Q2 2020 Elanco Animal Health Inc Earnings Call
[music].
Good day, everyone and thank you for standing by I would like to welcome everyone to be Elanco animal Health Q2 earnings call. All lines have been placed and typically it is that right.
After the speaker's remarks, there will be a question answer session.
He would like to ask any questions. During this time typically press Star then the number one on your telephone keypad if people like to withdraw your question press the pound to key. Thank you I would now like to turn the call goes into your home Jim Equipping. Please go ahead Sir.
Good morning, Thank you for joining us for Elanco Animal Health Q2, 2020 earnings call I'm, Jim Durfey head of Investor Relations joining me on todays call, our Jeff Simmons, our President and Chief Executive Officer, Buzzer, Katy Grissom from Investor Relations and Tiffany Kanaga is I returned to literally at the end of August as always during this conference.
Call, we anticipate making projections and forward looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide two and those outlined in our latest forms 10-K, and 10-Q filed with the Securities and Exchange Commission. The information, we provide about our products and pipeline.
And is for the benefit of the investment community. It's not intended to be promotional and is not sufficient for prescribing decisions you can find our press release the slides referenced on this call and an investor work book in the Investor section of Elanco Dotcom. The slides in the press release also contained further information about the non-GAAP financial measures that.
We will discuss during today's call will be happy to take your questions I'll now turn the call over to Jeff to provide highlights.
Thanks, Jim Good morning, everyone.
David 19 has impacted all of us in ways, we environment that has rapidly changing.
Since the dedication and creative.
Many of our employees and our customers in order to focus on the health and wellbeing of animals.
Despite these unprecedented time see lanka's maintaining disciplined focus on our long term strategy and execution can control.
With me today.
Up decisions across the business that are off to better competitive positioning.
And greater financial flexibility.
Typically over the last quarter.
We completed the inventory reduction reducing the hundred line with the 80 to one.
And our first quarter call, we delivered 2% price growth across our portfolio, which is all categories positive.
We re accelerated the growth of our portfolio of newly.
Hey, launched or acquired products to 14%.
And growing or maintaining market share for our key companion animal products in this group.
We improve receivable terms and manage discretionary operating expenses.
Finally, we completed all necessary activities to close the bare transaction.
These are all important facts for success as we move into the next era for a company.
Joining with Bayer animal health theme through the key factors impacting our revenue performance for the quarter.
The channel inventory reduction.
Was the most significant driver of the overall year on year revenue decline in the second quarter.
We completed our efforts on this front.
Working in collaboration with our distributor partners to determine the minimum.
Out of inventory necessary to ensure adequate stock and flexibility in order to maintain strong service levels for and customers around the world.
The impact in the quarter was roughly 100 million.
With about 45 million coming from U.S. companion animal about 45 million from U.S. food animal and about 10 million from international business.
While there will always be the possibility for channel adjustments for individual products, we do not anticipate further reductions in overall channel inventory levels.
Our relationship with distributor partners remains very strong and mutually beneficial app.
For the changes we've implemented and we're pleased with the increased level of focused generated by the consolidation.
Part and monthly CEO meetings, where there for us companion animal distributor on key logistics and.
Service related metrics.
It's from the streamlined structure spanning receivables cash conversion pricing margin and market share.
Importantly.
Nearly all the expected volume from our four rationalized distributors has been converted to our four retain distributors. The limited volume loss only about 1% of our total us companion animal business.
Was well within our business case expectations and was more than offset by margin recapture.
Which we re purpose to support internal demand generation efforts.
In the second quarter Elanco outgrew, the U.S. fleet tick heartworm market overall.
Increasing our market share in this competitive space based on kinetic dispensing data.
Our internal demand generation efforts paired with a valuable capabilities of our distributor partners like home delivery ecommerce platforms pet owner owner engagement and digital marketing tools. They are working and our commercial competitiveness has been enhanced since the decision to focus our distributor.
Relationships.
As anticipated.
Coal that 19 also had a meaningful impact on our global business in the second quarter.
Representing by our estimate an approximate 75 to 85 million headwind.
Based on changes as compared to our underlying business trends.
The majority of the pandemic headwind was felt in our global food animal business as processing plant closures reduce for pressured producer economics.
Impact at all three major pull in swine processing capacity was reportedly down nearly 40.
Declined slowed the movement of cattle into feed yards and created signet.
Assessing.
Which in turn reduce the opportunity for producers to maximize the use of our products.
Impacting several key Elanco brands.
For swine producers implemented no grow diet.
As pigs weighted in slots for slots and pressured processing plants and profitability Wayne.
As we moved through June and ended July production capacity rebounded to about 95%.
However.
A sizable backlog of cows and pegs remains that likely won't be resolved until the end of 2020.
Extending this period of volatility into the next few quarters.
And poultry international markets experienced pressure from reduced demand most notably in foodservice.
That pressured price.
We continue to expect medium term benefit for poultry.
As a result of economic pressures facing consumers and the likely trade down from them to lower cost this lower cost protein option.
On the companion animal side.
Brands administered in the clinic, notably Vacs, most affected by the pandemic.
I think in the second quarter.
In the us traffic in veterinary clinics significantly decrease.
Wellness visits those that include vaccines, where most severely impacted with revenue from those visits down nearly 40% at the lowest point.
However, as we move through April on into May wellness visits improved with a V shaped trajectory and clinic revenue reached double digit year over year growth by the end of June.
As clinics process, the pent up demand for vaccines and restock their fringes, we posted our strongest single month of vaccine VDI sales in June.
Outside of vaccines.
And other brands administered in the clinic, our assessment suggests that trends around the majority of our parasiticide portfolio and also Gallup brand, we're not meaningful impacted by the pandemic.
Internationally fed clinic traffic remained depressed throughout the quarter, reducing sales of products across the portfolio.
Re opening and recovery are occurring at different rates across the world, but we saw promising early indications in some markets in June notably in Europe.
We believe the second quarter represents the most pro.
Found impact for both companion animals, and livestock has really while we do expect sequential.
When proved meant in the coming quarter pandemic, particularly in livestock.
The balance of 2020.
How bringing it back to our value creation strategy, our innovation portfolio and productivity approach that continues to drive our performance and deliver results.
We are in execution mode, and we are delivering.
On the innovation front, our 14 products launched or acquired since 2015 grew 14%.
This is a strong rebound from the decline we saw in the first quarter.
And can be seen on slide 15.
Earlier in July we received a positive opinion in Europe audit for the treatment of bovine in swine respiratory disease. We see this injectable antibiotic is a strong addition to our cattle and swine portfolio.
Crack to deliver at least five launch equivalents by the end of 2021 from legacy Elanco.
As we look at portfolio.
Let me share some details on the underlying.
Performance and each of the key areas of our business.
Starting with our us companion animal business.
We are focused on underlying demand.
And as the outbound sales of our products into vet clinics and alternative channels, what we call.
Sales.
They have been growing mid single digits over the last year.
This trend continued into the second quarter.
With June being our highest CVI month ever.
While the month incorporated some pent up demand from April and May for vaccines June was strong across the portfolio.
Vet clinic dispensing data from kinetic provides insight about the strength of our products with end users.
Chris Leo continues to gain market share in the U.S. flea tick hardware and market, surpassing two brands since the beginning of the year in both dollars and volume.
Additionally, we believe our messaging and promotion around the benefits of using interceptor plus in CRE deleo together for the broadest overall parasiticide coverage continues to gain traction.
As a leading indicator kinetic data shows that year to date through June and instances, where interceptor plus is sold with a flea and tick solution. It is sold with crude elio 43% of the time.
This is 73% improvement compared to the same time last year.
Additionally June was the highest VDI month ever for crude Elio.
Moving to pain Gallup prana is outpacing the branded market for both new Pat acquisition and dollar growth on a year to date basis compared to last year.
Finally in outside the vet channels in the us.
Our parasiticide and pain products collectively grew 28% in the second quarter parent primarily driven by continued E commerce expansion outgrowing the market and gaining share again this quarter.
Next our U.S. food animal business was significantly impacted by the channel inventory reduction and Cove and related pressure on animal protein production.
In addition to the competitive and environmental pressures in 2020 that we've shared previously.
Coming into the second quarter, our us food animal business had experienced flat to slightly negative VDI over the last 12 months.
The pandemic created a distinct impact in the quarter, causing a deviation from that trend line.
Aside from coal bid our strategy to maximize romance and sales remains intact, leveraging our strong portfolio and value strategy. We are ahead of our initial expectations for value retention approval.
Remains is meaningful therapeutic differences have.
And to switch to the generic.
While we anticipate a reduction in cattle had days.
We remain confident and our ability to maintain dosing levels in share within the expected range.
Finally in our international business, we continue to see underlying growth.
Excluding the.
Reduction of channel inventory.
Chris Leo and Gallup, France.
Expansion drove growth in campaign on food animal Aqua pulled.
Great and our swine portfolio in China.
Although pressure from African swine fever persists in China, we're encouraged by the re population efforts of large industrialized farms.
As a lead indicator.
And the first half of 2020 outgrew the first half of 2018.
This is driven by ARPU.
Tools for producers to maximize.
Higher value picks higher pig guys.
On productivity we exercised.
Discipline across operating expense in cash management in the quarter and we improve working capital.
This discipline is an important point.
Weight of emphasis across all parts of our organization and the second quarter, our manufacturing productivity efforts, along with price provided about 300 basis points of benefit to gross margin.
And finally I'd like to provide an update on the Bayer acquisition as we prepare prepare to close in the coming days.
Since our last earnings call, we've received antitrust clearances and regulatory approvals for the transaction and divestitures and all necessary jurisdictions.
We're pleased with a complimentary NATO with divestitures in line with previous communications and consistent with the business case established for the deal.
Additionally.
Hey, we've announced the second level of seem.
To being ready to operate eight on day one.
Finally.
Thanks internal value capture target already underway towards achievement.
Let me summarize.
Clearly our sales in the quarter have been impacted by one the reduction in channel inventory and to the effects of coal that on the business. However, I remain encouraged by the underlying demand for our products. The good traction that we're seeing and our strategy to enhance commercial competitiveness in say.
Sales marketing and our distribution.
Partnerships.
As well as the overall organizational discipline.
And its execution across the company all of which are setting the stage for a successful integration of Bayer animal health.
Now I'll turn the call over to Todd to provide more color on our results as well as the outlook.
Thanks, Jeff.
Slide five summarizes our presentation of GAAP results will slide six describes the items considered new adjusted financials.
Slide 17 to 20 of adjustments made to the GAAP result to arrive at our adjusted presentation.
I'll focus my comments on our adjusted measures in order to provide insights on the underlying trends in our business. So please refer to todays earnings press release for a detailed description of the year on year changes in our second quarter GAAP results.
Looking at the adjusted measures on slide seven you'll see the total ankle revenue decreased 25% in the quarter on a constant currency basis total ankle revenue decreased 23% and correlate the revenue decreased 22% growth.
Gross margin as a percentage of revenue was 49.5% of the Clive afford other 90 basis points compared to the second quarter of last year driven.
Our geographic and product mix and the cost of our fixed manufacturing footprint spread over lower total sales.
These headwinds were partially offset by continued productivity gains and positive price, which combined to provide approximately 300 basis points of benefit.
Total operating expense decreased 18% in the second quarter marketing selling and administrative expense decreased 19% to $162.8 million due to cost management as our business move to primarily virtual operations in the quarter.
Adjustments the variable pay expectations as a result of performance and the decision to ship certain marketing expenses from the second quarter ended the third quarter. According 20.
Our expense level sequentially lower from the first quarter by about $18 million.
Our dsos decreased 14% to $59.4 million or 10% of revenue also reflecting cost management with Love's travel abroad, and person meetings adjustments to variable pay as a result of performance and a shift in project expenses from the second quarter ended the third quarter levels. The shift has been negatively.
Impacted the critical path of key projects.
Operating income declined 57%, reflecting the impact of sales gross margin operating expense results I just described.
At the bottom line Q3, adjusted net income decreased 64% to $36.3 million, but Q2 effective tax rate was 17.2% and our adjusted EBITDA margin the 16.7%.
On slide eight you continue to effective price really and volume on our revenue performance. We've already discussed many aspects driving the overall results. However, I'd like to highlight the price was up 2% for the quarter and positive in each category. We believe this reflects the value of our innovative products and the.
Disciplined we're applying around price managements, despite competitive pressures. Additionally, FX was a 2% headwinds as we saw ongoing dollar strength in the second quarter.
Slide nine provides details on our overall performance until you have some internationally both of which were impacted by the channel and Covance.
For core revenue you off declined 36% and international is down 9%.
We expect to file our 10 June shortly but moving to slide 10, Let me now provide an update on working capital cash and deal financing components.
As we have discussed working capital as an area of focus for us and they view us in Q2, we hold all distributors at 60 day payment terms as a result, we've improved our receivables as a percentage of sales for the lowest level since the IPO enhancing our financial flexibility and improving our dsos.
We ended Q2 with $1.4 billion of cash and equivalents our balance sheet.
Dollars over the first quarter. In addition, we completed the sale leaseback of Australia facility and focused on critical capital expenditures only these actions bolstered our balance sheet. Despite our lower sales in the quarter setting us up well for the closure of the bare transaction.
Recall that our financing structure with a bare steel includes the cash portion every share portion.
In conjunction with the deal close our term loan b of $4.275 billion will be funded.
Through this of the of the proceeds from the secondary equity issuance from Q1, we will pay bear approximately $5.3 billion in cash subject to certain standard purchase price adjustments and we anticipate issuing approximately 73 million shares of stock to bear.
After closing the deal we will have a new southerner.
$50 million revolver available, which is subject to a covenant tied to the term loan b.
The baseline Covenant EBITDA was calculated the last four quarters, a pro forma EBITDA for the two companies and will be inclusive of the second quarter of 2020 for both Allegro and bear. This amount is expected to be approximately $1.1 billion, but covenant is established and 65 for some of this about or approximately.
$725 million.
The calculation will be finalized in conjunction with the close based on our current expectations for the combined business, we do not foresee any issues with generating sufficient EBITDA going forward in order to stay comfortably above our debt covenant level.
20, Twond is uniquely cash heavy year, given the stand up of the independent Elanco, specifically, our IP infrastructure and ERP system and the execution of the bare transaction and the build of the requisite ERP infrastructure for the integration.
We estimate 2021 cash needs for these areas to be approximately $250 million to $353 million less than this year.
Finally, let me note that the legacy bear animal health business will transition to a new ERP system that we have implemented along with our partner Tata consultancy services of on clothes. We realize this is not insignificant endeavor through extensive collaboration between bear a Lego and Tcs, we're full confidence in the system.
Our teams are prepared and equipped to address any challenges we might face.
We believe we have established the appropriate oversight accountability and resources to ensure minimal disruption during this transition period and going forward.
Now I'd like to transition to our outlook starting with slide 11 today, we are providing revenue guidance for legacy Elanco for the third quarter as well as a number of modeling assumptions for the combined company below the EBIT level, while we do not intend to meet your practice of providing only revenue in quarterly guidance. We determined this to be the most.
Appropriate path for this quarter, given the timing of the deal closed and the complexities of reporting on the combined company in the third quarter.
For the third quarter 2020, we expect legacy Elanco total revenue to be between 660 million and southern $10 billion. This range excludes about $12 million to $20 million of expected third quarter revenue from products that are being divested as part of closing the bare acquisition.
As we discussed earlier, the pandemic and the corresponding economic impacts represent variables for industry at our company in the back half of 2020.
Our guidance reflects an estimate of approximately $30 million to $50 million of covert related pressure in the third quarter.
Although we saw signs of recovery over the course of the second quarter, we do expect certain challenges to carry into the third quarter, primarily at our global food animal business and international companion animal markets. Currently we have not assumed the second phase abroad shutdowns, either in veterinary clinics or meat processing facilities, which both contributed to.
In them, our pressure on the industry and the second quarter.
Our newest companion animal side or the data currently appears and support a V shaped recovery, we expect international markets will be slower to recover.
Additionally, as a reminder of the third quarter of 2019, we experienced the initial stocking as a leading brick and mortar retailer prepared to add pet prescription services to its pharmacies.
Benefit last year was in the high teens millions across several brands on the unfavorable comparison will partially offset the growth we expect across both companion animal categories.
In food animal, we anticipate a negative impact from the continued backlog of animals awaiting processing lower animal numbers continued reduced demand from food service and pressure producer economics over the course in the second half the largest impact as expected our cattle business.
Turning to gross margin for legacy Allay go operations in the third quarter, we expect moderate sequential improvement from Q Twos challenge. The result, as fixed cost de leveraging should lessen we continue to capture productivity efficiencies and we remain disciplined on price.
Additionally, the fluid gross margin from the divested products represent the mix headwind, but in line with our deal assumptions.
With respect to operating expense, we anticipate third quarter R&D normalizing back to historic levels, and thus DNA rising somewhat above the first half and prior year levels due to the timing of labor investments more than offsetting some ongoing savings such as reduced travel.
Finally, we intend to provide company guidance during our third quarter earnings call. However, we wanted to offer clarity on a few items to support modeling, which can be found on slide 12.
Now I'll turn it over to Jeff to summarize.
Thanks, Todd in summary, I want to thank our team for their disciplined execution as Weve navigated. These unprecedented challenges were eager to close the Bayer animal health transaction in the coming days and we look forward to sharing more with you about the combined business on our third quarter earnings call in at the end of the at the.
And as excuse me and Investor day in December.
Before we move in Q in a I'd like to take this opportunity to thank Jim for his outstanding contributions to Elanco over the last two years.
Jim has been instrumental and cultivating our relationships with the investment community and its providing meaningful council and guidance to our team will miss having him around and wish him. The best of luck upon as returned to Lily.
We're very pleased to bring on Tiffany Kanaga a lead to the lead our Investor Relations. We're excited about the perspective, she brings to the team and I look forward to all of you engaging with her over the coming weeks.
With that I'll turn it over to Jim to moderate the QNX.
We'd like to take questions from as many colors as possible. So we ask you limit your questions to two or one with two parts I think we have about 30 minutes a little bit more than that so Adrian if you could provide the instructions for the Q in a and take the first caller.
Hi, Dan if you like to ask a question first started the number one that is done one for questions. The first question comes from the line of Michael Ryskin with Bank of America.
Hey, guys. Thanks for taking the question.
I want to started with a appreciate all your comments in the prepared remarks, Jeff on some of the distributor moves.
Thats, where there has been most concern from investors I want to get a better sense of what gives you confidence that that has really normalize and that the 160 million you took out in the first half that's a onetime move and this is the the appropriate a run rate go forward just because there is there's always uncertainty could there be a lingering effect or could there be another wave of this in the second half for.
2021, and then I have a follow up asked so let me be clear, yes, we do believe that we are at the right levels.
Product, but again as we stated clearly.
As we consolidated down to four district executed just his plan, we've not only deliver that strategy, but as you've seen we've delivered across the board from better margin tighter financials and increase to share.
And I would say uneven speaking to the Ceos are the major distributors. This week, we feel very good about the delivery in Q2, how we're optimizing and focusing this relationship and how we've re we've taken inventory level.
Most to what we would say are the minimal levels necessary to optimize service and then to reach channel. These four major distributors against what they are extremely good at.
I think the results that we've shown as you look into what we've done in terms of gaining share and the tech fleet hardware and market that campaign that we have with IDEXX and these distributors on worms, as well as the movement than we've seen even with pain that it is working at delivered and our competitiveness actually increased in the quarter that we made the disk.
Vision. So we're very comfortable at these levels are correct and we continue to stay in a buy sell relationship, but it's very targeted on what they do best and what we do best So again executed just as we had communicated and again the at the $100 million at 80 to 100 million it's within.
The range. The reason it's at the higher end of the range is that primarily due to the increased demand of the products.
And Mike just add on.
As we communicated last quarter, if there's a material impact on revenue from a change in inventory, we will make sure to communicated to the street just like we did Oh for this quarter and as we delivered.
You had a follow up Mike.
Yes, Thanks, that's helpful.
The comment on strong gains in the U.S. alternate channels E Commerce.
And then 28% growth meaningful for the total company wants but.
I was wondering do you have any indication.
In some acceleration in the shifts the E commerce does to the online alternate channel or away from that or is that a little bit more of a temporary action, while that officer close and you had some comments in the prepared remarks on vaccine trends sort of how that move round throughout the quarter.
I was curious what about parasiticide. Some other products that are more amenable to online sales.
Is this temporary or is this is at the beginning of something more.
Yes, So I would say you know the market's been growing double digit in in this retail driven heavily by E commerce as Weve talked in the past Michael in that that those trends continue food drug mass and suddenly other spaces have not been as as aggressive on growth, but to yes. No question I think we believe clearly as we.
Look at the data that coal bid has accelerated the awareness of pet owners that they're able to have a more convenient way to shop in a and actually have delivery to them and tele medicine has accelerated this as well so again first quarter Elanco grew 35% and outgrew the market.
We grew 28% in Q2, so we're in outgrowing the market. So we are growing share I think thats driven a lot by our capabilities and it bodes extremely well as you know for Bayer that is that is leading and this and had the longest legacy in this segment. So I believe that it's accelerating the trend.
I also think very importantly, as the veterinarian is still in the center still will be in the center any land goes working very diligently to enable veterinarians to bridge on them to participate in this as well and our distributor partners is one of the top areas. They are adding value I was on the phone last night with.
The CEO of one of the major distributors talking about this is trend and how we are able together to partner and create the veterinarian and putting them more in the middle I think I think the wellness visits as we said the v. The V shaped trajectory you know a lot of what's driving that as there was a catch up on what was behind and I think compliance is.
Up as people are you know president weather patterns throughout the entire day on a lot of the data showing that because of that their awareness of their Pat needs is increasing at the same rate.
Adrian can we take the next question.
The next question comes.
From the line of Nathan Rich with Goldman Sachs.
Good morning, Thanks for the question.
Just maybe just following up on on just your last comment there I mean have you seen the pent up demand in the companion animal business continue.
In the July and how should we kind of think about underlying growth moving forward.
And then if I could ask the second question around margins.
I think you had called out the 300 basis points of margin improvement from productivity and price in the second quarter could you maybe talk about what you've seen year to date.
And kind of bigger picture the underlying gross margin has been under pressure given the impact of co bid and destocking, but those headwinds abate.
The the underlying gross margin performance suffer from the productivity and pricing the decision.
Yes, Nathan so great great questions, you know I think I think the one.
The thing I would say is that we are coming out of a V shaped recovery in companion animals, I think theres still a lot of dynamics to look at relative to international the retail there was just brought up so I think a you know we're going to need to second half to see what trends stick and but I would say this appeal.
Things as I mentioned, we do not see the pandemic impacting our overall parasiticide and pain business and add the companion animals has has recovered we believe from on the sat back and we saw in March and April I would say as we look specific any elanco again commercial come.
Patent of NIS, we see sustaining and growing with the moves that we've made we've been at mid single digits over the last 12 months. That's continued in Q2 two despite the coal that impact I think in a competitive space and Parasiticides Nathan we've seen elanco continue to outgrow the market year to date in dispensing.
Sales, so we're trying to get to that.
End user data and we're gaining market share I credentials, probably the one to note that we continue to see you know a gain in market share in this category again, surpassing a couple brands and a big driver to that I would give some credit to you know our targeted focused approach with the distributors any landfill.
Heavily channeled and focused on driving demand and the campaign with interceptor plus again, those two having the broadest overall coverage. So I would say net net the market continues to do well we need to watch it in the second half we need to look at the slower recovery and reopening of vet clinics intern.
Nationally, but when I look at the the Linco portfolio, our commercial strategy and our approach I feel I feel that things noted in Q2 will will continue as we go forward.
They with respect to your question on gross margin. We did continue to have a good productivity.
Creation in Q2, the 300 basis points being a combination of both the price we saw across our portfolio as well as the continued.
Reduction in manufacturing costs across our network. We've continued to make very good progress on driving a pie costs lower with our procurement initiatives. We now have our Fort Dodge.
Manufacturing facility for vaccines up and running so overall, we feel very good about how that continues to progress.
At the same time, which over the impact in Q3 will negatively affect gross margin.
It is hitting some of our higher margin food animal products and that's just a mix issue that will continue to fight through but as we break out of this and get further into the future. We still feel very good about our margin trajectory and our productivity initiatives that are driving that.
Great. Thank you.
So we take next question.
The next question comes from the line.
Chris Schott with JP Morgan.
Great. Thanks, so much for the questions just to here maybe first building on those margin comments can you talk about your longer term margin targets you laid out with the Bayer deal to those targets still hold when we think about the combination of who bid and some of the changing distributor relationships through thing because timelines, maybe being pushed out restructuring as we think about looking.
Got a few years is kind of or things basically on track or or do we need. So we got to reset expectations. There and then my second question.
Maybe also have a buyer with that business coming on board should we anticipate any further changes to the distribution strategy for the company as you would should normalize the two businesses or every releasing the bulk of the of the changes occurring as over the last six months or so thanks so much.
Chris Thanks for the question with respect of longer term gross margin, we feel good about our long term trajectory that we've talked about with legacy Alliant go of delivering on that 1000 basis points of margin improvement that being said the current impact from Covidien. Some of the impacts on the portfolio as a result will slow that down and we.
I would expect it will deliver as quickly as we previously thought that being said we are excited by the bare portfolio that comes on it is a higher gross margin portfolio in total that our current elanco portfolio and so as we bring it together, we look forward to giving more of an update and investor.
Good day in December.
Chris relative to Bayer and its impact on distribution I would say right now and again, having Joyce Lee Andr come onto the leadership team. We've got good good awareness and since the FTC approval, we're going to the next level of planning what I would emphasize is one elanco our targeted by Sal again.
And limited inventory as low as possible and still optimizing service levels and focusing in targeting our efforts I would say we feel very good about that approach and feel very good about our second half plans as you look at Bay or a reminder, a good majority of the companion animal business for bear and.
And their business overall is a retail business that is sold direct.
So again that takes out the the inventory concerns and again, it's a it takes out just we will continue to assess whether distribution partners, especially these exclusive ones that have differentiated services on ways that we can continue to optimize both the growth share and bottom.
Line.
Great Adrian is there another question.
The next question comes from.
The line.
Pricing with Morgan Stanley.
Yes, thanks very much.
And thank you for all the details so I have two questions first.
I was hoping that you could provide a little bit more color on the channel inventory worked out of 160 million in the first half of 20.
When was that revenue originally booked was that all and 29 screens or was some in 2018 as well and then second with respect to the buyer.
Stand up costs and also the buyer Ts say expenses will these be included or excluded from non-GAAP earnings.
Earnings.
And then finally, just one little quick question, which is with respect to complicated.
When do you expect to integrate the buyer IP platform with the new Elanco, that's a p. system, that's being installed in January thank you.
Dave Thanks for the question as we discussed on the Q1 call.
This reduction of $160 million of inventory will get us to below the levels of inventory we had in 2016 by more than 10%. So this was a historical strategy, we had with respect to inventory in the channel, we reevaluated that strategy and with the covert impacts previous shock.
Both our distributor partners as well as the small business owners that are the independent veterinarians across the country. We made the change a bit of Q1, and then continued to conclude from all of the end up work, we were doing with our distributors, but the high inventory levels, we're no longer driving the demand the done historically.
As we've made this broader shift as Jeff mentioned earlier, we feel good that we now have inventory levels across the world and across species federal summers efficiently.
With respect to the bare stand up.
These.
We running with yes, it with.
But will be part of our adjusted results.
Part of where we are in the fact that we did not get to you.
Assays from bear is that going forward, we'll be running both systems one for legacy like go one for legacy good results and we'll give Doug.
Sure Yeah in Q over Q3 call in November and then on them.
Moving forward Oh from the standpoint of women, we would integrates the team has done a great job throughout the covert.
And then pick on advancing the away Amco independent New S. 84, Honda system that will go live in Q1 of 2021, that's very much on track him and the team I was really focused and done a great job of running through a lot of testing and preparation for that so we will stable.
Realize that then the over the course of 2021 at the same time, we're going to become very good operating of the ERP system for the legacy bear business.
The timing of bringing those together will depend on a number of doctors regarding the efficiencies and where it fits within our overall capital deployment efforts given there wouldn't be a cost to integrate the bare system and we've not yet determine that as we want to work through and understand how we operate on both systems.
Certainly as we've talked about synergy timing, we gave a five year synergy number.
The time, we announced the bare deal 275 to 301, delivering those numbers some of that.
It is more back loaded than we would tip because of the complexities of operating the two systems and when that integration would occur.
Adrian I know the question.
Your next question comes from the line of Amir rested with Evercore.
Hi, Thanks, so much for taking my questions I wanted to focus on inventory and perhaps also quick follow up on distribution strategy as well.
Perhaps starting on inventory is it fair for us to assume that the current level of inventory as we stand today is two months or less for the companion at this point and I'm curious if you linco as a company would yield going to possibly making quarterly disclosures quarterly breakout of exact inventory level days.
And I ask because there are several large biopharma companies that have done that irrespective, whether they've had inventory issues or not and then and then Jeff could you just clarify on their side I know one of the logical one of the lot nickel rationale for deal was that he lanka's expertise on the non agencies.
Right.
On the.
That side could be leverage over to the bare portfolio, but to do that wouldn't that automatically name that some level of inventory for beer portfolio has to be introducing distribution channel I just want to understand how to think about that thank you.
Yeah rumor so.
I think I think it's critical to to emphasize and where I would want to put the attention is you know what we have transitioned to and again, we've been pretty clear on this that we have transitioned to a buy sell that is targeted that is optimizing and is focusing as you know.
As an industry has changed significantly.
And by going to these four we can already see that where they buy sell that is targeted and with the optimizing not just inventory, but terms services paying for the things that they do extremely well has optimize the entire p. and now as well as market shares in the marketplace.
To be able to say, hey, disclosing elements of agreements with distributors or overall, what I would say is there a significant difference is even bring the marketplace and you've seen this as you've looked at consolidation as well as even new services.
As in acquisitions that they made an adjacent areas that makes each one of our arrangements on different with different dynamics and so what we would say as as as Todd was very clear on this one our overall strategy if it changes from a buy sell this all at this time or the levels change.
Quarter to quarter, we would make that very clearly known to the investment community. We believe that has the right strategy and write approach both from transparency as well as from a competitiveness standpoint, and I really want to emphasize again that the concerns or were noted in the beginning in the quarter relative to the ended up.
Quarter, we have delivered across the board relative to all values from the metrics of pricing to cost efficiencies margin and market share and I believe the distributor relationships are as strong as they banned and a and we're very much optimizing at this point in time, so that to me is key.
He now as you move to bear as I shared earlier.
The majority as you know is in this retail space, which is direct and what we would say is it's working and it's early but again with choices expertise and a candidate Luther that will lead the retail business will bring that expertise and but it's it's working their businesses in a strong position will make.
No changes initially and we'll assess on the vet business that they have absolutely. We'll look at you know is the agency REIT or should that be optimized into the agreement that we currently have and we'll be looking with some of these distributors that the global business overall that we've done as well so I hope that addresses the question humor, but again, we feel.
Very good about the decisions we made they were the right decisions and they gave US you know very significant results here in the second quarter.
Adrian do we have more questions.
Your next question comes from the line of Kathy Miner with Cowen.
Just just two quick ones.
One could you just remind us whether your expected impact from the swine fever is still going to be neutral overall for the year.
Second of all Ami talked about Credentialing interceptor, plus doing very well has no impact from the recent competitive.
Dictation, so far thank you.
Yes, as I mentioned and I want to clarify is in my and my comments I'm, yes.
Okay, and swine fever continues to persist.
That said down in some Asian countries and up and others. So there's still some variation that that is out there that trend that we have seen no. Kathy is that these industrialized integrations are re populating at a greater rate will.
Predict that they will be a higher per se.
San edge of the overall peg production going forward prices are very high which is driving as quickly as and as fast as Pos.
Table and Elanco as it's been swine business in the first half.
Outgrew the in 2020 outgrew, the 2018 business, which was before.
The overall, so again, our b to b relationships our product.
The offering the portfolio there.
And that helped enhances the overall economics of the animals, So from Sal production all the way.
Very good I would tell you that.
Assaf will persist ended the second half and we'll keep our eyes on it we believe that it's in line with our expectation and we'll probably be a little bit positive to that expect.
Patient.
Relative to set asides, yes, we feel very good about our intercept.
Well campaign the data the rollout our distribution partnership is definitely played a role in this as well and it's tracking to our expectations relative to the competitive assumptions that we laid out in our guidance at the beginning of the year.
Yeah.
The next question comes from the line of Elliot Elliot Wilbur with Raymond James.
Thanks. Good morning, just wanted to ask a one additional question with respect to the restructured it.
Distribution relationships, specifically thinking about moving the terms to 60 days, how do we think about the the cost of doing that and it also sounds like there's a margin benefit to elanco from restructuring the agreements and I'm trying to just get better same yet how those two may net.
Out and then for Todd just to clear to Craig clarification question around synergies I'm sure. You've said this at some point in time, but I can't recall the the the response, but the expected synergies in association with the buyer transaction is that a net number or will there will some portion of that be reinvested into the combined entity.
Thanks.
[laughter].
Thanks, Bill it for the question overall, the terms and 60 days, we don't view is having a cost too well. We've got this was all part of a number of different factors in every distributor relationship, but that's one though we are implying we you'll be able to see from the 10-Q, when we file it with Dsos improvement of.
Nearly 10 days in the quarter and are very pleased with how the working capital played out as shown by the overall $185 million of additional cash all about Q1.
With respect to the synergy question.
And the margin benefit from the contracts again as we've talked we've always has been working with distributors on changing the margin looking for more pay for performance for all of them a and overall as Jeff mentioned, we continue to feel very good about.
Their delivery.
Order, taking advantage of what they are really good out where they augment our sales force that's out there connecting with us it really driving our overall launch of our companion animal products as we think about the synergies.
Isn't that number over the five year, the two or 75 to 300 million and then you know as Weve also communicated we expect the cost to achieve those synergies to be in about a one time basis or another $275 million to $300 million and I would emphasize again related to the commission benefits that we receive.
Kind of in Q2 were reinvested in our Salesforce. So when we look at metrics. It spans across as we mentioned receivables and Dsos margin market share any even share of voice, we look its share of voice.
Net net with us in our distributors.
Next question Adrian.
The next question comes from the line of Biology, let's start with Barclays.
Hi, Thank you good morning for taking my questions.
Lastly, Jeff could you help us understand how the all producers are behaving currently.
Especially as it was under the cash flow guns theme have endured in Q2.
You asked the seems to be expecting decline sign rowing in Q3.
Is it fair to expect then this be seems will be struggling for the four updates on the two to three quarters' smaller thank you.
Yeah. It's a great question lot of dynamics, right, now and and I could go across all species, but if we just look at pork, yes, I think just looking at the facts and I think a lot more to play out here and I'll touch on a couple other factors, we got to keep our eyes on but you know again you asked live high prices dropped I think you know to multiyear lows as you know.
In in early July heading down 41% year on year.
You know is theres inventories continue to weigh on the market. So quite a story in the U.S. compared to maybe China, where there is low demand high trade and higher.
We need to expect yes, additional cuts to the breeding heard to better align supply and demand the backlog still exists.
Current prices remain weaker we you know with them with the realized a realized.
Market value of pegs, I believe below today breakeven.
So and but I think I think trade, it's something to keep our eyes on I mean, despite ongoing disruption in global markets.
Exports remain very robust and what I know a lot of U.S. producers are really hoping for I think they're up 32% year to date and I think almost all of that growth is driven by China. So.
I think the things we got also watch for is any re occurrence of coal, but that's not in a in the guidance that we shared I.
I think at the processing plants have done a much better job with the processes that they have in place in the mitigations in place that even if something re occurred there much better prepared on than they were but again as the backlog plays out herd size has to be lowered and and trade has to continue to incur.
East to stabilize I believe a pig situation that'll probably be rough the rest of this year into next year.
Thank you Thats helpful. My second question is on the innovation side.
Can you give an update on our end range and R&D.
Projects, especially now seeing therapeutics and if we can I just made any launches from the R&D standalone in the next 12 months either from Elanco say dollars can speak about it from the acquired business Yeah, Great. Great question. So we've said publicly about five having five launches on track.
During the rest of this year and into next year and include the coast a body and experience that we talked about.
What I would emphasize and then of course, we we have a we've announced a incorrect so as well coming in Europe, but what I would emphasize is a couple of things first of all we feel very good about that on.
Estimate will put more color on that and our December Investor Conference also our research teams now after our antitrust approvals have already gotten together with bear and the the leadership teams have been named and they're looking at that joint pipeline and again meeting and meeting the expectations that we.
Had and we'll talk a lot more about that that combine pipeline as we get into the second half of the year and into the Investor Conference. So five launch equivalent on legacy land go more to come.
Awareness of what bear brings and again, we feel very good about said the bear.
Pipeline capabilities in the synergy and I think you saw that synergy by the limited antitrust overlap.
We're almost at the hour, but I think there are few more callers in the queue. So let's work through the remaining Oh list Adrian So if we can quickly go to the next month.
The next question comes from the line and even here.
Hi, Thank you so much for taking my questions John Congrats on the companion animals right.
Two questions if I may.
Apologies if I Miss this but.
What does the free cash flow that you generated in Q2 and associated with that been wondering about the cash flow conversion.
You know your other major competitor out there has a different level of capital conversion around 100% versus a 55% that we've seen.
Out of block over the last a few years now I know that you're working on improving that and looking forward to seeing that but just.
Wondering what steps in particular will help you got to somebody rather peers.
And then my second question is around.
Leverage when do you anticipate that you will get down to below three times.
Debt to EBITDA. Thank you so much.
Moving things for the question, while the Q later today here, we wanted to make sure. We got our Q3 results are taking care of before we close the as mentioned in the opening remarks that will allow us to have our Q2 results as well as behr pro forma results included in the.
EBITDA metrics for our debt covenant.
Overall was very pleased with operating cash flow in the quarter, you'll see it's by far the best quarter. We've had it in a number of quarters a as shown by the hundred 85 million of additional cash on our balance sheet.
Versus the end of Q2, despite the continued investments on the independent away go stand up as we think about free cash flow a large part of our cash is going into building out our independent a leg to stand up as well as the integration of the bare transaction as mentioned in.
The opening remarks.
Expecting 2020 was the spend 250 to 350 million of cats less next year as we get all of this behind us so with that Caspian conversions going to improve when we get you know independent goes behind this five years out you know the CAD version will be a much better as well.
With respect to the leverage you know again, we will start the transaction at a higher leverage amount. The we'd originally expected worry that the deals are result of our business performance over the last 12 months.
This will all get finalized at the close of but again, we feel good about the resilience of this industry and our go forward.
Opportunities to drive and create real cash flow and to use that to repay debt. So while the timing of getting the three below three times has been pushed out as I said in the last quarter. That's in terms of quarters not in years.
Great real quickly next question.
Your next question comes from the line updated listen.
<unk>.
Hi, Thanks for taking my question.
Through the inventory level I'm, just trying to clarify what the revenue base of the businesses. So when we're looking at 21 point you should we be basing our revenue growth rate.
Maybe 2019 2018 versus 2020, Adam I hope it impacts and then for my second question, if I could just good.
On the Q3 guidance.
Does that assume any luck demand in that market secondly.
Thanks, Dave for the question, Yes, I think 2019 levels would be more attuned to give an underlying demand and what we think about her for 21 22 going forward versus the 2020 and that obviously.
Cove. It is as we've laid out and obviously, we're hopeful for a vaccine to help the overall world and deal with this pandemic as quickly as that comes together from Big pharma with respect to our Q3 guidance. We think that most of the demand did play out and got caught up in June.
And so we've not factored in additional big pent up demand in the Q3 guidance.
But we just provided.
Vice versa, not not assuming of another walk down or another wave of covert either.
Yes.
Adrian do any more questions.
The next question comes from the line.
Right.
Hi, Good morning did you give us some guidance SGN names.
I agree.
So I was personally.
And then my second question could you come soon we ship any inventory de stocking impact on revenues function suite.
Hi. This is just a quick one given this indexes you are here and Tim you next week, you and disease, we signed in 2021 phone. Thank you.
Yeah. Thanks for the question as we said we view the inventory destocking as complete to there wouldn't be an impact on that in Q3.
With respect to.
The as you get a as I mentioned in the opening remarks, we do expect that the sequentially be higher in Q3 as a result of decisions with respect to our marketing spend in addition, some some bounce back on the impact of performance as well on the accrual for bonuses.
That being said, we'll continue to have savings on travel the why because we're not expecting a bowl back to work conditions, given the pandemic and the recent increase across new and some of our international markets as well so.
Overall that is where we sit with respect to the debt and the refinancing a rough to remind me the question.
Yeah, and avant if you are still on CFO with respect to repay the 2021, Bob I mean that and we do have a bomb coming in August of 2021, we'll be looking to repay that when that comes due with the free cash flow the business will generate and that will clearly.
Improve our overall leverage or whether or not we do anything to go out and tender for bonds or otherwise and something the treasury team. We'll look at from a overall cost of capital to do that relative to current rates.
You are aware, we will have interest rate coupon step ups as result of the transaction and change in our credit ratings that was part of the reason we saw increased interest expense in Q2 over Q1 was the impact to boost up ups auto full quarterly basis in Q2, the other impact.
Interest expense came from the exiting of us with net investment hedges that we talked about on the last quarter call as well.
Adrian anymore.
The next question comes from the line, Kevin Keyes Reg G.
Hi, Thanks for squeezing me in mentioned me International it's already for companion, a slower than what you're seeing in the U.S.
Just wondering if there's any kind of geographic mix or is that pretty.
Universal across international markets, maybe either Oh, you can give about how should be thinking about.
What the curve that recovery should look like internationally. Thanks.
Yeah, Kevin There's there's limited data out there when you look at in Australia, and Japan overall, and Weve you know, we keep our eyes on that and look at our business in our in our local or effort, but I would say that he knew was impacted very similar to the U.S. and a pretty significant way we are seen as I've.
Mentioned in my comments in June we saw some nice recovery there and so I would tell you that to you know the big five countries in Europe are are a good share of our business internationally and a and bear would be the same Australia and Japan.
A little bit limited and less information, but I would say a little bit behind it potentially what we see in Europe. So that's that's at a high level and again our.
Our business becomes a lot more global and a lot more mixed between into that and retail on here in the next few days when we bring to bear business and that durability and that globalization and will create a at a diversity in the globalization of create more durability against some of the differences.
Good.
Any more questions later.
Your next question comes from the line of John Kreger with William Blair.
Hi, Good morning. Thank you for the time this is Jon Kaufman on for Chris here.
Jeff you you've done a number of deals, including some larger ones under its a really umbrella as you think about all the steps required to integrate and acquisition, particularly one of his magnitude are there adjustments that you have to make to the integration plan as a result of pivot.
You know how do you bring to bear people into the fold just given the circumstances and obviously there are number moving pieces right now due to coven.
Plus we don't yet have been section that into how they are did this quarter. So if you're looking at this from and outsider's perspective, what should we be what should we be looking for Q3 in Q4 earnings that suggests that the merger is going according to plan.
Yeah, that's a great great question. So just in a very high level a couple of things I would say with many integrations you always start with this as you start to get within days of it is one are the assumptions in the rationale still holding true.
And what I would tell you is the answer is absolutely if anything cobot is probably enhance that when you look at more companion animal [laughter] more international for more durability and a even more diversity on the food animal side, but the big one is the retail side on on non Kobe, It and what that's done on the Petside.
So what I would say is assumptions I and rationale or holding true.
Too and I think we just completed the last two days virtually that preparedness for the first two levels of senior leadership and the company and I think clarity is important I would probably won't be able to gave you a whole lot in Q3, and that's why we've said, we'll give you more information and more linkage.
Against our assumptions in that November earnings call for Q3, and then in the December Investor Conference. Our senior team is working to prepare but my top objective in Q3 is that both businesses have momentum.
And the very complimentary our assumptions hold true those top senior leaders have clear goals of what they need to achieve for the rest of the year, what they need to do for value capture and putting putting their teams together so for me and making sure. The systems are all working as well I mean, those are the things that.
We we are focused on in Q3, so that actually momentum continues and disruption is minimized. That's that's our goal and why we've strategically placed the Investor Conference in December as we believe that will be the point in time, when we have the most clarity in the more depth of information that we can share to you.
I think were stuff. Thank you.
Thanks, a lot Jeff one were little tire 10, after the I want to Infosys just in close I think very clearly Q2 was marked with two big events Cove. It and this distribution inventory change I, what I would like to hear very clearly is the execution against doing and controlling what we can control we feel.
Very good about the strategy change would distribution in inventory and paid off and has created a results immediately within the quarter that we made the change I think you're seeing the durability of this industry with the recovery that we're seeing and we are days away from making and the largest.
Transaction in industry history, we're ready for it the teams are ready and now we're going to create the next platform of opportunity in potential the rationale and the assumptions that we put together almost a year ago on Elanco plus bear hold true and this same mode of execution is gonna be late against that opportunity.
D., what I believe the strongest leadership team.
At two to three levels deepened the organization that have ever led the company and I close by saying again I. Thank you a very big sincere. Thank you to Jim Gray and absolute Class Act an expert in his field and to launch this company in what we've done in the first two years.
I would not have been possible without without Jim you're paying I know a lot of you feel the same way as I do on that and we welcome Tiffany and we're excited about the Nextera. The company. Thank you for your interest and Elanco.
This concludes today's call you may now disconnect.
[music].
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