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 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 Steve Frank. Steve, you may begin.

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. 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 3, 2022. We also cite operational results, which exclude the impact of foreign exchange. With that, I will turn the call over to Kristin.

Thank you, Steve, and welcome, everyone, to our 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 U.S. 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 U.S., 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 U.S. 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 U.S. at the end of the third quarter. We are investing in building a feline market for pain treatment and undertreated conditions for cats. Outside of the U.S., 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 livestock-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 in certain markets outside the U.S. 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 reflect 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 humankind 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 U.S. approval for Librela, we have confirmed dates for the FDA site inspections outside the U.S., 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 go into 2023. Given the importance of companionship and nutrition provided by pets and farm animals, 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.

Thank you, Kristin, and good morning, everyone. As Kristin mentioned, we had a solid quarter with growth across several 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 and 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 flea, 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 U.S. diagnostics portfolio was partially offset by growth internationally in the quarter. In the U.S., 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 diagnostics 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. U.S. 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 the U.S. 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 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 normalizes 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 U.S., 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 U.S. were $231 million for the quarter, growing 6%, with Apoquel and Cytopoint each contributing to growth. Year-to-date, our U.S. derm portfolio has grown 12%. Growth is tempered by prior year COVID-related spikes in derm visits that drove visit growth of 25% in Q3 2021 and helped 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. U.S. livestock declined 7% in the quarter as expected, with sales of cattle products impacted by generic competition for Jackson. Meanwhile, our U.S. poultry portfolio continues to be negatively impacted by the expanded use of lower-cost alternatives and generic competition for Zoamix. U.S. 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 companion animal products resulted from growth of monoclonal antibodies for alleviation of osteoarthritis pain, our key dermatology products, and Simparica Trio. We remain excited about 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 producer 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 U.S. 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.

Thank you. We will take our first question from Erin Wright with Morgan Stanley. Please go ahead, your line is open.

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.

Sure. Thank you, Erin. I'll begin and then let Wetteny elaborate. The first point to note is that the veterinary business remains strong, with demand for our products surpassing pre-COVID levels. We still maintain a healthy business. As we assess the challenges in the second half of this year, the most significant has been supply issues, which Wetteny can further clarify. This was a major factor for us in Q3. Looking ahead to Q4, while we could discuss the number of vet clinic visits, we firmly believe that supply constraints have been the primary factor affecting us. The good news for 2023 is that the supply challenges we experienced this year, such as issues with MABS, have been resolved. We are now fully supplied for MABS in all launch markets. We did face parasitic issues in Q2 and Q3; however, our supply arrived too late in Q3. Competitors took advantage of this gap, which prolonged our return to shelf space more than expected. Nonetheless, we anticipate that these parasitic problems will stabilize by Q4. We also experienced challenges with Revolution and Simparica in Q3, which is a crucial quarter for us. The positive aspect is that demand for these products remains robust, and we have addressed most of our supply concerns. While some minor issues may persist, particularly with vaccines, which is common in our industry due to the variety of products we supply across species globally, we are confident that we have resolved the major challenges anticipated this year related to MABS. We expect to manage the parasitic issues for both Trio and Revolution by year-end. We have solid plans in place, and while some vaccine challenges will continue, they are generally expected. Wetteny, would you like to address the subsequent questions?

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 in 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 that FX and supply account for more than 75% of that, with supply being by far the largest majority of that.

Thank you. We'll take our next question from Michael Ryskin with Bank of America. Please, go ahead.

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 timeline 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 the second half of 2023 or later in 2023 launch. So just walk us through the dynamics there. Thanks.

Sure. I'll start and then Wetteny can add to this. Regarding competitors, I am confident that we will regain our shelf space, and I view this situation as temporary. We are not concerned because, as Wetteny mentioned, our product is well received by both customers and pet owners, with a growth rate of 65% this year. I believe we will reclaim that space, so I see it as temporary. An important consideration about Simparica Trio is that, according to our latest information, we do not expect competition to emerge early in 2023. As a private company, it can be difficult to gather information about some competitors since many are not public, but currently, our intelligence indicates that we do not anticipate any new launches against us early in the year, and we plan to take advantage of that to gain market share. This is positive news for Trio. Regarding Librela, we were hoping for an approval this year, but depending on when we receive it next year, everything will be adjusted accordingly. We still expect a launch as anticipated, but without knowing the precise timing of the approval for next year, the timeline will shift proportionately. This is the only update I can share. We are confident that we will have a launch next year, but we will have to provide further updates once we receive the final approval. Wetteny, did I miss anything?

I want to share a few thoughts on Trio. The combination of flea, tick, and heartworm treatment remains a relatively new standard in care. This market, which exceeds $5 billion globally, is expanding from topicals and orals to include topicals and collars, and now triple combinations. We expect to grow within this market despite competition. The trends we observed as we transitioned from Q2 to Q3 appear to be a temporary setback, and we anticipate regaining our market share. While competition could emerge in 2023, we do not foresee it starting early in the year. Regarding Librela, we're very pleased with its performance in Europe, which has exceeded our expectations. Although we've faced capacity issues limiting our ability to meet demand this year and have had to delay launches in other markets, we anticipate launching the product in more markets beyond the U.S. and Europe next year. Librela continues to perform strongly for us. The delay in U.S. approval will not hinder growth in this area, as the percentage of dogs using the product and the demand indicators are promising for continued expansion in the pain treatment market.

And we'll take our next question from Nathan Rich with Goldman Sachs. Please, go ahead.

Thank you for the questions. I have a follow-up regarding the supply constraints as well. Wetteny, based on your comments about the revenue revision for the second half, the supply constraints appear to have an impact of around 200 to 300 basis points on second half volumes. I'm wondering if that estimate is accurate. Also, looking ahead, do you expect any challenges in the fourth quarter? It sounds like most of the constraints might be resolved by the end of the third quarter. I would like to know what we should anticipate for the fourth quarter and if there will be any ongoing supply constraints into 2023, or if everything should be resolved by that time. Thank you.

Yes. So, look, what I would say is, supply issues are 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. In particular, we saw more of an impact here in Q3, given the timing of our recovery on some of these. 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. 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 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.

And we'll take our next question from Louise Chen with Cantor. Please go ahead. Your line is open.

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 the 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.

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 competitors 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 are still movements 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 U.S. 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?

Yes, absolutely. In terms of livestock, historically, this segment has seen growth in the range of 3% to 4%. However, due to the influence of generic competition affecting products like Draxxin and Zoamix, our performance has been below that average. If we were to exclude the impact of Draxxin, we would actually see growth in our livestock business, even during the quarter where we reported a negative 3 for Q3, which is similar to the prior quarter. Looking ahead, we expect livestock performance to be slightly below what was seen in Q3, mainly because of heightened generic competition. As we move from 2023 into 2024, we will need to assess the broader macroeconomic factors. Specifically, when considering key cattle markets in Brazil and the U.S., we need to keep monitoring the overall environment. In terms of innovation, we are continuing to roll out new products, though their impacts are not fully reflected this year due to the pressure from generic competition. For example, in poultry, we are launching vector vaccines in the U.S., and we have introduced new swine vaccines elsewhere, although we have faced some supply constraints that limit visibility on their effects. Beyond this year and past the effects of generic competition, we expect to see growth in our livestock business. Additionally, regarding derm product competition, we noted in our last earnings report that we did not anticipate competition in the first half of next year, and three months later, there have been no updates. Therefore, based on our assessment, we do not foresee any competition arising in the first half of next year either.

And we'll take our next question from Jon Block with Stifel. Please, go ahead. Your line is open.

Thank you, everyone. Good morning. I have a couple of questions to start off. I believe the margin from 2022 remained largely stable despite the decrease in revenue. Wetteny, you talked about managing operating expenses, but I understand you also aim to invest as there are significant new opportunities ahead. How should we view this? Are we looking at an emphasis on operating expenses for investment in 2023, or can we expect the profits to grow reasonably faster than the revenue next year? Kristin, shifting gears a bit, could you provide more details on the company’s perspective regarding the resolution of supply constraints in 2023? The Trio issue seemed somewhat unexpected to me. Additionally, do we consider these sales entirely lost or at least partially postponed? It seems that transitioning from a triple back to a duo might allow for some recovery early in 2023. Thank you.

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 U.S., 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 as our target.

I'll address your second question about supply resolution visibility. At the start of the year, like many other companies, we anticipated supply challenges. We were somewhat surprised by the delays specifically with Trio and Revolution, as we expected these issues to be resolved more quickly. We were aware that this was a capacity issue, and we needed to build additional capacity, particularly with a third party. However, bringing that third party on board took longer than anticipated. We put a dedicated operational team in place to address this, but the resolution took more time than we had hoped. I'm confident in the progress we're making because we hold weekly calls to monitor the output for both Revolution and Trio, and performance has been strong. They are consistently delivering and are operational. This ongoing visibility is why I have strong confidence moving forward. Wetteny shares this confidence as we work through back orders heading into Q4. Our focus is on getting product to market, prioritizing the largest markets first, and we aim to fulfill supply for everyone by the end of this year or early next year. However, with a product like Revolution, it takes time to fully replenish supply in key markets, but we are confident because we understand the capacity issues involved. For Librela and Solensia, the delays were due to component parts. We were also competing for these components, which required us to make trade-offs between products. Currently, we have full supply of these items. Various challenges stemmed from COVID and capacity constraints, which have impacted many companies. Nevertheless, our leadership team is managing these issues carefully, as Wetteny and I communicated in our first and second quarter calls. We maintain complete visibility on the status of each product, which reinforces our confidence about when we will achieve full supply in important markets. Is there anything else you would like to add?

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 competitive standpoint. But what we've learned over the last two-plus years, be in this space, is it's not if you recover from a supply constraint, it’s when you recover that 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 the fall cattle run in the U.S., 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 toward 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.

And we'll take our next question from Brandon Vazquez with William Blair. Please go ahead. Your line is open.

Hi, everyone. Thanks for taking my question. I wanted to focus on the fact that we discussed how 75% of the lowered guidance was due to foreign exchange and supply constraints. The remaining 25%, or less, I believe was related to veterinary staffing issues. Could you provide some insights into what changed, what may have worsened in the veterinary staffing situation, and how that is trending into the fourth quarter? This will help us frame how it might pose a challenge as we move into 2023. Also, how confident are you that this is not a demand issue as macro conditions decline, but rather solely a veterinary staffing issue? Thanks.

Sure. I'll start by reiterating that demand at the vet clinic remains fundamentally strong. Current staffing and vet visits are ahead of pre-COVID levels. This isn't a situation where everything has dropped off and we're uncertain about the future. It's more of a realignment. Our confidence in demand stems from the fact that there are more pets now, not fewer visits. The pandemic led to a boom in pet ownership, and many pet parents are millennials who invest more time and money in their pets and their preventative care, driving demand higher. We believe this demand will continue to hold strong despite other macroeconomic challenges. Our focus is on how to better utilize vet techs and other resources to maximize the number of pets vets can see. This is a capacity issue rather than a demand problem. We need to create more capacity than what existed pre-COVID, which can be achieved by enhancing productivity in various areas. To put it into perspective, overall spending per visit is up 9%, and clinic revenues increased by 5% this quarter. While there was a 4% decline in vet visits, that occurred at unprecedented levels compared to last Q3. The veterinary industry is fundamentally in good shape, and we need to assist them in handling the influx of new pets, but demand remains robust.

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 lockdowns 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 U.S. 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.

And we'll take our next question from Chris Schott with JPMorgan. Please, go ahead.

Great. Thanks so much. I have a couple of quick questions. I'd like to return to Trio. Regarding the competitor delay for early next year, I want to clarify if there will be any supply issues that could limit Trio's growth in 2023, or if this was primarily a one-time issue in 2022. Can you fully capitalize on that delay in competition as we look towards the spring season next year? My second question focuses on the ongoing supply issues. I understand that in the near term there may not be much that can be done. Is there a possibility to hold higher inventories or approach supply differently in the future to prevent similar issues from arising again? I recognize that this may not be manageable in Q3, but as we consider 2023 and beyond, do you see this as a temporary situation with limited options for management? Thanks very much.

Sure. As you look at Trio for 2023, we will be able to leverage the opportunity. The challenge we faced this year was getting new capacity online with a third party, which took longer than expected. That is now online and performing well. Therefore, we remain confident going into next year that we can take advantage of that opportunity and have plans in place to do so. What was your second question?

The ability to manage inventory and so on to.

Yes, we've already made efforts in this area. Our focus is on resilience and better inventory management. We have invested significantly in ensuring we have necessary component parts because being out of stock incurs substantial costs for the company. We are carefully considering our investments, and much of the current inventory increase is due to raw materials to ensure we can produce our key products. Inventory management is feasible if you have the capacity. This year, our major challenges were securing capacity for key products and obtaining component parts, particularly for MAB. We have resolved these issues and have the capacity operational. In some cases, we can leverage inventory effectively, but this is limited when faced with challenges related to capacity or component parts. If you have any additional comments on this, feel free to add.

The only thing I would say is, 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 competitive standpoint. But what we've learned over the last two-plus years 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 U.S. 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.

And we'll take our next question from David Westenberg with Piper Sandler. Please go ahead.

Hi. Thank you for taking my questions. Most of my inquiries regarding the supply chain have already been addressed. So, I’ll begin with Librela. You mentioned that it’s a blockbuster product, but it’s only available outside the U.S. Typically, we view animal health, particularly for companion animals, as being roughly equal between the U.S. and other countries. Is there something unique about the international market that has contributed to its success, or should we still consider it a $200 million product if it were available in the U.S.? Additionally, Wetteny, you mentioned increased competition in the livestock sector and I recall past comments regarding poultry vaccines and Draxxin. Draxxin has been an ongoing concern. Can you provide insight into whether the competition we’re observing this quarter can be quantified, and how much of this is simply market dynamics in livestock, considering those dynamics have shown some weakness? I’d like to understand which aspects are temporary and which might be more enduring. Thank you for the questions.

Sure. I'll respond to your first question, and then Wetteny will address the second. Regarding Librela, we're proud that it's been a blockbuster during its first full year of launch outside the U.S. It's important to note that it hasn't yet launched in every market outside the U.S. If you take a moment to consider the global pain market for dogs, it has traditionally been valued at around $400 million. We believe this product has the potential to double that market size. We've discussed previously how we envision growing it from $400 million to $800 million. We are confident in this outlook due to the strong efficacy of the product. This means we can help more dogs in need since it doesn't have the safety profile issues seen with other products. We're also observing that customers are using it for longer periods. Currently, it’s the leading pain product in Europe. A noteworthy statistic is that 40% of customers using Librela are new to the category, which highlights the product's appeal. Additionally, we're experiencing a 90% reorder rate. Therefore, we believe there is substantial potential for expanding the product into other markets, as Wetteny mentioned, beyond those already launched internationally. It's worth noting that for advanced technology products, the U.S. market often surpasses international markets. Thus, we remain very optimistic about the product’s success, not only internationally but also as we introduce it to the U.S. and expand its reach globally. Now, Wetteny, would you like to address the second question regarding livestock?

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. 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 were roughly in the mid-$300 million, let's call it, $350 million in revenue. That by far is the largest 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, it's just a little bit more intensification in terms of products that have become generic if they are sizable.

And we'll take our next question from Steve Scala with Cowen. Please, go ahead.

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.

I will begin, and Kristin can chime in if she wishes. Regarding supply challenges, we have outlined in detail what occurred and why the effect was more pronounced in the third quarter, although we also made significant strides as the quarter ended. The difficulties we experienced in the third quarter, particularly concerning parasiticides like Trio, included outages at various strengths that persisted throughout the year. Particularly in Q2 and Q3, these outages allowed competitors to take advantage and fill the shelves in veterinary clinics. Consequently, as we entered Q3, during the peak parasiticide season, we noticed that new patients were opting for other products, moving from collars and topicals to orals from competitors instead of our offerings due to these gaps. This explains the heightened impact we observed, especially with Trio. Revolution has also been a consistent issue this year and continues to be as we move into Q4, contributing to ongoing uncertainty around some products. Supply issues with vaccines have been somewhat typical in the industry this year, particularly noticeable in Q3 with the fall cattle run in the U.S. so those outages had a more significant effect this quarter. I hope that provides sufficient context, and if there's anything more, you can reach out to Steve separately. Regarding capacity for monoclonal antibodies, the manufacturing process involves long lead times. We have been working on expanding capacity for some time, which gives us confidence for next year in meeting demand across Europe and launching additional products internationally. Our monoclonal antibody manufacturing occurs at multiple locations, and we've increased our capital expenditures from last year, expecting further rises in the next year or two as we invest in capacity. Monoclonal antibodies are crucial for us, especially with products like Cytopoint in the pain franchise and others in our pipeline, necessitating these investments in capacity.

I want to clarify a couple of points. First, the mention of uncertainty relates to the macroeconomic landscape. We are witnessing strong consumer demand, but there is still a belief that a recession could occur in the first three quarters of the year. To be clear, the uncertainty I referenced was not connected to supply issues, but rather to the broader economic environment as we look ahead to 2023 or even the fourth quarter of this year. Regarding China, in the third quarter, we saw a 35% growth despite the lockdowns, reaffirming our point that demand for our products remains robust. It's noteworthy that a few years ago, our business was predominantly livestock-focused. Last year, it was evenly split between livestock and companion animals. Currently, the lockdowns are affecting livestock more significantly, but the companion animal segment, which is nearly 50-50, has experienced growth that is almost double China's overall growth. Therefore, despite the lockdowns, we view China as a strong and growing market for us. If the lockdowns were to lift soon, which recent news suggests might not happen in the immediate future, livestock could recover more quickly. However, even amidst these lockdowns, we still saw a notable 35% growth in the third quarter in China, and I want to emphasize that point.

We'll take our next question from Elliot Wilbur with Raymond James. Please, go ahead.

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.

I will begin and Kristin may have additional comments. To start, regarding currency, the top line impact from foreign exchange this year, due to the strength of the U.S. dollar, is approximately 4%, equating to a headwind of about $39 million compared to last year. When we consider the effect down to the bottom line, it amounts to around 8%, translating to approximately $0.36 in earnings per share headwind. This is $0.07 worse than our previous guidance due to the ongoing strength of the U.S. dollar. While we do not intend to predict future foreign exchange movements, our guidance reflects the rates at the end of October, and we will keep you updated, primarily focusing on operational growth in the context of FX impact. Regarding pricing, on a year-to-date basis, our companion animal product sales have seen about a 5% price increase. However, this increase is largely offset by generic competition, particularly for Jackson, resulting in a net growth of 1% for the quarter. Year-to-date, our price increase is about 2%. While we account for the effects of generic competition, the companion animal segment, which includes our innovative products, continues to experience strong demand, prompting us to implement a price increase of about 5%. In terms of margins, we are seeing approximately a 90 basis point decline year-over-year, with foreign exchange being the primary contributor. Excluding FX, the decline is about 20 basis points. Essentially, our pricing is balancing out the rising manufacturing costs and other factors. Overall, our pricing strategies align with industry trends; our veterinary practices are also adjusting their pricing in response to strong demand, similar to our 5% increase in the companion animal segment.

And we'll go next to Balaji Prasad with Barclays. Please go ahead.

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.

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 U.S. 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.

No.

And there are no further questions at this time. I'll turn the call back over to Kristin Peck for any closing remarks.

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.

Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.