We kept driving innovation and strengthening our diverse portfolio of 13 blockbusters and more than 300 product lines across eight species and seven major product categories. We successfully launched our triple combination parasiticide Simparica Trio. We also achieved approvals for the first ever long acting monoclonal antibodies for osteoarthritis pain in dogs and cats, with Librela’s authorization for dogs in the European Union and several other markets, and Solensia’s first authorization for cats in Switzerland. We also continue to build on our vaccine portfolio in livestock with the approval of our CircoMax [Myco] [ph] swine vaccine in the European Union. And in poultry, we continued advancing our recombinant vector vaccine with the approval of Poulvac Procerta HVT-IBD in the U.S. Meanwhile, in diagnostics, we successfully launched Vetscan Imagyst, our breakthrough platform using cloud-based artificial intelligence for veterinary clinics. We were able to do all this while staying anchored to our purpose, and advancing the five long-term priorities that I set out at the beginning of the year, including sustainability, where we made important progress in our ESG programs and metrics reporting. We look forward to sharing our long-term ESG goals in the coming weeks. And finally, we delivered financial results for 2020 that were in line with the guidance we provided last February before the impact of the global pandemic was known. For the full year, we generated 9% operational growth in revenue, primarily based on new products in our companion animal business, the continued strength of our key dermatology portfolio and growth in China. And as part of our long-term value proposition, we once again grew revenues faster than the anticipated growth for 2020 and faster than the historical industry rates of 4% to 6%. As part of our value proposition, we also delivered on growing our adjusted net income faster than revenue. For the full year, we delivered operational growth of 10% in adjusted net income while adapting our operations within pandemic, and continuing investments in our pipeline and new product launches. We generated strong fourth quarter results, which Glenn will discuss in a minute. And these performance trends give us confidence in our growth drivers and strong momentum for 2021. We expect to continue growing revenue faster than the market in 2021, driven by ongoing strength in pet care, continued expansion in markets outside the U.S., most notably China, and acceleration of our diagnostics portfolio penetration. We are guiding to operational growth of 9% to 11% in revenue for full year 2021. Growth expectations for the companion animal market are in the mid single digits. And we expect [indiscernible] to grow significantly faster than that based on the continued uptake of Simparica Trio, the strength of our key dermatology portfolio and the launch of monoclonal antibodies in markets outside the U.S. Positive pet care trends during the pandemic based on increased adoptions and people spending more time with their pets should continue driving market growth in the near-term. Data in the U.S. shows visits to veterinary clinics have rebounded and the average revenue per visit has continued to increase. Over the long-term, we see these trends moderating as adoption rates normalize and people eventually returned to the workplace. The specialty care regimen and chronic care treatment that began in the pandemic should continue, and our innovative portfolio across dermatology, parasiticide, pain, vaccines and diagnostics have us well positioned for continued growth [impacting] [ph] share as we shift the curve. In terms of livestock market, we expect low single digit market growth in 2021, as the impact from COVID-19 will still be felt as a number of products experienced loss of exclusivity. We expect the [indiscernible] to grow in line with the market, even as we face increased headwinds from generic competition for Draxxin, our leading anti-infective product. We are confident we can leverage our lifecycle innovation strategies together with the overall diversity of our livestock portfolio, including swine product sales in China, to help us address the loss of exclusivity for Draxxin and maintain livestock growth that will support our 2021 guidance. Longer-term, we will continue to invest in livestock innovations and data-driven animal agricultural solutions. As we continue through 2021, we will be building on the progress against our five priorities; driving innovative growth, enhancing customer experience, leading in digital and data analytics, cultivating a high-performing organization and championing a healthier, more sustainable future. Our investment plans and focus on growth for 2021 include continuing the successful launch of Simparica Trio in the U.S. and other markets, as well as the ongoing adoption of other new parasiticide, Revolution Plus and ProHeart 12. Driving growth in dermatology through increased use of direct-to-consumer advertising and disease awareness campaigns in the U.S. and globally. Our focus remains on growing this market and increasing customer loyalty to our innovative treatments, which we expect to help us top $1 billion in annual sales for the first time. As noted earlier, we'll be investing in the launch of the first monoclonal antibodies for osteoarthritis pain in dogs and cats in Europe in the first half of 2021, and advancing the regulatory process in the U.S. and other markets. While we remain confident in the eventual U.S. approval of these products based on the safety and efficacy data we submitted, at this point, we believe it is unlikely we will receive approvals for Solensia or Librela in the U.S. in 2021. We continue to work through regulatory reviews and manufacturing inspections with the FDA, and we will continue to keep you updated on this process on future calls. And finally, we're continuing our development of digital and data solutions that will support more individualized animal care and more efficient and sustainable operations for producers. In conclusion, I'm incredibly proud of what our people accomplished in the face of such uncertainty during 2020, and it gives me great confidence in our continued success and full year guidance for 2021. As we navigate through recovery from the global pandemic and capitalize on the growth opportunities we see ahead, but optimism comes from what drove us over the last year. The resilience and essential nature of the animal health industry, the diversity, innovation, and market leadership of our portfolio, and the agility and passion of our colleagues to face any challenge. Now, let me hand it off to Glenn, who will speak more about our fourth quarter results and guidance for the full year 2021. Glenn David : Thank you, Kristin, and good morning, everyone. We had another exceptional year with revenue of $6.7 billion and adjusted net income of $1.8 billion, both exceeding the high-end of our November full year guidance range. Full year revenue grew 9% operationally and 7% on a reported basis, with adjusted net income increasing 10% operationally and 5% on a reported basis. Going deeper into the numbers, price contributed 2% to full year operational revenue growth with volume contributing 7%. Volume growth consisted of 3% from new products, 3% from key dermatology products and 1% from acquisitions with other in line products flat for the year. We again saw broad-based revenue growth with U.S. growing 11% and international growing 7%, operationally. The innovation we brought to the market and the diversity of our portfolio was key to our strong performance, as companion animal grew 17% while livestock was flat on a year-over-year basis. Performance from companion animal was led by our parasiticide portfolio bolstered by the launch of Simparica Trio, which generated revenue of $170 million. This added approximately $150 million of incremental revenue and exceeded our expectations set prior to the pandemic. Sales of Simparica also grew double digits for the year with operational revenue growth of 16%. Our key dermatology portfolio demonstrated continued strength in 2020, growing 23% operationally, generating revenue of $925 million and increasing more than $170 million versus prior year. The COVID-19 pandemic created a difficult market environment for livestock. However, we are encouraged by the resiliency displayed in 2020. We remain optimistic that global livestock will return to modest growth in 2021 as the recovery from African swine fever in China continues and consumption patterns normalize. Operational growth and adjusted net income of 10% was driven mainly by strong revenue growth and operating margin expansion. Now moving on to our Q4 financial results, where we posted another strong quarter with revenue of $1.8 billion, representing an increase of 9% operationally and 8% reported. Adjusted net income of $438 million is an increase of 3% operationally and flat on a report basis. Operational revenue grew 9% with 2% from price and 7% from volume. Volume growth of 7% consisted of 4% from new products, 3% from key dermatology products, 1% from acquisitions and a decline of 1% from other in line products. Companion animal products led the way in terms of species growth, growing 25% operationally, while livestock declined 5% operationally in the quarter. Companion animal parasiticide grew 52% in the quarter, gaining market share in the U.S. of more than 7% in the flea, tick and heartworm segment versus the same period in the prior year. This includes the continued adoption of Simparica Trio which generated sales of $60 million in Q4. Our key dermatology products, Apoquel and Cytopoint again had significant global growth in the quarter with $257 million of revenue, representing 27% operational growth versus an extremely difficult comparative period in which key derm grew 29% for the fourth quarter of last year. Our diagnostics portfolio again made positive contributions to revenue with reference lab expansion and double-digit growth in consumable and instrument revenue. The recovery in wellness visits continues to be a catalyst for growth following the slowdown from social distancing restrictions earlier in the year. As we noted on our previous earnings call, the early fall cattle run hold a portion of fourth quarter sales into the third quarter, leading to a weaker quarter in cattle than we would typically expect. This was the primary driver of the 5% operational decline in livestock for the fourth quarter. For the remainder of the livestock portfolio, swine posted a second consecutive quarter of growth. With the herd rebuild continue in key accounts as the market recovers from African Swine Fever in China. Our aquaculture business grew high-single digits in the quarter and along with swine partially offset the decline in cattle and poultry. Now moving on to revenue growth by segment in the quarter, U.S. revenue grew 11% with companion animal products growing 30% and livestock sales declining by 15%. For companion animal, the positive trends at the vet clinic continued in Q4 with patient visits up 2% and revenue per visit increasing by 13%. Companion animal growth in the quarter were driven by sales of our Simparica franchise, as well as key dermatology products. We maintained an increase investment in direct-to-consumer advertising in both therapeutic areas and continue to see a good return on that investment. Simparica Trio performed well again in the quarter, with sales of $56 million. We remain extremely encouraged for the future growth of our product and the growth of the overall market segment as a material portion of Trio sales came from new patients to the category. Key dermatology sales were $176 million for the quarter, growing 32% with significant growth for Apoquel and Cytopoint. Our investments to support the franchise have been instrumental in driving more patients into the clinics. Companion animal diagnostics sales increased 22% in the quarter as a result of reconciled expansion and growth in point of care instruments and consumables. U.S. livestock declined 15% in the quarter driven primarily by cattle, which had a portion of Q4 sales pulled into the third quarter as a result of the earlier movement from pasture to feedlot. The remaining species declined as well with COVID-19 and pricing pressure negatively impacting our swine business. Poultry declines are largely attributed to product rotation and less producer profitability, leading to reduced usage of our premium products. To summarize U.S. performance innovation and return on investment, once again drove exceptionally strong growth in companion animal, while livestock was down in the quarter, the results were in line with our expectations. Revenue in our international segment grew 7% operationally in the quarter. Companion animal revenue grew 17% operationally and livestock revenue grew 2% operationally. Increased sales of companion animal products resulted from growth in our parasiticide portfolio, vaccines and key dermatology products. Parasiticide growth in the quarter was again driven by comparative franchise with further adoption of Simparica Trio. In Q4 we observed a series of favorable market trends, such as increased pet ownership and medicalization rates in Asia. Overall companion animal grew in every major market except Italy and the UK, which had arguably the strictest lockdown protocols. Companion animal diagnostics grew 16% in the quarter led by an increase in point of care consumable usage. Swine revenue grew 14% operationally, posting a third consecutive quarter of double digit growth. Swine sales in China grew in excess of a 100% for the second straight quarter. Key accounts expanded their use of vaccines and other products as they continue to rebuild herds from smaller farms to large scale operations. China, total products grew 45% operationally in the quarter and 34% operationally for 2020. Brazil was also a significant contributor to international growth in the quarter, growing 18% operationally. For the fourth quarter and full year 2020, Brazil delivered double digit growth in all species except poultry, which modestly declined. Overall, our International segment delivered strong results despite the challenges presented by COVID-19. Our diversity across products and geographies enabled our International segment to again be a significant driver of growth. Now moving on to the rest of the P&L for the quarter, adjusted gross margin of 67.7%, fell 80 basis points in a reported basis compared to the prior year resulting from other manufacturing costs, inventory charges, recent acquisitions and elevated freight expense. This was partially offset by favorable product mix and price increases. Adjusted operating expenses increased 10% operationally, resulting from increased advertising and promotion expense with Simparica Trio and Apoquel, partially offset by T&E savings. Return on investment from our DTC campaigns has been very favorable and we remain – and will remain an important investment to support future growth of the business. The adjusted effective tax rate for the quarter was 13.5%, a decrease of 70 basis points driven by the impact of net the discrete tax benefits, partially offset by jurisdictional mix of earnings. And finally adjusted net income and adjusted diluted EPS for the quarter grew 3% operationally. In December, we announced 25% annual dividend increase continuing our commitment to grow our dividend at or faster than the growth in adjusted net income. In addition, we resumed our share repurchase program in January with $1.4 billion of remaining capacity under the current authorization. Now moving on to the guidance for 2021, please note the guidance reflects foreign exchange rates as of late January. For 2021, we are projecting revenue between $7.4 billion and $7.55 billion, representing 9% to 11% operational growth. We are expecting foreign exchange favorability in 2021 of approximately 200 basis points. We expect companion animal to be the primary driver of growth in 2021 with the continued strength of our diversed parasiticide portfolio which includes full year of Simparica Trio sales. We believe market dynamics for companion animal will remain strong in 2021, allowing for further expansion of our key dermatology products, as well as our diagnostics offerings, which we anticipate will grow faster than the overall animal health market. While we expect the pace of certain trends that accelerated in 2020 to moderate, such as increased spend per visit. Our view is that 2020 has a status of the higher base for future growth. We anticipate livestock will return to global growth in 2021, primarily driven by more normalized food consumption patterns. Geographically, we expect total company sales growth to be relatively balanced between our U.S. and International segments. However, we do expect continued and meaningful growth in China and other emerging markets. I'd like to touch upon the key assumptions that underpin our expectations for revenue growth. Beginning with dermatology, our guidance does not assume a meaningful competitive entry in 2021. And with continued investments behind the franchise, we believe revenue will exceed $1 billion for the full year. We also do not assume the triple combination product will launch in the U.S. in 2021 to compete against Simparica Trio. We're extremely excited about our monoclonal antibodies for pain, with both Librela and Solensia having long-term blockbuster potential. However, as Kristin mentioned, while both products will launch in the first half of 2021 in the EU and other international markets, we do not currently expect either product to receive approval in the U.S. this year. For the remainder of the P&L, adjusted cost of sales as a percentage of revenue is expected to be approximately 30%, which is relatively consistent with our cost of sales in 2020. Adjusted SG&A expenses for the year are expected to be between $1.775 billion and $1.85 billion. With the increase in 2020 focused on supporting primary drivers of revenue growth, including recent and future product launches, key brands and recent acquisitions, and reference lab expansion in diagnostics. Adjusted R&D expense for 2021 is expected to be between $500 million and $520 million as we remain committed to investing in pipeline opportunities for new therapies and life cycle innovation. Adjusted interest and other incomes deductions is expected to be approximately $260 million with the increase over 2020 driven by increased interest expense, as well as lower interest income. Our adjusted effective tax rate for 2021 is expected to be approximately 20%. The increase in 2021 is primarily related to the impact of favorable non-recurring discrete items that occurred in 2020. Adjusted net income is expected to be in a range of $2.08 billion to $2.13 billion, representing operational growth of 9% to 12%. Our guidance reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue, during the year when we'll be making meaningful investments to support future growth. Consistent with 2020, we are anticipating elevated capital expenditures in 2021 to support investments in manufacturing, focused on internal sourcing of API, capacity increases and facilities to support pipeline opportunities. We're also investing in information technology to support our recent acquisitions, as well as digital capabilities and data analytics. Finally, we expect adjusted diluted EPS to be in the range of $4.36 to $4.46 and reported diluted EPS to be in the range of $4.02 to $4.14. While guidance represents full-year expectations, we do anticipate growth will be more heavily weighted towards the first half of the year. This is largely due to full-year Simparica Trio sales and a favorable comparison versus Q2 2020 as a result of COVID-19. To summarize 2020 was another exceptional year in which we delivered 9% operational revenue growth and 10% operational growth and adjusted net income. And the year represented a unique set of challenges. Our guidance for 2021 highlights our ability to grow revenue organically above the market and grow adjusted net income faster than revenue even during times of elevated investment. Before turning it over to Q&A, I'd like to express how proud I am of our colleagues and all we've accomplished amidst an unprecedented set of circumstances. While there is no assurance that the New Year will be without similar challenges faced in 2020, we cannot be more excited about the opportunity to again deliver on our long-term shareholder value proposition. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] And then we will take our first question from Jon Block with Stifel. Please go ahead. Jon Block : Thanks, guys. Good morning. Congrats on just a great 2020. For the quarter, 4Q 2020 gross margins were a bit below despite big companion animal growth. And next year it seems like you're guiding to flattish, call it, gross margins again, despite what seems like positive mix shifts. So, Glenn, can you talk about that a bit? Why are we not seeing a bit more in gross margin considering the companion animal performance? And is expanding gross margin still a part of the long-term story? And then I'll stick with sort of guidance. Just really big hummers on 2021 guidance out of the gate. You talked about livestock versus companion. Can you talk through the components of companion animal a little bit more? I don't know if I specifically heard a Trio number, but is it safe to assume Trio of $400 million plus in any other components you’d call out? Thanks, guys. Glenn David : Sure, Jon. So firstly, you look at the gross margin expectation for 2021. It is relatively flat versus 2020. As you mentioned, the mix with companion animal will be beneficial as we move into 2021. Some of the offsets to that, there were some of the investments that we're making in other areas such as reference labs, which come at a lower margin, particularly in the early stage of their life cycle is we're building those labs, [indiscernible] the margins will be a little lower until they reach their full operating scale. So that's some of the offsets. So there are some positives in terms of the companion animal mix. Some offsets there with some of the longer terms we’re investing and making in other areas. In terms of the drivers of companion animal growth, so obviously we do expect Trio to be a significant driver of growth for 2021. We're not putting a specific number on Trio, but we would expect the contribution from growth in 2021 to be at least as big as what we achieved in 2020. So that'll obviously be one of the drivers, also continued growth in our dermatology portfolio. We saw very strong performance in 2020 with 23% growth in that portfolio operationally for the year. We do expect that portfolio will exceed $1 billion as we move into 2021. Also in companion animal diagnostics, we expect very rapid growth in diagnostics as well. In the fourth quarter, we saw 20% growth and we expect that will help carry us forward with the strong momentum that we had in the quarter into 2021, as well as strong performance that we're seeing in many of our emerging markets, such as China and Brazil. So those are some of the factors that are driving the strong companion animal growth. Operator : Our next question comes from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Hey, thanks, guys. I'm going to ask a quick two-parter. First one is going to be on the livestock market, and just specifically on Draxxin. Are you starting to see some competition? I know the patent has just rolled off, but any early comments you can tell us in terms of pricing from competing launches and sort of [indiscernible] expectation of the market share? But also what steps you are taking? And how meaningful the headwind do you expect in 2021? And then broader on livestock, we've read a lot about input costs going higher on corn, things of that potentially pressuring producers in some markets, poultry and swine. How does that factor into your outlook for a low single digit growth? And then a second question would be just a little bit more on the companion animal expectations for 2021. I mean, obviously, you're growing well above the market, but any thoughts on sort of in line portfolio? And you commented on Trio, and you commented on strong derm strength, and that you see in Librela. But just can you sort of comment on Revolution Plus and on the rest of the in line portfolio there? Kristin Peck : Thanks, Mike. So starting on Draxxin, we are expecting a number of competitors to enter in the U.S. market. Again, the LOE is this month, so it hasn't happened yet. I would say more probably entrants than we expected a few months ago, but we don't think that will last. Obviously, I think the market will shake out obviously to a few. As we said previously, typically, we expect about - to lose about 20% to 40% share over several years. In the case of Draxxin, given the large number of competitors, we do expect that to be factor, but we don't really expect it to be overall different. And really partly what drives that I think is we do believe that a lower price on Draxxin will expand the market for macrolides overall, and therefore the market itself will grow. We also think we're positioned well from a broad portfolio, strong technical. We do expect that the price to come down in that 20% to 40% that is an expectation. But as we said, this is all baked in right now to our guidance, so the expectation around where Draxxin is going to be is there. And if you look at broader livestock, you referenced some of the [info] [ph] costs. As you heard in some of our opening remarks, we are expecting low single digit growth, so a return to growth in livestock overall. And some of that will be led in the U.S. [indiscernible] a lot of that will be led outside the U.S. As a reminder, about 60% of our livestock business is outside of the U.S. and we're seeing incredible growth right now in China and some other markets, Brazil, et cetera. So overall, we do think some of the [info] [ph] costs in U.S. will be a pressure, but we have, given the diversity of our portfolio, looking at some large markets, our second largest market is China, our third largest market is Brazil, we do see strength in livestock there. So we overall do believe livestock will return to low single digit growth in 2021. And we continue to believe it will return to normal growth in the mid single digit range 4% to 6% over the medium term. So, Glenn, I'm not sure if you want to take the incremental question on the broad companion animal trends in 2021. Glenn David : Yes. So the trends for companion animal will remain very strong. It's really driven by the breadth of our portfolio. So we talked a lot about the growth that we expect to see from Trio from our derm portfolio, from our diagnostics portfolio. Also in 2021, we'll have the launch of our monoclonal antibodies for pain in Europe, as well as some other markets. We’ll also be a key contributor to growth. But then there are other products that round out the portfolio; products such as ProHeart 12, products such as Revolution Plus. Also the growth that we're seeing in markets like China, where companion animal is growing very rapidly, markets like Brazil. So there are really many areas of growth that we see. And that's driven by the fact and we do have the broadest portfolio in companion animal. We're able to leverage that with our customers. Operator : And our next question comes from Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : Hi, thanks for taking my question. So what are the macro factors that you see for Zoetis in 2021, as it pertains to livestock feed prices, weather, any other headwinds or tailwinds that you see out there? Thank you. Kristin Peck : Sure, Louise. Good to hear from you. As you look at livestock overall, we're seeing some of the macro trends as sort of a recovery in China around AFS is driving significant portion of the growth from a swine perspective. China is still going to be importing a decent amount probably less than in 2020 from other markets around the world sort of maintaining that. We're also hopeful that you'll see an increase in dine out, which will send a signal to the industry to expand herds. So I mean 2020 was obviously hit with many different factors, but we do see both an increase in demand. And in markets where our technologies have really leveraged some of the emerging markets, we're seeing significant uptick there. There will remain challenges in some of the U.S. producers, obviously, for some of the [info] [ph] costs, et cetera, but we do believe you'll see more of a return to normalcy as we move into 2021. And that's why we were guiding at sort of the low single digit, but we do believe in the medium-term, we'll be back to sort of a mid single digit overall. Operator : And our next question comes from Erin Wright with Credit Suisse. Please go ahead. Erin Wright : Thanks. I'm curious how the multi-formulation approach towards parasiticide is resonating across your customer base. I guess this is [indiscernible] you haven't had any strength historically [indiscernible] cannibalization of legacy products there playing out in line with your expectations? And then my second question is on the new pain meds. How should we think about the contributions from them this year in Europe or other countries, will be meaningful at all? And how should we think about the dynamics that are impacting approval in the U.S.? Do you still anticipate? Are you still confident that these will be blockbuster products for you with the launch in the U.S. in 2022? Kristin Peck : Thanks, Erin. I heard the second question on labs, which I can answer. You were breaking up in digitizing on the first question. I think we more or less have it, so let us give a shot, and you can comment if we missed out some of what we heard. So starting on your second question on the labs, we were very excited to now have Librela approved and launching in the first half of this year in the EU, Brazil, Canada and Switzerland. And Solensia, we continue to expect approval in the EU in the first half of this year and to be launching sort of mid-year. We already do have approval on Solensia in Switzerland. And we remain confident in the eventual approval based on the safety and efficacy data we submitted in the U.S. But if you saw in our remarks and our release, the approval timeline has moved out a bit. We believe this has to do with the fact that this is the first monoclonal antibody approved by the FDA in animal health. Our previous one Cytopoint was actually USDA. It's making it a little harder for us honestly to predict some of the regulatory process. We're continuing to work through the regulatory process and manufacturing inspections, and we'll continue to keep you updated. We don't think that changes the overall peak sales of this product at all, but it is a slightly different process. And I guess, Glenn, might have understood a little bit better, but we'll try your first question. I know we missed it. Glenn David : Yes. So, Erin, I think your question was around how we're performing with the breadth of our portfolio from parasiticide with our customers. And I think that's going very well in the veterinary clinics. We're really able to offer our customers a variety of options based on how they want to best treat the animals. And I think that shows in the performance that we saw on the Simparica franchise in 2020. Not only did we exceed our goals for Trio with $170 million in sales in the year, but we also saw significant growth in Simparica, which really exceeded our expectations. So we grew operationally 16% with Simparica. What we saw was that the advertising and driving patients into the clinic for Simparica Trio actually benefited the overall portfolio. We also saw a very positive growth in ProHeart 12 as well. So we think the breadth of the portfolio and the parasiticides was really a benefit and our field colleagues really able to execute very well with that portfolio. Kristin Peck : Was that your question? Did we get it all? All right, you can come back in the queue. We missed you, sorry about that and look a little bit digital. Operator : Okay. We'll take our next question from John Kreger with William Blair. Please go ahead. John Kreger : Hi, thanks very much. Just maybe a quick follow-up on the Librela and Solensia timeline in the U.S. Do you have a sense for how far pushed back the approval of timing might be? And do you think you need to collect additional clinical data? Kristin Peck : Yes. We don't have a great sense right now. We're still working through the regulatory and manufacturing process. We also – the FDA is going to require inspections. Our facilities are outside the U.S. So the exact timing of when they're going to be able to do that is a little bit uncertain. So I don't have a great sense. If we did, we would have obviously given more specific guidance. We do not expect it to be in 2021, which is what we're being fair right now. And as soon as we know more, we'll be happy to update in future calls going forward, but unfortunately I don't have greater – again, we remain very confident that it will eventually be approved. But we need to go through a new process with a regular that hasn't an animal health under CBM approved in monoclonal antibodies previously. So it's a little bit different for us. So this is the best we know at this point. John Kreger : Great. Thank you. And then a second question. Can you maybe just sort of frame the diagnostics plan for 2021? It seems like results are starting to accelerate there. Are any of the investments being focused in the livestock? Should we really think about your efforts right now being concentrated with companion animal? Kristin Peck : Sure. For 2021, our focus remains on companion animals. We're very pleased with our progress on placements, which is a really good leading indicator of usage. As you saw, we had double-digit consumable growth as well, which we're quite pleased with. As we look at new products, we've added the Imagyst platform. We're excited with its first indication, obviously in fecal, that's the AI-powered one. We're looking for additional indications there. So the last piece there would also be reference labs. So we're continuing to expand our U.S. reference lab. So we’re probably adding about three to five more labs this year. So we believe diagnostics is a core part of our portfolio. It's a market that grows at 10%, but we're really pleased that we're starting to see some strong momentum across the different parts of it. So both reference lab as well as placements as well as consumables. So we remain very committed to the space and are pleased with our progress over there. Operator : And our next question comes from David Westenberg with Guggenheim Securities. Please go ahead. David Westenberg : Hi. Thank you for taking the questions and congrats on a great year. Can you give us a little bit of flavor on where Trio is taking share from? I think you mentioned there's some new to the category, but I'm just kind of trying to get a flavor is it legacy – just legacy flea and tick? I mean, what component is heartworm? And basically, what I'm trying to do is get a good sense of how big this can grow in terms of both the heartworm market and the flea and tick market? And then just a second related question on Trio. Is there any synergies, particularly on the sales synergy from the direct-to-consumer marketing campaigns, you might be able to benefit maybe derm or maybe even there's a cost synergy? So thank you very much. Kristin Peck : Sure. So starting on the Trio, we did see an increase in share in Q4 of 7%. So we are taking share in a number of places that's coming from. If you think about it, the first is new poppies, where I think we're doing quite well with new I think poppies. Also new people to the category overall, I would say, people who maybe previously had gotten products over the counter are moving in. And we are taking share from some of the other established competitors in this space. So I think we're seeing strong growth overall, I would say there and pleased at our share. If you look at the potential for the product, the two competitors NexGard and Prosecco are each $600 million products a day. So we continue to believe there's significant growth. We remain under index to be honest with you in parasiticide. So we continue to see this as a significant part of our overall growth From a sense – are there synergies with derm? Not really is what I would say, except for on a cost side. Obviously, we can get better buying power when you replace DTCs by leveraging the spend across both. But beyond that, we don't see strong synergies honestly between the DTC on one affecting the other, unless our clinic has to carry bolts and things like that, but we think maybe the only synergy there is just in our buying power by leveraging the combined DTC sense. Operator : Now we can go to our next question from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Hi, good morning. Thanks for the questions. Kristin, maybe to start, what do you think the launch curve looks like for products like Librela and Solensia? Obviously, a new way for vets that treat osteoarthritis and chronic pain. I guess kind of what are your initial kind of impressions on sort of the level of demand that's out there from vets for this type of treatment? And how will Librela be priced relative to existing treatments on the market? I know it can be kind of up to $100 a month here in the U.S. I'm sure it varies a lot by market, but just any comment on pricing would be helpful. Kristin Peck : Sure. I think the lifecycle for Librela and Solensia in the curve will be a slightly different. Librela is entering a market that's $400 million today. So it's an established market. So I think the ability for – people are already bringing their dogs in for OA pain. So I think we have the opportunity with Librela to expand the number of patients given the safety and efficacy profile and the compliance benefits of the product. I think we can also increase days on therapy. So it also helps us to grow the market and then obviously price to your point. So it is priced at a premium to many of the products on the market today. It is not – obviously, we don't have a price in the U.S. since we don't even have an approval yet in the U.S. I think Solensia is going to be a little bit different because the curve is going to take a little longer. And that has to do the fact that there really isn't a market today in most parts of the world. If you had a cat, there really was no treatment, so cat owners have kind of been condition to not bring their cats in. We've started focusing, about a year ago to try to build that market, make pet owners aware what OA pain looks like in cats and get – encourage them to start bringing their cats to the vet, and then getting vets to treat that. We think it's a significant market, but you have to first medicalize some of these conditions and treat it. It's significant. There's 60 million cats in the us U.S. And really only – but 40% of them have away, but only 18% of them are really identified by that. So we think both are significant markets that we can grow the market. So Solensia is more about creating a market. And I think you can look at our success in doing that with dermatology with Apoquel and Cytopoint. So we're investing early as Glenn has been talking about some of the guidance over the last year and for 2021 and building those markets. But I would assume the curves of Librela will be much faster than the curves of Solensia as we're building a market. Operator : And our next question comes from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi. Good morning and congratulations on the results. A couple of questions from me. Firstly, since livestock recovery this year seems to be so contingent on China. And there are news of regulatory of illegal vaccines being used and the recurrence of ACF. So I want to understand what you're seeing on the ground and how should we have our heads around the re-hurting cycling in 2021? Second on operating margins, considering that you will not have the dilutive impact of diagnosis that we saw in 2020. Should we be looking for better operating margins considering that revenue mix is better? Livestock should be in a recovery? And if so, what are the offsets to this. Thanks. Glenn David : Sure. So when you look at overall livestock, and particularly in China, so we've seen very positive performance in livestock in China this year. So from a livestock perspective, we grew 45% in China this year and we expect continued strong performance in China in 2021 as we continue to see the herd rebuild, recovery from African swine fever. And where we're seeing that recovery is particularly in our larger accounts and the larger accounts use more of the multinational products than our premium products. So we've seen a really rapid acceleration of our growth, for example, in the second half of the year in swine in particular in 2020, we grew over 100% in swine in China. And we expect very positive momentum moving into 2021 and very significant growth from China in 2021. In terms of the operating margins, there are a couple of things to look at as we move into 2021. A, number of areas of investments that we have in our SG&A, really continuing to support the growth of Trio as well as the monoclonal antibodies for pain as well as dermatology. We've increased our DTC investment in 2020, particularly around Trio and derm, and we plan on continuing that in 2021, as we saw very positive return on investment there. Obviously, we'll continue to invest in R&D. And that'll be an area of continued investment as we've seen a very positive return on that investment as well. The other thing to consider when you look at the overall guidance, which – with revenue growing 9% to 11% and income growing 9% to 12%; one of the reasons that income isn't growing more rapidly is the change in assumption in tax rate between 2020 and 2021. In 2020, our rate was 18.3%. Our guidance for 2021 is approximately 20%. If you neutralize for the impact of the tax rate, our adjusted net income would actually be growing 2% faster, so more 11% to 14%. So we are seeing margin expansion, but the impact of the tax rate is diluting that to some degree. Operator : And we'll go next to Chris Schott with JPMorgan. Please go ahead. Chris Schott : Great. Thanks so much. Can you talk, first, maybe a bit about innovation on the livestock side? It seems like the market between COVID and similar dynamics has been kind of a bit lackluster in terms of growth the last few years. So what does it take to get back to mid single digit growth on the livestock side? And what are some of the bigger innovation trends we should be watching there? And then a second question was just following up on the topic of margins. As we start looking after 2022 and beyond, should we be thinking about a sustained window of higher expense growth as you get many of these new launches off the ground? Or as a lot of that groundwork already been, I guess, invested as we go into 2020 and 2021? I'm trying to get a sense of how we should think about longer-term margin expansion dynamics, assuming we continue this very healthy top line set up that seems to be playing out. Thanks so much. Kristin Peck : Thanks Chris. We have been talking about the fact that to really get to the mid-single digits in a sustainable way. You're going to need innovation. I think there are few spaces where you're already starting to see that and some that will be coming. The first is around the vector vaccine space, which we have been talking about. In 2020, we launched our first one in the U.S. for Newcastle. In 2021, we launched one for IBV. We're looking for more launches there. This is a significant market, it’s about a $300 million market growing double digit. So we do see vector technology and poultry, which is one of the faster growing, species being an area of innovation and growth for us. We also think more broadly that immunotherapies are going to be really important for two reasons. One, there are alternatives to antibiotics and secondly, healthier animals are more productive. So it also increases productivity for producers. So I think immunotherapies, which we've been working on for a while and have a partnership with Colorado state to develop will be important. The other sector that I think is really important to focus on is precision livestock farming which we also think has great potential. We're leaders right now in the genetic space there and genetic testing, we also purchased PLA as you know, we're looking at really back-to-back individual animal care and herd monitoring and I think that's probably the next big wave, that's probably more of a medium-term growth driver, but I think there's a number of spaces where you're going to see innovation at the livestock, across vectors, immunotherapies, and precision livestock farming. I'll let Glenn take the second question on long-term margin expansion. Glenn David : Yes. So in terms of the long-term margin expenses, there are a couple of factors to consider. So for 2021, we mentioned that the gross margin is relatively flat and talked about some of the drivers of that with some of the investments we're making in reference labs, also the impact of the Draxxin LOE this year on gross margin. So as we move into the 2022 and beyond some of those impacts will be a little less than we would expect to see continued expansion in gross margin. In terms of the overall operating expenses, beyond 2021, obviously there will be one-year where T&E normalizes, when things get back to normal from COVID, but beyond that impact, we would expect that we would continue to be able to grow our expenses at a pace below that of revenue. So we'll probably continue to grow R&D in line with revenue. That may vary any given year based on the opportunities, but SG&A based on the infrastructure that we have globally established, we should be able to grow that somewhere between inflation and revenue. So we would expect to continue to see expansion there on an overall operating margin perspective. Operator : Our next question will come from David Risinger with Morgan Stanley. Please go ahead. David Risinger : Yes, thanks very much. And let me add my congrats on another phenomenal year as well. So I have two questions first with respect to the monoclonal antibody approval delays. So it's for both cats and dogs, but it wasn't quite clear to me whether the FDA wants more clinical data or whether there are manufacturing issues because – manufacturing questions, because I think Kristin, you had mentioned manufacturing. So if you could just clarify on both of them what the FDA issues are, whether they're clinical or manufacturing? And then second. , Zoetis’s R&D has obviously been amazingly differentiated from competitors, struggled to bring blockbuster companion animal products to market, even including follow-ons to Zoetis’s top growth drivers over several years. And so considering that, can you just help us understand the unique aspects in Zoetis’s R&D and its ability to maintain separation from the competition? Thank you. Kristin Peck : Sure. Thanks David. With regards to the monoclonal antibodies Librela and Solensia, it really is just working through the regulatory process and the questions that they're asking and they're requiring inspections of site. So at this point we have not been asked for any clinical data, but we're still in the regulatory process is what I was saying. It is the first time doing that with the FDA, so it's just a new process for both. Understandably it's the first time they're looking at some of these types of products, so they have a number of questions. So it really is just going through the regulatory review process and trying to manage new manufacturing inspections, which I do know probably the COVID is definitely affecting that a little bit, but we're just working through that. So at this point, we have not been asked for any additional clinical data and we don't think there's any manufacturing issue at this point. We're just still working through the review process and what their expectations are. With regards to Zoetis R&D, you know what I was saying is, I think it's the partnership between R&D, manufacturing and our commercial organization. It's taking those insights to the commercial as customer needs and partnering early on with R&D to develop products. I think the other thing we've done really well is partner with manufacturing to be able to scale those products and be able to bring them to market. We manufacture own monoclonal antibodies. As you know we've got very strong manufacturing capability, which is I think important for launching many of the products and scaling up at the level. We certainly learned the hard way early on in our journey about investing in that partnership, when we thought some of the challenges we had got supplying Apoquel. So I think from an R&D perspective, obviously I think we have great scientists, but I think it's the rigorous though process and partnership they have with our commercial and our manufacturing colleagues and our willingness to invest in disruptive technologies and take those risks that we've been doing. We've been managing over the last eight years. Anything you would add there Glenn? Glenn David : I think it's exactly what you said, Kristin. We talked about the inter-connect capabilities between commercial manufacturing and R&D. And I think that works extremely well here. Like Kristin said, identifying what the key needs are in the marketplace, early on coming up with solutions and making sure that the products that we're able to manufacture and we've been very successful in doing that. Operator : Our next question will come from Kathy Miner with Cowen and Company. Please go ahead. Kathy Miner : Good morning. Thank you. First question I have is relates again to the monoclonals. Can you just clarify when you talked about plant at-site inspections being needed is it correct then that both either one or both of the monoclonals are manufactured outside of the U.S.? The second question also on the products. Is the intention to launch both the cat and dog ones at the same time, is there an advantage to doing one or the other and we can speak just about the EU markets, where you have approval. And the second question on the derm products, you've targeted 1 billion in sales for this year. Can you talk about some of the drivers behind that? Is it outside of the U.S.? Is it more , et cetera? Thank you. Kristin Peck : Sure. So first of all Kathy, great to hear from you. Secondly, on the math they are both the manufacturing facilities are different for them, but they are outside the U.S. And prior approval inspections, regulator can handle them differently, but they are going to be required probably for both of these products and they are both different, but they're both outside of the U.S. And I think your second question was around the derm sales growth in U.S. or ex-U.S. We still believe we're under penetrated outside the U.S. There’s the same number of dogs in the U.S. and outside of U.S. gets two-thirds of our sales in derm remain in the U.S. So we do there’s significant opportunity. It has been hard to get scale outside the U.S., historically mostly because we have been now able do direct-to-consumer advertising, that is brand specific. One of the investments we are going to make for the first time is doing just overall disease awareness in direct-to-consumer advertising in 2021. So we cannot be specific with brands, but in derm, we really are the only products. So hopefully if you raise awareness around a disease and that there are treatments you can encourage people to speak to their vet and get the best care. So that I think is one of the reasons why International, we are hoping will start to grow faster, but I have to give our U.S. team tremendous credit and they continue to grow the market. The investment in direct-to-consumer advertising, raising awareness to our products are bringing more pets in and getting more pets treated in. In the U.S., there are still 6 million dogs, who need our products or need a derm solution who aren't getting one. So we do believe there's still growth in the U.S., although we would expect, though I'm sure I know last years, we've seen very strong growth out of the U.S., we would expect over time for the U S growth start to decline the overall growth and more of the growth to come from international, but we still believe there's significant potential in both. Operator : And our next question will come from Elliot Wilbur with Raymond James. Please go ahead. Elliot Wilbur : Thanks. Good morning. And congratulations on the strong performance of Trio in a challenging year. Kristin, just maybe want to dive in a little bit more on the launch details around the product. Seems like obviously one of the reasons for its relative success this year versus earlier expectations was just more or less cannibalization of Simparica than originally expected. But wondering if you could just share with those additional metrics in terms of where you are with respect to clinic penetration rates? How many targeted clinics have you been able to actually reach, just additional metrics around the uptake in launch would be helpful? Then just thinking about the product longer term, obviously very strong first year. Well, if I think about launching the logs on the human health side, I mean generally five years out, you're looking at something on the order of 6X to 10X, first year sales, not sure if that's applicable in the companion animal market, but just some thoughts in terms of maybe longer term launch analogs with respect to the product? Thanks. Kristin Peck : Sure. With regards to the launch of Trio. I would say there's a lot of unique characteristics of the Trio launch. A, we launched at the height of the pandemic in the U.S. So I'm not sure how to compare that to other people's launches. We were slower to penetrate clinics, I would say in Q2 and Q3, but we're quite pleased that by the end of the year we reached all of our penetration goals. So I think our penetration has been quite strong, given the delay really the outperformance was our share once we were penetrated within the clinic, the ability to get more of the patients on our product has been really strong. And that gives us good confidence as we move into 2021. As Glenn mentioned a few minutes earlier, we are expecting a similar contribution. For starters, we'll have a Q1 where we didn't have sales last year, but with the penetration we were able to achieve by the end of the year, which is reaching the goals we had wanted. We think that we can just get the same pull through that we had at those clinics in 2021, we'll continue to see a great growth across with them there. We're also seeing it also pull our broader parasiticide portfolio. So I'm not sure I would say – I would use a human health analog, but I continue to remind everybody works. We remain under-penetrated in this space. And the herd is the single biggest category in the animal health space, it's $4 billion globally with $2.5 billion in the U.S. Continuing to see about 15% growth in Simparica beyond Trio, globally, it shows that there's significant opportunity here for us to continue to grow. And we were quite pleased if you looked at overall care, we had an increase in share of 7% in Q4. So we think we can continue to take share on this and grow it overall. So I'm not sure it looks like human health. But with our biggest competitors already being $600 million products. I think we've got strong ability to continue to grow as get at least our fair share in this space. Glenn David : Yes. And the only thing, I have to add in terms of the question on peak sales. What becomes challenging with peak sales is the timing of competition and that remains unknown. Obviously for 2021, our current guidance does not expect another triple combo within the U.S. and the timing of that will obviously impact what our overall peak sales could be for the product. Operator : And our next question will come from the Navin Jacob with UBS. Please go ahead. Sriker Nadipuram : Hi, good morning. Thanks for taking the question, this is Sriker Nadipuram on for Navin Jacob, I just have a couple of specific questions. Can you quantify that revenue impact in 2020 of the earlier fall cattle run? And do you expect this to recur – this adverse negative revenue impact you expect this to recur in 2021? And then can you quantify the difference in gross margin in diagnostics from your therapeutics portfolio or your corporate average? Thanks very much. Glenn David : Yes. So in terms of the impact of the early fall cattle run for 2020, that did not have an impact for the year that was just the seasonal impact between Q3 and Q4. I think you saw the very strong performance in Q3, you saw the opposite occur in Q4 of this year, and then predicting seasonality of that in 2021 obviously is difficult, but we focus more on the full year obviously in terms of the overall impact. In terms of gross margin for the diagnostic business, we don't specifically provide gross margins by therapeutic area or by species. But overall we always say our companion animal business obviously has the higher margin, diagnostics in general is lower than some of our key therapeutic areas. Operator : And our next question will come from David Steinberg with Jefferies. Please go ahead. David Steinberg : Thanks. I have two questions. [indiscernible] one of the tailwinds from the pandemic, the increased adoptions around the country, around the world and in previous comments, I think you said there were about 3.2 million adoptions annual. I was just curious, now that 2020 is in the books, do you have any data, how many more adoptions there were last year? And the other tailwind, you've called out is just the increase in dollars per visit. And as most pet owners get vaccinated, they go back to work, how durable do you think both the increased dollars per visit and increased adoptions are. And is there any chance that could reverse when those people are back to the office? And a final question Trio, potential Trio competition, I think Glenn you said no expectations for competition this year, you previously said no competition in the first half of this your, when do you actually, I know it's murky, but when do you actually think there might be your first competitor and also what gives you such great confidence that there would not be any competition in 2021, I simply asked that because it was such a successful launch , it's obviously a target for competitors? Thanks. Kristin Peck : Sure. with regards to pet adoption, there are 135 million pets in the U.S. In a typical year, you see about 3.2 million adoptions. So even a 10% increase in that isn't going to dramatically change things, but we are seeing an increase in vet visits which we think is a positive trend. And we do expect that to continue in 2021. So as Glenn mentioned earlier, we did see a 2% increase in vet visits in Q4. We are expecting that to continue. So I think you are seeing maybe a proportional to what were the incremental pets that were adopted. We don't have very specific numbers, but, I would say assume it's somewhere between like 2% and 10% there, it'll be helpful. And I do think we're going to continue to see an increase in visits. You asked us well about spend per visit, which was incredibly strong in 2020. We don't believe it's going to remain that strong to be honest with you. We still think it will grow. If you look generally speaking at our space, we've seen overall revenues of clinics growing in the mid-to-high single digits on normal year. I'm not sure what 2021 is going to look like, but assuming it's somewhere close to a normal year, we do think you're going to see strong growth overall there in spend, overall revenue in the vet clinic, both with growth in total number of visits, as well as a spend per visit. With regards to the trio questions on competition. We don't have the visibility that human health has as to when we'll get competitors. To be very frank, we would have expected a competitor by now. We would have expected one in derm as well. So we're not exactly sure what the challenge is, but we don't have a great way of knowing other than rumor mill in the market and strategic accounts who often try to renegotiate with us when they think a competitor is entering the market, which we haven't seen yet, that does not mean that, someone couldn't surprise us. So there could be, but we want it to be clear what our guidance was based on. So at this point, given we don't have any specific knowledge, we will assume we do not have competition in 2021. And as to when they would come, honestly we don't really know, but to your point, these are large markets, both your question on Trio but as well as derm and we are expecting competition. We just at this point do not have any specific knowledge. So our guidance did not include an assumption for competition in either space. Our next question from Gregg Gilbert with Truist Securities. Please go ahead. Gregg Gilbert : Hi, going back to the diagnostics field. Glenn, you mentioned a growth rate there, I think 20% plus. Can you talk about to what degree that rate is influenced by M&A, if at all? and maybe more broadly about your strategy there? Clearly there's an element of sort of building and catching up, but I'm also curious on sort of how you're trying to differentiate or leapfrog competition broadly from a diagnostic standpoint? And then Glenn, are you seeing any signs of upward pressure on key input costs? As the world thinks about commodity price inflation or at least the potential for it? Thanks. Glenn David : So in terms of the diagnostics growth for the quarter, like you said we did see a 20% growth in diagnostics. A part of that was driven by the reference lab acquisitions that we had. So net of that organic growth was around 12% to 13% in diagnostics for the quarter. So still very positive growth in the quarter. We saw a nice momentum as we move throughout the year, and we think that'll carry us well into 2021. Also, we established a much better infrastructure for diagnostics in 2020 in two ways. A, we fully integrated into our core SAP system in the diagnostics business. So we now are able to provide one phase to our customer in terms of billing as well as product offerings. The other thing that we did was we made significant improvements in our bi-directional connectivity, improving significantly throughout the year. At the beginning of the year, we had that connectivity to about 30%. We increased that at the end of the year to over 70%. So we think that establishes very well as we’re moving to 2021, as well as some of the new innovation we're bringing with the images platform as well. So we think those are some of the key drivers as we move into 2021, as well as the continued reference lab expansion that we're embarking on. So we're very excited about the growth that we expect to see in diagnostics in 2021. In terms of key input costs and inflation for us from a manufacturing perspective, there's nothing in particular that we see particularly challenging. Obviously for 2020, we had some elevated freight costs because of the impact of COVID-19 that will probably continue as we move into 2021 that is embedded in our guidance, but nothing else of a significant impact. Operator : There appears to be no further questions at this time. I will turn the call back over to the speakers for any additional or closing remarks. Kristin Peck : Thank you. Thanks everybody for your questions and your continued interest in the Zoetis today. We look forward to keeping you updated on our business throughout the year and continuing to deliver the results and innovations that you and our customers expect. Thanks so much for joining us. Operator : Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,021
| 2
|
2021Q2
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2021Q1
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2021-05-06
| 3.888
| 3.993
| 4.391
| 4.552
| 6.86589
| 37.15
| 34.3
|
Operator : Welcome to the First Quarter 2021 Financial Results Conference Call and webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed on a listen-only mode. And the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, Keith. Good morning, everyone, and welcome to the Zoetis first quarter 2021 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and Glenn David, 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 statement in today's press release and our SEC filings, including, but not limited to, our annual report on Form 10-K in 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, Thursday, May 6, 2021. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and good morning, everyone. I hope you and your loved ones are all staying healthy and able to get vaccinated for COVID-19, if not already, then soon. We've been very fortunate in the U.S. as vaccination rates are up and infection rates are trending down overall. But that is not the situation everywhere. In many countries, improving access to vaccines and controlling infection rates are critical hurdles for a more comprehensive global recovery. Yet with the extraordinary measures being taken by so many, I remain optimistic about the steady progress we're making to beat this pandemic. I'm also very proud of what we've been able to do at Zoetis and our own small way to support the global effort. We've been able to keep our colleagues safe, encourage and assist them with vaccinations where possible, and continue serving our customers in the care of their animals. And we're off to a very strong start in 2021, executing on strategies for building on our innovative pet care portfolio, expanding in key markets by the U.S. and accelerating our growth in diagnostics. In the first quarter, we grew our top line revenue at 21% operationally, our best quarter ever, with 25% operational growth internationally and 19% growth in the U.S. China and Brazil led our international performance with 75% and 48% operational growth respectively, exhibiting their strength in both companion animal and livestock product sales. In total, our companion animal portfolio grew 34% operationally based on the strength of our parasiticide and dermatology products, while our livestock portfolio grew 8% operationally with solid growth in cattle, swine and fish products. Digging deeper on pet care, it has been one year since the launch of our triple combination parasiticide, Simparica Trio. It is exceeding expectations and has been well received by customers, with a-90% plus penetration rate in our largest U. S. corporate accounts. Simparica Trio is the latest growth catalyst for a portfolio of small animal parasiticides. After several successful innovations in the last few years, these products made up 16% of our total sales in the first quarter and includes such brands as Simparica, Simparica Trio, Revolution, Stronghold and ProHeart. We believe the ongoing market shift to e-commerce is another boost for this category, helping to increase compliance and months on therapy. And our direct-to-consumer campaigns for Simparica and Simparica Trio continued showing a solid return on investment in markets around the world. Meanwhile, our key dermatology portfolio led by Apoquel and Cytopoint, demonstrated continued double-digit growth. We are seeing excellent traction and significant growth of off the range international markets. Our dermatology portfolio has further growth potential as we continue expanding our international customer base and seek to become a more common first-line treatment for osteoarthritis in dogs. Veterinarians and pet owners alike appreciate the exceptional standard of care that our products can provide. In the companion animal space, we also continue to be pleased with our diagnostics portfolio, which grew 47% operationally in the first quarter. We have grown our point-of-care diagnostic sales made excellent progress on improving our connectivity solutions in veterinary practices, and have seen our cloud-based VetScan Imagyst platform receiving very positive customer feedback, with placements exceeding expectations in the early launch. We're also making progress on our reference labs integrations and look forward to future expansions in this space, both in the U.S. and internationally. Our growth in livestock was driven by the performance of cattle, swine and fish in the first quarter. Cattle product sales in the U.S. were strong as the food service sector has started to recover and generic competition for DRAXXIN was later than expected. Meanwhile, swine benefited from the continued recovery from African swine fever in China. Thanks to the unprecedented growth in revenue and our continued financial discipline and adaptability throughout COVID-19. Our adjusted net income 3%, 4% operationally. Looking ahead we are leading guidance for operational growth and full year revenue to the range of 10. 5% to 12%. And while we had an unusually strong first quarter, we expect more normalized revenue growth in the second half of the year due to tougher comparative quarters and increasing generic competition for DRAXXIN. Glenn will provide more details on other guidance updates in his remarks. Since the beginning of the year, Zoetis has continued to advance our key priorities, including key milestones for new products and life cycle innovations and geographic expansions for major brands. Since our last earnings announcement, we received approval in the European Union for Solensia the first injectable monoclonal antibody for the alleviation of pain associated with osteoarthritis in cats and will be launching this year. Osteoarthritis is vastly underdiagnosed and undertreated today due to limited options for therapy and difficulty recognizing pain in cats. Meanwhile, Librela, our monoclonal antibody for the alleviation of OA pain in dogs, has launched in the EU. And we're seeing a great customer response from vets and dogs owners who referenced increased activity, social ability and quality of life for their pets. In the U.S., we continued discussions with the FDA regarding our regulatory submissions and manufacturing inspection for Librela and Solensia, and we now anticipate approvals for both products in 2022, with Librela likely later in the year. We will provide updates on U.S. revenue expectations for these products in 2022 as we get further clarity on approval timing and rollout plans. It is also worth noting that in China, which is our second largest market in terms of revenue, Zoetis recently received approvals for several leading products, Fostera PCV MH a 1-shot vaccine for pigs, Excenel RTU EZ, a key anti-infective for cattle and swine, and Revolution Plus, our latest parasiticide for cats. We continue to strengthen our portfolio in China, one of our key catalysts for growth. We're also maximizing our key brands with more geographic expansion. In poultry, we expanded our line of recombinant vector vaccines with approval of Poulvac Procerta HVT ND in Canada, Brazil and several other smaller markets. And in parasiticide, we received additional approvals for Simparica Trio in Japan, Mexico and several other smaller markets. In terms of sustainability, we published our long-term goals in March with specific commitments to continuities, animals and the planet. We've built a comprehensive and rigorous approach through our Driven to Care program, and our goals include support for 10 of the 17 United Nations Sustainable Development Goals. We'll be releasing more detail on these goals and our initial progress in our sustainability report this June. In closing, the fundamental growth drivers for our industry continue to show strong and sustainable momentum. Pet adoption trends and higher spending per visit in the U. S. along with increased medicalization rates in markets outside the U.S. all continue to bode well for significant growth in our companion animal and diagnostic portfolios globally. We feel very confident about where our companion animal business has come over the last few years, launching innovative new products, defining new standards of treatment and expanding our global reach. In 2014, our companion animal business was 34% of our total revenue. Last year, it had grown to 55% based on the strength of our innovation and investment in growth, and we see that continuing to expand. In livestock, the industry is in a more limited innovation cycle, and we expect modest growth for the year. Livestock growth is tied closely to the pandemic and how quickly the foodservice industry recovers. For Zoetis, we also anticipate increasing headwinds of generic competition to DRAXXIN, but we expect our life cycle innovation and competitive strategies to help us mitigate the impact. While U.S. livestock may present challenges for us in the near term, I feel very positive about our catalysts for growth in pet care, diagnostics and international markets like China and Brazil. We continue to be led by our companion animal parasiticide and dermatology portfolio with more growth to come, and we see a bright future ahead for our monoclonal antibodies for pain. Diagnostics is accelerating its growth as we increase our global footprint, expand our reference labs and demonstrates the potential for VetScan images to veterinary clinics. And internationally, China continues to be a market with significant growth potential, not only in swine products but with a sizable opportunity for increased medicalization of pets. And we expect major growth to continue in Brazil across the companion animal and livestock portfolios. As always, we remain confident that Zoetis' diverse portfolio across products and geographies, our continued pipeline of innovative new products and life cycle innovations, and the agility and commitment of our colleagues will continue driving our success in 2021 and beyond. Now let me hand off to Glenn, who will speak more about our first quarter results and updated guidance for the full year 2021. Glenn David : Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a very strong start to the year, delivering substantial growth on a global basis and across species and therapeutic areas. Today, I'll focus my comments on our first quarter financial results, the key drivers contributing to our performance, and an update on our improved full year 2021 guidance. In the first quarter, we generated revenue of $1.9 billion, growing 22% on a reported basis and 21% operationally. Adjusted net income of $603 million was an increase of 33% of on a reported basis and 34% operationally. Operational revenue grew 21%, resulting entirely from volume increases with price flat for the quarter. Volume growth of 21% includes 13% from other in line products, 5% from new products, and 3% from key dermatology products. Companion animal products led the way in terms of species growth, growing 34% operationally, with livestock growing 8% operationally in the quarter. Performance in companion animal was driven by our parasiticide portfolio, which includes sales of Simparica Trio in the U.S., certain European markets, Canada, Australia and Mexico. We also saw growth in our key dermatology products, Apoquel and Cytopoint, as well as in small animal vaccines and diagnostics. Following blockbuster sales in year one, Simparica Trio begin 2021 with strong first quarter performance, posting revenue of $90 million, growing sequentially each quarter since launch. The underlying dynamics that drove first quarter sales are very favorable for significant future growth, such as increasing clinic penetration and robust reordering rates within penetrated clinics. I'd again like to mention how pleased we are with the performance of our broader parasiticide portfolio which, in addition to the Simparica franchise, had significant growth in the Revolution, Stronghold and ProHeart franchises as well. U.S. market share within the flea, tick and heartworm segment is now at an all-time high of 31%, representing an increase of more than 9% for the first quarter versus the same period in the prior year. Global sales of our key dermatology portfolio were $245 million in the quarter, growing 24% operationally. We remain confident that key dermatology sales will exceed $1 billion this year. Our diagnostics portfolio grew 47% in Q1, led by increases in consumable and instrument revenue. 2020 presented challenging conditions for our diagnostics business, as social distancing restrictions limited our ability to enter vet clinics and increase our market share. However, our vast product portfolio, commitment to innovation, and ability to leverage the breadth of our medicines and vaccines portfolio has us well positioned to grow faster than the overall diagnostics market. Livestock growth in the quarter was primarily driven by our cattle and swine businesses. Improving market conditions from the COVID-19 recovery as well as successful promotional activities led to increased sales across the cattle portfolio. In addition, later-than-expected timing of generic entrants led to strong first quarter sales for DRAXXIN. Our swine portfolio grew 19% operationally as large producers continued rebuilding herds as they recover from African swine fever and created significant demand for our products. Poultry sales declined in the first quarter as producers expanded their use of lower-cost alternatives to our premium products. The decline in poultry partially tempered the growth in cattle, swine and fish. Now let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 19%, with companion animal products growing 32% and livestock sales declining by 4%. For companion animal, pet ownership and pet spending trends remain promising. While severe weather caused a slight decline in vet clinic traffic for the quarter, revenue per visit was up more than 10%. In addition, pet ownership has increased and is trending towards a younger demographic, and younger pet owners typically spend more on pet care. This is a key driver for increased revenue per visit and creates robust demand for our diverse portfolio. Our small animal parasiticide portfolio was the largest contributor to companion animal growth, growing 74% in the quarter. Diagnostics, key dermatology products and small animal vaccines also contributed to growth. Simparica Trio continues to perform well in the U.S. with sales of $83 million. The Simparica franchise generated sales of $112 million in the quarter and is now the number two brand in the U.S. flea, tick and heartworm segment. Companion animal diagnostic sales increased 62% in the quarter as the continued recovery at the vet clinic and a favorable prior year comparative period led to significant growth in point-of-care consumable revenue. Key dermatology sales were $157 million for the quarter, growing 16% with significant growth for Apoquel and Cytopoint. U.S. livestock declined 4% in the quarter, driven primarily by poultry as producers switching to lower-cost alternatives unfavorably impacted our business. Swine also declined in the quarter, which is attributed almost entirely to a favorable nonrecurring government purchase, which occurred in Q1 2020. Cattle grew 6% in the quarter as promotional programs and the timing of generic entrants drove growth across the product portfolio. Growth in cattle partially offset the declines in poultry and swine. To summarize, U.S. performance was once again strong in what remains a very favorable companion animal market environment, in which we offer the broadest and most innovative product portfolio. Although livestock declined in the quarter with expectations of further declines for the year, we are encouraged by a series of foodservice trends such as increased dining out and school and business reopenings. Revenue in our international segment grew 25% operationally in the quarter, with companion animal revenue growing 37% operationally and livestock revenue growing 17% operationally. The strength in companion animal was fueled by the continuing trends of pet adoptions, increasing standard of care by pet owners, and our investments in advertising, all of which drove growth across our parasiticide and dermatology portfolios. Companion animal diagnostics grew 18% in the quarter, led by a 24% increase in point-of-care consumable revenue and a second consecutive quarter of double-digit increase in instrument placement revenue. We began early experience programs for Librela, a monoclonal antibody for alleviation of OA pain in dogs. The feedback from the programs has been extremely positive, and further solidifies our view of the long-term potential of the product with an EU launch currently underway. Our feline monoclonal antibody, Solensia, will begin early experience programs in Q2. And with an EU launch to follow in the third quarter. Solensia will provide cat owners an innovative therapy to address one of the largest unmet needs in animal health. Our international livestock business saw double-digit growth across all species with the exception of poultry, which grew low single digits in the quarter. Swine revenue grew 29% operationally led by growth in China of 128%, marking the third consecutive quarter with swine growth in excess of 100%. While additional outbreaks and strains of African swine fever have occurred, we believe it is contained to a specific region and a limited number of customers. Cattle grew 11% operationally in the quarter as a result of marketing campaigns, key account penetration, and favorable export market conditions in Brazil and several other emerging markets. Our fish portfolio delivered another strong quarter, growing 39% operationally driven by strong performance in Chile, the timing of seasonal vaccination protocols, and the 2020 acquisition of Fish Vet Group. All major markets grew in the first quarter, many in double digits. China total sales grew 75% operationally, which, in addition to the significant growth in swine, delivered 59% operational growth in companion animal. Brazil grew 48% operationally in the quarter as sales of Simparica, the leading oral parasiticide in the Brazilian market, drove a 73% operational increase in companion animal. Overall, our international segment delivered strong results, again, demonstrating the value of substantial geographic and species diversification. Our companion animal business benefited from favorable trends such as rising medicalization rates outside the U.S. And while swine was the largest growth driver for our international livestock business, the contributions were broad-based with growth across all species. Now moving on to the rest of the P&L. Adjusted gross margin of 71% increased 70 basis points on a reported basis compared to the prior year as a result of favorable product mix, partially offset by foreign exchange and other costs, including freight. Adjusted operating expenses increased 8% operationally, resulting from increased compensation-related costs and advertising and promotion expense for Simparica Trio. This was partially offset by reductions to T&E costs as a result of COVID-19. The adjusted effective tax rate for the quarter was 19%, an increase of 230 basis points driven by a reduction in favorable discrete items compared to the prior year's comparable quarter, partially offset by the favorable impact of the jurisdictional mix of earnings. Adjusted net income and adjusted diluted EPS grew 34% operationally for the quarter, primarily driven by revenue growth. We resumed our share repurchase program in the first quarter, repurchasing approximately $180 million worth of shares. Along with our dividend, share repurchase is a critical component of our shareholder distribution strategy. We remain in a strong liquidity position and are highly cash generative. And as a result, we expect to be able to execute on all investment priorities including direct-to-consumer advertising, internal R&D and external business development, while still returning excess cash to shareholders. Now moving on to our updated guidance for 2021, which we are raising as a result of our first quarter performance. Please note that our guidance reflects foreign exchange rates as of late April. For revenue, we are raising and narrowing our guidance range, with projected revenue now between $7.5 billion and $7.625 billion and operational revenue growth between 10.5% and 12% for the full year versus the 9% to 11% in our February guidance. Adjusted net income is now expected to be in the range of $2.12 billion to $2.16 billion, representing operational growth of 12% to 14% compared to our prior guidance of 9% to 12%. Adjusted diluted EPS is now expected to be in the range of $4.42 to $4.51, and reported diluted EPS to be in the range of $4.08 to $4.19. Our key assumptions for 2021 have not changed materially since the guidance we provided on our Q4 2020 call. However, our current view is that we will not face competition in the U.S. for Simparica Trio or our key view is that we will or our key dermatology products until the second half of 2022. On our fourth quarter call, I mentioned that we anticipated growth to be heavily weighted towards the first half of the year, and I'd like to take this time to expand upon that further. We are expecting first half 2021 growth to materially outpace growth in the second half of the year, primarily resulting from Simparica Trio sales and the favorable Q2 2020 comparative period related to COVID-19. Subsequently, we expect growth to moderate in the second half of the year as a result of increased generic competition for DRAXXIN as well as challenging comparative periods when pent-up demand in the first half of 2020 worked its way through the system in the second half. Now to summarize before we move to Q&A, we've delivered strong operational top and bottom line growth in the first quarter with significant gains in both companion animal and livestock and across nearly every therapeutic area and geography. In addition, we raised and narrowed our full year 2021 guidance. And while growth will moderate in the back half of the year for the reasons I outlined, we again expect to grow faster than the market and feel very positive about our position for sustained growth beyond this year. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We'll take our first question today from Erin Wright with Crédit Suisse. Please go ahead. Erin Wright : Great. Can you speak a little bit more about the underlying trends you're seeing across the U.S. livestock business? How has that segment performed quarter-to-date? And it seems that DRAXXIN competition has played out a little bit better than your expectations, but has anything changed in terms of how you're thinking about that headwind over the course of 2021? And then my second question is on parasiticides. It does represent a larger portion of your portfolio than it has historically. I guess how should we think about the seasonality of that business, the purchasing patterns both across retailers and vet clinics? And did you see any sort of pull forward outsized stocking dynamics in the quarter that we should be aware of and what your guidance now assumes for Simparica Trio? Kristin Peck : Sure. Thanks, Erin. As you think about U.S. livestock, as Glenn mentioned, overall U.S. livestock was down 4%, but there was lots of different trends in there. U.S. cattle was up 6% in the quarter. And I think if you look at that, that was driven by later-than-expected entrants in the generics. So we were expecting more entrants sooner. But to your point, we don't really think it's going to end up playing out any differently by the end. And so what do I mean by that? If you look at that, we think the entrants will come, we think once they do, we'll likely end up -- if you look at generics, it's certainly 20% to 40% on penetration. And what we said is we think that's likely what it's going to be with DRAXXIN, both in the U.S. and in the EU and really around the globe. But as you think about that, it's likely going to happen a little bit later in the year. So we did do better in the beginning of the year. But if you look at that and you compare it to how we did internationally on DRAXXIN more specifically, so although you saw 6% growth in DRAXXIN in the U.S. internationally -- sorry I meant overall DRAXXIN internationally is actually down, and that was because we did have a multiple entrants sooner in that. So I don't think livestock really is going to play out any differently. We did see, as Glenn mentioned, a decline in poultry overall. And there is some seasonality obviously if you think about cattle. Swine was down and poultry. But overall I think we continue to remind, if you look at livestock overall for us, it was up 8%. I think what often people underappreciate it is that 60% of livestock is outside of the U.S. And although we focus a lot on U.S. cattle, the growth as you saw in China across swine which had 128% growth, and in Brazil still meant livestock did quite well. As you think about the parasiticides, I'll let Glenn sort of take some of that and get into some of the more specific trends. Glenn David : Yes. So thanks, Erin. So from a parasiticide perspective, we had a really strong quarter with the Simparica franchise, 133% growth in the franchise. Great performance from Simparica Trio with $90 million in the quarter alone, and Simparica also delivering $74 million with 38% growth. In terms of seasonality, we typically do see Q1 and particularly Q2 being the stronger quarters from a parasiticide portfolio perspective, particularly in the U.S. However, as we do see Simparica Trio on a ramp-up curve, the impact of that seasonality may be a little different this year as we do expect to continue to increase our clinic penetration and adoption and market share within the clinics as well. So there definitely is some seasonality within the parasiticide portfolio. But with the continued ramp-up on the product, it may not be as severe as you would typically see with an established product. Operator : Our next question is from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : I want to start on China, just really incredible growth this year -- this quarter. Obviously, you highlighted some of the aspects there. African swine fever bounce-back. And then companion has been doing well there for a while, and it's nice to see that, that continues to grow. I'm just wondering if you could opine on how sustainable that is. I mean that 123 million number, is that a new jumping off point that we should be thinking about in terms of run rate going forward and obviously growing from that? Or could there have been some bulk orders, for example in swine, as some of these producers restart their operations? And then another question for Glenn. On the OpEx guide, I'm just wondering if you could talk through a little bit of the details of what you're assuming for operating leverage in the second half. Are there any additional DTC programs for Trio? Are you restarting to see any expense? Is there any inflation factor in? Just wondering how we should think about the SG&A ramp going forward. Kristin Peck : Thanks. Thanks, Mike. So starting with China, and I'll let Glenn take the second question. We do think this is a very sustainable growth driver in China, and really what drives that is a few things. One, I think you'll see African swine fever continuing a rebuild of the herd there. It is going to take a few years to rebuild that, so I think that is going to be for the next few years of sustainable growth. You saw swine grow in the quarter at 128%. But I think what's also really important to focus on is how well companion animal did, which grew 59%. We've been launching a number of new products, as I mentioned in my opening remarks. We had the launch of Fostera PCV MH as well as Revolution Plus. So continuing to bring in new products, seeing really, really good growth across both companion animal and livestock, makes us believe that China and the investments we've even talked about in building additional facilities there and growing our biologics footprint, we are very bullish on China continuing to be a sustainable growth driver for the company. Do you want to take the question onwards? Glenn David : Yes. And I just want to make other comments on China, Mike, to your other question as well. We did have $123 million in sales. Q1 typically does tend to be the larger quarter of sales for China. So that necessarily isn't one that you would run off of for the rest of the year. But to Kristin's point, I'm very excited about the growth prospects that we have for China for the year. In terms of the OpEx, we grew 8% in OpEx in the first quarter, which is pretty indicative of what the guidance range would indicate for the year. But there'll be different dynamics throughout the quarters to that. So for Q1 with the growth of 8%, that really was driven by a lot of the incremental DTC that we had for Simparica Trio in the quarter. And also, we didn't have savings from T&E in Q1. We had the savings from T& E in Q1, because in Q1 of 2020, that was pre-COVID. We still had our elevated T&E spend. As we move throughout the year, obviously we're not going to have that benefit. So the impact of the incremental DTC for Simparica Trio will be there, but we also increased our spending for DTC for Simparica Trio throughout the year last year. So a number of different factors, but the overall level of growth for the year perspective is pretty similar to what we saw for the quarter. Operator : And our next question is from Jon Block with Stifel. Please go ahead. Jon Block : First one, Glenn for you, just in the overall top line steps up, do we attribute that solely to companion animal? It seems like livestock, just based on your comments, might still be in the up low single-digit range. And maybe more specifically, is the step-up in companion just due to Trio? I mean if you annualize out the 90 million, you get to 360 already. And it seems like that was in and around the original guidance when we think about the contribution to growth. And then, Kristin, maybe just can you give a little more color on what you're seeing in the poultry market? Was those lower end competitive dynamics specific to the U.S.? Did it surface in international? Maybe what's going to be the Zoetis' response in coming quarters? Glenn David : Sure. So in terms of the overall top line step-up in the guidance, there are a number of factors that drove that beyond just companion animals. So obviously very pleased with the performance of Simparica Trio, and that is definitely one of the drivers for the guidance range. But as Kristin mentioned, also very strong performance in China, off to a very strong start to the year. Strong performance in Brazil as well, Brazilian market grew 48% for the quarter. So that's off to a very positive start. And then our diagnostics business as well. We had 47% growth in our diagnostics business in the quarter. So many of our key growth drivers for the long term performed very well in the quarter, which also then enabled us to raise the guidance for the year. So it's across a number of different of our key strategic growth drivers that enabled us to raise that guidance. In terms of poultry in the U.S., we did see some challenges this quarter as our producer customers did move to some cheaper alternatives from our products. That is something that we'll evaluate through the year. We do expect that there will be a movement back at some point to our products, but that's something that will evolve over time in terms of the efficacy that they see from those cheaper alternatives compared to our more premium products. Operator : Our next question is from Louise Chen with Cantor Fitzgerald. Please go ahead. Louise Chen : So I wanted to ask you how you think the animal health industry might change post-COVID? And do you still expect a headwind this year? And what have you factored into your guidance for recovery? Kristin Peck : Sure. Thanks, Louise. We look at some of the trends you've seen this year, and a lot of these are more sustainable on the pet care side. And I think the trends, that I'll talk about in a second, are a little bit different on the livestock side. What you've been seeing over the last few quarters is an increase in revenue per visit. That has been sustainable. And as we looked last year at the sort of 10%, again as we talked about in Glenn's remarks, a 10% increase in revenue per visit. And what's been driving that is there's increased pet ownership, and that really has maintained. People are continuing to spend more time with their pets. I think you see the trend of these new pets being adopted by millennials and Gen Z, and they spend more on those pets. So we see that as a trend that will continue to drive growth overall for the industry. And then these pets will ultimately age. And as these -- all these new pets age, a lot of our chronic products will become even more relevant. I think this is also driving important growth in our diagnostics business, which grew 47% in the quarter. Again, pets can't tell you what's wrong with them, so I think vets are getting really increased focus on doing diagnostic tests in a lot of these wellness visits. If you think about livestock, I mean there's two trends to look at. One is just when we produce more protein as people go out more, really what you're going to need to see to be significant improvements here globally as an increase in travel and entertainment. And I think we're now seeing people going back to school, maybe going back to work, maybe traveling from personal. But getting that travel and entertainment industry back up will help drive the growth in livestock globally, I think, over some of these coming quarters. So slightly different trends, but we continue to remain bullish. And the way we see our growth is with an increasing pet care business. We see great growth in pet care from everything from our in line, our products, our derm, our new mabs. Looking at increased growth in China and Brazil, which again as we talked about, we think is sustainable. And then lastly, continued investment in growth in our diagnostics business, which we're quite excited about. Operator : Our next question is from John Kreger with William Blair. Please go ahead. John Kreger : Question about Librela, Now that, that product is launched in the EU. Can you talk a little bit more about the clinical differentiation you're seeing compared to some of the existing oral alternatives? Kristin Peck : Sure. We're -- as you probably know, we began the early experience in the EU, and we'll be launching formally in Q2 for Librela. The early experience information that we saw was really, really positive. Both -- obviously it's got a strong safety profile. But the efficacy, it's working very quickly faster than I think some of our customers expected. And they're seeing significant improvements in the quality of life and in the pain of these dogs. So we remain very bullish that customers are looking for an alternative to the products in the market right now. And we've seen a really strong uptake in that. This is still a significant market. If you look at sort of $90 million in the EU today, 40% of those dogs have OA, and currently only 28% of those are treated. So the early experience data that we've seen to date and the early launch makes us very optimistic for the success of this product. And as we mentioned before, we expect this product to be a blockbuster. Operator : And our next question is from David Westenberg with Guggenheim Securities. Please go ahed. David Westenberg : So can you remind us why there's such species-by-species differences in the U.S. and international livestock market, given that protein is inherently global? And then for my second question on the diagnostic portfolio, I think you confirmed 46%. That is a huge number. So can you talk about the components of growth of that, and if some of that in the kind of the organic growth rate there? Kristin Peck : Okay. I'll take the first question, and then Glenn can take the second one. Although protein is global, the dynamics are very different in each species in a few ways. One, obviously if you look at consumption, as people move into the middle class they're generally starting with milk and then eggs then poultry. Then they move up to swine and then beef. There's also differences geographically on what people consume. Obviously, China is a huge swine market. That's not true in the U.S. where you see probably more poultry and beef. So there are really different consumption trends as well. The other real big differences is who produces in each market in each species, how much is exported. In the U.S., there's a significantly larger export market for poultry and for swine. So there's very different dynamics for each of the different species as people trade up and trade down different protein sources. As you think about where people are sourcing those processors who are big export markets versus internal production. So -- and it does lead to very different dynamics. The other major dynamic you should think about is that the ability for each producer to change their supply is actually quite different. Once you have a supply of cattle, they take many years to grow. You can't all of a sudden pare back in cattle. Poultry producers can decide not to use a bunch of eggs and grow chickens, which only take a few months. So it's very different in their ability to react to the market, and therefore you do see different decisions being made. And you probably saw in the papers today, there's huge demand for poultry right now, and I think poultry producers are going to have to sort of start scaling up. They can do that quickly. They can make those decisions and expand their flocks very quickly. That is a very difficult thing, it takes a lot of time for a swine or a cattle producer. So that's why you sometimes see some of these different dynamics across species. Glenn David : And regarding diagnostics, a very strong quarter for our diagnostics portfolio. We grew 47% in the quarter overall. And that growth was really balanced from many different areas. So we saw the U.S. grew 59% in the quarter in diagnostics, with strong growth in our consumables really pulling through the increased instrument placements that we saw last year really drove increased consumables in the quarter. Also strong performance for our reference lab business and increased growth in our instrument revenue as well. So really strong performance in the U.S. And also for the U.S., it was an easier comparative period to Q1 of last year as well. International, very positive growth as well, growth of 24%, again really driven by strong growth in consumable usage in the international markets as well as increased instrument revenue as well. So very balanced strong growth in our diagnostics portfolio in the quarter. And we think that sets us up well for the year, and we do expect that our diagnostics business will outpace the growth of the overall diagnostics market in 2021. Operator : Our next question is from Elliot Wilbur with Raymond James. Please go ahead. Elliot Wilbur : A question for Glenn and Kristin, I guess with respect to expectations of additional competition on Trio and in the derm portfolio, I mean what's changed in terms of your line of sight there, based on specific feedback from the channel or just the absence of any competitive noise, whatsoever? And then quick question for Glenn, just thinking about SG&A trends over the balance of the year. I mean the guidance at the midpoint on SG&A and the top line implies roughly a 300 basis point step up. How much of that is just sort of increase in normalized baseline expenditure versus targeted investment spend? And how should we be thinking about the progression of SG&A levels over the balance of the year, relative to some of the investment programs that you have budgeted? Kristin Peck : Sure. Thanks, Elliot. I'll take the first question. Yes, as Glenn mentioned in his opening remarks, we are not expecting competition in the U.S. for Simparica Trio or for our derm portfolio, Apoquel or Cytopoint, until maybe mid- -- the second half of 2022 at the earliest, to be honest with you. This is just based on our competitive intelligence, which is, as we said from the start, is not perfect. There is not great information, but we definitely don't expect it this year. And based on what we've heard, we don't think it's in the first half of next year at the earliest. So again, we are always prepared for competition to come. We're never exactly clear when it will be. But I think our -- we're very optimistic that we -- the very least this year in the e first half of next year. And we'll be aggressive in growing these products as we've seen.But I would remind you, certainly if you look at Simparica Trio, that we've done incredibly well with Simparica, and it was the third to market. And we continue to grow this franchise already around the world, the Simparica franchise even with other competitors on the market. So anything you want to add there, Glenn? Do you want to take the second question? Glenn David : No, I'll move to the second question in terms of the OpEx spend and what we there are a number of different areas that are driving the incremental OpEx this year. Part of it is a normalization from the COVID impact in 2020. We would expect that T&E expenditures would begin to increase, particularly in the second half of the year. But also our compensation costs as we ramped up hiring some positions that may have been on hold, with the impact of COVID, were just more difficult to fill. We are increasing our hiring really to support the strength of many of our key brands and to continue the growth there. From a DTC spending perspective, we would expect more DTC spending this year driven by a couple of different factors. A, we have some Simparica Trio on the market for the full year. So we will support that with advertising expenditures for the full year as well. And we also continue to see strong growth in many of our brands, such as our dermatology portfolio, and will continue to increase and support those brands those brands of direct-to-consumer advertising, not only in the U.S. but outside of the U.S. as well where we are increasing our DTC spend behind many of our brands, including Simparica as well as our dermatology portfolio. So there are a number of areas will spend really to support the significant revenue growth opportunities that we see not only for this year but for many years beyond. Operator : Our next question is from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Just two for me on following up on Librela, could you maybe give us some thoughts around the gross margin impact of the 40 to 60 pound price points that they're introduced at? And what's your internal expectations around usage of this product? How do you see it evolving? While recommendation is once a month injection, so one. Two, on ASF, in the past you have been quiet about ASF vaccines. We saw news flows recently that started some trials and collaborating on it. So could you maybe take us through your -- what the time lines around the trials are? And when do you expect to be a part of the ASF vaccine program? Glenn David : Sure. So from a Librela gross margin perspective, I'll start with pricing for Librela, which is very important in terms of the overall profitability of the product. Now that we've launched in the EU, we have priced that product at a premium to the current therapies on the market, really consistent with some of the other products that have brought significant innovation in some of our other categories, such as dermatology. You would see Librela price at a premium similar to that. So we would expect that Librela will be a high-margin products consistent with the overall companion portfolio, which typically is above our overall gross margin level. So that will be a positive contributor to gross margin over time. In terms of ASF and our development for vaccines, as we've said before, this is a very complicated disease state. It's going to take many years to find a solution. We are active in those development studies, but it will be a multiyear time frame before we find a solution for African swine fever. Operator : We’ll take our next question from Kathy Miner with Cowen & Company. Please go ahead. Kathy Miner : Two questions, please, first on Librela. Can you clarify, I believe in your comments you said that you expected approval of Librela later in the U.S. than Solensia? Does this reflect just filing timing? Or is there some other dynamic here? And the second question, a little bigger picture on business development, it seems Zoetis has been pretty quiet in terms of M&A this year. Can you comment a little bit about your outlook for the rest of 2021 and some of the areas you may be focusing on there? Kristin Peck : Thanks, Kathy. Yes, as we mentioned, we are expecting the approval of both Librela and Solensia in 2022. And if there's nothing specific about why Librela is actually later than month. It has to do with filing timings and just general process on the 2 of those. But again, we remain quite confident and optimistic in the approval of both of those. And as we get closer, we'll be able to provide more specific guidance on revenue and launch timing, et cetera. But no, there's nothing specific as to why Librela is going to probably be later in the year than Solensia. it's just timing of submissions and back and forth with the regulators. So Glenn, do you want to take the second? Glenn David : Yes. So from an M&A perspective and our areas of focus for 2021, so build development remains a key area and part of our capital allocation strategy, and we remain focused on that. A couple of areas that we continue to pursue, consistent with what we've discussed in the past, is any specific geography where we may have an opportunity to gain additional share or presence in an area, that we may not be at the level of market share that we are globally. Those are areas that we will continue to focus on and look to bring in additional products into our portfolio. Also, many of the areas that we've stressed as areas of strategic importance to us, whether that's in areas such as precision livestock farming, genetics, diagnostics. Those are areas that we'll also continue to remain focused on as well as if there are only development assets as well that we believe would bring strength of our R&D portfolio, we can generate greater value than the existing company. So we remain focused on M&A. We evaluate many opportunities, and we will look to continue to use that as a prime area for capital allocation moving forward. Operator : We’ll take our next question from David Risinger with Morgan Stanley. Please go ahead. David Risinger : So congrats on the exceptional performance. I think you hear my 6-year-old puppy in the background barking, and I'm wondering if you have a barking consumption. Anyway, so I wanted to just move little bit a if my phone line cut out. So could you provide additional details on companion animal innovation prospects beyond monoclonal antibodies for pain? It'd be helpful to understand areas of unmet need and the potential cadence of material new companion animal product introductions in coming years. And I know that you can only comment on this at a high level, but anything you can offer would be helpful. And then second, given likely inflationary pressures ahead on costs, what is your plan for product price increases in companion animal and livestock? Kristin Peck : We are quite excited with regards to our innovative portfolio in both companion and livestock. And as you think about companion animal, we're really focused on continuing to grow our franchise in parasiticide and look for additional products there. Continuing to look at exciting areas such as additional add-ons in our dermatology portfolio. And really, we think the platform of our monoclonal antibodies goes way beyond pain, to be honest with you. There's lots of other chronic and other conditions. We think that technology will help with and super excited about our portfolio in diagnostics. Really building new indications with our images platform, our AI, cloud-based diagnostics expanding reference lab. So I think there's a really bright future as we look at continuing to expand our pet care portfolio globally. So Glenn, I don't know if you want to take the question with regards to inflation. Glenn David : Yes. With regards to inflation and the impact in -- we'll have on pricing across our portfolio, so we do expect over the long-term to continue to be able to take price increases ranging from 2% to 3% per year. This year will be a little muted in 2021 because of the impact of the DRAXXIN LOE. But beyond this year, we do expect to be able to return to that 2% to 3% average pricing. That will vary based on the product as well as the geography. Typically, in our more innovative products, we're able to take a little bit above that 2% to 3%. Products that have been on the market a little longer generally get a little below that 2% to 3%. And then in higher inflationary markets, we typically take pricing beyond that 2% to 3%. So we don't see any significant changes to that in the short to medium term, other than the fact that in 2021 because of the impact of the DRAXXIN LOE, we'll be below that 2% to 3%. Operator : Our next question is from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Maybe going back to the launch of Librela and Solensia in Europe. I guess Kristin the -- given your experience with the kind of early feedback from vets, I mean has that changed your expectations around what the launch curves could look like? Because these are kind of new products to treat pain. So just wanted to get your kind of updated thoughts on what you think kind of uptake will look like? And should we think about the launch curve maybe similar to the derm portfolio, kind of given that both of these therapies were relatively kind of innovative at their launch? Kristin Peck : Thanks, yes. I think we are very bullish with regards to the launch curves of both Librela and Solensia in the EU. I think we're now just in early experience with Solensia, so it's probably a little earlier there. But again, as we said I think a little bit previously, I do think the launch curves are going to look different between Librela and Solensia a little bit. Librela is going to enter an established market. The great news is the vets are already very comfortable with injectable monoclonal antibodies even Cytopoint. So I think you'll see a really nice uptick, and I think we'll do very well there. Solensia is a little different. You have to get more cats to the clinic. You have to medicalize those cats and treat them. It's a little harder to sense OA in cats. That being said, we'll have a much better sense as we get to the next quarter since we're just beginning early experience right now. We're really bullish on this in the medium term how fast that uptake happened. I think early experience, which is what we're in right now, we'll be able to better inform that as we get to the next quarter. But the science behind it, the safety, the efficacy is really, really strong. And what's different, as we've talked about for Solensia, there really are very few alternatives for cats. So if we can build a market, which I think Zoetis has demonstrated its ability to do, we're really excited about what that launch curve will be better informed as we finish early experience, which we're adjusted now. Anything you add on that one? Glenn David : No, I just echo what you said, Kristin. I'm very excited by the feedback that we saw with the early experience program. It does give us even greater confidence and more enthusiasm around the potential for these products in the EU and globally. And we're continuing to update our forecast based on the feedback that we get. Operator : And our next question is from Chris Schott with JPMorgan. Please go ahead. Chris Schott : A couple of ones here. Just on Trio, I guess with competition not expected until the second half of '22, does that change how you're thinking about kind of peak market share potential for the product, given you have this kind of three-year window to really establish yourself in the market prior to seeing any type of real competition here? And then second, I know you talked -- touched on this a little bit before, but so on livestock in general. It seems like we're for a very strong start of the year. I know part of that is DRAXXIN. But with reopenings seeming to go pretty well in most markets so far, are you feeling better about these markets than the beginning of the year? Or are you still a bit cautious, just given kind of some of the -- I guess uneven openings that we're seeing across the world? Kristin Peck : I'll start and let Glenn build on this. We are very optimistic on Trio, and ultimately it probably changes the curve a little bit of how fast we get that competition on the market. But I think it's important, as I mentioned in my earlier comments, these products still grow even when competition enters. And I think this is something we keep underscoring. When compared to there to market. It is growing like crazy and taking share. I think when you put the marketing muscle, the technical experience muscle of Zoetis behind the product. Even with competition, we still expect these products to grow. So we will probably build our share faster but we do expect even with competition that these products in these categories will continue to grow also bringing more people into prescription products versus some of the over the cattle, really bringing new solutions I think we'll continue to grow these products in the longer term. I don't know if you want to build anything that and address the life back one. Glenn David : Yes. No, just to say, obviously the longer out in the market alone, the better in terms of accelerating that peak sales curve. But to Kristin's point, this is a very large market, and we do see products on the market and franchises on the market that are approaching $1 billion today, even without a triple therapy in the U.S. So we think there is significant opportunity for future growth for this franchise. In terms of livestock, we are off to a strong start, and we do think that the reopening trends are positive for the overall animal health industry and the growth in livestock. We're also very pleased with the performance that we've seen in many of our key markets, particularly outside of the U.S. markets such as China and Brazil and what we've been able to accomplish there. And we expect those trends to continue to be very positive. Obviously, we do have some dynamics, particularly to our portfolio within livestock with the impact of DRAXXIN. But overall the fundamentals in the industry are remaining positive. Profitability is up for many of our producers, which is also very encouraging for the overall industry, and we think will be positive for the longer-term outlook for livestock. Operator : Next question is from Greg Gilbert with Truist Securities. Please go ahead. Greg Fraser : It's Greg Fraser on for Greg Gilbert. On international livestock, obviously very robust growth in the quarter. And you spoke to the dynamics in China and some other markets. As the strong demand trends for the overall business continued in the second quarter? And how are you thinking about growth for international livestock for the full year? Kristin Peck : Yes. So just when you look at our overall livestock portfolio globally, we grew about 8% this quarter. As you mentioned, that was really driven by the international growth of 17%. As we said in our February call, we do expect that globally, the livestock business will grow in the low single digits. That hasn't changed materially based on the strong performance that we saw in the first quarter. So with that growth, we would expect international livestock to grow more rapidly than the U.S., really driven by the dynamics with China and Brazil, but still expecting low single-digit growth for our livestock business for the year. Operator : Navaan Ty with Citi. Please go ahead. Navaan Ty : Actually, my question has been partly answered this. Could you comment on maybe the pet ownership and the average revenue per companion animal going forward and longer term? And remember, we expected growth to moderate once we all return to the office. Do you have updated thoughts on that front? Kristin Peck : Sure. Thanks. As you think about pet care, we've been having a few quarters with 10% or higher revenue per visit. That has been -- continued to be sustained. We think the trends driving this is the increased pet ownership, which hasn't changed. There was a little bit of a fear, as we were in Q3 of last year with a lot of these dogs being returned or cats returned or re-homed, and we really haven't seen a significant trend there. So we think the increased pet ownership even if people go back to work, most people are going to have flexible arrangements. They're still going to be home with their pet more than probably they were before. And they build a bond with those pets and they notice things and they build habits that we think will be sustained as we do that. And again, the other important trend here is who is owning these pets? Millennials and Gen Z, who tend to spend more pet. So we really continue to see pet ownership trends and spend for pet continuing. I mean is it going to be 10% every quarter? I'm not so sure. But historically just to remind you, I think it was 5% to 6% historically. So it's still a very strong growth driver overall for the industry, and I think these trends may be higher than what it historically has been on a go-forward basis, just given who's adopting the pets and increased focus on the pet is an important part of the family. Operator : We'll go next to David Steinberg with Jefferies. Please go ahead. David Steinberg : I just had one question to follow up on potential Trio competition. A year ago, you were expecting competition I think the second half of this year. And then you pushed it into next year and now second half of next year. And so just curious, I know you said you have limited visibility, but what do you think the sources of the delay might be? Would it be technical manufacturing or formulation issues or heightened regulatory issues, delays in inspection or FDA looking for different things. Just curious since you initially thought it would be relatively soon, what could be the technical and regulatory issues surrounding the potential delay in the launch of competitive. Kristin Peck : Thanks, David. I have to say you have a very good list there of potential reasons. I mean the honest answer is we don't really know why there are specific delays? And are they dissimilar delays for different companies. It's very difficult for us to assess that. There's not a lot of great details information. So I mean our list of the ones that we consider were all the ones you just mentioned, to be perfectly honest. But which one it is for which company? I'm not really sure. I mean some -- maybe because they launched their first litter, for example, one of the companies. But for the others, it's not exactly clear exactly what is driving those delays. So I wish I could be a little more helpful here, but honestly we don't really know. Operator : It appears we have no further questions. I'll return the floor to our speakers for any closing remarks. Kristin Peck : Okay. Well, thanks for your questions today and for your continued interest in Zoetis. We look forward to keeping you updated as our business throughout the year and continue to deliver our results and innovations that you and our customers expect. So thanks so much. And stay well, everybody. Operator : And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.
|
ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,021
| 3
|
2021Q3
|
2021Q2
|
2021-08-05
| 4.081
| 4.185
| 4.664
| 4.795
| 6.86523
| 35.95
| 38.4
|
Operator : Welcome to the Second Quarter 2021 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is, Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be made available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] And it’s now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you. Good morning, everyone, and welcome to the Zoetis second quarter 2021 earnings call. I am joined today by Kristin Peck, our Chief Executive Officer; and by 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 in the company's 8-K filing dated today, Thursday, August 5, 2021. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and good morning, everyone. I hope you and your loved ones are all staying healthy and getting vaccinated for COVID-19. I’d like to start the call by welcoming our new Chief Financial Officer, Wetteny Joseph, who is joining me on the call today. As the former CFO of Catalent, Wetteny is a veteran of the biopharma industry and very familiar with many of you in the investment community. Wetteny joined us on June 1 and is off to a fast start learning all about the company and animal health, everything from cattle guarding and drive impacts to pet care trends and parasiticide season. I am confident that Wetteny will make strong contribution to our ongoing market performance, value creation and leadership in animal health. I also want to take a moment to thank Glenn David for his partnership and all of his contributions to Zoetis as CFO over the last five years. Glenn has taken on a new role overseeing our international operations, and other business units including PHARMAQ, BioDevices, and Pumpkin Pet Insurance. I know he will bring his signature leadership qualities, business skills and industry knowledge to this role and continue driving profitable growth in these areas. Now turning to the second quarter, we achieved strong results once again with 22% operational growth in revenue and 28% operational growth in adjusted net income. Our companion animal portfolio generated 36% operational revenue growth, driven by our pet care parasiticides, key dermatology products, vaccines and diagnostics. Meanwhile, livestock product sales were up 3% operationally and remain in line with our expectations for more moderate growth this year. The second quarter results also reflected favorable comparisons to last year's second quarter, when the uncertainty of COVID-19 and related lockdowns were more severely felt across the animal health industry. We are raising full year guidance for revenue and adjusted net income again this quarter to reflect our first half performance and confidence in the underlying growth drivers of our business. We remain on track for a very strong year and continue to focus on sustaining our investment in long-term growth opportunities. With the strong cash flow and positive outlook, we are investing internally and externally in innovative new products, market expansion plans, and direct-to-consumer promotions that will support future growth. Our team has been delivering strong growth, based on internally developed companion animal, parasiticides, led by our Simparica, PROHEART Revolution Plus franchises. We’ve redefined care for the dermatology category with our development of Apoquel and Cytopoint, and we see more growth potential coming from our monoclonal antibodies for osteoarthritis pain, new vector vaccines for poultry, and the industry's first cloud-based diagnostic platform with AI capabilities. In terms of our monoclonal antibodies for of alleviation of OA pain in dogs and cats, we continue to anticipate U. S. approval for Librela and Solensia in 2022. Meanwhile, initial customer response from vet and pet owners in Europe has been excellent and we recently received approval of Solensia in Canada. I always say, with great pride, that we have the best field force in the animal health industry and we will continue to expand the scope, effectiveness and digital tools in ways that can enhance our customers’ experience and support our growth objectives. We've also seen a positive return on our investments in direct-to-consumer promotions for Simparica Apoquel, and disease awareness over the years. And DTC remains an area of ongoing investment to support our parasiticide and dermatology portfolios. And finally, we continue to look externally for business development opportunities that can complement our portfolio and expand our market presence or capabilities. Yesterday, we announced plans to acquire Jurox, a privately held animal health company based in Australia expected to close in the first half of 2022. The acquisition will provide us with growth opportunities, manufacturing capacity, and increased capabilities in Australia, our fifth largest market. And also bring us a range of companion animal and life livestock products primed for global expansion. As I wrap up my remarks, our growth story for this year remains very consistent based on three recurring catalysts. First, our companion animal portfolio, driven by our triple combination Simparica Trio and other parasiticides, our dermatology treatments, Apoquel and Cytopoint, new monoclonal antibodies for pain and our Vet Scan diagnostic systems. The entire portfolio is benefiting from strong pet care trends in terms of increasing clinic visits, rising spend per visit and a focus on diagnostics and specialty care, especially among newer and younger generations of head owners. Recent estimates for market growth in companion and animal products are in the high-single-digits and Zoetis continues to expect to grow faster than the market. We are gaining share in the approximately $5 billion global parasiticides market for pets, and we excited by veterinarian and pet owner responses to our new monoclonal antibodies for pain. We also continue to see progress in the early launch of VetScan Imagyst, which leads to our second catalyst for growth, diagnostics, which posted 38% operational revenue growth in the second quarter and access to vet clinics in the U. S. rebounded from the year ago quarter. Our third growth catalyst is international, where we continued to generate strong operational growth, driven by China and Brazil, which grew at 30% and 40% respectively. All our catalysts for growth are buoyed by our priority to Champion, a healthier and more sustainable future, the commitments to our communities, animals, and the planet. You can read more about our progress on these ESG goals and our first Sustainability Report, which is published in June. In closing, we had a great second quarter and we're focused on delivering our record-setting year. The market dynamics in animal health remains strong, steady and resilient, even during the challenging times, based on people's unbreakable bond with animals. For the remainder of the year, our diverse portfolio, innovative pet care products, strengthen in diagnostics, and expansion in international markets will continue driving our performance. Now, let me hand things off to Wetteny. Wetteny Joseph : Thank you, Kristin, and good morning, everyone. Before I discuss our second quarter performance, I would like to take a moment to express how excited I to join Zoetis, a company with an exceptional opportunity for meaningful for long-term growth, driven by the durability and resiliency of the existing portfolio, a robust product pipeline and a key focus on future innovation. I look forward to leading an outstanding finance organization and maintaining the financial principles and investment strategies, which position Zoetis as the world leader in animal health. I would also like to express my appreciation to the Zoetis colleagues and the investment community for such a warm and gracious welcome. I had the pleasure of speaking with several of our investors since becoming CFO and I look forward to connecting with many more in the coming weeks. Now shifting the focus to earnings. This morning, I will provide commentary on our second quarter financial results, the key contributing factors to our performance and an update on our improved full year 2021 guidance. In the second quarter, we generated revenue of $1.9 billion, growing 26% on a reported basis and 22% operational. Adjusted net income of $566 million was an increase of 33% on a reported basis and 28% operationally. Operational revenue grew 22% with 2% from price and 20% from volume. Volume growth includes 12% from other in line products, 6% from new products and 2% from key dermatology products. We delivered another strong quarter and remain encouraged by the performance of our business, health of the overall industry and our outlook for the future. It is worth noting that Q2 2020 is a favorable comparative period due to the impact of COVID-19. The pandemic caused widespread uncertainty last year, which led to clinic closures, supply chain disruptions, and shifts in consumer demand from restaurant and foodservice to grocery stores. This materially impacted several aspects of our companion animal and livestock businesses. Now let's dive further into the details of the quarter. Companion animal products led the way in terms of species growth, growing 36% operationally with livestock growing 3% operationally in the quarter. Performance in companion animal was again driven by our parasiticides portfolio, led by sales of Simparica Trio and with significant contributions from the broader portfolio. We also continue to see growth in our key dermatology products, Apoquel and Cytopoint, as well as in vaccines and diagnostics. Simparica Trio had continued to perform exceptionally well, posting revenue of $139 million, representing growth of more than 200% versus the comparable 2020 period. In addition to sales, we are exceeding our other performance measures as well, such as clinic penetration, share within penetrated clinics and reordering rates. The strength of our entire companion animal parasiticides portfolio was evident again this quarter growing 50% operationally with meaningful growth in the ProHeart and Revolution strong growth franchises in addition to the Simparica franchise. Having the broadest and most innovative portfolio within a larger and expanding therapeutic area is as bullish on future growth in parasiticides. Global sales of our key dermatology portfolio was $280 million in the quarter, growing 22% operationally. Cytopoint had an particularly strong quarter, growing 42% operationally and generating quarterly revenue of $100 million for the first time since launch. Year-to-date sales for key dermatology products of $524 million in our view remains unchanged that sales will exceed $1 billion this year. Our diagnostics portfolio had operational growth of 38% in Q2, led by increases in consumable and estimate revenue as the business continues to recover from the impact of the pandemic. With our sustained investments in diagnostics, the newest technology we are bringing to the market and the ability to leverage the breadth of our medicines and vaccines portfolio, we are well-positioned to grow faster than the diagnostics market, which is expected to grow double-digits and outpace the overall animal health markets. Livestock growth in the quarter was primarily driven by our cattle and swine businesses. Cattle grew 3% and swine grew 6% operationally, despite price reductions as part of our generic defense strategy and higher input costs, weighing on producer profitability in the U. S. Data suggests the foodservice service and restaurant industries continued to recover in the second quarter, which is a crucial dynamic for demand of our premium products. Poultry was the only species to decline in the quarter, which fell 4% as producers in the U. S. expanded their use of lower cost alternatives to our products. The decline in poultry partially offset the growth in cattle, swine and fish products. Now let's discuss the revenue growth by segment for the quarter. U.S. revenue grew 22% with sales of companion animal products growing 34% and livestock product sales declining 8%. U.S. quarterly revenue exceeded $1 billion for the first time in company history. For companion animal, pet ownership and pet spending trends remain robust. Placement revenue increased double-digits in the quarter and patient visits and spend per visit were up as well. While we expect some of the trends to moderate, our view is we will remain above pre-COVID-19 levels. In addition, a meaningful portion of pet acquisitions, which occurred during the pandemic were by millennial and GenZ. This infuses a solid foundation of younger pet ownership, who are willing to spend disproportionately more on all aspects of pet than prior generations and will be a key growth driver for companion animal medicines, vaccines and diagnostics moving forward. Our companion animal parasiticides portfolio was the largest contributor to companion animal growth in the U.S. growing 59% in the quarter. Key hematology products, vaccines and diagnostics also contributed to growth. Simparica Trio had an incredibly strong quarter in the U.S. with sales of $120 million generating the highest revenue by a single product in the U.S. for Q2. The Simparica franchise generated sales of $153 million, growing 96% and remained the number two brand in the U.S. flea tick and heartworm markets. Key dermatology sales were $197 million for the quarter, growing 23% with significant growth for Apoquel and Cytopoint. Diagnostics sales increased 22% in the quarter with growth in instruments, rapid, test, point-of-care consumables and reference lab revenue. U.S. livestock sales fell 8% in the quarter, driven by declines in cattle and poultry with swine essentially flat for the quarter. Q2 cattle sales were negatively impacted by a promotional program in the first quarter of this year, which pulled forward a portion of second quarter sales. In addition, price reductions as part of our generic defense strategy and higher input costs weighing on beef and dairy end-markets, presented challenges to our cattle business this quarter. Poultry declined in the quarter, as produces expanded use of lower cost alternatives to our premium products as a result of higher feed cost and labor wages and smaller flux sizes reducing disease pressure. We also face generic competition for Zoamix, our alternative to antibiotics in medicated feed additives. To summarize, our U.S. operations delivered another strong quarter, led by our innovative and robust companion animal portfolio. The end-market dynamics for companion animal remain extremely healthy with pet ownership and pet spending trends driving an environment conducive to sustainable future growth, which is expected to more than offset the near-term weaknesses in our U.S. livestock business. Now turning to our international segment. Revenue in our international segment also grew 22% operationally in the quarter with companion animal revenue growing 41% and livestock revenue growing 10% operationally. The trends fueling strength in our international companion animal business are very similar to those in the U.S. The increasing medicalization rates and standard of care by pet owners, coupled with significant investments in advertising and promotion to support new product launches and key brands drove growth across our parasiticides, vaccines, diagnostics, and key dermatology portfolios. Diagnostics were one 106% operationally in the quarter, with consumables and instrument revenue, each exceeding 100% operational growth. Librela, our monoclonal antibody for of alleviation of OA pain in dogs launched in the EU in the second quarter. Feedback from the early experience trials in Q1 was encouraging and second quarter sales exceeded our expectations further supporting our optimism on the long-term blockbuster potential of the product, as well as monoclonal antibodies as a platform for future growth. Our feline line monoclonal antibody for alleviation of OA pain Solensia began early experience programs in the second quarter with an EU launch following in Q3. As previously mentioned, OA pain in cats is a significant unmet need in animal health and we're excited to provide pet owners with a novel product in a space that has previously lacked innovation. Meanwhile, our international livestock business had its second consecutive quarter with growth across all species led by strong operational growth in cattle and swine. Cattle growth in the quarter was driven by marketing campaigns, key account penetration and favorable export market conditions in Brazil and several other emerging markets. Revenue growth in swine is largely attributed to China, which grew 38% operationally. The theme for growth in swine remain consistent with previous quarters has large key accounts increased their use of our vaccines and other products as they continued to expand production as the market shifts from smaller farms to larger scale modern operations. Our fish portfolio continues to perform very well, growing 25% operationally. Growth was driven by strong performance of Alpha Flux in Chile, vaccine volume in Norway and the 2020 acquisition of Fish Vet Group. From a market perspective lens, all major markets grew double-digits in the second quarter with the exception of Japan, which declined slightly in Q2. China and Brazil had strong quarters, growing 30% and 40% respectively on an operational basis. Growth in companion animal across emerging markets remains a key driver of our international business and in addition to the growth in China and Brazil, our other emerging markets companion animal business grew 68% operationally. Overall, our international segment delivered strong results, demonstrating the importance of our diversity across species and geography. The livestock business continues to perform well and increasing pet acquisitions and pet care spending are extremely encouraging trends for long-term growth in companion animal. Now moving onto to the rest of the P&L. Adjusted gross margins of 71% is essentially flat on a reported basis, compared to the prior year, as favorable product mix and price were offset by higher manufacturing cost and freight. Adjusted operating expenses increased 23% operationally, resulting from increased compensation-related costs, advertising and promotion expense and freight. The adjusted effective tax rate for the quarter was 20%, a decrease of 230 basis points, driven by the favorable impact of a jurisdictional mix of earnings, lower GILTI tax and an increase in favorable discrete items, compared to the prior year's comparable quarter. Adjusted net income and adjusted diluted EPS grew 28% operationally for the quarter, primarily driven by revenue growth. We remain in a very strong liquidity position and continued our share buyback program, repurchasing approximately $165 million worth of shares in the quarter. The strength of our balance sheet and substantial free cash flow generation allows us to make significant investments for future growth, while still returning excess cash to shareholders. Before I review our updated guidance, I would like to reiterate a point that has been discussed on prior earnings calls, which is that, we expect growth to moderate in the second half of the year as a result of varying comparative periods, where pent-up demand created by COVID-19 in the first half of 2020 worked its way through the system in the second half of the year in addition to the expected increased generic competition for DRAXXIN. Adjusting for the variability in the comparative period due to the pandemic, our phasing of top-line growth would be more normalized and consistent quarter-to-quarter throughout this year. Now moving on to our updated guidance for 2021, which we are raising and narrowing as a result of our second quarter performance, strength of our product portfolio, and favorable market dynamics, which we expect to continue in the second half. Please note that our guidance reflects foreign exchange rates as of mid-July. For revenue, we are raising and narrowing in our guidance range. We’ve projected revenue now between $7.625 billion and $7.7 billion and operational revenue growth between 12.5% and 13.5% for the full year versus the 10.5% to 12% in our May guidance. Adjusted SG&A expense for the year are expected to be between $1.87 billion and $1.91 billion, versus $1.82 billion and $1.87 billion in our prior guidance. The increased spend represents additional advertising and promotion investments, a significant portion of which will occur in the third quarter, as well as compensation-related cost due to the company performance. Adjusted net income is now expected be in the range of $2.135 billion and $2.175 billion, representing operational growth of 13% to 15%, compared to our prior guidance of 12% to 14%. Adjusted diluted EPS is now expected to be in the range of $4.47 to $4.55 and reported diluted EPS to be in the range of $4.09 to $4.19. Now to summarize before we move on to Q&A. Our strong performance in the first half of 2021 continues to underscore the value of our diversity, innovation and durable business model. We again raised and narrowed our full year 2021 guidance and expect to grow faster than the markets. We continue to focus on long-term sustainable growth by investing in our pipeline, including infrastructure to support current and future product launches and remain very positive in our outlook for sustainable growth beyond this year. Now I’ll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] And we will take our first question from Michael Ryskin with Bank of America. Michael Ryskin : Thanks for taking the question, as always I will congrats on another strong quarter. I want to start with Simparica Trio, just a really break out quarter with $139 million. I mean, by our projections, something in the $450,000 to $500,000 range, has been out of the picture for the rest of the year. So I just want to get better a sense of where you're seeing an incremental growth coming from? I mean, we did note a little bit of a tick down in regular Simparica in the U.S. year-over-year. So just wondering if you could kind of little again on cannibalization just revenue expectations as you move forward? And then, my second question will be on the operating leverage. I was wondering we’ve talked about in the past, but definitely saw a notable step up sequentially in SG&A coming in somewhat above my estimates. You mentioned a lot of the advertising spend, a lot of compensation-related expenses. Could just give us a sense of how much this is expected to persist going forward? Obviously, it’s going to play a big role in the operating leverage in the second half of the year and given some of the comps, I want to get a better sense of what goes into that $490 million and sort of how to think about that? Kristin Peck : Great. Thanks, Mike. I'll take the first question and I'll let Wetteny take the second question on the leverage. Yes, Simparica, and Simparica Trio did had a phenomenal quarter. Overall, as Wetteny mentioned, we had 50% growth in parasiticides. But, as you look at the quarter for Trio with the $139 million, it was incredibly strong. And I would say, Trio is and has been outpacing our expectations. In fact, the Simparica franchise in Q2 was the second largest in the flea tick, heartworm space. So, we're very excited. We expect to continue to see this product grow. The market itself has now grown to over $5 billion. So, we remain super excited. We're doing well both on our penetration of clinics, as well as reorder. So we see strong momentum that we think will continue into the second half of the year. So, I’ll let Wetteny take your second question. Joseph Wetteny : Yes, in terms of SG&A, indeed, the step up that you see in terms of our trend there is really largely driven by R&D investments, as well as advertising and promotion behind our strong brands, given momentum that we have in the market and the strong market conditions that we are in. We are really putting advertising behind our key brands You mentioned Simparica as a franchise, both Trio, particularly in the U.S. and other markets, but also Simparica continues to grow internationally for us and we want to take advantage of the momentum that we have in this very large market, $5 billion plus. And so, we'll continue to do that as we enter into the back half of the year, particularly, in Q3, as we said in the prepared commentary. But that's really largely what’s driving in. In terms of compensation-related costs, this is really more of a variable low compensation areas that are really in line with the performance of the company there, as well. Operator : And we will take our next question from Jon Block with Stifel. Jon Block : Great. Thanks, guys. Good morning. Chris, maybe I'll start on the monoclonal and I know it's early, but how are you seeing Librela being used in these international practices? In other words, is it market expansion? Is it taking share from other solutions or cannibalization or remedial? Any color you have there would be helpful. And then just to shift gears on livestock, it's always choppy and can move around. But is there anything more structural going on in the U.S. market in regard to generic competition? And maybe on that last point, how is traction playing out? You mentioned that it seems like maybe less impact to-date, but is the overall year assumption still unchanged? Thanks guys. Kristin Peck : Sure. Thanks, Jon. Good to hear from you. I'll take the first question and I'll let Wetteny take the second question on livestock. We have been very excited at the uptick in Librela. As what we're seeing and your question about how is it really being used. We've seen really strong efficacy of the product. The feedback we've gotten and through early experience in our first quarter of sales is just us really quick efficacy. So, they are noticing differences pretty quick. It's improving quality of life, better socialability. So we really think more and more vets are looking at this as a first-line therapy. We do think that there are significant opportunities for Librela to grow the category. The dog categories you've talked about before, currently is $400 million. But we believe by bringing this type of innovation to the market, support them globally, but bringing this type of innovation from the safety and efficacy profile, we think we have the ability to potentially double that market, if you look at how many dogs there are, how many have away and how many are treated. So, we look at the opportunity to grow this market in a few ways. Certainly, as I talked about getting more animals, getting more days on treatment, and better compliance and then, certainly with price of this product is priced at a premium to those are already in the market. So Wetteny, do you want to take the second question on livestock? Joseph Wetteny : Yes, sure. Look, in terms of livestock, we don't see a structural change here in terms of your question and the performance that we're seeing is right in line with our expectations. Livestock grew 3% on the quarter. And as we've said, livestock has tend to grow somewhere around the 4% range in the past but we expect it to be in low-single-digits. This year, and really the global growth in that area is driven by international markets, particularly when you think about emerging markets like China and Brazil, et cetera, in the U.S. with the generic competition for DRAXXIN, we expected to see some headwind there. And it's really playing out in line with our expectations. One more point I’ll make is, if you recall, in Q1, we did have some promotions again in line with our generic defense strategy that really accelerated some of our revenue into Q1 from Q2. So that's playing out a little bit in terms of what you're seeing in the livestock figures for the U.S. But we expect to see further declines in terms of livestock for the remainder of the year and all that’s factored into the guidance that we raised today as well. Operator : And we will take our next question from Louise Chen with Cantor. Louise Chen : Hi. Thanks for taking my question here. Just curious how durable you think this increase in the vet visit, plus spend per pet will be over the longer term? Thank you. Kristin Peck : Thanks Louise. Great to hear from you. Yes, we're very confident in the durability of the companion animal trends that you've seen throughout 2020 and 2021. So, as you look in the quarter, we saw overall clinic revenues up 14% and that was equally split between vet visits and spend per visit. And our confidence in the fact that these durable trends really have to do with a few things; one, there are more pets. We've talked about that for a number of quarters. The other thing is, it's going to increase in the standard of care, the expectations of pet owners, greater use across the portfolio, greater use of diagnostics, more people home noticing more about their pets. But the other really important trend that's going to continue to play out is who is adopting a lot more of these pets and that's a lot of millennials and GenZ and they tend of spend more on their pets. They're very engaged in their care. So, we see these as durable trends that will continue, and will remain a big growth driver for the company over the coming years. Operator : And we will take our next question from John Kreger with William Blair. John Kreger : Hi. Thanks very much. I have a gross margin question. I realize the monoclonals are sort of a new class for you guys as Solensia and Librela ramp, do you expect the gross margin on those products to be better or worse than what you see across your traditional product portfolio? Joseph Wetteny : Yes. Look, we certainly - given the safety and efficacy profile of these products, we expect to be priced at a significant premium to existing therapies including on remedial. So, I would say, it would be above sort of our average gross margin that you see across our portfolio. John Kreger : Great. Thanks, Wetteny. Joseph Wetteny : Thanks, John. Operator : And we will take our next question from Katie Try. Sorry, Katie Tryhane with Credit Suisse. Katie Tryhane : Hi. Thanks for my question. You highlighted the strength in diagnostics. Can you just speak about some of the advantages and success that you've had with bundling strategies with therapeutics? And can you speak to what you're seeing in terms of competitive placements for instruments? You also called out the new VetScan Imagyst platform. I mean, how has that been performing today? And how do you expect that to contribute to growth in the business going forward? Thanks. Kristin Peck : Thanks, Katie. As you look at diagnostics, it was a very strong quarter with 38% operational growth. Diagnosis, as we've talked about remains a very attractive segment with double-digit growth. And it really - it's core to the way that that practice operates. Again, pets cannot tell you exactly how they are feeling. So we continue to see this being a really strong part of our continuum of care strategy. It's critical to the best practice. We did incredibly strong growth as you saw in the quarter in international making significant placements, very strong in the U.S. and we're focused on a few things there. Certainly, it's placements as we talked about where we are seeing good growth there, stronger in the quarter in international than the U.S. but also really driving consumable use. And we think that remains a big opportunity for us versus competition getting more consumable use in the placements that we have. And then, really adding on to the innovation, so, if you look at the images launch, it had done better than our expectations. We continue to see very strong growth there. Right now, the indication for the VetScan Imagyst is in sequel and that's a large market, it’s about $500 million, growing at 7% to 8%. So, we see really strong growth there. I don’t know, what 8% and adds? Joseph Wetteny : Not it’s probably 1%. Operator : And we will take our next question from David Westenberg with Guggenheim Securities. David Westenberg : Hi. Thank you for taking the question. I am going actually continue on that concept. And can you - that was just asked with Katie. Can you help us conceptualize the size of the non-therapeutic revenue for Zoetis on a go-forward basis? And whether or not we should see it as a revenue contributor or as maybe a means of driving therapeutic revenue? And I am going across the categories with like diagnostics, insurance, Embrex, genomics, et cetera. And then, just a quick clarification question to the answer to Jon Block’s question on the doubling of the pain market. Was that just in dogs? And then, cats is just a plus beyond that or was that $800 million or the doubling of $400 million just the dog and cat? Thank you. Joseph Wetteny : I'll start and see if Kristin wants to add anything. In terms of non-therapeutics, if you look at diagnostics, for example, where we saw 38% growth this quarter. So roughly $99 million of revenue on the quarter on the base of what we reported for the year. So, in relative terms, it's not the largest proportion of our revenue streams, certainly, but we are, very much excited about the potential for the future in the very fast growing markets as diagnostics which is expected to grow faster than the overall animal health space for us. And really one more point that I'll make is, overall, we expect diagnostics as Kristin covered earlier, does have the impact continuum of care, we think overall increasing the use of diagnostics as we look to medicalization across pets will have a positive effect on overall therapeutics in the long haul, we think that's also an exciting opportunity for the long-term. Kristin Peck : Sure. And I can take your second question with regards to the cat market. Yes, we think that would be incremental. It is a little hard to size the cat market today. There is really not much of an OA pain market in the U.S. There is some international products that are approved. But, as we talk about doubling the dogs from $400 million to $800 million, if you recall and it's again it's a little hard to size the cat market, maybe it's a $100 million. We think you can double that as well. So I think that could be a $200 million market, which would make the OA category for us across dogs and cats, potentially a $1 billion market that we can play. And so, we think this is a very exciting space for us. Operator : And we will take our next question from Balaji Prasad with Barclays. Your line is now open. Balaji Prasad - Barclays: Hi. Good morning, and thanks for questions. Just a couple for me. Firstly, on the parasiticides market, do you have a sense of relative size of where mix gotten better in the quarter and if Trio growth came in at the cost of competitors or some market expansion? On the same point, you recently got a label expansion for Simparica. Could you also just describe take us through the implications for it commercially? And on the guidance side, could you also just take us through what led to a 1% revenue guide change and the 2% increase in SG&A? And where those increased expenditure is going into? Thanks. Kristin Peck : Sure. Thanks, Prasad. I'll take the first question, and I will let Wetteny take the second one. As we look I don’t – I can't get into what our competitors products sales are. We remain quite excited for what the comparative is doing. We did get the additional label claim that was expected, that was included in the guidance that we had. In the sense of where are we getting some of those sales from, it is an end. So, we are both growing the market. I think more people are moving back into prescribed products versus some the over-the-counter. But we're also seeing that we are taking share from many of our competitors, as well. So, it's an exciting opportunity across both dimensions. Wetteny, do you want to take this other question? Joseph Wetteny : Yes. Look, one thing I would add in terms of parasiticides, I think it's a $5 billion market, that's growing around 5% and we're gaining share in this marketplace. We do think that with a triple combo, it's improving compliance with respect to heartworm, et cetera and so that we'll have the opportunity to continue to expand the market, as well. So we're very pleased with the performance across our parasiticides portfolio and the share that we're gaining. We will continue to invest behind this product and this portfolio, as well. Kristin Peck : Did you want to take the increase in guidance question? Joseph Wetteny : Yes, look, certainly, and when you look at our guidance, compared to where we started in the year and given the overall market - positive market dynamics that we see, our portfolio is performing very well. Kristin covered some of the trends around vet visits and so on. All those are contributing towards optimism and you've seen the year-to-date performance that we've delivered. And in fact, we've taken our guidance in terms of top-line operational growth up from where we started in the year at 9% to 11%, now at 12.5% to 13.5%. So full three points above where we started the year. So, we're very pleased with how we started the year. I think if you look at from a overall perspective, certainly, the first half and the second half of the year, if you look at purely top-line, it's really roughly in line, pretty consistent sort of phasing across the year. The growth rates will moderate based on last year, largely not really a matter of how this year is executing for us. We're in a very positive market dynamic with very strong performance across our portfolio. Last year, given the pandemic, there was a bit of variability across the year. There was disruption in the first half of the year, given COVID-19, which created more demand that got pent-up and caught up in the back half of the year. So that's going to create a dynamic in terms of what the Vs look like in terms of growth rates first half versus second half. But we are very pleased with where we are and we are going to continue to invest behind our key portfolios and brands. Operator : And we will take our next question from Chris Schott with JPMorgan. Chris Schott : Great. Thanks so much for the questions. I just want to focus a little bit more on U.S. livestock. Can you talk a little bit again about the 2Q dynamics? Because it seems like you were going up against a fairly easy comp, but this was still down about 8% So, I was trying to get a sense of like, as we think about the rates of decline you're expecting in the business in the second half of the year, just help us conceptualize what type of erosion you're thinking about as we go up against, what seems like some tougher comps for those quarters? And then, maybe from a longer term perspective, just walk a little bit through about how you're thinking about recovery for U.S. livestock as we think about both poultry and cattle as we get past some of these kind of more challenging near-term dynamics and just think about the longer term business? Thanks so much. Kristin Peck : Thanks, Chris. I'll start on more on the strategic drivers and I'll Wetteny get into some of the specifics here. Livestock really has performed as we expected. As we talked about going into the year with the of LOE of DRAXXIN, we did expect a decline in general as we talked about for the last few years. That's generally 20% to 40% over two to three years. And as we said, we thought that would be faster. As you look at the quarter, we did see a 19% decline overall in DRAXXIN, specifically. And I think that is of the key factors in the U.S. And as Wetteny mentioned earlier, I think this will continue. But if you look at broader livestock, historically, it's a low to mid-single-digit grower. Certainly, if you saw in 2019 with AFS and China and 2020 with COVID, it's been lower than what you've historically seen. We do believe as we said that overall this will trend back to a market growth in the mid-single-digit, call it, around the 4% range, maybe be 3% to 5%. And then we think the vet will be in line with that, it could be slightly lower over the next few years if you see this year and really the strategic driver of that is that we have a number we have the largest number of products hitting, lots of exclusivity. And as you look at our guidance, that's why it is baked in. So, it wasn't just DRAXXIN we also have one in poultry, you were just referencing had Zoamix and BMB as well. But again, we've got good growth in some of these other species as well. If you look at poultry, we're really excited at the growth of vector vaccines. It’s a $300 million market, growing 13%. We've already launched two of them Newcastle and IBD and that will be a growing portfolio for us. But, I'll like Wetteny get into some of the more specific numbers, but I do think if you look at livestock just more strategically on a higher level, I think it's going to be a lower grower than companion animal. But we do think it goes back to historical levels. Wetteny, if you want to build on that? Joseph Wetteny : Yes. Look, I mean, look, if you look at livestock across the world with protein consumption population growth, income levels rising, et cetera, we expect those to continue to drive growth in livestock for the long-term. We delivered 3% on the year, as we said it’s as expected and as was covered in the prior earnings call, we expected declines in the U.S., particularly given the generic entry for DRAXXIN. Now, the first quarter did benefit a bit from two things. One, there was a little bit of a delay in terms of the entry of generic for DRAXXIN, but also we ran a promotion in the first quarter that accelerates some revenue into Q1 taking it out of Q2. So, if you take those in consideration, which are exactly in line with our defense strategy, livestock really is performing exactly as we expected. Now, given that the intensification of generic competition as we expected, just began really into the late first quarter into the second quarter, we expect the decline to continue. And again, they are right in line with our expectations here. Operator : And we will take our next question from Steve Scala with Cowen. Steve Scala : Thank you. A local paper in Nebraska reported last week that Librela is being manufactured at the Lincoln plant. If that is correct, then is that product ultimately destined for the U.S.? And as the U.S. regulatory process evolves, can you confirm that it is still the case that no new clinical data is required? Thank you. Kristin Peck : Sure. We mentioned - I mentioned earlier, we do believe we will see approval in the U.S. for both Librela and Solensia in 2022 with Librela most likely in the second half. We have long-term strategies from obviously multiple sites. I don't think the U.S. will be manufactured out of Librela at launch. We certainly are looking at potentially adding sites just given the strength as I mentioned earlier of that product. So, we have been having ongoing conversations of regulatory authorities and we remain on track for the guidance we previously provided, which is approval for both of those products with Solensia likely earlier in the year and Librela later. But you should not probably expect that we are producing out of Lincoln Nebraska at launch for Librela. Joseph Wetteny : Look, given our global footprint and presence, you should not beat anything into the location of manufacturing in terms of where products are destined to. In particular, we'll continue to leverage both our footprint as well as third-parties that are manufacturing. And so I wouldn't draw any conclusion from that. Operator : And we will take our next question from Elliot Wilbur with Raymond James. Michael Parolari : Hi guys. This is actually Michael Parolari filling in for Elliot. Thanks for taking my question. So, I believe you said in the past that Trio has had about a 90% uptake on top corporate accounts. Just wondering if you provide an update though on penetration across all targeted accounts. And then, in relation to the DTC campaign, I know you said in your prepared remarks that it remains beneficial. But just wondering if you could give a updated timeline line on how long you could see it continuing? And then also how you see incremental spend really driving ROI here? Thank you. Kristin Peck : Sure. Thanks, Michael. We continue to see very – we are at or surpassed all the clinic penetration that we expected for Trio. So we're quite pleased with that. And right now, we're a little more focused on reorder rates, as I mentioned. We think reorder trend for us now is I think our penetration is where we would expect it and it’s very broad across the U.S. for Trio and we're to really focused on those reorders, which we now have at 80% continuing to grow those overall reorder rates. Direct-to-consumer advertising is critical in this category. It is $5 billion. It is a category that consumers really do go in and ask for brand. We do obviously track our ROI in this and as you've seen and as Wetteny mentioned earlier, we will continue to invest behind this brand. We have seen incredibly strong ROI in doing so. And that is why you're seeing us step up that spend. As we talked about earlier, it has outpaced our expectations. I think that has everything to do with the innovative nature of this product, but it also has to do with the investment we put behind that in direct-to-consumer advertising and investing with our field force and we will continue to do that. You should expect this year and next year, certainly, we have a window of opportunity with no competition in the U.S. and we will leverage that opportunity. We still don't know exactly when we'll see competition. At this point, we don't expect any into the second half of 2022 at the earliest as we mentioned. But as long as we do not have competition, we will invest aggressively behind this brand. And even when we do, we will do it as well, because we've seen very strong ROI in doing that. Operator : And we will take our next question from Navaan Ty with Citi. Navaan Ty : Hi. Good morning. Could you comment on the capital allocation? Should we expect to a continuity of financial policy going forward? And also, following Jurox, should we expect further geographic expansion via bolt-on acquisition in addition to the internal investments? Thank you. Joseph Wetteny : Yes, sure. So, in terms of capital allocation, you should expect consistency in terms of how we've managed capital allocation with the focus first and foremost on internal investments. We have opportunities in terms of R&D, investing behind our brands, on advertising and promotion perspective, CapEx to support our growing pipeline including monoclonal antibodies, et cetera. That's really our first priority. Of course, we'll take advantage of any opportunities from a business development perspective for M&A that helps to accelerate our growth in various markets in areas, as well. So that really follows in terms of investments. And then, as we have free cash flow generation very strong free cash generation, we'll look to return cash to our shareholders. We’ve increased our dividends as you've seen typically faster than our revenue and we reinitiated our share buyback program, which we were continuing. So, that remains consistent, I would say with the best. Kristin Peck : And then, on direct, do you want to just comment on that BD geographic expansion? Joseph Wetteny : Yes. So, look, certainly in Jurox, we are excited to be bringing them once we get through the process here over the next six months and close the transaction. We try to bring Jurox into the Zoetis family. Australia is our fifth largest market globally. And this is really at our core. It does increase our presence in a therapeutic area with the leading product, as well. So we're very excited about that opportunity and what it does for us. And we will continue to look for bolt-on opportunities to bring on both the core, as well as other areas of the business whether it's diagnostics or what have you, as well. Operator : And this does conclude today's question and answer session. I will now turn the program back over to Kristin Peck for any additional or closing remarks. Kristin Peck : Great. Thank you everybody for your questions today and for your continued interest in Zoetis. We look forward to keeping updated on our business throughout the remainder of the year and continuing to deliver on our results and innovations that you and our customers expect. So, thanks so much for joining us today. Stay safe. Operator : This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful day.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,021
| 4
|
2021Q4
|
2021Q3
|
2021-11-04
| 4.278
| 4.375
| 4.884
| 4.977
| 7.24294
| 40.89
| 40.98
|
Operator : Welcome to the Third Quarter 2021 financial results conference call and webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions]. If at any point your question has been answered, you may remove yourself from the queue while pressing the pound key. In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. Your line will be muted when you complete your question. [Operator Instructions]. It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, Operator. Good morning, everyone. And welcome to the Zoetis Third Quarter 2021 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 projection. 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 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 US GAAP. Reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release, and in the Company's 8-K filing dated today, Thursday, November 4th, 2021. We also cite operational results which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and welcome everyone to our third quarter earnings call. We delivered strong results. Again, this quarter with 10% operational growth in both revenue and adjusted net income driven by our innovative portfolio of petcare parasiticides and dermatology products. Our US business grew revenue 7% operationally, while international grew revenue 14% operationally. In terms of species, our Companion Animal portfolio generated 19% operational revenue growth in the quarter with great performance in markets around the world. Our latest innovation in parasiticides, the triple combination Simparica Trio is increasing its global adoption. Our groundbreaking dermatology products, Apoquel and Cytopoint, continue to redefine and expand the category. And we completed the first full quarter of sales for both of our new monoclonal antibody therapies for osteoarthritis pain in dogs and cats, Librela and Solensia. These new products are exceeding expectations and receiving very positive feedback from veterinarians and pet owners in European markets, where they've been launched. When you add all of this to our growth in diagnostics for Companion Animals, I see our business continuing to capitalize on the positive demographics for pets. Increased spending on pet wellness and treatment will be sustainable well beyond the pandemic. And our portfolio and pipeline habits well-positioned to continue leading and innovating in this market. Livestock product sales continue to present a more complex picture for the industry and Zoletis with market dynamics vary widely by species and geographies. As we expected, our livestock portfolio declined 2% operationally in the third quarter, largely due to generic competition across, cattle, poultry, and swine and most significantly in the US We have taken proactive strategies to protect these product lines, including the introduction of a lifecycle innovation like drafting KP. But pricing pressure remains due to the increasing effects of generic competition. On the positive side, we saw 7% operational growth for livestock and international as markets like Brazil, Chile, and other emerging markets performed well. Our long-term advantage in livestock continues to be our diverse portfolio and strength across geographies and product categories like medicines, vaccines, and medicated feed additives. We also continue to invest in R&D programs that align with our customers long-term needs for more efficient and sustainable production methods, which can be built anew therapies, analytics and digital solutions. We remain on track for a record setting year with updated guidance for operational revenue growth in the range of 14% to 14.5% and adjusted net income growth in the range of 16.5% to 18% for 2021. Our major catalyst for growth has performed well this year and have more runway ahead for 2022 and beyond. And when do we make the right investments and continue successfully executing our growth strategies. Our strength in petcare has an incredibly strong foundation across parasiticide, dermatology and vaccine. To the first 9 months of 2021, our Companion Animal portfolio has grown 29% operationally. We also remain very excited about the long-term blockbuster potential of our new monoclonal antibody franchises in pain, Librela and Solensia, as they grow in Europe and we make progress on approvals in the US We currently expect approval of Solensia in the US in the first half of 2022, with Librela remaining more likely in the second half. Our revenue growth in international markets has been 20% operationally to the first 9 months, driven by China, Brazil, and other emerging markets. We continue to expect growth to come across both our Companion Animal and livestock portfolios in these markets. Finally, our diagnostics portfolio remains a key catalyst for growth with 28% operational growth through the first 9 months. We are gaining significant traction with our expansion of the point-of-care portfolio in markets outside the US We always believed international expansion was one of the biggest value drivers for the Abaxis acquisition once we combine that portfolio with the global Zoetis footprint. The acceleration of international growth for diagnostics is a very positive sign and continues gaining momentum. We also recently added digital cytology testing to our VetScan images platform in the US, UK, Canada, Australia, and New Zealand. This means we can now offer a network of expert remote pathologists, in addition to artificial intelligence technology for fecal testing. We're seeing our strongest early adoption of VetScan images in Germany, Australia, Spain, and the UK. And we will continue developing additional applications for the platform over time. In addition to our ongoing investments in R&D programs and direct-to-consumer campaigns, we are investing in manufacturing capacity to meet increasing demands for our new parasiticide products and monoclonal antibody therapies. Expansions are underway at our sites in Kalamazoo, Michigan, Lincoln, Nebraska, and Tullamore, Ireland. All of these are significant multiyear projects to ensure we have ongoing reliable supply, while maintaining a diverse global network of third-party contract manufacturers that give us the greatest flexibility and redundancy. Our supply chain team has done an excellent job over the last two years to optimize inventory levels of key products, while minimizing the impact of a challenging global supply landscape. We continue to carefully monitor and manage our supply chain and inventories. And finally, before I hand things off to Wetteny, I wanted to note our recent news about changes in our R&D leadership team. Long-time R&D leader, Cathy Knupp will be retiring at the end of the year and ensuring a smooth transition through February. I am very grateful to Cathy for building the most innovative and productive R&D organization in the animal health industry. And for leaving us with a rich pipeline of future innovations and R&D talent, which includes her successor, Rob Polzer. Robin has been with Zoletis since 2015. Working on many of the innovations that have come to market recently in parasiticides and monoclonal antibodies. He has experienced running our global therapeutics and biologic R&D organization and is the right leader for the future of innovation at Zoetis. In closing, I want to thank our colleagues for delivering another great quarter and bringing the value of Zoetis to our customers every day. We are confident in the updated guidance we have provided and see the fundamental growth drivers of our business continuing into 2022 and beyond. Now, let me hand things over to Wetteny. Wetteny Joseph : Thank you, Kristin and good morning, everyone. The focus of my comments today will be on our third quarter financial results, the contributing factors that drove our performance and an update of our improved full-year 2021 guidance. In the third quarter, we generated revenue of $2 billion, growing 11% on a reported basis, and 10% operationally. Adjusted net income of $597 million was an increase of 14% on a reported basis and 10% operationally. Operationally revenue grew 10% with 2% from price and 8% from volume. Run growth is comprised of 5% from new products, including Simparica Trio, and 3% from our online portfolio, primarily our key dermatology franchise. Now let's dive further into the details of the quarter. Companion Animal products again led the way in terms of species growth, growing 19% operationally, with livestock declining 2% operationally in the quarter. Our parasiticide portfolio made the largest contribution to Companion Animal growth driven by sales of Simparica Trio and continues strength across our broader portfolio including the Proheart franchise, Simparica, and Revolution Stronghold Plus. We also saw robust growth in our key dermatology products, Apoquel and Cytopoint. Simparica Trio had another exceptional quarter posting revenue of $122 million, representing operational growth of 140% versus the comparable 2020 period, with year-to-date sales of $350 million. We believe the global fleet second hardware market will continue to expand and that our broad and innovative portfolio, which were 32% operationally in the quarter has us well-positioned to capture share and outpace our competitors. Global sales of our key dermatology products were $321 million in the quarter, growing 26% operationally. Total sales exceeded $300 million for the first time in Company history. And we remain ahead of schedule to surpass $1 billion in dermatology sales for the year. Our diagnostics portfolio had operational sales growth of 7% in Q3 against a very challenging comparative period as the third quarter of 2020 had a sharp increase in wellness visits following wide fill clinic closures in the second quarter. Our International Diagnostics portfolio performed very well, which as Kristin mentioned, was a key component for the strategic rationale of the Abaxis acquisition. Diagnostics remains the key growth driver for Zoetis, and we will continue to make significant investments in new technology, expand our reference [Indiscernible] footprint, as well as provide flexible solutions to our customers. Our equine products delivered strong results with operational sales growth of 20% in the quarter as horse shows and racing return to pre-pandemic levels and field growth in vaccines, as well as nutritional and pain products. The expected decline in livestock in the quarter was primarily driven by our US cattle and US poultry businesses as our international segment delivered operational growth across all species. Globally, our cattle business declined 5% operationally in the quarter driven by the impact of generic competition for DRAXXIN and a difficult comparative quarter resulting from COVID-19 dynamics and earlier fall cattle run in the US in the third quarter of 2020. Poultry also declined in the quarter as producers in the US rotated to lower-cost alternatives to our premium products as a result of current market dynamics. Sales were also negatively impacted by generic competition of Zoamix and BMD, our alternatives to antibiotics in medicated feed additives. The decline in cattle and poultry offset the growth in fish. Swine was essentially flat in the quarter as decline in the US, primarily from pricing pressure on our anti-infective and vaccine portfolio as a result of generic competition, offset the growth internationally from further key account expansion. Overall, we delivered another strong quarter, bench marked against a very difficult prior-year comparative period on both the Companion Animal and livestock sides of our business. Now, let's discuss the revenue growth by segment for the quarter. US quarterly revenue exceeded $1 billion for the second consecutive quarter, with revenue growth of 7%. Sales of Companion Animal products grew 17%, and lifestyle product sales declined by 13%. For Companion Animal, Petcare trends continued to be robust. Vet clinic revenue and patient visits grew again this quarter against growth rates from the third quarter of last year, which were well above historical levels. Our view remains unchanged that certain trends will moderate, but we remain above pre-pandemic levels. Growth in US Companion Animal was led by our parasiticides portfolio and our key dermatology products. Simparica Trio continues to perform well, with US sales of $110 million and year-to-date sales north of $300 million. This quarter is also an excellent representation of our commitment to invest in the broader parasiticide portfolio as we launched the targeted DTC campaign for Proheart and prevalent heartworm geographies. Key dermatology sales were $270 million in the US for the quarter, growing 20% with significant growth for Apoquel and Cytopoint. US diagnostic sales grew 2% in the quarter, which as I mentioned earlier had a very difficult comparative period. However, year-to-date performance has been strong at 23% growth. US livestock sales declined 13% in the quarter. Our US cattle business faced the comparative period that's a robust growth at third quarter performance of 2020 benefited from an early for cattle run and pent-up demand work its way through the system. In addition, generic competition had not entered the market in the third quarter of 2020. Our generic defense strategy has been successful as we have been able to maintain a greater volume share of the [Indiscernible] market than originally expected. Although additional generics will likely enter the market in the coming quarters. From an end market perspective, producer profitability remains challenged by input costs, primarily feed and labor. US poultry sales declined in the quarter as smaller flocks resulted in lower disease pressure, allowing producers to expand usage of lower-cost alternatives through our highly efficacious premium products. In addition, generic competition is creating pricing pressure on our Zoamix NBNT franchises. To summarize, our US operations delivered another strong quarter driven by our innovative and robust Companion Animal products along with petcare and markets, displaying very strong fundamentals. The near-term weakness in our US livestock business has been expected and has been more than offset by the strengthened Companion Animal, which demonstrate the importance of diversification across species. Now, turning to our international segment. Revenue of our International segment grew 14% operational in the quarter with Companion Animal revenue growing 24%, and livestock revenue growing 7% operationally. In the second half of 2020, we saw a material uptick in medicalization rates and standard of care by pet owners, a trend which has continued through the third quarter of this year. We entered and made significant investments in advertising promotion to capitalize on favorable market conditions and drive growth. Companion Animal achieved broad-based growth internationally in the quarter, led by strong performance of our key dermatology products. Through 3 quarters of 2021, year-to-date sales are in excess of total sales on the entire prior year. In addition, we are in the early stages of a DTC campaign for key dermatology, which we expect will create additional demand for our products. Paracitisides had a strong quarter internationally, led by significant growth in the Simparica franchise, which benefited from DTC campaigns and drove growth in Brazil, Eastern Europe, and Latin America. Librela our monoclonal antibody for alleviation of [Indiscernible] pain in dogs, has done extremely well, generating $15 million in quarterly sales in a select number of markets. Feedback from veterinarians and pet owners on the quality-of-life improvement for the patients has been extremely encouraging. Our feline monoclonal antibody for alleviation of [Indiscernible] pain Solensia, had positive feedback from the early experience programs in Q2 and launched in the EU this quarter. [Indiscernible] in cats is a significant unmet need in animal health and our view is that Solensia will become a blockbuster product, with the pain market for cats becoming approximately a $200 million global category overtime. Our international diagnostics portfolio grew 20% operationally in the quarter, with significant growth in consumable and instrument revenue. And strong growth across a number of geographies such as the UK, Australia, China, and various other markets. Moving onto livestock, our international business again delivered growth across all species, led by strong operational growth in cattle and fish. Cattle growth in the quarter was driven by further key account penetration and favorable export market conditions in Brazil, in several other emerging markets. Our fish portfolio continues to perform very well, growing 21% operationally. Growth in our fish portfolio was primarily the result of increased sales of our Alpha Flux Sea lice treatment product, as well as strong growth in vaccines. Performance in swine and poultry were also fueled by growth in key accounts, as well as overall market growth, primarily emerging markets. At a market level view for international segment, all major markets grew operational in the third quarter with the exception of France, which was essentially flat in Q3. Emerging markets was again a key contributor to our international performance, led by Brazil, which was 22% on an operational basis. As we expected, growth in China slowed in the third quarter as lower pork prices challenged with this or profitability. However, the Companion Animal business in China, which grew double-digits once again, offset the weakness in swine. Overall, total emerging markets has grown significantly in both the quarter and on a year-to-date basis. Our international segment again delivered strong results of robust growth in Companion Animal and growth across all species in livestock. On a year-to-date basis, our international segment has grown 20% operationally with our Companion Animal and livestock businesses, each growing double-digits. While following pork prices in China are creating a headwind that is moderating growth in swine, it is more than offset by the growth across other species and markets for the demonstrating the importance of our diversity across species and geography. Now moving on to the rest of the P&L. Adjusted gross margin of 70.7% increased 110 basis points on a reported basis compared to the prior year as favorable product mix for an exchange, low inventory charges and price were partially offset by higher manufacturing costs, freight and distribution costs. Adjusted operating expenses increased 19% operationally, with SG&A expenses growing 20% operationally resulting from increased compensation-related costs, as well as increased advertising and promotion expense, freight, and T&E. Our [Indiscernible] expenses were 17% operationally driven by higher project spend. The adjusted effective tax rate for the quarter was 16.7%, a decrease of 330 basis points due to favorable changes to the jurisdictional mix of earnings including increased favorability related to foreign derived and tangible income, and an increase in favorable discrete items compared to the prior year's comparable third quarter. Adjusted net income and adjusted diluted EPS grew 10% operationally for the quarter, primarily driven by revenue growth, gross margin expansion, and a lower effective tax rate. Our liquidity position remains very healthy. And in the third quarter were $3.3 billion in cash and cash equivalents following a $600 million repayment of long-term debt in August. Our financial flexibilities in a very strong position, which allows us to make meaningful investments in our business while returning excess cash to shareholders, as demonstrated by our repurchase of Zoetis shares of approximately $200 million in the quarter. Now, moving on to our updated guidance for 2021 through a raising and narrowing as a result of our performance in the third quarter and confidence in our ability to deliver sustainable future growth. Please note that our guidance reflects foreign exchange rates as of mid-October. For revenue, we are raising and narrowing our guidance range with projected revenue now between $7.7 billion and.$7.75 billion and operational revenue growth between 14% and 14.5% for the full-year versus the 12.5% to 13.5% in our August guidance. Adjusted SG&A expense for the year are expected to be between $1.91 billion and $1.94 billion versus $1.87 billion and $1.91 billion in our prior guidance. The guidance rate largely represents additional compensation-related costs, as well as increased advertising and promotion spend to support growth of new products and key franchises. Adjusted net income is now expected to be in the range of $2.2 billion and $2.225 billion, representing operational growth of 16.5% to 18% compared to our prior guidance of 13% to 15%. Adjusted diluted EPS is now expected to be in the range of $4.62 to $4.67, and reported diluted EPS to be in the range of $4.23 to $4.29. Now, to summarize, before we move to Q&A. Three quarters, we've delivered strong operational top and bottom-line growth with revenue growing 17% operationally. And again, raised and narrowed our full-year 2021 guidance. We have achieved significant growth across our key franchises and are extremely excited about our new product launches, and product pipeline. Now, I hand things over to our operator to open the line for your questions. Operator. Operator : And at this time, [Operator Instructions]. Again, in the interest of time, we ask that you limit yourself to one question and re-queue again with any follow-ups, your line will be muted when you complete your question. Today's first question comes from Michael Ryskin with Bank of America. Please go ahead. Your line is open. Michael Ryskin : Great. Thanks for taking the question, guys and congrats on a strong quarter and raised the guide. I want to start on DRAXXIN real quick. You touched on generic impact in US livestock a number of times in your remarks, we assume that's predominantly from DRAXXIN. Can you give us an update if you're seeing any stabilization there or are you expecting for the headwinds in 4Q '22 or 4Q or 2022 or given those trends improve and stabilize from here? Wetteny Joseph : Yes. Thank you. We were very pleased to deliver another strong quarter and position to raise a guidance once again for the year. With respect to DRAXXIN, as expected, we continue to see the effect of the LOE and DRAXXIN was down about $15 million in the quarter. Now, our defense strategy here is working well and we are largely maintaining our market share although that does have the effect on price. So, we're very pleased with how the product is performing as well as DRAXXIN KP in terms of maintaining largely the market share from a volume perspective here. As we look forward, we are expecting further generic competitors to come into this space from a DRAXXIN perspective, and that we believe will continue into next year as well. Kristin Peck : And the only thing I would add there, as we said, this is completely in line with our expectations, not just that we gave this year, but that we've been talking about when the generic enters. We generally said it takes somewhere between 20% to 40% over a number of years. We said in the beginning of this year that that would likely be a little faster and we're on track to be doing that. We expect probably somewhere around a 20% head-on price for us on this product in the year. So, in line with the expectations, Mike. Operator : Thank you. We'll take our next question from Louise Chen with Cantor. Please go ahead. Louise Chen : Hi. Thanks for taking my question here. So, as we start to think about 2022, what are some of the pushes and pulls hereperce for example, will recovery from food services and restaurants be a tailwind in 2022 for livestock? And what else should we be thinking about? Thank you. Kristin Peck : Thanks, Louise. We are really excited for a number of the growth drivers that we saw this year, which we really think will continue into next year. I think our strength in parasiticide, our strength in derm, I mean, that will be a billion dollars this year growing at 26% in the quarter. Diagnostics, again, year-to-date, 28%, we think continues into next year, really strong performance in our emerging markets. China, Brazil, and other emerging, which I think will continue into next year, not to mention our pain monoclonal antibodies. So, I think we have a lot of the growth drivers this year that we think will continue into next year. I mean, obviously things we're going to watch for next year, there could be headwinds for us. Could be the timing of competition for potential product against Apoquel or Simparica Trio, as Wetteny mentioned in his remarks, we're not really expecting that until the second half of 2022. Again, we don't have great visibility into that. Obviously, we think [Indiscernible], once we lap some of this draft and impact that will lessen as a real headwind for us. But overall, we really think that durable growth drivers you saw this year really continue into next year and we're pretty confident about that. Operator : We will take our next question from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Thanks so much. If I can maybe follow up on the revenue outlook, Wetteny, for 4Q. I think historically 4Q has been a bit of a stronger quarter. You mentioned the competition on DRAXXIN. Is there any other dynamic that we should have in mind in terms of the revenue cadence for the fourth quarter? And I guess, with the focus on inflation and cost pressures in the market, do you feel like you've seen any pre-buying of products or stocking up from customers in either the livestock or companion business. Thank you. Wetteny Joseph : Yes. Sure. Look, we continue to see really strong underlying market dynamics overall. And our portfolio is really well-positioned and continues to perform very well against those dynamics. As we discussed on the prior earnings call, what we're seeing in terms of growth rates in the second half of this year is more reflection of how the phasing occurred last year versus this year, given our position in the market. Again, the strong market dynamics that we continue to face here. If you look at last year, the second half had almost 17% more revenue in the back half in the first half of last year. And so that's really what's driving the comp here. Those are the phasing of last year where this year is a little bit more normalized. As Kristin just referenced, we see a number of growth drivers for us, not only from the overall market, but also our portfolio across [Indiscernible], as we look at pain, diagnostics as well, with the one area -- the area that we're watching, including DRAXXIN. To your point around inflation, is you know given our portfolio and innovative products that we have and demand we see for those products, they position us well to take price. And you saw a 2% price in the quarter included in 10% operational growth. And we'll continue to look at opportunities to continue to do that as we go into next year, you saw in the quarter our gross margins actually expanded by 110 basis points versus last year Q3, and so that despite some headwinds in the areas of freight, etc. So, we'll continue to monitor those and take price where we can give the innovative products that we bring to the market [Indiscernible] Operator : And our next question is from Jon Block with Stifel. Please go ahead. Jon Block : Great. Thanks, guys. Good morning. See if I can [Indiscernible] a couple. The first on livestock and quite honestly was pleasantly surprised by the international livestock up 7% operationally. There's just a lot of noise out there with other companies and swine chatter. So, I guess the first question is, was that a clean number? No pull forwards and maybe just talk to this market overall, do you still view it as a low single-digit grower for you this year with eventual improvement to mid-single-digit in call it '22/'23? And then just a pivot, Kristin or Wetteny. I know we're not going to get a 2022 guide, but maybe conceptually at a high level, how do we think of '22 in terms of a year where the delta -- how do we think about the delta between revenue and EPS growth? And I guess where I'm going with this is a lot of innovation for you where you're still dominating the market. So conceptually, do we just think about it as another year of spending, supporting the portfolio of DTC where the delta between those 2 revenues -- revs and EPS might be a little bit tighter than prior years? And sorry for the long-winded questions. Thanks. Kristin Peck : Sure. I'll take the first part of the question then I will let Wetteny take the second half, Jon. Livestock is a complex picture. So, I think your insight is quite well-founded. In the sense of not just the difference between US and international, but the difference between the specie. So, as you rightly mentioned, the US was down significantly in livestock and that's pretty much generic competition against DRAXXIN, Zoamix and some other products that we mentioned before. But to your point, international was up 7% and that was still with a really rough time in China as you saw in the quarter with China livestock down about 10%, but more than made up for by China's Companion Animal. And really it has to do with the mix between species that are growing quite quickly for us like fish, cattle, and poultry, maybe struggling but you look at strong growth in emerging markets, which is what's really booing livestock. And as we've said in previous quarters, how US livestock goes does not mean how overall lifestyle goes. So, I think we really, the diversity of our portfolio across species, across geographies continues to really be one of the strengths for us at least. And we do think overall you'll see a flat to low single-digit growth overall across the Company for us in livestock, that maybe a little bit slower than the market, as we said, because of DRAXXIN and some of the key LOEs that we have. And ultimately, once we lap some of those LOEs, we think you do go back in '23, '24 to a mid-single-digit exactly where we've always been. So, the historic growth of livestock is around 4%. And as we said, we think it absolutely returns there. And what's the reason to believe? Well, if we're growing international in the quarter at 7%, and really the US is mostly getting hit by the generic. Once we lap those, we do believe you can get back to a livestock growth in the sort of mid-single digits, the way it historically has been. But I'll Wetteny take your second question. Wetteny Joseph : Yes. As we've discussed just before here, we're well-positioned, going out of this year into next year, to continue to sustain growth beyond this year. In terms of how you might see things flow through the P&L, our long-term value proposition is to grow adjusted net income faster than revenue. We don't see any reason to depart from that. However, given the opposition across a number of really key brands and demand that we see, we'll take the opportunity to invest behind those brands to drive DTC by other awareness campaigns, etc. We're also are investing in R&D, as well as Diagnostics and other areas that we believe will help us accelerate and enhance growth going forward. So that may, at times, cause that difference to be a little bit tighter as you said, from time to time, but it's to drive that growth -- that enhanced level of growth that we see, given the opportunity that we see in the market. Operator : Thank you. We'll take our next question from Erin Wright with Morgan Stanley. Please go ahead. Erin Wright : Okay. Thanks. Can you provide us any metrics on the contributions from Librela and Solensia in the quarter or any metrics around reorder rates of the products in certain markets and how the launch is progressing relative to your expectations at this point in the expected timeline again for the US launch. And then second, just more broadly on Companion Animal trends. Any monthly metrics you can give us over the course of the quarter and kind of what's expected for the fourth quarter and beyond in terms of the underlying demand trends across that market? Thanks. Wetteny Joseph : We continue to be very pleased with the performance of Librela and Solensia in the European markets where we've launched the product. The feedback has been very, very strong from vet and pet owners as well. We saw $50 million of revenue from Librela in the quarter and about $2 million from Solensia. Again, really the first full quarter of those products being in those select markets for us. In terms of where we're expecting approval for next year and we continue to expect approval for Librela as Kristin mentioned, in the first half of the year. Kristin Peck : Solensia. Wetteny Joseph : I'm sorry. Solensia in the first half. Sorry about that. Kristin Peck : No worries. Wetteny Joseph : Solensia in the first half. With Librela, more likely in the second half of the year in the US. Kristin Peck : And I'll take the second half of your question, Erin, with regards to US Companion Animal trends. We don't have the monthly data, but just putting some of this in context, we believe that we look at the data overall right now. We're seeing overall vet clinic revenue growing 7%, which is higher than the historical rate. It's been a little bumpy over the year. I mean, weather, lots of different dynamics have been driving it. You saw 8% in Q1, 14% in Q2., we are seeing 7%. The way we sort of see this is, we think it overall will be higher than historical norms. Is it -- is the double-digit that you saw consistently in 2020? No, but I don't think -- we saw very weak as you saw in Q1 and there's a huge bounce back in the second half as we saw last year, we do think that revenue at that clinic will continue to grow above historical rates. We're not really sure, as I said last quarter that we think that's going to be double-digit, but historically it grew 5 to 6. Is it going to be 7 to 8? I think our view is it will still be stronger than normal, but maybe not in the double-digits overall. But I mean, its still seeing strength, if you -- anyone of you who have been trying to get an appointment for your dog or your cat at the vet, it's pretty challenging to get one. So mostly because the demand really does remain high there. Operator : Our next question comes from Chris Schott with JPMorgan, please go ahead. Chris Schott : Great. Thanks so much for the questions. I just -- my question on the derm portfolio, you've built a billion-dollar franchise here, but it's really about competition coming in 2022 or beyond. What are you anticipating in terms of the impact that a competitor launch could have? I think historically you've talked about a second entry, more building the market than maybe directly cannibalizing your existing business. But I guess as you've had a longer window of time to develop this, do we reach a point where that competitive launch, I guess, more impacts your growth versus -- I guess the heart of the question is, how much more room is there for market expansion as a new player comes in? Thanks so much. Kristin Peck : Sure, thanks Chris. Yes, I mean, our derm portfolio has continued to grow and I think what we've really discovered is there still a large number of untreated animals out there. So, if you look at, we still believe there are 7,000,000 dogs that are diagnosed with some form of itchiness that are still not being treated. We do believe there's significant market growth. There's still geographic expansion. We've really invested heavily in direct-to-consumer advertising to grow this market. People are home more with their pets. They're spending more time. So, I think people are really starting to notices itch and bothering them more maybe than it did historically. So, they are seeking help. We've also really invested in programs such as in the US are Petcare rewards program, which it making customers loyal to our product. So, we have been expecting competition to be frank. We probably thought it would've happened before now, but we think there's lots of rooms to continue to grow this market. And so, will it remain at 26% of you saw in the quarter? Our growth might go down a little bit, but I still think this will be a growing market for us, just given the large number of untreated dogs in the US and around the globe. Operator : And our next question comes from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi. Good morning. Thanks for questions. Main focus on China, but the [Indiscernible] and it's because you often spoken about China as a major market, understandably. Can you help us understand the expectation that are in the market and any comparative range of prizes that you think this market would support? And also, far behind would applicable to be in terms of getting introduced are launched in China. Thank you. Wetteny Joseph : Yeah, I'll start and see what Kristin what's to add here with respect to China. As expected, we saw growth decelerate in China this quarter with about 1% growth in the quarter but keep in mind, China has actually grown 35% on a year-to-date basis. We're up against a very solid comparative on last year where we saw 63% growth in the quarter. And swine was actually up 159% in the same quarter last year. Again, the pricing dynamics [Indiscernible] which we discussed on the last call started about mid-June. And so, we expected to see sort of decline in the pork area. Now, the other part of your question is long-term. What do we expect in the market? We do see continued opportunity to grow substantially in China over time as we bring more and more robotics to the market. But also, if you look at what's happened since African swine fever, you see a concentration more on larger producers versus backyard forms, and we think that [Indiscernible] well in terms of whole medicalization over time, as well for our premium products with respect to swine. And then on the Companion Animal side, we continue to see really robust growth in China. In Companion Animal, we saw double-digit growth this quarter. And Companion Animal which obviously was partly offset by the swine. So long term, we continue to expect really solid growth in China, which is our second largest market, driven by the market dynamics that we discussed. Although there may be cycles that we'll see in swine as we're going through right now from a pricing standpoint. Kristin Peck : The only thing that I could add to that, is we obviously have launched Apoquel there. It is doing well, it is growing. This is a specialty product in a market that's traditionally been mostly a primary care generalist market. So, we're really excited to grow that. And I think we have a very strong pipeline of products coming into China and new innovation that we're going to be bringing in just like we brought in Apoquel, the approval right now for Cytopoint, which has not yet launched there. And honestly lots of products behind that we're really excited to be launching in China. So, we -- it is our second largest market. We do think it's going to continue to have very strong growth. As Wetteny said, with our year-to-date at 35%, we're really bullish on our ability to continue to grow in China. Operator : Our next question comes from Steve Scala with Cowen. Please go ahead. Steve Scala : Thank you. I have a question on Librela and Solensia in Europe. There are several parts of the question. Are owners are returning monthly for the next injection or is the time between injections longer than that? What is the average patient cost of each injection? And just to clarify, I think you said Solensia in cash is $200 million opportunity. Why is that? Why is that only $200 million? Why isn't it multiples of that? Thank you. Kristin Peck : Sure. Again, I can start there. We are really pleased with Librela and yes, we are seeing animals return. I don't have the specific number of days that they're coming back. We can certainly look into that and see if we can get that data for you. It is priced at a premium to both Rimadyl, as well as to Gala plans on the market, so given it has a phenomenal, both safety and efficacy profile, it has been priced at a premium. The price obviously varies from market-to-market, so I don't think we have that overall information. With regards to the second part of your answer on Solensia, half is it quite different markets. So, although today the market in dogs is 400 and we believe we can double it. The market is actually pretty higher to size in cats. There are very few approved products out there today to treat cats, so I hardly even say what it is. It's not zero, maybe tens of millions, it's certainly not hundreds of millions of dollars. And cats are less medicalized than dogs. So, you really have to first medicalize those cats. You have to be able to -- cats like to hide their pain. So, you also have to find a way that pet owners can notice pain in cats better and identify it and bring them to the vet. So, the reason we've said it's a smaller market is, the number of cats that are medicalized are just smaller, and then the number that are actually treated is really small. So, the first thing is you need to be able to identify [Indiscernible] with pet owners, convince them to take their cats to the vet and build a market from scratch. Cat owners, when they used to call the vet when their cat was severing from pain, from osteoarthritis. We're told it really wasn't anything. There's no product in the US, for example, whatsoever. So, it's really about retraining pet owners that there is a product that can meet their cat sneeze, and helping vets really bring the cat into the vet. A lot of pet owners don't like putting their cats in crates to bring them to the vet as you probably know. But we're very confident that we have a strong pipeline for cats that will increasingly medicalized cats’ overtime and helped build this market. But as we said, just given the number of medicalized cats will be a smaller market than the dog space. And it will likely take a little longer to build it. Operator : And our next question comes from Christine Rains with William Blair. Please go ahead. Christine Rains : Hi. Congrats on a great quarter and good morning. My question is that we noticed that Trio declined sequentially for the first time, so I was just hoping to have some color on this and how it's performing versus your expectations. Thanks. Wetteny Joseph : Sure. Look, we saw another strong quarter across our parasiticide franchise. Small animal parasiticide grew about 32% in the quarter with $391 billion. We've had Trio sales of $122 million, $350 million so far through this year on a year-to-date basis. The part that continues to do extremely well, particularly in our large corporate accounts, where the penetration rates about 90% and we're seeing about 80% of the order rates as well. So, we continue to gain share in this very large market. If you recall, last year we launched the product, and so we've now -- without lapping it. And in terms of parasiticides, a sort of seasonality starts to play into [Indiscernible] in terms of what you might see as well. So, this is really in line with our expectations and we couldn't be more pleased with how the product is doing in the market. And now that we've really penetrated well with the large corporate accounts, we're now going into some of the mid-size accounts as well. So, we continue to see the product gain momentum and again, in line with our expectations. Operator : Your next question comes from Navaan Ty with Citi. Please go ahead. Navaan Ty : Good morning. Can you share your stats of pet ownership going forward and average revenue per Companion Animal visit? And apologies if I missed them. And can I quickly ask are you able to comment on the EU Commission investigation to the Belgian office? I understand it was related to anti-trust allegation. Thank you. Kristin Peck : Sure. I'll start with your question with regards to the investigation and then Wetteny can take the second half of your question on Companion Animal. On the [Indiscernible] inspection pertains to the [Indiscernible] decision to discontinue the clinical development of a single experimental drug candidate. We're working with the EC to ensure it has all the necessary information that it needs. And we are confident that we can align the concerns which are prompted the investigation. So, I think your second part of the question was on Companion Animal trends. The 7% which was broken up between 3% on traffic and 4% on spend per visit, but I don't know Wetteny if you've got any comments on that? Wetteny Joseph : Yeah, sure. As Kristin mentioned, we saw 7% revenue growth for vet with about -- with visits up 3% and a revenue per visit up about 4%. And that's up against a prior year where we saw real increase in the third quarter in terms of vet visits, etc., given the effects of the pandemic. We continue to expect that these statistics will continue to be above pre-pandemic levels, or they would moderate from their peaks. Other -- two other important points to recall here is that if you look at pet ownership or more, we're seeing millennials and Gen-Z bring pets into their homes, and they are doing a lot more research and looking at petcare and wellness, and they are willing to spend more on their pets. So, the increase in pet ownership, we expect that to continue to provide really strong tailwind in the industry for spending on pets as we look forward and as those pets continue to age as well. Operator : And our next question comes from Dave Westenberg with Jefferies. Please go ahead. Dave Westenberg : Thanks. Good morning. I have a question on potential competition for Simparica Trio. I know it's been a bit of a moving target. I think initially you thought it could even happen this year and I think it's been pushed out to the rate three times, perhaps to second half of '22. Just curious. I know competitor tight-lipped about what they're doing. But any thoughts from year-end and why there continues to be a delay here, do you think it's regulatory? Or it -- could it be technical? And if it's technical, is this something that could delay competition for many years to come? And then just -- hypothetically, if competition comes into derm segment around the same time as competition comes for Simparica Trio, do you think you have the flexibility to show above segment growth during this period? Thanks. Kristin Peck : Sure. I wish we knew exactly. I mean, we had the same theories that you do that there could be certain technical reasons for some competitors. And let me be clear. Everyone's working in this space. This is the parasiticides. It's the largest single market in Animal Health at $5 billion. So, I think if you're pretty much any of the large companies we compete with, they're all trying to come up with their own triple combination. So, I don't know that it's the same thing that's holding each of the companies back. I mean, we're not really clear. It definitely could be regulatory, it could be technical, it could be manufacturing CMC. We're not exactly clear. And to your point, there's really very few public companies who actually disclose much about their pipeline. So, our ability to know where people are is quite limited. We just -- and we always -- I know it's a little [Indiscernible] keep pushing it out. Sort of like 6 to 12 months from whenever you ask the question because we haven't seen it and we haven't heard it in corporate accounts and they're negotiating with us, we think it's definitely another 3 -- every quarterly with another 3 plus months out. And that's really where some of our back comes from. And yes, we are confident that even if you'll see, we are planning on competition in these key products, but I think that it's the strength and diversity of our pipeline globally that makes us confident we can continue to grow above market. We've got diagnostics, we've got pain mAb. We still think you're going to be growing in [Indiscernible] to be honest with you, it's still a lot of unmet medical needs, so yes, we remain confident that we can grow above the market even if we do start to face competition in some of these key franchises. Operator : And we'll take a follow-up from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi, thank you for the follow-up. And just a question on DRAXXIN, I mean, [Indiscernible] in detail, but I know that you've got approval for DRAXXIN KP in July, probably launches some time in Q3. So, a lot of expectations from the KPs [Indiscernible] ensure that the market stays flat or is this go for this to [Indiscernible] growth? And secondly, on the same, it seemed that 'til now [Indiscernible] launched January versions. You call out a couple of more generates. Any more are you expecting next year? Thank you. Kristin Peck : Sure. DRAXXIN KP was part of our defense strategy. I don't think it's going to restart growth for us necessarily to market as we're seeing generic competition, but it is as Wetteny outlined in his remarks at the beginning of this call. It's helped us retain our share. It provides incremental innovation and incremental benefit to our customers and a reason, obviously, to stay with that. Yes, we have had in the US two competitor s so far. We've heard up to three more are potentially coming. I don't know why they haven't -- we would've expected them this year, so their approval -- whether or not they actually entered the market, we're not really --we not sure when and if on that, but we would've said we probably have a few more entering. Operator : It appears we have no further questions. I'll return the floor to Kristin Peck for closing remarks. Kristin Peck : Great. Look, thank you everyone for your questions today and for your continued interest in Zoetis. Just to summarize, I think we delivered another strong quarter of results driven by our diverse global portfolio and strength in Petcare parasiticides and dermatology products. We are raising our guidance for the full-year 2021 and we remain on track for a record-setting year for us. And we're continuing to invest in the areas to support our long-term growth. And we remain confident in the fundamental growth drivers for animal health and for Zoetis into 2022 and beyond. So, thanks so much for joining us today. Have a great day. Operator : This will conclude today's program. Thanks for your participation. You may now disconnect.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,022
| 1
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2022Q1
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2021Q4
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2022-02-15
| 4.51
| 4.65
| 5.078
| 5.18
| 8.05834
| 41.73
| 44.8
|
Operator : Welcome to the Fourth Quarter and Full Year 2021 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 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. Steve Frank : Thank you, Catherine. Good morning, everyone and welcome to the Zoetis fourth quarter and full year 2021 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 statement 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 filings dated today, Tuesday, February 15, 2022. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve and welcome everyone to our year end earnings call for 2021. I am happy to report that Zoetis delivered its strongest performance ever in 2021, thanks to our innovative, diverse and durable portfolio and the talent and commitment of our colleagues. We grew revenue 15% operationally, which is once again above the anticipated growth rate for the animal health market. And these results were highlighted by 27% operational growth in our companion animal portfolio with 1% operational growth in livestock. Our parasiticide dermatology vaccines, diagnostics and monoclonal antibody therapies all contributed to these strong results driven by the positive trends in pet care, trends that we see continuing to be a key growth driver in 2022 and beyond. From a segment perspective, we saw solid balance across our global footprint with the U.S. up 14% and international growing 17% operationally. Operationally, for the year, China grew 25%, Brazil grew 28% and other emerging markets grew 22%, leading the way for our international performance. Another major growth driver for the year has been our global diagnostics portfolio, which grew 21% operationally with significant strength in international markets and the continued launch of VetScan Imagyst, our AI-driven diagnostics platform. Based on the strong revenue performance, we were able to deliver 19% operational growth in adjusted net income for the year, while investing significantly in our latest product launches as well as staffing, R&D and manufacturing projects for future growth. Looking ahead, we believe this momentum sets us up well for 2022. We expect to continue growing revenue faster than the market in the coming year driven by continued strength in pet care, expansion of our diagnostics portfolio internationally as significant growth in both companion animal and livestock product sales for emerging markets, including China and Brazil. As a result, we are guiding to full year operational growth of 9% to 11% in revenue. Wetteny and I will discuss more details about the full year 2022 guidance. But let me share some views on the year and other updates. First, the essential nature of animal health continues to be affirmed by our performance during the COVID-19 pandemic. We have seen the fundamental drivers such as increased emphasis on pet wellness, a growing global population and continuous consumption of animal-based proteins all reinforce the animal health industry as a positive investment choice. In terms of the companion animal market, people’s commitment to the health and well-being of their pets has continued to drive higher spending and new opportunities for innovation, geographic expansion and increasing levels of care. Pet owners spending in animal health remains one of the more durable trends in consumer spending as people place a premium on the health and well-being of their pets, even during challenging economic times. In January, the Human Animal Bond Research Institute and Zoetis released the results of a new global survey of more than 16,000 pet owners and 1,200 small animal clinics, which reinforce how deep the connection is between pets and pet owners and how that dynamic relates to views on veterinary care and the related benefits of pet ownership. In the study, 92% of respondents said there was no reason they could ever be convinced to give up their pets and 86% said they would pay whatever it takes if their pet needed extensive veterinary care. The strength of the human animal bonds strongly correlated with higher rates of veterinary treatment for both preventative care and specific conditions in their pets. This study and other research support our focus on advancing an innovative pipeline for pain, dermatology and parasiticides for pets and we continue to invest in our field force, direct-to-consumer marketing and manufacturing capacity to bring these products to market. Moving on to the livestock industry, the need for safe and reliable sources of animal protein continues to be a fundamental growth driver for the industry, particularly in emerging markets. In any given year, weather, disease and market dynamics may have various regional impacts, but the underlying demand continues to be served locally or through global trade across more than 100 markets, where Zoetis products are sold. We have continued to see Zoetis’ livestock business show modest growth during the pandemic and recent economic challenges based on our strength internationally. We see that international growth continuing this year, while we continue to see declines in the U.S. driven primarily by generic competition in certain product lines. Our competitive strategies in pricing and new lifecycle innovations will help us mitigate some of that impact. Livestock products are a key element of our global strategy and long-term growth and we have continued to expand our vaccine product lines like Poulvac Procerta for poultry and Alpha Ject Micro for fish as well as DRAXXIN KP as a treatment for cattle. We are also exploring more livestock innovations around greater efficiency, precision animal health and more sustainable food production. We have been focusing on our investments in vaccines for prevention and maintaining healthy animals, data analytics for more individualized animal care and research into other sustainability improvements around immunotherapies. I was particularly excited by two recently announced additions to our precision animal health portfolio, Performance Ranch, a new cloud-based cow-calf management software this simplified tracking of individual animal performance and health product usage and our new block yard platform, which is blockchain technology developed in cooperation with IBM to provide a secure way to share information across different segments of the animal production supply chain. For Zoetis, we continue to stay focused on our five strategic priorities for the long-term and we are optimistic about the growth drivers we see for 2022. Pet care will remain a major growth driver for Zoetis globally based on our diverse and innovative portfolio. We see continued growth potential for our dermatology portfolio, which surpassed $1 billion in revenue for the first time in 2021. Our parasiticide driven by our triple combination, Simparica Trio as well as Revolution Plus, Stronghold Plus, Simparica and ProHeart 12 will continue to achieve growth as we gain market share in major markets and look at further lifecycle innovations and label gains across the portfolio. Librela and Solensia, our monoclonal antibodies for control of osteoarthritis pain in dogs and cats will continue to increase their revenue in 2022, primarily in the EU and we are making regulatory progress for these products in the U.S. We received FDA approval for Solensia in January with the launch expected in the second half of the year and we still anticipate approval of Librela in the second half of the year, assuming FDA inspections are completed at a facility outside the U.S. As we begin 2022, we are seeing strong demand in the EU for Librela and Solensia and we remain confident in the blockbuster potential for Librela in 2022 and Solensia in the longer term. We continue to optimize our global supply chain and manage ongoing challenges, which have been creating isolated constraints for Librela, Solensia and some of our other products. As always, maintaining a consistent reliable supply for our customers is our top priority and we have been communicating with them about any impacts to their orders. We want to ensure all pets can continue their treatments without interruption, especially for chronic treatment of OA pain. Our global manufacturing network is working around the clock to ensure reliable supply for our customers as they did throughout 2021 and our full year guidance and strong growth reflects our views on supply. Diagnostics is our next major growth driver in 2022 with a fully integrated point-of-care business that is prime for strong growth internationally, along with the expansion plans for relatively new reference lab operations. We are making significant progress in one of the fastest growing markets for animal health. We are adding more dedicated field force and customer service resources, while developing more offerings that will leverage our portfolio across the continuum of care. And finally, we see significant growth opportunities in emerging markets, including China and Brazil, where we see excellent opportunities for both our companion animal and livestock products based on increased medicalization and other positive trends. Meanwhile, our R&D team, along with external partners, will continue to generate the industry’s most productive pipeline in the years to come, with more than $500 million in R&D spending in 2021 our largest ever annual investment for R&D. We continue progressing research to address allergies, livestock health, chronic pain and inflammation, chronic kidney disease and diagnostics through our vaccines, therapeutics and digital technology platforms. In conclusion, I want to thank our colleagues for delivering another terrific year and for always bringing the value of Zoetis to our customers, everyday. Zoetis remains well-positioned in terms of our market leadership, financial strength, investment strategies and diverse portfolio to deliver sustainable growth to investors in 2022 and beyond. Now, let me hand things off to Wetteny. Wetteny Joseph : Thank you, Kristin and good morning everyone. 2021 was an exceptional year for us with revenue of $7.8 billion and adjusted net income of $2.2 billion both exceeding the high end of our November full year guidance range. Full year revenue grew 16% on a reported basis and 15% operationally with adjusted net income increasing 21% on a reported basis and 19% operationally. Looking deeper into the 2021 numbers, price contributed 1% to full year operational revenue growth, with volume contributing 14%. Volume growth consisted of 6% from other inline products, 5% from new products, including Simparica Trio and 3% from key dermatology products. Revenue growth was again broad-based with the U.S. growing 14% and international growing 17% operationally. Our strong performance was driven by our innovative, diverse and durable companion animal portfolio, which grew 27% operationally. Our livestock business, which faced generic competition on key franchises as well as challenging macro conditions in certain markets, grew 1% operationally on a year-over-year basis. Performance in companion animal was led by our small animal parasiticide portfolio bolstered by full year sales of Simparica Trio, which generated revenue of $425 million, an increase of $305 million compared to 2020 sales. Sales of Simparica also grew double-digits for the year, with operational revenue growth of 13%. For the year, the Simparica franchise grew 82% operationally, with revenue of approximately $0.75 billion. Our key dermatology products performed incredibly well, growing 24% operationally with approximately $1.2 billion in revenue for the year, performing above our expectations. Our diagnostics portfolio grew 21% operationally in the year, with strong contributions from our U.S. and international segments and we will continue to make meaningful investments in the coming years to drive global growth. We do believe the adoption of diagnostics products and services outside the U.S. represents larger growth opportunities geographically and feel we are favorably positioned to capture future growth in those markets. Our livestock performance in 2021 depicts the importance of geographical diversification. Generic competition and challenging market conditions weighed on our U.S. performance, but were offset by solid growth internationally, primarily in emerging markets. The modest livestock growth on a global basis was in line with our expectations for the year. Moving on to our Q4 financial results, we posted another strong quarter, with revenue of $2 billion, representing an increase of 9% on both a reported and operational basis. Adjusted net income of $474 million is an increase of 8% on a reported basis and 5% operationally, of the 9% operational revenue growth, 1% from price and 8% from volume. Volume growth of 8% consisted of 5% from new products, which includes Simparica Trio, 2% from key dermatology products and 1% from other inline products. Companion animal products led the way in terms of [indiscernible] growth, growing 21% operationally, with livestock 6% on an operational basis in the quarter. Small animal parasiticides were the largest contributor to growth in the quarter, where our innovative and diverse fleet, tick and heartworm portfolio grew 32% operationally. Simparica Trio posted revenue of $124 million, representing operational growth of 106% versus the comparable 2020 period and the third consecutive quarter with sales exceeding $100 million. Meanwhile, our key dermatology products, Apoquel and Cytopoint, again, had significant global growth in the quarter, with $360 million of revenue, representing 23% operational growth against a robust prior year in which key derm grew 27% in the fourth quarter of 2020. Our livestock business declined 6% in the quarter as a result of generic competition for DRAXXIN on favorable market conditions in the U.S., primarily resulting from elevated input costs as well as softer conditions in China, losses driven by reduced pork prices. Our fish business grew double-digits in the quarter and along with the strength of our emerging markets, partially offset the broader decline. Overall, livestock performance in the fourth quarter was in line with our expectations. Now, moving on to revenue growth by segment for the quarter, U.S. revenue grew 9%, with companion animal products growing 20% and livestock sales declining by 13%. U.S. pet care vet practice trends remained robust in Q4, with practice revenue growing approximately 8% with visits growing 3% despite challenging prior year comps. Companion animal growth in the quarter was driven by sales from our Simparica franchise as well as key dermatology products. We are driving growth in both therapeutic areas by making meaningful investments, primarily through direct-to-consumer advertising and field force and we continue to be pleased by the return on investment the programs are yielding. Growth of Simparica Trio was again strong in the quarter, with sales of $114 million growing more than 100%. We also met our clean penetration target and continued to take share within the clinics. Key dermatology sales were $216 million for the quarter, growing 22% with Apoquel and Cytopoint each growing significantly. Our investments to support the franchise have been instrumental in driving more patients into the clinic and we will continue to invest meaningfully in this space as the large portion of dogs with dermatitis remain untreated, representing an opportunity to further expand the market. U.S. livestock fell 13% in the quarter, primarily resulting from our cattle business, which as expected, was challenged by generic competition for DRAXXIN as well as elevated input costs continuing to weigh on producer profitability. Our poultry business was negatively affected by reduced disease pressure from smaller flock sizes as well as generic competition, while swine faced competitive pricing pressure on anti-infectives and vaccine products. Moving on to our international segment, where revenue grew 8% on a reported and operational basis in the quarter. Companion animal revenue grew 23% operationally and livestock revenue declined 2% operationally. Increased sales of companion animal products resulted from growth of our key dermatology products, our monoclonal antibodies for alleviation of OA pain and our parasiticide portfolio. Several key brands are benefiting from our international DTC campaigns in Latin America and parts of Europe and we remain excited with the long-term prospects of these programs. Overall, companion animal grew double-digits operationally in every major market in the quarter. We are encouraged by the performance of our monoclonal antibodies for OA pain, with Librela generating $15 million and Solensia delivering $3 million in fourth quarter sales. In the fourth quarter, Librela became the number one pain product in the EU in its first year, with the underlying performance metrics being very favorable for future growth. Reordering rates were in excess of 90% and compliance rates exceeded our initial expectations. In the past, we have highlighted the significant opportunity to expand the pain market. Therefore, we were extremely pleased to see approximately 40% of Librela and Solensia sales or from patients receiving medication for the first time. International livestock declined 2% operationally in the quarter as declines in cattle and swine were partially offset by growth in fish and poultry. Cattle declines were largely in the EU and Canada as generic competition for DRAXXIN weighed on sales. The decline in swine sales was primarily the result of lower pork prices in China negatively impacting producer profitability. Our fish portfolio grew double-digits again this quarter driven primarily by growth of Alpha Flux in Chile and the growth in poultry was largely attributed to further key account penetration. Now, moving on to the rest of the P&L for the quarter, adjusted gross margin of 69.6% increased 190 basis points on a reported basis compared to the prior year resulted from favorable product mix, lower inventory charges, favorable FX and price. This was partially offset by higher freight, manufacturing and other costs. Adjusted operating expenses increased 12% operationally with compensation-related costs being the primary driver of the 15% operational increase in SG&A as well as 3% operational increase in R&D expenses. Increased international advertising and promotion expense for key brands also contributed to higher SG&A, while R&D had increased project spend in the quarter. The adjusted effective tax rate for the quarter was 18.6%, an increase of 510 basis points, driven by the impact of prior year discrete tax benefits and changes to the jurisdictional mix of earnings. And finally, adjusted net income grew 5% operationally and adjusted diluted EPS grew 6% operationally for the quarter. In December, we announced a 30% annual dividend increase continuing our commitment to grow our dividend at or faster than the growth in adjusted net income. In the quarter, we repurchased approximately $200 million of Zoetis shares and announced the authorization of a $3.5 billion multiyear share repurchase program. Because we generate significant free cash flow, we have the ability to grow our business through organic investments and business development and return excess cash to shareholders without consuming our cash balance or being dependent on elevated leverage. Now moving on to guidance for 2022, please note that guidance reflects foreign exchange rates as of late January. We are expecting an unfavorable foreign exchange impact versus prior year by approximately $160 million on revenue, which is roughly 200 basis points and approximately $0.12 on EPS, which is about 250 basis points. For 2022, we are projecting revenue between $8.325 billion and $8.475 billion, representing 9% to 11% operational growth. We again expect companion animal to be the primary growth driver in 2022 with the continued strength of our diverse parasiticide portfolio, further expansion of our key dermatology products, the adoption of our monoclonal antibodies for OA pain and the growth in point-of-care diagnostics and reference labs. We see a very favorable companion animal backdrop for 2022 while expecting certain vet clinics trends to moderate over time we believe they will remain above pre-pandemic levels. The catalyst for growth in 2022 and beyond stem from a younger pet owner demographic and the standard of care increases, which took shape over the prior 2 years. Our innovative portfolio, geographic representation and significant investments in key brands have us positioned extremely well to capture a meaningful portion of that growth. We anticipate modest livestock growth again in 2022 led by the contributions of our emerging markets. The macro trends which makes livestock and essential business remain intact, and we believe more normalized growth will occur in 2023. I’d like to touch upon the key assumptions that underpin our expectations for revenue growth. Beginning with companion animal, we do not assume a triple combination product will launch in the U.S. in 2022 to compete against Simparica Trio or competitive entrants for our key dermatology products, Apoquel and Cytopoint. As Kristin mentioned, in 2022, we expect Librela to become a blockbuster product in the first full year of sales with revenue exceeding $100 million largely from the EU markets. We remain very optimistic about the potential of Solensia as well. While the revenue curve will have a different shape due to the lack of an established feline pain market, we review Solensia as a long-term blockbuster product, which suggested a significant unmet need in animal health. In livestock, we expect generic competition to negatively impact DRAXXIN revenue by approximately 20% in 2022 comparable to the impact we saw this year. For the remainder of the P&L, adjusted cost of sales as a percentage of revenue is expected to be approximately 29%, where favorable product mix and price are expected to generate margin expansion. Adjusted SG&A expenses for the year are expected to be between $2.07 billion and $2.12 billion with the increase from 2021 focused on supporting primary drivers of revenue growth, including investments to support new and existing products as well as diagnostics. Adjusted R&D expense for 2022 is expected to be between $540 million and $560 million. Zoetis is the leader in animal health because of the novel products, disruptive innovation and life cycle enhancements we bring to the market. Our internal R&D engine remains the primary source of innovation, and we are committed to ensuring it will continue to be significantly funded as a priority in capital allocation. Adjusted interest and other income inductions are expected to be approximately $240 million, representing a minimal year-over-year change. Our adjusted effective tax rate for 2022 is expected to be approximately 20%. The increase in 2022 is primarily related to the favorable impact of foreign derived intangible income and nonrecurring net discrete tax benefits that occurred in 2021. Adjusted net income is expected to be in the range of $2.415 billion to $2.470 billion, representing operational growth of 10% to 13%. Our guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. We are anticipating a significant increase in capital expenditures in 2022 primarily related to investments in manufacturing expansions in Ireland, the U.S. and China. Finally, we expect adjusted diluted EPS to be in the range of $5.09 to $5.19 and reported diluted EPS to be in the range of $4.75 to $4.87. While guidance represents our expectations for full year financials, I would like to provide some color on the expected phasing of growth in 2022. We expect top line growth to be fairly consistent between the first half and second half of the year. However, due to the impact of generic competition for DRAXXIN, isolated supply constraints and the continued weakness of our swine business in China, we expect growth in the first quarter of 2022 to be lower than the remaining three quarters. In addition, the significant investments we are making early in the year to support revenue growth, primarily in companion animal, including diagnostics, along with very challenging comparative periods for T&E and other expenses, will impact Q1 materially more than the subsequent quarters. Now to summarize, 2021 was another exceptional year, our best performing year with 15% operational revenue growth and 19% operational growth in adjusted net income. Our guidance for 2022 reflects the strength of our innovative portfolio, our ability to successfully launch new products and establish new markets and our confidence in the end market dynamics for the spaces we compete in. Now I’ll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We will go first to Louise Chen with Cantor Fitzgerald. Your line is open. Louise Chen : Hi. Congratulations on the quarter and thanks for taking my question. So you’ve been very successful over the years in your R&D efforts. And where do you our next wave of innovation coming from? And is it going to be companion or livestock focused drugs or diagnostics? Thank you. Kristin Peck : Thanks, Louise. Good to hear from you. We are quite excited with regards to our pipeline. And I really think it is the innovative nature of Zoetis that has made us so successful. As you look at the pipeline, we’re excited about a number of areas, both across pet care and livestock. In pet care, continuing to innovate in the parasiticide space, it’s a $5 billion market. I think we can continue to bring innovation there, certainly, growing our osteoarthritis monoclonal antibodies for pain, Librela, Solensia continuing to innovate in the derm space. You saw us add Apoquel chewable in Europe, for example, there also leveraging that whole platform of monoclonal antibodies for other indications, we think is a big opportunity, really excited on diagnostics, the ability to continue to bring really disruptive innovation there. Certainly, our Imagyst platform and some of the new indications there is a great example. We also think taking a lot of our products and growing them in emerging markets will be valuable. And as you move into the livestock space, we’re excited about vector vaccines and poultry, vaccines in cattle and in swine and then really investing as well in our precision livestock farming and genetics portfolio. You probably saw we launched two new products there over the last few weeks. So we think there is significant innovation across both pet care and livestock and believe we have strong platforms in R&D for growth, investing over $500 million in R&D. Operator : We will take the next question from Mike Ryskin with Bank of America. Your line is open. Mike Ryskin : Great. Thanks for taking the question and congrats on the quarter and strong guide. Just to start, I know you touched on this in the prepared remarks, but I have to ask a follow-up on the Trio competition. We heard from one of your competitors that they may be closer than that. So even though you don’t expect competition and it’s not built into your assumptions for 2022, how would you react if you did see it? How would your assumptions be impacted? And how do you think you would adjust pricing or go-to-market? Sort of how would you see a flow through? And if I could ask just a quick follow-up to that, on pricing in general across the portfolio, what are your expectations for 2022? Are you going to be able to take more price, less price? Obviously, there is an inflationary environment. You have to think about livestock versus companion differently. So could you just talk us through your assumptions on price across the portfolio? Wetteny Joseph : Yes. So let me take that first. With respect to Trio, we continue to be very pleased with the performance of Trio and really the entire Simparica franchise. When you look at Trio, we delivered $124 million of revenue in the quarter. When you look across the franchise, we continue to see really strong growth. For the year, the franchise grew 82% across the board, so very pleased with that. And we’re putting significant investments behind the product and across Simparica as well in markets where you don’t see heartworm being prevalent. And so we’ve seen Simparica grow 13% on the year. And so we continue to make those investments in our field force as well as advertising and DTC campaigns across – our confidence is that we will continue to see growth even when this competitor is in this space. We have seen that in other cases where other products have come into the market. When you look at the fleet tick heartworm market, it’s the biggest market within animal health with $5 billion, and there are other products in the space that have better sizes of $800 million-plus. So as we look here, we continue to see more headroom to continue to grow this brand and this franchise even when there is competition. When I look at price, we delivered 1% of growth in price net in 2021. And we’re probably looking at about the same sort of range when we think about 2022. You have to keep in mind while we see opportunities to take price across the board, particularly in companion animal and behind our innovative brands and seeing really strong demand in the end markets. We will continue to pull that lever. In terms of what’s going the other way, as you’re aware, DRAXXIN is one with competitive – generic competition there with respect to that as well as Zoamix in BMD, we’ve seen that sort of partially offset, I would say, but we still delivered a net price increase in 2021 and we believe even as we look to offset inflation as we have done in 2021, we will have the opportunity to do that. We do look at price on a market-by-market and SKU-by-SKU basis. And so we deliberated about where we can be more aggressive, and we will take those opportunities as we go through. Operator : We will take the next question from Nathan Rich with Goldman Sachs. Your line is open. Nathan Rich : Hi, good morning. Thanks for the questions. I had two on Librela. Kristin, I think you said you expect Librela to be a blockbuster in ‘22. What have you seen with respect prescribing patterns for vets that have started to use the product? I mean has this displaced other products? Or are vets just diagnosing OA more? And can – and does the guidance for it being a blockbuster in ‘22 assume a U.S. launch? And then just as a quick follow-up to that, could you just go into more detail on the supply disruption that you mentioned for Librela? Is it an API issue or a factory issue? Just any more details that you could share there, that would be great. Thank you. Kristin Peck : Sure. Sure. Thanks, Nathan. We are very excited at the trends we’re seeing in Librela in Europe. For starters, it is now the number one selling OA pain product in Europe, which is pretty incredible given it wasn’t even a full year in Europe. And what’s really exciting about that is we’re seeing 40% of the prescriptions of pets that are new to the category. So I think for a lot of pet owners who are worried about safety or efficacy of the previous portfolios, they really see this as really a game changer. And the people who have been on it, we’ve seen a 90% reorder rate from clinics and very high compliance. So once they are on it, really staying with it, which gives us great confidence as we look into 2022 that we can get Librela to be a blockbuster product. To your question about, does that assume a U.S. launch, it definitively does not assume a U.S. launch. We would not – with an approval late in the year, we would not be able to launch Librela in 2022. So that would hit blockbuster status just outside of the U.S. And as you look at some of the supply challenges, the inputs to Librela are the same inputs as you would make a human COVID vaccine. So we’ve been really thoughtful about where we launch and making sure we do market by market, ensure we can supply. We have had challenges intermittently just having to do with the fact that the inputs are the same. So I think our supply chain team has done a phenomenal job. I mean, as a matter of fact, we’re already the number one selling in OA pain, but we are really thoughtful about where we’re launching. A lot of those are getting addressed. The capacity and a lot of those component parts in human health have increased. So we become more confident every quarter we can do that. But that is what was driving some of the short-term intermittent supply challenges we had in Europe. But I think if you look at our obvious guidance for this year, we can clearly see if we’re going to hit $100 million that we’re pretty confident we can address those. Wetteny Joseph : Yes. And I would just add with Librela in the fourth quarter, we were deliberate about holding back even new patients coming on. We just want to make sure that we can secure the inputs so that when it all comes on, they can stay on given that it’s chronic OA pain conditions. So – and we’ve been able to secure materials and be able to run, and we’re confident in in our forecasted demand here to be able to manufacture and deliver those. Operator : The next question comes from Erin Wright with Morgan Stanley. Your line is open. Erin Wright : Great, thanks. A question on the monoclonal antibody, can you speak to the pipeline outside of Solensia? And you have significant capacity there and you’ve entered multiple partnerships, including [indiscernible] products. How would you think about the targets there and the time line? And what’s next on that front? Do you see several monoclonal antibody launches for you over the next 3 to 5 years? And then on diagnostics, you mentioned increased focus internationally. And can you speak to how that strategy is progressing, I guess, both in the U.S. and internationally for reference lab as well as on point of care. And is international reference lab also on your radar screen? Thanks. Kristin Peck : Thanks, Erin. Yes, if you look at the monoclonal antibody platform, we do see this very much as a platform for growth with Librela and Solensia being the second and third. As you know, we also have a Cytopoint. We are the only one with any monoclonal antibodies approved right now. So I do think we have a good head start. We do see this similar to what you see in human health with application across a number of diseases. So we have not been terribly public about that pipeline. I think we’ve talked about a few such as chronic kidney disease, etcetera. But obviously, in our world, our pipelines are not public, but we are very excited. We have invested in building significant capacity across monoclonal antibodies both in the U.S. and outside the U.S. in multiple facilities just given our excitement on the fact that this is a really important space. We do have a number of partnerships with human health companies and even some small animal health companies in this space. So we’re really excited at the pipeline and believe we can continue to launch new products, new mAbs over time. And I will let Wetteny take the diagnostic question. Wetteny Joseph : Yes, we continue to be very excited about the diagnostics space with growth above the animal health space in general. If you look at 2021, we delivered 21% growth in diagnostics across the year and particularly when you look at – although we grew both across U.S. and international. And we’ve always said that international was the more level playing field where we look to be aggressive and we continue to make investments across field force, reference labs, etcetera, here. You’ve seen us innovate in this space with Imagyst, the first AI platform with – indication. We look at additional indications coming on there as well. And so we will continue to make those investments, and diagnostics is one of our key growth drivers as we look ahead. Operator : We will go now to Jon Block with Stifel. Your line is open. Jon Block : Thanks, guys. Good morning. It seems like you’re implying 2022 companion animal growth, roughly mid to high teens, a very solid growth rate. Maybe I can just put you guys a little bit on some of the key products, any specifics for Trio when we think about 2022 or call the Simparica franchise and/or the atopic derm franchise just maybe in terms of contribution to growth? And then a little bit of a follow-up. Those Librela – certainly the Librela numbers are really solid international numbers, add the gate where the medicalization rates are usually a lot lower. So Kristin, can you just comment, does this still hold where, longer term, this is still like a 70-30 U.S. international split in terms of revenue from those novel therapeutics when we look out a number of years? Thanks, guys. Kristin Peck : Sure. I will start with your second question on just Librela, Solensia and international. They are solid. Look, we are really focused on increasing the medicalization and the adoption of new technologies outside the U.S. I think it’s been a key focus for Glenn David since he has moved into the international group. I mean as you know, there is a very similar number of animals in the U.S. and outside the U.S. And to your point, historically, the revenue splits have been quite different. But we are really looking at, especially in categories right now where we are the only product out there, derm is one, but even monoclonal OA pain, really thinking of unbranded, really seeing we can raise the standard of care, it’s a key focus for us as well on the diagnostics space, how we increase medicalization outside the U.S. I think it will evolve over time. And I am not sure when it gets to the equal number of animals. But really why we feel we have a lot of optimism international, if you think about some of the emerging markets, where they are adopting new technologies, and that curve is quite different. So, if you look at the increase in China, Brazil, across a number of emerging markets, they are really moving up that curve much, much more quickly. And we also see our belief that we can continue to do that in some of the key categories. And to your point and your first question, we continue to see growth potential in derm. We do not expect a competitor in 2022 in derm. Again, I don’t have any data, but you always ask me, why do I leave that, I mean based on just what I know today, we could obviously be wrong. So, we are going to invest aggressively as we have been doing in direct-to-consumer. We still believe there are 6 million untreated dogs in the U.S. alone who have itch and don’t have treatment. And if you saw the growth that we delivered in 2021 across derm, it’s 24% growth and already at over $1 billion, we still see growth in derm. Certainly in paras, we are going to aggressively grow that portfolio through direct-to-consumer advertising amongst other things in 2022 to make sure we have the highest share as we enter. I think the brand equity there has been really strong. So, we continue to see significant opportunities as well in paras. So – and I think you also can add in emerging markets across all these continuing to do really well. So, as we look at growth, obviously, growth will be led, as you referenced by our companion animal business in 2022. And I think what’s important is there is not one key platform that’s driving that. It is multiple. It is derm, it is paras, it is diagnostics, it’s mAbs, it’s emerging markets. So, we do think we have a range of platforms to continue to grow in 2022 and beyond. Operator : We will go now to Chris Schott with JPMorgan. Chris Schott : Great. Thanks so much for the questions. Just a follow-up on Librela and capacity in the U.S. launch. I guess by the time that drug is approved later this year, do you expect some of these issues will be addressed by then, or should we be thinking about either a gap between approval and rollout or a more targeted rollout as you are dealing with capacity? I am just trying to get a sense of is this something that’s the next few quarters that you are going to be addressing most of this, or is this going to be an ongoing kind of challenge given the kind of broader capacity demands in the industry out there? And then the second question, I was – just maybe a longer term operating margin question. And the guidance implies moderating – moderate kind of operating margin improvements in ‘22. As I think about longer term, do you see kind of a sustained period where we are going to see OpEx growth that’s kind of keeping up with overall sales growth so that you are seeing some margin improvement but not a ton, or do we think about a window where there is maybe a larger margin improvement cycle coming as we maybe think out to 2023 and beyond as maybe some of these initial investments on derm, Trio, etcetera, kind of start to plateau at some point in here? Thanks so much. Wetteny Joseph : Yes, sure. Let me take both. So, going to your first question with respect to Librela, as we said in the prepared commentary, we continue to anticipate approval sometime late in 2022, that is hedging on an inspection that the FDA has to do at a facility outside the U.S. By the time this product gets approved and as we continue to leverage our global manufacturing footprint and our plans, we anticipate having the manufacturing capacity that we need to meet demand across the market. Now, we will certainly leverage our learnings from our launches outside the U.S. in terms of how we go about executing that with respect to early experience programs, etcetera. But at this point, we are confident in our ability to manufacture to meet customer commitments across that product when it gets approved. Now, going on to operating margins, as we have said, we see opportunity to really invest behind a number of areas to drive long-term sustainable growth. And we are doing so, whether you look at R&D, investments in our field force, for example, investments in advertising campaigns, DTC campaigns behind our brands that we can really drive growth in – particularly in areas where we have an advantage like being the only triple combination in the U.S. as we speak as well as in the derm area. As we do that, we will be aggressive, but we are mindful to grow the bottom line faster than the top line. And that may narrow the range that you see from time-to-time. But certainly, the business has the ability to continue to expand margins, and we have demonstrated that. But we are going to be aggressive about those opportunities when we see them, which may narrow that range. In terms of how long do we continue to see that, as long as we see the opportunity to continue to drive growth and grab more share, we will execute on those, but be mindful of that value proposition. Operator : We will go now to Balaji Prasad with Barclays. Your line is open. Balaji Prasad : Hi, good morning and congratulations on the quarter. Firstly, on the R&D pipeline, the innovations that you called out and the focus that you called out six, seven areas for innovation, I am not sure if I am reading too much into it, but I thought oncology pipeline was the same. I remember this being flagged as an important carrier in the past. Have you had a change of thought around oncology as a key area of innovation? And just on Librela, does your success in the first year drive you to revisit your thoughts around the longer term opportunity in the clinic pain market? You have called it out as a market which can potentially double over the next few years. Is there an upside risk to those numbers? Thank you. Kristin Peck : Sure. As we talk about the pipeline, certainly oncology is in there. We don’t get very specific with regards to that. I don’t believe we have ever said anything specific with regards to oncology historically. It’s certainly an area we are looking at, but I would say some of the other focus areas we talked about, we used to think in the near-term will likely drive more value. As you look at Librela, as the outlook changed. I mean we think that taking a $400 million market that’s been established for a long time in doubling it is pretty aggressive. We are – we probably have more conviction in our ability to do that is what I would say just based on the first two full quarters that we have launched the product outside the U.S. So more confidence there and more confidence as well that we can take what is almost like a nonexistent market in the cat for Solensia and make that a $200 million. So, I am not sure we are willing to say above that. I think doubling a market as a pretty aggressive timeline – pretty aggressive there. But I do think our commitment and our conviction and our ability to do that and do it faster, certainly, I would say, is strong. Operator : Our next question comes from Christine Rains with William Blair. Your line is open. Christine Rains : Hi, congratulations and good morning. I am just hoping to have some more color about the Solensia rollout in Europe and how that can translate into the U.S. So, just kind of how are you reaching cat owners given the low medicalization of cats and the fact that cat owners don’t really bring their cats into the vet very often? And also, is this a vet-administered product or something pet owners can do at home via injection? Thanks. Kristin Peck : Sure. The one thing we have done with Solensia was the learning from Cytopoint. Certainly, as you bring new technologies and create new markets, it starts with really with your KOLs. So our plan, as you probably saw in 2021, which was first start with early experience with some of the key opinion leaders in each of the markets to get them experience, to get them talking for general practitioners to be able to call them and sort of hear their experiences seeing videos. As you think about, you made a really good point you have seen with regards to pet owners. We are also trying to provide tools for pet owners to be able to know when their cat is in pain. Cats do a great job of hiding it. So, that’s really been a focus on videos to show them what it looks like, so they can sort of notice it, giving a big awareness campaign there and then helping vets understand how to make it easier for people to either bring their cats in or there is some now cat-only clinics or the ability to have vets go out and do injections or have technicians go out and do injections. We are not focused right now on having monoclonal antibodies being able to be done by consumers at their house. This is a pretty advanced technology. Our focus is really on helping to raise awareness, increase the medicalization and make treating these cats easier either at the clinic or at home. There is really no reason, for example, technician, once the vet that has seen it can’t do the monthly injection at home. So, we are just seeing really positive, but it takes a thoughtful creation of the market. And as I talked about before, that would be our plan in the U.S. as well. We will start with early experience, get that – get the KOLs talking, get things of able to be seeing multiple cats. And that really helps us, once you get in the GPs, ensure that they are using it and they know how to do it successfully. So, that is our plan as we think about it. Operator : We will take the next question from Elliot Wilbur with Raymond James. Your line is open. Elliot Wilbur : Thanks. Good morning. I guess just two questions for Kristin, specifically with respect to your outlook for the livestock segment in aggregate, anything you could say about growth expectations for the specific species and what – which of those may have more risk based on your current assumption than others? And then just switching gears to the international markets and specifically thinking about regions where you showed 20% plus or stronger growth, Chile, Italy, China, etcetera, can you just talk maybe a little bit more about the key drivers there? How much of the growth is coming from companion versus livestock? Which markets is the company over-performing? And what are the key drivers of that over-performance? Thanks. Kristin Peck : Sure. Thanks, Elliot. I will take the first, and I will let Wetteny take your second one on some of the specific international markets. As we talk about livestock, first of all, it has been hit much harder with COVID than the pet care space. Pet care has actually been a beneficiary of COVID. And it’s, by its nature, a cyclical industry. So, it can go up and go down. Ultimately, we believe as you look at sort of once we get past the DRAXXIN and some of the other big product LOEs, it will go back to mid-single digit growth. But if you double-click that a little way, obviously, the biggest challenge for us specifically has been cattle, and that’s really been led by DRAXXIN, which overall last year declined by 15%, which was in line with our expectations. We expect in 2022 to have a 20% decline as we had a full year with generic competition there. But there is a lot of bright spots as you look at different species to your point. You look at fish, they grew 23% in 2021. We see that as a fast-growing species with really positive fundamentals. We think poultry, which grew last year 6%, maybe a little bit more challenged, obviously, in the U.S. with some of the generic competition there. But we are really excited about some of the innovative things that we are launching there. We saw swine last year at 4%. So, livestock is not one, as you know, and it obviously varies by market. And I think it’s important to sort of note as you look at international, it was growing in livestock significantly last year. So, if you really pull out the DRAXXIN effect. As we look at livestock, we do believe it will go back to, for us and for the industry, mid-single digits. For us, we have just got to get out of some of these near-term LOEs. We are also excited about our pipeline there, which we think, again, can drive incremental growth above the market as we launch innovation into that sector. So, I don’t know, Wetteny, you want to take some of the specifics on the international markets, emerging markets, Brazil, China. Wetteny Joseph : Yes, absolutely. Look, one of the most remarkable things, at least in my first year here, that I have come to realize is what we are seeing in terms of trends on companion animal not just in the U.S., but we are seeing them across the emerging markets. Now if you step back, international is still about just over 50% of our international revenues, our livestock and companion animal is about just over 40%. However, the pace of growth that we are seeing across markets, I am comparing absolutely phenomenal. Markets like China that used to be mostly livestock is now about 50% companion animal. And elsewhere, even when we talk about Brazil, we are seeing a really great year across cattle, etcetera. Brazil is growing double digits in companion animal. So, we believe those trends – those same reasons that are driving growth for companion animal, where pet owners prioritize the health of their pets and are willing to spend more on them, we are seeing those across international markets and we see those outpacing growth versus livestock, although we have seen livestock growth in international markets, as Kristin mentioned. It was 8% growth in livestock in 2021 across our international markets. And if you look at species, fish, for example, is 100% of our fish business is outside the U.S. So, that’s one area of growth that we anticipate as well. So hopefully, that gives you some color looking across international. Operator : The next question comes from Navann Ty with Citi. Your line is open. Navann Ty : Hi, good morning. Could you discuss your expectation on vet staffing in the near-term and the potential impact on Zoetis Companion Animal segment, if any? And then I have a second question on Simparica Trio. Can you give us more details on the label expansion, how significant could be the new indications? Thank you. Kristin Peck : Thanks so much. I will start with the vet staffing. They are sort of short-term and long-term. We did see something challenges in the U.S. in December and January, given absenteeism with COVID, and that was sort of short-term. So, as you look at trends overall in the U.S., we continue to see those to be strong with 8% revenue growth led by a 3% increase in traffic and spend per visit at 5%. Double clicking on that traffic 3%, we think, again, it will get back to sort of what are our more normal trends. There has been a challenge, as you mentioned, given there are so many more pets being seen, making sure that the staffing levels at both the vets and the technicians side remain strong. We are really focused on partnering with both the ADMA and the ADMC in the U.S. and honestly, around the globe to ensure there is a reliable supply of vets and vet technicians. But importantly as well, to make sure that the veterinary profession and vet clinics remain really attractive jobs, and so it’s really partnering with different organizations to make sure that, that is the case. I would say everyone is aligned here. I think you are seeing significant increases in compensation for many of these vets. We firmly believe that they are doing the right things to make sure that they can provide the great customer care and pet care that they need to. But obviously, it’s something that we are highly invested in partnering across the industry to make sure that pets get the care that they need and the staffing levels remain high. It is a challenge given the very quick growth in the number of pets that were adopted over the last 2 years. So, the challenge is there, but we are really confident that in partnership with many other companies, pharmaceutical companies as well as vet clinics and associations, we can ensure that the vets and the vet technicians can meet that need. Do you want to – there is a question on Trio label extensions in the future. I don’t think we have been specific about what we are looking at there and we wouldn’t just for competitive reasons. Operator : The next question comes from Kathy Miner with Cowen. Your line is open. Kathy Miner : Hi. Thank you. Just a couple of follow-up questions. First on Solensia and the U.S. launch, can you just clarify that the launch in the second half of this year is just a setup for getting education and preparation as opposed to any supply issues? And will you be coordinating the marketing with Librela in the U.S. once it gets approved? Second question, just to follow-up on the derm side of it, for 2022, I don’t think you said a growth target, but clearly, you have got to be pretty optimistic with no competition coming in for this year. Do you think that you could see growth get – matching the 2021 trends? And do your assumptions for the derm include a U.S. chewable or any feline options? Thank you. Kristin Peck : Sure. So, with regards to Solensia, yes, we are focused when we think about the long-term to ensure that we start with early experience. We build that market, and we will obviously launch shortly thereafter. But we are not concerned there on a supply issue. The plans that we have assume supply for exactly what we are planning on doing. So, that is not what’s driving that one. And derm in 2022, we continue to expect robust growth obviously with – right now, as we talked about, we are not expecting competition next year, of course, we could be wrong, but we are not. And therefore, we will invest aggressively, not just in the U.S., but outside the U.S. That does not, to your question, assume that we have Apoquel chewable in the U.S. and nor does that number that we are talking about in derm assume that we are having it for cat. So, we really believe with Apoquel, Cytopoint, Apoquel chewable outside the U.S., we can continue to drive robust growth in 2022 across the category. Operator : This will conclude our Q&A session. It is now my pleasure to hand the program back to Kristin Peck for any additional or closing remarks. Kristin Peck : Great. Look, thank you, everyone, for your questions and your continued interest in Zoetis. Just to summarize, I am really proud of what Zoetis delivered in 2021, having our best year ever. And we see that positive momentum really continuing into 2022, as I think you heard today from both Wetteny and myself, we will continue to build on our diverse global portfolio and really our strength in pet care, diagnostics and emerging markets to grow faster than the market in 2022 and beyond. And we are committed to the investments in talent, technology, manufacturing and innovation that will spur our future growth. So, thanks so much, everybody, and talk to you soon. Operator : This does conclude today’s program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,022
| 2
|
2022Q2
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2022Q1
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2022-05-05
| 4.734
| 4.818
| 5.266
| 5.342
| 8.18442
| 38.73
| 35.92
|
Operator : Welcome to the First 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. 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 is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis first 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 reports 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 5, 2022. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and welcome, everyone, to our first quarter earnings call for 2022. Zoetis delivered a strong quarter to start the year with 9% operational revenue growth and 8% operational growth in adjusted net income driven by the strength of our companion animal portfolio. We generated similar growth for both the U.S. and international segments, with 9% and 8% operational growth, respectively. Our strength across parasiticides, dermatology products, monoclonal antibodies and diagnostics are all capitalizing on the marriage of positive trends in pet care with customer-driven science coming from Zoetis. In the first quarter, we grew 20% operationally in our companion animal portfolio. As we expected, our livestock portfolio continued to face challenges, declining 6% operationally in the quarter largely due to declines in swine product sales in China and generic competition from DRAXXIN. As we look at the rest of the year, we are updating our guidance to reflect the negative impact of recent changes in foreign exchange rates, but this has no impact on our previous operational growth rates and assumptions for the year, even as we face uncertainties related to the war in Ukraine, COVID-19 lockdowns, inflation and ongoing supply chain constraints, we remain confident in the underlying strength and performance of our business. Our diverse portfolio, global scale, talented colleagues and continuous innovations remain the foundation of our long-term success and durability, and we continue to invest in the resources, marketing programs and manufacturing capacity we need to support our growth. In R&D, we're building new capabilities and pipeline across our companion animal and livestock portfolios to ensure our long-term performance. In the first quarter, we continued to receive approvals for new products and indications, develop life cycle innovations for major brands and expand our portfolio into new markets. On the livestock side of the business, we expanded our cattle vaccine portfolio with an approval in the U.S. of Protiviti, the first modified live vaccine to offer protection against mycoplasma Bovis. This vaccine provides cattle producers and veterinarians with broader overall protection against bovine respiratory disease. We also gained approval in Brazil for Draxxin KP, which is also a treatment for BRD and combines the antimicrobial properties of DRAXXIN with the nonsteroidal anti-inflammatory ketoprofen to rapidly reduce fever in a single dose. Draxxin KP is also approved in the U.S., Canada and European Union, Australia and Mexico, and it has been an important part of how we continue to distinguish the DRAXXIN brand in the face of generic competition. In poultry, we received approval in Brazil for Poulvac® Procerta™ HVT-IBD, our recombinant vector vaccine that is also approved in the U.S. and Canada. On the companion animal side of the business, we received another approval for Solensia, the industry's first monoclonal antibody for osteoarthritis pain in cats, adding Australia to the U.S., European Union, U.K., Canada and Switzerland and another mAb therapy, Cytopoint, received a claim extension in Canada so it now covers both the treatment of atopic dermatitis and allergic dermatitis in dogs. Cytopoint and Apoquel continue to grow significantly and expand the dermatology market as disease awareness and treatment options become more known to pet owners. We have a strong leadership position based on our innovative science and do not believe competing products will come to market in 2022. We also continue building our multipurpose diagnostics platform, Vetscan images with the recent addition of blood smear testing. Introduced in September 2020, Vetscan images is a first-of-its-kind technology with a multitude of applications, including AI fecal analysis, digital cytology image transfer and now AI Blood smear, all helping veterinarians broaden their in-clinic diagnostic offerings to provide the best care possible for dogs and cats. For the last two years, I've been speaking to you about our catalyst for growth, and those continue to drive our performance. Our outlook for growth in international markets remains very positive based on a diverse global footprint and continued expansion opportunities for key brands like Simparica Trio, Apoquel, Cytopoint, Librela and Solensia. In terms of Ukraine, we have condemned the Russian invasion from the outside, and we are deeply saddened by the senseless violence being brought upon the people of Ukraine. Our company, colleagues and the Zoetis Foundation have worked together to provide veterinary care, medicines, financial support and evacuation assistance to those in need. With every decision, even the most difficult and complex ones, we're guided by our purpose to nurture the world and human kind by advancing care for animals. While we have suspended all investments and promotional activities in Russia, the continued care of pets and livestock remains an essential responsibility for Zoetis and our colleagues, and we remain focused on maintaining a critical supply of animal medicines and vaccines for veterinarians and producers there. We anticipate a negative impact of about 1% to our original full year growth expectations due to Ukraine and Russia, but we are maintaining our previous operational growth rates based on the overall strength of our companion animal business and the positive momentum of expanding our U.S. pet care and diagnostic commercial teams. Speaking of Diagnostics, another catalyst for growth, we delivered 12% operational growth in the first quarter. We continue to invest significantly in this space to accelerate our growth. For example, we've been shifting our go-to-market model this year and building a dedicated field force for our diagnostics portfolio. This hiring is a significant part of a 40% increase to our total U.S. companion animal field force. We see field force expansion as a key lever to supporting growth opportunities in our diagnostics and pet care businesses. We also continue to see very strong growth in pet care as we expand our major companion animal brands in markets around the world. Simperica Trio is doing very well as it continues to gain market share based on veterinarians preference for an innovative triple combination parasiticide for dogs. Pet owners have also been demonstrating strong loyalty rates after trying Trio, and we are excited by the ability of our direct-to-consumer campaigns and additional field force colleagues to increase interest in this product. Librela is also doing incredibly well across Europe, and we remain confident in the blockbuster potential for Librela in 2022 and Solensia in the longer term. As we see improvements in supply, we will be launching Solensia in additional markets such as Canada and Australia this year. In terms of the U.S., we are still planning a launch of Solensia in the second half of the year, and we anticipate approval for Librela by the end of the year, assuming FDA inspections are completed at facilities outside of the U.S. Overall, we continue to benefit from pet care trends in terms of increased demand, clinic revenues, pet ownership and spending habits. Finally, a brief update on supply. As I mentioned last quarter, we are managing certain isolated supply constraints for Librela, Solensia and some of our other products as we compete for some limited manufacturing inputs critical to human health during the pandemic. We were also seeing additional global supply challenges related to Russia's invasion of Ukraine and the recent COVID-19 resurgence in China. While some of these challenges are Global manufacturing and supply network to mitigate any impact to our overall business. And our commercial teams are ensuring control launches for new products and coordinating with customers to minimize any impacts on their animal care. In conclusion, we are off to a good start for the year, and we're maintaining our operational growth expectations for the full year. Our diverse and durable portfolio, global scale and pipeline of innovations have us well positioned to meet customer needs and shareholder expectations for this year and beyond. Thank you. Now let me hand things off to Wetteny. Wetteny Joseph : Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a very strong start to the year with continued growth across a number of our core product franchises. Today, I will focus my comments on our first quarter financial performance, the key drivers contributing to our performance and provide an update on our full year 2022 guidance. In the first quarter, we generated revenue of $2 billion, growing 6% on a reported basis and 9% on an operational basis. Adjusted net income of $625 million grew 4% on a reported basis and 8% on an operational basis. Of the 9% operational revenue growth, 3% is on price and 6% from volume. Volume growth of 6% consisted of 5% from new products, which includes Simparica Trio and Librela, 3% from key dermatology products, while other in-line products declined 2%. The decline in other in-line products was expected and largely the result of a difficult comparison to the prior year and the impact of our swine business in China. Companion animal products led the way in terms of species growth, growing 20% operationally with livestock declining 6% on an operational basis in the quarter. Our small animal parasiticide portfolio was the largest contributor to growth in the quarter, where our innovative and diverse fleas, tick and heartworm portfolio drove growth of 25% operationally. Simparica Trio posted global revenue of $164 million, representing operational growth of 83% versus the comparable 2021 period. In Q1, Simparica Trio was the number one canine parasiticide sold in the U.S. in terms of revenue, and we recently launched Trio in Japan, a sizable international heartworm market. Meanwhile, our key dermatology products, Apoquel and Cytopoint, had significant global growth again with $307 million of revenue, representing 28% operational growth against a robust prior year in which key derm grew 24% in the first quarter. In Europe, our recently launched monoclonal antibody Librela, which is for osteoarthritis pain in dogs, also meaningfully contributed to growth in the quarter, posting $21 million in sales. Our Global Diagnostics portfolio recorded $98 million in revenue and had operational sales growth of 12% in Q1, growing across both our U.S. and international segments. Growth was largely driven globally by consumable usage and new products. We also continue to see growth in the placement of new devices in international markets. Diagnostics remains a key growth driver for Zoetis, and we continue to make significant investments in our field force, new technologies and reference grew 24% in the first quarter. In Europe, our recently launched monoclonal antibody, umbrella, which is for osteoarthritis pain in dogs, also meaningfully contributed to growth in the quarter, posting $21 million in sales. Our Global Diagnostics portfolio recorded $98 million in revenue and had operational sales growth of 12% in Q1, growing across both our U.S. and international segments. Growth was largely driven globally by consumable usage and new products. We also continue to see growth in the placement of new devices in international markets. Diagnostics remains a key growth driver for Zoetis, and we continue to make significant investments in our field force, new technologies and reference lab. I think revenue will continue to grow at levels above what we were seeing prior to COVID as the standard of veterinary care continues to increase through innovation, better demographics, higher compliance and more pets. Companion animal growth in the U.S. was driven largely by sales from our parasiticide portfolio as well as key dermatology products. Growth of Simparica Trio was again strong in the quarter with sales of $147 million in the U.S., growing 77%. We continue to meet our clinic penetration targets and take share within individual clinics with additional runway for future revenue growth. Federal on and satisfaction material is approximately 90% key dermatology products sales were $194 million for the quarter, growing 23% with APOQUEL and Capon each significantly contributing to growth. Our investment to support the portfolio have been instrumental in driving more patients into the clinic, and we will continue to invest meaningfully in this space as a large portion of dolls with dermatitis remain undertreated, representing an opportunity to further expand the market. In an effort to support all of our long-term sustainable sources of growth in our companion animal portfolio. In April, we launched our new pet care go-to-market strategy, expanding our U.S. companion animal field force by approximately 40% and creating dedicated and separate diagnostic and pharma coverage for our portfolio of products. U.S. livestock declined 11% in the quarter, primarily resulting from our cattle business. This was expected as we experienced challenges from generic competition for Jackson, which didn't exist in the same quarter last year as well as elevated input costs continuing to weigh on producer profitability. Meanwhile, upholstery business continues to be negatively impacted by the expanded use of lower cost alternatives resulting from reduced disease pressure from smaller foxises as well as generic competition for Zoamix. Swine products sales grew in the quarter as a result of favorable market conditions for producers and higher disease equivalence. Moving on to our International segment, where revenue grew 3% on a reported basis and 8% operationally in the quarter. Companion animal revenue grew 23% operationally, and livestock revenue declined 3% operationally. Increased sales of companion animal products resulted from the growth of our key dermatology products, monoclonal antibodies for alleviation of ore pain and our parasite portfolio. Semak brands continue to benefit from our international direct-to-consumer campaigns in Latin America and parts of Europe, and we remain excited with the long-term prospects of these programs. We are encouraged by the performance of our monoclonal antibody for OA pain with Librela generating $21 million and Cerencia delivering $3 million in first quarter sales. Librela remains on track to exceed $100 million in revenue this year. As we mentioned last quarter, Librela became the number one pain product in the EU in the first year of launch, with the underlying performance metrics being very favorable for future growth. Reordering rates remain at around 90%. Compliance exceeded our initial expectations, and we'll continue a significant opportunity to expand the pain market with a meaningful percentage of dogs on Librela being new to the market. Meanwhile, international livestock declined 3% operationally in the quarter. opportunity to expand the pain market with a meaningful percentage of dogs on Librela being new to the market. Meanwhile, international livestock declined 3% operationally in the quarter. This decline was driven predominantly by our swine portfolio in China. As we indicated over the past several months, increased port supply in the market like to a significant decline in pork prices, which impacts producer profitability. In addition, our first quarter of 2021 presented a difficult comparative period as pricing and producer profitability in that quarter had been at an all-time high. While we expect China to return to growth in the back half of the year, we anticipate a challenging second quarter for our swine portfolio. Partially offsetting our decline in swine was growth in our fish, poultry and cattle portfolios. Our fish portfolio grew double digits again this quarter, driven by growth of the AlphafluxCLIce treatment product and AlphaGeLivVac vaccine for SRS in Chile. Sales of cattle products grew in key markets due to favorable market conditions and pricing in Brazil and Australia as well as demand generation efforts in emerging markets such as Turkey and China. Now moving on to the rest of the P&L for the quarter. Adjusted gross margin of 71.6% improved Advertising and promotion as well as direct-to-pet owner campaigns for key brands. R&D expenses increased 4% operationally due to higher compensation costs. The adjusted effective tax rate for the quarter was 18.9%, a decrease of 20 basis points, driven by the impact of favorable discrete tax items and settlements with certain tax authorities, slightly offset by changes in the jurisdictional mix of earnings. And finally, adjusted net income grew 8% operationally and adjusted diluted EPS grew 9% operationally for the quarter. Capital expenditures in the first quarter were $115 million. We are still anticipating a significant increase in capital expenditures for the full year 2022, primarily related to investments in Ireland, the U.S. and China to support manufacturing capacity needed to meet our long-term growth demands. In the quarter, we returned over $0.5 billion to shareholders through a combination of share repurchases and dividends. We purchased approximately $361 million of Zoetis shares, representing our largest dollar-based quarterly share repurchase ever. Now moving on to guidance for the full year 2022. Foreign exchange rates on our updated guidance are as of late April and reflect the recent strengthening of the U.S. dollar. Please note that any update to our full year guidance are related directly and only to foreign exchange and that the ranges of our operational growth rates for revenue of 9% to 11% and adjusted income of 10% to 13% remained the same as our previous February guidance. We are holding these top and bottom line operational growth rates the same despite the conflict in Russia and Ukraine, negatively impacting our expected full year operational growth by 1%. We feel we can offset this impact with the strength of our companion animal portfolio. Beginning with revenue for the full year 2022, we are decreasing both the low and high end of the range by $100 million to reflect the impact of foreign exchange. We are now projecting revenue of between $8.225 billion and $8.375 billion while maintaining our expected operational growth of 9% to 11%. and bottom line operational growth rates the same despite the conflict in Russia and Ukraine, negatively impacting our expected full year operational growth by 1%. We feel we can offset this impact with the strength of our companion animal portfolio. Beginning with revenue for the full year 2022, we are decreasing both the low and high end of the range by $100 million to reflect the impact of foreign exchange. We are now projecting revenue of between $8.25 billion and $8.375 billion while maintaining our expected operational growth of 9% to 11%. For adjusted net income for the year -- adjusted net income is now expected to be in the range of $2.365 billion to $2.4 billion, while maintaining our expected operational growth of 10% to 13%. And finally, we expect adjusted diluted EPS to be in the range of $4.99 to $5.09 and reported diluted EPS to be in the range of $4.65 to $4.77. Sales of companion animal products will be the primary growth driver in 2022 with the continued strength of our diverse prior silicide portfolio, further expansion of our key dermatology products, the adoption of our monoclonal antibodies for OA pain and growth in point-of-care diagnostics. We also continue to see a very favorable global companion animal backdrop for 2022. For livestock, the fundamental macro trends, which make animal protein on essential business remain intact, and we believe more normalized growth will occur in 2023. While our guidance represents our expectations for the full year, I would like to provide some color on the expected phasing of growth for the remainder of 2022. We expect top line operational growth for Q2 to be slightly below Q1 as today business and certain supply chain activities. We also expect a similar foreign exchange impact in Q2 that we experienced in Q1, where reported revenue was negatively impacted by about 3%. In addition, the significant investments we are making early in the year to support future revenue growth, including field force expansion in the U.S. and incremental DTC advertising will drive OpEx growth in Q2 at a faster rate than revenue, impacting Q2 bottom line profitability more materially than in the back half of the year. We expect that foreign exchange in Q2 will have a negative impact to the bottom line of about 5%. Our full year 2022 guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. Our success is derived from our diversified portfolio of enduring brands driven by multiple sources of in-line growth, and agile and disciplined innovation engine and our infrastructure to develop and expand markets globally. We extract to continue to execute across multiple dimensions of our business and capitalize on favorable end market dynamics for the foreseeable future. Now I'll hand things over to the operator to open the line for your questions. Operator : [Operator Instructions] Our first question is coming from Erin Wright of Morgan Stanley. Erin Wright : Great. I have one on companion animal trends that I have to ask here. What are you seeing at the clinic level if you could parse out a little bit more of what you're seeing across the U.S. and international in terms of demand trends, what you're seeing in terms of capacity constraints at the vet clinic level? And what is implied in your guidance at this point in terms of operational growth across the companion animal segment? And then a follow-up on Trio, I guess, where do you stand now in terms of market share in canine parasiticide at this point? And how much do you think Simparica Trio is taking share versus expanding the market with greater compliance? Kristin Peck : Okay, Erin, it's Kristin. Great to hear from you. So we fundamentally and structurally believe the pet care industry is in great shape. I think as you've seen some of these trends over the last few years, there's a very high standard of care. The demographics of who is adopting these pets over the last few years being millennials, the number of pets you have out there and honestly, the aging of pets. So we do not think there is a demand problem. I think you saw in the quarter potentially a difficult cost to what you saw last year. If you look overall, a 5% increase at the vet clinic, there is a little bit less traffic, as you referenced. I think those are some of the shorter-term capacity constraints. But remember, we've got a lot more pets. So you're really -- the base is much larger than it's historically been. But given Omicron, there was definitely some challenges at some of the vet clinics. But the other thing to consider about the data that we would just highlight is that it really pulls out a lot of the large corporates who have found more innovative ways to structure their business to add more capacity. And I think you'll see more of that coming overall. There were the short-term labor shortages. The other thing to really focus on, we would say is if you look at Zoetis' business, it's a little different, the nature of our business and our innovation, we have a lot of chronic medications. It doesn't require tons of visits. So we focus a little bit more on the spend per visit as we look at it. We also have alternative channels, which for us in the quarter grew 34%. So we remain very optimistic with regards to pet care trends overall? And maybe, Wetteny, you can take her second question on Simparica. Wetteny Joseph : Yes. Sure, Erin. Look, very, very pleased with the performance of Simparica Trio posting $164 million of revenue in the quarter, up 83%, became the number one canine parasiticide in the U.S. And as we've shared before, we have 90% penetration across large corporate accounts, et cetera. And within those penetrated clinics, we continue to take share as well. Satisfaction level with our product is about 90% among pet owners, and we also just launched Simparica Trio in Japan, which is a key heartworm market as well, just in the middle of this quarter. So I'm very pleased with the performance with Trio. Operator : Our next question comes from Christine Rains, William Blair. Christine Rains : I was just wondering if I could have any update on diagnostics contribution to the quarter and overall performance? Is growth tracking with your expectations? And can you comment on system placements versus testing volume growth. And if you would have made any additional reference lab purchases? Wetteny Joseph : Yes, sure. I'll take this, Christine. Thanks for the question. Look, I'm very pleased with the performance of our Diagnostics business in the quarter. We grew 12%, posting $98 million of revenue. We really saw strong growth across both U.S. and international, both replacements as well as consumables. So we're very pleased with the performance of the business. In terms of reference lab acquisitions, we did not have any in the quarter. Obviously, we made a number of acquisitions that we -- in the U.S. and continue to make investments across technology. You might have seen images, for example, we've added additional indications here with blood smear in addition to fecal and digital psychology. So we continue to be very pleased with the performance of the business. Operator : Our next question comes from Louise Chen of Cantor. Louise Chen : Congratulations on the quarter. Just curious what has been the impact of inflation on your Animal Health business, both companion and livestock and how do you see potential increase in inflation or continued inflation impacting your business going forward? Kristin Peck : Thanks, Louise. I'll start and then I'll move it to Wetteny. We've seen historically that pet owner spending has been incredibly durable right now, we've got about 63% of our revenue in companion animal. But if you look at the February research, 86% of pet owners would spend whatever it takes. So we do see inflation, and Wetteny can certainly get into how we've taken price, et cetera. But I think we've obviously seen increase in labor cost and freight and fuel. But Wetteny can really talk about the fact that we've been able to leverage price especially in our companion animal business. So Wetteny, do you want to go over some of those numbers? Wetteny Joseph : Yes, sure. Given we continue to see very strong underlying demand from pet owners, we have very innovative products across our portfolio. We've been able to demonstrate that we can take price at or above inflation levels in the past, and we don't see any reason why we won't do that now. If you look at this quarter, for example, our total growth included 3% of price. Now if you parse that out and you look at just companion animal globally, we took 6% of price. And so we'll continue to use that lever as we proceed. But given the dynamics, Kristin just mentioned, underlying strength in the market, we'll continue to have that availability to us. Kristin Peck : And the only thing I'd add there is, despite inflation, I would just note that in 2021, we increased our margins and our guidance for 2022 does the same. So I think it really shows the durability and resilience of our industry. Operator : Our next question comes from Nathan Rich of Goldman Sachs. Nathan Rich : Kristin, I'd be curious to get your view following up on the commentary you have on just vet visit trends and vet spending trends. Do you see more variability in sales for your products that are administered need to be administered by the vet? And can you just remind us how big of a percentage of your companion animal business that is? And then a quick follow-up for Wetteny. It looks like the revenue guidance came down by $100 million. It looks like operating profit may be down by $50 million. So it seems like a high decremental margin on the revenue reduction. I guess does that just reflect kind of the composition of the expense base? Just to be curious kind of any color you can shed on that dynamic. Thank you. Kristin Peck : Sure. I mean, I'll start off with your first question. Again, if you look at our overall portfolio and the nature of our business, I think the level of innovation, we're not as susceptible to vet visit trends. You basically what percentage has to be administered in the vet clinic. I don't know maybe around 50% that would be vaccines injectables. But I think if you look at the sales of Librela being now the number one pain product in Europe, clearly, for things that are really important to pet owners, they are getting into the clinic. Regular checks for vaccines, we're not seeing any significantly negative trends there. So I think chronic medications, which is a huge part of our business. And if you look at dermatology and parasiticides, which are growing at pairs are growing at 25% in the quarter, derm at 28% in the quarter. We're clearly not really suffering from the slight decline in the U.S. in trends. But Wetteny, you can take that second question. Wetteny Joseph : Yes, sure. As we've said, we've revised our guidance solely to reflect FX. We continue to maintain our operational guidance range, both top and bottom for the company that we came into in February that we gave. So from an FX perspective, top line impact is about 3%. It's about $260 million of an impact. And as you referenced, the change you're reflecting the change in FX has a wider impact on the bottom, and that's really largely driven by FX in losses given our exposure across certain currencies, particularly the euro. If you look at the first quarter, for example, you see a wider impact at the bottom that you see at the top, driven by the impact of that as well. Operator : Our next question comes from Michael Ryskin of Bank of America. Michael Ryskin : Congrats on a strong result. I want to start with livestock markets. I mean we've known livestock was going to be weak for a while, and so it's not a huge surprise. But so I just want to get an update on how you're seeing a couple of factors that are going, both DRAXXIN, are you still sort of projecting lapping the tough comps around the summer and sort of what are your expectations for DRAXXIN exiting this year and next year, and then broader conditions such as drought in the Midwest and the United States, rising input costs. Sort of how do you see that playing out for U.S. livestock and internationally? And then a follow-up question for Wetteny, if I might. You guys touched a number of times in the prepared remarks on field force expansions or investing in growth, investing in the opportunities in companion animal. Just wondering if you could go into a little more detail on how that's going to play out? When do you see that shown up in the numbers when you think you'll start seeing the payoff for that? And just sort of talk about labor pressures, wage pressures, how that affects your thought process there? Kristin Peck : Great. Mike, I'll take the first part of it, which is the broader livestock trends and then Wetteny can take the DRAXXIN and the field force question that you've got. I mean, look, as you know, well, historically, livestock has grown around 4% I think if you look at 2019 and 2020, you saw sort of some unusual events that affected overall industry livestock growth. Obviously, African Swine Fever in China, as you remember, and then overall COVID, but then as I think as you look at 2021 and 2022, Zoetis has been unusually impacted and that has everything to do with where DRAXXIN is. And Wetteny can get into the numbers, but that has played out exactly how we expected it to. Our long-term outlook, as Wetteny mentioned a few minutes ago in his prepared remarks, remains unchanged. We think you're going to start to go back to more normalized growth in 2023 and beyond, basically because feeding the world is a powerful trend, the desire for protein and higher quality protein. But let me let Wetteny get into some of the specifics on the DRAXXIN numbers and then your second question. Wetteny Joseph : Yes. So as we said from the very beginning with the cycle DRAXXIN, we expect it to have about a 20% impact to the top line in the first year and another 20% in the second. So what we're seeing across livestock right now is playing out exactly as we thought. In fact, in 2021, we did a little bit slightly better than that with respect to DRAXXIN. And we continue to have the effects -- positive effects of life cycle innovation like Draxxin KP, and we're maintaining most of our volume. And the margin for DRAXXIN remains very attractive for us as well. So as we expected, we've seen competitors come in, but the performance has been at or slightly better than we expected. Broadly speaking, I think if you look at swine, for example, in China, there was a pretty significant impact on the quarter with respect to large stock. Again, we expected that coming in. And it's really looking at where swine prices are in China versus a year ago, where they were at all-time highs and have been at all-time lows essentially here and the lockdowns having an impact on sort of demand consumption as well in this case. So with respect to the field force, if I can transition to that part of your question, very pleased to be able to expand our field force here. We have the broadest portfolio across the market. And if you look at innovation that we have coming as well with respect to the pain franchises for Solensia that we are probably launching across the second half of this year. And as we get approval for Librela and launched that as well in the U.S., we continue to have opportunities to really capitalize on the market dynamics and the strong demand and have additional field force, which we see a strong return on those as well. We're also launching a dedicated sale force for diagnostics, separate and apart from our Rx teams, which we believe will have, again, a very positive return for us as well. Now you can see that with those plans, we still have an operational levered P&L where we're growing the bottom line above the top line. So top line in 9% to 11% and the bottom at 10% to 13% with approximately a 40% increase in our field force. Operator : Our next question comes from Jon Block of Stifel. Jon Block : Great. Maybe just a couple of quick ones. For U.S. Librela approval, was that a slight push, Kristin, to year-end '22 for mid-'22? If it was, maybe just if you could elaborate on what still needs to get done there for approval? And if it is here in '22, how are you from a supply standpoint? Do you think that product will be ready for early 2023 U.S. launch? And then maybe just as a quick follow-up. Wetteny, can you talk about the supply chain and cost and how you feel there? Companion animals expected to be a big year-over-year in '22. So you've got this positive mix shift, you've got price running ahead of what it normally does. I think you called out 3% versus 1% last year. And GM still expected to be flattish. So you just would love some color on how you're feeling in the supply chain. Kristin Peck : Sure. Thanks, Jon. I'll start with the first question and let Wetteny take the second. With regard to Librela, no, this is exactly as we expected. We were expecting an approval later this year. We continue to expect that, as we wrote in the market, there's no change there. We still require an ex-U.S. site visit, as we said all along. So I would say there's really no update there. And to your second question, when would you expect a launch? We're obviously, as we would in any product working to build up supply. But as always, in our industry and especially with regards to biologics and monoclonal antibodies, the standard in our industry is it takes somewhere between three and 9 months to get up to a full launch. So is a monoclonal antibody. We'll do an early experience sometime in the first half, again, depending on when the approval is and launch shortly thereafter. We're quite excited about this. Obviously, we're working hard to build up that supply as soon as we get the approvals of the site, et cetera. So everything on Librela is exactly where we were before, really absolutely no change there. Wetteny Joseph : Yes. And I'll take the supply chain part of the question, Jon. Look, our supply chain has proven to be very resilient despite challenging elements over the last couple of years. We delivered 15% operational growth last year with 14 of that in volume. So we put an ability to continue to navigate through those. Currently, we are looking at China, for example, where the lockdowns have had an effect certainly in our first quarter, and we see that in our second quarter as well, which is why we included those in our prepared commentary around Q2 expectations. But in terms of price, we are pulling that leverage 3% total for the company. On the companion animal side, which now that's about 53% of our company if you look at the first quarter, companion animal has grown almost 60% over the last two years, if you look back to 2019 level. So again, very strong market dynamics and demand. We do see the mix shift being very positive for us with more companion animal and with our innovative products that are launching as well. But we do have some offsets when you look at livestock, particularly DRAXXIN, as we just talked about in line with our expectations, but certainly are giving price and maintaining the volume and, as I said, still at attractive margins for us. But that's really the main offset if you look at it across the year. Operator : Our next question comes from Balaji Prasad of Barclays. Balaji Prasad : One each on combined and livestock, firstly on atopic dermatitis. I estimate that you currently probably have around 35% of the market share in the U.S. between Cytopoint and Apoquel. With the -- what percent of the incremental market is allergic dermatitis and is this market open for you as you get the label extension. On the same subject, do you also have an update on your oral JAK inhibitors and which is expected to come later this year, how that would influence the market share at all? On the livestock side, could you quantify if there are any opportunities that are coming to you through the Chinese consumption shifting towards beef and poultry will be swine, are you there's not much of a trend there? Kristin Peck : Sure. I'll start on the overall derm. As you saw, it grew about 28% in the quarter, driven by expanding our direct efforts. Certainly, you see we're investing more in our field force pet care rewards. I also think genuinely, it's just more people home with their pets. I don't have the specific share numbers. We can certainly get back to you on that I think it's over 70% in the U.S., our share of the atopic dermatitis, allergic dermatitis markets overall in the U.S. and especially it's even more if you want to look at revenue. But we're really pleased with where that's going. With regards to competition, I know our favorite question, we don't absolutely know. We would expect competition on it. At this point in time, as we look at 2022, we are not expecting competition in 2022, we would expect it in 2023. As our latest intelligence, obviously, we could be wrong there. But expectation is competition for derm on a small molecule basis will come in 2023. With regards to our own pipeline internally, we don't discuss that. So I don't think we have any color there. But I don't know, Wetteny, do you want to take the second question? Wetteny Joseph : Yes, sure. Just one thing to add on the first one. For us, really, when we look at Derm, it's less about market share, it's a lot more about market expansion. There's certainly an opportunity when we look at the number of dogs that suffer from each [indiscernible] are not being treated. About 6 million, and of the 7.6 million that are being created, so a good portion of them are undertreated with either antihistamines or steroids. So we do think there's an opportunity with respect to the under treatment there. Now I'll shift over to your question around livestock, particularly around China. We have seen an increase in beef consumption here, which certainly benefits us when you look at our business in Brazil, for example, that exports into China from a beef perspective as well as in China set of activities. And so it's still -- in terms of in China, it's still relatively small compared to swine, for example, but we are seeing good trends there that are favorable to us. Operator : Our next question comes from Chris Schott of JPMorgan. Chris Schott : First, can you just remind us about your sensitivity to economic growth? I know you're seeing very healthy demand in the companion side right now and you've been able to take price. But if we enter a mild recession in some parts of the world, particularly Europe, what type of pressures would you anticipate, if any, to your business from that? And my second one was on protein demand. I know you've touched on this in a couple of other questions, but it does seem like we're entering kind of a challenging macro environment with food prices growing very rapidly, especially in the emerging markets. Do you see that as a risk at all in terms of global protein demand consumers trading down on protein that could kind of dampen kind of your livestock recovery as we look out to kind of 2023 and beyond. Kristin Peck : Sure. Thanks, Chris. Good to hear from you. As you think about the economic challenges, potential economic risk across the globe, I think one thing you've seen about the animal health industry I was referencing before, the research is 86% will spend what it takes. And I think it's also really important to focus on the fact that our companion animal business is growing 50% between 2019 and 2021. As Wetteny mentioned, it was about 63%. And that is just a more durable business as you think about getting through economic challenges. We grew through the beginning of COVID, for example. As you look at it, we've grown during the Great Recession. And that was when our companion animal business was only 35%. So I think structurally, if you look at our business, it's more positive now than it was during the Great Recession, so I do think we're going to be pretty resilient as we go through those times. But I'll let Wetteny add anything wants to and then take your protein demand trend question. Wetteny Joseph : Yes, I think you've covered it well, just a companion animal. It's a bigger percentage of our business now is proving to be very resilient. And structurally with respect to demographics we have more Gen Z and millennials, owning pets, more pets. And if you look across our portfolio, a number of chronic conditions that we're treating that are very resilient even as we've seen in the past and structurally even stronger now. With respect to livestock, you do see the potential for people to trade down in proteins going from beef down to chicken or pork and then et cetera. So we do think that can happen in terms of looking across the globe. We do have a growth portfolio across different species, obviously. But that is one of the areas that we think is a little bit less than what we see in companion animal, where extremely resilient. Now we do, overall, though, when you look at protein consumption, we do see that growing over time, particularly as you could look across emerging markets, growing populations increase in sort of sole income, et cetera, and growing middle class across different markets. We see those continuing to maintain growth to protein consumption, we do have the pandemic, which actually has been negative from a lifestyle perspective. I think folks look at the pandemic and think about the positive effects on the companion animal side. but that has actually been largely negative. And so we do believe that they'll -- in addition to our DRAXXIN, which we've talked about, we do anticipate a return to growth in livestock as we get out into 2023, 2024 timeframe. Operator : Our next question comes from Steve Scala of Cowen. Steve Scala : You mentioned enhanced spending per pet. Our understanding is that this is due to two things, enhanced compliance and catch-up in routine wellness checks. Is that what you've seen? If so, how much does each contribute? So how much does enhanced compliance contribute versus catch-up in routine visits. The concern is that the catch-up in routine visits would seem like a onetime boost. And if that's the case, then what are the long-term implications of not -- no longer getting that boost and just enjoying the trends of the enhanced compliance? Kristin Peck : Sure. I mean, I guess what we would say is that you're seeing more animals, you're seeing Wetteny's mentioned the demographics of who is adopting these animals, people who spend more time, more money on them, the aging of pets. So I'm not sure we would probably parse the data the way you do to be perfectly honest. Obviously, we are seeing increased compliance. I think alternative channels sort of online and autoship, even from clinics, is really helping driving that increased compliance. But I would say if you look at our portfolio, it's innovation. It's bringing disruptive innovation that people are excited about, looking at Paris, a single product that does three things. people are excited about. You look at monoclonal antibodies. You look at dermatology. We have great chronic medications that are not as susceptible to how many visits you make. If you get a prescription for par, it lasts the year. So I guess we would look at the data slightly differently than what you're looking at it. And more importantly, for our business, we think the nature of our business and the level of innovation and the demographics of both the number of animals and who's adopting them remains very positive. Wetteny Joseph : Yes. I would say it's a combination of just an increased standard of care for animals, particularly for pets that's aided by the innovation that's come out of Zoetis across derm and parasiticides and now with pain and the demographics of the owners that actually put a premium on the health of their pets that's driving this. And I think people are doing more in those visits as well, which is driving sort of the revenue per visit figures that you see, which is, again, part of the reason that we don't think the visits themselves are as meaningful as the spend per visit. Operator : Our next question comes from Elliott Wilbur of Raymond James. Elliot Wilbur : One question around the EU launch experience and dynamics to date with respect to Librela and Solensia. Just how some of the early experience is shaping expectations for the U.S. launch areas of over underperformance where you've been positively surprised. And just thinking about dynamics such as persistence, do you have any sense of the number of patients started on therapy that are returning for follow-up injections, Librela share of new patient starts. And I know it's still relatively early, but is -- or are you seeing or are you expecting to see an increase in overall patient volumes from the launch of these products? And then just as a quick follow-up here, how important was -- or is the mAb opportunity in the U.S. in terms of driving your decision behind the sales force expansion? Kristin Peck : Sure. Thanks, Elliot. Great questions on Librela. We are super excited at the launch there. To get to some of the specific information you have for us. As we said, this is now Librela in Europe is now the number one selling product for pain. What's really exciting also about that is 40% are patients that are new to the category. So I think this is really changing the game for a lot of people, maybe for safety reasons, couldn't take what the other products were are really coming into the vet clinic. And to get to your other question, there's a 90% reorder rate. So which gets that -- if you come in for one injection, are you staying with the product? The answer is yes. And this is why we believe in its first full year in Europe alone, Librela will be a blockbuster product for us. We did about $22 million in Q1. This definitely does inform as we think about U.S. launch. It informs why we want to start with early experience getting each of the best, especially the KOLs used to what it looks like. How to treat, how to manage it. And then really building that excitement which worked incredibly well for us in Europe which will do again in the U.S. And really I think our expectations for the product have increased based on the success we’ve seen already. So Solensia, we are very excited as well. It's a very different market, it didn't exist before. As we talked about we're really creating the market as what is demonstrated time and again. It's ability to do that as it in derm. But again you got to get the cast to the clinic as you know there are less medicals lives than dogs. You've got to help cat owners know what pain looks like. But we remain super excited about Solensia. It will just be, as we said, the ramp will look slightly different on Solensia than it does with Librela. But we're just as excited, and we think it's potential is very strong there. Do you want to add anything, Wetteny? Wetteny Joseph : No, just a part of the question on the field force, I wanted to just make a comment on, which is, look, we have the broadest portfolio, as I mentioned before. And we continue to add innovative products to that. And so we carefully analyze sort of the coverage across clinics and across products for our field force and are very confident that this is an investment that's going to have that's going to yield positive returns for us across our products, existing products, opportunities to expand in the existing products as well as new products that are coming on. Operator : This concludes our question-and-answer session at this time. I'd be happy to return the call to Kristin Peck, CEO, for any concluding remarks. Kristin Peck : Great. Thank you all for your questions and for the continued interest in Zoetis. I just want to summarize, I think Zoetis is off to a strong start of the year. We've got continued strength in products for pet care, and I think as you've seen, a diverse and durable global portfolio, we're really happy to be maintaining our operational growth expectations for the full year despite the negative impact of foreign exchange and other headwinds. And we're continuing to make ongoing investments in talent and technology, manufacturing expansions and innovation that have us well positioned to support our future growth plans as well. So I look forward to keeping you updated on future calls and hope you have a great day. Thanks so much, everybody. Operator : This does conclude today's Zoetis Q1 2022 earnings call and webcast. You may now disconnect, and everyone, have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,022
| 3
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2022Q3
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2022Q2
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2022-08-04
| 4.857
| 4.89
| 5.39
| 5.44
| 7.9827
| 32.49
| 29.06
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Operator : 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. Steve Frank : 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. Kristin Peck : 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 know pet owners love their dogs and cats and pet care remains a very positive and robust market, showing little impact from broader consumer concerns with inflation for the global economy. As we expected during the pandemic, that clinic visits are normalizing over time and spending continues to show strong growth based on the latest U.S. numbers. The positive dynamic between pets and pet owners, which I've spoken about before, is proving sustainable and recession-resistant due to people's affinity for their pets, a willingness to prioritize medical care for their pets and key demographic drivers such as the increased pet ownership by Gen Z and millennials and the greater percentage of high income households owning pets. Our innovative companion animal portfolio is well suited to address these customer needs. Our key dermatology products continue to demonstrate strong growth, 22% operationally for the first half, and we see opportunity to expand in underpenetrated markets especially internationally and introduce life cycle innovations like Apoquel chewable tablets. We have more to come in the pipeline for dermatology, and we do not foresee any competitors for Apoquel or Cytopoint this year or in the first half of 2023. In terms of parasiticides, the Simparica franchise, including Simparica Trio, is performing extremely well. having grown 47% operationally through the first half of the year and is gaining share in the industry's largest category. We currently anticipate a competing triple-combination parasiticide to be approved in the U.S. in the next 6 months with a possible launch next year. However, we believe Trio will continue to grow based on a strong label, proven efficacy and the support of DTC marketing in the U.S. and international markets. Our monoclonal antibodies for pain, Librela and Solensia, are performing very well in approved markets across Europe, and we remain very confident in the blockbuster potential of these breakthrough treatments. In terms of the U.S., we have begun early experience trials for Solensia and expect a broader market launch in the fourth quarter. And we still anticipate approval for Librela later this year, assuming FDA inspections are completed at facilities outside the United States. Meanwhile, our operational growth in international has remained steady throughout the first half of the year at 8% despite COVID lockdowns in China and revenue reductions in Russia and Ukraine due to the war. Excluding the impact of Russia and Ukraine in the first half, our international sales would have grown 9% operationally. This is the latest example of how our diverse portfolio and global footprint drive steady and sustainable growth for the business. While some markets may be experiencing setbacks in the quarter, other markets like the U.S., Australia, Southern Europe and other emerging markets are driving our performance. In the second half, we see China returning to stronger growth if COVID stays in check, and we continue to expect the diversity across geographies and species to remain strong. In terms of livestock, we expect continued pressure from generic competition, primarily in U.S. cattle and poultry products. However, we are generating growth across various livestock species in markets outside the U.S. and fish continues to perform exceptionally well. Finally, like many companies, we are managing through supply constraints this year with certain products. We continue working hard to optimize our supply chain this year so we can meet the increasing demand for certain key products. Looking ahead, we will continue to invest in the resources DTC marketing and manufacturing capacity we need to support of future growth and achieve results for our customer and shareholders. We’re advancing our driven-to-care sustainability goals that were established last year. And we published our 2021 progress update and ESG metrics in the second quarter, highlighting achievements toward our DE&I aspirations, expanded clinic goals and support for the veterinary profession. We are committed to staying on our journey to be the most sustainable animal health company in the world. We also continue to invest in R&D, business development and new capabilities across the business to enhance our portfolio and ensure our long-term growth. In the second quarter, we continued to receive approvals for new products like Poulvac, Procerta-HVT-IBD ND, expand key franchises like Apoquel into new markets and acquire new businesses to complement our portfolio such as Basepaws, a pet care genetics company. In closing, our business continues to perform extraordinarily well in one of the most dynamic markets I've ever seen. Diversity, innovation and customer focus are our cornerstones for excellence. I want to thank our colleagues for their tenacity, commitment and resilience as we continue to deliver for our customers and shareholders. Thank you. Now let me hand things off to Wetteny. Wetteny Joseph : 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 were 22% operationally in the second quarter of 2021. In Europe, our monoclonal antibodies, fostered pain in dogs and cats also meaningfully contributed to growth posting $31 million in sales. Our global companion animal diagnostics portfolio recorded $83 million in revenue in Q2, declining 9% operationally. Growth in our international diagnostics portfolio was more than offset by a decline in our U.S. business in the quarter. In the U.S., we experienced a decrease in sales resulting from our new grocery market model and the build-out of a sizable and new dedicated field force for diagnostics. While disruptive in the short term, this investment is putting the necessary fundamental elements in place to position and grow our diagnostics portfolio over the long run. We expect the effectiveness of our new diagnostic sales force to improve gradually for the remainder of the year. Diagnostics remains core to our business and a key long-term growth driver for Zoetis. Sales of livestock products declined 1% operationally in the quarter, negatively impacting growth across the portfolio were global generic competition for Jackson and the War in Ukraine. China swine products again declined due to lower pork prices and COVID-related lock downs. Our U.S. poultry portfolio also continues to be challenged by generics and cheaper alternatives to Zoetis. Meanwhile, our fish portfolio again grew double digits in the quarter. And along with the strength of our sheep products in Australia, partially offset the broader decline. Overall, livestock performance in the quarter continues to be in line with our expectations. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.1 billion in the quarter, growing 9% with companion animal products growing 13% and livestock sales declining 7%. Focusing first on companion animal. U.S. set practice revenue trends continue to be positive with practice revenue growing approximately 5%. Spending per visit remained strong again this quarter, increasing over 7%. Visit declined more than 2%, primarily due to challenging prior year comparisons. In terms of best visit traffic, it is worth noting that business in the second quarter were above the number of visits pre-COVID in the second quarter of 2019 and the trend line for growth in visits over the last several years continues to slow favorably. I would also like to point out that our companion animal portfolio in the U.S. had volume growth of 8% in the quarter. Our injectable portfolio of products that must be administered in the vet clinic also saw volume growth in the quarter. These products include Cytopoint, vaccines and Poulvac. Underlying demand for veterinary care remains robust throughout the country even as people return to work. While labor challenges do exist as they do across most industries, we believe vet clinic revenue will continue to grow at levels above what we were seeing prior to COVID as the standard of veterinary care continues to increase through innovation, better demographics, higher compliance and more pets. Companion animal growth of 13% in the U.S. was driven largely by sales from Simparica Trio as well as key dermatology products. Growth of Simparica Trio was again strong in the quarter with sales of $208 million in the U.S., growing 74%. We are pleased to see that a significant number of Trio customers are new to the flea, tick and heartworm category altogether. In addition, we continue to meet our clinic penetration targets and take share within individual clinics. These dynamics will provide additional runway for future expansion of both the broader market and revenue growth for Trio. Key dermatology product sales were $219 million for the quarter, growing 11% with Apoquel and Cytopoint is significantly contributing to growth. Year-to-date, our derm portfolio grew 16%. Our investments to support our derm portfolio have been instrumental in driving more patients into the clinics and we will continue to invest meaningfully in this space as a large portion of dogs with dermatitis remain undertreated, representing an opportunity to further expand the market. U.S. livestock declined 7% in the quarter, driven primarily by sales of cattle products as a result of generic competition for Jackson. Meanwhile, our poultry portfolio continues to be negatively impacted by the expanded use of lower cost alternatives and generic competition for Zoamix. Swine products sales grew in the quarter as a result of increased disease prevalence and favorable market conditions for producers. Moving on to our International segment, where revenue grew 2% on a reported basis and 8% operationally in the quarter. Companion animal revenue grew 16% operationally and loss lag revenue grew 2% operationally. Increased sales of companion animal products resulted from growth of monoclonal antibodies for alleviation of osteoarthritis pain, our key dermatology products and the Simparica franchise. These core brands continue to benefit from our international direct-to-consumer promotional campaigns and we remain excited with the long-term prospects of these programs. We continue to be pleased with the performance of our monoclonal antibodies for OA pain with Librela generating $26 million in Solensia delivering $5 million in second quarter sales. Librela remains on track to exceed $100 million in revenue this year. As we have mentioned in prior quarters, Librela is the number one pain product in the EU with the underlying performance metrics being very favorable for future growth. Reordering rates remain high. Compliance continues to exceed our initial expectations, and we continue to see significant opportunity to expand the pain market with a meaningful percentage of dogs on Librela being new to the market. It is also worth noting that we are observing similar pet owner and vet clinic trends in many of our key international markets that we are seeing in the U.S. The higher standard of care and better demographics as well as a more rapid adoption of innovation continues to expand markets for our products and we expect these trends to continue. Volume growth in our international and companion animal portfolio was 10% in the second quarter, and we also saw growth across our injectable products, including monoclonal antibodies, vaccines and Cytopoint. Meanwhile, international livestock grew 2% operationally in the quarter with solid growth across fish, cattle and sheep. Our fish portfolio experienced increased demand for vaccines in key standard markets, including Chile and Norway. Cattle grew through favorable market conditions and price in key emerging markets, including Australia, Turkey, China and the U.K. Sales of sheep products grew as a result of favorable market conditions and new product launches in Australia. Growth was partially offset by continued weakness with the price of pork and COVID-related supply challenges in China as well as unfavorable producer rotational programs with MFAs in Europe and reduced stock sizes in Latin America impacting poultry. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 69.8% decreased 120 basis points on a comparable basis to the prior year, resulting primarily from unfavorable foreign exchange impacts as well as higher manufacturing, freight and other costs partially offset by favorable price and mix. Adjusted operating expense increased 10% operationally with SG&A growth of 8% operationally, driven by promotional and marketing expenses related to key brands and new product launches as well as T&E cost beginning to return to pre-COVID levels. R&D expenses increased 16% operationally due to higher compensation costs, increased spending on projects and higher operating costs. The adjusted tax rate for the quarter was 20.7%, an increase of 70 basis points, driven by changes in jurisdictional mix of earnings and lower discrete tax benefits related to share-based payments. And finally, adjusted net income grew 9% operationally and adjusted diluted EPS grew 10% operationally for the quarter. Capital expenditures in the second quarter were $146 million. We are still anticipating a significant increase in capital expenditures for the back half of 2022, primarily related to investments in Ireland, the U.S. and China to support manufacturing capacity needed to meet our long-term growth demands. In the quarter, we returned over $600 million to shareholders through a combination of share repurchases and dividends. We repurchased only $450 million of Zoetis shares, representing our largest share repurchase ever. Now moving on to our updated guidance for the full year 2022. For operational revenue growth, we are maintaining the midpoint and narrowing the range of growth to 9.5% to 10.5%, previously 9% to 11%. We are increasing our operational growth expectations for adjusted net income to a range of 11% to 13%, previously 10% to 13%. This change in guidance signals increased confidence in the back half of the year due to the continuing outperformance of companion animal, easing of certain supply constraints and an improvement in our business in China. Please note that our guidance for adjusted interest expense and/or ID was changed to reflect favorable changes to interest income. Foreign exchange rates on our updated guidance as of late July and reflect the continued strengthening of the U.S. dollar. Beginning with revenue for the full year 2022 due to the narrowing of our range and the impact of foreign exchange, we are now projecting revenue of between $8.225 billion and $8.325 billion. We now expect adjusted net income to be in the range of $2.35 billion to $2.39 billion. And finally, we expect adjusted diluted EPS to be in the range of $4.97 to $5.05 and reported diluted EPS to be in the range of $4.65 to $4.75. While guidance possess our outlook for the full year due to the unique factors impacting our business in 2022, I would like to note that our guidance for growth, especially for revenue and adjusted net income will be rated towards the end of the year. While we expect operating expenses to be incurred at a similar rate across that half of the year, we are noting an easier OpEx pop in Q4 than Q3 due to heavy spending in the fourth quarter of last year. Also, in Q3 of last year, we experienced an unusually low adjusted effective tax rate of 16.7% due to favorability related to foreign-derived intangible income and certain discrete items. We do not expect similar favorability this year. Our full year 2022 guidance once again reflects our value proposition of growing revenue in line with or faster in the market. and growing adjusted net income faster than revenue over the long term. Our success will continue to come from our diversified portfolio of enduring brands driven by multiple sources of in-line growth, productive innovation, and an infrastructure to develop and expand markets globally. We expect to continue to execute across multiple dimensions of our business and capitalize on favorable end market dynamics for the foreseeable future. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We'll take our first question from Michael Riskin Of Bank of America. Michael Ryskin : 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. Kristin Peck : 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. Wetteny Joseph : 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. Operator : Our next question comes from Erin Wright of Morgan Stanley. Erin Wright : 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? Kristin Peck : 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. Wetteny Joseph : 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. Operator : Our next question is from Jon Block of Stifel. Jon Block : 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. Kristin Peck : 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. Wetteny Joseph : 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. Operator : Our next question comes from Christine Rains of William Blair. Christine Rains : 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? Wetteny Joseph : 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. Kristin Peck : 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. Operator : Our next question comes from Nathan Rich of Goldman Sachs. Nathan Rich : 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? Kristin Peck : 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. Operator : Our next question comes from Louise Chen of Cantor Fitzgerald. Louise Chen : 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? Wetteny Joseph : 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. Operator : Our next question comes from Elliot Wilbur of Raymond James. Elliot Wilbur : 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? Kristin Peck : 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. Wetteny Joseph : 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. Operator : Our next question comes from Balaji Prasad of Barclays. Balaji Prasad : 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? Kristin Peck : 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. Wetteny Joseph : 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. Operator : Our next question is from Chris Schott of JPMorgan. Ekaterina Knyazkova : 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. Kristin Peck : 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. Operator : 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. Kristin Peck : 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. Operator : This does conclude the Zoetis Q2 2022 earnings conference. You may now disconnect your lines, and everyone, have a great day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,022
| 4
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2022Q4
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2022Q3
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2022-11-03
| 4.916
| 4.94
| 5.465
| 5.5
| 7.33659
| 30.47
| 29.13
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Operator : Welcome to the Third 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. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-in or on the Investor Relations section of zoetis.com. At this time, all participants have been placed in a listen-only and the floor will be open for your questions following the presentation. [Operator Instructions] In the interest of time, we ask that you limit yourself to one question and then queue up again with any follow-ups. [Operator Instructions] It is now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis third 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 US GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release and the company's 8-K filing dated today, Thursday, November 3, 2022. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and welcome, everyone, to our third quarter earnings call for 2022. While the world faces a dynamic external environment and uncertainty in the global economy, our business has been tested and continues to perform well, based on our diverse durable portfolio and global footprint. In the third quarter, we delivered solid results with 5% operational revenue growth, reflecting steady performance across our innovation-driven companion animal portfolio, especially in our international markets. Our international business grew 8% operationally and the US grew 2% in the quarter. As we've been saying for some time, supply challenges throughout the year remain a headwind to meeting global demand, and those impacts were more pronounced in the third quarter. Supply has been improving in certain product categories, such as parasiticides, and we continue prioritizing supply for key products and markets. However, we do expect constraints in some categories to continue. Overall, positive pet care trends in terms of increasing spend and pet owner demographics continue to underpin the strength of our business. With 10% operational growth in companion animal products in the third quarter, we continue to see strong demand globally for Simparica Trio and other parasiticides, our key dermatology products, Apoquel and Cytopoint, small animal vaccine and monoclonal antibodies, Librela and Solensia. In the US, supply constraints for companion animal products tempered some of our expected growth in the quarter, and we also experienced an impact related to workforce challenges in veterinary clinics. The decline in clinic visits is stabilizing at pre-COVID rates, as clinics struggle with capacity issues. That being said, average revenues per visit continue to rise in the US as pet owners place a premium on the care of their pets, a positive long-term trend. This commitment to pet well-being is also demonstrated in the success of our monoclonal antibodies for osteoarthritis pain, Librela and Solensia. They are performing exceptionally well in the EU and Solensia is on track after being launched in the US at the end of the third quarter. We are investing in building a feline market for pain treatment and undertreated condition for cats. Outside of the US, companion animal products showed strong growth of 17% operationally. In some of our largest markets like China and Australia, we're seeing our innovative pet care products contributing more and more to growth in these traditionally live stock-driven markets. Meanwhile, our global livestock business performed largely as expected in the third quarter, with a decline of 3% operationally. We continue to face generic competition for livestock products, especially in cattle and poultry, and we face supply constraints in products such as vaccines. However, we are seeing solid pockets of growth, especially in aquaculture and poultry products and certain markets outside the US. As we stabilize from the generic competition, and review more consistent supply, we will improve our livestock performance. Looking ahead, we remain confident in the innovation-driven strength of our business especially in areas such as parasiticides, key dermatology products, vaccines and monoclonal antibodies. I am optimistic about the fundamental growth drivers and essential nature of the animal health industry to weather challenging times. However, we are revising our full year guidance to affect lower-than-expected sales in the second half of the year due to supply constraints, veterinary workforce challenges and recent changes to foreign exchange rates. We believe it is prudent to take a more cautious view, given the increasing uncertainty around supply, inflation and other macroeconomic conditions that have become less predictable. As we look ahead, to our tenth anniversary as an independent company next year and I reflect on all that we've achieved in the last decade, I feel very positive about where we are and the capabilities we have to overcome any challenges we face. Historically, we've always been able to adapt our business to meet evolving customer needs, drive growth faster than the market and achieve our purpose in nurturing the world and human kind by advancing care for animals. The human animal bond and people's connection to pets and farm animals is powerful. It's a bond we support with a diverse portfolio that remains the strength of our business, and we see strong global demand for innovative products, especially in companion animal parasiticides, dermatology, vaccines, diagnostics and monoclonal antibodies for pain. Positive pet owner demographics and their willingness to spend on the care of their animals remain long-term sustainable drivers of growth, despite some of the workforce challenges in clinics and livestock continues to be an important part of our business, an area where we drive significant value for our customers and shareholders. To sustain our growth, innovation remains our lifeblood, and we continue investing in the industry's leading R&D engine at Zoetis. Our monoclonal antibody portfolio for OA pain is a game changer. It has been performing exceptionally well as a pet treatment and growth driver in an increasing number of markets, and Librela is expected to be a blockbuster for Zoetis in 2022. In terms of the US approval for Librela, we have confirmed dates for the FDA site inspections outside the US, but their timing makes it unlikely to have an approval this year. Given our ongoing conversations with the FDA, we are confident in receiving approval in the first half of 2023 with a launch planned for late in the year. In closing, our business continues to perform well in a dynamic market and we are well positioned to advance our strategic growth opportunities in parasiticides, dermatology, pain, diagnostics and emerging markets. Even as we face challenging supply constraints, generic competition and macroeconomic uncertainty, I remain confident in the resilience of our business and colleagues, as we finish 2022 and we go into 2023. Given the importance of the companionship and nutrition provided by pets and farm minimals and the power of the human animal bond, the animal health industry has consistently grown in the mid-single digits, even in down markets. And as the leader in animal health, we have the pipeline, market leadership positions, global scale and financial strength to continue outpacing the market. Throughout the last 10 years in various market conditions, we have grown the top line an average of about 8%. And even in the last recession, when our business was more livestock than companion animal, we still grew. As we look toward the end of the year and into 2023, I expect us to continue setting the bar on innovation, cultivating a high-performing culture and delivering superior customer experiences. All of this will have us growing significantly above the market and building enduring value for shareholders in this dynamic market. Thank you. Now let me hand things over to Wetteny. Wetteny Joseph : Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a solid quarter with growth across a number of our core franchises, driven by our companion animal performance, especially in international. Today, I will focus my comments on our third quarter financial results, the key drivers contributing to our performance and provide an update on our full year 2022 guidance. In the third quarter, we generated revenue of $2 billion, growing 1% on a reported basis and 5% on an operational basis. Adjusted net income of $566 million declined 5% on a reported basis and grew 2% on an operational basis. Of the 5% operational revenue growth, 4% is from volume and 1% from price. Volume growth consisted of 4% from new products, which includes Simparica Trio and our monoclonal antibodies for osteoarthritis pain in dogs and cats, Librela an Solensia and 1% from key dermatology products, while other in-line products declined 1%. The decline was largely the result of supply challenges. Companion animal products continue to be the primary driver of growth, growing 10% operationally, with livestock declining 3% on an operational basis in the quarter. Simparica Trio was the largest contributor to growth in the quarter. Trio posted global revenue of $172 million, representing operational growth of 43% versus the comparable period in 2021. We expect to continue to grow the addressable market for flee, tick and heartworm globally and see significant room for growth with brands like Simparica Trio, Simparica, ProHeart and Revolution Plus. Meanwhile, our key dermatology products, Apoquel and Cytopoint, had solid global growth, especially internationally, with $343 million of revenue, representing 11% operational growth against a robust prior year in which these products grew 26% operationally. Year-to-date revenue is $966 million, representing 18% operational growth. Sales of our monoclonal antibodies for osteoarthritis pain in dogs and cats in International continue to exceed expectations, posting $37 million of sales in the quarter. Switching to Diagnostics. Our global Companion Animal diagnostics portfolio recorded $78 million in revenue in Q3, declining 9% operationally. Despite declining revenues, we saw solid new instrument placements in the quarter. The decline in our US diagnostics portfolio was partially offset by growth internationally in the quarter. In the US, our diagnostics results were also impacted by the vet clinic workforce challenges, and we continue to experience a slowdown in sales as we transition to our new go-to-market model and build out a sizable and new dedicated field force for diagnostics. While disruptive in the short term, this investment is putting the necessary elements in place to position and grow our diagnostics portfolio over the long run. We expect the effectiveness of our new diagnosis field force to improve gradually into 2023. Diagnostics remains core to our business and a key long-term growth driver for Zoetis. Meanwhile, sales of lifestyle products declined by 3% operationally in the quarter. Our portfolio continues to be challenged by generics and cheaper alternatives to Draxxin in cattle as well as Zoamix in poultry and supply challenges for certain products. Our fish portfolio grew 19% operationally in the quarter and along with the strength of our sheep products in Australia, partially offset the broader decline. Now moving on to revenue growth by segment for the quarter. US revenue was $1.1 billion in the quarter, growing 2%, with companion animal sales growing 6% and livestock sales declining by 7%. Focusing first on companion animal. The effects of our ongoing supply challenges were more pronounced in the third quarter, tempering growth in our parasiticides. In US companion animal, we are also seeing vet clinic workforce challenges limiting appointment availability as visits declined 4% in the quarter. Despite lower visits, practice revenue is growing approximately 5% and as spending per visit remained strong again this quarter, increasing more than 9%. The decline in clinic visits is stabilizing at pre-COVID levels, as the impact of higher pet ownership growth rates due to COVID normalize and vet practices deal with workforce challenges. However, underlying demand for veterinary care remains robust throughout the country, even as people return to work. While vet clinic workforce challenges do exist, we believe vet clinic revenue will continue to grow at levels above what we were seeing prior to COVID as the standard of veterinary care continues to increase through innovation, better pet ownership demographics, higher compliance and more pets. Even with the robust comparative year, we continue to see volume growth in our companion animal products, driven by our innovative products, such as Trio and our key dermatology products, Apoquel and Cytopoint. Growth of Simparica Trio was again strong in the quarter with sales of $157 million in the US, growing 43%. Despite the impact of supply constraints and the vet clinic workforce challenges, we continue to take share within individual clinics. These dynamics will provide additional runway for future expansion of both the broader market and revenue growth for Trio. Key dermatology products sales in the US were $231 million for the quarter, growing 6% with Apoquel and Cytopoint each contributing to growth. Year-to-date, our US derm portfolio has grown 12%. Growth is tempered by prior year cover related spice in derm visits that drive visit growth of 25% in Q3, 2021, and help accelerate market expansion. This growth was also impacted by the ongoing pet clinic workforce challenges. We expect continued expansion of the market for the foreseeable future. US livestock declined 7% in the quarter as expected, with sales of cattle products impacted by generic competition for Jackson. Meanwhile, our US poultry portfolio continues to be negatively impacted by the expanded use of lower cost alternatives and generic competition for Zoamix. US swine product sales declined 3% in the quarter, driven primarily by increased competition for vaccines. Moving on to our International segment, where revenue declined 2% on a reported basis and grew 8% operationally in the quarter. International Companion animal revenue grew 17% operationally and livestock revenue was flat operationally. Increased sales of comparing animal products resulted from growth of monoclonal antibodies for alleviation of osteoarthritis pain, our key dermatology products, and Simparica Trio. We remain excited with the long-term prospects of these innovative brands and expect future direct-to-consumer advertising to help drive additional growth. Sales of companion animal vaccines also contributed to growth in the quarter. We continue to be pleased with the performance of our monoclonal antibodies for OA pain with Librela generating $31 million and Solensia delivering $6 million in third quarter sales. Librela remains on track to exceed $100 million in revenue this year, a new blockbuster for Zoetis. As we have mentioned in prior quarters, Librela is the number one pain product in the EU with the underlying performance metrics being very favorable for future growth. Reordering rates remain high. Compliance continues to exceed our initial expectations and we continue to see significant opportunity to expand the pain market with a meaningful percentage of dogs on Librela being new to the market. We saw volume growth in our international companion animal portfolio in the third quarter and we also saw growth across our injectable products, including monoclonal antibodies and vaccines. Meanwhile, international livestock was flat operationally in the quarter. Our fish portfolio grew 19% operationally and experienced increased demand for vaccines in key salmon markets, including Norway and Chile. Sales of sheep products grew as a result of favorable market conditions and new product launches in Australia. Growth was offset by swine sales, which declined due to supply constraints across international and lower sales across Europe due to reduced exports to China and higher input costs for producers. Sales in Brazil also declined as we are seeing supply challenges on cattle products. Additionally, inflationary impacts on consumer spending are driving consumption away from beef to lower-cost animal proteins such as pork and chicken and reducing reducer profitability. Lastly, the Jurox acquisition, which is based in Australia, was completed on September 30 and is not reflected in our Q3 results. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 69.8% decreased 90 basis points on a comparable basis to the prior year, resulting primarily from unfavorable foreign exchange impacts. Operationally, gross margin slightly declined, driven by higher manufacturing, freight and other costs, which were largely offset by favorable mix and price. Adjusted operating expenses increased 3% operationally, with SG&A growth of 3% operationally, driven by T&E costs beginning to return to pre-COVID levels as well as freight and logistics. R&D expenses increased 4% operationally due to higher compensation costs and higher operating costs. The adjusted effective tax rate for the quarter was 20.9%, an increase of 420 basis points due to unfavorable changes to the jurisdictional mix of earnings, including decreased favorability related to foreign-derived intangible income in the prior year period. And finally, adjusted net income grew 2% operationally and adjusted diluted EPS grew 4% operationally for the quarter. Capital expenditures in the third quarter were $154 million. In the quarter, we repurchased approximately $375 million of Zoetis shares and returned over $0.5 billion to shareholders through a combination of share repurchases and dividends. Year-to-date, we have repurchased almost $1.2 billion of Zoetis shares. Now moving on to our updated guidance for the full year 2022. For operational revenue growth, we are lowering our growth to 7% to 8%, previously 9.5% to 10.5%. We are also lowering our operational growth expectations for adjusted net income to a range of 9% to 11%, previously 11% to 13%. This change in guidance is reflective of our Q3 results, continued impact from supply challenges and the ongoing veterinary workforce challenges. Foreign exchange rates on our updated guidance are as of late October and reflect the continued strengthening of the US dollar. Beginning with revenue for the full year 2022 due to lowering of our guidance and the impact of foreign exchange, we are now projecting revenue of between $8.0 billion and $8.075 billion. We lowered our operating expense guidance for the full year, reflecting lower expenses in both Q3 and Q4, which reflects our ability to manage costs. Additionally, it is worth noting that our expected Q4 expense decline is also impacted by an easier comp due to heavy spending in the fourth quarter last year. Additionally, our guidance for adjusted interest expense and OID was changed to reflect favorable changes to interest income. We now expect adjusted net income to be in the range of $2.27 billion to $2.31 billion. And finally, we expect adjusted diluted EPS to be in the range of $4.83 to $4.90 and reported diluted EPS to be in the range of $4.51 to $4.59. While lower, our full year 2022 guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue over the long term. Our success will continue to come from our diversified portfolio of enduring brands driven by multiple sources of in-line growth, productive innovation and our infrastructure to develop and expand market globally. We expect to continue to execute across multiple dimensions of our business and capitalize on key growth opportunities for the foreseeable future. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : Thank you. [Operator Instructions] We'll take our first question from Erin Wright with Morgan Stanley. Please go ahead, your line is open. Erin Wright : Great. Thank you for taking my question. So when we think about some of these headwinds and tailwinds related to 2022, what is now proving to be more challenging than anticipated? Is it mostly the supply chain issues, or is it other factors here? And can you quantify the supply chain constraints, what sales would have been excluding these dynamics? And then, how should we think about those broader headwinds and tailwinds from an operational perspective into 2023, as we think about both livestock and companion animal, should low single-digit livestock growth in 2023 be the right way to think about it? And then, if that's the case, how do we think about companion animal operational growth in 2023? And I'll stop there. Thanks. Kristin Peck : Sure. Thanks, Aaron. I'll start and I'll let Wetteny build on this one. I mean, I think, the first thing to start with is fundamentally and structurally the veterinary business and importantly, demand for our products remains stronger than it was before COVID. I think we've got still a very healthy business. If you look at sort of the headwinds as we looked at the second half of this year, by far, supply was the biggest, and I'll let Wetteny comment on sort of sizing them I would say that was the significant driver for us in Q3. And as we look into Q4, I mean, certainly, we can talk about vet clinic visits as well. But I think for us, we really believe that the supply issues that we were facing were really the primary driver for us. And as we look into 2023, I think the really good news around that is -- as we look at the ones we faced this year, as we talked about supply from the beginning of the year, we had MABS issues. We worked through that. We're now in full supply on our MABS in all the markets that we've launched in. So I think that one is one we've addressed. We did have paras challenges in Q2, Q3, honestly, our supply came in too late in Q3. And I think if you look at Simparica Trio in particular, our competitors took advantage of the top shelves. And so it's taken us a little longer to get back on shelf than we had hoped. But again, I think the paras problem will work itself out as you look into Q4. We have challenges as well in Rev. for Rev and Simparica, Q3 is a really important quarter for us. And so I think you saw that. I think, again, the really good news is demand remains strong for these products, and we've addressed most of those supply issues. There'll be some small ongoing ones, as you know, in our industry, Aaron, you followed us a long time. We always have challenges around vaccines. When you supply as many products as we do across as many species globally, there's always some level of it, and some of those will continue into next year. But we're really confident that the biggest challenges we were anticipating this year around MAB have been addressed. As you look at paras, both Trio and Rev, we'll work through that by the end of this year. We have really clear plans in place. I mean, obviously, there'll be some ongoing one in vaccines, but that's more usual, of course, but Wetteny, do you want to sort of get some for second and third questions? Wetteny Joseph : Yeah, sure. Erin, as we've been saying throughout this year, supply certainly remains a headwind to meeting global demand. And as Kristin mentioned, the timing of recovery on some of these is very important. So as we went throughout the year and face supply constraints, particularly in Trio, despite the fact that Trio has performed really well for us, growing 65% on a year-to-date basis. The reality is, we had outages throughout the peak parasiticide season for Trio to Q2 and Q3, though we recovered late in Q3, the impact was such that we allowed competitors to be more aggressive about placing products on shelves, which we saw that impact as we exited Q3. But going forward, we do anticipate continuing to see some impact for Revolution, Revolution Plus, where we are selectively looking at key markets to deliver those products against others. So that is something that we're carrying into the fourth quarter, and we have reflected in the guidance that we have issued today. So while our business faces other impacts outside of supply, whether it's workforce or macro in certain markets. By far, the supply constraints are the biggest impact here, looking at how we've seen the year sort of transition versus what we saw earlier. And so, if you look at the guidance change here of about $200 million reduction in guidance, I would say, FX and supply account for more than 75% of that, with supply being by far the largest majority of that. Operator : Thank you. We'll take our next question from Michael Ryskin with Bank of America. Please, go ahead. Michael Ryskin : Great. Thanks. And I have a quick follow-up on that last point and then touch on something else. So on the supply issues, I think a lot of what you just commented on, Kristin and Wetteny was that, as you guys have these challenges in the quarter, your competitors took advantage of stock shelves. How should we think about that longer term? Is that a temporary switch over? Meaning, can you gain that back once you resolve especially some of the older products of Revolution, but also Trio, whether that happens this quarter or next quarter, are you going to be able to push those competitors out of those positions easily, or is that something that’s going to be a little bit more of a challenge to regain your footing there? And then, I also want to touch on Librela approval. It seems like that time line has slipped a little bit with the OUS inspection date. I'm just wondering, how does that change your launch expectations and ramp expectations in the United States. I mean, you talked about second half 2023 or later in 2023 launch. So just walk us through the dynamics there. Thanks. Kristin Peck : Sure. I'll start and I'll let Wetteny build on this one. As you think about competitors, yes, I am very confident that we will get our shelf space back, and there's -- this is -- I very much see this as temporary. We're not worried as Wetteny said, this product is really well received by our customers and by pet owners. It's growing 65% on the year. So I am very confident we will get that back. So I see that absolutely as temporary. So I think the other important thing here as we look at Simparica Trio, in particular, is that, when it comes to competition, the latest update we have is we are no longer expecting competition early in 2023 based on what we're hearing. As always, this is hard as a private company, and no one gives us much information on some of the private companies here and that a lot of them are not public, but our basic intelligence at this point is, we don't see something launching against us as well early in the year, and we'll clearly leverage that opportunity to gain share as well. So I think that is also incremental news as we think about Trio. And when it comes to Librela, I mean, obviously, we were hoping for an approval this year, depending on when we get it next year, we just have to -- everything moves based on what that is. So we're still obviously hoping for a launch as we expected. But without knowing the exact timing of the approval into next year, it just moves proportionately, as you probably know. So I think that's just the only incremental news there. We're confident, well, no matter what, we'll get a launch next year. But the timing of it is just we'll have to update it once we get the final approval on that. I don't know, Wetteny, did I miss anything there? Wetteny Joseph : I'll just add a couple of points on Trio. Look, if you look at combination, flee, tick, heartworm, it's still a relatively new standard of care. And what you continue to see is in this very important part of the market, which is north of $5 billion globally. This expansion going from topicals and orals -- topicals and collars into orals and then now with triple combinations, we'll continue to expand that into the market and grow the market as well. So even with competition, we expect to continue to grow. So this dynamic that we described that occurred as we exited Q3 -- between Q2 and Q3, we see that as a temporary effect, and we'll continue to drive our share here. And particularly, since we are not anticipating a delay in terms of competition, though it's hard to say exactly when it will come. It could come in 2023, but we don't expect it early in the year. With respect to Librela, what I would say is, we continue to be extremely pleased and the product continues to perform better than our expectations across Europe. And though we've had capacity constraints that didn't allow us to be able to take full advantage of demand this year and we've had to actually make trade-offs in terms of delaying launches in other markets. As we exit the year, we anticipate next year being able to launch the product in additional markets outside the US and outside of Europe. And the product, again, continues to perform really well for us. So we're very pleased with that. And so this sort of delay in terms of when the actual approval will happen in the US, given the dynamics we're seeing in terms of the expansion of 40% of the dogs that have been put on the product and new to the market. The less of time duration of use of the product, et cetera, all bode well for sort of continued growth in this area and expansion of the pain market beyond the timing of the launch, et cetera. Operator : And we'll take our next question from Nathan Rich with Goldman Sachs. Please, go ahead. Nathan Rich : Great. Thanks for the questions. I had a follow-up on the supply constraints as well. Wetteny, it seems like based on your commentary on the second half revenue revision, the supply constraints would be something like a 200 to 300 basis point impact on second half volumes. I just wondered to see if that number is in the right ballpark. And as we think about the go forward, will there be a headwind in 4Q? It sounded like those -- a large majority of the constraints that may have been resolved by the end of the third quarter. Just wanted to see what we should expect for the third -- for the fourth quarter, excuse me. And then into 2023, would you anticipate there to be any lingering supply constraints or should everything be resolved at that point? Thank you. Wetteny Joseph : Yes. So, look, what I would say is, supply issue is not unique to us, given the wide variety of products and species. It's relatively commonplace in this industry, as I've learned coming in about a year-and-a-half ago. I think the level that we're seeing now is certainly elevated over the last couple of years. And in particular, we saw more of an impact here in Q3, given the timing of our recovery on some of these, right? So I do think we expect to see some continued impact into Q4, but we reflected those in the guidance that we just issued today. I mentioned Revolution, for example, being one of them and quite frankly, throughout the years in the MABS where we are confident in our ability to fulfill demand next year, not only in Europe but other markets outside of Europe. We've made trade-offs in MABS even between, for example, Cytopoint and Librela, right? So I do think those impacts have had their effects on this year. But as we go into next year, we're confident in those. I think vaccines is an area that you typically see certain supply constraints in and challenges, and I think we'll continue to see those into 2024 and as we exit the year, we'll continue to make progress on Revolution, but it is certainly having an impact on the fourth quarter as well is what I would say. Of course, we'll have a lot more color to provide on the next call with respect to 2023, but we feel confident on the biggest products that have the greatest impacts. If you look at Trio from a parasiticide perspective, confidence in terms of supply going into next year. And for our MABS, particularly Librela launches, et cetera, and for Cytopoint for next year, we feel very confident about that as well. So those are big movers for us going into 2023. Operator : And we'll take our next question from Louise Chen with Cantor. Please go ahead. Your line is open. Louise Chen : Hi. Thanks for taking my questions here. So I wanted to ask you with the potential competition coming for some of your key products next year. Do you still think you can grow through those if they do come next year? And then second question I had for you is on innovation and livestock. When do you see that next phase of innovation and when will we possibly see growth getting beyond that sort of 3% to 4% that we've seen historically for a while? Thank you. Kristin Peck : Sure. Louise, in your first question with regards to competition, I think the good news is we're not expecting competition early in the year anymore on Trio. But regardless of when competition arises, I do think we'll continue to grow through this. If you look at this category, even when [indiscernible] were introduced and you saw one then two then three, this category grew, we launched a triple combination, and we grew incredibly well. I think there was plenty of space here. Wetteny mentioned earlier, there's still movement from topicals and collars and this is a really innovative category. So I do believe you'll continue to see growth. As you look at dermatology, I would say the same thing. I think a competitor can help us continue to grow this market. There are still 6 million untreated dogs. The usage of this product in international is still significantly below that of the US when you have the same number of dogs with the conditions. So we continue to believe there is growth across these. Obviously, growth may decelerate in derm with a competitor, but I still think these are going to be growing markets. I think the innovation. And don't forget, we continue to look at life cycle enhancements for all of these products. We are not stopping with what we have. So I think there's a lot of visibility into a competitor might come, but not necessarily some of the innovations in these key product categories that we'll continue to do. With regards to innovation and livestock, Wetteny, do you want to take that one with regards to growth rates? Wetteny Joseph : Yes, sure. Look, I think if you look at livestock, as we said, this is a segment that has grown in the sort of 3% to 4% range historically. And given the impact that we're seeing from generic competition for Draxxin, Zoamix, et cetera, we've been performing below that. But as we sit here, if we, for example, were to pro forma out the Draxxin impact, you would see growth in our livestock business, even in the quarter that we delivered negative 3 on Q3, which is similar to last quarter. And so, I think, as we look to exit this year, I think livestock will be slightly below the performance you saw in Q3, given the intensification of some of the generic competition. But beyond that, as we look beyond out exiting 2023 into 2024, et cetera, we'll have to take a look at what the macro is. I think if you look at cattle in key markets across Brazil, and elsewhere in the US, we'll have to really continue to look at what the macro is. But in terms of innovation, we continue to make innovation that, quite frankly, you're not seeing the impact of them in the current year because of the impact of generic competition. So if you look at inhibition in terms of poultry with vector vaccines that we're starting to launch in the US. If you look at some of our swine vaccines that we're launching elsewhere, we've had some supply constraints in those as well. So you're not seeing the full effect of those. But beyond this year and beyond the generic competition is that sort of supply pull, you start to see growth coming out of our livestock business. I just want to make one more point going back to derm. We don't -- last earnings, we said we don't see competition for derm in the first half of next year. Now, three months later, there's still no new news, right? And so, I think, as you know, in the space, it's not that we have specific data on what folks have. And so, it's about a six-month time frame that we look ahead. And three months later, we still don't see anything. So it's not to say that we expect competition next year is just we don't have any data that says there will be any in the first half. So I just want to make that clarifying point as you asked the question around competition next year. Operator : And we'll take our next question from Jon Block with Stifel. Please, go ahead. Your line is open. Jon Block : Thanks, guys. Good morning. I'll ask both upfront. I think the 2022 out margin was, I believe, largely unchanged despite the lower revenue. And Wetteny, you mentioned managing OpEx, but I think you guys also wanted to invest, you've got some notable new opportunities in front of you. So how do we think about that? In other words, is this an OpEx push on the investment into 2023, or should we still expect the bottom line growing decently above the top line next year 2023? And then Kristin, just to shift gears, can you just maybe elaborate a little bit on, call it, the company's line of sight into these supply constraints fully resolving in 2023. At least for me, it seemed like the Trio issue came as a little bit of a surprise. And maybe just a tack on to that, do we think of these sales as lost, fully lost or at least a portion push? Because I would think from a consumer to go from -- to a triple and then back to a duo, is there something where some of these can be recouped in the early part of 2023? Thanks, guys. Wetteny Joseph : Yes. So I'll take the first part of the question in terms of how we see margins and investments, et cetera. We've made a number of investments across the business, whether you look at what we're doing in R&D, what we've done with respect to our field force, and we'll continue to do across the diagnostics in our pet care field force, for example, in the US, we're making investments across our supply chain and manufacturing, obviously, given the demand we're seeing across our products and anticipated launches of other products out into the future. So we'll continue to make those investments, but we do have the ability to manage discretionary spend and you see that play out in the third quarter, where OpEx was below top line growth. And in fact, other than the tax rate difference to last year, if you look at our earnings before taxes, those grew at 8% on a 5% top line growth. So you see that leverage playing out in the P&L. And we have the ability to continue to do that. And I think we'll continue to use price to drive margins. The mix is favorable to us, given companion animal continues to grow faster than livestock. So companion animal grew 10% in the quarter where livestock declined 3%. So that mix is favorable to us, although, we see some offset with respect to inflation and so on, but you continue to see those drivers, and we can anticipate those going into next year. So we'll continue to make investments in select areas, again, prioritizing R&D prioritizing manufacturing and supply chain, for example, but we'll manage discretionary spend elsewhere to still deliver a leveraged P&L, which is what we've said. Now there may be quarters, where that doesn't play out exactly. But I think if you look at a year, you will see us continue to do that. And that margin between top line growth and bottom line growth may be less than what the business naturally can do, but that's because we're making investments where we see the need, but we will still manage to deliver annually a leveraged P&L is our target. Kristin Peck : And sure, I'll take your second question around visibility into supply resolution. When we started the year, like many companies across many different sectors, we knew supply challenges would be there waiting on things as you look at ones where -- to your point, were we a little surprised by what happened with specifically Trio and Rev. I mean the honest answer is yes, we thought they would resolve faster. It's not that we weren't aware this was a capacity issue. We needed to build capacity and specifically some of this at a third party. And honestly, getting that third party on took us a little longer than we expected. We set a really an OpEx team over there to try to work on it and the timing of the resolution took us longer than we expected on that one. Why am I have visibility to why I say it's better, because we're having a weekly call, I'm looking at their output on a weekly basis for both Revolution and Trio, and they're doing really well. I think they're delivering consistently. They're up and running. And so I have visibility, and that's why I have strong confidence. And that's why Wetteny has strong confidence that as we look in to resolve through Q4, we're managing through back orders right now. So we just got to get product out to market, and we're prioritizing the markets at the biggest ones and right now, and we'll get it to everyone by the end of this year, early next year. But when you're back, a few months on a product like Rev+, for example, in markets where that's a huge product, it takes a little while to get them fully back in supply. And that's why we have full confidence. We knew what the issue was. It was capacity there. With Librela and Solensia, it was component parts, and we knew we were competing as well. That's why Wetteny was talking about, we were making trade-offs between products there. We have that in full supply. A lot of these were some were COVID-related. Some of these were capacity related and some were component parts related. It's been challenging for many companies to work through this. But we are as a leadership team managing this very carefully as Wetteny and I said in the first and second quarter calls, constantly working with GMS, we have full visibility into what is happening for each of these products, and that's why we have confidence as to when they will resolve and when we'll get into full supply in key markets. So hopefully, anything else want to add there. Wetteny Joseph : Look, I just think one of the things that I've really learned in the last 18 months be in this space is, it's not if you recover from a supply constraint, it’s when you recover really matters. So we talk about that already in parasiticides from a season perspective. But that's true across livestock. If you look at gaining supply in time for fall cattle run in the US is important. And so, if you missed that window, you have a greater impact than you thought. So if you were planning to and executing towards the timing of that, and you cover a little bit later, that's where you start to see the impact. And I think that's what's played out here as we exit Q3 and why some of this might appear as a little bit of a surprise to you. Operator : And we'll take our next question from Brandon Vazquez with William Blair. Please go ahead. Your line is open. Brandon Vazquez : Hi, everyone. Thanks for taking my question. I wanted to focus on -- we have talked about 75% of the lowered guide was FX and some of the supply constraints. Maybe that smaller portion, the 25% and less, I think, was vet staffing issues. So maybe, can you talk a little bit about what kind of changed what incrementally maybe got worse in the vet staffing issues, how that's trending into the fourth quarter, so we can kind of frame up how that might be a headwind as we go into 2023? And really how -- what kind of confidence you have that, it's not maybe a demand issue as macro conditions worse and it's really just a vet staffing issue? Thanks. Kristin Peck : Sure. I mean, look, I'll go back to where I started. If you look at demand at the vet clinic, there's no question that it is fundamentally remaining strong. Current staffing and vet visits is ahead of where it was pre-COVID. So this is not like, Oh My God, everything went down, where are we going. It is a realignment. And I think what -- why are we confident in demand? Well, there are more pets, I mean, why we have a capacity problem is not actually that there are fewer visits, is there are more pets than we had before as we saw the sort of pandemic boom. The pet parents are more millennials. They spend more time on their pets, spend more money on their pets. They're more invested in the preventative care of their pets, which increases demand. So we remain very confident that demand is very strong. It has proved resilient through other challenging macroeconomic times. So what we need to work with vets on is how to better leverage vet techs and other ways to make sure that they can see as many pets as they possibly can. So we remain very confident, this is not a demand issue. It is a capacity issue. We have to create more capacity than they had pre-COVID. There's ways of doing this by helping them improve their productivity across the different spaces. But, I mean, just putting that in numbers, why are we confident there we're fine is, if you look overall right now, the spend per visit is up 9% and clinic revenues are up 5% in the quarter. We did see a 4% decline in vet visits, but that was over a quarter at unprecedented levels, if you look back to last Q3. So the veterinary industry is structurally and fundamentally in good shape. We have to help them create additional capacity for all the new pets we have, but I think demand remains strong. Wetteny Joseph : I would just say, look, as I said earlier, there are other factors that impact our business. I mean you do see some macro in some select markets. So if I look at Brazil, for example, you see a trade down from beef to poultry and swine. If you look at China, we continue to see lockdowns impact consumption, particularly on the livestock side. But if you look at companion animal performance, even in those markets, despite the significant letdowns in China, you see strong double-digit growth in companion animal. We saw double-digit growth in companion animal even in Brazil, despite the macro. So I do think this speaks to the resiliency of particularly on the companion animal side of the space, even in challenging macro areas. And then, the other thing I'll say with respect to a very strong comp is, if you look at derm, our third quarter last year, derm grew 26% globally. It was north of 20% in the US. And so when you have labor capacity constraints at the vet clinic, being able to perform above that level of growth from a prior year perspective becomes a challenge. So, again, supply is by far the biggest challenge we faced all year and certainly in the third quarter. But the macro continues to be largely from a demand perspective, remaining strong. Operator : And we'll take our next question from Chris Schott with JPMorgan. Please, go ahead. Chris Schott : Great. Thanks so much. Just a couple of quick ones here for me. I just want to come back to Trio. With this competitor delay that you're talking about for early next year. I just want to make sure I'm clear. Is there going to be any supply issues as a rate limiter for growth of Trio in 2023 or was this more of a onetime issue in 2022. So, I guess, can you fully take advantage of that delay in competition as we think about the spring season next year? And my second question was on the ongoing supply issues. I know this is -- in the near term, you can't do much about this. Is there an ability to either hold higher inventories or just think about supply differently kind of going forward to ensure that, I guess, these issues don't happen again in the future. Again, I know you can't deal with that in the 3Q, but just as we think about kind of 2023 and beyond, or do you view this, as discussed, a moment in time where there's not much of an ability to manage this? Thanks, so much. Kristin Peck : Sure. As you look at Trio for 2023, yes, we will be able to leverage the opportunity. Again, the challenge we had this year was getting new capacity online with a third party that took us longer than we expected. That is online and performing well. So we remain confident going into next year that we can leverage that opportunity and certainly have plans in place to do so. And your second question was around -- what was your second question? Chris Schott : The ability to manage inventory and so on to -- Kristin Peck : Yes. I mean, look, we're holding -- by the way, we have tried to do that already. If you look -- focusing on resilience and managing inventory better. If you look at our inventory, we've invested a lot in making sure that we have component parts. As we see in our industry, being out of stock has a significant cost for the company. So we're certainly looking at how we can invest in that. But prudently, a lot of the buildup you're seeing right now is in raw materials and things like that to make sure we have on hand what we need to make it, and we're focusing that on our most important products. So you can manage a lot of this through inventory, assuming you have capacity. But if you look at the biggest challenges we faced this year, it was getting on board capacity in key products and getting some of the component parts for things like MAB. And we have figured that out, but -- in the sense of the MAB, and we do have the capacity online. So you do -- you can definitely leverage inventory in certain cases, except when your challenge is capacity or a component part. But I don't know if you want to add to. Wetteny Joseph : The only thing I would say is, look, the actions we've taken this year will continue to execute against give us confidence in our ability to capitalize on the opportunity here with a delay from a competition standpoint. But what we've learned over the last two-plus years is, things happen in this world, whether it's US or Europe and so on. So barring any sort of major events, we do feel confident with our ability to capitalize on this and execute to meet the demand for the product. And we anticipate we'll continue to see demand beyond when a competitor comes into place as well, for the reasons we've already stated. Operator : Okay. We'll take our next question from David Westenberg with Piper Sandler. Please go ahead. David Westenberg : Hi. Thank you for taking my questions. Most on supply chain have already been answered. So I'll start with Librela, I think you mentioned it's a blockbuster. It's only outside of the US. I think we typically think of animal health as being or companion animal as being kind of half in the US, half outside the US. Is there something specific about outside the US that's made it resonate so well, or should we still think of this as maybe a $200 million product if it was available in the US? And then a question for Wetteny, you mentioned a lot more, I think, on competition in livestock and I've heard commentary in the past. I mean, I think you said poultry vaccines and Draxxin. Draxxin, of course, has been the ongoing issue. Can you talk about -- is there a way to quantify how much more this quarter or what we're seeing now is competition versus just dynamics across livestock because, of course, dynamics across livestock have been a little bit on the weaker side. And I just want to see how much is transitory and how much of this might be permanent. Thank you for the questions. Kristin Peck : Sure. So I'll take your first question, and I'll let Wetteny take the second question. As you think about Librela, we are proud that it is a blockbuster in its first full year in launch outside the US. I would note that it hasn't even been launched in every market outside the US. I wouldn't even say it's everywhere there. And if you just take a slight step back here, as you look at the pain category globally in dogs, traditionally, it's been about a $400 million market. We believe with this product, we can double the size of that market. And we've talked about this before, taking a $400 million market to an $800 million market. We believe we can do this, because we think this product's efficacy is really, really strong. And so, if you think about that, we think we can get more dogs to be cared for. It doesn't have some of the safety profile issues of other products. We're seeing that people are staying on it longer. It is already in Europe, the number one pain product, as you think about it. So we are -- we very strongly. If you look at this, 40% customers to Librela are new to the category. This really speaks to the power of this product, that's excitement with us. And we're seeing a 90% reorder rate. So I think you're going to see significant potential for this product, as you look at growing it outside to other markets as Wetteny mentioned earlier, beyond the ones that's already launched in international. And then certainly, when you add to the US. We've seen in some of these really advanced technology products, the US is often bigger than international on most of these products. So we remain very optimistic for the success of this product, just based on so far, it's -- we've talked about this on previous calls, it's done incredibly well and where we've even been upside surprise, is how many months many customers are staying on it. So, we'll continue to see how that evolves over time, but we're very optimistic about this product, not just in international, but as we bring it into the US and as we expand it across international. But Wetteny, do you want to take the second question on livestock? Wetteny Joseph : Yes, sure. Look, the first thing I would say is, there is no structural change with respect to the competitive nature of livestock. It's always been competitive and it remains so. So our commentary here today and what we've been talking about over the last couple of years isn't necessarily different. What is, is that generic competition has had an impact on us over the last couple of years as we anticipated, as we said. So Jackson, if you look at Jackson prior to LOE, we are roughly in the mid-$300 million, let's call it, $350 million in revenue. That by far, the largest sort of individual product within livestock. And so, certainly, as we anticipated, about a 20% impact in the first year, another 20% in the second year. The first year was a little bit better than that. It was south of 20%, but the second year is above that. And so, still in the neighborhood, maybe a little bit worse than what we thought initially, with respect to Jackson, but there's no other large product like that. I would say, in the portfolio, though Zoamix also has seen some competition, but it was nowhere near the size of a Jackson. So short story is, no change in terms of what we're seeing in terms of the competitiveness of livestock, is just a little bit more intensification in terms of products that have become generic if they are sizable. Operator : And we'll take our next question from Steve Scala with Cowen. Please, go ahead. Steve Scala : Many thanks. First, just to clarify, in the prepared remarks, it was stated that supply challenges were more pronounced in Q3 and that there is increased uncertainty. Can you clarify why supply challenges peaked in Q3 and why there is now more uncertainty as opposed to what was seen in Q2 or apparently what is anticipated in Q4? And then secondly, China lockdowns were mentioned. Can you quantify the impact? And then lastly, what is the capacity of Lincoln to manufacture the pain monoclonal antibodies? I thought at one point, some small-scale manufacturing was done there. Is that a possibility to be expanded? Thank you. Wetteny Joseph : So I'll start and see if Kristin wants to add anything. With respect to the supply challenges, I think we've described in a fair amount of detail what we saw happen and why the impact was more noticeable in the third quarter, though we also made significant progress as we exited the quarter. So the impact that we're seeing in the third quarter, if we double-click on parasiticides, for example, particularly with Trio, I mean, from Q1, we have -- we've had outages on Trio across certain strengths, et cetera. And we continue to run with constraints throughout the year. But in particular, in Q2 and Q3, those outages really left more space across vet clinics for competitors to fill those shelves. And so, as we got into Q3, again, continuing to be in the parasiticide season, we saw switchovers with respect to new patients coming off of collars and topicals, for example, going into orals, rather than coming into our product going into some of our competitors, because our competitors filled shelves when we had gaps. So that's why we saw a bigger impact in that in terms of what we saw, particularly for Trio. Revolution’s been an issue, quite frankly, throughout the year and remains so, even as we've gotten into Q4 here, which is why we say we continue to see uncertainty in certain products here. Vaccines, I would say, a relatively commonplace across the industry in terms of having supply issues. And again, we've seen a little bit more of those this year. And again, particularly in Q3, given the cattle run in the US in the fall, et cetera. So we saw some of that -- the impact of those outages more pronounced in the quarter. So hopefully, that gives you plenty, if there's a follow-up, I'm sure you can take it up with Steve offline as well. But that's the detail that we've shared. With respect to capacity for MABS, these are long lead time areas, right? If you take the time to manufacture, it's long lead time, the time to add capacity in monoclonal antibodies is also relatively long. So we've been working on those for some time, which is why, as we've gone through this year, we -- and we express confidence into next year being able to not only capitalize on demand that we see across Europe, but we'll be able to launch in other products outside of Europe across our international segment with confidence, because we have been able to expand in various areas. I won't go into a specific site in terms of what their capacity is. But suffice it to say, our monoclonal antibodies manufacturing is more than just one location in terms of where we do that. And you've seen us take an uptick as well in terms of CapEx going from last year to this year, we've talked about that all year. And you continue to see an uptick in CapEx as we go into the next year or two as well, because we continue to make investments in capacity and monoclonal antibodies are an important platform for us, not only with respect to derm with Cytopoint with the pain franchise, but other products that we're working on in our pipeline, we require those. So we'll continue to make investments with respect to MAB on capacity. Kristin Peck : A few follow-ups there. I mean, for starters, the comment on uncertainty had to do with the macroeconomic environment. The question is, we're still seeing very strong consumer demand, but there's still a belief that we'll have potentially a recession in Q1, Q2, Q3. It was not about increased uncertainty, to be clear, in supply. It was uncertainty as to the macroeconomic environment and what we'll be looking at into 2023 or even in Q4. So let me be clear, the uncertainty comment that was not related to supply. The only -- the comment I'll make is with regards to the China question. I mean, look, in Q3, China grew 35% even with these lockdowns, again, underlying what we've been saying, the demand for our products remains very strong. What's important there is, if you look like four or five years ago, it was a majority livestock business. It became about 50-50 last year between livestock and companion animal. And if you look at it right now, the lockdowns are clearly impacting livestock, but companion animal, and given its close to 50-50, grew almost double what you see as China's growth that. So even with the lockdowns, we really see China remaining a strong market for us and growing quite well. So I think we can weather those lockdowns. I mean, look, if we -- the lockdown staff, which does not appear based on the news in the last 24 hours, to be something that's going to be happening in the near term, you might see livestock recover a little faster than what it is. But again, even in this environment, even with lockdowns, you saw 35% growth in Q3 in China. So I would just underscore that. Operator : We'll take our next question from Elliot Wilbur with Raymond James. Please, go ahead. Michael Parolari : Hi, guys. This is actually Michael Parolari on for Elliot. Thanks for taking my questions. So first one from me, you guys might have touched on this earlier, so apologies if I missed that commentary, but any early commentary on how we should be thinking about currency impacts on top line and margin trends into 2023? And then second question is, growth contribution from price this quarter, I believe, you said, was 1% compared to 3% over the past two quarters. Most of the industry seems to be moving in the other direction, given the current macro environment. So just wondering, if you guys could touch on perhaps what negatively impacted that growth contribution in the period and how to be thinking about that moving forward? Thank you. Wetteny Joseph : Yes, I'll start. And -- and see, what Kristin will add. First of all, with respect to currency, if you look at this year, top line impact from FX, given the strength of the US dollar is about 4%. So on the year, 4% which is roughly $39 million headwind versus prior year rates. If you look at the impact all the way down to the bottom line, it's about 8%. And so, from an EPS standpoint, that's about $0.36 of headwind. It's about $0.07 worse than our prior guidance, given the continued strength of the US dollar. So that's where we are. We're not going to forecast what FX might do. But our guidance is based on where rates were at the end of October here. And we'll continue to update, but we'll focus on commentary around operational growth given, given FX impact, but that's the impact that we're seeing this year. But if I didn't go into price here, on a year-to-date basis, if you look at our companion animal product sales and revenues, we've taken about 5% price on a year-to-date basis. And so, what is offsetting that largely is what we've been talking about here today, which is, the generic competition, particularly on Jackson, that's offsetting that growth where you see a net of 1% in the quarter. But on a year-to-date basis, our price is about 2%. If you include the impact of generic competition and higher than that without -- but companion animal is where we have innovative products, we continue to see strong demand, and we're taking price to the tune of about 5%. And if you look at our margins, roughly 90 basis points down year-over-year, FX is by far the biggest contributor to that. So if you take FX out, you've got about 20 basis points. So essentially, our price is offsetting increases in manufacturing costs, et cetera, being price and mix and so on is what we're seeing. So that's where the offset is. We're right about where you might see across elsewhere in the industry, our vet practices, given the strong demand we continue to see are actually taking price at or above what we're taking in that 5% on companion animal as well. Operator : And we'll go next to Balaji Prasad with Barclays. Please go ahead. Unidentified Analyst : This is actually Makayla on for Balaji. Thanks for taking my question. Just on Trio, just wondering what the penetration has been for corporate accounts and just how much room is left for further expansion? Thank you. Wetteny Joseph : Yes. So we've been very pleased with the penetration across large corporate accounts. We're about 90%, but we still see more room, even within those large corporate accounts to increase utilization of Trio. And we continue to work on those, and that's part of where our expanded field force in the US is focused in addition to, obviously, with the launches of other products, et cetera, and across derm to continue to penetrate and so on. So we've been very pleased with the overall penetration across large corporates. We continue to work on smaller and mid-sized accounts as well. And we see more room within those penetrated clinics to get better utilization on Trio. I don't know if you would add anything to that, Kristin. Kristin Peck : No. Operator : And there are no further questions at this time. I'll turn the call back over to Kristin Peck for any closing remarks. Kristin Peck : Great. Look, thanks, everybody, for your questions today and for your continued interest in Zoetis. Just to summarize, we continue to see strength across our diverse global portfolio, especially in our products for pet care and the fundamental drivers of animal health, as I've said throughout this call, remained fundamentally and structurally very strong. We continue to invest in talent and innovation, certainly in manufacturing expansions, as we've talked to you today that can support this future growth, while adapting and optimizing our business for the increasingly dynamic macroeconomic environment that we all operate in. We look forward to keeping you updated on future calls. Thanks so much for joining us today. Operator : Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,023
| 1
|
2023Q1
|
2022Q4
|
2023-02-14
| 4.914
| 4.88
| 5.436
| 5.4
| 7.4771
| 27.83
| 28.11
|
Operator : Welcome to the Fourth Quarter and Full Year 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. 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 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. Steve Frank : Thank you, operator. Good morning, everyone and welcome to the Zoetis fourth quarter and full year 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 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, 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, Tuesday, February 14, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve and welcome everyone to our fourth quarter and full year 2022 earnings call. Today, we reported strong full year results for 2022, in line with the high-end of our guidance from November and thanks to our diverse portfolio, global scale and talented colleagues. Our 8% operational revenue growth for the year was driven by our innovative companion animal portfolio, which grew 14% operationally while our livestock portfolio declined 2% operationally, primarily due to generic competition and market challenges, especially in the U.S. Thanks to our broad global scale and diversity, we delivered well-balanced operational growth across our U.S. and international segments, which grew 7% and 9% respectively. For the year, we generated operational growth in all of our top 13 markets despite the economic challenges, continued COVID recovery and political uncertainty created by the war in Ukraine. Reflecting our longstanding value proposition, we grew our adjusted net income faster than sales for the year with an operational increase of 11% for the full year and we use this performance and financial strength to continue investing in the R&D, manufacturing capacity and sales and marketing resources to support our future growth and pipeline. As we begin 2023, we will stay adaptable to the evolving macroeconomic factors and geopolitical tensions around the world and focus on executing our plans. We remain very confident in the fundamental and resilient global demand for animal care. And most importantly, we are confident in Zoetis’ ability to continue delivering solid sustainable growth as we resolve our prior supply constraints and build share of our market-leading franchises. Looking ahead, we are committed to our track record of value creation and above-market performance even in the face of today’s economic uncertainty. We are well positioned with our strategic priorities and capabilities to expand in large and growing product areas like parasiticides, dermatology products, monoclonal antibodies, vaccines and diagnostics. We are guiding to a range of 6% to 8% operational growth for revenue in 2023 and adjusted net income growth in the range of 7% to 9% operationally, which reflects our increased investment plans for R&D and manufacturing to support growth. As the world leader in animal health, a market that has grown on average of 5% to 6% through various economic cycles over the last two decades, we feel very positive about how our portfolio, pipeline and strategy can drive long-term sustainable growth and create value for our customers and shareholders. Wetteny will discuss more details about the 4Q results and full year 2023 guidance, but let me provide some additional perspective on our business and set the stage for some of our growth drivers for the year. First, we have remained the world leader in animal health over the last decade, outperforming the market and bringing groundbreaking innovation to veterinarians, producers and pet owners who care for animals. We marked our 10-year anniversary as a public company on February 1, a decade, which saw us bring more than 2,000 new products and lifecycle innovations to market, build a diverse portfolio, featuring market-leading franchises and 15 current blockbusters generate consistent above-market revenue growth and deliver a total shareholder return of more than 500% all while increasing our market cap from $16 billion in 2013 to about $75 billion today. While we celebrate those accomplishments, I am even more excited about where we can go in the next decade and by the talented colleagues, innovative pipeline and best-in-class capabilities we have brought together at Zoetis. Our colleagues’ purpose-driven mindset and steady performance in the face of adversity give me confidence in the continued execution, innovation, growth and durability of our business. As we turn to 2023, we are focused on five key growth catalysts for the year. In dermatology, we see excellent growth opportunities even after nearly a decade of game-changing innovation that began with the introduction of Apoquel in 2014 and has continued with the success of our first monoclonal antibody, Cytopoint, as well as recent lifecycle innovations like Apoquel chewable. We continue to see even more opportunities to grow and expand in this market. In pet parasiticides, the largest single product area in animal health, we continue to gain share and are now the second largest in revenue for this category. We have improved supply in 2023. We expect to continue expanding share in this market and supporting our diverse global portfolio beating Simparica Trio, our triple combination product. In the area of pain, we are off to a great start with our two monoclonal antibodies for osteoarthritis pain, Librela for dogs, which became our latest blockbuster in 2022 and Solensia for cats. We are once again revolutionizing care in this category and seeing very positive early reaction to both products in their large markets as we continue to expand geographies and supply. In terms of the U.S. approval for Librela, we remain confident in receiving approval in the first half of ‘23 with a leasing plan for late in the year. In diagnostics, we continue to generate solid above-market growth in international markets above our go-to-market model in the U.S. and drive greater global adoption for VETSCAN IMAGYST, our AI-based diagnostics platform. And finally, as population growth and economic mobility drive more demand for animal protein and pets, we see major opportunities in fast-growing emerging markets outside the U.S., where our portfolio is well suited to meet those evolving needs. Overall, our business continues to be weighted towards higher growth, innovation-driven areas in companion animal and these will remain our growth drivers for the foreseeable future. Meanwhile, our livestock portfolio will remain a valuable cash-generating piece of our business as we continue to recover in the U.S. from generic competition and show solid growth in emerging markets. As always, we will stay disciplined yet adaptable, and our approach to the new market opportunities, potential challenges and economic shifts that could occur. And in conclusion, Zoetis remains well positioned in terms of our market leadership, financial strength, investment strategies and diverse portfolio to deliver sustainable growth in 2023. Thank you. And I will hand this off to Wetteny. Wetteny Joseph : Thank you, Kristin and good morning everyone. As Kristin mentioned, we had a strong year in 2022 with revenue of $8.1 billion and adjusted net income of $2.3 billion both in line with the high end of our November full year guidance range. Full year revenue grew 4% on a reported basis and 8% operationally with adjusted net income increasing 3% on a reported basis and 11% operationally. Looking deeper into the operational growth for the year, price contributed 3% to full year operational revenue growth with volume contributing 5%. Volume growth consisted of 4% from new products, including Simparica Trio and our monoclonal antibodies, Librela and Solensia, and 2% from key dermatology products, partially offset by a decline of 1% from other in-line products. Revenue growth was broad-based with positive operational growth in each of our top 13 markets, which make up approximately 85% of our total revenues with international growing 9% operationally and the U.S. growing 7%. Our growth was driven by continued demand for our innovative new products in our companion animal portfolio, which grew 14% operationally. Our companion animal portfolio now makes up 64% of our global revenues. This growth was partially offset by our livestock business, which declined 2% operationally, primarily due to the generic competition, supply constraints as well as challenging market conditions in certain geographies. Performance in companion animal was driven by our small animal parasiticide portfolio, which grew 20% on an operational basis. Simparica Trio generated $744 million in sales, growing 58% on an operational basis. Our Simparica franchise reached $1 billion in global revenue for the first time in 2022. Our key dermatology products generated $1.3 billion in sales posting strong growth of 17% operationally with double-digit growth in both international and the U.S. Key derm growth in our international markets was especially strong at 27% operationally. We continue to see solid growth in our monoclonal antibodies for osteoarthritis pain. As expected, sales of Librela eclipsed the $100 million mark on the year, marking Zoetis’ 15th blockbuster product. We look forward to Librela’s expected launch in the U.S. in late 2023. Solensia contributed $30 million in sales in 2022, primarily from international markets, with solid penetration in the U.S. after a launch late in the year. Our companion animal diagnostics portfolio declined 2% operationally in the year, with declines in the U.S., partially offset by growth internationally. Our livestock business declined 2% on an operational basis. Our portfolio continues to be challenged by generic and cheaper alternatives to DRAXXIN in cattle as well as Zoamix in poultry. We do expect the generic impact to begin to moderate in 2023. Additional declines were driven by supply challenges on certain livestock products as well as unfavorable market conditions, especially the U.S. cattle and China swine markets. Moving on to our Q4 financial results, which was another strong quarter. We closed Q4 with revenue of $2 billion, representing an increase of 4% on a reported basis and 9% on an operational basis. Adjusted net income of $539 million is an increase of 14% on a reported basis and 27% operationally. Of the 9% operational revenue growth, 3% is from price and 6% from volume. Volume growth consisted of 3% from new products, which includes Simparica Trio as well as Librela and Solensia and 2% from key dermatology products, while other in-line products grew 1%. Companion animal products grew 15% operationally while our livestock portfolio was flat in the quarter. Simparica Trio was the largest contributor to growth in the quarter, posting global revenue of $171 million, representing operational growth of 39% for the quarter. We expect Simparica Trio to continue to grow the addressable market for fleet taking hardware globally and drive the conversion from collar and top parasiticides to oral combination products. These dynamics will provide additional run-rate for future expansion of the broader market and revenue growth for Trio even once competing triple combination products enter the market. Our key dermatology products, Apoquel and Cytopoint, had solid global growth in the quarter, posting $347 million of revenue, representing 14% operational growth against a robust prior year in which key derm grew 23% operationally in the fourth quarter of 2021. Our monoclonal antibodies for osteoarthritis pain in dogs and cats continue to grow posting $39 million of revenue in the quarter, primarily in international markets. Meanwhile, sales of livestock products were flat on an operational basis in the quarter, with growth in fish and poultry offset by the impact of generics and supply constraints on cattle and swine products. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.1 billion in the quarter, growing 7% with companion animal sales growing 12% and livestock sales declining by 6%. Focusing first on companion animal, we returned to double-digit growth in the quarter, as we resolved the majority of our supply issues from earlier in the year. In the U.S. veterinary practice revenue is growing approximately 6% and spending per visit remained strong again this quarter, increasing 10% despite a 4% decline in clinic visits in the quarter. The visit decline reflects comparison to the peak visit numbers in 2021, driven by pandemic after-effects and increased adoption of pets as well as the impact of veterinary workforce challenges that have limited some clinic capacities. Absolute clinic visits remain above pre-pandemic levels. We continue to see growth in the retail segment outpacing other channels. In Q4, sales to our retail partners grew by 49%. Simparica Trio continues to drive growth in the quarter with sales of $158 million in the U.S., growing 39%. With the supply constraints from earlier in the year largely resolved, we were able to leverage promotional efforts to drive growth and regain market share in the quarter. Key dermatology product sales in the U.S. were $239 million for the quarter, growing 11% with Apoquel and Cytopoint, each growing double-digits. We expect to continue the expansion of the market for the foreseeable future. U.S. livestock declined 6% in the quarter as expected, with sales of cattle products impacted by supply restocking for certain products in the third quarter of 2022 as well as the impact of generic competition in cattle and poultry. Moving on to our International segment, where revenue was flat on a reported basis and grew 12% operationally in the quarter. International companion animal revenue grew 21% operationally and livestock grew 4% operationally. Increased sales of companion animal products resulted from growth in our parasiticides portfolio, our key dermatology products and our monoclonal antibodies for alleviation of osteoarthritis pain. Our international small animal parasiticide portfolio had a very strong quarter. Growth was driven by revolution franchise, which rebounded well from supply challenges, especially in China. Our key dermatology products contributed $108 million to revenue and grew 22% on an operational basis in the quarter, with growth in Cytopoint across all key markets and continued double-digit growth of Apoquel. We continue to be pleased with the performance of our oral pain portfolio with Librela generating $26 million and Solensia delivering $7 million in fourth quarter sales internationally. Librela sales in the quarter dipped slightly below the prior quarter due to the removal of supply allocation in certain markets, which led to higher inventory levels at the end of Q3. We expect to see significant contribution to growth in 2023 coming from Librela across our International segment. Moving on to our International Livestock segment, which grew 4% operationally in the quarter. Our fish portfolio grew 25% operationally due to increased demand for vaccines in key salmon markets, including Norway and Chile. Sales of poultry products grew due to increased demand for poultry protein. Growth was partially offset by swine sales, which declined due to supply constraints in certain vaccines across international. The slight decline was partially offset by growth in China, driven by a weak comparative quarter in the prior year and improved swine market conditions. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 68.1% decreased 150 basis points on a reported basis compared to the prior year, resulting primarily from unfavorable foreign exchange impacts. Operationally, gross margin declined 60 basis points, driven by higher inventory charges as well as higher manufacturing and freight costs, which were partially offset by favorable price and mix. Operationally, adjusted operating expenses decreased 6% with SG&A declining 9% driven by lower compensation-related expenses and lower advertising and promotion, partially offset by higher freight and logistics related expenses. R&D expenses increased 10% operationally due to higher compensation costs and higher project spend. The adjusted effective tax rate for the quarter was 20.8%, an increase of 220 basis points, primarily due to lower net discrete tax benefits in the quarter and a lower benefit in the U.S. related to foreign-derived intangible income. Adjusted net income grew 27% operationally and adjusted diluted EPS grew 30% operationally for the quarter. Capital expenditures in the fourth quarter were $171 million. In the quarter, we repurchased approximately $400 million of Zoetis shares and returned over $0.5 billion to shareholders through a combination of share repurchases and dividends. For the year, we have repurchased almost $1.6 billion of Zoetis shares and returned over $2.2 billion to shareholders. In December, we announced a 15% annual dividend increase, continuing our commitment to grow our dividend at or faster than the growth in adjusted net income. Now moving on to our guidance for the full year 2023, please note that guidance reflects foreign exchange rates as of late January. We are expecting foreign exchange to have a minimal impact versus the prior year, with the full year impact neutral at revenue and slightly accretive at adjusted net income. The foreign exchange impact in the first half will be unfavorable versus prior year, particularly in the first quarter. In the second half of the year, foreign exchange is expected to be favorable based on the late January exchange rates. For 2023, we are projecting revenue between $8.575 billion and $8.725 billion, representing a range of 6% to 8% operational growth. Volume will be 1% to 2% at the low end of our guidance range and 3% to 4% at the high end. We again expect companion animal to be the primary growth driver in 2023 with the continued strength of our diverse Simparica Trio portfolio, the adoption of our monoclonal antibodies for OA pain and further expansion of our key dermatology products. Despite the decline in vet planning visits last year, industry fundamentals remain strong. Business remain above pre-COVID levels and clinic revenue is at an all-time high as the standard of care continues to increase. We anticipate modest livestock declines in 2023, driven by the generic impact on DRAXXIN sales, particularly in the first half as well as unfavorable market conditions in U.S. cattle. These declines will be partially offset by growth in poultry, driven by increased demand for poultry protein and new product launches as well as fish. The fundamental trends which make livestock an essential business remain intact. I’d like to touch upon the key assumptions that underpin our expectation for revenue growth. For companion animal, we assume a triple combination product we will launch in the U.S. in the first half of 2023 to compete against Simparica Trio. We expect this entrant will help Trio drive the conversion from topicals and collars to triple combination or parasiticides and still project significant growth for Trio. We do not expect competitive entrants in 2023 for our key dermatology products, Apoquel and Cytopoint. We expect another year of robust growth of our key derm portfolio coming from continued expansion of the dermatology market and price. We are excited about the continued growth in our OA franchise and plan to launch in several new markets next year. For the remainder of the P&L, adjusted cost of sales as a percentage of revenue is expected to be in the range of 29.5% to 30%, where favorable foreign exchange price increases and product mix are partially offset by higher input costs. Adjusted SG&A expenses for the year are expected to be between $2.06 billion and $2.1 billion, with the increase from 2022 focused on supporting primary drivers of revenue growth. Adjusted R&D expenses for 2023, is expected to be between $635 million and $660 million. R&D spend can fluctuate year-over-year. This increased investment is reflective of both new projects as well as those advancing in our pipeline. Zoetis is the leader in animal health because of the disruptive innovation, novel products and life cycle enhancements we bring to the market. This increase in R&D expenses reflects our commitment to ensuring our capital allocation prioritizes innovation. Adjusted interest and other income reductions are expected to be approximately $170 million. Our adjusted effective tax rate for 2023 is expected to be in the range of 20% to 21%. Adjusted net income is expected to be in the range of $2.49 billion to $2.54 billion, representing operational growth of 7% to 9%. Our guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. We expect 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. We are anticipating capital expenditures in 2023 to increase to $950 million to $1 billion. We continue to make investments to support our future growth, including manufacturing capacity for monoclonal antibodies as well as oral solid dosage. Finally, Zoetis and the animal health industry remain resilient in the face of economic headwinds. Our 2023 guidance range is reflective of uncertain macroeconomic conditions and the impact of veterinary clinic labor challenges. While guidance represents our expectations for the full year, Q1 revenue is expected to be below the low end of the operational growth rate in our full year guidance due to a variety of reasons. First, Q1 2022 was a strong comparable quarter as we saw robust growth with limited impact from vet clinic labor constraints as well as minimal disruption from our diagnostics field force model change, which began in Q2. Additionally, in the quarter, we expect to see lingering impacts of the latest COVID wave in China. Lastly, the return of supply on certain products, including Simparica Trio, and subsequent channel restocking as well as promotions to regain share in Q4 2022 modestly increased inventory levels in the channel in the short-term. In Q1, we expect a modest decline in adjusted net income versus the prior year as a result of the timing of our 2022 sales force extension in the U.S., which did not start until Q2, as well as the R&D investment noted earlier, which is also off a low base in Q1 2022. Now to summarize. 2022 was another strong year despite some challenges, we significantly outperformed the market and continue to take share, all while growing the bottom line faster than the top line. As we begin 2023, we once again expect to grow faster than the market, driven by the strength of our innovative portfolio, our ability to successfully launch new products and expand existing markets and our confidence in the end market dynamics for the spaces we compete in. Now I’ll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We will take our first question from Michael Ryskin from Bank of America. Michael Ryskin : Great. Thanks for taking the question and congrats on the quarter, guys. I’m going to throw in a couple of just real quick. First, I would have to get your latest thoughts on NexGard plus BI triple combo now that it’s been unveiled at VMX. Just what are your expectations for Simparica Trio growth this year, if you could give us a ballpark for that? And then second, I want to talk about R&D spend in 2023. It seems to have jumped quite a lot year-over-year, and that’s a big part of why operating margins aren’t expanding as much as we’re used to. Any specific programs you want to highlight? And anything you can say in terms of when that R&D spend will translate into future launches? Is this something that’s sort of in the regulatory phase or weight clinical phase? Just give us a sense of where the extra $100 million year-over-year is going? Thanks. Kristin Peck : Sure. Thanks, Mike. I’ll take those and let’s see if Wetteny has anything to add. The first, on Trio, obviously, we had a phenomenal year with 58% growth. We’re really proud of that. Obviously, we got back in clinics after some of the supply problems, and we’re fully back there. We’ve got 90% penetration with an 80% reorder rate and are now the number two fleet tick heartworm there. We are expecting competition from NexGard Plus sometime in the first half. We actually assure you don’t know exactly when that will be but we continue to expect the market to expand, and we continue to expect Simparica Trio to be growing on the year. I mean, albeit probably not at 58%, but we expect to have a very strong year. I think what you’re going to see is really moving more customers from collars and topicals into what is a best-in-class fleet to heartworm combined oral products. So we expect to continue to go through this as we’ve continued to say, we don’t have any more information on the exact timing there. But we’re going to be aggressive. As you’ve seen us in Q4 and Q1, really investing behind this brand doing DTC, etcetera. So we expect strong growth there continuing even with a new entrant. And when you think about R&D spend, and I’ll start and I’ll see Wetteny wants to build there. We’ve gotten questions often from you and from a lot of our investors. Why don’t you spend more in R&D or if you had a program would you invest in it? And I think what we’re demonstrating is we see a very strong pipeline here. These incremental investments to your question are certainly the bigger ones are in late-stage development going into development that cost that, but also some great new technologies in the research side as well. So it’s brought across the portfolio. It is a significant investment. And hopefully, it’s assigned to all of you of our confidence in our pipeline and the strength of our R&D engine and our willingness to invest in that for the short and the long-term across their – we see obviously really big platforms there in parasiticides continuing to invest there, in dermatology and across our monoclonal antibody franchise, certainly, looking at long-acting as we’ve talked about, but also new disease areas. So I don’t know if I missed anything, Wetteny, do you want anything? Wetteny Joseph : No. Look, I’ll just add a couple of points. Going back to Trio, we expect, as Kristin said, for Trio to grow significantly in the year, although as we now are well into our third year with a product, we wouldn’t expect it to continue to grow at 58%, which is what it did in 2022. Now the timing of our supply recovery in 2022 and the fact that as we see competition come in, it may drive some promotional activities that might drive some variability in terms of quarter-to-quarter in terms of where the growth is. But for the total year, we expect significant growth on Trio. And then on the R&D spend, it’s our practice that we don’t actually dictate what the investment in R&D is going to be. We let the pipeline dictated. And so as we see programs either coming into research or coming out of research into development or into late development as those programs require spending, and we do a full ROI spec, etcetera, on them, we go ahead and fund those. And so we’re very pleased to see that the pipeline is demanding this level of investment and we will still be able to deliver faster growth at ANI in revenue based on our guide of 6% to 8% of revenue and 7% to 9% at adjusted net income. Operator : Our next question comes from Jon Block from Stifel. Jon Block : Great. Thanks, guys and good morning. Wetteny, the 4Q GM of 68.1% was a little bit below us for the quarter, but the 2023 guidance of 70% to 70.5% was certainly solid. So maybe if you can just talk to the drivers for ‘23 gross margin or those the supply chain easing, maybe a little bit about the cadence? And then maybe just sort of as a tack on to that or the second question. In 2022, it was sort of a tale of two halves for atopic derm. One H was operational around 20%, two H operational, I think it was closer to 10%. I think you guys alluded to solid growth in ‘23, but do you want to just frame that for us? Is it a continued deceleration of atopic derm into ‘23 with no competition because I think you clarified that? Or can we expect some level of stabilization, call it, in that high single, low double-digit range for the atopic derm franchise? Thanks, guys. Wetteny Joseph : Yes. So I’ll start and see if Kristin would add anything here. Let’s start with gross margins. Look, if you look at the year, we were able to expand margins on the year. And certainly, as we explained in the prepared commentary, we saw FX come in to the tune of about 80 basis point headwind against gross margin in the fourth quarter. And certainly, we’ve seen input costs or some manufacturing costs impact the gross margin picture that you saw in the fourth quarter. But given where OpEx came in, you saw substantial growth at ANI versus revenue where revenue came in at 9% in the quarter ANI coming and 27% growth in the quarter. I think as we go into 2023, given the timing of our price increases, which started at the beginning of the year, as you know, certainly, we’ve seen some inflation in input costs coming out of ‘22, but we go into ‘23 price increases that start to change that as we go into ‘23, which is why we give guidance where we see about 40 basis point margin – gross margin expansion on the year. And obviously, a point, if you look at the midpoint of our guidance on growth higher at ANI versus the top line is what I would say on the margin point. And certainly, as you look at continued growth of companion animal outpacing the growth of livestock in the business, that mix will be favorable to us in addition to what I already covered from a price perspective. I think if you look at the atopic derm, we delivered $1.3 billion of revenue in 2022, that’s a 17% increase. And we’re almost at 10 years since Apoquel was launched and it’s just amazing to see that we continue to expand the market, and we believe there is more room to expand not only in the U.S., where we grew 12% in 2022, but particularly in international markets, it takes longer to get to peak sales levels, and we delivered 27% growth in international. I think we will continue to see really solid growth across the business. We have had double-digit growth in 2023. Though it may not be at the level that you’ve seen in 2021, where we grew to think about 23% and then 17% in 2022, but we continue to see room to continue to expand the derm market here. Operator : Our next question comes from Erin Wright from Morgan Stanley. Erin Wright : Great. Thanks. So two questions here. One, how much did the lingering supply chain issues impact on Simparica Trio sales in the quarter, if at all? And how much did the stocking benefit offset that in the fourth quarter? And did you benefit across other product lines in terms of distributor stocking that we should be aware of in terms of that first quarter cadence as well. And just if you could talk a little bit more and maybe you touched on this with the gross margin dynamic. But in terms of overall price, you are taking across the two core species segments here. And then my second question is on Librela. Can you give us an update on the U.S. Librela approval? And what does guidance assume in terms of U.S. contribution from Librela is that material in 2023? Thanks. Wetteny Joseph : Yes. So let me first touch on your questions around supply, and it’s Trio as well as other products. As we said in the third quarter call, while we had some outages in supply during the year, particularly in the third quarter, competitors actually took advantage of that and run promotions. And we certainly intended to run promotions as we recovered on supply, which we did in the fourth quarter. And so I think the timing of our supply recovery, whether it’s for Trio in the U.S. or for Revolution in China will drive some stocking levels, certainly as we enter into 2023, which we discussed. But I think typically, you’ll see some increase in inventory levels from Q3 to Q4 anyway, because distributors are anticipating our price increases and the intent to drive a little bit of that. So I would say when I look at across other products, it’s probably more in the range of typical increase that you would see. But if you look at Trio, we’re probably, if I had to bracket it in terms of the impact on Trio, if you back out, what would typically be an increase from Q3 to Q4 anyway. So the incremental contribution in the fourth quarter, I’d put somewhere in the $25 million to $30 million range. So it’s not a significant number for us. And certainly, as we discussed already, we factored that into our guidance, and we expect significant growth from Trio on the year. With respect to Librela, look, we continue to expect and I’m very confident that we will see an approval in a well in the first half of the year, our plans have not changed. We continue to plan to have an early experience program run on the program once we’ve gotten approval and we have the label set, etcetera, and that will transition into a launch sometime late in the year. Kristin Peck : And our practice – just to build on that, our practice on that is that we do not include in our guidance or our budget if we’re expecting a late launch in the year. We’ve always done that as those have cover us for a while. So Librela is not in our current guidance that we provided. We will update the guidance once we have a better sense. And obviously, this is a big product and when it launches, it could have a big impact. So whether or not you have 1 month, 3 months, etcetera, 4 months, it makes a big difference. So we will update guidance once we have a better sense of that approval. So to clarify your second question, Librela is not in the guidance that we provided. We fully do expect to have it, but we will update our guidance once we have a better sense of what the exact timing is. Wetteny Joseph : Yes. And we will give a better bracket in terms of what we expect the impact depending on the timing of the launch and what we see through the EEP program, etcetera. Operator : Our next question comes from Louise Chen from Cantor. Louise Chen : Hi, thanks for taking my questions, here. So I wanted to see if you could give more color on how you’re investing in supply to meet the growing demand for your products and when you actually expect to complete – or what your objectives here? Thank you. Wetteny Joseph : Yes, I’ll take that. And see Kristin would add on anything. We are investing in a number of areas when it comes to our supply network, upload a couple of categories, I’d say, in the short – near-term, we have investments clearly in inventory to help absorb any shocks that come through the supply chain. We’re making investments in our demand planning processes and tools to give us better visibility etcetera as well as we don’t see that we are building in, in certain aspects of our inputs now coming into our manufacturing process. Longer term, as you may have listened on the prepared commentary, we’re making significant capital investments across our network across the network in the U.S. to support our monoclonal antibodies, both for products that have already been approved and are launching. And what we have in our pipeline is well from a math perspective. It is a platform that we continue to innovate on. And then all solid dose as well, whether it’s parasiticides, derm session in various aspects. We are making investments throughout the network for those we’re making investments to support our vector vaccine manufacturing, for example, as well for livestock and so on. So we are making investments across the organization, investments in tech and digital to leverage data again, to give us better visibility as well for the long-term to support our long-term growth aspirations. Kristin Peck : The only thing I would build on there, Louise, is I mean if you look at the CapEx number that Wetteny was talking about in his prepared remarks, of $950 million to $1 billion. That is clearly the highest CapEx that we have had. But I also think you should look also at what we said were about R&D. And if you look at significant new investments in R&D, those are going to be products that we are going to have to be able to manufacture in a few years. What you are seeing is the commensurate investment in our manufacturing capabilities to be able to launch those products and really critical platforms across the globe. So, we are very confident in where our pipeline is, and we are going to invest in our manufacturing capacity to deliver on those products over the medium to long-term. Operator : Our next question comes from Nathan Rich from Goldman Sachs. Nathan Rich : Hi. Good morning. Thanks for taking the questions. The first one on Trio, I would be curious just to get a sense of what kind of factors you are watching as you think about the impact that competition could have. And magnitudes that would kind of push you to the higher or lower end of your range for competition. And are you anticipating any changes to pricing or your promotional cadence when competition enters? And then my second question on DRAXXIN. Just how much of a drag will that continue to be in 2023? I think you have previously said that you will start to cycle the second year of competitive entry in the first quarter, but I think there has been some more recent price changes. So, just curious what we should expect in terms of the impact on the livestock business this year? Kristin Peck : Sure, Nate. I will take the first question and then I will let Wetteny take your second question on DRAXXIN. Look, we have been expecting competition for a long time on Trio, I would say. So, I would say we are well prepared for what that is. We have been investing heavily, obviously, behind DTC, really investing with our customers and with pet owners directly to make sure that when competition enters, that we have very pleased customers. And a few things I will point to there, obviously, it’s our direct-to-consumer advertising, I would say, our broad portfolio and our – as you look at our relationship with corporate accounts, we are very strong with corporate accounts. We are their preferred product. So, I think that will provide some resiliency. But I would also say auto ship remains a real strength. This is not a sector where people often switch unless there is a really good reason. So, new dogs they will make a choice. But they are not – I think customers are already on our product are not going to be that inspired to change. And if you look at the dynamics certainly in the U.S. around retail, it grew 43% on the year. It’s now about 11% of our U.S. business. And I highlight that because the more that insulates us from potential new entrants coming. And we obviously expect NexGard Plus, but I am sure there will be others over the next 1 year to 2 years that enter as well. So, we are really investing in insulating ourselves from that impact by investing in pet owner loyalty programs, DTC, a broad portfolio with innovation with our customers wanting to do corporate account side also underscore. And then lastly, auto ship and strong relationships with the retail sector. So, do you want to take the second question on DRAXXIN? Wetteny Joseph : Yes, absolutely. Look, as we said from the very beginning, we were expecting DRAXXIN to have about 20% decline in the first year of generic competition and then another 20% in the second year. The first year was slightly better than our expectations coming in somewhere around 16% decline. But the second year was a little bit worse. So, I think we are sort of in that ballpark. I think the second year is about 25%. So, we are at a level now that once we lap, I would say, the second year, which would be through the first quarter of ‘23, which is why in the previous commentary, we said, particularly in the first quarter, I think we are at a low enough level, won’t be as meaningful as an impact on us, and I think the drag on our overall are stock business won’t be as significant. So, I would still expect some pressure on livestock given where U.S. cattle, for example, as a market is we are watching swine, particularly in China and anti [ph] has across other regions to determine where we end up lending. But we think livestock will be slightly down year-on-year, maybe marginally better than we – than you saw in 2023, where livestock was down 2%. Operator : Our next question comes from David Westenberg from Piper Sandler. David Westenberg : Thank you for taking the question. So, I want to kind of continue with the some on Trio dynamics. Can you talk about maybe if you got any word on in terms of what the label might look like on the competitive launch? And can you give a little bit more color? I think you said in the prepared remarks that you expect it to come from collars and topical. What are you kind of seeing in the marketplace that suggests that as opposed to whether maybe legacy oral parasiticides? And then kind of the second question here is on the increase in R&D spending, are you going to continue to give out some of the – what you have in pipeline about – I think you guys usually give out six months in advance to Wall Street. Is that kind of still the expectation when you talk about pipeline? And thank you very much. Kristin Peck : Hi Dave. I will start on Trio and then maybe Wetteny can clarify if there is anything I am missing, and then let me take the R&D question as well. Look, we don’t have any clear signs of what the label of competition will be. We are very confident in our current label. We don’t think it has any holes. I have got to tell you, we are at 100% heartworm protection. So, I am not really sure where you are going to hit us on that. We have also been out on the market now since 2020 with this, which means we have a very strong set of safety data as well. So, I am sure, as always, they will – competition will enter and they will try to find any angle they can. But we don’t really think there is any holes in our label right now that we are concerned about. We are in puppies, if you look back to Simparica. And the second part of your question, look, yes, they will move from single agents. I think they will, single agents from just flea, tick or just heartworm products, I think we will move into the combination label for sure. But we are not expecting pricing to be a big factor initially. And really, that has to do with who is entering, because if they don’t enter the market similarly priced or higher than their current two products, they are going to cannibalize themselves. So, I think really, the power of who is entering does not lead us to believe that price is going to be a major factor and who enters. I mean obviously, we will adapt to whatever comes, whatever label they have, but we remain very confident in our label, in our relationships and in our data today. But – do you want to take the second question, or do you want me? Wetteny Joseph : Yes. Look, it’s only small addition I will do to Trio is we do get to 100% heartworm after the first dose. So – and with the product being in the market almost 3 years and satisfaction levels being very high and penetration across clinics, etcetera, we are very confident on our position as competition enters into the space. On R&D, look, I think unlike human health in animal health is not as much visibility as given with respect to what’s being specifically worked in the pipeline, we see that as a competitive advantage for us given our track record and how we continue to drive innovation in the spaces that we enter. And so we won’t necessarily be changing that significantly here in terms of what we have in here, but we have talked about various aspects of unmet needs that if you were to ask veterinary practitioners, what are the top 5 or 10 unmet needs that they have, I think you would imagine that we are working on all of those areas. Operator : Our next question comes from Chris Schott from JPMorgan. Chris Schott : Great. Thanks so much. I just had a question on the overall volume comments you made. I think it was 1% to 2% volume growth at the low end versus 3% to 4% at the high end. Can you just elaborate on the dynamics there? So, how does that look at for companion versus livestock? And maybe as part of that, what’s implied in terms of vet visit growth this year? And is that even a relevant swing factor in any of the overall outlook for the business? Thank you. Wetteny Joseph : Yes. So, look, I think if you look at our 2022 results, the net price contribution is about 3%. Now if you take vaccine out, that number is about 4% and companion animal would be at the higher number here, with certain products essentially above that. Now, we are very pleased to be able to take price, which typically is about 2% to 3%. And here in 2022, it was about double what we would normally do, and we still saw about 5% volume growth in 2022. So, as we look at 2023, I think you would see price with DRAXXIN impact being less than it was in ‘23 in particular, plus how we are going into price in certain products, I think you are going to expect a higher price contribution on the year, the timing of that in terms of where customers may have bought ahead of the price increases and so on. So, you might see a little bit of a lag in terms of when you see the price picture play out, but you would see at the low end of our range, but it’s a bigger contributor. But at the upper end, it’s all additional volume. In terms of where we see clinic traffic, certainly, we have seen vet visits come down versus the peak that we saw in 2021. In the fourth quarter, visits were down about 4%, but revenue per visit was up 10% and total revenue was up 6% on the quarter. Again, continuing the trends that we see as being sustainable which is pet owners willing to pay for innovation and seeing sustainably higher revenue for pet clinics. Now, we are still very early in 2023. But as we look at data, in January, we are seeing some increases in vet visits. Again, as we expected, we have been running above pre-pandemic levels. So, even in Q4, where visits were down 12%, they were actually still 2% above Q4 2019. And so we have been saying that, that’s the element to continue to watch. I think one month is a little bit early to call it, but we are expecting visits business to be flat to up in 2023, and we are starting to see some signals of that earlier in the year. Operator : Our next question comes from Brandon Vazquez from William Blair. Brandon Vazquez : Hi everyone. Thanks for taking the question. My first is just on the diagnostics side, you guys have, I believe talked about this before, but maybe can you refresh us on where you are on some of the commercial changes, I think it was in the U.S., where those are and what that might mean for growth and potentially accelerating that business into ‘23-plus? And the other is just on China. You guys had a nice rebound there. I think you mentioned a little bit of supply coming back on the market, but maybe tempered that a little bit with COVID headwinds. So, curious how those two shake out maybe 1.5 months into this first quarter? Thanks. Kristin Peck : Sure, Brandon. I will start and let Wetteny build on both of them. So, in diagnostics, first of all, just ready and are joining you from our national sales meeting actually out in Denver. And I would say the energy in our diagnostics team is just amazing. So, we will – as Wetteny mentioned in his prepared remarks, Q1, a little, but we didn’t have them on board until Q2 of 2022. So, what we are expecting as we look into 2022 as we get into the sort of middle of the year and the end of the year is really a return to at least market growth in the U.S., if not faster. We have continued to see very strong growth in international, as you saw from last year, and we expect that to continue into the year. So, we are really excited about the new field force, having them on the ground, having them fully up to speed. Wetteny and I spent a lot of time with them yesterday. So, I would say super optimistic overall in diagnostics, returning to growth across the board, certainly, the images platform and investments there. And then I will start on China and let’s see what Wetteny has to build on it. We did see overall strong growth in the year of 11% and we are optimistic so far year-to-date in sort of the return in China. We have seen both on the companion and animal side, a really strong rebound there as we look into – certainly, for us, our year is both December and January. December, obviously, with the number of people home stick there was a little weaker, but we are seeing really strong rebound in January. And we are looking, I think at a strong year for us in China. Also, as you look at livestock with opening up China, more return to eating out to travel, to tourism will not just be good for China, to be honest with you, it could be good for livestock across the globe. So, it’s one to watch, obviously, there is huge uncertainty around China not to mention geopolitical tensions and potential UFO these days. But we stayed really confident in where we think China will be for the year. But it remains a big risk both for China as well as for livestock across the board because I think a lot of if China returns, they will see China buying a lot of poultry, beef, etcetera, from Brazil, Europe, the U.S. there. But I don’t know if you want to build anything either on the diagnostics question or China, Wetteny? Wetteny Joseph : Look, it’s great to be here in Denver with a large number of our colleagues on Valentine’s Day. But look, I think China, we have been very pleased to see how China ended the year high-double digit growth on the quarter. My comments around supply was just the timing of recovery, particularly on revolution, Revolution Plus in that market that might create some dynamics on quarter-to-quarter. But we are expecting really solid growth out of China this year. I think the first quarter though, given the timing of the COVID waves. Just as a reminder, our international segment closes in – at the end of November, which means the quarter really started in December for them. And so a lot of that occurred in the first quarter, and we are seeing that having an impact, but we do see a rebound and as Kristin said, it has implications for other markets in terms of exports into China, but we are expecting a really solid rebound there. Operator : Our next question comes from Elliot Wilbur from Raymond James. Elliot Wilbur : Thanks. Good morning. Wanted to go back to some of your early commentary around growth expectations for the key derm franchise? And just specifically thinking about the key levers in 2023, Kristin, I wonder if you can maybe just talk about, especially given the high level of penetration of Apoquel in the U.S. What the key levers there are going for or whether it would be price, new market entry, geographic expansion or just outperformance by Cytopoint relative to Apoquel? And then for Wetteny, just – I don’t know if you said this in your prepared commentary or not, I didn’t catch it if you did. But within gross margin guidance, could you just talk maybe about the inflationary headwinds that are sort of embedded in your guidance for this year? Thanks. Kristin Peck : Sure. I would say a few things on derm, both domestically as well as globally. We will be looking to expand and I think as Wetteny said in his prepared remarks, reaching peak sales in some of these markets takes a little bit longer outside of the U.S. So, we are continuing to see very strong growth in dermatology, both in Apoquel and Cytopoint as well as life cycle innovation remains really important for us here. The movement to Apoquel Chewable – it’s been growing much faster than we expected and the conversion there remains very, very strong. So, I think it’s both, you are going to see growth in volume, certainly potentially a little more globally. But beyond Apoquel, I mean I think Cytopoint, that’s really love it and so do customers. It’s 100% compliance. So, I think if you look at the overall franchise, Apoquel, Cytopoint, Apoquel Chewable, we will probably see greater growth outside the U.S. So, we are both looking at volume. We have taken price consistently here. And certainly, 2023 will be no different here. So, I think you will see growth from both price and from volume, you will see chewable really building on it. I think you will see a real uptick in Cytopoint. Again, we are back to absolute full supply. We, as you know, last year, did need to make some trade-off decisions there, because that the same impacts as our other mAbs and in some of our vaccines with regard to some of the COVID vaccine supply challenges we had. But we are back full speed. So, we are also really investing in other big growth drivers here will be direct-to-consumer advertising in international. So, we are going to do unbranded DTC as we have started last year. And we are really – even in the U.S., you still have 6 million itchy dogs that are currently undiagnosed and not treated. So, we really continue to see growth here, as we said, double digit, as Wetteny mentioned earlier, but I will let Wetteny take the second question, obviously, on inflation in 2023 and etcetera. Wetteny Joseph : Yes. So, look, I think across the macro elements, we have been appropriately prudent in how we have laid out this guidance in the range that we have given today. But specifically on gross margins, if you look at inflation, as we are preparing to come into the year, we are certainly accounting for significant inflationary pressure on some of our input costs, energy, Europe, etcetera. But as we have entered the year, I think they are a little bit better than what we anticipated coming into the year, but still significant inflation that’s baked into what we have here, which obviously are more than offset by our mix and our price, which is why you see some modest gross margin improvement year-on-year as we go through the year. But we have factored in a fairly significant inflationary pressure in the gross margin figures that we gave. Operator : And our last question comes from Balaji Prasad from Barclays. Unidentified Analyst : Hi. This is Akhila on for Balaji. Thanks for taking our questions. Just two for me. I guess could you first just provide some additional color on business development priorities for the year? And then building upon an earlier question, what are your volume expectations from new pet additions for the year? Thank you. Wetteny Joseph : Yes. So, look, when you look at our capital allocation priorities, certainly investing in the business is the first place we go. And clearly, we are poised to significantly invest in the areas of R&D as well as across our supply chain and manufacturing – you saw the significant increase in R&D spend anticipated for 2023 versus 2022. And our CapEx numbers are going to be in the range of $950 million to $1 billion on the year. Certainly, as you look at our strategic priorities, they are aligned with where we look at from a BD perspective in terms of where there might be opportunities to accelerate some of those execution on our strategies. And they span across our current slate of businesses, including some of the R&D areas in terms of external innovation and so on. BD is one of those areas, as you know, is hard to predict in terms of exact timing and so on, but it is an important lever that I would say, second after investing in the business. And then thirdly, as you saw in 2022, we are returning capital to shareholders to the tune of $2.2 billion in total between share buybacks and dividends. Alright. I think you had a question – sorry, I think you had a question in terms of new pets. Look, if you look at the growth in the industry over the last two decades, it’s been about 5% to 6%. The way I look at it, vet visits, in essence, as you see pet population growth and so on, it would be reflected in that. They have accounted for about 1% of that growth historically. So, the bigger element of growth here is really pet owners’ willingness to spend for innovation, and you see that reflected in the spend per visit figures that are far more in terms of the impact on growth historically, and we anticipate that continuing. So, as you sit here today, I wouldn’t say new pet increases is a major factor into what we are looking at. It’s our innovation and pet owners willing to pay. And the demographics of pet ownership with Gen Z and millennials willing to spend more on pet health and prioritizing those as well as higher income households that are bringing pets and more pets into their homes. Those are the factors that we watch that contribute to growth. Operator : It appears we have no further questions at this time. I will now turn the program back over to CEO, Kristin Peck. Kristin Peck : Thank you so much, and thanks everybody for your questions and certainly for your continued interest in Zoetis. And just to summarize, we see really positive and sustainable demand for our products based on the fundamental drivers of animal health, we see continued strength across our diverse global portfolio, especially in our products for pet care. And we are continuing to invest in the talent, the pipeline and the manufacturing capabilities that can support our future growth, while adapting our business to the increasingly dynamic environment where we operate. So, we look forward to keeping you updated on future calls, and thanks so much for joining us today. Operator : Thank you, ladies and gentlemen. This concludes today’s conference. You may now disconnect.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,023
| 2
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2023Q2
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2023Q1
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2023-05-04
| 4.929
| 5.012
| 5.447
| 5.578
| 8.31492
| 30.04
| 29.33
|
Operator : Welcome to the First Quarter 2023 Financial Results Conference Call and a Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-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. Steve Frank : 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. Kristin Peck : 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% up 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 trending 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 would 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 2020, 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. Wetteny? Wetteny Joseph : 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%age 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% percent operation only with $290 million in global revenue. This decline is attributed to the impact of pre-price increased 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 of 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 operational 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% operational 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 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 benefit 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 expected 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 go in-line with or faster than the market. Now, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions]. We'll take our first question from Jon Block from Stifel. Please go ahead. Jon Block : Thanks guys. Appreciate it. Good morning. I'll ask both upfront I think importantly, is the channel now normalized in the U.S., Kristin? And then some rough crude math, but if you were down 7% U.S. companion animal and sales out were up 8% -- it's over like a 1500 basis point delta. And I sort of landed over $100 million in sales if you quantify that. So can you guys bridge how you get there? I guess there's $25 million to $30 million of parasiticides last quarter, or [does these] (ph) working down inventory by a week, whatever you can do to bridge that would be helpful. And then a quicker one, an easier one, Librela, I think you said approval still expected 1H. So launch 2H, is that the full launch call it before the end of the year. And then again, Kristin, how do you feel on your ability to serve demand we believe there's a lot of Solensia users that are chomping at the bid to get at it. So do you expect U.S. Librela supply to be an issue at all call it, 1H ‘24? Thanks guys. Kristin Peck : Sure, Jon. I'll start with your second question. It's pretty straightforward. Yes, we continue to expect approval of Librela in the first half with the launch in the second half. The timing of exactly that a full launch, we would obviously, we've always said do early experience first and then go to full launch, the full launch could be very late in the year. But as we continue to -- and I'll reiterate again, the Librela is not in our numbers for the year. We do not include in our numbers for the year, a product that's expected to launch very late in the year for obvious reasons. So, we would do early experience. As we've always done with a full launch -- if we did a full launch, it will be very late in the year based on what we're saying. And no, we do not anticipate any supply challenges, on a full launch in 2024, whether it's late this year or early 2024, we don't see any challenges there. On your second question on distributor, I think we'll spend a bunch of time on that today. Obviously, there's a lot of complexity in that one. But again, it is in-line with what we expected and we really don't think the trend you see in the quarter is going to continue. Let me let what get into all the details because I know this is probably the biggest question we've been hearing early this morning. So, Wetteny, you want to go through some of the details? Wetteny Joseph : Sure. Jon, the start of your question was, are we at normalized levels, I’ll start there, first? And yes, we're at normalized levels here sitting here in the second quarter. And let me just step back and give you a little bit more details here. As Kristin said, we came into the year and as you may recall on the last call, we described how we saw increased buy-in in the fourth quarter. Driven by promotions that we ran on parasiticides, given we have recovery of supply late in the year, as we got through some of our supply constraints. And there was more pre-priced buy-in given the level of pricing pieces we're coming into 2023 with, in the fourth quarter above what I would call normal levels pre-price buy-in. So, we expected to see destocking in the quarter, which is why we said that the first quarter would be below the low end of the range of growth that we have for the year at 6% to 8%. So we've seen destocking in the first quarter down to I would say the lower end of our normal range that we've experienced historically. And as we step into -- and by the way, given rising interest rates, that is not unexpected. And then as we got into April, we saw slightly more destocking as we started the quarter, but those have normalized and have been reflected in the guidance that we just reiterated today. And so we're not anticipating a return back to normal levels in terms of inventories or assumption in our guidance is that they'll stay about where they are now. Now to be clear, if you look at the end market demand dynamics, they remain very strong. As we said in our earnings release, sales out of distributors into clinics were up 8% on a volume basis in the quarter. And if you look at retail, sales out pet owners were up 35% on the quarter. We've seen for the first time in about a year vet visit increased by 2%, and if you look at derm patients, for example, visit increased in the quarter versus a year ago. And so again, we've seen normalization since then, and by the way, international markets where we didn't see -- we haven't seen and don't expect to see the level of destocking that we've seen in the U.S. you saw 10% operational growth in our international markets across livestock and companion animal. And so again, without an extremely return to those levels and these are factored into our guidance, and we're contemplated when we gave the initial guidance back in February. Operator : And we will take our next question from Erin Wright with Morgan Stanley. Please go ahead. Erin Wright : 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 side of going ahead of competition? Thanks. Kristin Peck : 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 a 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 onetime 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 it's 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 on 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 compliance, 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. Wetteny Joseph : Yes, I would just add that 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, we'll 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. Operator : And we will take our next question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : 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 to 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 68% operational growth. So just talk about the step up in 2Q, 1Q to 2Q versus 2Q to 3Q, 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 tariff through the rest of the year. Thanks. Wetteny Joseph : Hey, Mike. I'll start with progression for 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%. Kristin Peck : 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. Operator : We'll take our next question from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : 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? Wetteny Joseph : 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 call 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 its 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. Kristin Peck : 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. Operator : And we will go next to Louise Chen with Cantor. Please go ahead. Louise Chen : 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 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. Kristin Peck : Sure. We are excited for our Investor Day. We spent a 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? Wetteny Joseph : Yes, happy to, Kristen. So look on diagnostics, we have seen increased productivity from our diagnostics team, particularly if you look at the U.S. where we made the change about a year ago into the second quarter. In this first quarter, we actually saw very strong placements across our instruments, including images as well. Those will help drive growth from a consumables perspective if you look at the rest of the year consistent with our guidance, we said we would expect to see improvements in terms of that to the productivity given the new field force and the change out that we did last year. And we would expect to see return to growth in the U.S. in the back half of this year. And again, we're lapping those changes that we made, which we believe -- firmly believe are going to drive long term growth for the business in addition to innovation that we continue to work on in terms of diagnostics. Operator : And we will take our next question from David Westenberg with Piper Sandler. Please go ahead. David Westenberg : Hi. Thank you for taking the question. So just to get on the Simparica Trio franchise and so in the distributor dynamics here, I usually think about the parasiticide portfolio is being heavy in March to August season. As we take a step back or take a zoom outlook, do you think any of the dynamics that have happened with some of the distributor destocking is going to be a net negative for the annual sales of the product? Put it another way, do you think maybe at this impact the timing of missing the flea and tick season in any of this kind of dynamic? And then just to reiterate on the inventory question on the livestock portfolio, it doesn't have the same dynamics, right? So I mean like the price increases in livestock were not the same as the price increases in companion. Therefore, you wouldn't see some of that same distributor dynamic. And then if I could squeeze just one more, just I want to -- I didn't see the inventory or the balance sheet yet, so just wanted to see if inventory levels trended up or down. Thank you. Sorry. That was one. Kristin Peck : 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. Wetteny Joseph : Yes, look, I think there were couple 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 slightly increase 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 favourable 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. Operator : And we will take our next question from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi, good morning, everyone. Thanks for the questions. Couple from me. Firstly, could you give an update on the supply chain issues which impacted growth in 2022, be it in the vaccine side Trio or [indiscernible] and would you foresee or anticipate any supply chain issue impacting any of your key products this year? Secondly, I wasn't sure I got the derm decline fully. This is not a distributed independent segment. Can you provide some numbers around the derm segment and help us understand what led to the decline? Thanks. Kristin Peck : 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 derm segment if you can clarify some of these questions? Wetteny Joseph : 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 form 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. Operator : And we'll take our next question from Chris Schott with JPMorgan. Please go ahead. Unidentified Analyst : Hi. This is [Katarina] (ph) on for Chris. Thank you so much for taking our questions. So, first on price increases, any feedback from the price increases in the beginning of the year, are you seeing any pushback from veterinarians or pet owners and any initial thoughts of how you'll be approaching price increases in 2024. And then the second question is on diagnostics, any thoughts on the proposed Mars Heska acquisition and the impact that will have on the diagnostics market? Does it change Zoetis’ plans and diagnostics or the investments you're making in that market? Thank you so much. Kristin Peck : Sure. Thanks, [Katarina] (ph). I'll take your second question first and then let Wetteny take your first question on the pricing. I really think the margin acquisition of Heska confirms that the veterinary diagnostics market continues to be incredibly attractive investment area. Most importantly it reinforces our strategy, we think the sound around committees executed around in the U.S. specifically building our reference lab network and continuing to invest in innovation importantly in our point of care. We've had a robust start to 2023 as we look at our images, our virtual lab, our reference lab offering, we really believe it's resonating with customers. And really our focus is on leading with cutting edge medicine, really rolling out our virtual lab, which we really think is a differentiator. And we think that's what differentiates what it's overall is innovation in the space, innovation around point of care, innovation in customer experience and innovation in the reference side. So no, we really see that acquisition as reconfirming our strategy. And really we're going to accelerate our growth focus on innovative diagnostics. So, Wetteny, do you want to take our second group of questions around pricing? Wetteny Joseph : Yes, sure. Look, we have not seen any pressure in terms of end market demand given our price increases. We took 5% price on the quarter that's up versus 3% last year. If you look at the end market dynamics that we described earlier, you're seeing significant growth out from distributors to clinics, but also importantly, you're seeing significant growth from retail into pet owners. And we continue to see increased patient visits, for example, in derm, etcetera. So we have not seen any resistance there in terms of price increase. And by the way, if you look at international, we grew 10% in companion animal in the quarter given price increases as well and despite some pre-price buy in, which is normal in the fourth quarter. So we haven't seen any signs of that. If you look at livestock, that actually offsets some of the -- marginally offset some of the price increases we would have seen in companion animal. We can just see some impact on Draxxin, but not meaningful not at the level that we've seen previously as we previously said and actually we saw some volume offset to that positively offsetting some of the price on the Draxxin side. So all told in good shape in terms of what we're seeing in terms of market reaction to our prices. And in terms of what it means for 2024, too early to tell. We won't go into that yet. Operator : And we'll take our next question from Brandon Vazquez with William Blair. Please go ahead. Brandon Vazquez : 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, like 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? Wetteny Joseph : 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 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 so 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. Operator : And we'll go next to [Steve Scholar with PD Cohen] (ph). Please go ahead. Unidentified Analyst : 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, improve dosing or something else? Thank you. Kristin Peck : Sure. The new manufacturing facility in right outside of Atlanta, Georgia will be both to support current products and the growth in our current products as well as we'll target launching some of our new monoclonal antibodies out of that facility as well. It's a very large facility. It gives us tons of flexibility, which is what we found really exciting about the opportunity to be able to use it for lots of different things and really build a strong centre in the South with a great labor market, really good access to workforce that we think makes a lot of sense. So we actually -- we see it’s the facility's ability to do both and that is currently the intention. As I mentioned in my prepared remarks, we would expect it to be fully operational by 2026 and doing both at that point. With regards to Investor Day, we will be looking at the whole portfolio. We'll give you more details which we've been asked for around the pain opportunity and what we're expecting there. We'll also talk about some of the new disease areas we've mentioned before. It will give you a sense of what we think those markets could look like. A lot of those markets are new markets, so we'll help you size that market. We'll talk a lot about what our pipeline looks like. And what we're doing now. So we'll give you information both on a species basis importantly on sort of key technologies as we talked about in monoclonal areas -- monoclonal antibodies. And then also lastly, talk about some of these emerging big new markets that we think we can attack with some of our new novel technologies. Operator : And there are no further questions at this time. I'll turn the program back to Kristin Peck for closing remarks. Kristin Peck : 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 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 catalyst; 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. Operator : Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.
|
ZTS
|
Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,023
| 3
|
2023Q3
|
2023Q2
|
2023-08-08
| 5.074
| 5.14
| 5.651
| 5.74
| 7.9
| 30.47
| 28.86
|
Operator : Welcome to the Second Quarter 2023 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 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. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis second 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, Tuesday, August 8, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and welcome everyone to our second quarter earnings call for 2023. I hope you were able to join us or listen to our Investor Day this past May. If you missed it, please checkout our replay on zoetis.com. I think you will find it worth the time in learning more about Zoetis and where we see future growth in animal health. We appreciated the opportunity to step beyond the cadence of our quarterly earnings call and speak to about the long range perspective on our business and on our industry during Investor Day. We also appreciated your questions and the ongoing dialogue about the issues most important to you. As you know, we shared more detail about our growth strategy, innovative pipelines, and the key franchises, capabilities and investments we are making to build on our competitive advantages as the world leader in animal health. The four tenets of our value proposition were affirmed and expanded on throughout the day, and you can expect us to revisit that framework and provide progress updates in future investor interactions. Our goal is always to ensure that you understand how we are positioned to deliver on our value proposition, the revenue growth, strategic investments, margin expansion and capital returns. With that covered, let's turn now to the second quarter financial results. Today, we reported strong second quarter results of 9% operational growth in revenue and 12% operational growth in adjusted net income based on our diverse portfolio across markets and species. As expected, we return to a more balanced segment growth this quarter with 11% operational growth internationally, and 7% growth in the U.S. Our companion animal portfolio grew 11% operationally, driven by our major franchises in dermatology, osteoarthritis pain and pet parasiticides. The second quarter results and drivers were more in line with our performance trends in recent years, with innovations and strength in our companion animal portfolio leading the way. Meanwhile, our livestock portfolio grew 4% operationally in the second quarter, driven by sales of poultry, cattle and fish products, and continue to demonstrate the benefits of our diversified portfolio across species and geographies with a strong first half. Overall, the first half of 2023 has played out much as we expected. We have grown revenue 6% operationally in the first half, driven by strong results from our international markets and livestock performance, which were partially offset by the distributor destocking we explained in the first quarter. As expected, the impact of distributor destocking in our U.S companion animal portfolio has stabilized and was not a significant factor in the second quarter. We continue to see strong customer demand for our companion animal portfolio. For the first half of 2023, companion animal grew 5% operationally. We believe companion animal should be a bigger driver of performance for the remainder of the year with a stronger second half driven by our key franchises. While we are monitoring how inflationary pressures may impact pet care spending in markets around the world, the underlying demand has remained steady and resilient to date, and this is what we have seen historically. In the U.S., veterinary clinic visits continue to stabilize staying relatively flat through the first half of the year, and clinic revenue and spend per visit were both up about 9% in the U.S in the first half. Meanwhile, our livestock portfolio grew 8% operationally in the first half of 2023, reflecting strong growth internationally and continued supply recovery in our U.S cattle products. We expect live -- livestock growth for the full year to be in the low single digits operationally, reflecting tougher comparisons in the second half of the year for our U.S portfolio. With the first half of the year playing out largely as expected, we are maintaining our full year guidance for operational growth of 6% to 8% in revenue, and 7% to 9% in adjusted net income, at our companion animal portfolio we expect Librela and Solensia to continue to ramp up in various markets as we build our franchise for osteoarthritis pain. One way we are supporting growth for both products is increased use of direct-to-consumer campaigns in launch markets. These campaigns are building disease and product awareness, creating conversations among vets and pet owners and accelerating our efforts in markets where DTC is available. We're also pleased to have received U.S regulatory approvals in the second quarter for Librela and for Apoquel Chewable. Both have been performing well in markets outside the U.S to date. Librela is expected to launch in the U.S in November with an early experience trial beginning in September. As we look at the second half, we continue to expect strong growth, even as we factor in uncertainty around the macroeconomic conditions and drought that exists in certain countries around the globe, particularly Asia Pacific, and tougher comparisons for U.S livestock portfolio in the U.S. As we have seen historically in these types of environments, our global footprint and diverse portfolio provide more stability to our business during uncertain times. And we remain ready to pivot resources and investments to the greatest opportunity areas that it can ensure we continue to deliver on our commitments. For example, we continue to expand in large and growing product areas, such as parasiticide, dermatology, monoclonal antibodies for pain, vaccines and diagnostics, and invest in the franchises and capabilities that support our future growth, many of which we discussed at Investor Day. Before I wrap up, three quick points around our colleagues. First, I want to welcome Ester Banque to our Zoetis Executive Team as EVP and President of U.S Operations. Ester joined us in July coming most recently from Bristol Myers Squibb, and having spent a major part of her career at Novartis as well. She brings diverse global experience in health care, and an impressive track record of driving results to Zoetis. And I'm happy to say she is already off and running with the U.S business. I also wanted to call out the recent publication of our 2022 sustainability report. This year's report captures how sustainability is integrated across the business and shares the progress we are making toward are driven to care aspirations. This report honors our outstanding Zoetis colleagues who champion our purpose and work every day to make us the world's most trusted and valued animal health company. And finally, I wanted to mention a recent recognition from Fast Company, which names Zoetis as one of the Best Workplaces for Innovators. Shaping animal care through innovation is something we've always done across the company, and it's been a key element of our success. This is a well deserved honor for our culture, and our people who continuously strive to solve critical unmet medical needs in animal health from chronic illnesses, like osteoarthritis pain and allergic dermatitis for pets to emerging infectious diseases, threatening the food supply. I'm truly proud of our colleagues for receiving this recognition. In conclusion, with a solid first half behind us, I remain very positive about achieving our full year guidance, thanks to the purpose driven colleagues, innovation driven culture and diverse portfolio that continue to drive our success. Thank you. And now let me hand it off to Wetteny. Wetteny? Wetteny Joseph : Thank you, Kristin, and good morning. As Kristin mentioned, we had a strong second quarter with balanced growth across both our companion animal and livestock portfolios, as well as our U.S and international segments. In the second quarter, we generated revenue of $2.2 billion, growing 6% on a reported basis and 9% on an operational basis. Adjusted net income of $652 million were 15% on a reported basis and 12% on an operational basis. Of the 9% operational revenue growth, 4% is from price and 5% is from volume. Volume growth consisted of 2% from other in-line products, 2% from new products, including our monoclonal antibodies for osteoarthritis pain and 1% from our key dermatology portfolio. Companion animal products are the primary driver of growth this quarter, growing 11% operationally with livestock growing 4% on an operational basis in the quarter. For companion animal, our key dermatology portfolio was the largest contributor to growth in the quarter, posting $355 million in revenue, our largest quarter ever and representing 14% growth on an operational basis. We saw double-digit operational growth in both international and the U.S. driven by strong growth in Cytopoint as well as growth driven by Apoquel and the conversion to Apoquel Chewable in certain international markets. Our monoclonal antibodies for osteoarthritis pain in dogs and cats, Librela and Solensia posted $69 million in revenue globally in the quarter with strong demand for both products as well as the impact of the launch of Librela in several new international markets. Our companion animal parasiticides also contributed to growth in the quarter, driven by our Revolution franchise, which had $103 million in revenue and grew 22% operationally. Simparica Trio also contributed to the parasiticide growth with $248 million of revenue and growth of 5% operationally. Our global companion animal diagnostics portfolio recorded $92 million in revenue in Q2, growing 12% operationally. We saw double-digit growth in the U.S. driven by high instrument placements in the quarter and disruptions from the implementation of our new field force model that impacted the prior year. Sales of our livestock products grew 4% on an operational basis in the quarter. We saw growth across both our U.S. and international segments driven by poultry, cattle and fish. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.2 billion in the quarter, growing 7% with companion animal products growing 7% and livestock sales growing 5%. As Kristen mentioned, our companion animal performance in the quarter reflects the stabilization of the distributor inventory levels that were a headwind to our growth in Q1. U.S. vet visits were flat in the quarter. [Indiscernible] revenue growth and average revenue per visit were both up 8%. These trends are in line with expectations and continue to reflect the stabilization post-COVID. Turning to U.S. product performance. Our key dermatology product sales were $241 million for the quarter, growing 10% and benefited from higher periodic patient visits in the quarter. Cytopoint sales continue to drive growth with vets and pet owners showing a preference for injectables. Our U.S. small animal vaccines revenue grew 20% in the quarter, driven by higher sales of our canine influenza virus vaccine due in part to a competitor back order as well as higher sales into certain corporate and strategic accounts. Apoquel Chewable posted sales of $213 million in the quarter, growing 2%. Growth was driven by inpatient demand across all channels, partially offset by a difficult comparison period given the timing of distributor shipments from last year during our supply challenges as well as aggressive competitive promotion in the current quarter. Our growth cadence for Trio across the year will be impacted by the timing of supply recovery in 2022, and we expect growth rate improvement in the second half. As expected, we received FDA approval for Librela in the U.S. in May. We look forward to starting our early experience program in late Q3 with an expected November launch. Now turning to U.S. livestock. We saw 5% growth in our livestock portfolio in the quarter, primarily from our cattle business where we saw significant growth in Jackson, resulting from a favorable comparative quarter last year when an anticipated midyear price reduction limited sales in the quarter. Additional U.S. cattle growth came from Synovex, which benefited from our reimplementation label claim. Our U.S. poultry portfolio also contributed to growth of 11% based on our vaccine portfolio and an increased focus on egg layer market. We also benefited from favorable MFA rotations at certain large producers. Moving on to our International segment, where revenue was $1 billion, growing 6% on a reported basis and 11% operationally in the quarter. International companion animal revenue grew 17% operationally in the quarter, while livestock revenue grew 4% operationally. Increased sales of companion animal products resulted from growth of our small animal parasiticides, our monoclonal antibodies for osteoarthritis pain and our key dermatology products. Our international parasiticide portfolio growth was primarily driven by a revolution franchise with $57 million in revenue, growing 52% operationally driven by the lack of supply last year, which particularly impacted China in the second quarter of 2022. Our Simparica franchise also contributed to growth with continued market share expansion, especially in Latin America, Europe and Asia. We continue to see strong adoption of Librela and Solensia. Librela generated $48 million in revenue with 89% operational growth in the quarter driven by strong growth in Europe, supported by our direct-to-consumer advertising efforts in major markets and recent launches in various international markets, including Canada, Australia, Brazil and Japan. Solensia delivered $11 million of second quarter sales internationally, driven by higher demand and supported by direct-to-consumer marketing efforts. Our international key dermatology portfolio grew 22% operationally. We continue to see double-digit operational growth across most of our major markets, driven by growth from and conversion to Apoquel Chewable as well as from Cytopoint with higher compliance and new patients. Our growth also benefited from a weak comparative quarter in Japan, which was impacted by pre-priced buy ups in Q1 of last year. Moving on to our international livestock portfolio, which grew 4% on an operational basis in the quarter. Our poultry portfolio performed well with growth driven by key account penetration and MFA rotations in core poultry markets, including Europe, the Middle East and Latin America. Our fish portfolio continues to perform well as a result of increased sales of vaccines across salmon markets in Norway and Chile. Lastly, our cattle portfolio saw gains in Turkey, Brazil and Argentina from strong price growth and the recovery of supply issues. Now moving on to the rest of the P&L for the quarter. Adjusted gross margin of 72.4% improved 260 basis points on a reported basis compared to the prior year, resulting from favorable foreign exchange, price increases and favorable product mix. This was partially offset by higher manufacturing costs in the quarter. Adjusted operating expenses increased 8% operationally with both SG&A and R&D growing 8% operationally driven primarily by headcount-related compensation costs due to the timing of new hires in 2022 and the impact of annual salary increases. The lower growth in R&D expenses this quarter is reflective of the timing of spend in project investments and not a reduction in our expected R&D spend for the full year. Year-to-date, adjusted R&D expenses has grown 13% operationally. The adjusted effective tax rate for the quarter was 21.5%, an increase of 80 basis points, driven by higher net discrete tax expenses in the quarter, mainly related to changes to prior year's tax positions and less favorable jurisdictional mix of earnings, partially offset by a higher benefit in the U.S. related to foreign-derived intangible income. And finally, adjusted net income grew 12% operationally and adjusted diluted EPS grew 14% operationally in the quarter. Capital expenditures in the second quarter were $166 million and continue to be on track with our expectations for the year. In the quarter, we repurchased $324 million of Zoetis shares. Now moving on to guidance for the full year 2023. Please note that guidance reflects foreign exchange rates as of late July, beginning with revenue for the full year due to unfavorable foreign exchange we are slightly lowering our revenue range while maintaining our guidance on operational revenue growth. We expect revenue between $8.50 billion and $8.65 billion, representing a range of 6% to 8% operational growth. With the approval of Librela in the U.S., we are now including our projected sales for November and December in our guidance, which are expected to be immaterial to our overall operational growth rate. Their impact on the full year revenue is largely offset by potential uncertainty in China as well as broader macroeconomic conditions in certain markets. Operationally, the first half has played out largely as we expected with 6% operational revenue growth. We expect stronger growth in the second half of the year overall, especially in our U.S. companion animal business. In livestock, which has grown 8% year-to-date on an operational basis. We anticipate unfavorable comparisons in the second half, driven by the timing of price decreases in Jackson in the U.S. last year, and the resumption of supply of several products after outages in the first half of 2022. We expect adjusted net income to be in the range of $2.50 billion to $2.55 billion, slightly above our previous guidance while maintaining our previous guidance of operational growth of 7% to 9%, driven by foreign exchange favorability in cost of sales and expenses, which were partially offset by unfavorability in revenue. Reported diluted EPS increases to a range of $5.15 to $5.27, which is impacted by foreign exchange and a one-time gain from a business development deal. And finally, due to the impact of foreign exchange, we are increasing adjusted diluted EPS to be in the range of $5.37 to $5.47. Just to summarize before we go to Q&A, we saw strong well based growth in the second quarter, growing in both companion animal and livestock as well as in the U.S. and internationally, with contributions from price and volume. We expect stronger growth as we move into the second half. We remain confident in our ability to deliver on our operational full year guidance commitments. We continue to see improving fundamentals in the overall industry and remain committed to delivering on our value proposition to grow revenue faster than the market and to grow adjusted net income faster than revenue. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We will take our first question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Great. Thanks for taking the question and congrats on the quarter, Kristen and Wetteny. I want to start with Trio real quickly. We've seen -- we finally see NexGard Plus in the U.S. from Boehringer Ingelheim. I just want to ask, how do you see this market playing out? There's a lot of debate on the label differences Trio versus NexGard Plus, the 6 month versus 1 month warm detail as well as how it's going to be priced with the promotions being put out at the start of the launch. So what are your expectations for Trio now that the competition is finally here both for second half and for 2024. And if I could squeeze in a follow-up. I want to ask on Librela. It continues to be really well OUS. I think it's on track for over 200 million this year from OUS alone. Any learnings or changes to your assumptions now that you can take that into the U.S. launch. Fair to say that it could be incremental 75 million, 100 million to revenue next year? Thanks. Kristin Peck : Sure. Thanks, Mike. I'll start with the first question and let Wetteny follow-up on Librela. Yes, as we saw the -- this was the label for NexGard Plus was largely what we expected. I think Simparica Trio clearly has a superior label, and it was first to market. Right now Simparica Trio is #1 in companion animal [indiscernible] in the U.S. As you look at where we are, we've had 3 years of demonstrated efficacy and experience with this product. And we'll clearly leverage our retail auto ship to continue that. As you look at NexGard Plus, it obviously does not, as you saw, have heartworm from first dose -- it has 4 ticks versus 5. It doesn't yet have a label to prevent line. It has a lower minimum weight. So we really do think we have a strength in our Simparica Trio label will be aggressive, obviously, in competing against them. We are expecting a much stronger Q3 for the product based on comparable. So we expect a strong second half for us. We are expecting significant promos. We watch them do this before. This is something BI does often. So beyond the promos, we think we can be very competitive with our product based on the strength of our label, the strength of the experience with the product. Our relationships clearly with the corporates and really with a very pleased pet owner who's on this product. So obviously, we're ready for some significant competition, but we remain very confident overall and our strength in [indiscernible], and we see a stronger growth obviously in the next quarter and the second half for [indiscernible] overall. But Wetteny, do you want to take this question on Librela? Wetteny Joseph : Sure. Mike, thanks for the question. Look, we remain really on track with EU performance, and we are very pleased to see $48 million of Librela revenues in the quarter, up 89% versus the prior year. We also launched a product in a number of new markets in our International segment including Japan, Australia, Brazil and Canada. Those contributed about $10 million for the quarter. So we continue to see really strong demand for the product, and we are starting to initiate DTC campaigns, which will continue to drive awareness across both Librela and Solensia in our markets. It is already, as we said last year, the #1 osteoarthritis pain product in the EU. Look, we won't necessarily get into what the expectations are for next year. Obviously, we'll do that as we get into guidance for the year. We are expecting to continue to see strong growth for Librela on the balance of the year. I will note, last year, we did see a bit of an uptick in the third quarter. That was, as we released the allocations that we are on, and we saw clinics order a bit more, that was offset in Q4. So just a little bit of a dynamic in Q3 and Q4. But really with the new markets as well as continued growth in EU, we are expecting very strong growth in the third quarter as well. Operator : Thank you. We will take our next question from Nathan Rich with Goldman Sachs. Nathan Rich : Hi. Good morning. Thanks for the questions. First, Wetteny, I wanted to start with the outlook for companion. I think you had talked about it improving in the back half of the year. Was that relative to the 5% growth in the first half? Or is that relative to the second quarter growth, which is obviously higher. Any context you can kind of provide as well on just kind of cadence through Q2 versus 4Q would be helpful. And then just a follow-up on the commentary on Trio. Could you maybe just talk about the 2% operational growth and the different factors that impacted that in the quarter and then the kind of type of growth that you would expect in the back half of the year, just given the competitive launch that you mentioned as well as maybe a normalization of supply. Wetteny Joseph : Yes, I'd be happy to take this and see what Kristin wants to add. With respect to companion animal, as we said, and I think you saw us really reiterate our guidance from an operational perspective 6% to 8%. Now while livestock has seen about 8% growth in the first half, we saw 4% growth in livestock in the second quarter operationally. We are expecting -- as we said in the prepared commentary, livestock to come in, in the low single-digit range. So I think you can clearly see that the growth in the back half of the year is going to be significantly driven by companion animal. And as we said also, given the timing of supply in 2022, we are facing -- relatively speaking, an easier comp in the U.S. companion animal business in the third quarter versus, say, the fourth quarter. So I think those will play out in terms of how you get -- how you map out to our guidance on an operational perspective, being largely driven by companion animal in the back half of the year. I think overall, not just from a companion animal perspective, overall, I would expect the third quarter to be another strong quarter for us. I would expect us to come in somewhere between the mid and high-end of our annual range. We said after last quarter, given the distributor destocking impact to a normalized growth for the rest of the year which would translate to somewhere -- if you just pick the midpoint of our guidance, that will be around 8%. We came in slightly above that, really in line with our expectations on the quarter. And so you can map out what that means for the rest of the year, but I would expect Q3 to be slightly above Q4 given what I just shared from a companion animal perspective versus less like that has a tougher comp in the third quarter, particularly in the U.S. Trio, like Kristin said, we are starting [ph] very strong quarter in third quarter despite the competitive launch, which we believe to be imminent here. Part of that is the cadence last year. I think the rhythm of supply last year clearly had an impact where we saw a bigger Q2 last year than in Q3. So I think you're going to see that play out with respect to the Trio growth. And given the first mover advantages that we have with Trio that's been in the market for over 3 years and our confidence in terms of our label, et cetera, we expect to see continued growth across Trio and a strong year for the year for Trio. Operator : Thank you. We will take our next question from Jon Block with Stifel. Jon Block : Great. Thanks, guys. Good morning. I'll [indiscernible] the front. I guess the first one, just any color on the gross margin. Wetteny, I think the 2Q '23 gross margin, I believe, might have been the best in the company's history. So maybe you could talk about the drivers there and more importantly, are some of those drivers sustainable? And then the second question might build a little bit on a prior question, which is, is Trio the modest, call it, downside driver of the implied companion animal '23 growth? Because I think I've got it right. Essentially, livestock went from flattish to up low single digits. Obviously, overall operational stayed unchanged at 6% to 8%. So the implied CA came down a bit. Do we think about Trio being responsible for that? And maybe just a byproduct of some of the promotions that you called out earlier? Thanks for your time. Wetteny Joseph : Yes. Look, with respect to gross margin, you saw 72.4% gross margin on the quarter in Q2. That's up about 260 basis points versus last year. FX is about 200 basis points of that. And clearly, we've pegged our overall guidance on FX based on where rates were at the end of July. So I'm not going to venture to forecast what that might mean. But in terms of the other components that are driving our gross margin, price and mix, certainly were favorable for us. And as we've just discussed with respect to livestock having a tougher comp in the back half versus companion animal particularly into the third quarter, we expect price mix to continue to contribute favorably here. The other element, of course, is really manufacturing -- higher manufacturing costs. I think typically what you see is this first half is a little bit higher for us than the second half. Part of that is the mix with respect to cattle run in the fall that tends to have a little bit of a mix down on us overall. But I would say the overall mix for the company, given the back half strength in companion animal is going to be -- continue to be favorable. So we see that being something that will consistently sustain. And again, we won't get into next year's element until we get there. With respect to the second half, look, clearly, our expectations with Trio remain that we'll see strong growth contribution for Trio and we are going to see a very strong third quarter. I think some of the -- and by the way, the year has played out, as we said, we gave a range of 6% to 8% operationally, sitting here today after delivering a very strong second quarter, we remain in line with our expectations for the year at 6% to 8%. I think if you look at some of the areas that we're watching from a macro perspective, China is one of them. I think if you look at the data coming out of China, confidence levels for consumers are low, the savings rates are very high. And so we're watching that as well as the impact it has on the Southeast Asia region given the tourism impact that China has on that region. That's one of the areas. Certainly, we are watching here in terms of what goes into our thinking with respect to the balance of the year. Kristin Peck : Yes, I just want to reiterate, it is not -- I would not call Trio what is driving any change in the second half. I really want to emphasize what Wetteny said and what we said in our remarks. It really is, as we are looking at uncertainties with China, Southeast Asia, Australia with the drought. So I mean, as always, when you run a large global company, I think the advantage of Zoetis is the diversity of our portfolio and the durability. And that's by market, that's by species, and that's by therapeutic area. So we are obviously seeing strength in a lot of areas, but obviously, uncertainties remain in China, Southeast Asia and certainly in some other markets around the world, certain ones such as if you look at, say, at Spain, et cetera, which has got high inflation and weather issues as well. So I would say, I just want to be very clear. I don't think your characterization of Trio specifically repairs is the concern in the second half. It is much more around some of these macroeconomic and geopolitical and whether uncertainties that we're seeing in certain markets. Operator : Thank you. We will take our next question from Westenberg with Piper Sandler. David Westenberg : Hi. Thank you for taking the question. So can you talk about the derm market in 2024? I'm not talking necessarily, but you're specifically -- but how you expect growth in monoclonals versus growth in small molecule with an incoming competitor. And if I could just squeeze in one really short one. Just want to confirm, Librela U.S. is not in the 2023 guidance. Thank you. Kristin Peck : Sure. I can start with your second. Yes, Librela U.S. is in, as we did note, obviously, in Wetteny's remarks. But to get to your question on derm and Wetteny can certainly follow-up with you once on the derm question -- on the Librela question. But we have led the way, as you know, in dermatology with both a small molecule and large molecule. We've been driving awareness through DTC. We still think there's significant market potential here in developed and emerging markets. There's still plenty of dogs that are untreated here. We are really focusing on investing in direct-to-consumer branded in the U.S. and in some markets and unbranded outside. With that, if you're seeing this year, we are looking at double-digit growth. In Q2, we had 14% growth with double-digit growth in both products in the quarter, so real strength. And we are continuing to innovate here. I think you saw also approval for Apoquel-2 in the U.S. We will look for long-acting Cytopoint, look at species, we are expecting obviously competition. We've been expecting it for a while. We'll say again, we're expecting it in 2024, and we'll see what happens. But we really are seeing more of a preference from both the vet and the pet owner moving more to Cytopoint for compliance reasons, obviously, for EE [ph]. So I think we'll continue to see that. So we are seeing very strong growth in dermatology. Again, we are expecting double digits for the year. In the quarter, we had great strength against both, but I would like to be clear that as we are seeing do we think will grow faster. We are seeing greater focus from the vet and the pet owner on Cytopoint being a greater driver of our overall dermatology franchise, but really expect to follow that up with strong innovation continuing in what we think is a really important space, Wetteny do you want to add anything on derma's question or Librela? Wetteny Joseph : Yes. Look, I think clearly, a really strong quarter for us in derm in the second quarter, and we are expecting another strong quarter and strong back half for derm across and clearly Cytopoint driving that as well. Just with respect to Librela, I just wanted to add a little bit of color in terms of our thinking there. Certainly, very pleased to have received approval in May. But really, consistent with our expectations, we've been sharing for the last, I think, 2 or 3 quarters, we've been expecting an approval to be -- to come in the first half of this year followed by an early experience program and then the launch late in the year is what we've been saying. We remain on track with that. We are planning to begin the early experience program next month with the launch to follow somewhere in the November time frame. Given the holidays and what's typically a little bit slower time frame with respect to clinics, et cetera, we're not expecting the contribution here to be significant to the growth for the year. And look, we continue to see great performance outside the U.S., and we are launching in other markets as well in line with our expectations as I shared a little bit earlier with an 89% growth rate on Librela on the quarter. And so we have factored that into the guidance here, but again, not a significant contribution. Operator : Thank you. We will take our next question from Brandon Vazquez with William Blair. Brandon Vazquez : Good morning. Thanks for taking the question. Just first on EPS and guidance. I just wanted to clarify the beat was pretty strong in the quarter, I think about $0.09 relative to the industry [ph]. EPS at the midpoint for guidance came up 3 points and just clarify, is that entirely the delta between those two? Is that entirely FX? Or is there anything else there we should be keeping in mind? And then as we think of the rest of the year kind of following up on that guidance, I think you said 4% pricing in the quarter. Can you just remind us when some of these pricing increases came in? Does the benefit of pricing kind of slow down in the back half? And does that imply any improvements in volume and guidance? Thanks. Wetteny Joseph : Yes, happy to answer. Look, as we said, we really reflected two things in our guidance today is, as we said, in fact, last quarter, FX was an area that we are watching, given the volatility that we are seeing across certain currencies that we operate in. And so we've updated guidance for FX both at the revenue line, which is negative. About -- it's about 75 basis points of growth essentially on a reported basis, that's impacting FX. So we reflected that here. But it's actually a positive contribution when you come down to EPS to the [indiscernible] $0.03. So what you're seeing there from an adjusted basis is really all FX. From a reported standpoint, we're also reflecting some gains that we saw from a couple of DB [ph] deals that are elevating the reported rate from an EPS perspective. The only other color I would ask -- add here with respect to the second half from the cadence is, again, we are expecting a very strong second half from a companion animal perspective versus livestock with the comps. I think if you look at the third quarter, we probably saw a bit lower OpEx in the prior year versus the fourth quarter. So I would expect OpEx will also be a little bit higher in Q3 versus Q4 as you look at the balance of the year. But other than that, I think price is something we typically do early in the year. There are certain markets where we may do a midyear price increase as well. But overall, price is something that happens fairly early in the year and pretty consistent with what you've seen in our numbers today. Operator : Thank you. We will take our next question from Chris Schott with J.P. Morgan Unidentified Analyst : Hi. Thank you so much. This is [indiscernible] on for Chris. So first question, on dermatology, can you just remind us where you are in terms of life cycle management? Any additional color that you kind of see with the dermatology portfolio kind of evolving over the next several years in terms of maybe potential new mechanisms or mode of administration. And then the second question is on Europe. You obviously had a very strong quarter for companion ex U.S. this quarter. Can you just elaborate a bit on the trends that you're seeing there and how you see them holding up in the second half of the year? Thank you so much. Kristin Peck : Sure. Thanks, [indiscernible]. I'll take your questions and see what Wetteny wants to build on it. Life cycle innovation, obviously, is critical in dermatology. We're quite focused on it in a number of areas. I think you saw approval in May of -- or in the quarter of Apoquel Chewable which we had approved outside the U.S., but now got approved in the U.S. This is really important for a lot of pet owners who have trouble getting their dogs to take pills. So a chewable has real value there. We are also looking at monoclonal antibodies, looking at more long acting in that space. We are also looking at life cycle innovation around other species. Clearly, dermatology is a significant issue amongst many companion animals. So we'll continue to look for opportunities there. It is a big market. We will continue to lead in innovation and in life cycle innovation across a number of different areas. I said, from small molecules to monoclonal antibodies to additional species. So we are really focused there. As you look at Europe, I mean, I think for most companies that we say, the growth in Europe was ahead of what many of us expected for the year, mostly because I think we were expecting energy to be a much bigger issue certainly through the winter, et cetera. But we've seen a great strength, particularly in Northern Europe. But I would say that if you look at Southern Europe, I don't think it's performing as well as Northern Europe. They've got greater inflationary markets there as well as a number of weather issues with severe heat waves and drought across markets like Spain. But we really see the underlying demand in Europe and Northern Europe remaining strong, and we are seeing strong growth there. So I'm not sure, Wetteny, if you want to build on any of those comments. Wetteny Joseph : Yes. Look, I think just stepping back from a companion animal performance perspective, we've continued to see strength there across our international markets. Even in emerging markets, just in Poland recently you're seeing a real uptick in terms of companion animal continuing to take hold. I think some of the innovation that we have may take some time to take hold in other markets outside the U.S. and it takes longer to get to those peak sales. We are continuing to see really strong derm growth across our international markets and so on. So we believe that is sustainable. The first half, we've seen really strong growth there in terms of companion animal. Across international, we saw 17% operational growth in companion animal in the quarter following a 10% growth in Q1. I would continue to expect double-digit growth, maybe not at the level we saw in Q2 in the back half for international, we continue to see double-digit growth there. Operator : Thank you. We will take our next question from Louise Chen with Cantor. Louise, your line is unmuted. Please go ahead with your question. Louise Chen : Hi. Thanks for taking my question. So I wanted to ask you some of the pushes and pulls to your commitment to the mid to high single-digit revenue growth that you've talked about over the next 3 to 5 years? Thank you. Kristin Peck : Sure. Thanks, Louise. We remain committed to the guidance we provided at Investor Day back in May. We really -- I would start with just the resiliency of the animal health industry. The industry itself, historically, as you know, grows at 4% to 6%. We see really strong tailwinds driving the industry over the next medium to long-term, increasing medicalization, especially in emerging markets, increases in population, really, the strength of the human animal bond. We are seeing increasing willingness to pay with 86% of pet owners say they'll pay whatever it takes to take care of their pet. But really where I think it differentiates Zoetis' innovation. Our innovation across chronic diseases. We look at -- what we can do as we talked about some of our new franchises that we think we will build over that time period as well. We look at an increasing global population, which is obviously driving the need for more sustainable ways of producing agriculture and meats and proteins, so we really think Zoetis will continue to outperform a market growing 4% to 6%. Historically, we've outperformed close to 3%. Zoetis is well diversified, and we are the innovation leader. We've got strong franchises today that are continuing to grow. Dermatology to be set, again this year are growing double-digit, parasiticides, OA pain, we've got strong diagnostics, emerging markets. So we really believe the industry is very attractive and very resilient. But most importantly, I think Zoetis as a leader in innovation will continue to drive this important space. Operator : Thank you. We will take our next question from Balaji Prasad with Barclays. And Balaji, your line is open. Please go ahead. Unidentified Analyst : Good morning. This is [indiscernible] for Balaji. Thanks for taking our question. A quick one on the global parasiticide market. On the Investor Day, you expect the global parasiticide market to expand from 6.3 billion in 2022 to around 10 billion to 12 billion by 2032, which implies a CAGR of around 6%. You also mentioned that Zoetis expect to grow faster than the market in this segment. So would you give us above half range of the market share of Zoetis parasiticide business in the next 3 to 5 years? How much our future growth in this segment will be supported by new product launch and how much will be supported by revenue growth of Trio and Revolution Plus? Thank you. Kristin Peck : Sure. Thanks for the question. I'll start and I'll let obviously Wetteny build there. We are the leader in parasiticides. We are really proud of that. We really see this as an important franchise. We have a broad set of products from Revolution to ProHeart to Simparica to Simparica Trio. We will be continuing to innovate in this important area. It is, by far, as you talked about, the largest therapeutic area in animal health. We really see a few things. Obviously, we are going to lead with innovation. We are going to lead with innovation in products that are easy to use, that really meet the customer demand as well as what our veterinarians are looking for. And we believe there's continued innovation in the space. We are looking at long actables, we are looking at injectables. We are looking at other combinations. Controlling parasites is critical to the overall health of the animal because if you don't, it creates lots of other issues. for animals. So we'll continue to grow in this important space. We think it will continue to be a major contributor to Zoetis' growth over the time period. So I don't know Wetteny, you want to add anything there? Wetteny Joseph : Yes. Look, what I would say is parasiticide is a -- the biggest sort of market segment within animal health. It's also a very competitive space. Now if you look at [indiscernible] combination, all medications, these are relatively new standard of care, and we are going to continue to see those expand the market with respect to the number of doses as well as from a price perspective. And this is the area that we play in the oral space largely. And so I would expect us to grow faster than the market. But again, it's a competitive space, and we'll continue to innovate as others do as well. Kristin Peck : Yes. The only thing I'd also add there is one other growth that we haven't talked about much today is increase in compliance. I think if you look at retail and auto ship [ph] and injectables, I think right now, if you believe that the research will show you the average pet is really on a bet 6 to 7 months, when they should be on 12 months for many of these products. So I think if we can do a better job of driving compliance either through auto ship on e-commerce or home delivery through the vet or dual [ph] as injectables where you can guarantee compliance. So we think there's lots of potential growth drivers for Zoetis to continue to drive this market and take share. Operator : Thank you. We will take our next question from Steve Scala with TD Cowen. Unidentified Analyst : Hi. Good morning. This is Chris on for Steve. We had two questions. First, on the U.S. pet health market. You mentioned U.S. vet visits were flat in the quarter. Is this capacity driven? Or is it more related to demand and weakening new patient visits and oneness visits? And then second, do you expect any headwind from the restart of student [ph] loan repayments this fall? Thank you. Kristin Peck : Sure. Thanks. As you look at the vet visits, they -- we really have seen them, on average, be flattish for the first half of the year. But to be clear, they're still ahead of where they were pre-pandemic, we do not see that as a demand issue. As we've talked about on previous calls, it's really more of a supply issue in the sense of the veterinary workforce challenges. We are working hard to partner with vets to help address this. Certainly, we are finding new efficiencies in their clinic helping to support as we can, adding more vet tech, et cetera, financial support, you name it, to support it. But we are not seeing any concerns around demand for veterinary health care. We are really focused on making sure that the supply is there. So no, we are not seeing , we don't look at the flat vet visits and have a cause for concern. Historically, just so you know, vet visits have been, give or take, flat to 1-ish historically. So this is not really concerning. And if you look at the first half of the year, we saw a 9% increase in both average revenue per visit and revenue overall in the clinic. So we are continuing to see really strong demand for veterinary care and for our product, and we don't really see that changing. And now on your second question on headwinds from student loan, we're not expecting that to be a significant driver for us in the back half of this year or in 2024. Operator : Thank you. At this time, we have no further questions in queue. I'll turn the floor over to Kristin Peck for any additional or closing remarks. Kristin Peck : Great. Thank you all for your questions today, and importantly, for your continued interest in Zoetis. Looking ahead, we really want to underscore that we remain confident in our full year guidance really because of sustainable underlying demand for animal health, as we just talked about, especially in uncertain times. We believe that the enduring strength of the human animal bond, their willingness to spend on pet health and the essential need for a safe and affordable food supply are all fundamental drivers of our growth. And I believe no one in the industry has a stronger set of capabilities and colleagues when it comes to meeting these customer needs, to advancing animal care and to creating shareholder value. So we look forward to keeping you updated on our progress, and thank you for your time today. Have a great day. Operator : This does conclude the Zoetis second quarter 2023 financial results conference call and webcast. You may disconnect your line at this time, and have a wonderful day.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,023
| 4
|
2023Q4
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2023Q3
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2023-11-02
| 5.216
| 5.3
| 5.835
| 5.935
| 7.84326
| 30.26
| 30.67
|
Operator : Welcome to the Third Quarter 2023 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be made available approximately 2 hours after the conclusion of the call via dial in or on our 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. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis third 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'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, November 2, 2023. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve. And welcome, everyone, to our third quarter earnings call for 2023. We generated strong performance in the third quarter, driven by our diverse companion animal portfolio of key dermatology products, pet parasiticides, monoclonal antibodies for osteoarthritis pain and diagnostics. We delivered 8% operational growth in revenue and 13% operational growth in adjusted net income, despite continued market challenges in China. We showed balanced segment growth this quarter with 8% operational growth internationally, and 8% growth in the U.S. Our companion animal portfolio grew 11% and our livestock portfolio grew 3% operational -- operationally in 3Q, in line with our overall expectations. Through the first nine months of the year, we have grown our revenue 7% operationally, as customers place a premium on the animal health benefits that our products delivered, even in times of economic and geopolitical uncertainty. As the market leader in animal health, we compete in an essential global industry that has been resilient during various economic cycles. And we continue growing above the market based on a steady pipeline of new products, lifecycle innovations, and commercial execution. We are on track to achieve our full year operational guidance and have narrowed it around the midpoint of the range, as we continue to balance headwinds and tailwind in the marketplace. We are executing well on the drivers where we have more control, like the successful launch of Librela in the U.S., while also mitigating the downside of macroeconomic declines in China, both of which were not considered in our original guidance this year. Once again, our diverse portfolio across product categories and geographies generate durable, reliable long term growth. We continue to expect our key companion animal franchises to be our core catalysts for growth. We anticipate strong growth and our market leading dermatology portfolio for the year, building on the ongoing direct to consumer or DTC digital campaigns that support disease and product awareness. As well as the continued introduction of life cycle innovations like Apoquel Chewable. Our compare to franchise and broader portfolio of parasiticides continue to perform well in this increasingly competitive product category, based on our innovative and highly effective products and promotional support from DTC. In terms of new products, we're very pleased with the U.S. launch of Librela, our canine monoclonal antibody for osteoarthritis or OA pain. This product has been very well received by veterinarians and pet owners in the U.S., as well as other major markets globally. And we have built ample supply for continued growth in the U.S. and elsewhere. Solensia, our monoclonal antibody for OA paining cats has also been well received by veterinarians in markets around the world. As we look to help increase medicalization of cats. We're building awareness of this condition among cat owners, and introducing our monoclonal antibody treatment through DTC campaigns, as well as AI tools like cat pain IQ, which helps that and pet owners use videos to identify this condition. Our diagnostic portfolio has been showing stronger year-over-year performance in 2023, with 14% operational growth in the third quarter, and we continue to refine this business to better serve customer needs across our comprehensive portfolio. For example, we're simplifying our reference lab service and operating model in the U.S. and focusing on expanding our larger regional hubs, which can deliver one-day turnaround and have more modernized operations. We also continue to emphasize the benefits of AI technology and our virtual lab services to enhance the speed and quality of our diagnostic solutions. With all this in mind, we are narrowing our full year guidance for operational growth to a range of 6.5% to 7.5% in revenue and a range of 7.5% to 8.5% in adjusted net income, keeping the same midpoint as our prior guidance. Wetteny will provide more details on guidance in his remarks. We continue to see strong underlying customer demand this year and into 2024, even while recovery in China is still a notable uncertainty. The majority of that practices in the U.S. continue to see high customer demand for veterinary services. However, labor constraints and more limited hours continue to hamper their ability to meet this demand. Year-to-date, clinic visits are flat as we expected. We did see a modest decline in clinic visits this quarter in the U.S., while clinic visit revenues and average revenue per visit were up. Looking ahead, we remain confident in the sustainable underlying demand for animal health, based on the strength of the human animal bond, people's willingness to spend on pet house and the essential need for safe and secure food supply. We expect to achieve double digit operational growth for our companion animal portfolio this year and low single digit operational growth in our livestock portfolio. Before I wrap up, I want to reiterate a theme I discussed earlier this year at Investor Day. It's the confidence we have in sustaining our key market leading franchises across dermatology, pet parasiticides and osteoarthritis pain based on life cycle innovations in these categories as well as the pipeline we are exploring in other areas of unmet need. We are firmly committed to investing in our portfolio as well as the DTC programs and capabilities we need to support our growth, while managing costs and creating value for our shareholders. Despite economic and geopolitical uncertainties in China and elsewhere, we believe we will continue to grow faster than the market for the remainder of 2023 and into 2024. This confidence stems from our diverse portfolio across markets and species. Our industry-leading franchises, the ongoing launch of Librela and the operational excellence and agility that our people deliver every day for our business and for our customers. So thank you, and let me hand this over to Wetteny. Wetteny? Wetteny Joseph : Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a strong third quarter, with broad-based growth across both our U.S. and international segments across both companion animal and lifestyle portfolios and across both price and volume. For the quarter, we were able to deliver results in line with our expectations, even in light of continued headwinds in China. In the third quarter, we generated revenue of $2.2 billion, growing 7% on a reported basis and 8% on an operational basis. Adjusted net income of $629 million grew 11% on a reported basis and 13% on an operational basis. Of the 8% operational revenue growth, 5% is from price and 3% is from volume. Volume growth consisted of 2% from new products, including our monoclonal antibodies for pain, Librela and Solensia and 1% from our key dermatology portfolio. Our companion animal portfolio was the main driver of revenue growth, growing 11% operationally. Livestock also contributed, with operational growth of 3% in the quarter. Companion animal growth was again driven by our innovative products with double-digit operational growth in our key dermatology portfolio, our monoclonal antibodies for OA pain, Librela and Solensia and Simparica Trio. Our key dermatology products generated $393 million in sales globally, posting growth of 14% on an operational basis with double-digit growth in both the U.S. and international. Globally, our monoclonal antibodies for OA pain posted $77 million in combined revenue in the quarter. Growth came primarily from our European markets as well as from the impact of new launch markets internationally. With the October full launch of Librela in the U.S., our pain products are now available in most major markets. Simparica Trio posted global revenue of $206 million in the quarter, representing growth of 20% operationally versus the comparable 2022 period. Growth was driven by expanded DTC advertising support globally as well as from increased field force and promotional focus. Our companion animal diagnostics portfolio reported revenue of $90 million and grew 14% operationally, with growth contributions from both the U.S. and international. Our life sci portfolio grew 3% operationally, with international growth partially offset by a slight decline in the U.S. Growth in livestock was driven primarily by price, especially in high inflationary markets. We also saw volume growth in our poultry portfolio, driven by increased usage of vaccines as well as our antioxodio product, Zoamix in the U.S. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.2 billion in the quarter, growing 8%, with companion animal products growing 11% and livestock sales declining 2%. On the companion animal side, while vet clinic visits declined 1.5% in the quarter, we continue to see robust play in revenue growth, up 6% versus a year ago. Average revenue per visit is up over 7%. On a year-to-date basis, clinic visits are flat, while clinic revenue is growing 8%. These trends highlight the continued durability of pet owner willingness to spend as well as the continued impact of vet clinic staffing challenges. Our companion animal revenue growth continues to outpace veterinary clinic revenue growth, due in part to our continued upsized growth in retail channel. Turning to product performance. Companion animal growth in the U.S. was driven by our key dermatology portfolio, Simparica Trio and Solensia. Key dermatology product sales in the U.S. were $260 million in the quarter, growing 13%. Simparica point sales continued to drive growth in the quarter, with vets showing a preference for injectables due to higher compliance and pet owners appreciating the longer duration of treatment. Apoquel sales were driven by growth in the retail channel as pet owners continue to rely more heavily on retail for ongoing pharmacy needs as well as retail auto ship programs that drive higher compliance. Our latest dermatology life cycle innovation at Apoquel Chewable was launched in the U.S. in October. Apoquel Chewable has been well received in Europe, as pet owners favor the ease of chewable administration over film-coated tablets. Simparica Trio posted U.S. sales of $184 million in the quarter, growing 17%, driven by increased focus in our parasiticide promotional programs. We continue to see patient share growth in Simparica Trio, even with the recent competitive launch in the triple combination space. We remain confident in our ability to compete through our superior label, strong retail channel presence, and the strength of our corporate and specialty relationships. In the U.S., our pain products posted sales of $15 million in the quarter. We continue to see solid player penetration growth for Solensia, as well as an uptick in Feline clinic visits and expect to continue to drive awareness of Feline OA through our DTC advertising campaigns. Librela has been well received by early experience program participants and their patients during the third quarter. We moved to a full launch in mid-October. We have been very pleased with post launch performance thus far, and are confident that we have ample supply to meet our demand expectations. Our U.S. companion animal diagnostics portfolio posted growth of 18% in the quarter, as we continue to see positive results from the new field force we introduced last year. We saw strong placement growth in the quarter, especially on our images device. U.S. livestock sales declined 2% in the quarter, primarily resulting from the timing of supply on certain cattle products in the prior year, where we had an improved supply position and restocking in the channel, which drove a strong comparable quarter. The Q3 decline was partially offset by growth in our cattle productivity implant, Synovex due to extended label claims. The cattle decline was partially offset by growth in poultry due to vaccines and the extended use of Zoamix, an alternative to antibiotic medicated feed additives. Moving on to our International segment, where revenue grew 8% on both a reported and operational basis in the quarter. International companion animal revenue grew 12% operationally and livestock grew 5% operationally. Increased sales of companion animal products resulted from growth in our monoclonal antibodies for OA pain, our key dermatology products and our small animal parasiticides portfolio. Growth in our OA pain products was bolstered by field force focus and DTC awareness campaigns in early launch European markets, specifically the U.K. and Germany, as well as the continued uptake in markets launched earlier this year. Librela sales were $50 million international or 55% operational growth in the quarter, despite a slightly more difficult comparator in Q3 of 2022 due to the removal of supply constraints in our international markets. We remain confident in our ability to supply our forecasted demand for Librela. Solensia sales were $12 million in the quarter. Our international key dermatology portfolio contributed $133 million of revenue and grew 17% operationally. We saw double-digit growth across most of our major markets and strong uptake of Apoquel Chewable. Apoquel growth was driven primarily by the delayed itch season in Europe and Canada. Cytopoint growth was driven by continued patient expansion and higher compliance in existing patients. Our international small animal are parasiticides portfolio growth of 9% operationally was driven by our Simparica franchise, with Simparica posting $40 million in revenue, growing 29% operationally, driven primarily by demand generation in emerging markets. Simparica Trio posted $23 million, growing 47% on an operational basis, driven by growth in corporate account contracts. The Simparica franchise performance was partially offset by a 16% operational decline in Revolution franchise, driven by a difficult comparable period in China, due to the return of supply in the prior year as well as the ongoing impact of the current economic conditions. As Kristin mentioned, we have seen declines in China due to the ongoing economic challenges, particularly on the companion animal side, which were not fully reflected in our initial guidance. We continue to monitor economic conditions. However, we are not expecting an improvement this year or into the first half of next year. Our international livestock segment grew 5% operationally in the quarter, driven primarily by price increases, especially in high inflationary markets. Growth was driven primarily by our cattle portfolio, which grew 8% operationally. Brazil was the largest contributor, where we have seen price growth, supply recovery on certain products as well as continued improvement in cattle industry dynamics. Additionally, the prior was a weak comparative period due to the impact of supply disruptions and a more uncertain industry dynamic led to a lowering of channel inventories in the quarter. Our poultry business also contributed to growth in the quarter, growing 9% operationally due to increased key account penetration in emerging markets. Now moving on to the rest of the P&L for the quarter. Adjusted gross margin of 70.5% improved 70 basis points on a reported basis compared to the prior year, primarily driven by the impact of price increases and lower freight charges. This was partially offset by higher manufacturing costs, inventory charges and product mix. Adjusted operating expenses increased 7% operationally, driven primarily by higher SG&A expenses, which were 5% operationally due to higher competition related expenses. R&D expenses grew 13% on an operational basis in the quarter, driven by higher compensation-related expenses as well as increased project spend for our pipeline projects. The adjusted effective tax rate for the quarter was 19.6%, a decrease of 130 basis points due to favorable jurisdictional mix of earnings and a higher benefit in the U.S. related to foreign-derived intangible income, partially offset by lower net discrete tax benefits. And finally, adjusted net income was 13% operationally and adjusted diluted EPS grew 15% operationally for the quarter. Capital expenditures in the third quarter were $145 million. We now expect full year capital expenditures to be in the range of $725 million to $750 million. In the quarter, we repurchased $250 million of Zoetis shares. Now moving to guidance for the full year 2023. Please note that guidance reflects foreign exchange rates as of late October, which reflect the continued strengthening of the U.S. dollar. Beginning with revenue for the full year. Due to unfavorable foreign exchange rates, we are revising our reported revenue range while narrowing our guidance on operational revenue growth. We expect revenue between $8.475 billion and $8.55 billion, with a range of 6.5% to 7.5% operational growth. Our previous guidance was 6% to 8%. We have been pleased with our operational performance thus far. While foreign exchange headwinds have been larger than expected, our year-to-date operational revenue growth of 7% is in line with our expectations. We expect to benefit from the approval and launch of Librela in the U.S., which is included in our revised guidance last quarter as well as the performance of our Lifestyle business. However, ongoing uncertainty in China has continued to offset upside potential. We are expecting adjusted net income to be in the range of $2.49 billion to $2.51 billion, also slightly lower, driven by unfavorable foreign exchange. Operationally, we are narrowing our growth expectations to a range of 7.5% to 8.5%, previously 7% to 9%. Expected reported diluted EPS narrows to a range of $5.14 to $5.21. And adjusted diluted EPS narrows to $5.38 to $5.43. Finally, to summarize before we go to Q&A. Our broad-based growth across species and geographies despite the challenging economic environment in China, continue to highlight the resilience of our portfolio and of the animal health industry. We remain committed to growing above the industry, driven by our innovative portfolio, commercial execution and multiple sources of in-line growth. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We'll take our first question from Jon Block with Stifel. Please go ahead. Jon Block : Great, thanks guys. Good morning. I promise one long question. So in companion animal, the overall revenue was a bit shy of what we had expected, but you really had great performance what we call sort of the big 5 products. So atopic derm, Trio map, the big 5 were all ahead of our estimate. So maybe if you guys can talk a little bit about the ongoing uptake of some of those key big 5 products even with a more difficult consumer, right? Because people view some of those as discretionary. Again, the results were really strong and even despite the more difficult consumer. And then the flip side would just be like anything to site regarding the legacy products, right? So if you back into legacy that might have been modestly down year-over-year. And a quick part B on the follow-up, Kristin, you mentioned faster growth for Zoetis than market and get in '24. I don't think we're really surprised by that. You've done that year in and year out. But can I push you a little bit on how we should think about for Zoetis in '24 versus Zoetis in '23? In other words, if we take into account the OA pain uptake, if you would, could we see accelerated growth for the company in '24 versus '23 when we think about all the moving parts? Kristin Peck : Wow. Okay. So John, great question. I think there's like 20 questions on that one. So I don't know how we would do that, but let me start, and then I'll let Wetteny build on it. To your point, we had really strong growth across our franchises. And if you look at dermatology, it's 14% in the quarter, Paris [ph] at 10%, diagnostics at 14% and the overall pain portfolio at 91%. So there really was strong growth across all those. Obviously, leading the growth there will be pain. And as you look into 2024, we see that as well with significant optimism about where that's going to go, we're very pleased with where that launch is. These are both Librela and Solensia, 2 products that are very early in their life cycle with significant growth. And I think if you really double click if you look at international, who already have these products in the market for a while, you're seeing great growth. Importantly, we're continuing to see really strong compliance on those products across Europe. As someone who currently has a dog who has an early experience, who look at their second dose of Librela, the difference that it makes, I really can't see any pet owner taking their dogs off these world-leading medications. So maybe Wetteny, if you want to take on some of the detailed questions you had around derm, paris and Solensia. But to your point, we remain very optimistic looking into 2024 about the strength of our companion animal portfolio and the 11% was in line with what we expected to be honest. But Wetteny, do you want to give more detail on some of that? Wetteny Joseph : Yes, absolutely. Look, the 11% growth operationally in companion animal is right in line with our expectations coming into the quarter. And the overall growth of 8% operational, I would even say, is slightly above. If you recall on the last call, we said expect Q3 to come in somewhere between the mid and the high end of our growth rate. So that's roughly between 7% and 8%, so at the high end of that. But in terms of consumer, look, as we've said time and time again, if you look at the therapeutics category in terms of the value in pet health as well as some of the chronic conditions, as Kristin mentioned, consumers have not been treating those as discretionary. Even when you see some relative softness in pet spend, it doesn't carry over into the health care piece in terms of therapeutics, et cetera. And we've seen that play out in many ways even as I'm sure we'll get into a -- clinic visits are slightly down in the quarter. Clinic revenue is up almost 7%, and we're growing faster than that. Again, retail being a part of that, and we'll get into that in a little bit more detail. When I look at the big products, as you described them, John, derm, Triomabs, all up double digits and up across U.S. and international. I mean our growth this quarter was broad-based, across companion animal livestock U.S. international price, 5% volume on 3%. So really broad-based. And I think that really underscores the breadth of our products as well as our innovation and the value that consumer and pet owners place on products. The legacy products, when I look at in line, keep in mind, when we talk price, we tend to see price lift in those legacy products as well. But when it volume, it wasn't down. In-line products were actually flat on the quarter year-on-year with some lift on price. So hopefully, that helps. But I share the optimism Kristin described with respect to 2024. I mean we have multiple sources of growth, not only the Librela launch in the U.S. You've got continued growth across international markets for Librela and Solensia as well. And of course, we'll have price as a lever in addition to in-line products we just talked about. Livestock is now back to growth, and we'll look at what that looks like when we come back with guidance next year. And then we expect growth across our key franchises as well in terms of derm, paris and diagnostics. So I'll cap it there as a long answer to a long question, but we'll take the next one. Operator : Certainly, we'll take our next question from Erin Wright with Morgan Stanley. Erin Wright : Thanks. On Librela, can you talk a little bit about the initial feedback for U.S. practices? Will there be any initial clinic level stocking? I think you said your expectations are intact there. But any lumpiness quarter-to-quarter that we should be thinking about? Has anything changed in terms of your expectations there? And then as we think about margin expansion next year, given Librela won't be at critical mass so that we may weigh on the gross margin. But is there still some underlying operating leverage that we should think about across the business? Kristin Peck : Sure. Thanks, Erin. I'll take the first half of the question, and Wetteny can take the second half of the question. We launched in the U.S., the early experience trial in September with 400 clinics. As I mentioned, my dog puppy was actually one of those dogs. We went to a full launch in mid-October once we got a full dose in, and that's really the uptake was really strong. Very pleased with the results. We're obviously still in the early stages, but we're seeing it very similar to what we saw in Europe. Both vets and pet owners are super excited. We make sure that we've got ample supply as both Wetteny and I mentioned, because we do see this as a strong ramp, as you saw what happened in international. International had a supply constraint for a while. And as soon as we open that, we saw where that really went. So we continue to see really strong demand. Penetration is going really well in the clinics in the U.S. and the experience is broadening. There will be some small initial stocking for sure in some of those clinics, but I don't know if I would call that lumpiness going into next year. There definitely was obviously, they stock it. And our hope is we continue to just continue to drive that growth going forward. It is the number 1 selling OA pain product in Europe. We expect it to obviously be the same in the U.S. If you look at the U.S. in particular, Erin, there are 26 million medicalized dogs with OA. So this is a big market that we're going after, and this is a game-changing product. So we really see a very strong potential with this. We think Librela will expand the market. And as we've mentioned before, we really do think Librela and Solensia alone can be a $1 billion portfolio for us. And that's in a market today that was only $400 million. So I think that sort of underscores where we see growth there. But do you want to talk about the margin expansion issue, Wetteny? Wetteny Joseph : Sure. I will. Look, you're right, Erin. In terms of -- as we said, when you look at ABS at peak, once they ramp up, they will be additive and accretive to our gross margins. We believe they're also accretive to our contribution margin, even when there are what I'll say is subscale in terms of getting towards their peak. So as we launch into the U.S., which is a large market, obviously, as you said, we'll see a little bit of a headwind from a gross margin perspective. But given many of the investments that we need to drive this field force, et cetera, already in the books, if you will. There will be some incremental A&P and DTC. And once we have the right level of penetration of the product in clinics, but that's still going to leave room for contribution margin lift in the product. So that will be, I would say, a factor from a gross margin standpoint. But we'll give more precision in terms of guidance for '24 at the next call. But as you can read from us and what we're saying today, we're very excited about '24. We're optimistic on '24, given the levers I just described. So in line with what we said at Investor Day, we expect to grow in the mid- to high single digits. I think you'll continue to see us look for margin expansion given the mix up in companion animal versus large [indiscernible], but I won't give you any more and more specific than that. Operator : Thank you. We'll take our next question from Nathan Rich with Goldman Sachs. Nathan Rich : Great. Thank you, so much the question. I wanted to stick with Librela. And Kristin, specifically ask about how vets are diagnosing OA pain and starting dogs on therapy? You obviously talked about the large number of pets that could benefit from this, but relatively few dogs on treatment. I guess, anything you can share in terms of diagnosis rates for practices that were in the early experience program and where those diagnoses are coming from? Are these dogs currently on a pain product and maybe switching to Librela or these new dogs being diagnosed? Anything there would be great. And then a quick follow-up on the international performance of Librela. It looks like it was roughly flat sequentially on a constant currency basis. Any learnings on seasonality or anything like that on the international side, now that that's been on the market for a little bit? Kristin Peck : Sure. A few things I'd say there. Unlike cat pain, which we can certainly talk about if someone has a question on it. Dog OA pain and osteoarthritis has been diagnosed quite well by that. This is not hard to diagnose dogs, unlike cats, do not hide it. You can sense they're less active. They limp. They don't want to go upstairs. It is not hard to diagnose. And a lot of these dogs are already being treated. They're being treated with our product, Rimadyl and other OA products. There's diets for this is not a space where there's not a developed market, a developed protocol for diagnosis. That is not the case in cats, where we do have to really develop protocols for diagnosis. What we saw initially is the first dogs they put on are the most symptomatic dogs, where they know that like they really are really struggling. I think if you look at what we've seen in international is as vets get more comfortable with it, they then start providing it for dogs earlier in the OA pain, which actually is even better. They have greater quality of life over time. So our experience of diagnosis is really coming out of international, which is normally initially the dogs they first put it on are the one suffering the most where their pet owners are begging for it. And then over time, you move into earlier stages of OA. But again, this is not one that is hard to diagnose for vets. They have protocols to do that today. So we're not really as concerned here in the diagnosis part. I think what we really need to do and we see growth in '24 and beyond in '25 and '26 is having that really provide a product like Librela to dog earlier in their disease, which I think will be a good growth driver. And in international, that is definitely not the case. We're seeing phenomenal growth right now. It is definitely not flat. But Wetteny, do you want to get into some of the specifics of the international growth situation there? Wetteny Joseph : Yes, absolutely. Look, if you look at Librela, we delivered $53 million in revenues in Q3. That's a 65% growth operationally. Now if you look at the preexisting markets, they were up about 33%. So that's an incremental $10 million or $11 million in the quarter year-on-year growth in the pre-existing markets. And then new markets that have been launched this year is about $10 million that includes a little bit from the U.S. from the early experience program. So year-on-year growth and then sequentially, I think was your question, and we're still up a few million sequentially. Just keep in mind, Q3 last year, as we said, we have a bit of a tougher comp for Q3, because that's when we released sort of the allocations that we're on and the supply constraints. So that is factoring a little bit, but we still had 33% in the in the EU sort of locations in markets where we had previously launched. So that's still a very robust growth despite the comp. Operator : Thank you. We'll take our next question from David Westenberg with Piper Sandler. Please go ahead David Westenberg : Hi. Thank you for taking the question. Just on 2024 on derm, do you expect the competitive launch outside of the one we already know from Elanco. How comfortable do you feel about your decision to price Apoquel Chewables at parity with your existing products? And are there any analogs for chewables as a competitive differentiator in front of a competitive launch? And just as a quick follow-up on the R&D. It did step down a little bit, and I think you're guiding for it down. Is there anything are we reading in it too much to say maybe there's not a new product -- a significant new product in 2024, 2025 and maybe reading into that too much. Kristin Peck : Sure. As we look for competition in dermatology to your question, we are expecting competition in the second half of next year. Our knowledge is that really there's only one that we're aware of at this point that we're expecting in 2024. We obviously don't know when in the second half that it would be coming. But we're well positioned for competition. As we've been preparing for competition for a while. We both have Cytopoint, we have monopole antibodies. We've got Apoquel. We've got Chew. We've got a pipeline behind that of continued life cycle innovations with longer-duration monoclonal antibodies, other species. So dermatology is a critical portfolio for us. We're continuing to grow. We did 14% in the quarter. So we're going to invest heavily behind this to make sure that we can continue to grow both our portfolio and the market overall. And if you look at chewable pricing, our strategy was let's move everybody to a product that's even easier that their dog like even more that they see as a treat, before you have competition, which we're expecting to be in a film coated tablet, similar to the original Apoquel. So we do see this as a really strong defense strategy for us. We've been seeing great as you look at the growth in international in the quarter. It was led by the conversion to Apoquel Chewable. And in the U.S., a lot of the growth in derm for us was also led by retail, which has done really, really well. To your point on R&D, I'll let Wetteny take it, but there's absolutely nothing going on there in the sense of any weakness in our portfolio. But Wetteny, do you want to talk about sort of what drove some of that? Wetteny Joseph : Yes, absolutely. Look, as Kristin just said, we remain on target with our regulatory milestones with respect to R&D spend was up about 13% year-over-year on the quarter. So clearly, well above our revenue growth rate. So what you're seeing in terms of our overall expectations for the year versus where we're landing is just a matter of timing on the span of gross projects, but nothing significant or notable there. Again, we continue to drive innovation, both across new innovation as well as life cycle innovation across our portfolio, and we're very excited about the progress we're making in R&D. Kristin Peck : Yes. It's mostly just timing of investments. I mean it varies quarter-to-quarter. Operator : Thank you. We'll take our next question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Right. Thanks for taking question. Mostly, I want to focus on Trio. You had a really solid result in the U.S., but it's sort of in that ramping up phase. Can you talk a little bit about what you're seeing in the market between yourself and the key competitors, BI, Merck, Elanco and specifically, BI just flashed NexGard PLUS, we saw a relatively surprising decline in Bravecto revenues from Merck? So I'm just curious, any change to competitive dynamics, anything you're seeing in terms of pricing or stocking or destocking and how that impacts Trio? And then just a follow-up on the very last question. CapEx as well, you slashed the guide this year pretty significantly. I think I heard you say Wetteny, the $725 million to $750 million and previously it was I think, $900 million to $1 billion. So just curious, did that get pushed out into '24 as well? Or is there -- any other change there? Kristin Peck : Sure. I'll take the first half of the question, see if Wetteny want to build on it and then Wetteny, if you want to handle the CapEx question. We did see strong growth in Trio in the quarter, 20% in Q3 for Trio. It remains the number 1 fleet tick heartworm in the U.S. by revenue. And really importantly, it's continuing to grow share. It's up 3% in the quarter. It's also growing patient share, which was up 2% in the quarter. So we're expecting solid growth this year. Obviously, we -- there's a new competitor. But in the Q4, I would also say to watch, we got a challenging comp as you look at us in Q4. If you remember, we got back into stock and ran a number of promotions in Q4 of last year. But we continue to expect strong growth for the year there. Even with the destocking that we saw in the U.S. in Q1 and the pre-price buying, as we talked about before that you had in Q4 of 2022. So we see this as a franchise that will continue to grow. A lot of our growth is really being driven by our auto ship, by retail, which remains very strong for us, with our corporate accounts. This is also a category where you do see low switching once you get on a product. So we do believe the broadest portfolio, but continue to see strength in Trio. So we're happy with the growth we've seen there. But Wetteny, anything you add that I miss there, and you want to talk about CapEx? Wetteny Joseph : Yes, sure. Look, on Trio, I think you covered it well, $206 million of revenue in the quarter. That's up 20% operationally. We're very pleased with that, including the patient share gains that Kristin already described. On CapEx, yes, we did reduce our CapEx expectations for the year from about $950 million to $1 billion down to $725 million to $750 million. This is really on timing of project spend. We remain committed to the investments that we're making. And this is still representing about a 25% increase in CapEx year-over-year. So as we said at Investor Day, excise CapEx to remain elevated for the next couple of years, and then we'll start to bring that down sort of in the range of a growth rate that approximates our revenue growth range as you go beyond '24, ‘25-time frame. So again, really just don't matter of timing is what you're seeing from a CapEx standpoint. Operator : Thank you. We'll take our next question from Brandon Vazquez with William Blair. Please go ahead. Brandon Vazquez : Hi. Good morning, thank for taking my question. On the companion animal side of things, it's a nice strong quarter. I think you had said, if I heard you correctly, that in 2023, you expect full year organic growth, double digits. The question being, I think you're at 7% year-to-date. I'm kind of being a little dangerous here and playing with my model live, but I think it implies kind of like a high teens organic growth in companion animal in the fourth quarter. One, am I thinking about that correctly? And then two, what's kind of giving you the confidence that the business can do that, especially, I think Q4 is a little bit more difficult year-over-year comp. Wetteny Joseph : Yes, I'll be happy to take that. Look, we continue to see, as you saw this quarter, 11% operational growth in companion animal. And though we have some tough comps, as Kristin just referenced with the Trio answer on previous question, we are expecting very, very strong growth across companion animal. And keep in mind, we have some comp challenges with respect to livestock, which will decelerate from what it is on a year-to-date basis, about 6% to a low single-digit growth. So as you look at what's factored into the guidance that we just gave in narrowing the range, but still maintaining our midpoint, if you will, you can factor that into your equation in terms of what the livestock versus companion animal mix is as we exit the year. Operator : Thank you. We'll take our next question from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi. Good morning. A couple of questions from me. Firstly, to the extent you can without commenting on any '24 guidance. Can you highlight some of the macro factors and how you expect that to change? Speaking -- looking at the diagnostic space of consumer trends, better option volume? And secondly, a bit more specific. Can you speak about your Librela supply plans? You recently opened a facility, a new facility in Lincoln and what impact does that have for supply costs and margins? Kristin Peck : Sure. I'll start with the beginning and then Wetteny maybe you can build on it. We continue to see very strong macro drivers in animal health. It's really led by the humanization of pets, which is a global trend. It's also led we continue to look at 2024 as to who's adopting those pets, which is more of millennial and Gen-Z and importantly, more income households, who are really raising the standard of care that they want to spend on their pets. We see this as important drivers as we bring real innovation to the market with Librela, with Solensia certainly continuing with Cytopoint which is growing very strongly. So we look at the drivers of pet care globally, which is really who's adopting the pest, how they want to spend on their pets and looking at revenue per clinic, which continues to grow very strongly, which is what we're really correlated against. It's something that continues into 2024. These are strong macro drivers for us. As we've spoken about on the livestock side, we really believe that market historically, and we believe in the future will continue to grow. 2% to 4%, low single digits. And as we said, we were going to return to that growth rate as we start to fully lap the challenges with DRAXXIN. So as you look at livestock, what's driving that is a growing middle class and more consumption of protein, with the whole Ozempic thing aside, which really hasn't really impacted livestock or the consumption of protein globally, really because of who is really driving a lot of that growth, which is middle classes across the globe, and more and more people entering that and seeing and upgrading their protein. So we look at those macro drivers, and we really don't see any changes if we look into not just 2024, but 2025 and 2026. And when we bring innovation to those markets, we believe we can continue to grow ahead of that. So Wetteny, I'm not sure if I missed anything there, and if you want to take the second half of the question? Wetteny Joseph : No, I think you covered the macro dynamics well, Kristin. On the supply question with respect to Librela, we are very confident in our supply plans to meet the demand expectations for Librela that we have certainly for '24 and beyond. Mentioning the Lincoln facility, certainly in addition to both our internal capacity and third party that we are using, we continue to invest internally. And I think if you look at Lincoln that will be a factor, particularly as you go beyond 2024, with respect to supply planning fully well and other maps as well. So again, very confident in our ability to meet those demand expectations, and we've already factored the ramp that we saw in Europe in our thinking around demand there as well. Operator : Thank you. We’ll take our next question from Chris Schott with JPMorgan. Please go ahead Chris Schott : This is Ekaterina on for Chris. Thank you so much for taking a question. So first, very quickly, just on veterinary visits and the pressure we've been seeing there recently, can you just remind us how sensitive Zoetis is to be dynamic and maybe your latest thinking around how visits are going to trend maybe into 4Q and potentially into 2024, if you want to comment on that. And then the second question is just on U.S. cattle. Can you just elaborate a little bit more on the dynamics you saw in the quarter? Because I think one of your competitors mentioned the timing of the cattle kind of was shifted earlier this year. Is this something that you saw as well? And does that potentially create a headwind for you as you think about the fourth quarter? Kristin Peck : Thanks, Ekaterina. I'll take your first question and Wetteny can build on me and then take the second. That business were flat year-to-date, which is what we've expected and what we talked about previously. In the quarter, they were down around 1.5% and as you discussed, we're really not as reliant on vet visits. The better proxy for us is revenue because again, remember that a lot of our products don't need to be purchased in the clinic. If you look at both auto ship, as you look at retail, you look at chronic medications, all of this continues to have us a higher correlation with overall revenue growth in the clinic. Historically, as we talked about before, vet clinic visits are flat to maybe 1% and if you look at where they stand today, they're still ahead of where they were pre-pandemic. So we don't pay as much attention to that vet clinic visit. If you look at revenue in the clinic, our growth in companion animal was higher than even that number, and that's because we're driving so much innovation there overall. So if you look at vet clinics business, we're not as tied to that number as we continue to say. So I don't know if there's anything I miss there Wetteny, what you want to build on, and then you want to take the second question? Wetteny Joseph : Yes, sure. The only thing I would add on the vet clinic visits is you see our growth continues to outpace that of the clinic growth. And the vet visits were not as they're important, right? But we're not as sensitive to visit because therapeutics and chronic indications tend to power through that. And you can still see volume growth even as visits are down. And then the retail piece, which is continuing to grow. We've seen an additional 24% points as a percentage of our pet care revenues in the U.S. each year. So we've gone from 11% from about 5% just a few years ago. So we continue to see that in the quarter, it was up about 35%, if you look at our retail sales. So those are the factors I would add. With respect to the cattle dynamics and livestock in general, I would say clearly, we've had a very strong start to the year through the first 9 months. Livestock is up about 6%. Clearly, we're signaling that will come down in the fourth quarter. And that's really more of a factor of variability across quarters, given the timing of supply that we've had in the prior year versus the current year. The timing of when we've taken price adjustments for Jackson, for example, which impacted Q2 versus Q3 as well as Q4 this year as we're anticipating a step in that -- at the end of the year. So that will put some more pressure on Q4. We factored all that into our guidance that we've just issued today, which we are still in line with our expectations that we started the year with, which is right around our midpoint, we just narrowed it. So all those are in. With respect to capital dynamics around, we haven't seen anything that would say there's a pronounced shift with respect to the cattle run here. But again, we factored all these items into our thinking and what we've just iterated today from a guidance standpoint. Operator : Thank you. We'll take our next question from Steve Scala TD Colin. Please go ahead. Unidentified Analyst : Hi. This is Chris on for Steve. Thanks a taking a question. We had 2. First, on the U.S. on the parasiticide market, can you provide an update on the estimated volume share of topical today? And then looking ahead to 2024, what is the risk of significant pricing pressure on Trio from the month of Credelio Quattro. Assuming a non-inferior product label type seems like the main level they could both to grow their market share. And then a clarifying question on U.S. Librela, can you confirm that U.S. sales were 0 in Q3? And then looking ahead to Q4, do you still expect sales to be immaterial for the full year? Wetteny Joseph : Yes. Look, I'm not sure if I got the second question, but I'm going to give it a shot and then ask you to clarify. On the parasiticides market, we still estimate in terms of volume, nearly half is still in the collars and topicals, but from a value perspective dollars, we're significantly leaning on the calls and prescription. As those are at higher price points. I think you're asking a specific question about share for specific products within the topicals and collars and I don't have that to hand. But if it was a different question, I'll ask you to clarify after I give you an answer on Librela. So Librela, in the third quarter was minimal. As you know, in September, we had an early experience program. That was only about 400 clinics very limited with KOLs to get them using the product and being able to talk about it, et cetera, and helping with refining protocols and so on. And so the number was like $3 million in the quarter, not meaningful at all. And given the timing of the full launch in October and with the holidays coming, it is not going to have a meaningful impact on the full year growth again on that point. But I'll ask you to clarify if I didn't get the question right on Paris. Operator : It appears disconnected at this time. Kristin Peck : Next question? Operator : And there are no further questions at this time. I'll turn it back to Kristin for closing remarks. Kristin Peck : Great. Thank you, everybody. Great questions today. Once again, we want to reiterate that we remain confident in our ability to achieve our full year guidance based on the diverse and innovative portfolio that continues to drive our success. We are firmly committed to continuing to invest in that portfolio as we look at the opportunities ahead of us, through DTC and building our capabilities to support our growth, but we'll also continue to manage our costs and ensure we're creating value for our shareholders. We continue to grow faster than the market by focusing on our people and our colleagues and on operational excellence and agility. They deliver every day for our business and for our customers. So we look forward to updating you on the full year and our long-term value proposition and hopefully seeing many of you in San Francisco at the JPMorgan Healthcare Conference to kick off 2024. Thanks, everybody. Operator : Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
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Health Care
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Pharmaceuticals
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Parsippany, New Jersey
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1952
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2013-06-21
| 2,024
| 1
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2024Q1
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2023Q4
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2024-02-14
| 5.357
| 5.42
| 5.982
| 6.04
| 8.29402
| 29.87
| 32.68
|
Operator : Welcome to the Fourth Quarter and Full-year 2023 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be made available approximately two hours after the conclusion of the call via dial-in or on our 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. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis fourth quarter and full-year 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'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, Tuesday, February 13, 2024. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve and welcome, everyone, to our fourth quarter and full-year 2023 earnings call. Today, we reported strong full-year results driven by the success of our diverse portfolio across markets and species, game-changing innovation, and the outstanding commitment of our purpose-driven colleagues. We delivered 7% operational revenue growth, growing faster than the industry, propelled by steady demand for innovative products that enable our customers and the animals they care for to thrive. With the ongoing momentum of our monoclonal antibodies for osteoarthritis or OA pain, we saw segment growth of 6% of the US and 9% operational growth internationally. Our companion animal portfolio remains a key growth driver, up 8% operationally, and we saw a return to growth for our livestock portfolio, up 6% operationally. While we continue to operate in an environment of global uncertainty, our diversity across markets, species, and therapeutic areas, has sustained our performance, further demonstrating that animal health is a durable, essential, and growing industry. Our track record of innovation, from pioneering breakthroughs to product lifecycle enhancements, has solidified our position as the industry leader, consistently growing above the market and enables us to create market-leading franchises. We don't just follow trends, we make markets. The launch of Librela and Solensia, the first two injectable monoclonal antibodies for the alleviation of osteoarthritis, is fundamentally improving the quality of life for dogs and cats, and strengthening the human-animal bond. That's why today Librela remains the number one selling OA pain product in Europe. At Investor Day last May, and again at the J.P. Morgan Healthcare Conference, I shared that our own pain franchise could have peak sales exceeding $1 billion, and we are excited about Librela's performance since its US launch in October, which reaffirms that view. Due to high clinic penetration, we've activated our direct-to-consumer or DTC efforts faster than any other product in our history, which we expect to provide a tailwind for commercial growth. Similarly, Solensia has also been well received, with strong clinic penetration around the world, with increased opportunity as we generate more awareness of OA pain in cats. Within our dermatology franchise, we've established ourselves as the trusted partner to veterinarians, and after nearly a decade of impressive growth, we still believe we have room to expand this market. Increasing pet owner's awareness that itch is a medical condition that requires treatment, improved compliance, and the opportunity to address even more unmet needs, underpins our optimism. We remain confident that we can sustain growth thanks to our differentiated products like Cytopoint and Apoquel chewable, the first and only chewable treatment for the control of allergic itch and inflammation in dogs. Our parasiticides portfolio, and particularly Simparica Trio, remains a key growth driver, even in the face of increasing competition. This continued success highlights our strategic execution, label strength, and the efficacy of our products. The performance across our key product franchises not only reinforces our market-leading position, but also better innovation consistently meet the evolving demands in veterinary medicine. As we begin in 2024, we will stay disciplined and adaptable to the evolving macroeconomic and geopolitical backdrop around the world, and focus on executing our plans and continuing to grow faster than the market. Two durable global trends give us confidence in that future growth, the powerful human-animal bond, and the world's growing need for a sustainable supply of animal protein. Our commitment to operational excellence ensures we are ready to scale to meet those demands and navigate unforeseen challenges, while delivering shareholder value. Looking ahead, we are committed to our track record of value creation and above-market performance. Our dedication to innovation remains the cornerstone of our market-leading position. We've consistently demonstrated agility, outpacing the market to bring groundbreaking solutions that meet and exceed customer expectations. We will continue to leverage that advantage and we're guiding to a range of 7% to 9% operational revenue growth in 2024, and adjusted net income growth in the range of 9% to 11% operationally, which reflects our ongoing investments in R&D, supply chains, and commercial excellence, to cultivate new markets, drive growth, and create value. As you've heard me say time and time again, we are confident in our strategy, portfolio, pipeline, and capabilities to deliver value to shareholders and customers, while performing above the market. Our focus positions us well to navigate potential challenges and capitalize on emerging opportunities. In closing, we'll continue our relentless pursuit to exceed customer expectations and invest in advancing the capabilities that differentiate Zoetis. As we look to 2024, I could not be more excited about our future. Our key growth drivers will continue to showcase our commitment to nurturing the world and humankind by advancing care for animals, and our ongoing innovations will expand the market, reaffirm our best-in-class product portfolio, and defend our position amid competition. I want to reiterate the four tenets of our value proposition discussed on Investor Day. We will grow revenue faster than the market. We will invest in innovation and growth capabilities. We commit to growing adjusted net income faster than revenue, and we'll return excess capital to shareholders. While there is need and demand to improve the quality of life for animals, Zoetis will continue leading the way and setting the standard for performance and growth. This is core to our vision, to be the most trusted and valued animal health company, shaping the future of animal care through innovation, customer obsession, and purpose-driven colleagues. Thank you. Now, let me hand it over to Wetteny. Wetteny? Wetteny Joseph : Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a strong year in 2023, with revenue of $8.5 billion and adjusted net income of $2.5 billion. Our full-year revenue was near the top end of our guidance range, while our adjusted net income was slightly below our guidance range, primarily due to the impact of foreign exchange, as well as an impairment charge related to a prior acquisition. Our revenue growth was broad, with strong growth across both our US and international segments, both our companion animal and livestock portfolios, and due to both price and volume. Full-year revenue grew 6% on a reported basis and 7% operationally, with adjusted net income anchoring 7% on both a reported and operational basis. Of the 7% operational revenue growth, 5% is from price and 2% is from volume. Volume growth was driven primarily by new products, including our monoclonal antibodies for OA pain, Librela, and Solensia, as well as our key dermatology products and Simparica Trio. On a segment basis, our US business posted $4.6 billion in revenue, growing 6% on the year, while our international segment reported revenue of $3.9 billion, with operational growth of 9% on the full year. Additionally, while China represents less than 5% of our global revenues, the ongoing economic weakness there continues to impact our business, and represented a half a percentage point drag on our total company operational revenue growth for the year, entirely in volume. Our full-year growth was driven by continued demand for our innovative companion animal portfolio, which grew 8% operationally. Our livestock portfolio also had a strong year, with operational growth of 6%. Performance in companion animal was led by OA pain mAbs, which posted $321 million in global revenue for the year. Growth came from first wave European markets, as well as from the impact of new launch markets in 2023, including the US. We continue to see penetration of our pain mAbs grow within vet clinics, and a high level of satisfaction amongst both vets and pet owners. Our key dermatology products generated $1.4 billion in sales globally, posting strong growth of 8% for the year on an operational basis. Simparica Trio contributed global revenue of $813 million in 2023, representing growth of 9% operationally, despite distributor inventory headwinds in Q1 and aggressive competitive promotions for much of the year. Our companion animal diagnostics portfolio recorded $356 million in revenue and grew 7% operational, with growth contributions from both the US and international. Our livestock portfolio had a strong year, with 6% operational revenue growth, driven by both price and volume. Moving on to our Q4 financial results, which was another strong quarter. We closed Q4 with revenue of $2.2 billion, representing an increase of 8% on both a reported and operational basis, posting our third consecutive quarter of at least 8% operational revenue growth despite a tough comparative, particularly in US companion animal. Adjusted net income of $569 million is an increase of 6% on both a reported and an operational basis. Of the 8% operational revenue growth, 6% is from price and 2% is on volume. Volume growth consisted of 4% growth from new products and a 2% decline in our inline products. Volume from our key dermatology products was flat in the quarter. On a segment basis, our US business posted $1.2 billion in revenue, growing 9% on the quarter, while our international segment reported revenue of $982 million, with operational growth of 8% on the quarter. Our companion animal portfolio was the main driver of revenue growth in the quarter, growing 10% operationally. Livestock also contributed, with operational growth of 6%. We saw double-digit companion animal growth in both our US and our international segments, driven by our innovative products. Our OA pain mAbs were the primary driver of growth, posting $124 million in combined revenue in the quarter. Global growth came primarily from the impact of new launch markets, bolstered by the Q4 full launch of Librela in the US. Simparica Trio generated $208 million globally in the quarter, representing growth of 21% operationally. Price was the primary driver of growth in the quarter, followed by volume growth, driven by expanded DTC advertising support globally, as well as from increased field force focus. Our key dermatology products generated $375 million in sales globally, posting growth of 7% on an operational basis. Our companion animal diagnostics portfolio recorded revenue of $87 million and grew 8% operationally, with growth contributions from both the US and international. Our livestock products ended the year on a strong note, with growth of 6% operationally, growing in both our US and international segments. Growth was driven equally by price, which grew despite headwinds from drags in price decreases, as well as by volume, with growth in Synovex from our expanded label claims. Now, moving on to revenue growth by segment for the quarter. US revenue was $1.2 billion in the quarter, growing 9%, with companion animal sales growing 10%, and livestock sales growing 4%. Companion animal again posted double-digit growth in the quarter, bolstered by the full launch of Librela at the start of the quarter, all while facing a tough comparative quarter with promotional activity and heavier than normal pre-price buying at the end of last year. In the US, vet clinic visits were flat on the quarter and flat for the year, while we continue to see solid clinical revenue and revenue per visit, growth of 6% for the quarter and 7.5% for the year. Our US companion animal revenue growth continues to outpace veterinary clinic revenue growth due in part to our innovative therapeutics, as well as our strong presence in the retail channel. Moving on to product performance, growth in the US was driven by our pain mAbs, Simparica Trio, and our key dermatology portfolio. Our combined pain mAbs posted $58 million in US sales in Q4. We moved to a full launch of Librela in the US early in the fourth quarter, and we have been pleased with the results our field force has been able to drive thus far. Librela posted $44 million in US sales in the quarter, which is at the higher end of our initial expectations. It's important to note that while we are not leveraging distribution for our pain mAbs, there's a significant clinic stocking impact in the first few months after launch. We have seen higher than expected penetration and reorder rates through the end of the year, as well as rapid patient share growth in the canine pain category. Solensia had sales of $14 million in Q4 in the US. We have seen a marked increase in feline vet visits and feline revenue growth in the clinic. In the US, feline OA patients are up 23% for 2023. Simparica Trio posted US sales of $185 million in the quarter, growing 17%. Growth was driven primarily by price as we were in promotions in Q4 of 2022 following our Q3 2022 supply challenges, and in advance of a then expected competitor launch in early 2023. In our second quarter, with competition in the triple combination space, we continue to see patient share growth in Simparica Trio. We remain confident in our ability to compete and grow in this space through the strength of our label, retail channel presence, strong corporate and specialty relationships, and the significant advantage of being first to market. (Indiscernible) dermatology product sales in the US were $252 million in the quarter, growing 6%. Cytopoint sales continue to drive growth through both price and volume, with vet and pet owners referring its injectable method of administration. (Operational) franchise growth is driven by better net price realization on lower volume due to promotional activity at the end of last year. Our US companion animal diagnostics portfolio posted growth of 9% in the quarter. US livestock grew 4% in the quarter, primarily driven by growth in poultry as a result of favorable rotations back to certain medicated feed additives and the extended use of Zoamix, as well as share gain due to competitor supply constraints. Sales of both swine and cattle products increased in the quarter, primarily as a result of increased supply of vaccines that were limited in the same quarter of the prior year. Moving on to our international segment where revenue in the quarter grew 9% on a reported basis and 8%, excluding the impact of foreign exchange. International companion animal grew 10% operationally, and livestock grew 7% operationally. China represented a 3% drag on our international segment operational revenue growth in the quarter. Higher sales in companion animal products was led by our pain mAbs, our key dermatology products, and our small animal parasiticides portfolio. Growth in our OA pain products was equally driven by sales force focus and DTC awareness campaigns in early launching European markets, as well as continued uptake in markets launched earlier this year. Librela sales were $53 million internationally or 93% operational growth in the quarter. Solensia sales were $13 million internationally in the quarter, growing 77% operationally. Our international key dermatology portfolio contributed $123 million in revenue, posting growth of 10% in the quarter on an operational basis. We continue to see benefit to Apoquel from our DTC awareness campaigns across several international markets and conversion to Apoquel chewable has been positive. Growth in Cytopoint continues to benefit from higher rates of conversion from Apoquel and overall market growth. Our international small animal parasiticides portfolio grew 4% operationally, driven by our Simparica franchise, with Simparica posting $48 million in revenue and growing 32% on an operational basis in the quarter, driven primarily by price, a strong parasiticide season, and demand generation in emerging markets. Simparica Trio contributed $23 million internationally, growing 72% operationally, driven by high peak season sales in Australia and continued uptake in Europe, driven by key account penetration and field force effectiveness. This growth was partially offset by a 33% operational decline in our Revolution franchise, which generates a high proportion of sales in China where we had a tough comparative quarter due to the return of supply in Q4 of 2022, as well as the ongoing impact of the current economic conditions. Continuing on to international livestock, which was 7% operationally, driven primarily by price increases in all species, especially in high inflationary markets. Our poultry portfolio also benefited from favorable MFA rotations in certain markets. China had an unfavorable impact on our international livestock sales in the quarter, particularly in our swine portfolio. Now, moving on to the rest of the P&L, for the quarter adjusted gross margins of 67.1% decreased 100 basis points on a reported basis compared to the prior year. On an operational basis, adjusted gross margins decreased by 20 basis points, resulting primarily from higher manufacturing costs, which were partially offset by price increases and lower freight costs. Adjusted operating expenses increased 11% operationally, driven primarily by higher SG&A expenses, which grew 10% operationally, primarily due to higher competition-related expenses, as well as a charitable contribution related to the funding of the Zoetis Foundation. R&D expenses grew 17% on an operational basis, driven by higher compensation-related expenses, as well as portfolio progression of key pipeline projects. Finally, other income and deductions were higher in the quarter due to an impairment charge related to an acquisition. The adjusted effective tax rate for the quarter was 18.8%, a decrease of 200 basis points, primarily due to higher net discrete tax benefits in the quarter, a higher benefit in the US related to foreign derived intangible income, and a more favorable jurisdictional mix of earnings. Adjusted net income grew 6% operationally, and adjusted diluted EPS grew 7% operationally for the quarter. Capital expenditures in the fourth quarter were $198 million. For the full year, we had capital expenditures of $732 million. Lastly, we continue to return excess capital to shareholders. For the year, we have returned approximately $1.8 billion to shareholders through a combination of share purchases and dividends. In December, we announced a 15% annual dividend increase, continuing our commitment to grow our dividend at or faster than the growth in adjusted net income. Now, moving on to our guidance for the full year of 2024. Please note that guidance reflects foreign exchange rates as of late January. We are expecting foreign exchange to have an unfavorable impact on our growth versus the prior year. At net revenue, we expect foreign exchange to negatively impact our growth by 90 basis points, with the impact being more pronounced early in the year and decreasing later in the year. At adjusted net income, we expect FX to negatively impact our growth by 150 basis points, with significant unfavorable impact in the first half of the year, transitioning to slight favorability in the second half of the year. As a reminder, we do not actively forecast FX, so these estimates assume rates remain where they were as of late January. For 2024, we are projecting revenue between $9.075 billion and $9.225 billion, representing a range of 7% to 9% operational growth, with growth across both price and volume. We expect companion animal to be the primary growth driver in 2024. With the expected impact of the US launch of Librela, we expect to see robust growth from our OA pain mAbs, both in the US and internationally. Our current clinic penetration levels for Librela in the US are exceeding our expectations, and as Kristin mentioned, we have launched our DTC efforts ahead of schedule to drive increased pet owner awareness. Even with the expectation of competitive entrance, we anticipate mid to high single-digit growth in both Simparica Trio and our key dermatology portfolio. For livestock, 2023 exceeded our expectations. Our growth in the year benefited from several tailwinds, including improvements in supply in certain markets, as well as competitive out of stocks. While our outlook for the upcoming year is more optimistic than it was as we entered 2023, we do expect our growth rate to normalize and be in line with livestock industry growth. I'd like to briefly touch upon the key assumptions that underpin our expectations for revenue growth. For companion animal, we are not projecting significant change to the current vet clinic trends. We expect US visits to grow flat to 1%, and expect to see growth in therapeutic visits aided by the impact of our OA pain products. For our companion animal parasiticides, we continue to expect meaningful growth from Simparica Trio. We expect new entrants will help continue to drive the conversion from topicals and collars to triple combination of our parasiticides, a space where we are the market leader. In our key dermatology products, we are prepared for competition and confident in our ability to defend and grow our share through our three differentiated dermatology products, the strength of our customer relationships, and the expertise we have gained from almost 10 years in the space. Lastly, while we are not assuming a change in the current economic situation in China, we do expect a headwind to growth, especially in the first half as the situation worsened over the course of 2023. Now, moving on to the rest of the P&L. Adjusted cost of sales as a percentage of revenue is expected to be approximately 29.5%. We continue to make investments to ensure we can support expected future growth in our portfolio, especially in monoclonal antibodies. These investments are driving short-term margin impacts from lower site utilization. This is offset by price increases and favorable product mix. Adjusted SG&A expenses for the year are expected to be between $2.17 billion and $2.22 billion, with the increase from 2023 focused on supporting primary drivers of revenue growth. Adjusted R&D expenses for 2024 is expected to be between $665 million and $675 million. Spend is driven by the advancement of key pipeline projects, as well as higher compensation-related expenses. Adjusted interest expense and other income and deductions is expected to be approximately $210 million. This is significantly higher than the prior year as our growth here is negatively impacted by the non-recurring royalty settlement income we reflected in Q1 of 2023, as well as the impact of lower interest income. Our adjusted effective tax rate for 2024 is expected to be in the range of 20% to 21%. Adjusted in income is expected to be in the range of $2.65 billion to $2.70 billion, representing operational growth of 9% to 11%. Our guidance once again reflects our value proposition of growing revenue in line with or faster than the market and growing adjusted net income faster than revenue. We expect adjusted diluted EPS to be in the range of $5.74 to $.584, and reported diluted EPS to be in the range of $5.34 to $5.44. And finally, we are anticipating capital expenditures in 2024 to be in the range of $800 million to $850 million. These levels remain elevated compared to historical spend levels as we continue to make investments to support our future growth. To summarize, 2023 was another strong year. Even with distributor inventory headwinds entering the year and a challenging economic environment, especially in China, we again outperformed the market. We continue to grow share even in spaces where we face new competition, and we remain confident in our ability to expand existing markets and create new ones in the future. As we move into 2024, our guidance highlights our ability to again grow faster than the market, driven by our innovative product portfolio and multiple sources of growth, as well as our ability to grow our bottom line faster than our pipeline, while making meaningful investments for the future and returning significant excess capital to our shareholders. Now, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] We will take our first question from Erin Wright with Morgan Stanley. Please go ahead. Erin Wright : Right. Thanks for taking my questions. So, can you talk a little bit about the reorder rates and feedback and expectations around Librela for 2024 in the US and some of those stocking dynamics that we should think about quarter-to-quarter? And then a bigger picture question just on margins and profitability, and there are some moving factors in 2024, such as FX and the ramp up of Librela that weigh on margins, but can you talk a little bit more about the potential margin leverage that you could see across your business as you expand in some of those faster-growing and higher margin categories in 2025 and beyond? And if you could describe a little bit more about that longer term margin leverage. Thanks. Kristin Peck : Thank you, Erin. I will take the first question on Librela and let Wetteny take that second question. Yes, we were very pleased with how we did with Librela in the first full quarter of launch in Q4. As you saw, we did about $44 million in the quarter, $47 million for the year, including the early experience trial. And really how we achieved that was our penetration was ahead of schedule, as we mentioned in the prepared remarks. Given that penetration, which is in the high 60s, we actually began DTC ahead of what we were expecting. Reorder rates are coming in exactly where we expected, in line with our expectations. So, that makes us really confident as we go into the year. We're looking at what - your other question was what kind of stocking or inventory build we saw in the clinics. It's hard to give you a firm number. It's somewhere between a quarter and a third, I would say, overall in stocking. But look, this is the number one selling pain product in Europe, and we have no doubt it will be that in the US as well. So, we're quite pleased and certainly ahead of our plan on penetration. And look, with our direct-to-consumer advertising investments, we've already started late last year and into Q1 to drive growth in this product in the US. So, I'll let Wetteny take the second question. Wetteny Joseph : Yes, sure. Look, when looking at margins, yes, indeed there are some moving factors when you think about 2024 and then beyond. We do have Librela in 2023, as we said at Investor Day. If you look at our monoclonal antibodies at peak, particularly as we ramp up production in our capacity, which was built to make sure that we're confident in being able to take advantage of demand, they started out as being dilutive to the overall company average. For example, in 2023. As we go into 2024, Librela becomes accretive to our overall margins, but still below what you would consider our innovative companion animal products. And as we exit 2024 into 2025 and beyond, it becomes more in line with our innovative companion animal products. So, overall, beyond 2024, I won't give you specific guidance here in terms of what to expect, but I think if you look at it, we continue to expect companion animal to outpace the growth of livestock. So, that mix will continue to be favorable for us. And as we get into the higher levels of production for monoclonal antibodies, they're also accretive to overall margins and we're positioned to be able to leverage our SG&A base as well. So, all of those should translate to margin expansion through the P&L over time. But as we've demonstrated, we're not afraid to make the right investments behind our products, behind our key franchises as we see them, investments in R&D, as you saw in 2023. And as the guide implies, R&D will continue to grow faster than revenue as well. So, those investments will slightly offset some of those, but we'll position to continue to expand. Operator : Thank you. We'll take our next question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Great. Thanks for taking the question, guys. First, I want to touch on margins, maybe both for 2023 and 2024. So, it looks like you're guiding - back of the envelope math, you’re guiding to about 100 bps of margin expansion in 2024, but you also did finish 2023 lower than we would've expected. I think 4Q especially came in significantly lower. And you called out some headwinds during the call in terms of FX. You called out some timing, some contribution to the Zoetis Charitable Foundation. Any way you could kind of back that out, give us sort of a cleaner number for what margins should have been in 2023, and then maybe what some of those one-time headwinds would have as an impact to 2024, just to give us a better sense of underlying margins and underlying EPS. And then my second question is just following up on Librela, I don't believe you actually quantified a target. So, I want to - just given what you did in 4Q, a major focus point, is something like $200 million to $250 million for Librela for 2024 reasonable? And especially - that's for US, but then on the O-US side, we've heard some concerns maybe coming out of Europe. And it seems like Librela has sort of been a little bit flat over the last couple of quarters in international markets. So, any color on what's going on internationally. Thanks. Wetteny Joseph : Yes, sure, Mike. Let take this and then see what Kristin wants to add. So, take a look at margins. Indeed in 2024, we are guiding to about 100 basis points of expansion and margins. Keep in mind, when you look at 2023 and how we ended, Q4 had about 100 basis points of margin impact. And about 80 of that is from FX. So, you're talking about roughly 20 basis points when you consider manufacturing costs and a little bit of mix. Now, looking at mix, we had clearly really strong and quite frankly a strong year in livestock. And we're actually here at the national sales meeting for our livestock with our livestock team in Utah. And look, they've had a great year, and we expect livestock continue to grow as we go into 2024, but clearly ended stronger at the end. So, that created a little bit of a mix, and as well as outperforming our expectations exiting the year is also, as I said, a bit diluted. So, when you look at mix and manufacturing costs, you're still talking about 20 basis points of headwind exiting 2023. Most of the impact here is coming from FX, about 80 basis points. The other items that we referenced in our prepared commentary with respect to impact on the quarter and how we ended, FX as I explained, the impact on our finish here, if you take a look at FX, which is clearly non-operational, and you factor non-recurring items like the impairment charge for the prior acquisition, those two items are about $0.07 of headwind in the quarter, in 2023 in the fourth quarter. So, that's really the vast majority of what you saw impacting us here. Of course, we don't forecast FX. So, what we bake into our guidance for 2024 is essentially what would happen if we assume FX rates stay where they are at the end of January here. And with that, on a constant basis, we would expect to expand margins in 2024. And so, that's really consistent with how we've approached our forecasting in the past. And I won’t sit here and guess at what FX is going to do throughout the year 2024. that will have an impact either favorable or unfavorable, depending on how that goes. For the other part of your question, I just want to maybe talk a little bit about Librela, how we expect Librela. Clearly, when you think about how we will deliver on 7% to 9% operational growth in revenue, price is a pretty significant factor. We continue to expect to be running price above our historic levels of two to three points, and perhaps slightly below what you saw in 2023 at 5%. And then Librela with the US launch clearly is going to be a significant factor. Certainly, $44 million in the quarter in Q4 was - again, very pleased to see that. We do see about a quarter to a third of that being initial stocking. So, you can model that out. In terms of what that would translate to, we're still in the early stages of our launch, but we're very pleased with what we're seeing so far, as we discussed already. In international, we couldn’t be more pleased with what we're seeing. If you look at international, the fourth quarter, you still have about 47% growth if you look at the base markets where we were launched at the beginning of the year. And then the new markets are driving another bit of growth. You have another $12 million contribution from those new markets, in addition to the US $44 million. So, I think what we have to really take into account here is, as we've been launching in markets in Europe, there's some stocking that happens from quarter to quarter as we do those launches. If you factor those out and you just focus on those markets that were already launched, we're talking about 47% growth in the quarter, which has been consistent over the last few quarters, about 50%, give or take growth. So, we couldn’t be more pleased with what we're seeing in the international markets. Kristin? Kristin Peck : No, it’s great. Operator : Thank you. We’ll move next to Jon Block with Stifel. Please go ahead. Jon Block : Great. Thanks, guys. Good morning. Wetteny, any revenue cadence in the year to call out? You've got sort of that easier 1Q 2023 comp, but you were also noting more acute China headwinds in the first half. So, just how do we think about it? Do we sort of look at it on a two-year stack basis? And then on the guidance for the full year, maybe GM fell a little bit below what we were thinking, but SG&A expense, despite the investments, Kristin, that you called out, the accelerated DTC, the SG&A was a little bit lower than where our heads were at. So, maybe you can just talk through those items, why we're only seeing, seems like low to mid-single digit SG&A growth year-over-year. I don't know if some of that's blunted by FX. And then just finally, I'm sorry, Librela, due to the stocking, do you still expect Librela to be up in the US 4Q 2023 to 1Q 2024 as it absorbs the stocking? Thanks, guys. Wetteny Joseph : Look, I'll take the cadence point first and then see what Kristin wants to add in terms of Librela expectations. Look, sitting here, I would expect a roughly balanced cadence across the year. Now, let's take a look at Q1, which is a specific point you raised in your question, Jon. If you look at Q1, certainly, if you look at companion animal in the US, there's an easier comp. We had destocking the first quarter last year, clearly something we look to see as an easier comp that we come up against. But at the same time, you had a 12% growth quarter in livestock in Q1. And so, I think if you look balance - those don't completely balance, but it's livestock growth, both in the US as well as international. And then you have China, which clearly started to more deteriorate in terms of the economic conditions there throughout the year. So, that becomes a heavier, I would say, headwind coming into Q1 as well as the conditions, weather conditions in Australia, et cetera, having an impact there. So, I think if you balance those out, and last point I'll make is, Librela, clearly very pleased with how we exit Q4 and enter into Q1, but it's going to continue to contribute more and more as you go through the year. So, Q2 and Q3 would be more than Q1. Therefore, the contribution from Librela accelerates through the year and it doesn't have as much relatively speaking in Q1. So, when you take all those into consideration, I actually see a roughly balanced year. Now, we did make references to FX, so from a reported basis that again, taking a look at where the FX rates were a couple weeks ago, you do have a heavier impact in terms of both revenue and bottom line. On the FX factor, hopefully what we provide in prepared commentary is helpful there. So, that's the other piece you have to think about. But when I think about operational base growth, I mean, we did exit the year with good momentum as we exited Q4 and into Q1, again looking at US companion animal. But that's how I think about it. Now, is Q1 going to be higher than Q4 from a Librela perspective? I think if you factor about a quarter to a third of impact coming from stocking, that's $12 million to $15 million. So, even if you had a flat, that means you grew by $12 million to $15 million going into Q1. I won't call it exactly here right now. What I would say is we're pleased with how the product is performing, but we are still in the early stages of this launch. Operator : Thank you. We'll take our next question from David Westenberg with Piper Sandler. Please go ahead. David Westenberg : Hi. Thank you for taking the question. So, last year we saw some discounting in front of the NexGard combo launch. Do you anticipate there might be similar competitive dynamics in front of a Elanco’s Quatro launch? And how are you thinking about that in consideration with the gross margins? And then just the second one on just the DTC efforts in Librela? I don't think there is DC allowed in Europe, but can you talk about maybe some of the learnings that you learned in Europe in terms of marketing and how they might apply specifically around communication of the vet? The vet obviously is the one that understands the superior safety profile with monoclonal antibodies and may maybe how that messaging can come out. Thank you. Kristin Peck : Sure. I'll start with that one and Wetteny can certainly build on it. I mean, I want to first underscore, we had a very strong Q4 with Trio, with 21% growth in the quarter with competition. For the year overall, Trio grew 9%. So, we're very pleased with that. As we guided and Wetteny mentioned earlier, we're expecting mid to high single digit growth in Trio for the year. So, this obviously underscores, and we think we'll see that both in price and in volume. So, we do anticipate, obviously a competitor entering. I'm not exactly sure what - how Purdue or Proctor will do it. Our expectation is that is not a differentiated product. They do mention tapeworm, but you get tapeworm from fleas, and we absolutely control fleas. So, therefore, that's really not a differentiated product. So, we are used to having good competitors, obviously with NexGard. I'm sure there'll be some heavy promotional, but I think our strength, honestly, with our corporate accounts, the experience, switching is low for people with this product. It's very unlikely someone on Trio is going to switch. We're doing quite well with retail and auto-ship, which I think also protects us. And we expect a new competitor to expand the market. What we're seeing a lot is a movement into the triple combos out of topicals, collars, et cetera. So, as we look at that, we're confident in our Trio number as we look into the year. And with regards to your question on, what do we learn from Librela in Europe? So, we cannot do branded advertising for Librela in Europe, but we can do overall advertising for disease awareness and encouraging people who have pets, both dogs and cats with osteoarthritis pain, to bring them to the vet. And we are seeing real impact of that disease awareness. I think it's been a long time where pet owners have not had a product that they could turn to, and encouraging them that there is a new product and that they should go to the vet and be seen. We are seeing really positive uplifts from direct-to-consumer advertising, even when it's not branded. So, I don’t know, Wetteny, if you wanted to add into that. Wetteny Joseph : Yes. Look, I think you covered it, Kristin. Trio’s been performing really well for us in the face of direct competition in the US. Couldn't be more pleased, and to be gaining patient share in the face of competition, I think that speaks a lot to what we've been talking about, which is the power of our relationships, the strength of our label and being first to market. So, look, there'll be some initial, I'm sure heavy promotion that happens when a new competitor comes in. We factor some of that into our thinking here. But until we see the label and see what they do, we won't home in on specific reaction and so on. But we're very confident in our ability to continue to grow the franchise. And we're saying we're going to see mid to high single digit growth across Trio in 2024 as well. Operator : Thank you. We'll take our next question from Nathan Rich with Goldman Sachs. Please go ahead. Nathan Rich : Great. good morning and thanks for the questions. I wanted to ask on the derm franchise. I think you had talked about mid to high single digit growth for the franchise overall. I guess specifically, are you assuming a headwind within that guidance from the competitive entry that's likely to occur against Apoquel this year? And can you talk about the strategies you're maybe putting in place to defend market share for that product? And then a quick follow-up on China, could you maybe frame the type of headwind that you expect in China in 2024? And does that impact more on the companion or livestock side of the market? Thank you. Kristin Peck : Yep, sure. I'll take the derm question, and I think Wetteny can follow up on your China question. Look, we saw strong growth both in the quarter and overall in derm at 8%. And I just want to underscore that that growth is obviously understated given the price, if you're looking at the pre-price buying that we saw in late 2022. As we look at our guidance for mid to high single-digit growth for our derm franchise in 2024, that is the expectation that we will see a competitor launch. We expect this market to continue to expand and grow, as we've talked about. There are 85 million dogs in the US who have pruritus. There is still over 6 million untreated dogs and 3.5 million who are treated, but with steroids and sort of over-the-counter products. So, we strongly believe this is a market we can continue to expand. Look, we've had two products been on the market seven and 10 years, respectively. We've had millions of dogs on these products. Our products have been proven over time to be safe and efficacious, and they're trusted by pet owners. They're trusted by vets, and we're seeing more and more a switch to Cytopoint, both a preference for compliance by both the pet owner and the vet. And our competition, we're expecting to come in a film-coated tablet. And if you look at that, we're really focused on investing in applicable chewables and moving them to chewables, which pet owners really prefer. We've been successful in doing this in Europe. We're quite focused on doing this in the US and we're also continuing to look at innovation in the short term, on the long acting. So, we are going to defend this franchise. We're confident in this franchise. Our guidance of mid to high single digits demonstrates that we believe we can continue to grow this market in the US and around the world, not just defend our brand, but continue to bring lifecycle innovation to the space over time to grow our share. Wetteny, do you want to take China? Wetteny Joseph : Yes, sure. And one point on derm, of course we have a mid to high single-digit growth expectation that we laid out in our guidance, of course, across a broad range of expectation. There’s various scenarios around competitor entry, timing, pricing, et cetera, will play into that. And the label that they have, of course, will be playing into how that plays out. But we're confident in our ability to grow. Our franchise has been around for a decade in this space. On China, we've been consistent on this one. I think we continue to see sort of the broad economic situation there to remain where it is. We're not expecting it to deteriorate nor improve, at least through the first half of our year. And we also have stronger comps similar to the second half of 2023, a little bit less so into the first half of 2024, but still headwinds into the first half of 2024. You continue to see consumer confidence being low and swine prices remaining fairly depressed in consumption there as well. So, all those factors. Of course, long-term, we continue to expect China to be a strong growth market. It has done exceptionally well for us over the last decade, but in the near term, we're not expecting that to be a contribution to growth. In fact, we'll see some declining comps in the first half on China. Operator : Thank you. We'll take our next question from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi. Good morning, everyone, and thanks for the questions. A couple. firstly, I just wanted to understand the currency dynamics better, considering that most of the nearly 100 basis points based on revenue and 150 basis points based on EPS seems to be growing from here. Why is FX so severe and any particular currencies hurting you? I mean, my general understanding is with $4 billion plus of export revenues and dollar weakening, I thought the impact would have been the other way around. Second question is around the FDA letter that Zoetis has received on Librela number. I want to understand how frequent or normal are these kinds of letters on the animal health side and the issues that FDA found with Librela’s promotion, with the inclusion of the P value on the secondary end points? And what is the current status now with regard to your communication with the FDA? Thank you. Kristin Peck : So, I'll take your second question first and then let Wetteny take it. I assume you're referencing the letter back in November. Honestly, the letter is uneventful and was well addressed. We immediately resolved the request for clarification. What you're talking about was a request for clarification on our promotional materials. We just made a minor change to the promotional materials and how we represented some statistical data. The concerns are well addressed and the modifications were accepted by the FDA. I mean, this isn't uncommon. So, I don't - that was easily resolved last year. That was a minor issue, but Wetteny, do you want to take the second question? Wetteny Joseph : Yes, sure. On currency dynamics - and again, we don't forecast FX, so we tend to report out what we see the impact is. And the dollar continues to strengthen against the number of currencies that we operate in. And there's a little bit of a disproportional effect that we see on some of the higher inflationary markets like Argentina. If you follow Argentina, there've been two really significant drops in terms of FX rates versus the dollar, if you follow back, as we ended last year, both in December and I think back in August, and there's a little bit of a delayed effect on those. Clearly, there's an impact on top line that we've talked about, but there's also a little bit of a delayed effect if you look at the impact it has on inventory and receivables that are on the books at the time. So, by the time you collect those, they have a greater impact, which is why you see the impact down the bottom line. So, combination of Argentina, Brazil, Turkey, those are more pronounced than their relative percentage of our revenues, given how significantly they devalue. That's what you’re seeing play out. But really across the board, if you look at how the dollar ended the year, it ended a bit stronger than you saw throughout the average of the year. Operator : Thank you. We'll take our next question from Brandon Vazquez with William Blair. Please go ahead. Brandon Vazquez : Hi, everyone. Thanks for taking the question. First, can you talk a little bit about the pre-price buying the quarter? Are you able to quantify how much of a headwind that was? And then maybe talk about should we expect that to be a headwind going forward at all? Are you guys still working through that? And a follow-up to that maybe higher level, is there anything in the pipeline or kind of in product cycle management that you guys can share with us? You're still spending a lot of money in R&D, and even for next year, it looks like that may not be a specific area to get leverage off of the R&D line. So, anything that you'd be able to share with us there would be helpful. Thank you. Wetteny Joseph : Yes, sure. I'll take the first one and then Kristin will cover the second one. Look, there's always some level of pre-price buying in our - as we exit the year, given what our price increases are going to be. I would say compared to the prior year where there was higher than average pre-price buying ending 2022 into 2023, which had the effect on 2024, we more actively managed customer orders in terms of pre-price buying exiting 2023, and that gave us really first the underlying market strength and momentum that we carried into, but also I would say our order position walking into January 2024 was certainly in better position than say the prior year. So, we more actively manage those, but there's always some level in the numbers. Kristin Peck : Sure. And the question with regard to R&D, obviously we are very confident in our pipeline. I think we've been the most innovative company in animal health. And as you look at the how we exceeded market growth every year for the last 11 years, it is due to the innovation in our pipeline. We are investing both for the short, medium, and long-term in animal health different than human health. That really makes a difference. You look at sort of what I call like lifecycle enhancements that we just launched such as Apoquel chewable, which will significantly support our key brands. We're also looking at pretty disruptive innovations as well. As you look at sort of the short one-to-three-year term of innovation, we're excited really for some of our long actings. And we've talked a lot about investing in the medium to long term in really important new franchises as well such as renal chronic kidney disease spaces, looking at cardiology, looking at oncology and diabetes. There's really important spaces of unmet medical need in animal health that we're really excited to tackle. We're continuing to invest behind our diagnostics, as well as behind our livestock business, looking at new vaccines and immunomodulators in our genetics business. So, we have a very diverse pipeline because we have a diverse portfolio. So, we're continuing to invest behind that and remain very confident in that. Operator : Thank you. We'll take our next question from Chris Schott with J.P. Morgan. Please go ahead. Chris Schott : Great. Thanks so much for the questions. Just two for me. Just latest on vet visit growth. I know it's not the primary driver of growth for your business, but you're targeting 0% to 1% this year. And I'm just trying to get more color on what’s the underlying kind of dynamics here. Is this mostly still vet capacity? Is it macro dynamics? Just any color there would be appreciated. And then my second question was just coming back to Librela ex-US. From your perspective, how penetrated is the market for monoclonals at this point? And where do you see the largest opportunity for growth in these markets? I'm sure you have a sense of like, are we in the second inning or the seventh inning of the ramp ex-US? Thanks. Kristin Peck : Sure. I mean, starting on the first, we are not very levered, as we've spoken about many times before to vet visits. I mean, obviously, they're not inconsequential. Our view of zero to one is that's where it's historically been. That is historically what you see in vet clinic visits over time. So, I think we're really saying it's back to a normal. What's really happening is there's strong end market demand. There remains some capacity issues in the US, but I think some of that's being addressed by more stuff going to auto-ship and retail and online, which has also been supporting it. But we really sort of view the year, as you look into the year for 2023, although we saw flat vet visits, we saw revenue and revenue per visit up 7.5%. So, we really are seeing really strong growth, obviously overall in revenue, and we're much more correlated over time with that, just given the strength of our portfolio, et cetera. And to your second question with regards to Librela outside the US, I think we're still early innings. And really where I think we see the growth is, right now that product is primarily being used in severe dogs. I think getting it into more moderate dogs, I mean, I think, obviously, at least as someone, in my 50s, I will say my hip hurts right now, but everyone doesn't know that who is around me. And so, the reality is, osteoarthritis exists in animals long before they're limping and can't walk up the stairs. And the more we can control that pain early, I think is critical. So, I think what we're really trying to change the paradigm is getting Librela in first line use for animals with osteoarthritis pain, and getting it into more of those moderate dogs. And we think the more we can do that, the more we can continue to grow the market here and grow our franchise. So, we know, we believe we're in early innings across the globe with regards to osteoarthritis pain with both Librela and certainly with Solensia, where we still have to continue to grow awareness for osteoarthritis pain in cats. Operator : We'll take our next question from Steven Scala with TD Cowen. Please go ahead. Chris LoBianco : Hi, this is Chris on for Steve. We have two questions. First on Librela, to what degree are US vet capacity constraints a headwind to longer term treatment compliance? And then is there a regulatory path for the approval of an at-home owner-administered formulation? Thank you. Kristin Peck : Sure. Obviously, making sure that pet owners can get in monthly for their injections is critical. So, vet capacity is certainly something that we're quite focused on, but I think after the first visit, this is an injection that can certainly be done by a vet tech, and I think the industry's really focused. And we've been partnering with corporates, with the AVMA, with lots of people to really think about how to change the paradigm of vets to vet techs and clinics and things like that. So, we believe there are solutions to really address some of the vet capacity issues. So far globally, and by the way, this vet capacity issue is not just a US issue. It's global. So far, it hasn't affected the growth of our key products. And your second questions with regard to home delivery, you want to take that one? Wetteny Joseph : Yes. Look, I think the regulatory path to that isn't really the direction we're going in terms of where we think we can make an impact here. Livestock innovation not only in our OA pain mAbs, but across our portfolio, are really, really important. And as I look ahead, I think longer acting formulations, both Solensia and Librela, will be the direction that will help with this, even though, as Kristin said, we're not seeing any significant impact in terms of our ability to grow the mAbs. I think initial visits where the vet has to see the pet and do the injection beyond that, the techs are able to do it, et cetera. And that varies a bit, but, but we don't see that as being a significant impact for us. Operator : We'll take our next question from Navann Ty with BNP Paribas. Please go ahead. Navann Ty : Hi, good morning. Thanks for taking my questions. I have two, one on Librela and one on Trio. The first one on Librela, with continued investments in 2024, what are the remaining SG&A needs in addition to the current DTC campaign? And just a clarification, do you currently expect Librela to become potentially gross margin accretive in 2025? And then on Trio, can you help us explaining the switches from the NexGard Plus? Are they mostly from BI’s own NexGard rather than from Simparica Trio, and you see uptake from BI on younger dogs and puppies mostly? Thank you. Wetteny Joseph : I’ll take the first one on Librela. Look, of course, we are going to be making investments and we already started, because as you heard in the prepared commentary, our penetration levels are running above our expectations, and we've launched DTC on Librela, and we're already doing DTC across Europe and international markets as well. As we look ahead, we did make significant investments in our field force going back about a year and a half or so ago. So, we're able to leverage those investments and we don't see incremental investments beyond those to drive our expectations and take advantage of demand on the product. The gross margin picture, as I mentioned earlier, it is dilutive if you look at 2023, and particularly because you saw us outperform expectations on Librela in 2023, right? As you go into 2024, Librela margins are actually accretive to the overall company margin leverage. So, 70%-ish gross margins for the company, Librela is above that, but it is below the gross margins that you would see in our innovative companion animal brands. As we get beyond 2024, you will start to see it at those innovative levels, which is well above the company average. So, hopefully that helps clarify that point. Trio, as we've said, we've seen really strong performance in Trio, posting double-digit growth. Trio grew 17% in the US in Q4, and we continue to gain patient share, which means again, switching is low when you have a product that's safe, efficacious, and been in the market for almost four years now. So, we're very pleased with what we're seeing. I don't know, Kristin, if you want to add anything. Kristin Peck : The only add, we're doing quite well with puppies. You asked specifically with regards to puppies. I mean, puppies are on the Trio label, so I just want to emphasize that. I know it wasn't on the original Simparica. So, I mean, really you are looking at new starts, we see a lot of puppies and we see a lot of conversion from single and dual-agent customers to a triple combination, and certainly a movement to more people from topicals to oral. So, there's lots of ways for us to continue to gain market share for that product, but we're doing quite well with puppies, to answer that other part of your question. Operator : And there appears to be no further questions at this time. I'll turn the call back to the speakers for any closing remarks. Kristin Peck : Great. Thank you all so much for the questions, and honestly, for continued interest in Zoetis. I want to underscore that the enduring strength of the human-animal bond for pet owners’ expectations of human quality healthcare for pets, and the need for safe and secure food supply, all underscore the animal health industry is essential and very durable. We remain confident about our strategy and the ongoing value proposition, because we know that our colleagues will make a difference every day in everything that we're doing. And with their support, I want to reiterate that we expect to grow faster than the market again in 2024, not just in line, and to grow operational revenue by mid to high single digits. We are firmly committed to investing in our innovative pipeline, our portfolio, and the DTC programs we need to support the broadening and building billion-dollar franchises. The animal health industry is resilient even in times of uncertainty, and we are poised to navigate these challenges because our portfolio diversity, our commitment to exceptional customer experience, operational excellence and agility, and we look forward to keeping you updated on our progress on future calls. Thanks much for joining us today, guys. Have a great day. Operator : Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.
|
ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,024
| 2
|
2024Q2
|
2024Q1
|
2024-05-02
| 5.44
| 5.44
| 6.031
| 5.97
| 8.22406
| 31.06
| 29.52
|
Operator : Welcome to the First Quarter 2024 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately 2 hours after the conclusion of the 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. Steven Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis First Quarter 2024 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, May 2, 2024. We also cite operational results, which exclude the impact of foreign exchange. And with that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and good morning, everyone, and welcome to our first quarter earnings call for 2024. Today, we reported outstanding first quarter results, underscored by steady demand for our products, a focused strategy and our purpose-driven colleagues. We delivered 12% operational revenue growth and grew adjusted net income 15% operationally in line with the tenet of our value proposition. Driven by the launch of our osteoarthritis pain franchise, the U.S. led the way with 16% growth and 8% operational growth internationally. More specifically, globally, Librela grew 189% operationally, including $40 million in sales in the U.S., in line with our expectations. The powerful human animal bond fueled demand for our companion animal portfolio with 20% growth operationally, while livestock declined 1% operationally. This quarter's results even amidst global uncertainty are a testament, once again, to the power of our diverse and durable portfolio across markets, species and therapeutic areas. It also highlights the continued rise and resilience of the animal health industry. Our purpose and performance are rooted in science, which has always been the great disruptor. And as animal health is increasingly essential for nutrition and companionship, caregivers demand even more high-quality innovation. That means we identify the most prevalent area of unmet veterinary needs and invest in, develop, manufacture and deliver life-changing products that customers have been waiting for. Take, for example, Librela and Solensia, our injectable monoclonal antibodies to treat OA pain in dogs and cats, which are helping millions of pets return to play. With more than 18 million doses distributed worldwide, we are providing long-lasting relief to animals, many of whom were previously undiagnosed or untreated due to limitations of NSAIDs. With nearly 40% of all dogs suffering from OA pain globally, we believe just 1/3 of those are being treated. So we're just scratching the surface of care. And cats are visiting the clinic more often. In fact, we're helping curb clinic fears with Bonqat, the first FDA-approved product to alleviate anxiety in cat, which means we're expanding care in a historically under-medicalized area of the market. We understand that social media is a form for convening, a place for pet owners to connect and to share, but we also have responsibility to empower our customers to make informed decisions grounded in science and data. We are unwavering in our commitment to rigorous safety and quality standards, which has earned us the trust and confidence of veterinarians worldwide. Backed by that commitment, Librela and Solensia are safe and effective. They are anchored in 10 years of science and have been used in Europe for more than 3 years. In the U.S., 78% of veterinarians who are at the center of care are very satisfied with Librela. This is driven by real-world experience and consistent with the feedback we hear in other markets. And our research indicates that 46% of vet globally will treat OA earlier and 65% will treat more dogs now that Librela is available. To accurately reaffirm the safety and efficacy of these therapies, we are doubling down, working directly with veterinarians who need these products, hosting live sessions with our Chief Medical Officer and expanding online education and training while deploying capital to expand our DTC strategy. And veterinarians continue to be confident in Librela as evidenced by a recent blind survey of U.S. vets confirming that perception, and intent to prescribe remain unchanged. We remain confident that OA pain could be our next $1 billion franchise because we are meeting the needs of an underserved market. We are growing by nearly every metric, including adoption, penetration, reorder rates, patient share and expanded utilization. And looking at our 4-week rolling average in the U.S., we're excited to report that sales steadily increased through April. Our performance speaks to the power of the human animal bond. Discerning pet owners want options, and they will work with their vets to find relief for their best friends. Beyond OA pain, Zoetis has been able to lead the market in other key categories because we deeply understand our customers' needs. This allows us to not only compete in existing markets, but again, to create entirely new ones. And science has created something completely unique to our industry, two $1 billion franchises. Our parasiticide portfolio expanded the total market based on deep customer insights. Before Simparica and Simparica Trio, we were #5 in this category. These innovations changed how we compete. Today, we are #2 and continue gaining share and growing the market even in the face of competition. Similarly, we were first to recognize that new therapies were needed to treat canine itch safely and effectively. That market foresight changed the treatment paradigm and revolutionized pet care. A decade of dermatology has led to 3 products; 20 major life cycle enhancements, including Cytopoint, the first ever animal health monoclonal antibody and the first chewable with Apoquel chew. From what was once believed to be just a $100 million market has grown to $1.4 billion because we know what our customers need. Today, more than 18 million dogs are treated for allergic itch and atopic dermatitis and another 13 million remain untreated globally. We built a $1 billion franchise and demonstrated the durability of our portfolio. And we will continue growing this franchise underpinned by strong brand equity, first-mover advantage, life cycle innovations and strong customer relationships. We've led in parasiticides, dermatology and now OA pain. And each time our innovations have created new categories in animal health, you've seen the total industry opportunity expand. Now moving to livestock. I'm sure you all saw the news this week on the announcement of our agreement with Phibro Animal Health to sell our global medicated feed additives and certain water-soluble product portfolios and related assets for $350 million. This deal is another great example of Zoetis' disciplined capital allocation strategy to focus investments in areas with the greatest growth potential and innovation that are aligned with our key capabilities. I'm confident that under Phibro's management, the global reach of these products will continue to expand to meet customer needs worldwide. We remain very committed to livestock and just sharpening our focus and our core innovative livestock growth areas, including preventative antibiotic alternatives and genetics. In summary, for more than 70 years, Zoetis has been leading the industry with our commitment to innovation. We've invested over $5 billion in R&D since our IPO, which has brought more than 300 product lines to the market. Science is and always has been the great disruptor and at the core of our success in delivering the innovations that veterinarians, livestock producers and pet owners expect from us. Our pursuit of science has led to breakthroughs in dermatology, like Cytopoint and Apoquel chew; in parasiticide with Simparica Trio; and now the latest in OA pain with Librela and Solensia that are revolutionizing animal health. Blazing new trails isn't easy. But time and again, our purpose-driven colleagues have proven their ability to expand our industry leadership and forge entirely new markets. And we remain committed to delivering strong growth through our innovative franchises and diverse portfolio while continuing to invest for the future. Looking ahead to the remainder of 2024, our increased operational guidance reflects the resilience of the animal health market and the execution of our strategic growth priorities. We will continue to be disciplined, yet adaptable in our approach to the opportunities, potential challenges and economic shifts that occurred throughout the year. And with that, I will turn it over to Wetteny. Wetteny Joseph : Thank you, and good morning, everyone. As Kristin mentioned, we had an outstanding start to the year driven by the underlying strength of our companion animal portfolio, particularly our innovative products, as well as price growth across all species. In the first quarter, we generated revenue of $2.2 billion, growing 10% on a reported basis and 12% on an operational basis. Adjusted net income of $634 million grew 4% on a reported basis and 15% on an operational basis. Our 12% operational revenue growth was due to the underlying strength of our companion animal portfolio, aided by the impact of a weak comparative quarter in our U.S. companion animal business. However, the majority of this [ probability ] to growth was offset by headwinds related to economic conditions in China, the impact of a tough comparative quarter in livestock due to the timing of supply for certain products last year and inventory destocking related to our U.S. diagnostics sales model change. Of the 12% operational revenue growth, 7% is from price with 5% growth in volume. While we saw price growth across our portfolio, price was favorably impacted by hyperinflationary markets, especially Argentina, which contributed 2% to our overall price growth. The volume growth was driven primarily by new products, including our monoclonal antibodies for OA pain, Librela and Solensia, as well as our key dermatology products and Simparica Trio. On a segment basis, the U.S. posted $1.2 billion in revenue, growing 16% on the quarter, while our International segment reported revenue of $1 billion with operational growth of 8% in the quarter. Our companion animal portfolio was the main driver of revenue growth in Q1, growing 20% operationally. This growth was partially offset by livestock, which declined 1% on an operational basis. We saw double-digit operational companion animal growth in both our U.S. and our International segments again this quarter, driven by the strong performance of our innovative products with contributions from both volume and price. Simparica Trio was the primary driver of growth in the quarter, generating $243 million globally, representing operational growth of 61%. We saw strong demand for Trio as well as continued growth in patient share even with competition. Our OA pain meds were also a significant contributor to growth, posting $131 million in the quarter. Global growth came from the impact of new launch markets, both in the U.S. and internationally. In our early launch EU markets, recent vet surveys showed an increase in muscle on therapy and expansion into more moderate OA cases. Our key dermatology products grew 25% operationally in the quarter with $360 million in global revenue. Growth within dermatology was driven primarily by our Apoquel franchise, where we are seeing solid conversion to Apoquel Chewable, including a modest impact from initial distributor stocking in the U.S. Cytopoint growth continues to be driven by vet and pet owner preference for injectable methods of treatment. Our global companion animal diagnostics portfolio declined 12% operationally with declines in the U.S. driven by our distribution model change. These declines were anticipated as our distribution partners sold off their remaining inventory due to our transition to a direct-only model for our U.S. diagnostics portfolio. U.S. declines were partially offset by growth internationally. Our livestock portfolio declined 1% operationally, as expected, driven by a tough comparative quarter in the prior year especially in the U.S. as well as impacts from the ongoing economic conditions in China. This decline was partially offset by price growth in our other International markets. Now moving on to revenue growth by segment for the quarter. U.S. revenue was $1.2 billion in the quarter, growing 16% with companion animal growth of 25% and livestock posting a 7% decline. The companion animal performance in the quarter was driven by Simparica Trio, our key dermatology portfolio, and the impact of the launch of Librela in the U.S. as well as the impact of a weak comparative quarter. Our outstanding U.S. companion animal growth came in the quarter where we saw vet clinic visits decrease 1.5%. We continued to see growth in the therapeutic visits while wellness visits drove the decline. Sales outgrowth in the retail and home delivery continued to outpace vet clinic fulfillment, which is based on growing pet owner preference for these alternative channels. This dynamic is expected to put continued pressure on total vet clinic visits without impacting our expectations for revenue. Despite the visit decline, revenue and spend per visit in the clinic grew 4.5% and 6%, respectively, which reflects continued pet owner willingness to pay. Turning to product performance. Simparica Trio posted sales of $205 million in the quarter, growing 61%. We continue to be the market leader in the triple-combination parasiticide space. Our leading footprint across channels has allowed us to continue to drive dosage growth through increased compliance even with declines in wellness visits at the clinic. In addition to a weak comparable period in the prior year, we are seeing favorable price realization due to more targeted discount programs to vets as well as channel dynamics. The dermatology product sales in the U.S. were $233 million for the quarter, growing 27%. We saw growth in both price and volume and across both Apoquel and Cytopoint. Both also benefited from a weak comparable period in the prior year. Market demand for our dermatology products remained high. In the quarter, we saw growth in both our patient share as well as higher periodic visits in the clinic. Additionally, growth of retail autoship programs continued to bolster compliance. At the beginning of April, we made Apoquel Chewable available through our distribution partners. Our pain meds, Librela and Solensia, posted a combined $57 million in U.S. sales in Q1. Librela generated $40 million in the quarter with underlying vet demand continuing to build on the momentum from our full launch in Q4 of last year. Excluding the impact of the initial clinic stocking, which we have provided last quarter, we are seeing robust sequential quarter growth in Librela, in line with expectations. We continued to see good growth in penetration as well as strong reorder rates, which are approaching 80%, all of which points to positive real-world satisfaction in the clinic and among pet owners. We remain confident not just in the safety and efficacy of Librela, but also in our expected performance. As Kristin alluded to, we have seen steady increasing trends in our trailing 4-week sales average in the U.S., even into April, after the increased media attention. We continued to see steady progress in Solensia, which had U.S. sales of $17 million in the quarter, more than doubling our prior year Q1 sales. We have indicated the feline market needs significant development, but we are pleased with our progress thus far. Solensia is now the market-leading product for feline OA pain in the U.S., and we have seen a significant increase in the medicalized patient pool since launch. Our U.S. companion animal diagnostics portfolio declined 21% in the quarter, driven primarily by distributor inventory work-downs following our channel strategy change. This destocking is in line with our expectations and has negligible impact on our underlying clinic demand. U.S. livestock declined 7% in the quarter while our underlying business performance in the quarter was as expected. Our results are reflective of a strong comparative period in Q1 of 2023, in which we grew 15% due to the return of supply on several products, primarily in cattle. Sales of swine products declined due to decreased sales of vaccines as well as JAKs. In poultry, we saw declines as a result of increased generic competition in our medicated feed additive products. Moving on to our International segment where revenue grew 3% on a reported basis and 8% excluding the impact of foreign exchange. Companion animal grew 14% operationally and livestock grew 2% operationally. Increased sales of our international companion animal products were driven by oral pain meds, key dermatology products, vaccines and small animal parasiticides. This growth was partially offset by impacts in China. Our International OA pain meds grew 67% operationally to $74 million in combined revenue in the quarter. International Librela sales were $l59 million, growing 71% operationally. Growth is balanced across new launch markets and our first wave EU markets. We continue to see evolution in the European markets, where we have seen expansion in Librela's use in moderate OA cases, which according to the latest vet surveys now represents the majority of the Librela patients in Europe. We remain pleased with the success of our DTC advertising campaigns in increasing pet owner awareness of OA. Solensia sales were $15 million internationally in the quarter, growing 54% on an operational basis. Our International key dermatology portfolio grew 23% operationally in the quarter, posting $127 million in sales. We saw double-digit operational growth across most of our major markets, driven by higher compliance and new patients. Growth was also favorably impacted by prepriced increased buy-ups in Japan and certain European markets. Our International small animal parasiticides portfolio grew 6% operationally driven by our Simparica franchise with Simparica Trio growing 58% operationally to $38 million in sales. Trio growth benefited from continued uptake in Europe driven by key account penetration and sales force effectiveness as well as contributions from Trio's launch in China. Simparica posted $56 million in revenue, growing 22% on an operational basis in the quarter. This growth was partially offset by a 29% operational decline in our Revolution franchise, which generates a high proportion of sales in China. International livestock grew 2% operationally in the quarter driven by price increases as in high inflationary markets. Price growth was partially offset by volume declines across all of our species, partially driven by a tough comparative period in the prior year due to the return of supply of certain livestock products. The volume declines in livestock were driven by cattle due to a tough comparable period related to supply and worsening market conditions in Australia. Our International swine portfolio saw volume declines driven by China, where we saw lower hog prices as well as a reduction in herd sizes. In sheep, we saw declines from herd reductions due to expected weather conditions in Australia and New Zealand as well as supply constraints on a key product. As we mentioned last quarter, we continue to see economic challenges in China, where low consumer spending and higher urban unemployment have reduced spending. We are also seeing a slowdown in livestock with lower pork prices and smaller herd sizes. The impact on our growth is expected to moderate late in the year, but we expect to continue to see headwinds throughout the year across both companion animal and livestock. Now moving on to the rest of the P&L for the quarter. Adjusted gross margins of 70.7% declined 10 basis points on a reported basis compared to the prior year. Foreign exchange had an unfavorable impact of 180 basis points on our reported adjusted gross margins. Excluding FX, we saw higher margins due to price increases, favorable mix and lower freight costs partially offset by higher manufacturing costs, especially in hyperinflationary markets. Adjusted operating expenses increased 11% operationally, driven primarily by SG&A growth of 10% operationally, mainly due to higher compensation-related expenses as well as increased advertising and promotion spend on our OA pain meds. R&D grew 13% on an operational basis, driven by higher project spend related to both recent acquisitions as well as advancements of our pipeline candidates. The adjusted effective tax rate for the quarter was 19.7%, a decrease of 80 basis points, primarily due to a higher benefit in the U.S. related to foreign-derived intangible income and a more favorable jurisdictional mix of earnings. And finally, adjusted net income grew 15% operationally despite a $31 million headwind to growth from the nonrecurring benefit of our prior year royalty settlement. Adjusted diluted EPS grew 17% operationally for the quarter. Capital expenditures in the first quarter were $140 million. In the quarter, we repurchased $339 million of Zoetis shares. Before moving to guidance, I wanted to comment on our recent announcement to divest our medicated food additive portfolio and certain water-soluble products to Phibro Animal Health. This is a transaction that demonstrates Zoetis' disciplined capital allocation strategy to focus our investments on innovative solutions that advance animal health, productivity and sustainability. This divestiture will allow us to remain focused on other livestock solutions, including vaccine, biologic and genetic programs that are more aligned with our strategic priorities. Now moving on to guidance for full year 2024. As we have mentioned, we had an outstanding first quarter that highlighted our ability to deliver through multiple sources of growth. Our performance in companion animal, especially in parasiticides and our key dermatology franchises, exceeded our expectations. Additionally, we continue to be pleased with the progress of the U.S. launch of Librela and are confident in our ability to meet expectations. We are, therefore, raising our 2024 operational guidance provided during February's earnings call. Note that guidance reflects foreign exchange rates as of late April. The updated foreign exchange rates negatively impacted our reported revenue guidance by approximately 2% and our reported adjusted net income guidance by approximately 4% when compared to our initial guidance issued in February. For the year, we expect revenue between $9.05 billion and $9.20 billion, representing a range of 8.5% to 10.5% operational growth. Our increase in operational growth is reflective of Argentina's pricing impact as well as due to performance in our companion animal parasiticides and key dermatology products. We now expect our full year operational growth for Simparica Trio to be double digit while we expect growth in our key dermatology products to be in the high single-digit range. As we stated earlier, we remain pleased with our U.S. launch of Librela. Our expectations for Librela for the year remain unchanged. Moving down the P&L. we now expect adjusted net income to be in the range of $2.62 billion to $2.67 billion, representing operational growth of 13% to 15%. And finally, we expect adjusted diluted EPS to be in the range of $5.71 to $5.81 and reported diluted EPS to be in the range of $5.34 to $5.44. Just to summarize before we go to Q&A, we are very pleased with our start to the year. While our reported results are reflective of various foreign exchange-related headwinds, operationally, we continued to deliver growth across our key therapeutic areas and across most of our major markets. This growth highlights the diversity and dependability that allows us to continually outpace the animal health market. Additionally, we continue to lead the way, creating new markets and launching new innovation that increases the standard of medical care for animals. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] With that, we will take our first question. It's coming from Michael Ryskin with Bank of America. Michael Ryskin : Great. First, I want to ask just about the guide change. It seems like there's just so many moving pieces right now : the FX moves, you've got all the price you're taking in Argentina, some of the stocking comments for Apoquel Chewable, and obviously, Librela. Just this early in the year to decide to raise the guide, just sort of like what went into that? And what do you see as the upside risks or downside risks to that as you go through the year? And then just a quick follow-up question, and I'll squeeze both in. My question is on margin. With all the price, with all the strength in companion, gross margin was still a little bit weaker in the quarter and you're not raising EPS operationally for the year. So just what's going on with the gross margin and why isn't the flow-through for the companion animal portfolio better? Wetteny Joseph : I'll be happy to take this, Mike. Look, we're very pleased with an outstanding quarter to start the year, clearly delivering 12% operational growth at revenue; 15% at adjusted net income from an operational perspective. Couldn't be more pleased with this. In terms of the guidance, of course, there are puts and takes, as you laid out. The performance in the quarter, when we think about the prior year comps, we think these are largely offsetting puts and takes that go into the performance. And I think that feeds into the later part of your question, which is how do we decide to go into increasing our guidance from an operational perspective. But when you look at the puts and takes, clearly the performance from our Trio and key derm, seeing growth as we continue to ramp the launch of Librela not only in the U.S., but across International markets gave us a lot of confidence in terms of underpinning the growth that you saw in the quarter from an operational perspective. Yes, there are some easier comps when you look at the companion animal business, particularly in the U.S. We talked about those at length last year with the destocking and the timing of promotional activity, et cetera. But we also had some headwinds where we had strong comps across livestock, in particular, because of the timing of supply last year as well as the China market that we've been talking about we expected, as well in Argentina given the pricing impacts, et cetera, and then Australia and New Zealand. So when we take a look at those, we think there's probably 1 to 2 points of tailwind on a net basis is what we would estimate coming into the quarter. But then when you look at the bottom line, 15% operational growth in adjusted net income despite the royalty settlement that we had last year, again, is an offsetting element so we still end up with a sort of an operational growth that's in the same range that we've delivered. And so though it's still early in the year, we have confidence in the underlying market and demand that we see across our products. We're seeing increased periodic visits into the clinic for dermatology. Trio, despite head-to-head competition, had a phenomenal quarter, up 61% with $243 million of revenue with the U.S. leading that at 61% as well. So when we take all those into consideration -- and we're seeing price realization across the globe, including increased price from a hyperinflationary market like Argentina, so these gave us enough confidence to be able to raise the guidance and still be very confident in delivering the revised guidance that we did today. Now in terms of margins, let me just make sure I give you -- cover that. If you look at the headline, right, the gross margins are down about 10 basis points. FX had about nearly 200 basis point headwind in this. I think it's important to remind everyone there was a significant devaluation in Argentina that occurred 2 times last year, right? In December as well as prior to that in August. The December devaluation is actually in our first quarter. Keep in mind, our International operations close their books a month earlier. So December is actually Q1. So you're seeing the impact of that Argentina devaluation play out, particularly as you look at inventories and the effects on COGS, cost of goods sold, as well as lower in the P&L. And so when you factor those out, we actually had about a 200 basis point expansion operationally in our gross margins, which again aided our way into the expansion of adjusted net income and growing that at 15%. Operator : And our next question comes from Jon Block with Stifel. Jonathan Block : I guess I'll ask both upfront as well. Wetteny, I'm getting a lot of questions on Argentina, so hope this is clear. The strength of the top line was big. You raised the guide revenue by 150 bps for the year. You mentioned 200 bps of year-over-year growth in the quarter from Argentina, if I have that right. But what is the incremental growth contribution from Argentina for the year? I do think everyone is like trying to figure out what the raise is, call it, like ex Argentina due to that market's hyperinflationary environment. I hope that's clear. Let me know if it's not. And then maybe just to shift gears, Kristin, on Librela, very helpful comments on the April run rate. And [ I'll recheck ], we hear about a safe drug that might have some issues in dogs with neurological issues and so just would love your thoughts on that. And does the company plan to do any, call it, follow-up studies maybe addressing select AEs, that would be great. Wetteny Joseph : I'll take the Argentina question first and then Kristin will cover Librela. Look, the way I look at it, as we said in the prepared commentary and you quoted here, there's a 200 basis point contribution to the top line from Argentina in the quarter. And so if I were to say, look, we're still early in the year and we'll continue to look to take price in that market. And we'll have to watch how that plays out between price and volume as we go. It's a hyperinflationary market. We're pegging what we're looking at based on the actuals and what we anticipate. But again, it's still early in the year. So if you were to take this 200 basis points and you spread them for the year, in effect, you could say there's 50 basis points contribution to the year, if I don't account for any more price from here on, right? And so that's kind of how you look at it. And you'd say, well, the other 100 basis points in the raise is from the rest of the underlying business. The answer is somewhere between there, right? But certainly, contribution from the growth we're seeing, which we said is above our expectations for our derm franchise delivering $360 million, growing 25% on the quarter, as well as Trio, which continues to perform really well for us. And so those, I would say, are significant contributors to the top line guide that we gave. So we're increasing the top line by 150 basis points in terms of the range of operational growth. And Argentina is a piece of that, but I would say there is a significant contribution from the underlying business as well. Kristin Peck : Sure, Jon. And I'll take the second part of your question on Librela. I mean, first, I really want to underscore that we have the utmost confidence in the safety and efficacy of Librela. It has been used for over 3 years across the globe in over 14 million dogs and it's approved in over 50 countries. And if you overall look at the rate of reported adverse events, it's about 18% per 10,000 or 0.18% globally. And I think it's important to keep in mind that no single adverse event is classified under the EMEA guidelines as more than rare, which is more than 1 to 10 out of 10,000. So we remain very confident in the safety and efficacy of this product. We watch these reported adverse events very carefully. It's an important part of what every pharmaceutical company does to make sure that we understand any trends that we're seeing. We remain very confident in the data. I really want to underscore, they've been on the market for 3 years. So we continue to watch the AEs that are coming in. And to be clear, the top adverse events today are, number one, lack of efficacy, so it's not working maybe as well as they wanted; polydipsia, which is frequent drinking; and the third being polyuria, which is frequent urination. So the other ones you're talking about remain a rare side effect. In other words, not more than 1 in 10,000. So hopefully, that answers your question. Operator : Our next question will come from Erin Wright with Morgan Stanley. Erin Wilson Wright : Great. Just another one on Librela, just given the stellar trends that you were mentioning, how do we think about the quarterly progression from here in the second quarter. And then also just like new patient starts, like how has that looked since kind of the media attention. And then on livestock and just a broader rationalization kind of the business with the selling of the feed additives business, which made sense. Do you see other opportunities to further prune the portfolio and presumably this lifts your long-term top line growth targets and margin profile just on the improved mix alone and the focus you can have on these higher-growth, higher-margin businesses. What does Zoetis look like in 3 to 5 years down the road because it could be potentially more skewed to that? And how do you think about that? Kristin Peck : Sure. I'll let -- Wetteny, why don't you start with Librela performance and the questions you got there and then I can take the livestock question after that. Wetteny? Wetteny Joseph : Yes, I'd be happy to. Look, we delivered $100 million of revenue in Q1 on Librela. That's 189% growth over the prior year. Clearly, the U.S. contributing $40 million is a big part of that. But we're very pleased with the performance across our International markets as well for Librela. And we saw a really strong sequential quarter growth across our International markets, and we continue to see the uptake. We're very pleased as well, when surveyed, European vet clinics actually indicating that now they're seeing more than 50% of the cases being moderate cases, which is very encouraging, as we continue to progress the product having been out there for 3 years. In terms of the progression for the year, clearly, we continue to ramp in the U.S. And as Kristin said and we said in the prepared commentary, as we look at -- on a rolling 4-week basis through the quarter and beyond the quarter into April, we continue to see steadily increasing orders of Librela as well, which again caused us to be able to be confident in our expectations for Librela as we look at the guidance that we gave as well. We're not going to get into very specific quarter-by-quarter. But I would say, if you look at the $40 million in Q1, there's very little to no stocking in that number. Now we did speak at length in February about the stocking in the initial launch in the fourth quarter. We had about 2.5 months at the end of the year for the product launch and you have to factor holidays as well into that. And we saw a very fast penetration into the 60-plus percent in clinics very quickly, which means that there's a lot more stocking in that. Now we give you a range of somewhere between 1/4 and 1/3 of that being stocking, I would say it's likely in the high end of that range. So when you factor that into the $40 million this year, this is a really substantial sequential growth in Librela, and as we said, we continue to see momentum in the product. The one thing I would remind everyone is in International, we did have a number of markets that we launched in the second quarter last year. So we'll be lapping those across the international markets. Those included Canada, Brazil, Australia, Japan and so we'll be lapping those. But we still continue to expect to see strong meaningful growth for the product as well as sequential growth as we go through the rest of the year is what I would remind you in terms of how we expect progression for Librela. Kristin Peck : Sure. And Erin, I'll take your second question on livestock. As you and I have talked about many times, livestock generally historically in our industry has grown at around 2% to 4%. I know we grew less for a period of time when we were facing the LOE on DRAXXIN and with some [ large ] disease outbreak across the globe. But I think you're seeing is Zoetis over the last year and going into this year is we're turning more to those historic levels. I think as you look at this year, we expect to be above that level. Again, as Wetteny mentioned, Q1 is not a good indication if you look at sort of the comparable that we had there. So we remain very confident again in livestock. We believe we'll end at the higher end of that range. As you look at the divestiture of our medicated feed additive and water-soluble portfolio and assets, we've continued to be disciplined around our capital allocation. We divested our Pumpkin Pet care last year. This is something that, as a leadership team, we continue to do. We look at every asset we have. We want to make sure that we're investing in the highest areas of growth. So I think that actually is something that's just a rigorous part of how we manage the company. And I think as you look at livestock, obviously, the divestiture of the medicated feed additives portfolio will increase the overall growth of the company and the overall growth of livestock and also help overall on margins. But our real focus of the divestiture really had to do with doubling down and investing in what we see are great potential in the livestock industry and really playing to what are our core strength in preventatives, into antibiotic alternatives, into genetics as we think about vaccines and biologics and new genetic solutions. So again, we'll continue to look at our portfolio, as we always have and as we've done every year, but remain confident in livestock and -- especially this year in our ability to grow faster than the market. Operator : Our next question is coming from David Westenberg with Piper Sandler. David Westenberg : Congrats on the quarter. So you gave a lot of commentary on April and Librela sales, and it sounds like there's week-on-week build. Just to confirm that is in [ fact ] clinic administration or end market that you're looking at versus like stocking or sales out from you. Veterinarians are really behind the product. It seems like there is some consumer social media kind of stuff. I just want to confirm that the DT sales advertising is on track or if there's any kind of changes there? And then just finally, if I could squeeze in just one more. In terms of your assumptions on that high single-digit in derm, what is the assumption in terms of competitive launch there? Wetteny Joseph : Yes, David. Look, I'll take a stab at this and then Kristin may add some. First of all, when you look at Librela sales in the U.S., keep in mind, Librela is sold direct to clinics and the turnaround is very fast. And so there's no sort of channel dynamics to play out in terms of what we're seeing. What we're seeing from week to week is actually coming directly from what the clinics are ordering. And then look, DTC continues to be on track. As we said in our prepared commentary, part of the increase you see in our SG&A spend is really advertising and promotion behind our pain franchise, and clearly, Librela in the U.S. is a big part of that. And then when you think about derm, of course, very pleased with our performance here, $360 million, up 25%. Now there is some soft comp in that. But when we neutralize for that, we still see really, really strong underlying growth and strong demand. And we continue to be able to take price across derm. Now of course, it's still early in the year. So as we look at, particularly in the back half, we are factoring different scenarios around what's the timing of competition. And while we remain confident in our ability to continue to grow our franchises post competition, as we're doing in Trio, there can be some near-term or short-term promotional activity that we are mindful, right? So we do factor those into our thinking in terms of how we land at the high single-digit range, which is up from what we said last time, which was mid- to high single digit. So clearly, our confidence continues to increase there. Operator : And our next question is coming from Balaji Prasad with Barclays. Okay. We will take our next question from Brandon Vazquez with William Blair. Brandon Vazquez : First, on Librela, I'll ask two upfront here. On Librela, can you guys talk about are you starting to see any pockets of that going from maybe the more severe OA dogs and being used in the moderate OA population? Anything you guys can do to kind of help push that market development because that seems to be the bigger opportunity as you -- as this grows over the coming years. Follow-up, second question is you're spending over $600 million in R&D now. I think we're about a year out from the nice Investor Day you guys held for us last year. Any meaningful updates in the pipeline that you guys can share with us, either new products or life cycle innovation, that might be coming in the near to medium term? Kristin Peck : Sure. Wetteny, do you want to take the first one on Librela and I can take the R&D question? Wetteny Joseph : Yes. I'd be happy to. Look, we continue to be very pleased with the performance of Librela, as we said, both the U.S. and International. We did complete a recent survey of vet clinics across European markets. And after 3 years in the market, we are certainly seeing the transition to having a lot more moderate cases. In fact, vets, based on surveys, are saying more than 50% of the cases they're seeing now are moderate and even some mild cases coming into the mix. So that's very encouraging. And again, and that also contributed to an increase in months on therapy going somewhere between 7 and 8 months now is what we're estimating based on those surveys with vets. So that progression is what we count on and anticipate, and we're seeing that across International markets. We're still very early in the U.S. But that's the sort of progression we would expect. And we'll continue to educate vets on the product, as we've talked about, to continue to drive that as we move forward. Kristin? Kristin Peck : Sure. And Brandon, to your second question on our R&D. Yes, you probably saw the strong growth in R&D in the quarter that is really because we remain very confident in our pipeline in many of the key areas that we mentioned at Investor Day, which was, I guess, a little less than a year ago, really investing behind some of the key therapeutic areas, both our long-lasting monoclonal antibodies, which will be some of the more near-term launches. We are not making any announcements on today's call, obviously, with regards to that. But that's going to be some of the more near-term launches. And then as we talked about, very excited as you look at renal, as you look at oncology and cardiovascular and diagnostics to continue to invest in those areas where we see huge potential. As you look at renal, cardiology, in oncology, we always said, as we said last year, those are more in the 4 years-plus range. So there's no near-term updates there. But we continue to launch products. As you look at -- as I spoke in my script about on Bonqat, which is around anxiety for cats, that's really important. It may not seem a huge product overall, but it's an unlock for the rest of our portfolio. If we can get cats to the clinic, we can sell more -- a lot of our other products, and more importantly, meet the needs of the cat population, which to date has very under-medicalized. So I know we don't give you all the visibility that you're dying for in R&D. But I think as you can see, we've continued to deliver on our pipeline and both in really innovative products, like what you're seeing Librela and Solensia, but also life cycle innovations that will really extend the life of important franchises such as some of our long-acting monoclonal antibodies, which should be more in the near term. Operator : Our next question is coming from Steve Scala with TD Cowen. Christopher LoBianco : This is Chris on for Steve Scala. We had two questions. First, on livestock, are you seeing any impacts on ongoing outbreak of H5N1 avian influenza? And then second on the U.S. companion animal market, what underlying trends are you seeing in U.S. pet adoption and abandonment rate? And are you seeing any change in share of wallet, share of consumer pet spend on medicines versus other product categories? Kristin Peck : Thanks, Steve (sic) [ Chris ]. I'll try to take those, and Wetteny, certainly, if there's anything I missed, you can jump in. Look, we, like all of you, are continuing to watch the outbreak of H5N1. If you look at the portfolio that we have and our capabilities, we stand ready to support both governments and customers across the globe as they look at potential solutions to address H5N1, both on the vaccine side and on the diagnostics side. To date, we have not been requested to do that. But I think like many of our peer companies, we stand ready to support government authorities when that's needed. I do want to reassure people, I mean, data has come out that the milk is safe. Data came out from [ FISS ] this morning reassuring people that the meat base is safe. So we have not seen any impact to our business whatsoever with regards to this. This is a major issue for our customers. And our real focus is supporting them through this and making sure that we focus on what we can do certainly around biosecurity surveillance and detection, which we're more and more engaged with the U.S. FDA and others, given our diagnostics portfolio as well. So no, we have not seen any impacts to our business to date on that. Regards to the U.S. and looking at -- we have not seen a significant U.S. national increase in people bringing their pets back to shelters. I know there's been some isolated here and there, but as the overall U.S., that is not a trend. And those pets that they all adopted during COVID are all aging and continue to be drivers of our growth, not just in the U.S. globally. And I know there has been some talk around consumer sentiment and is that really changing. Obviously, we've seen some changes in sort of collars or treats and things like that. But what's really been clear and what we've talked about for a long time is when you think about animal health care, it's essential. They are not skipping on their animal health care. And if you look at the trends in the quarter as you look at increase in [indiscernible] visits, as Wetteny talked about, the reality is when their animal needs care, they are getting that care. And as you look at spend per visit in the U.S., we're seeing spend per visit up 6% in the U.S., which means, again, consumers and pet owners want to take care of their animals and they continue to invest in this. You look at the strength of the human-animal bond, this is another reason that we say animal health is a very resilient industry that people will continue to invest in the health of their pets, and that's certainly what we're seeing in the quarter. And as you saw, our expanded operational guidance for the year really being driven by our companion animal portfolio is what we expect for the year as well. Operator : We'll take our next question from Nathan Rich with Goldman Sachs. Nathan Rich : First, just a clarification on Argentina and the price increase. I guess, the price increase you referenced coincide with the December devaluation? It sounds like that price increase wasn't contemplated in the initial operational revenue range for the year. So I guess, like as we think about the impact going forward, I'd imagine that contribution should be similar over the balance of the year, I guess, assuming no major change in the currency dynamics in that market. So is that the correct way to think about it? And then on derm, the company decided to start selling Apoquel Chewable through distribution. Could you maybe just talk about the factors that led to that decision? And any impact on top line and margins for Apoquel as well as the broader portfolio as you think about the potential benefits of selling that portfolio through distribution. Wetteny Joseph : I'll take the first one, Nathan, just on Argentina. Look, clearly, the devaluation occurred prior to us issuing guidance and we have plans and continue to see our ability to take price fairly significantly in that market perhaps beyond what we factored in. And so yes, we won't sit here and forecast what FX is going to do or what's going to happen in Argentina. It is a hyperinflationary market after all, so we'll continue to monitor that. And so we're only through one quarter here and we're all on our way through the second quarter, so we're factoring that into our thinking as well. And we are seeing an ability to continue to do that. But we can't sort of forecast, forecast for the rest of the year what will happen there. So we are a bit measured in how we treat that. I would say a portion, again, to what I said earlier, a portion of our increase is certainly coming from that. I would say somewhere between 1/3 to half of the increase we're giving in terms of operational guidance is coming from that because we are getting the operational lift from price there. And the rest of it coming from the rest of the underlying business, as we've talked about, is how I would think about that. In terms of derm, I'll start and then see if Kristin wants to add. Look, clearly, we have products in derm with Apoquel and Cytopoint, they've been in the market for over 10 years and 7 years, respectively. And the level of satisfaction on these products is very high among vets and pet owners. We've launched Apoquel Chewable as an important element because, one, there's a preference from pet owners and perhaps vets to have a palatable chewable. And so we see that as, one meeting, a need in the market as well as an important part of a defense strategy. And so as we anticipate competition in derm, we believe that competition will more likely be a film-coated tablet. And the conversion to Apoquel Chewable is important to us. We are seeing that conversion occur across international markets. In particular, if you look at Europe, we now have about 40% conversion to chewable after being in the market the last couple of years. So that's very encouraging. We just launched in the U.S. at the same time as we launch Librela. And so we want to look to potentially accelerate that transition in that conversion, hence, what went into the thinking here. And so it's still relatively early. There's only a little bit of contribution in the quarter here, perhaps out of the 25% growth you saw in key derm, there might be 2 points coming from that. And so we'll see some more of that occur in the second quarter, but it is an important part of our defense strategy. Operator : We will take our next question from Balaji Prasad with Barclays. Balaji Prasad : Apologies for missing my spot earlier and also in case my questions are a repeat. So on Librela, curious to understand how has your messaging changed, if at all, with the vets in how they use, how it reacts for dogs that they want to treat and what does this mean for the total addressable market, one. And two, can you help us understand the quarterly cadence for the rest of the year? I think the understanding before was that 1Q was expected to be the weakest quarter and second half stronger than 1H. On the back of this print, does this alter the quarterly cadence in any way? Kristin Peck : Sure. I'll take your first question, Balaji, on Librela. And Wetteny, I expect you can take the second one on quarterly cadence. As we think about how we're approaching vets, vets are at the center of care. And our focus has always been around ensuring vets are educated on the product, that they understand it, that they understand how it should be used, when it should be used, et cetera. Certainly, since a lot of the social media, we've been more committed than ever to make sure that vets have better access to a lot of the education we've always been providing. And we've significantly increased our education with vets and their access. So things that we've done. We've done over 1,000 webinars. We have daily sessions with our Chief Medical Officer, Dr. Richard Goldstein, to make sure they can have interactive sessions. We have an always-on customer support team. And I think, really, what you're seeing with regards to the vets and how they feel about the product is the confidence that they have access to the education that they need. And as you look at that, that is why you're seeing such a strongly positive experience, not just from pets, but from vets who really are confident in the product, as Wetteny mentioned, their confidence in prescribing the product more, their confidence in the safety and efficacy of the product. As we've talked about, we invest a lot in Zoetis in veterinary education, and we always have, and our vet operations in every market. So I think this is something that's been our strength. Clearly, with the social media, we have doubled down to ensure there's more access to this veterinary education to make sure that any vet who wants to understand more has access to experts, both internally as well as external KOLs, so they can best understand the product. And that again underscores our confidence in this product that we've talked about and the fact that we continue to believe this product will be -- this category, not just Librela, but Librela and Solensia, we continue to commit this will be a $1 billion franchise for Zoetis and that is really rooted in the safety and efficacy of this product and in investment we're putting into both vet and pet owners to make sure they understand the product. Wetteny Joseph : Yes. And Balaji, in terms of quarterly cadence and I'll answer the question specific with respect to Librela. If you mean it for overall, I can certainly recap that conversation. But look, clearly, $40 million contribution in the first quarter. And keep in mind, we continue to see really strong growth across our international markets, which moved 71% on the quarter as well. So those will continue to drive growth for us. We won't get ultra-specific in terms of the exact contribution as the quarters go, but we would expect to continue to ramp up from that $40 million through the year. And then, of course, the fourth quarter in terms of percentage growth, we'll be lapping the $44 million that we delivered in the fourth quarter and the first quarter of launch. Operator : We'll take our next question from Glen Santangelo with Jefferies. Glen Santangelo : Hey, Kristin, obviously, the outlook for Trio in derm continues to be encouraging here. But just given the recent launch of BI and the Elanco launches that presumably may be coming in the second half, if you could look out to 2025 for a second. I'm kind of curious if you anticipate any sort of noticeable shift in the competitive landscape or anything that you think might impact your ability to take price? And the reason I ask is some are getting concerned about increasing competition and a weakening consumer at the same time maybe would impact the company's ability to take price increases consistent with what you have done historically. So any sort of high-level commentary, I think, would be helpful. Kristin Peck : Sure. I'll start and then, Wetteny, you can certainly build on this one. We remain very confident and it's really based on our historical performance, and I think you can look at that, we invest in the local innovation across our franchises. We were #5, let's be clear, guys, in paras when we entered with Simparica and Simparica Trio and we're now #2. We're facing competition from the leader in parasiticide, and we grew our share of 0.7% if you look at Q1 in the U.S. So even with very strong competition, we continue to grow share. So we remain confident we can continue to grow our parasiticides and our dermatology franchises even with competition. I mean, paras has always been a very competitive space with most companies operating there. We think our strength, obviously, with the vets, our strength with pet owners, really seeing tremendous growth in our franchises for both Trio and derm in alternative channels, in home delivery and retail. And we see great strength there as you look at the autoship. We continue to increase autoship out there, which absolutely increases compliance, which we think is really important. As you look at, for example, the alternative channels, they grew 55%. Now that was a little bit of a weaker comp if you look at last year. But even if you adjust for all that, that's 25%-plus growth in the alternative channel. So we really believe that we can continue to grow this franchise based on the strength of our products, the strength of our portfolio, our life cycle innovation if you look at what we're doing with Chewable, as well as leveraging some of these new channels, which have the benefit of increased compliance. So back again, it's our confidence not just for '24, but for '25. I don't know, Wetteny, if you want to add anything on that. Wetteny Joseph : Look, the only thing I would say is two things. One, we are not seeing a weakening consumer. You saw us post high double-digit growth across Trio and our key derm franchise. And even if we normalize for some of the tailwinds from last year, we still have high double-digit growth across each of those. And so that certainly demonstrates continued demand products and our innovation. The other one I would say is, look, as we look ahead and we're not going to give guidance specific to 2025 here, but we're confident in our ability to grow in the face of competition. Now there can be some short-term promotional activity that might have some impact. But beyond those, we're confident in our products and we'll see what the labels are that we're going to compete against. Operator : We'll take our next question from Chris Schott with JPMorgan. Christopher Schott : Just two questions for me. Just continuing on Trio, can you quantify if there's a channel dynamic benefit you saw here? And just give us a little more color on maybe the size of that. And then the second one was Librela U.S. Should we expect a similar dynamic in the U.S. that we saw ex U.S., where initial uptake is more in the severe OA pets, which I think would be maybe a little bit less sensitive to some of the headlines we've seen over the past month and then the moderate piece of the business is happening kind of a year or 2 or further out? Or is the U.S. market you're thinking different where those severe and moderate may be scaling kind of simultaneously with each other? Kristin Peck : Sure. Thanks, Chris. I'll let -- you take, Wetteny, the Trio question. I can follow up on Librela. Wetteny Joseph : Yes, absolutely. Look, the short answer is no. There's no channel dynamics that we're seeing here. As I mentioned just a moment ago, we did have dynamics last year in the quarter where you saw destocking coming from promotional -- timing of promotions in the prior year and more prepriced buy-ups. And so that did provide some tailwind here. So we posted 61% growth globally, and that's the same percentage growth in the U.S., $205 million growing 61%. And if you were to say -- there's no precision here, but I would say our internal estimates is that if we factor in the tailwinds from last year, that may account for about half of the growth that we're seeing. So still remaining very significant growth on Trio, and there's no channel dynamics in terms of inventories to speak of in the current year. Kristin Peck : Sure. And on your second question with regards to Librela in the U.S., I mean, what we have seen historically in Europe and in markets that launched first is it is often put into the severe dogs who are desperate for a new therapy initially and moving to the moderate. But we've learned that lesson after 3 years in Europe. And so we're making sure as we launch in the U.S. that we get into that moderate. As you think about the early Experience Trial, for example, that we did in the U.S., we made sure there was a balance of mild, moderate and more severe cases so that they have experience and they can see the impact of the product in that. As you even look at some of the data that Wetteny spoke about earlier, which is we have more than 50% of -- outside of the U.S. of patients right now in moderate -- mild to moderate cases, which I think is tremendous growth. And what you're seeing when you do that is also an increase in compliance. So compliance is now between 7 and 8 months, up from 6 to 7 months outside the U.S. So our goal as we were launching in the U.S. as we designed the early Experience Trial and as we market with vets is to make sure that this is a product that can be a first-line therapy for mild, moderate and severe cases and making sure that we can get that conversion into mild and moderate, similar to where we are in Europe, faster in the U.S. So that is certainly our focus as we think about growing that brand in the U.S. Operator : We'll take our final question from Navann Ty with BNP. Navann Ty Dietschi : Thanks for the color on Librela. I have some follow-ups. What is the early effect from the vet from your online education sessions? And how many of vets approximately did you reach out to so far? Also interested in your early dialogue with the FDA, if any? Is that just a common surveillance after a product launch so far? Kristin Peck : Sure. Thank you. With regards to your first question on the vets we've reached out to, we've reached out to through our tech bulletins with letters directly from our Chief Medical Officer almost every vet in the U.S. -- any vet who's a customer of ours in the U.S. We think that, that's really critical. Any of those vets can join, for example, our open office hours with our Chief Medical Officer, Richard Goldstein. We've invited vets to these webinars and really working with our veterinary operations group in every area across the U.S. to make sure they have access not just to internal and external. So thousands of vets have attended these webinars to date. Again, this is something we normally do. Obviously, we put it -- it's had more urgency to make sure that we have more ways to engage with them, to make sure that the veterinarian's questions are answered. And as I think as you look at the fact that our 4-week trailing sales continue to accelerate, as Wetteny mentioned, is demonstration that vets still are getting the education they need to confidently prescribe this product appropriately there. And with regards to the questions with regards to our interactions with the FDA. As you know from covering us, those are regular conversations we have with the FDA all the time. That's a normal course of business for any company as you launch a new brand, as you expand that and sharing the information in the U.S. and having a dialogue around that, sharing the global information with them. So that's a usual course of what we would do as we launch a product, and honestly, even when the product's on the market for years. So we continue to be a usual course and collaborate with the FDA to make sure that they have all the information they need there. So there's nothing out of the ordinary there in the normal engagement with the FDA. Operator : And there are no further questions at this time. I'll turn the call to the speakers for any closing remarks. Kristin Peck : Thank you. Look -- sorry, back to me. Thank you. Look, I really want to thank everyone for joining today. I want to reiterate that this was an outstanding performance this quarter. I really want to thank our colleagues for their commitment. And hopefully, you see our focus on creating shareholder value. I think it's a strong start as we look forward to continued momentum in 2024. We are customer obsessed from unrivaled R&D investment to expanded manufacturing capabilities to a world-class, purpose-driven colleagues. Everything that we do at Zoetis is aimed at anticipating and addressing what we believe are the most pressing needs in veterinary care even before they're widely recognized by many others. And our scientific breakthroughs have firmly established us as a trusted and preferred partner to our customers. And we will continue to invest in the talent, the pipeline and the capabilities that will support Zoetis' future growth. So we remain committed to the safety and efficacy of our products and of our industry-leading products because our treatments change lives. Based on our track record of performance, I think our customers agree as well. So thanks so much for joining us. We look forward to engaging throughout the quarter. Operator : Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
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Health Care
|
Pharmaceuticals
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Parsippany, New Jersey
|
1952
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2013-06-21
| 2,024
| 3
|
2024Q3
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2024Q2
|
2024-08-06
| 5.489
| 5.54
| 6.016
| 6.07
| 8.61386
| 27.75
| 27.95
|
Operator : [Operator Instructions] Welcome to the Second Quarter 2024 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of the call via dial-in or on the Investor Relations section of zoetis.com. At this time all participants have been placed in a listen-only mode. And the floor will be open for your questions following the presentation. [Operator Instructions] It’s now my pleasure to turn the floor over to Steve Frank. Steve, you may begin. Steve Frank : Thank you, operator. Good morning, everyone and welcome to the Zoetis Second Quarter 2024 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 US GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable US GAAP measures is included in the financial tables that accompany our earnings press release and the company's 8-K filing dated today, Tuesday, August 6, 2024. We also cite operational results, which exclude the impact of foreign exchange. With that, I’ll turn the call over to Kristin. Kristin Peck : Thank you, Steve and good morning, everyone. Thank you for joining our second quarter earnings call for 2024, we had another outstanding quarter, growing revenue 11% operationally and 18% operational growth in adjusted net income. Success was fueled by strong demand for innovative products, our ability to capture and expand markets and the dedication of our purpose driven colleagues. Segment growth was well-balanced with 12% growth in the US and 10% operational revenue growth internationally even against a strong comparative quarter. Our innovative companion animal portfolio grew 12% operationally, while our livestock portfolio saw 9% operational growth across species and geographies. It's been an excellent first half of 2024, growing revenue 12% operationally, highlighting that our leadership stems from both industry-leading innovation and differentiated execution. We remain focused on our core strategy, delivering consistent results for our customers, the animals and their care and our shareholders and our unwavering commitment to excellence, has resulted in the most diverse and comprehensive animal health portfolio. We lead the industry in R&D investment, bringing over 300 science-driven innovations to market, including three of the top five best-selling products in Animal Health, Apoquel, Simparica Trio and Cytopoint. With our global footprint and world-class manufacturing facilities, we ensure consistent quality and on-time delivery. Our early investments in digital transformation, power and exceptional customer experience, while positioning us for future growth. We continuously refine our commercial strategies and for effective launches and market penetration. And our powerful brand recognition, targeted direct-to-consumer campaigns experienced sales reps and medical experts help us capture new market share and win loyalty. Our customers are at the center of everything we do from understanding their challenges to exceeding their expectations. Scientific innovation enables us to meet their demands while creating new markets, our commercial execution allows us to defend and grow that market leadership. The animal health industry has proven essential and resilient in all types of climates, but it is also dynamic and growing, and we are well-positioned to seize the opportunity. Look no further than our revolutionary osteoarthritis pain franchise, Librela for dogs and Solensia for cats. We are developing a market with breakthrough products that are safer and more effective, while offering convenience for veterinarians and pet owners. The results speak for themselves. Globally, Librela grew 142% operationally this quarter, fueled by the successful and ongoing US launch. But again, its innovation coupled with execution. Take Solensia, for example. Despite launching in Europe three years ago, we reported 60% operational growth this quarter. Our break-throughs are driving increased feline clinic visits, which in turn expands the total market. We along with veterinarians and pet owners are excited about how these safe and efficacious products are revolutionizing first-line treatment for chronic pain in dogs and cats of all ages. Given our proven track-record of building and scaling billion-dollar franchises, we remain confident about the OA pain trajectory, but we don't just launch products, we cultivate them for long-term success. Our key dermatology franchise exemplifies this commitment, delivering strong 18% operational growth driven by Apoquel and Apoquel chewable along with Cytopoint. We have transformed the management of atopic dermatitis in dogs, providing safe, effective and convenient solutions with over 23 million dogs treated globally and a decade of proven results Apoquel is the world's Number #1 prescribed oral medication for allergic itch and it is overwhelmingly endorsed by veterinarians worldwide with approximately 90% satisfaction, reflecting the trust and confidence they place in our market-leading brands. And we are still unlocking the opportunity. Today, there are approximately 20 million dogs globally with undertreated or untreated pruritic itch presenting a vast untapped market. Take the US, for example, we estimate that 10 million dogs are currently receiving veterinary treatment for itch. While the majority or roughly 70% received Apoquel or Cytopoint, there are 3 million dogs prescribed alternative options like steroids. Moreover, an estimated 8 million dogs are treated with over-the-counter products or not treated at all. This highlights the potential addressable market of 11 million dogs in the US, alone that could benefit from our safe and effective therapies. Internationally, the trend is similar with room for even more growth as dogs become increasingly medicalized, underscoring a significant global market opportunity that will fuel our ongoing growth. To solidify our leadership and win new patients, we are focused on DTC marketing to raise awareness, enhance medical education to improve compliance and expanding retail partnerships. Our ability to execute extends to the Simparica franchise, which grew 22% operationally for the quarter. We have not only navigated the changing competitive landscape, but embrace new opportunities with confidence and agility. Several pre trends are fueling our growth. First, pet owner demographics are shifting. They are younger, more affluent and connected by the powerful human animal bond. They are highly engaged and willing to invest in their pet health and well-being. Second, and Wetteny will say more on this. There is a significant channel shift aimed at meeting the evolving needs of these younger pet owners. We are making our products more accessible, ensuring they are available where and when they need them. This combination is a crucial part of our growth strategy, and the results are reflected in our performance. In this dynamic environment, our execution across all phases from launch to expansion to defense, set us apart, showcasing we can introduce, sustain and grow products in a competitive market. Our focus on innovation and execution cuts across every part of the business to create shareholder value. In our livestock portfolio, the sale of our medicated feed additive and certain water-soluble product portfolios remains on track to close in the second half of the year. Meanwhile, we are focusing on innovative solutions for producers, including preventative, antibiotic alternatives and genetics. As the demand for healthy and sustainable animal protein continues to rise, we remain committed to supporting our livestock customers. Our dedication to meeting their needs and adapted to the evolving market conditions ensures that we are well positioned to contribute to their success. Building on our outstanding performance this quarter, we remain confident in our ability to grow faster than the market and through competition as reflected in our raised guidance. While macroeconomic headwinds persist, Animal Health remains resilient and Zoetis' strong operational execution and innovative, diverse and durable portfolio enable us to navigate all kinds of market conditions effectively. We further demonstrated our commitment to shareholders and confidence in our growth trajectory with the recent announcement of a Board-approved $6 billion share repurchase program, which Wetteny will elaborate on. The animal health landscape is evolving, and our innovations are at the forefront. And while breakthrough innovation is a cornerstone of our strategy, our success is rooted in multiple drivers of growth. We are not just launching new products, we are transforming existing ones to unlock their full potential and better serve customer needs through life cycle innovations. That means taking proven therapies and developing new formulations, uses and delivery methods maximizing their impact and reach. This translates to value created for customers and shareholders alike by allowing us to bring critical new solutions to market faster minimizing development risk and costs by leveraging existing safety profiles of proven products and expanding the reach of established products. Our commitment to life cycle innovation is just one reason we are the leader in animal health. When combined with our market leadership, deep customer insights, strategic investments and our purpose driven colleagues, we are uniquely positioned to deliver against the four tenets of our value proposition. To grow revenues faster than the market, to invest in innovation and growth capabilities to grow adjusted net income faster than revenue and to return excess capital to shareholders. Our differentiated execution and innovative, diverse and durable portfolio ensures we are not just keeping pace, we are setting the pace and redefining what's possible in animal health. With that, let me hand it off to Wetteny. Wetteny? Wetteny Joseph : Thank you, Kristin, and good morning everyone. As you heard Kristin mention, our ability to execute on our commercial and strategic plans drove another outstanding quarter. We simultaneously executed across product launches, market expansion and market defense to propel us to a strong first-half. In the second quarter, we posted $2.4 billion in revenue, growing 8% on a reported basis and 11% operationally. Adjusted net income of $711 million grew 9% on a reported basis and 18% operationally. Quarterly growth was driven by our innovative companion animal portfolio. Globally, OA pain mAbs posted $149 million. Our Simparica franchise posted revenue of $384 million, which includes $299 million from Simparica Trio and our key dermatology franchise contributed $414 million. Our lifestyle portfolio also saw strong growth with $694 million in revenue. Looking closely at our success and execution. I'd like to focus first on OA pain. As we continue to execute our US launch strategy, we remain confident in our OA pain trajectory. Based on our experience launching other billion-dollar franchises, we know that first-in-class therapies require significantly more market development than lagging look-alikes. In the US, we have reached over 9,000 vets and veterinary technicians through interactive information sessions with our Chief Medical Officer and industry KOLs. This is on top of the thousands of interactions our sales reps and medical teams have had on individual vet visits. These interactions ensure our customers have the tools and resources to reinforce the safety and efficacy of Librela and Solensia with pet owners. Additionally, we are deploying capital to expand our DTC strategy. Pet owners know their pets better than anyone, and we want to help them detect the signs of OA and the available treatment options. We know these therapies are improving lives based on the positive testimonials from pet owners. The positive impact and reception of Librela are reflected in the market adoption. In the US, we see record penetration with over 80% of clinics now purchasing the product. No product in our history has penetrated this quickly. Reorder rates are approaching 90%, which is a leading indicator of customer satisfaction. In Europe, shipment is expanding to moderate and mild OA cases that were largely untreated, now making up more than 65% of total cases. This is just a glimpse into what we expect in the US over time, as Librela continues to expand the addressable market and gain market share. Despite our early success, we still have significant room for continued expansion. Our focus on execution doesn't stop after we launch a product. After more than a decade of exceptional safety and efficacy, our key dermatology franchise is still a critical performance driver, growing 18% operationally in the quarter. In the US, derm clinic visits are increasing, driving volume growth across both Apoquel and Cytopoint. The franchise including Apoquel, Apoquel chewable and Cytopoint is designed to cover multiple needs across different dermatological indications and their different methods of administration suit any vet or pet owner preference. Our derm products also address a full spectrum of pruritic cases, providing relief from acute and seasonal conditions, as well as treatment for dogs, with lifelong chronic conditions, which make up the majority of total derm revenue. And vets and pet owners are extremely happy with the results. In global studies, veterinarians report approximately 90% of that satisfaction with Apoquel safety and efficacy. Our comprehensive portfolio meets vets’ needs and the needs of their patients, and we are confident in our ability to grow revenue even in the face of competition. That confidence is fueled by the significant opportunities for market expansion that Kristin mentioned earlier. First, we are targeting the 8 million dogs in the US with atopic dermatitis that are either untreated or not treated by a vet through direct-to-consumer advertising, helping to educate pet owners on the signs of an itchy dog and our prescription treatment options. Additionally, in the US, there are 3 million dogs who are prescribed alternative products like steroids. We are confident in our ability to win these new customers through our proven safety and efficacy. We are also drawing more doses from the same patient base due to trends within pet health care, including [preference for] (ph) injectable therapies, chewable formulations and alternative channel growth, increasing compliance. Lastly, there are many markets where our key dermatology franchise is in the early stages of maturity. These markets should provide long-term growth trajectory and our outstanding international growth highlights this momentum. Our excellence in execution on our OA pain launches and key dermatology expansion has contributed to a great first half of the year. Now let us move on to our segment results. US revenue grew 12% in the quarter, with companion animal growing 13% and livestock posting 11% growth. For the first time, sales across our US companion animal portfolio surpassed $1 billion in the quarter. Performance was driven by our OA pain mAbs, Simparica Trio and our key dermatology franchise. Portfolio growth was largely driven by trends in retail and home delivery, reflecting the evolution of pet-owner preference for convenience and increased compliance on dispensing oral medications. In the clinic, usage of injectable therapeutic treatment is going to offset the alternative channel shift. Our pain mAbs, Librela and Solensia posted a combined $71 million in US sales in Q2. Librela generated $53 million, primarily on increased clinic utilization. As I mentioned to-date, market adoption is higher than any product in our history. Thus, we are confident in our trajectory. Solensia posted $18 million in revenue. We continue to be pleased with what we are seeing in the feline OA space. As Kristin mentioned, we see positive trends in feline OA visits which have nearly doubled since our launch almost two years ago. Simparica Trio posted US growth of 19% in the quarter on $254 million in revenue. We are entering our second year with competition in the triple combination parasiticide market, and we continue to execute on not just defending our leadership position with Trio, but growing it. Again we do not take a launch and done mentality. We posted 26% moving average total growth over the past 12 months. The majority of which was in a competitive market, highlighting not only our first mover advantage, but also the stickiness of our customer base. Lastly, in the vet channel, Simparica Trio is winning with Puppies, a leading indicator of future performance. In the absence of meaningful differentiation, vets and pet owners are reluctant to switch from a safe, efficacious product. The dermatology product sales in the US were $283 million for the quarter growing 17%. Apoquel was the largest growth driver with Apoquel chewable benefiting from increased conversion. Cytopoint growth continues to be driven by vet and pet owner preference for injectable solutions, especially for chronic cases. Earlier, Kristin alluded to shifting pet owner demographics in the evolving landscape. Much of our success with Simparica Trio and Apoquel has been bolstered by our ability to win in the growing retail and home delivery space. The convenience of these channels for self-administered products are increasingly popular with pet owners, and we are committed to making our products available where our customers need them. Currently, Simparica Trio is the best-selling prescription products in the retail channel and Apoquel is second. We estimate that over 20% of Trio sales and one-third of Apoquel sales now come via the retail channel. Additionally, the alternative channel growth rate for both Trio and Apoquel exceeded overall growth rate for these products this quarter. Growing pet owner preference for alternative channel convenience, has led to a decline in product-only clinic visits. This is why visits are not the best indicator of our performance, given we have consistently grown volume in an evolving landscape. Our US companion animal diagnostics portfolio grew 5% in the quarter, [returning to growth] (ph) after Q1 distributor inventory work downs following our channel strategies change. US Livestock had a strong quarter, growing 11% driven primarily from the timing of supply on ceftiofur, which had a soft comparable period last year. Moving on to our International segment. Revenue grew 4% on a reported basis and 10% excluding the impact of foreign exchange. Companion animal grew 12% operationally and Livestock grew 8% operationally. Our international companion animal portfolio growth was driven by our Simparica, key dermatology and OA pain franchises, partially offset by impact in China. Our international Simparica franchise grew 35% operationally. Growth was driven by Simparica, growing 38% operationally to $59 million in sales in the quarter. We continue to see increased use in Latin America and Eastern Europe, as well as price benefits in high inflationary markets. Simparica Trio grew 31% operationally on $45 million in sales benefiting from key account growth in Europe, continued focus on DTC and the positive impact of our recent launch in China. Our key dermatology franchise grew 19% operationally in the quarter posting $131 million in sales. We saw double digit growth across most of our major markets, driven by higher compliance and new patients. Growth was partially offset by headwinds in Japan due to pre-price buy-ins in Q1. As we highlighted earlier, we continue to see significant opportunity for growth. Many international markets are in the early stages of market development with significant runway for growth. Internationally, our OA pain mAbs grew 35% operationally, posting $79 million in combined revenue. International Librela sales were $63 million growing 32% operationally. As we highlighted last quarter, we have lapped the launches in our last significant international markets, which occurred in Q2 of 2023. Solensia sales were $16 million, growing 49% operationally. Our international companion animal diagnostics portfolio grew 15% operationally with strong performance across much of Asia and Europe. International companion animal growth was partially offset by expected declines in China, driven by Revolution franchise. International livestock grew 8% operationally in the quarter driven by price increases, primarily in cattle and poultry in high inflationary markets. We saw strong growth in our fish portfolio this quarter with contributions from price and volume driven by strong demand for vaccines in Norway. Growth in price and fish was partially offset by volume declines in most of our other livestock species, due to a challenging comparable quarter as well as the impact of unfavorable rotations. As expected the economic challenges in China persist, putting pressure on certain companion animal products, as well as livestock, especially in swine. Consistent with what we have said for several quarters, the impact on our growth is expected to moderate late in the year, but continued headwinds are expected throughout the year across companion animal and livestock. [Physical] (ph) discipline across the P&L is one of the things that unlocks successful execution. As we move on to some of the highlights, we wanted to reaffirm our continued commitment to reinvesting in our business and our confidence in the returns we see from those investments. Adjusted gross margins of 71.7% declined 70 basis points on a reported basis. Foreign exchange had an unfavorable impact of 130 basis points. Excluding FX, we saw higher margins due to price increases favorable mix and lower freight costs, partially offset by higher manufacturing costs, especially in high inflationary markets. Adjusted operating expenses increased 9% operationally contributing to this growth was SG&A increases of 7% operationally and 17% operational growth in R&D. Improvements in operational gross margin and prudent expense growth contributed to adjusted net income which grew 18% operationally. Adjusted diluted EPS grew 20% operationally for the quarter. Lastly, I want to highlight our share repurchase program. In the quarter, we repurchased a record high $533 million in shares. Additionally, on August 1, we announced that we received board approval for a new $6 billion share repurchase program, our largest program to-date. The shares are expected to be repurchased over a multiyear period of up to four years, and the program can be canceled at any time. The company's previous $3.5 billion share repurchase program, which was approved in December 2021 is expected to be completed this year. This commitment reflects continued confidence in our ability to return value to shareholders. Before moving to guidance, an update on the planned divestiture of our Medicated Feed Additives portfolio. As Kristin mentioned, we are expecting this divestiture to close some time in the second half. Our current guidance is not reflective of the sale and may be adjusted subsequent to the close of the deal. As we stated in our April announcement, this portfolio generated approximately $400 million in revenue in 2023 with roughly linear seasonality. Now moving on to guidance for full year 2024. Our outstanding first half performance particularly in our Simparica and key dermatology franchises, demonstrated our ability to drive growth through execution across our business and gives us confidence going forward. Thus, we are raising our 2024 guidance provided during May's earnings call. Please note that guidance reflects foreign exchange rates of late July. For the year, we expect revenue between $9.1 billion and $9.25 billion, a range of 9% to 11% operational growth. As we stated earlier, our OA pain trajectory remains on track. Our expectations for Librela for the year remain unchanged. We now expect adjusted net income to be in the range of $2.64 billion to $2.69 billion, representing operational growth of 13.5% to 15.5%. We are maintaining our commitment to grow adjusted net income faster than revenue over the long-term, while increasing our investment in demand generating activities such as direct-to-consumer advertising. While we saw exceptional leverage this quarter, subsequent quarters may have -- may not have the same level of operating leverage, due to the optimal timing of investments. Finally, we expect adjusted diluted EPS to be in the range of $5.78 to $5.88 and reported diluted EPS to be in the range of $5.35 to $5.45. In closing before we go to Q&A, the strength and diversity of our portfolio and our relationships, as well as our ability to execute on our strategic vision, continually allows us to outperform our peers. We have the utmost confidence in our best-in-class portfolio and colleagues to continue to set the benchmark moving forward. Now I'll hand things over to the operator to open the line for your questions. Operator? Operator : Thank you. [Operator Instructions] We will take our first question from Jon Block with Stifel. Please go ahead. Jon Block : Great. Thanks guys. And good morning. Wetteny, maybe the first one for you. Was there a split between price and volume for the quarter? Sorry if I missed that. And then how do we think about pricing contribution from here will call it a 2025 life cycle innovation possibly make price somewhat more durable than maybe some people are anticipating. And then the second question, I'll just ask both upfront. Kristian, you got a lot of innovation to spend on for the DTC. And so where do the best returns reside? I can make the argument Librela is the least penetrated but Apoquel and Trio arguably the annuity is longer. So maybe you can talk to how you're balancing the spend and the associated returns. Thank you. Wetteny Joseph : Sure, Jon. I'll take the first part of the question, and then Kristin will address the second one. Look, if you look at the stock we've had for the year, it is really been an outstanding start -- we're seeing demand across our innovative products and clearly a balanced growth picture when you look at the quarter with the US growing 12%, international growing 10%. We saw a companion animal growth at 12% and Livestock 9%. To get to your point around price and volume, I will cover the quarter but then I'll remind you of what the first half of the year looks like and what we are anticipating for the balance of the year. The quarter had about 8% price and 3% volume -- now if you look at the price contributions, you have about 2 points coming in from Argentina similar to the first quarter and as we anticipated in the second quarter. And that leaves you with roughly 6 points of price and 3 points of volume. Now I’ll tell you on a year-to-date basis, given where the comps were versus the prior year, you actually have a very balanced picture between price and volume. On a year-to-date basis, we've grown 12% operationally at the top-line. Separating out Argentina, you have 5% price and 5% volume. And that's roughly the balance we expect for the full year. It is just a little bit of nuance on a year-over-year basis based on the comps that is driving much higher volume in Q1 and much higher pricing in Q2. The last point I'll make is Trio had another outstanding quarter, and we are getting better price realization from more targeted promotions. In fact we did not run promotions in the second quarter compared to the last year where we did run a promotion. So that has a little bit of dynamic also playing out on the price picture if you follow that. Again, I'm very pleased with the performance overall stronger price contribution coming from that we expect roughly balanced price volume picture for the year. Kristin Peck : Thanks. And Jon, I'll take your second question. Look, as you saw in a quarter where we grew derm 18%, the Simparica franchise at 22% and Pain at 142%, clearly, the DTC is having a very positive effect in ROI on each of these. We actually think about it in a much more detailed way than what you were mentioning. We don't just look at it by brand, we look at it by channel. So what is connected TV, TV digital. And there's different ROIs for different. I mean some of these are building markets. As you said, some of these are just more consumer oriented. If you look at parasiticides, consumers really do drive a lot of that spend themselves versus derm and pain, where you have the both the consumer and the veterinary involved. So we look at it both by product. We look at it seasonality. And I'd say, we're investing significantly across all three, where we really believe both there's an opportunity to drive compliance and as well as an opportunity to grow these markets. So we’re aggressively investing across each, but we look at it in a very detailed level to make sure the ROI, any given channel we're investing at any given time of the year makes the most sense. Operator : Thank you. We'll take our next question from Erin Wright with Morgan Stanley. Please go ahead. Erin Wright : Thanks for taking my questions. On Librela first. So should we continue to see that sequential ramp in US Librela sales throughout the remainder of the year? And how are reorder rates sellout trends kind of throughout the quarter? How did that progress relative to your expectations and thoughts on potential label changes there as well for Librela? And then my second question is on just the competitive positioning now. I guess -- can you speak to how you're thinking about that now particularly in the dermatology category, but also in parasiticides and how much of the guidance update today was attributable to your view of your competitive positioning for the balance of the year? Thanks. Kristin Peck : Thanks. I'll take the first question. I'll let Wetteny take the second question on competition across all three. Obviously, very, very pleased with Librela's growth in the quarter to 142%. What we're really seeing and it is fundamentally improving the quality of life for dogs with OA pain. We've seen a really positive reception. They find it safe and efficacious, and it's really making a real difference. To-date, we have about 18 million doses. We are very pleased with the penetration to-date in the US, which is 80% with the reorder rate of 86%. So to your point on quarter-over-quarter growth continuing to see and expect the rest of the year to see a significant quarter-over-quarter growth in this product. As we mentioned on last call, we are always in ongoing discussions with the FDA, certainly in the first year after launch as they are doing their post-marketing reviews, we have been in those. We have had dialogue with them about possible changes to the Librela label as we've had in many of the other markets we've operated in. In those markets, as you look at it, we continue to see positive trends quarter-over-quarter in Europe after label changes we had in both the EU and the UK in both 2022 and 2023. So these are label changes, as you know, are not uncommon as we talked about last quarter. So we are really excited to see the growth we continue to see in Librela and really the excitement and positive stories from pet owners. So, Wetteny you want to take the second question? Wetteny Joseph : Sure. Look, when we look at the performance so far, it is been phenomenal across derm, and Trio for the first half of the year, as well as strong contributions obviously coming from our OA pain franchise. You heard the numbers coming in from Librela and Solensia, both in the US with the launch as well as internationally. When we think about the competitive landscape, look clearly, given what we are seeing and what we anticipate continuing because of momentum in the business, we are raising guidance based on the core business. I would say, Derm, in particular when we look at the competitive landscape, we've raised our expectations on derm to double digits. We are seeing high single digits previously. When we look at Trio, the update isn't really meaningful. We were anticipating to be late in the year, comparative launch. Anyway, it's a third to come to market, et cetera. So not any meaningful impact here in terms of how we think about the guidance. Operator : Thank you. We'll take our next question from Michael Ryskin with Bank of America. Please go ahead. Michael Ryskin : Great. Thanks. Both of my questions are going to be on derm market. So first, just a quick one on Apoquel chewable. You launched that recently, and there was a lot of excitement around that. I was just wondering if you could provide any color on how meaningful a contribution that's having to the better results you are seeing? Or if you think it is more traditional Apoquel that's still driving derm. And are there any inventory dynamics there we should be mindful? Was there any stocking with distributors in the quarter or year-to-date? Just an update on Apoquel chewable and then the follow-up on sort of the long-term opportunity. I think you gave a lot of color in the slides on the opportunity in derm in terms of the underpenetrated market, the untreated opportunity and steps you are taking to further penetrate that. My question is that's been the case for a number of years, and you have had derm on product in the market for over a decade now. So it seems like there is a sizable part of the market that's just resistant to treatment or possibly isn't go into the clinic, isn't amenable to this product? I'm just wondering how real do you think that opportunity is and what the barrier there is? Is that an education? Is that a cost price point? Is that a treatment modality issue. Just why is there still such a sizable unaddressed market in derm and what steps you can do to further penetrate that. Thanks. Kristin Peck : Thanks, Mike. I will take the second question on the long-term opportunity, and then I'll let Wetteny cover anything that I missed as well as cover all the dynamics you're asking for specifically around chewable. To your point, our Derm portfolio has been on the market for 11 years, and we posted 18% growth in the quarter. So I would say that there is a significant opportunity to continue to expand the market. I appreciate your comment on the slide. We did try to add slides this quarter to try to bring to light some of the stories that we're talking about, again, get some of those numbers out there for you. And specifically, what we were trying to address in that is the significant opportunity where we see two drivers really of the future growth. One is around compliance, and we are seeing really strong growth here around compliance. We can increase compliance through retail and auto shift. I even think chewable, which Wetteny will talk about, will help drive compliance. So we think there is a significant opportunity for more weeks and more months on therapy. And I also think there is a big opportunity to continue to expand the market. And building on what Wetteny said in his prepared remarks, there's 3 million dog owners right now that are prescribed to other products such as steroids that could be moved to our product. And then there's 8 million dogs with OA who might be using shampoos or things like that or over-the-counter treatment or might not be using anything at all. We see those as significant opportunities to continue to grow the market. That's 11 million dogs in the US alone. And as I mentioned in my remarks, internationally, we see the same key drivers and same opportunities, but with an additional one, which is that there is still many dogs yet to be medicalized in international. And as those dogs become more medicalized across many countries in China, Brazil, et cetera, we see a significant opportunity there. But I know you asked a number of questions on chewable, which I'll let Wetteny build on it as well as anything else you saw in Derm, you want to mention. Wetteny Joseph : Look, when I look at the derm picture, Mike I'm very excited about how we are thoughtfully targeting these sub-parts of the business beyond continuing to educate pet owners and so on, which is already benefiting us in terms of the growth we continue to see in this product 11 years later. So clearly, we are penetrating those areas, and we think there are some real ways we can smartly and thoughtfully target. Here above the about 7 million that we are already treating with our products. 11 million that we can go after here in the US alone, and Kristin just touched on that. And so we'll go into more detail on that, but we're very excited about how we are doing that there. In terms of true look, this is largely conversion for Apoquel. So I wouldn't say, that it is necessarily contributing to overall growth, but an important part of our strategy as we look ahead. We've seen the conversion rates outside the US, for example, in those markets in Europe, we have been in for, I think, about 2.5 or so years now -- those are now about 50% penetration in the US, as we ended the quarter, we were approaching about 1/4 conversion. I think we've crossed that since. So we are in that ballpark. So clearly, meaningfully converting from Apoquel, which again is an important part of our business, and we think could long-term contribute to overall growth given the ease of use and preference to pet owners, et cetera. Operator : Thank you. We'll take our next question from Brandon Vasquez with William Blair. Please go ahead. Brandon Vazquez : Hi, everyone. Thanks for taking the question. Maybe my first question, can you just walk a little bit through the increased guidance, maybe on the top-line and the bottom-line, specifically what is being passed through there. I think not to pick on, it was a great quarter. I think you'd be a little bit more, especially on the organic growth relative to our estimates, and I think less than that beat was passed-through. So just curious if there's puts and takes through the rest of the year that we should be keeping in mind for both sales and EPS on the bottom-line. Wetteny Joseph : Sure. Look, first of all let me just cover one last piece that I didn't cover on the last call, which was the contribution in terms of stocking around chew and then I will get Brandon, to your question around the guidance and what went into it in terms of puts and takes in top versus bottom. First of all, there is very little contribution in terms of net inventory into distribution on chew, it's about $4 million, so call it 1 percentage point out of the 18, we talked about on key derm globally, so not meaningful at all. Now to your point around the guidance look, we raised the midpoint of our guidance, about 50 basis points the same on the bottom. We are still very much committed and confident in driving operational sort of growth and expansion through the P&L. You've seen about 450 basis points separation between top-line and bottom-line. So clearly, continuing to demonstrate our core value proposition to grow the bottom-line faster than the top-line. I think what you're seeing here in terms of the guide, while it's the same raise at top and bottom in terms of basis points is because we see an opportunity to invest in the business in areas that will drive growth as we exit the year and enter into next year. And as we said continuously, we will make those investments as we see those opportunities, but still, again, sticking to our commitment to driving top and bottom. Now I think as you look at the back half of the year, I will note a couple of things. If you remember last year in the fourth quarter, we have basically an easier comp particularly on just the bottom-line in the fourth quarter, but these investments will impact the operational leverage you see in the third quarter. So we expect that to be not at the levels that you are seeing in Q2 here as you map from the guidance and the implications in the back half. So clearly, that half looks like about a 9% top line growth there at the top, leverage on the back half, but more heavily weighted towards Q4 versus Q3 in terms of that leverage. Operator : Thank you. We'll take our next question from Steve Scala with TD Cowen. Please go ahead. Christopher LoBianco : Hi. This is Chris on for Steve Scala. Thanks for taking our questions. We had just one on dermatology. Can you provide any color on the breakdown of key derm sales between Apoquel, Apoquel chewable and Cytopoint? How do you see this split evolving over time? And does Apoquel chewable provide extended patent protection for the brand? Thank you. Wetteny Joseph : Sure. I'll cover both here. Look, really when you look at the conversion strategy we have with Apoquel chewable versus Apoquel, we talk about the key derm franchise here versus breaking them out here. So we have 18% growth in key derm. If you look at both Apoquel the Apoquel franchise, as well as Cytopoint with double-digit growth in the quarter. Again, we continue to emphasize the combination of Apoquel and Apoquel chewable versus breaking them out, which is the reason that you heard the commentary from us as you did. In terms of patent protection, look there are various patents that cover the product, both across the active ingredient, as well as the formulation and dosing regimens. So they do very overall, if you look at the franchise, we are looking at patents that extend out to 2031. More details are available in the 10-K, if you want to pull that up from last year. And of course, this year 10-K we’ll cover that. Operator : Again we'll take our next question from Balaji Prasad with Barclays. Please go ahead. Balaji Prasad : Hi, good morning and congratulations on the quarter. Just a couple for me. Firstly, on -- I wanted to dig a bit into the nuances of pricing. Is there a difference in how pet owners pursue price hikes for pharmaceutical products versus diagnostics? The reason I'm asking is our veterinary survey consistently showing that pet owners are increasingly concerned about spending trends in diagnostics. It seems that this is not applicable on the pharmaceutical side would allow you to take on it, one. Two, could you also just size the fish vaccine business a bit, the growth? And in that context, what would an approval like Alpha Ject Micro translate to in terms of accelerating this revenue growth? Thank you. Wetteny Joseph : So look, maybe I'll take a stab at the first one, Balaji. Look, I think you've seen that spend in animal health, particularly pet owners is a doable spend, and they see their pet health as essential. We've seen that time and time again. And every survey we've done given the human animal bond, et cetera, shows that. I think when you look at pet health spend, 86% of pet owners are saying that they would spend whatever it takes if their pet needed extensive veterinary care. We've done market studies as well that demonstrated pet owners had a 20% reduction in their budget, they would still spend the same on their pet health. So clearly, underscoring this importance in terms of the importance of the pet health as a member of the family of pet owners, and we see that show up in terms of our numbers. I don't know if I have a view in terms of how that differentiates between therapeutics versus diagnostics. Clearly, as we look at the picture today, you continue to see strong volume growth in our business, even as you see very robust price as well. So clearly, we see that opportunity to continue to drive the business. That way, we are seeing some price realization. So it is not priced to – and pet owner is priced into channels in terms of vet clinics, et cetera. But you see our ability to continue to take price and still drive volume in the business given the innovative solutions we're bringing that are addressing chronic conditions for pet owners that they really, really care about. So we think that there's continued room to continue to do that. In terms of the fixed vaccine, I can't speak to the specific vaccine you talked about. Clearly, we saw 20% growth in our fish portfolio this quarter, this is largely driven by demand for vaccines in Norway, a very important market for us, so we are seeing both price and volume. Therefore, perhaps we'll take offline that specific one that you referenced. Operator : Thank you. We'll take our next question from David Westenberg with Piper Sandler. Please go ahead. David Westenberg : Hi, thank you for taking my question and congrats on great quarter here. So you definitely have products that drive visits in an themselves like Cytopoint and Librela but you also do have wellness dependent products such as vaccines and maybe I'd argue Proheart in that category. Can you talk about how those wellness products have been performing? Your expectation for how they do the rest of the year? And can you help frame the size of that -- those kind of products in your portfolio? And then if I could just squeeze in one smaller one. Were there any portfolio [minute] (ph) sales with your MFA portfolio that you're getting rid of? And why is that portfolio if there isn't more or less portfolio sales dependent? Thank you. Kristin Peck : Sure. I'll take your MFA question, and then I'll let Wetteny take the volumes and things like that across wellness and vaccine. As you think about our medicated feed additive business, as you saw, it was integrated into some of our portfolio contracts, but the majority of those contracts and the majority of the value is Wetteny outlined globally, our MSA sales last year in 2023 were only $400 million. So it's not inconsequential, but it is not a material way of the way we negotiate. Most of our negotiations across portfolio are in more innovative products that are essential to our customers. So no, we are not concerned in livestock, as we sell that business and our ability to continue to leverage our portfolio to provide the best value for our customers. So we're committed to continuing to do that. And I'll let Wetteny take the second question sort of on the wellness. Wetteny Joseph : Look, David, I think your question on wellness in terms of what's happening across the core portfolio brands versus the rest. I think at the heart of that question is really what's happening around visits, which we have continuously talk about that overall visits on a good indicator for our business, and you see volume growth across our pet care business each quarter even when overall visits are down. Now to get to your point, if you look at Apoquel, Cytopoint, the key derm franchise, if you look at Trio and Simparica franchise and OA pain. Those are all seeing increased volume across the business. I think if you then say what happened to the rest of the portfolio, it contributed about 2 percentage points to our growth. And that's largely price in this quarter, but that's just a dynamic versus the prior year in terms of both timing of when we had some vaccine availability in the prior year that added to supply last year. And therefore, it's a comp item, if you will, and then China has its impact in terms of whether you could the rest of the portfolio. So it's a little bit more price versus volume in the quarter. But overall, typically, we see about 1 to 2 point contribution to growth from the rest of the portfolio. And that's what we're seeing this year. Again, I’d underscore that we are seeing increased volumes across pet care regardless of the overall visit picture. And I think that is really what's important for us to [win with] (ph) our business. Operator : We'll take our next question from Glen Santangelo with Jefferies. Please go ahead. Glen Santangelo : Yeah, hi. Thanks for taking my question. I maybe want to touch on some of the topics that we just talked about, but -- we get a lot of questions from investors talking about the sluggish sort of pet ownership and vet visit trends and taking all that into the context of a weakening consumer here. And Wetteny, I heard your comments regarding how you view the consumer and your comments regarding how strong the retail channel has been for you all. But could you maybe help us reconcile some of those trends and data points as you think about taking the step to raise guidance in the back half of the year, I mean how conservative are you with respect to the consumer and how you think about those trends in general. Thanks. Kristin Peck : Thanks. I'll start and see if Wetteny wants to build anything here. I think what you are seeing is the -- you might see an impact in lower spending in pet discretionary -- but we are continuing to see consumer receive pet and medical care as very essential, and they are willing to spend. So if you look in the quarter, we saw about a 4% growth of revenue in the clinics, about 6.2% revenue per visit growth mean obviously, you are referencing the decline in overall clinic visits. But if you look at our US pet care numbers, we outpaced significantly overall in the US with 13% growth in our companion animal business. So we're seeing very strong demand for our products. These pet owners are young, they're affluent. They see the pet as a central member of their family and they are continuing to spend to keep their pets healthy and happy. So we are very optimistic as we look to the rest of this year and confident in the guidance that Wetteny provided and confident honestly, as we look into 2025, the consumer when it comes to essential veterinary care, still is willing to spend. We've done multiple studies as we've referenced before. 86% of pet owners would spend whatever it takes to take care of their pet. And even when faced with a 20% reduction in their income, they would not change what they spend to take care of their pets. Operator : Thank you. We'll take our next question from Chris Schott with JPMorgan. Please go ahead. Chris Schott : Hi, great. Thanks so much. Just two questions for me. On derm, is there an updated view on growth for that business in 2024 relative to the comments you made in 1Q just in light of the very strong first half results you've had. And maybe just a second part to the derm question. With your competitor announcing that their product may have a black box warning -- does that change your approach in terms of thinking about how you're thinking about either growing or defending the derm franchise, promotions, marketing, et cetera, as you go through not just the second half of this year about to 2025? Or -- are the plans largely unchanged in light of that update? Thank you. Wetteny Joseph : Sure, Chris. Thanks for the question. Look, if we look at the growth, I mentioned earlier on the call, given the competitive dynamics and quite frankly, just the strength of our growth as we continue to expand the market 18% growth in the second quarter. We are raising our expectations for key derm franchise. We said last quarter, it would be high single digits. We're now seeing it’s double-digit growth for 2025. Look, on your question, I'll start on the black box warning and turn it over to Kristin to add any additional points. Clearly, a black box warning is the most serious warning that the FDA will have on a product and when faced against a product that does not have one, also has been in the market for 11 years, over 23 million dogs have been treated with our Apoquel product. The satisfaction levels being above 90% or around 90% both on safety and efficacy that becomes a [total] (ph) order. So clearly, we talked about our excitement, quite frankly around still unmet need out there in terms of undertreated and untreated that we are targeting. We got this competition because we believe on offense here in terms of growing -- expanding use of our products is the best move. We got less of the competition. But clearly, it will position us well versus a product that has a black box label. Kristin Peck : And the only thing I'd add there is I think what's really exciting about Apoquel is that you don't have to trade off safety and efficacy there. It can be used across all durations of therapy, both acute seasonal and chronic I think the chewable really provides differentiation, especially at the consumer level. You don't have to worry about vaccine status, and it works very, very quickly. So I think that's what also gives us optimism and our potential to continue to grow this franchise. Operator : Thank you. We'll take our next question from Navann Ty with BNP Paribas. Please go ahead. Navann Ty : Hi, good morning. Thanks for taking my question. Just had one on Librela. If you had any updated thoughts on the transition to the moderate population, as well as the antitrust investigation in Europe. And then second, on vet visits, and I know that you are not as sensitive as other players, but if you have any outlook for that visit for the full year and next year? Thank you. Kristin Peck : Sure. First on your question on the EU Commission investigation. It actually has to do with an experimental compound that was part of the Nexvet acquisition, which was about seven years ago. We continue to believe our decision to stop the experimental compound was sound, rigorous and lawful, and we're confident the concerns will be unfounded when they finish their investigation with regards to that. You were asking me how we're doing in international with regards to Librela. Right now, about 65% of the cases are now mild to moderate, which we think is significant progress, this has been a big focus of ours, as we've mentioned on the previous calls. And with regards to your last point, I think on vet visits, we don't really have really good detailed information internationally on vet visits -- so there's not great information. It ranges by market to market, and there's not great sources. So I don't have any specifics I can share there. Operator : Thank you. We'll take our next question from Thomas DeBourcy with Nephron Research. Please go ahead. Tom DeBourcy : Hello. Thanks for taking the question. Just I guess, Livestock, I know maybe not top against a lot. But even excluding fish, your cattle poultry swine growth was pretty strong in the quarter. And I was just wondering, the last couple of years have been difficult for livestock market with inflation and other pressures. Just whether you see maybe a more sustainable mid or high single-digit growth in that market. I know kind of there is MFAs going get it out there, but just otherwise, whether the market may be improving. Wetteny Joseph : Yes. So look, great. We saw 9% growth in our livestock portfolio. As you've said continuously, livestock tends to grow the market, somewhere between 2% and 4%. Typically, -- this year, we are seeing increased price, particularly in those hyperinflationary markets like Argentina, for example. And so we would expect livestock as a market to grow towards the higher end of that range. And we believe we will follow that range as well. If you look at what we would expect in our results. I think when you see high single-digit growth rates like this, sometimes it's a comp for example, in the US, ceftiofur had an easier comp versus prior year. So you'll see an uptick in that. But overall, we expect livestock to be in that 2% to 4% range, perhaps a touch above that in this current environment given the pricing environment on those hyperinflation in our markets. Operator : And there are no further questions at this time. I'll turn the call back to the speakers for any closing remarks. Kristin Peck : Thank you. Thanks, everybody, for joining the call today and for your questions. Our ability to seamlessly integrate innovation and execution resulted in what I believe is an outstanding second quarter and first half of 2024, it led us to raise our guidance. And we are very excited about the continued momentum for the rest of the year. I think what we've clearly demonstrated is our ability to generate groundbreaking ideas and translate those into tangible results. We are laser-focused on our strategy to ensure we remain at the forefront of the industry. I believe our diverse and durable portfolio of trusted and best-in-class products positions us well to capitalize on the emerging opportunities and to really redefine how animals are cared for, for the long term. And finally, I want to express my heartfelt gratitude to all of our dedicated colleagues across the globe. We recently celebrated Purpose Months across our teams and geographies, highlighting how we bring our purpose to life every day with our customers, our communities and each other and their passion for nurturing the world in human time by advancing care for animals, is truly inspiring. Your hard work and commitment are the driving force behind our success. And I want to thank you for everything that you do. And I want to thank all of you for joining us today. Have a great day. Operator : Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.
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ZTS
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Zoetis
| 1,555,280
|
Health Care
|
Pharmaceuticals
|
Parsippany, New Jersey
|
1952
|
2013-06-21
| 2,024
| 4
|
2024Q4
|
2024Q3
|
2024-11-04
| 5.615
| 5.695
| 6.175
| 6.292
| 8.54753
| 29.44
| 31.22
|
Operator : Welcome to the Third Quarter 2024 Financial Results Conference Call and Webcast for Zoetis. Hosting the call today is Steve Frank, Vice President of Investor Relations for Zoetis. The presentation materials and additional financial tables are currently posted on the Investor Relations section of zoetis.com. The presentation slides can be managed by you, the viewer, and will not be forwarded automatically. In addition, a replay of this call will be available approximately two hours after the conclusion of this call via dial-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. Steve Frank : Thank you, operator. Good morning, everyone, and welcome to the Zoetis third quarter 2024 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, Monday, November 4, 2024. We also cite operational results, which exclude the impact of foreign exchange. And with that, I will turn the call over to Kristin. Kristin Peck : Thank you, Steve, and good morning, everyone. Thank you for joining our 2024 third quarter earnings call. Let me start by thanking our dedicated purpose-driven colleagues who helped us deliver another excellent quarter. Building on the strong momentum from the first half of the year, revenue grew 14% operationally and adjusted net income is up 15% operationally. We saw balanced double-digit growth across the business. Driven by steady demand for our key franchises, U.S. grew 15% and international revenue grew 13% operationally. Our innovative companion animal portfolio grew 15% operationally, while livestock grew 11% on an operational basis. Our consistent growth is fueled by a diverse, durable, and science-driven portfolio, carefully crafted through a deep understanding of our customers' evolving needs. By maintaining a strong focus on innovation, we set the standard for improving patient outcomes, higher customer satisfaction, and strong partnerships with veterinarians and pet owners. Our osteoarthritis pain franchise, Librela and Solensia, continues to make a transformative impact by addressing a critical unmet need, delivering 97% operational revenue growth globally. From our conversations with customers around the world, it's clear that our safe effective solutions are making a meaningful difference in patients' lives. We recognize the profound impact of our work, which only strengthens our commitment to developing this market. We have navigated this path before and understand that building a new category of care requires a steady strategic approach. As we lap the U.S. Librela launch, we continue to grow share, even in a market where canine pain visits typically slow down from Q2 to Q3. In fact, Librela is actively disrupting this trend by driving more clinic visits and increasing engagement. With $55 million in U.S. quarterly sales, we see significant opportunity to further expand share and utilization. In just 11 months, we have treated 1 million dogs, compared to an estimated 8 million receiving other treatments, and Librela have already become the fourth largest product in U.S. pet care. This highlights the demand and long-term growth potential, reinforcing our confidence in the franchise's $1 billion trajectory. With record market penetration in the U.S., we're only scratching the surface of broader utilization potential. We estimate that an additional 17 million dogs are suffering from untreated OA. That's because before Librela, NSAIDs were the only option for vets, which many untreated dogs could not tolerate due to pre-existing conditions. Globally, Librela opportunity is equally significant, with OA pain estimated to affect nearly 40% of dogs. And importantly, in the U.S., we see a similar non-linear growth curve to Europe, where revenue grew 18% operationally year-over-year, in year four of launch. Given our results there, we are poised to create and expand this market domestically. Drawing on that experience is key to positioning Librela as the preferred pain treatment by highlighting its safe, effective, and convenient choice for vets. We will leverage our strong partnerships and continue collaborating with veterinarians to expand treatment adoption, shifting away from two decades of reliance on NSAIDs. Results and trends like these reaffirm what we've long understood. The human-animal bond is undeniable. Today's generation of pet owners see their pets as integral members of their family and expects human-quality care. Monoclonal antibodies, increasingly important in human health, are a prime example of how we are bringing that same kind of innovation to animal health with treatments like Librela and Solensia. Our Simparica franchise continues to deliver impressive results as well, growing 27% operationally. While our science-backed innovations have created entirely new categories in animal health, we have also set the standard for competing in established markets. Through close collaboration with customers, we understood that overcoming first-mover advantage requires two differentiations, and long-term loyalty is earned with products that stand out in both safety and efficacy. The success of our Simparica franchise expanded the total parasiticides market and demonstrated that improving patient outcomes is not zero-sum, especially with significant unmet needs. In 2020, we pioneered the U.S. triple-combination parasite market with Simparica Trio, offering comprehensive protection against fleas, ticks, and heartworms in one monthly chewable. Trio is now the number one vet-prescribed parasiticide, with over 13 million dogs treated in just four years, and 86% of pet owners report high satisfaction. Despite increased competition, Trio prescription rates continue to climb as triple-combination products are gaining share, supported by our field force's scale and excellence in driving customer engagement. And our commitment to making our products accessible through the most convenient channels for pet owners has solidified Trio's retail leadership. Looking ahead to 2025, we anticipate a dynamic landscape, but perceive two key outcomes. First, consistent with historic trends, the overall addressable market will grow. Second, having more options will accelerate education of vets and pet owners. Increasing awareness of the benefits of broad-spectrum protection will drive conversion to triple-combination treatments. With our significant head start, proven efficacy, and convenience, along with our trusted relationships, we believe Simparica Trio will remain the preferred choice, even as new products enter the market. Similarly, 16% operational revenue growth across our key dermatology franchise demonstrates how disruptive innovation and strategic lifecycle enhancement drive sustained growth. Over a decade ago, we identified a crucial unmet need in veterinary medicine, a solution for canine dermatological itch that balanced safety and efficacy. Itch impacts the well-being of both pets and their owners. It's heartbreaking to see dogs struggling to find relief from persistent discomfort. We were first to address this challenge. Thanks to our relentless focus on innovation and execution, in just a decade, the market grew from $70 million to over $1.5 billion and growing. But we didn't just enter the market, we built it, cultivated it, and continuously evolved it, creating the industry's first $1 billion franchise. As a result, today, Apoquel is the number one prescribed medication in animal health, and the market and our customers have grown alongside us. And when vets wanted other options, we delivered truly differentiated first-line treatments like Cytopoint, the first monoclonal antibody to treat itch, and Apoquel Chew, a convenient chewable that enhances compliance. These therapies are trusted by veterinarians worldwide, bringing relief to over 23 million dogs globally, and we believe they are the best treatment options. And it's not only our product portfolio that sets us apart, it's our customer-focused approach to development. Vets trust our products for their rigorous safety standards and confidence in dosing regimens that allow for chronic uninterrupted use. Our research-driven approach to JAK inhibition selectively ensured that our treatments can be used safely alongside other medications, including vaccines. With over 20 million dogs globally with untreated or undertreated itch, the derm market growth potential is vast. Our proven performance reflects our commitment to expanding access and providing trusted first-line solutions. Similar to our experience in paras, we expect optionality will grow the overall market, a market where Zoetis has two first-line treatments that are known for being safe, effective and trusted. Even with alternatives, satisfied customers are far less likely to switch, and we continue to deliver the solutions they trust and rely on. Innovation, execution and a relentless focus on customer needs are the cornerstones of our key market-leading franchises. Turning to livestock, we recently closed the sale of our Medicated Feed Additive and certain water-soluble product portfolios to Phibro Animal Health. This transaction is a prime example of Zoetis' disciplined capital allocation strategy, allowing us to focus our investments on areas with the highest-growth potential aligned with our core capabilities. We remain deeply committed to livestock, sharpening our focus on key areas of innovation, including preventatives, antibiotic alternatives and genetics. For example, in September, we announced a strategic partnership with Danone to leverage Zoetis' genetic testing capabilities in promoting sustainable dairy production. This collaboration aims to help dairy producers and Danone's global supply-chain improve animal health and productivity with a focus on animal well-being. This strengthens long-term industry resilience, while also reducing environmental impact. Looking ahead, we anticipate the livestock industry to grow 2% to 4% annually, and we aim to be at the higher end of that range. Innovation will be a key driver of that growth. And to that end, we have updated our guidance to reflect strong performance across our key franchises, along with impact primarily from the MFA divestiture. Wetteny will guide into the details there. With 12% operational revenue growth through the first three quarters, we have outpaced our initial expectations, a testament to our agility in navigating a complex environment. As we look to Q4, we anticipate a return to our previous levels of above-market growth and remain on-track to meet our revised full-year guidance with strong momentum going into 2025. This quarter's results highlight the strength of our diverse, durable portfolio and unwavering commitment to delivering for our customers. Before I close, I want to extend my sincere gratitude to our colleagues. They embody our purpose, support our customers and drive our exceptional performance. Their dedication is what truly makes the difference. With their passion and commitment, we feel positive about our ability to deliver on the four key tenets of our value proposition, to grow revenue faster than the market, to invest in innovation and growth capabilities, to grow adjusted net income faster than revenue, and to return excess capital to shareholders. With that, I'll turn it over to Wetteny. Wetteny Joseph : Thank you, Kristin, and good morning, everyone. To reiterate, innovation and execution underpinned an excellent third quarter, driven by the strength of our diverse and differentiated portfolio. Another quarter of double-digit operational growth across species and geographies. The remarkable performance of our companion animal portfolio highlights the willingness of pet owners to spend on the health and well-being of their pets and the value of our products to pet owners and veterinary practices. Our livestock growth underscores the essential and growing need for animal protein around the world, and the important role our products play in helping producers keep their herds healthy. Put simply, we provide critical solutions central to animal health. Our success is directly tied to our customers, and our first-to-market innovations continue to fuel the growth and success of their practices. In the third quarter, we posted $2.4 billion in revenue, growing 11% on a reported basis and 14% operationally, with 8% driven by volume and 6% from price. Adjusted net income of $716 million grew 14% on a reported basis and 15% operationally. Revenue growth in the quarter was driven by our innovative companion animal portfolio. Globally, OP pain mAbs contributed $151 million. Our Simparica franchise posted $333 million, and our key dermatology franchise contributed revenue of $449 million. Our lifestyle portfolio also contributed strong growth with $758 million in revenue. Regarding our OP pain mAbs, Librela and Solensia, in Europe, after just 3.5 years on the market, Librela and Solensia are the leading treatments for OA pain and are driving market expansion by broadening treatment options across cases. As Kristin mentioned, many of these patients were previously untreated because they could not tolerate NSAIDs. In Europe and the U.S., Librela expansion into this patient group represents a significant market growth opportunity. In the U.S., the growing importance of mAbs cannot be understated. While overall U.S. clinic visits are down, particularly for prescription-only visits that are moving to alternative channels, therapeutic visits such as those for OA are on the rise. In the U.S., Librela has brought almost 0.5 million new patients to the OA pain category since launch by expanding the market with a new standard-of-care. Our performance within the Simparica franchise highlights our ability to meet the evolving needs of pet owners by delivering safe, effective products to convenient channels such as retail, where Trio is the top-selling pharmaceutical. Parasiticides is the largest, most competitive therapeutic category in animal health, and we have substantially increased our market share by being the first-to-market in the U.S. with a trusted differentiated product. Since the launch of Trio, we have gone from number five in this category to number two with clear triple combination market leadership. And in the first year of competition in U.S. triple combinations, we grew revenue by more than 25% and increased our market share. In the U.S., we estimate almost 60% of medicalized dogs are not on triple combination products. The increased share of voice for new entrants should accelerate the shift to triple combinations, where we have a first-to-market advantage. We continue to win with puppies, where Trio is the preferred choice for these new patients, signaling strong growth potential. Earlier, Kristin highlighted the deliberate balance between safety and efficacy with our key dermatology products. Apoquel delivered on that and quickly became one of the most important products in clinics. We understood our customers wanted more convenient options for derm treatment, and we delivered. We have multiple derm products with unique value propositions for both the vet and the pet owner. All of our products can be used on acute, seasonal and chronic cases and have years of real-world vet and pet owner satisfaction. As we face new competition, we remain confident in our growth trajectory. We have proven experience defending established brands and we are confident that our portfolio of first-line treatments remain among the most important products in vet clinics. Now let's move to segment results. U.S. revenue grew 15% in the quarter with companion animal growing 18% and livestock growing 5%. U.S. companion animal performance was driven by our OA pain mAbs, including the launch of Librela, as well as continued adoption and compliance of Simparica Trio and our key dermatology franchise. We continue to grow above-market, driven by increased therapeutic treatment for OA and dermatology, veterinarian's preference for injectables and evolving pet owner preference for retail convenience and home delivery, which also boosts compliance with oral medications. Our OA pain mAbs, Librela and Solensia, posted a combined $73 million in U.S. sales in Q3. Librela generated $55 million, primarily on increased clinic utilization. Penetration has reached 85%, faster than any product in our history. A crucial first step-in our successful launch was ensuring clinic availability. And again, we are just scratching the surface with OA. Just as we've seen with our key dermatology franchise, addressing unmet needs with revolutionary treatment can deliver long-term growth, and we believe Librela will be a growth tailwind for years ahead. Solensia posted $18 million in revenue, or 50% growth. While the incidence rate for OA in cats is similar to dogs at around 40%, there were very few treatment options for cats prior to Solensia. Since Solensia's launch in the U.S. two years ago, we have seen feline OA patients increase over 70%. With current feline medicalization rates significantly lower than dogs, boosting feline treatment presents a significant untapped opportunity. Simparica Trio posted U.S. growth of 29%, with $237 million in revenue. We previously highlighted Trio's momentum through the first year with competition, and our expectations remain high. As we have seen with previous generations of parasiticides, secondary entrants serve to accelerate conversion from older therapies. But in the absence of meaningful differentiation, they do not erode market share. In addition to robust volume growth for Trio, we continue to see the benefit of price driven by our lower promotional environment, and more thoughtful discounting across our customer base. In U.S. key dermatology, we saw 17% growth, or $303 million, for the quarter. Apoquel was the largest driver with outsized contributions from the retail channel. Apoquel Chewable growth outpaced tablet cannibalization declines, benefiting from increased conversion and compliance. Cytopoint growth continues to be driven by preference for injectables. U.S. livestock grew 5% in the quarter, primarily driven by volume growth in cattle, where we continue to see improved supply of [indiscernible]. This growth was partially offset by Draxxin price declines. Moving on to our International segment. Revenue grew 7% on a reported basis and 13% operationally in the quarter. International livestock grew 15% operationally and companion animal grew 11% operationally. International livestock grew 15% operationally in the quarter with equal contributions from volume and price. Cattle was the largest growth contributor, driven by the impact of price in high inflationary markets, as well as volume growth from higher demand and improved supply. Poultry growth was driven by price and key account penetration. Lastly, fish saw strong volume growth in Norway, driven by high demand for our vaccines, as well as the impact of a soft comparable period last year. International companion animal growth was driven by our Simparica key dermatology and OA pain mAbs franchises. Our international Simparica franchise grew 28% operationally, with $75 million in sales. Performance was driven by Simparica Trio, growing 39% operationally to $31 million in sales, benefiting from key account growth in Europe, DTC and the positive impact of our Q1 China launch. Simparica grew 22% operationally on $44 million in sales, driven primarily by Eastern Europe and Brazil. Our international key dermatology franchise contributed $146 million of revenue and 13% operational growth, with double-digit operational growth in Apoquel and Cytopoint. Growth was driven by Apoquel with strong DTC success, especially in European markets. Europe is also benefiting from strong adoption of Apoquel Chewable, where we now see more than half of doses dispensed coming from the chewable formulation. Our key dermatology franchise continues to expand internationally. Many countries are still in the early stages of derm market development and increases in medicalization as well as the benefits that chewable and injectables can offer, provide a significant run rate for growth. Internationally, our OA pain mAbs grew 27% operationally, posting $78 million in combined revenue. International sales of Librela were $62 million, growing 26% operationally. The growth of Librela was driven by higher use in Europe, as well as market expansion and share gains in second-wave launch markets. We see opportunity for continued market expansion from converting existing NSAID patients and increasing months on therapy. Solensia sales were $16 million, growing 32% on an operational basis. Now moving on to the P&L for the quarter. Adjusted gross margin of 70.7% grew 20 basis points with increases from price and mix, offset by higher manufacturing costs. Adjusted operating expenses increased 9% operationally. Growth was driven primarily by SG&A expenses of 9% operationally, largely due to higher compensation-related expenses due to company performance. R&D grew 10% operationally in the quarter on higher compensation-related expenses due to company performance and increases in project spend related to internal portfolio advancements. Adjusted net income grew faster than revenue at 15% operationally. Adjusted diluted EPS grew 17% operationally for the quarter. Now moving on to guidance for the full year 2024. Our raised revenue guidance reflects continued strong performance of our key franchises, partially offset by a reduction to sales for the divestiture of our Medicated Feed Additive product portfolio and certain water soluble products completed October 31. As Kristin highlighted, we remain committed to livestock and see opportunities in several therapeutic areas, enhanced by our strategic partnerships and focus. Please note that guidance reflects foreign exchange rates as of mid-October. For the year, we expect revenue between $9.2 billion and $9.3 billion, a range of 10% to 11% operational growth. This is both an increase and a narrowing of our revenue range versus our prior full year guidance. We now expect adjusted net income to be in the range of $2.67 billion to $2.695 billion, representing operational growth of 13.5% to 14.5%. Finally, we expect adjusted diluted EPS to be in the range of $5.86 to $5.92 and reported diluted EPS to be in the range of $5.33 to $5.39. We have seen outstanding performance in 2024 thus far with broad-based growth from our key innovative products across species and geographies, and we remain very positive on the remainder of the year and beyond. Our guidance, combined with our year-to-date results, does signal some expected deceleration in our revenue growth rate for Q4 specifically. As a reminder, revenue growth in Q4 will be impacted by the MFA divestiture, reflecting a reduction of two months of U.S. sales and one month from our international business out of our results in Q4. Additionally, we also saw the impact of stocking from the launch of both Librela and Apoquel Chewable in Q4 of last year. Normalizing for these items, Q4 will be more in line with our historical growth rate. We remain confident in underlying demand and market dynamics as we move into the fourth quarter and then 2025. Our outlook for next year remains positive. We continue to see favorable trends in our key franchises, including OA, dermatology and Simparica, as well as momentum from alternative channels. While we anticipate the recent tailwinds from higher inflation to normalize, our recent performance has significantly outpaced price-driven gains alone. Additionally, we expect headwinds in China to normalize in Q4 and moving into next year. We estimate these headwinds have had approximately 1 percentage unfavorable impact to our growth this year that should normalize in 2025. We are confident in our continued ability to grow above the animal health market, driven by the strength of our portfolio, pipeline and our dedicated colleagues. Now, I'll hand things over to the operator to open the line for your questions. Operator? Operator : [Operator Instructions] Thank you. We'll take our first question from Erin Wright of Morgan Stanley. Erin Wright : Great, thanks for taking my question. A two parter here. So first on Librela, how should we be thinking about the quarterly progression from here in terms of U.S. Librela, and how has the experience been in terms of reorder rates, and the months on therapy relative to your internal expectations? And then, just how we should think about that quarterly progression given the stocking dynamics in the fourth quarter and into 2025. And then as we think about bigger picture here, just several moving pieces into 2025 from a profit perspective, I guess you continue to invest in innovation Librela scales, you have favorable mix also from MFA sale. Like how do you think about the level of investment that you need to make next year, and sort of how much you're going to let sort of the enhanced product mix, more skewed towards that companion animal actually flow through in terms of margin expansion next year as well. So how do you think about those headwinds, and tailwinds I guess into 2025? Thanks. Kristin Peck : Thanks Erin. I'll start with overall Librela and move to Wetteny on sort of quarterly cadence, and the 2025 question you had. Look, we are really pleased with the performance globally with Librela with 123% growth, really remain committed to being a $1 billion franchise. And as you look at just the quarterly progression to-date, it's been the most successful launch in our company's history. In the U.S., we have an 85% penetration rate. Globally we're averaging over 90%. In the first 12 months, we've already got 1 million patients on the product, and we believe we've got a significant runway for growth. With only 1 million patients on that and 8 million still on NSAIDs. We think there's a really large addressable market. We can focus on higher compliance. So, we're very optimistic on that. I'll let Wetteny get into the quarterly cadence going forward as well as your 2025 question as well. Wetteny Joseph : Yes, Erin, as Kristin said, Librela has been our most successful launch in the history of the company by every metric that we look at in penetration and also the first 12 months revenue and approximately $192 million. Now as we don't tend to give guidance down to an individual product for an individual quarter. But what I would say in terms of the cadence of Librela, is that we'll continue to see and exiting this year into next year. We expect to see strong growth given our penetration. As Kristin said, about $1 million being treated, compared to NSAIDs that are at about 8 million. And so we know launching these major franchises, standards of care, take time. And one other item that is certainly clear, when you look at the historical visits around OA Pain, as Kristin said in the prepared commentary. We do tend to see a peak in Q2 coming down in Q3, and then typically comes back up a bit in Q4, but not to the level of Q2. So that's another element that I would give you to sort of consider as you think about, what to expect through the end of the year, and going into 2025. Now with respect to your second part of your question around considerations and profitability, et cetera. We continue to demonstrate an ability to grow above the animal health market. We certainly see that in our performance this year, on a year-to-date basis we're at 12%. We just raised guidance again for the third time this year, clearly well above the market, and are growing our just an income faster than our top line, including in this quarter, which as you recall last call. We highlighted the fact that we are increasing some of our investments, as we exit this year. And we still delivered faster adjusted income. And so as we look ahead, this is a core tenet of our value proposition that we'll continue to be mindful of, and we have the opportunity here as we look ahead to leverage investments we've made in the past, including field force investments in the U.S. And we see opportunity to continue to leverage those even as we continue to drive growth and launch products, across the market. We will continue to see some investments in DTC behind our key brands. Again, we're building a market, something we have demonstrated an ability to build the markets, expand them and defend them. If you look at what we're doing across our portfolio, right now. And an important part of that will be DTC and advertising promotion behind these products as we go into next year. We would anticipate again, as I've said before, the business has an inherent ability to grow the bottom line faster than the top. As you see the mix as well as price that we're able to take. How much we deliver in any given year may vary depending on the levels of investments we're making, but we may committed to growing the bottom line faster. Operator : Our next question is from Michael Ryskin of Bank of America. Michael Ryskin : Great, thanks for taking the question guys. I want to follow-up on a couple of points you touched on there. First, just in the quarter, thinking about Librela progression year-to-date, I know you had some stocking destocking dynamics earlier in the year. Just making sure for Librela, for Trio, for Derm. Was there anything like that in the third quarter in terms of inventory management with customers, people stocking for year-end or maybe destocking any promotions, anything like that? I just want to make sure we're looking at "clean numbers here" especially with some competing launches going on for some of these things. And then two, I want to touch a little bit on the MFA component. You updated the guide for that divestment for the fourth quarter, as you touched on two months in the U.S. on OUS, how should we think about full year 2025 impact in terms of updating our numbers? I think it's roughly $350 million annual revenues. But any you can say in terms of how much SG&A spent, how much R&D spend falls into that, just so we can start to true up our models for next year? Thanks. Kristin Peck : Sure. For starters, it was a clean quarter across our entire business in the U.S. and abroad. So there's no stocking dynamics or inventory buildups there. But I'll let Wetteny take the more detailed question on MFAs. Wetteny Joseph : Yes, sure. Look to Kristin's point, if you look at inventory levels, particularly across distributors in the U.S., which we have visibility into, not as much visibility obviously across clinics individually. But our inventory levels remain closer to the low end of our historical averages, similar to where we were over a year ago in Q1, after the destocking. So I would say that. And then within Librela, keep in mind, this is a whole chain product that, is being shipped direct to clinics and not going through distribution. So it's really a product. And given our penetration levels that we highlighted two quarters ago, there's not incremental penetration to really influence inventory levels here. So I thought I would add that, to the answer you already received. With MFAs, just a reminder of what we have disclosed previously. This is a business last year 2023, full year did about $400 million at about 30% margin. So I think that gives you and by the way, seasonality here is roughly linear across the year. So if you look at the divestiture this year, it's about half of a quarter, with two months of the U.S. and one month of international. You can run the numbers here in terms of what the impact, is exiting this year. And then, what that would be for next year, because we'd have three and a half quarters in the number in 2024 that, we'll be comping against. And I think that should give you. Even though I'm not getting into specifics on SG&A versus R&D, et cetera, I think that gives you an impact on through the P&L. Operator : Our next question is from Brandon Vazquez of William Blair. Brandon Vazquez : Hi everyone. Thanks for taking the question. I wanted to focus on parasiticides and Simparica Trio. It's been a really strong segment for you guys, especially Trio. Can you talk a little bit about despite more competition in the market, why you guys seem to be taking care. Perhaps it's something on the commercial side, and maybe some of the execution you guys have there. So just any color there, and how much that can continue into 25'. And then the quick follow-up, is just if there's any Wetteny for you, if there's any price mix commentary you could give us on the quarter, especially in the companion animal side? Thank you. Kristin Peck : Sure. Thanks, Brandon. Look, we're really proud of the performance of Trio. It is the number one prescribed parasiticide. It's already been used in over 13 million dogs. I think that the real focus here for us is Simparica growing 27% globally, is really having a phenomenal product. I think it starts with that. I think we were first to market with Trio, which I think has made a big difference. We've also been able to grow that product tremendously, leveraging alternative channels, which today is about 20% of that. But I think what's really underscoring all this, is that the oral flea tick and hardware market is growing 45% year-over-year. And that growth is moving more people into the oral category. And if you look at puppy share, which I think is a really good indicator of where we're going in the future. Trio has a 35% share in puppies. So I think between being a first mover advantage, having a phenomenal product that's got comprehensive coverage, it's convenient. It's a chewable. I think it's a great product. And look, we've partnered very closely with all of our customers, and certainly with our corporates. And I think you're seeing, the customers are really pleased with the product. So, we see strong momentum going into next year. And I'll underscore some of the comments that Wetteny said in his prepared remarks, which is what we've seen continuously as new entrants enter the market, is the expansion of the oral flea tick and hardware market and that is what we're expecting next year into 2025. So Wetteny, do you want to take the second half of the question? Wetteny Joseph : Sure. In terms of price mix and volume here? As you heard in prepared commentary, the 14% operational growth in the quarter was 8% volume and 6% price. Now your question, if it's related specifically to our parasiticides in the Trio performance, I would say it's about balance, with slightly more volume than price. Here and keep in mind as we've stated previously, we have more targeted promotions as well as discounts to our customers. Which is actually driving better price realization, and not just price increases if you will here on this product, which again has been a phenomenal execution I would say, and contribution to the growth that you're seeing on Trio specifically. Operator : Our next question is from Jon Block of Stifel. Jon Block : Thanks guys. Good morning. First one, are there any different marching orders for the sales force as U.S. Librela now largely moves from call it new practice adoption, to more driving utilization and getting into mild-to-moderate. Maybe the tack on to that would be any specific thoughts about 4Q revenue from U.S. Librela? Did you commit to q-over-q growth, because just wanted to follow-up there. That seems to be the only noise in the quarter quite honestly. And then, the second one would just be, any high level building blocks for 2025 revenue. Wetteny, you mentioned China headwinds of a point this year, I'm guessing for the most part that unwinds you've got Librela, their trajectory obviously some of the other key franchises. So again even at a high level any building blocks, for us to take into consideration? Thanks guys. Kristin Peck : Sure. I would say there's not any new sales marching orders. I think it's a lot more of continuing to focus on getting clinics, have more experience across not just severe, but moving into moderate, which we started probably a little while ago. That was a key focus even for us at launch. So, we'll continue to focus on growing the brand there, but I think it's really sticking with the key messages of the safety of the product. The efficacy of the product and really, demonstrating continuously the opportunity to look at the 8 million patients currently on NSAIDs and switching those NSAIDs patients over to Librela, assuming that that's the right product for that pet overall. So, we remain very, very pleased with this launch, and given how pleased we are at the launch, I think we're going to continue down the same tactics that we have. Certainly now that we've got the penetration, it's really focusing on expanding the use out of just not just severe, but obviously in moderate as well as really talking about the opportunity, given the different pets medical needs to switch from NSAIDs. So I'll turn the second part of the question over to Wetteny on building blocks for '25. Wetteny Joseph : Sure Jon. Look, we look forward to sharing our 2025 guidance on our next call in February, and just maybe a few reminders here that might be helpful in terms of directionally where we're headed, right. We have several sources of growth and we continue to see strong underlying demand, across our portfolio in most markets where we operate. Our outlook for derm and for Trio remain very positive, exiting this year and going into next year. We expect to see continued strong growth, across our OA pain franchise on a year-over-year basis. And even if you have more normalized pricing, we would expect those to be above, slightly above our historical pricing contribution of 2% to 3%. And as I covered in the prepared commentary, China will be more normalized as we exit this year starting in Q4, and into the next year. And so, you have less of a headwind going into next year, which was almost a full point in the current year. The last piece I would give is just reminder on the MFA and water soluble product portfolio. Removing those and I shared those numbers already in terms of what - those products did last year. So hopefully that's helpful, in terms of getting you into some sort of ballpark here. Operator : Our next question is from David Westenberg of Piper Sandler. David Westenberg : Hi, thank you for taking the question, and congrats on a great quarter. So a little bit touch on macro real quick just in terms of how you price relative to veterinary CPI, is that ever a consideration? And as we go into next year, do you also consider some of the clinic growth assumptions that we've seen? Yes, you are isolated in a lot of ways, because you can buy off channel. However, those initial scripts do need to come on visits, and we've seen visits for the last year being quite down. Now and then just a second on a clarification, Wetteny, I think you said in your prepared remarks reasonable promotion environment, or something along the lines of that. Can you clarify what you mean? If you meant Zoetis and industry wide. And specifically, I'm thinking about some of the promotion environments, beginning of next year, as we enter parasiticide season, you'll have a full season of Quattro. You might be lapping some of the promotions from NexGard Plus, I don't know anything like that. So if I could just get a clarity there? Thank you. Kristin Peck : Sure. Thanks, David. I'll start with your first one. And Wetteny, if I miss anything, please build on it. As we think about pricing, obviously we start with the pricing environment, and the overall inflation environment in any given market where we compete. But the primary thing that we really focus on, is a product-by-product, SKU-by-SKU view of our differentiation and the marketplace overall. I know you referenced that visits were down. We continue to say visits are not a good proxy for how animal health and more particularly how Zoetis does. Really what you're seeing is some of those wellness visits, and a lot of those are products, pickup products, visits. And a lot of that is going over to the alternative channel, which continues to grow very strongly. But if you look at the visits for our particular products around derm or around pain, they're up. And so, I think we really focus on what is the innovation and what is the value that our product provides, to both the vet and the pet owner. And I think that is what really primarily drives our pricing strategy overall. I'll turn the second question on the pricing - the promotional environment to you, Wetteny. Wetteny Joseph : Sure. Look, the only thing I would add to the visits, is even as overall visits are down in the U.S. If you look at the key therapeutic areas for us, OA Pain business up double-digits. Derm visits are up even as more and more of our Apoquel products, are being sold through the retail channel. So I think that really spells it and consistent with what we've been sharing for some time now. And then if you look at alternative channels, it has been a significant growth driver for us across the U.S. pet care, which, of course, reduces some of the dependency on clearing visits, as well as the auto-ship and higher compliance that, that drives. Alternative channels were up actually 34% year-on-year on the quarter, again, demonstrating that point. As far as promotional activities, my comment here is you see far more disciplined promotional environment this year, particularly when you compare it to last year, when we were up against a new competitor in the civil combination parasiticide space. So that comment really is to say, there's not as much promotional activity here, and that we are more targeted in terms of our discounting to our customers. Operator : Our next question is from Balaji Prasad of Barclays. Balaji Prasad : Hi, good morning and thanks for taking the questions. Two from me, one speaking a bit more about 2025. Could you comment about - comment on the incremental growth drivers and headwinds, especially that you see in 2025. And Wetteny, especially as we think about OpEx, again, I don't want to get into guidance, but if you can just comment on the pushes and pulls towards your OpEx spend in the year. Secondly, with regard to Simparica Trio again, can you comment on what kind of move - in terms of the $57 million - 57 million dogs that you have provided that could move to isoxazolines. What's the pace of conversion that could be achieved on a real estate basis? Thanks. Kristin Peck : Sure. Wetteny, do you want to take this? Wetteny Joseph : Sure. The first point in terms of next year, and again, I look forward to providing more specific guidance in February here. Balaji, look, I think as we've said at Investor Day, we see opportunity to leverage our SG&A from an OpEx perspective. We have been running R&D driven by our portfolio, and our pipeline progression faster than revenue. I think you see that coming in closer to revenue this year. We'll get into more detail in that in terms of what we would expect into next year, but that's certainly one consideration. I think when I think about other pushes and pulls, there's been a lot of conversations around Argentina this year. I think one thing to keep in mind is, as we have highlighted, the pricing that we have taken in Argentina this year you get in other hyperinflationary markets for that matter. Again, if you expect a more normalized pricing environment, and we would anticipate slightly above where our historical rate is, that incremental price you see from Argentina this year, which is actually on a declining basis. So Q1 was the peak we've come down in Q2 and in Q3, and we expect Q4 to be closer to 1%. I think that would be an item to consider as we go through next year. But one important point though is if you work down the P&L that, has actually had significant headwinds through inflation, through the middle of the P&L. And then from an FX perspective, if you look at the reported results, the net impact of Argentina year-over-year, is actually negative across the P&L. So I think that's really important points to keep in mind, as you're thinking about SG&A? And then the other point on - as we look at the parasiticide market, and what we expect to happen here, we've seen this before. This is the same that we saw, say, almost a decade ago with the launch of all isoxazolines, you saw really continual transition into those that continue to grow the market substantially. And clearly, when we look at the percentage of puppies that are getting put on a triple combination, which is much higher than the overall percentage of dogs that are on paras. So about a third of the prescription parasiticides are in triple combinations, but over 50% of puppies are. And so that gives you a strong indication, of what's going to continue to happen in that market. The split between how much is going from other orals versus collars and topic is not something we have a specificity on, but needless to say, that is where the market is going is towards those triple combinations. Kristin Peck : Yes. And Balaji, I would just encourage you to look at our slides from today, because we show you some of the graphs of what that actually looks like. And I think with a double-digit growth the fourth year on the market, I think it speaks for itself as well. Operator : Our next question comes from Glen Santangelo of Jefferies. Glen Santangelo : Yes. Thanks for taking my question. Kristin, it sounds like the company is confident in its ability to take another year of above-average price increases. And I'm kind of curious like what's sort of given you that confidence, and given the evolving competitive landscape and current macro climate? And then just a sort of part of that, could you give us an update on what percentage of the companion business, is flowing through alternate site versus the vet office, and if that's having any impact on any sort of pricing, or customer trends that we should be aware of? Thanks. Kristin Peck : Sure. I'll start with your second question. Retail grew 34%. I think it's a little bit over. I mean, Wetteny, you can correct me, around 10% of the U.S. business at this point? What is it a little higher? Wetteny Joseph : It's closer to 15%. If you look at all alternative channels, that's retail online as well as brick and mortar and home, home delivery as well combined. Kristin Peck : Yes. No, I think it's growing very strongly in the U.S. I mean, look, as we look at overall pricing, again, I'd go back to where I started before, which is look product-by-product and the innovation we're bringing. And I think what we've really talked about continuously is the diverse, durable and innovative portfolio that Zoetis has across species and globally. And so that's how we price our products. And we've continued, as we've seen competition, for example in parasiticides, been continuously taking price there as well where we see the convenience and the benefits that Simparica Trio offer. So, I don't have anything new to add here. I'm not sure Wetteny, if you do. Wetteny Joseph : Look, I think if you look at this year, right, we are taking price. If you take Argentina out, it's somewhere in the 4.5% to 5% range across the rest of our portfolio, right? And despite that, you see significant volume growth. This quarter, I think, is a testament to that 8% volume growth and 6% price. And so, if you look at our key product areas, actually derm you see price as well as substantial volume growth. So we think there's room for us to continue that, given the value that we bring with these innovations. Operator : Our next question is from Chris Schott of JPMorgan. Chris Schott : Great, thanks. Just two questions from me. Maybe first on Apoquel, can you just elaborate a little bit about how you're thinking about the impact from the Zenrelia launch - and maybe specifically, should we anticipate any slowdown to your growth due to some of their promotion activities, are you expecting relatively limited impact there? And then my second question would be on Librela uptake. Just any comments on how U.S. compliance is trending relative to your expectations? I know it's early, but just anything notable in some of those initial trends? Thank you. Kristin Peck : Sure. I'll start with Apoquel and then Wetteny, if you want to build on Librela uptake question. Yes, I mean another strong quarter, obviously, from Apoquel had 16% growth across the quarter. I think it's the number one product out there. It's got 11 years of safety, huge satisfaction rates across both consumers and veterinarians, with a 90% satisfaction rate. And I think our focus with the product, is continuing to grow the category. We think there's an opportunity for higher compliance, to address under or untreated dogs, to convert to 3 million dogs or on other treatments and 8 million dogs currently not on therapy. We're very confident in our ability to compete with this product given the satisfaction, given the safety and given the efficacy overall. We're very proud of the performance of this, and we look forward to strong performance obviously going forward in 2025 and beyond. You want to take - the update? Wetteny Joseph : Yes, sure. Look, I think as we've said before, this is our most successful launch cover in the company's history. And I think while it's a little bit early, to get into a ton of detail around compliance in the U.S. specifically. I always like to look at our international markets, which will continue to see strong double-digit growth across those markets for years out. And when we look at the transition into more moderate cases, which now represent more than 60% of our - of cases in - across Europe, for example, that's driving up much on therapy, to be above seven months. And compliance rates that are exceptionally high in that market. So I think this gives you an indication of where the market is, and given the efficacy and the revolutionary profile of this product, what it can do and what is actually doing across markets outside the U.S., and we're very pleased with where we are in the launch trajectory here in the U.S. as well. Operator : Our next question is from Steve Scala of TD Cowen. Chris LoBianco : Hi. This is Chris on for Steve Scala. Congrats on the strong quarter and thanks for taking our questions. We had two first, Zoetis has its best confidence in above-industry average sales growth, what is your level of confidence in being able to maintain this growth long-term based only on current on-market products, without contributions from pipeline of business development? And then second, how many competitive matches are you expecting in 2025? And how is this uncertainty impacting your thoughts on how conservative initial 2025 guidance will be? Thank you. Wetteny Joseph : Sure. I'll give that a shot. Look, I think if you look at our history over a decade, we have outperformed the market by three points on average. I would argue, if you look at the market growth rates this year, it's even above that. Now your question is how - what's our confidence level and be able to sustain that. We're very confident in our ability to sustain that given our existing portfolio. And bifurcating between existing portfolio and new launches is not something I'm going to venture into, because that is ingrained into how we go to market, and how we continue to invest in solving for our customers' greatest challenges. It's hard for me to give you what the growth rate would be without that. But what I would say is it's really important to note that it's not only when we launch, a brand new innovation in a new area. Is a continued life cycle innovation that we drive, which is almost historically 50% of our R&D spend. So we continue to grow the market and expand the market, adding additional claims as we go along the way, which is how we, over time, build markets. And I know there's a lot of questions around sequential growth, et cetera, it's not really about the sequential growth. It's never really super linear it's over time, building the market that once you build it, it's also very sticky, because you've established the standard and someone else has to come with something that is significantly differentiated in order to overtake you. And that's what drives our business. So, we're very confident in continuing to be able to outperform the industry. Operator : [Operator Instructions] We'll move next to Navann Ty of BNP Paribas. Navann Ty : Hi, good morning. Thanks for taking my question. One on competition and one on innovation. So on competition, can you expand on, which levers is what is using to defend Apoquel versus Zenrelia? Would that be or is it DTC about the safety, as well as near term pricing or anything else. And for Credelio Quattro, did you plan any promotions around that launch maybe to a lesser extent that when you were facing NexGard Plus. And then on innovation, are you able to discuss progress around the long-acting injectables, monoclonal antibodies and parasiticide and longer term innovation in CKD, oncology and cardiology? Thank you. Kristin Peck : Sure. With regards to competition, and your first question, I think, was on the derm space, we remain very confident in our ability to continue to grow our overall dermatology franchise, whether that's Apoquel, Apoquel, chewable or Cytopoint even with the new competition. We think again, our 11 years of safety and efficacy competing against a product with a box warning. I think is quite strong. I think our satisfaction, we'll continue to do the same tactics we always did. We don't see any need to change any of those. That's really around building deep relationships with our customers, sharing the performance of the product, investing in direct-to-consumer. We don't really see a need given the competition either with them really or also Credelio Quattro. What we continue to see is Wetteny remarked in his opening statement, is that really when new entrants come, it grows the market overall. They invest more in direct-to-consumer advertising, and you'll see more of a conversion over to the oral isoxazoline class. So we remain very confident. We're not planning on changing any of our promotional tactics, when you think about both the entrant and derm, as well as the additional entrant into the paras. Look, we expect everyone will enter paras, and that will only grow the category overall. As you think about innovation, as we talked about at our Investor Day, we really see long-acting across all of our key franchises, an important driver of growth haven't yet given specific guidance on when those launches will be, but those will be more of the near-term launches, as we mentioned in previous sessions. Operator : And there are no further questions at this time. I'd be happy to return the call to Kristin Peck for closing comments. Kristin Peck : Thanks, and thank you all for joining us. As always, we really appreciate your questions and importantly, your interest in Zoetis. The animal health industries is repeatedly proven, it's resilient, and our work remains essential, not only for animals, but for the people and the communities and the economy is impacted globally. So looking ahead, we are excited to strengthen our market leadership by leveraging this resilience, and driving long-term growth and value creation. And with that, I want to thank you for your continued trust, as you move forward with confidence and purpose, committed to shaping the future of animal health. Thanks for joining us. Operator : Thank you. This does conclude today's call. You may now disconnect, and everyone, have a great day.
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