Steve Frank - Zoetis, Inc. Juan Ramón Alaix - Zoetis, Inc.

Glenn David - Zoetis, Inc.

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.

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.

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.

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?

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.

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.

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.

Next question, please.

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?

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.

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.

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.

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.

I will ask Glenn to cover these two questions. Thank you, Louise.

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.

Next question please.

(41:34-41:44).

We couldn't hear you. Are you still there?

So, next question please.

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.

Thank you, Erin. Glenn, do you want to answer the gross margin question, please.

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.

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.

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.

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.

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.

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?

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.

Next question, please.

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.

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.

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.

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.

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.

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.

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?

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.

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.