Elanco Animal Health Inc (ELAN) Q3 2021 Earnings Call Transcript

Hello, and welcome to the Elanco Animal Health Inc. Q3 2021 Earnings Conference Call. After the speaker's remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Tiffany Kanaga. Please go ahead, ma'am.

Good morning. Thank you for joining us for Elanco Animal Health Third Quarter 2021 Earnings Call. I'm Tiffany Kanaga, Head of Investor Relations. Joining me on today's call are Jeff Simmons, our President and Chief Executive Officer; Todd Young, our Chief Financial Officer; and Scott Purucker from Investor Relations. 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 2 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 is for the benefit of the investment community. It is not intended to be promotional and is not sufficient for prescribing decisions. You can find our press release and the slides referenced on this call in the Investors section of elanco.com. The slides and the press release also contain further information about the non-GAAP financial measures that we will discuss today during this call. After our prepared remarks, we will be happy to take your questions. I will now turn the call over to Jeff.

Thanks, Tiffany. Good morning, everyone. We are approaching the anniversary of our Investor Day, an important moment in our journey of transformation. That established, one, our commitments for the newly combined Elanco as well as provided unprecedented transparency, marking an inflection point towards sustainable value creation. This quarter represents our fourth consecutive quarter of exceeding revenue guidance since our Investor Day. As we progress through 2021, it is clear our long-term growth algorithm is on track, and we are executing against our IPP strategy and commitments as laid out last December. Third quarter revenue on Slide 4 was $1.131 billion, which surpassed the midpoint of our guidance range by nearly $45 million, with over-performance once again in both sides of our business, Pet Health and Farm Animal. Our adjusted EPS of $0.19 was $0.02 above the midpoint of guidance, and adjusted EBITDA of $211 million was $4 million above the midpoint. We are expanding margins while also reinvesting for future growth despite inflationary pressures, as discussed in August. Today, we are raising our 2021 full-year revenue guidance and maintaining adjusted EBITDA and adjusted EPS guidance we provided in August, all three of which stand well above our initial targets from the December Investor Day. At the midpoint, we anticipate revenue of $190 million or 4% higher than the original December guidance. Adjusted EBITDA guidance is $85 million or 9% higher than originally stated, and adjusted EPS is $0.11 or 12% higher. 2021 is shaping up to be a strong step toward our long-term growth algorithm, providing an expected total year revenue increase of approximately 7%, reflecting the durability and diverse nature of our combined business. Our growth this year includes gains for our focus brands, momentum at retail, global execution for parasiticides and pain, and share gains in U.S. Farm Animal. These tailwinds are balanced with competitive dynamics, reemerging pressure from African swine fever, and generic challenges. We are also making steady headway toward our long-term margin targets, with approximately 300 basis points of adjusted EBITDA expansion anticipated this year on a pro forma combined company basis. Our margin expansion in 2021 is representative of a company-wide priority given to this important metric, supported by a comprehensive plan to sustain this trajectory toward our goal of 31% by 2024. Our teams are well-positioned to execute on the core business, while several recent strategic actions are enabling accelerated long-term value creation. The KindredBio acquisition closed at the end of August and advances Elanco's access to the fast-growing billion-dollar-plus dermatology market. With the combination of Elanco's internal pipeline, plus the KindredBio additions, we expect to be a key leader in this next era of Pet Health growth. KindredBio's three potential blockbusters launching by 2025, as well as full ownership of the canine parvovirus therapy, adds approximately $100 million to our innovation revenue expectations, bringing the total to $600 million to $700 million by 2025. As part of our increased focus on high-value, late-stage Pet Health pipeline progress, we welcomed Ellen De Brabander, our new Head of Innovation a few weeks ago. She is a highly accomplished R&D leader with a proven track record in animal health blockbuster development and is ideally suited to drive execution, ultimately building on the strong foundation established during Aaron Schacht's tenure. Aaron is now leading the potential carve-out of our early-stage microbiome R&D platform, of which we may retain a minority stake. The separation is expected to be completed by the end of the first quarter of 2022. We hope to have more details to share with you as this date approaches. Finally, on the productivity front, in June, we announced the exit of three manufacturing sites. On August 1, the sale of the Shawnee site closed. Further streamlining our footprint, we are accelerating our gross margin efforts, reducing annual CapEx, and improving working capital. We believe all of these strategic actions will combine to support consistent double-digit adjusted EBITDA and adjusted EPS growth ahead. On Slide 6, we provide the key drivers of our third quarter revenue performance. On a pro forma combined company basis, we grew approximately 6%, assuming the Bayer acquisition had occurred on January 1, 2020. Pet Health drove approximately one-third of the upside versus the midpoint of guidance, reaching $527 million in revenue for the quarter. Trends are moderating on incrementally tougher comparisons, leading to low single-digit year-over-year increases in U.S. vet clinic traffic during the quarter. However, growth is still very healthy on a multi-year basis. In turn, our vaccine business saw strong EDI performance. As we evaluate the stickiness of the trends in pets post-COVID that matter: first, the improved vet clinic experience, as well as wellness programs and improving compliance, should represent longer-term market expansion factors on the other side of the pandemic. Turning to parasiticides, third quarter Seresto revenue was $52 million, while Global Advantage family revenue was $121 million, each up 9% year-over-year. Both saw healthy gains in the U.S. and led our continued strength in international pet health. Seresto revenue was up 28% compared to 2019, getting back more in line with historical two-year trends, as the OTC parasiticide channel rebounded from transient weather-related challenges in May. We remain on track toward full-year expectations for Seresto with key initiatives already in place going into next year, creating a long runway to grow this trusted brand. Moving to Credelio, the global franchise is performing well in a competitive field. Credelio is the second fastest-growing brand in the global oral parasiticide market, according to the most recent available data. The flagship product achieved quarter and year-to-date EDI growth in the U.S., supplemented by international expansion and the launches of Credelio Plus and Credelio Cat. We continue to see good traction in the pairing opportunity with Interceptor Plus, and our sales and marketing teams across the world are driving our OTC and scripted parasiticide portfolio across retail, e-commerce, and the vet clinic as rising pet numbers and greater compliance provide a favorable and durable industry backdrop. Anticipated declines in our older brands, Trifexis and Comfortis, as well as a divested product drove legacy Elanco Pet Health down 2% for the quarter. Finally, in therapeutics, Galliprant outpaced the branded U.S. inset market, according to the kinetic data. The brand continues to grow nicely as a leader in pain, making progress towards becoming our tenth blockbuster. Turning now to the Farm Animal business, legacy Atlanta was up 8% in the third quarter. We saw demand-driven strength and share growth in our global cattle business. In the U.S., cattle feed numbers have remained elevated compared to historic levels, and placements were higher year-over-year. We achieved strong EDI performance in cattle and swine for Rumensin, Optaflexx, and Denagard in the quarter. Our U.S. farm animal growth reflects our value-based products and the presence of higher feed costs, as well as our comprehensive portfolio, our value beyond product offerings, and the beneficial industry dynamics. In China swine, we experienced ongoing headwinds from the reemergence of African swine fever, as discussed on our last call in August. Oversupply through financially induced herd liquidation has kept hog prices broadly at their lowest levels for the year, down about 60% since the start in January. We expect these macro challenges to continue in the fourth quarter. Our overall swine business remains competitive with a strong portfolio targeting larger producers that are better positioned in the market, so we believe we are well positioned for outsized success as the market rebounds. Our total Chinese business is still poised to deliver at least a percentage point of growth to total Elanco revenue in 2021. Finally, we drove double-digit growth in international poultry and aqua, as many of our international markets recovered from the 2020 pandemic impacts. Global poultry markets have seen significant improvement, with most regions now moving into profitable conditions, benefiting from increased demand and reopened economies. In aqua, salmon prices have been consistently positive year-over-year since mid-July, which is driving the use of our DNA vaccine Clynav to protect Atlantic salmon from pancreatic disease. Turning to Slides 7 and 8, since our Investor Day, we are growing, transforming, and elevating our business while prioritizing innovation. We have consistently outperformed revenue guidance since Q4 of last year. At the same time, we are on track toward our synergy commitments and our long-term margin and net leverage targets. We are moving with speed and decisiveness through several recent strategic actions to drive disciplined execution against each of the three pillars of our IPP strategy to enable accelerated value creation. Slide 9 outlines our innovation progress in 2021 with details around all eight products, which have now launched. We continue to expect these launches to contribute $65 million to $85 million in revenue this year. On the Pet Health side, where innovation is running above expectations, Credelio Plus launched in Australia in the quarter in time for the local parasiticide season. Credelio Cat and Elura are performing well and expanding our feline portfolio. In Farm Animal, Experior acceptance continues to grow with both producers and packers. The total value proposition is being substantiated in the field with expanded use from those that have tested the product in production systems. We have doubled the number of cattle on the product since the second quarter. We continue to see potential for blockbuster status for this unique product, the first U.S. FDA-approved product labeled to reduce ammonia gas emissions. As part of Elanco's pledge to be our customers' lead partner on their journey to net-zero emissions, we hosted leaders from across the global animal protein industry ahead of the United Nations Food Systems Summit to position animal agriculture as a meaningful solution to climate change while identifying opportunities to help our industry accelerate progress. Additionally, Elanco was recently named among the top 20 of Fortune's 2021 Change the World list, which recognizes companies that have made an important social or environmental impact on their profit-making strategy and operations. Our team's commitment to our purpose and continued execution in creating value for farmers, pet owners, veterinarians, stakeholders, and society as a whole. With that, I'll hand it over to Todd to provide more color on our results and our outlook.

Thanks, Jeff. Slide 10 summarizes our financial performance highlights, including our reported net income and earnings per share. On Slide 31 to 33 in the appendix, you can find the summary of the adjustments made to the reported results to arrive at our adjusted presentation. I'll focus my comments on our third quarter adjusted measures to provide insights on the underlying trends of our business, so please refer to today's earnings press release for a detailed description of the year-over-year changes in our reported results. Looking at the adjusted measures on Slide 11, you'll see that total Elanco revenue increased 27% in the quarter on a reported basis, with 1 point of benefit from foreign exchange for legacy Elanco. On Slide 12, there's a visual representation of our revenue outperformance versus the guidance range we provided in August. The key drivers in order of magnitude were global cattle outperformance, global pet health, and the retail channel, international poultry recovery, aqua, and currency tailwinds. Adjusted gross margin as a percent of revenue was 55.7%, an increase of 150 basis points compared to the third quarter of last year. The year-over-year improvement, which was achieved despite higher logistics costs, reflects the Bayer acquisition, the benefit of positive price and volume on Elanco's legacy portfolio, and continued productivity gains. The sequential deceleration of 240 basis points versus the first half of this year reflects seasonality as we move past the Northern Hemisphere parasiticide season. Total operating expense increased 19% in the third quarter, driven by the addition of the Bayer Animal Health business and KindredBio. Operating income increased 67%, reflecting the Bayer Animal Health acquisition, our top line execution, expense leverage, and discipline in synergy capture. Our adjusted EBITDA was $211 million, and our adjusted EBITDA margin for the quarter was 18.7%, up 200 basis points versus last year. At the bottom line, Q3 adjusted net income increased 55% to $93 million, and our effective tax rate in the third quarter was 23.5%. Now let's discuss our revenue performance more closely. On Slide 13, you will see a breakdown of the contribution from legacy Elanco and legacy Bayer portfolios by category. Legacy Bayer products contributed $421 million in the quarter. Pet Health drove $527 million of revenue or 47% of total Elanco. The sequential step down to less than half of our mix reflects seasonality. Cattle contributed $256 million or 23% of total Elanco revenue in the quarter. Poultry added $173 million, representing 15%. Swine $110 million or 10%. And Aqua, $44 million or 4%. On Slide 14, you can see the effect of price, rate, and volume on our revenue performance. To aid your analysis for our performance, the full benefit of the Bayer acquisition for the quarter is reflected in volume on the slide. We've achieved a 2% increase for legacy Elanco year-to-date and expect that to hold for the full year as well. Looking further ahead, we are focused on levers to drive revenue, including greater price increases that we have implemented historically for certain SKUs as inflationary pressures have risen, especially in transportation costs. Slide 15 provides a breakdown of overall performance between the U.S. and our international operations. We have outlined our geographic performance by Pet Health and Farm Animal, as well as contract manufacturing, all of which benefited from the addition of Bayer. We expect to file our 10-Q very soon. But moving to Slide 16, let me offer a few words on working capital and debt. We ended the third quarter with $453 million in cash and equivalents on our balance sheet and net debt. On August 12, we entered into a new 7-year $500 million credit facility. This new loan bears interest at a floating rate of LIBOR plus 175 basis points. The terms are generally consistent with those of a $250 million draw on a revolving credit facility that was used to fund the $440 million acquisition. We used $194 million of cash on hand to pay the remainder of the purchase price. Net leverage was 5.8x at the end of the quarter, and we continue to expect approximately 5.5x at the end of 2021, in line with our original projection from December 2020. Additionally, as we regularly update you, our aggregate channel inventory levels and distribution remained consistent with prior quarters in the U.S. and across our global business. Now we will transition to our full year and fourth quarter 2021 outlook, starting on Slide 18. We are raising our full year 2021 guidance for total revenue and maintaining our ranges for adjusted EBITDA and adjusted EPS despite a higher expected full year 2021 tax rate of approximately 24.5% than previously expected at approximately 24%. We now anticipate 2021 revenue of $4.73 billion to $4.77 billion. We also expect adjusted EPS of $0.97 to $1.03 and adjusted EBITDA of $1.035 to $1.075 billion based on an adjusted gross margin of 56.75% to 57%. We are updating our reported EPS guidance to negative $0.91 to negative $0.83, reflecting two noncash impacts from the third quarter. As part of our R&D processes, we terminated a Farm Animal portfolio project due to observed efficacy results. This action required a write-down of the value of this in-process R&D asset through the P&L. The second is a charge associated with the establishment of a liability for future royalty and milestone payments relating to our license agreement with KindredBio for the parvovirus therapy, which was settled upon the closing of the acquisition. Moving to Slide 19. We are providing guidance for the fourth quarter of 2021. We expect revenue of $1.078 to $1.118 billion, adjusted EBITDA of $190 million to $230 million and adjusted EPS of $0.13 to $0.19. Our fourth quarter revenue guidance reflects a year-over-year decline. I want to emphasize that we do not have a fundamental change in our core business performance, but are reflecting a number of well-known one-time impacts from last year. These fourth quarter comparisons include four items of note. First, we had a large retail customer order for approximately $10 million of OTC parasiticides in the fourth quarter of 2020 versus the first quarter of 2021. Second, we had $10 million from incremental U.S. cattle vaccine and in-plant revenue due to competitor stock outs. Third, we are facing a $20 million year-over-year decline in contract manufacturing due to the sale of our Shawnee manufacturing facility to TriRx and the discontinued human growth hormone production. Excluding the $60 million in total revenue-specific comparisons, our range reflects underlying growth of flat to 3.5%. Also incorporating the challenges of African swine fever from a tailwind in 2020 to a headwind in 2021. Our global teams continue to pursue productivity initiatives and synergy capture on both cost of goods sold and OpEx, which are expected to drive fourth quarter adjusted EBITDA of $35 million year-over-year at the midpoint of our guidance range and adjusted EPS of $0.04 at the midpoint. As we close out 2021 and head towards 2022, I want to note that we will provide initial 2022 guidance with our fourth quarter results in late February. While our balanced global portfolio continues to provide solutions to farmers and veterinarians around the world, we look forward to discussing our continued progression against our long-term growth algorithm with our anticipated growth in revenue, adjusted EBITDA, and adjusted EPS in 2022. Now I'll hand it back to Jeff for closing comments.

Thanks, Todd. To summarize, we continue to consistently post strong quarterly results as we move through 2021, further extending our track record of execution since acquiring Bayer Animal Health. The durability and diverse nature of our global business and our commercial execution is expected to drive approximately 7% of revenue growth this year and adjusted EBITDA growth of approximately 21%, with an expected increase in adjusted EBITDA margin by approximately 300 basis points. Our teams are focused on delivering on our financial commitments in 2021 and are excited to continue to grow revenue, adjusted EBITDA, and adjusted EPS in 2022, while delivering on our vision of food and companionship enriching life. Finally, I'd like to wish Tiffany success as she leaves Elanco after today to pursue an exciting opportunity outside of Animal Health. Our Treasurer, Dave Pugh, with 27 years of combined experience across Lilly and Elanco, will serve as our interim head of Investor Relations. I expect a seamless transition in our shareholder engagement under Dave's leadership, and we will continue to prioritize consistency, transparency, and accountability. With that, I'll turn it over to Tiffany to moderate the Q&A.

Thanks, Jeff. We'd like to take questions from as many callers as possible, so we ask that you limit yourself to one question and one follow-up. Lisa, please provide the instructions for the Q&A session, and then we'll take the first caller.

Your first question comes from the line of Michael Ryskin with Bank of America.

Great. And congrats on the quarter. I'm going to squeeze in both my first and my follow-up right away. So first, Jeff, in light of your comments just now that this year, you're seeing 7% pro forma growth, how do we take that comp into account when we're thinking about next year and the year beyond? Should we be thinking of the numbers as comp-adjusted relative to that long-term run rate of 3% to 4%? For the follow-up, you highlighted Kindred and the potential derm blockbusters, maintaining the 2025 innovation target of $600 million to $700 million. Can you provide any updates on timing for some of those blockbusters, specifically a derm product or a combo endoparasiticides? Is early 2023 doable, or should we be thinking more like 2024 for those areas?

Thanks, Michael. First, on 2022. As we said, we do continue to see growth in revenue, EBITDA, and EPS going forward. We also, as Todd stated, will share that guidance in our Q4 results in February. I think a few things are important to note to back up. Very clearly, I think this quarter, now four sequential quarters, is proving the strategy and the algorithm are right. 2021 is creating momentum that will carry into 2022. We have a more durable and diverse company. I think our plans are more balanced. Here are the key contributors for our growth in 2022. First, our focus brands—Seresto, Galliprant, and the Credelio franchise. Innovation, this year's and next year's innovation, the omnichannel with digital support, and the Farm Animal business continuing to lead growth against good industry backdrops for our portfolios in both Pet and Farm Animal. We'll convert that revenue growth, as well as anybody in the industry, into continued margin expansion. So we're going to hold to our belief in this growth algorithm we shared a year ago, and that will be our North Star as we move forward. I want to emphasize, we do see durable growth as we enter 2022 from these factors I just mentioned. Relative to Kindred, I would just like to say that we closed it in August, with a world-class team. We've retained all key personnel and there is already a nice complement between our derm development teams engaging on a regular basis. Ellen has been on board for only a couple of weeks, but she is now engaged and very much integrated into the center of all that.

Your next question comes from the line of Umer Raffat with Evercore ISI.

This is Mike DiFiore in for Umer. Congrats on the quarter. I just got disconnected, so I apologize if I missed this. A question for Ellen. Just general thoughts and color on your vision for the R&D organization that may be new or may have differed from the past. And my follow-up is what could explain the seemingly sudden turnaround in international poultry and aqua given that the prior ZoaShield headwinds and macroeconomic pressures experienced there. It seemed like in the first half of the year, it's been consistently mentioned that producers are suffering this macro pressure. But all of a sudden, there's this turnaround in 3Q.

Thanks, Michael. First of all, Ellen is not part of the call today. We will aim to have Ellen in the calls going forward. As I just mentioned, she is a couple of weeks in. In regards to poultry, yes, we have seen a significant rebound. As we shared at the beginning of the year, we had predicted this in the second half of the year. This rebound is driven by economic pullback caused by COVID in midsized markets where we had high market shares. We're seeing that recovery as people return to stores and restaurants, purchasing poultry, and we're seeing prices rise. With that, chickens are being placed back into barns, and our portfolios are winning. ZoaShield is right now just a U.S.-based product and is unrelated to that international poultry market rebound.

Your next question comes from the line of Nathan Rich with Goldman Sachs.

Maybe, Jeff, to follow up on the last question on R&D. Do you expect there to be any reprioritization or narrowing in the focus of R&D priorities? You talked about maybe a greater focus on Pet Health, but could we see any change in the pipeline to maybe focus on some of the larger opportunities that you're going after? And then just a question for Todd on the inflation that you're seeing and the ability to pass on costs. Can you help us understand the dynamics there?

Thanks for the question, Nate. I'll start with the R&D perspective. We plan to re-prioritize, and as we made the announcement on Ellen during the quarter, I view this, along with the Kindred acquisition and TriRX and footprint reduction, as another strategic move to strengthen our value proposition. Ellen brings extensive experience not only in refilling pipelines but also in late-stage development, having her name tied to some of the industry's biggest pet blockbusters. Our early-stage microbiome platform carve-out is allowing us to allocate increased resources and focus on these valuable late-stage assets. Our strategy reflects the increase in pets as a percentage and an increase in blockbuster potential products targeting larger markets like parasiticides, derm, pain, and wellness. I wouldn't anticipate any shift in our strategic agenda. As for Todd, I'll let him address the inflation question.

Regarding your question on inflation, we have increased prices by 2% year-to-date and expect that to be maintained for the full year. We are looking for greater price increases targeting our consumer OTC products, retail, and e-commerce type products. On the Farm Animal side, we provide highly valued products to farmers across the globe, and we aim to continue doing so where it makes sense. At the same time, there's slightly more generic competition on that side of the business at this moment.

The next question comes from the line of Chris Schott with JPMorgan.

Just following up on those inflation comments. I think you previously mentioned an impact from supply chain and inflation in the vicinity of about $0.03 this year. Should we be anticipating that kind of impact for 2022? Or do you believe there will be offsets? I'm trying to gauge whether this is a transient issue or something more long-term. Additionally, regarding parasiticides, as we think about next year's flea and tick season, have you experienced most of the impact on products like Trifexis from the new competition entering the market, or should we expect greater impacts going forward?

First, on your inflation question, Chris, we have a range of productivity initiatives continuing across the company. This includes addressing input costs at our manufacturing facilities and transportation costs, with particular attention to global shipping and port bottlenecks. We're continuously working to navigate these challenges, but it has certainly presented headwinds this year and is likely to do so in 2022. However, our team is diligently searching for ways to keep costs flat as we grow volumes.

Regarding the parasiticide market, the dynamics you mentioned are not unexpected. The legacy brands, like ours and others, are indeed being affected. The parasiticide market is growing, fueled by the entrance of innovations. Our results reflect a global holistic approach that we took, not only with our R&D strategy but also with the Bayer acquisition. Innovative products are expanding the market, and new entrants are also impacting legacy brands. Credelio is now the second fastest-growing oral brand, showing success in both our cat and dog markets.

Next question comes from Jon Block with Stifel.

Great. I’ll ask both questions upfront as well. There seems to be a wide range for Q4 EBITDA. Could you call out some of the variables that might push us to the high or low end considering we have about two months left in the year? And another quick question for Jeff. Regarding Credelio, did it achieve double-digit growth in Q3 2021, or was that growth overall?

On the EBITDA front, as you saw, we surpassed the midpoint of our guidance in Q3. We’ve essentially carried that Q3 beat into our Q4 guidance while maintaining our guidance. It's worth noting we've had lower depreciation than previously expected, which helps offset some inflationary costs. However, this change has negatively impacted EBITDA, given that less is added back. We remain confident in delivering the guidance we provided. Regarding Credelio, I won’t provide specifics on growth by country at this time, but I can confirm we continue to see overall strong growth tied to the Credelio franchise driven by the successful launch of Credelio Plus.

Your next question comes from the line of Balaji Prasad with Barclays.

Congrats on the results. Just two specific questions from me. Firstly, on Kindred Health, they had demonstrated both indications, expecting to submit the therapeutic claim in June. Conversations with Kindred management indicated they expect approval of both indications by year-end. Is that still the goal, and can you provide context on market launch expectations? Secondly, on Increxxa, with three more generic tulathromycin products coming, do you still see a growth path for this product over the next couple of years?

Great questions, Balaji. Regarding the parvovirus therapy, we are making good progress through our pipeline and expect to achieve approval and launch in 2022. However, we will not provide additional details at this stage. There is a significant need for this product, with data indicating that there are $250,000 annual cases of parvovirus, where many spend thousands of dollars without a great solution. We believe this product will offer a new opportunity to veterinarians. Regarding Increxxa, there are two markets to consider. In Europe, there are numerous generics, while in the U.S., there are only us and one other company. We anticipate more generics will enter the market. However, Increxxa is performing above our expectations in the U.S. due to its value-based approach, especially within the larger confined beef cattle portfolio. We will keep you updated on its performance as we move forward, especially into the fall season.

We'll take the next caller, please.

Your next question comes from John Kreger with William Blair.

Jeff, could you just give us an update on where you go next with the Bayer integration to drive some of the margin goals you have? Todd, a quick one for you—where would you like to see the receivable DSO relative to the 81 that you just reported a year from now?

Absolutely, John. We have maintained constant energy around a productivity agenda throughout the company. We are focusing on optimizing all aspects of the company that are non-value-oriented concerning our pipeline, commercial efforts, and key capabilities. In the near future, we will continue to pursue opportunities to maximize productivity and efficiency.

Thank you for the question regarding DSO. We're working to improve cash collection globally, focusing on collections, especially as our Farm Animal segment presents longer payment terms compared to our U.S. retail business. We expect to see improvements and should be below the 81 in Q3 of next year given these ongoing efforts.

Your next question comes from Elliot Wilbur with Raymond James.

I’m following up on the previous question regarding cash movement, especially considering acquisitions and working capital swings. Would you expect the company to maintain positive operating cash flow on a full year basis exiting this year?

You'll see in our upcoming 10-Q, we've reported $260 million year-to-date in operating cash flow, and we are on track to see growth in Q4 as well as progress in 2022.

Regarding China, I believe that African swine fever greatly enables us to target large producers effectively and help bring our portfolio to them. We have also brought in performance-based therapeutics to our product line-up. The poultry business is another area for successful growth—improved economic conditions allow us to leverage our concentrated brand and product offering. We aim to integrate our teams efficiently to bolster pet ownership initiatives and leverage strong product claims such as Advantage and Seresto. I want to assure you, the Asian market's aqua segment is also a viable growth avenue, where our warm water business stands ready for expansion. In sum, we vastly anticipate continued positive growth in China moving into 2022.

Your next question comes from the line of Navann Ty with Citi.

On poultry, you compete so heavily on low-cost products. Have you benefited from that in the U.S. and globally? And do you see it as a durable trend? My second question is regarding the SEC inventory destocking case. Can you discuss any updates regarding your dialogues with the SEC?

What I've learned over my years in the poultry business is that those in this industry value quality and analytics over mere cost. Our offering is competitive because we provide one of the largest performance and health databases available to our customers, enabling us to maintain our global number one position in poultry. Regarding the SEC, we don’t have any updates to share. There is no change in the scope of the context. We are cooperating with the SEC and believe that our actions were appropriate.

Thank you. We'll take one more caller.

Your next question comes from David Westenberg with Guggenheim Securities.

Is there any way to assess the value to weight context of MSAs regarding excessive freight costs that we might be experiencing in the industry? Additionally, can you remind us of the macro trends affecting livestock this year and how those will potentially impact next year's performance?

Indeed, you are correct that not every portfolio aligns seamlessly due to the inherent complexities across companies in the animal health sector. We do have specific portfolios tied to heavier-weight and more intricate supply chain dynamics. As Todd stated, we are committed to a productivity agenda to mitigate those costs. On the livestock front, the swine market's volatility due to African swine fever suggests a potential rebound in 2022, while pressure persists into Q4. The cattle business continues to thrive thanks to increased exports, and poultry conditions remain promising as we head toward the first half of the upcoming year.

Okay, Jeff. Let's hear your closing remarks.

Firstly, I want to thank you all for your interest in Elanco. Also, I want to extend my best wishes to Tiffany as she embarks on a new and exciting journey. She has played a vital role in our relationships with all of you. I am looking forward to the transition to Dave Pugh, who will serve as our interim head of Investor Relations. We will continue to prioritize transparency, consistency, and accountability as a core focus of our engagements. This quarter signifies a critical milestone for us. We have delivered four quarters of consistent execution, indicating our strategy and the decisions have paid off. While there remains much work ahead, the overall outlook for our sectors remains favorable. We are a strong and transforming company, progressing towards our goals while fostering excellent relationships across various segments that improve societal outcomes for animals. Thank you once more for your interest, and we wish everyone a great day.

This concludes today's conference. You may now disconnect.