PERRIGO Co plc Q3 FY2020 Earnings Call

Good evening, and welcome to Perrigo's Third Quarter 2020 Financial Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to hand the conference over to Mr. Bradley Joseph, Vice President, Investor Relations and Corporate Communications. Please go ahead.

Thank you, and welcome everyone to Perrigo's third quarter 2020 earnings conference call. We hope everyone is healthy and safe. I hope that you've had a chance to review the earnings and judicial review press releases we issued earlier today. A copy of the releases and the presentation for today's earnings discussion are available within the Investor section of the perrigo.com website. Joining today's call are President and CEO, Murray Kessler; and CFO, Ray Silcock. I'd like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for shareholders and investors and safe harbor language regarding these statements in our earnings press release. A few items to highlight before we get started. When discussing the business, Murray will reference only non-GAAP adjusted numbers for the quarter unless otherwise noted. All comparisons of operating results against prior year periods include the previously disclosed third quarter 2019 net sales adjustments for the market withdrawal ranitidine, as well as operating results attributable to the 2019 held-for-sale animal health business previously included in the Consumer Self-Care Americas segment. Comparisons to prior periods also exclude: one, divested businesses, which include contributions from the divested animal health business and the divested Rosemont business and Canoderm product, both previously included in the Consumer Self-Care International segment; and two, currency. Also, of note, organic growth excludes acquisitions, divestitures, and currency in both comparable periods. Lastly, in the appendix for today's call, we have provided reconciliations for all non-GAAP financial measures presented. And with that, I will now turn the call over to Murray.

Thank you, Brad, and good afternoon everyone. I want to begin today's call as I have all year by once again thanking each of our Perrigo colleagues for their continued efforts in delivering products needed by consumers and patients during the COVID-19 pandemic, for driving our Consumer Self-Care transformation, and for once again delivering on our financial commitments, despite a major product discontinuation. Before we dive into earnings, I want to take a moment to discuss today's outcome from the judicial review process in Ireland. The Irish High Court ruled that the issuance of the Notice of Amended Assessment by Irish revenue did not violate the company's legitimate expectations. We are obviously disappointed with the judge's decision that Irish revenue had the legal right to issue the assessment after revenue retrospectively and without warning re-characterized Perrigo's trade of intellectual property to exclude disposals going back to 1997. While the judge did not rule in our favor, I want to remind everyone that today's decision was based on a process argument and the judge was not considering the merits of our case under Irish tax law. We remain confident that Irish revenue is wrong on the merits of the case, and while we now need to assess whether to pursue an appeal of the judicial review decision or to proceed directly to the tax appeals commission to target the merits, we strongly believe Perrigo will ultimately prevail. I also remind you there was only upside to Perrigo today on the process argument and that this decision has no bearing on the actual tax assessment review. Likewise, no payment is due now, and would only be due if Perrigo were to eventually be unsuccessful through any appeal of the judicial review decision and the merits of the case with the tax appeals commission, achieving that final determination is likely to take years. Notably, it wasn't all bad news on the tax uncertainty this quarter. We did make progress on the $843 million US Athena tax assessment which was accepted by the mutual agreement program under the Irish-US income tax treaty. The Irish and US competent authorities have a history of resolving matters to avoid double taxation, and we are optimistic that this matter could be resolved or substantially reduce our overall tax exposures to the US and Ireland. But ultimately, the value of Perrigo will be determined by the success of our Consumer Self-Care transformation, not losses. So I'd like to get back to the business and focus the rest of this call on how the company is performing and how we are progressing against our transformation plans. Let's start on Slide 6 with a recap of the significant progress we've made over the past 18 months on our transformation. With intense focus on expanding our consumer portfolio, we have completed six bolt-on Self-Care acquisitions that most notably added a new platform for growth Oral Care. These purchases were partially funded by divesting two non-core businesses. We've also made meaningful investments in our go-to-market strategy, most notably in e-commerce, that are enabling us to recapture the Perrigo advantage. Our commercial teams are working around the clock to provide consumers and customers with essential products through the global pandemic, and our R&D and innovation teams have created a new product pipeline designed to always have at least $500 million in development to fuel organic growth. We've also launched our internal business intelligence platform to drive more sophisticated analytics and insights throughout our organization. And more than half of the leadership positions in the company have been infused with both external talent with world-class consumer experience and internal promotions of our up-and-coming stars. To foster greater collaboration and further enhance our ability to attract talent, we announced last week a new North American corporate headquarters to be located within the medical mile of downtown Grand Rapids. Our $100 million project momentum savings initiative is already generating operating expense reductions which have offset nearly all of the headwinds we faced so far this year. In total, we've invested more than $1 billion through M&A, increased the dividend by more than 20% compared to just two years ago, significantly increased infrastructure spending to support growth and service, while at the same time accumulating $850 million in cash on the balance sheet. The team did this all the while predictably meeting or exceeding our financial commitments for eight consecutive quarters. I'm proud of the entire Perrigo team and what they've accomplished in such a short time. And while the Board of Directors and I believe the company's valuation does not yet reflect these achievements, we believe it ultimately will and for that reason, the Board has authorized the purchase of $150 million in Perrigo stock between now and the end of the calendar year. Turning to Slide 7. We remain confident in our long-term consumer growth targets which we have illustrated here. The 3% net sales organic growth target is achieved through a combination of the initiatives highlighted. The 5% adjusted operating income growth is expected to come from revenue growth, coupled with margin enhancement, be it mix, cost savings and manufacturing efficiencies. These add another 2% of leverage as we expect sales and gross margin to grow faster than operating expenses as a result of our technology and capability investments. Though we trade at a sizable discount to leading CPG peers, our 3.5% compound annual growth rate targets surpassed peer growth expectations. On average, analysts estimate those peers to grow revenue by 2% and operating income by 4% on a CAGR basis over the next three years. Our consumer growth targets remain unchanged. Now let's discuss our performance for the next quarter and year-to-date as shown on the next slide. Third quarter consolidated net sales grew by 1.7% and were flat organically at $1.2 billion. Note, we established a $31 million net sales reserve related to the albuterol recall. This negatively affected third quarter revenue growth by about 70 basis points after including albuterol net sales prior to the recall. I'll walk through the sales growth in more detail in just a few moments. Adjusted EPS was $0.93 per share in the quarter, down 11% versus prior year, but remarkably in line with our guidance despite the albuterol recall and discontinuance. We attribute this to strong growth in consumer Self-Care Americas, CSCA, and better than expected recoveries in both the Consumer Self-Care International, CSCI, and base Rx businesses. On a year-to-date basis, consolidated net sales were $3.8 billion, up a very strong 10% versus a year ago behind organic revenue growth of more than 4%. Adjusted EPS is $3.10 year-to-date, which is up 4% versus a year ago, despite incremental COVID-related costs, albuterol recall-related costs, and the divestiture of Rosemont. We believe this in conjunction with our reaffirmed guidance today validates the underlying strength of Perrigo's diversified and durable business model, the importance of our products to consumers during these difficult times, the successful execution of our ongoing transformational activities, and the dedication and agility of our 11,000 team members worldwide. On Slide 9, you see the results for the Worldwide Consumer business, which is the focus of our Self-Care transformation. Worldwide Consumer net sales grew more than 4% in the quarter, with 1.6% organic growth. Year-to-date, Worldwide Consumer revenues are up 11% versus the prior year, with 4.6% organic growth, which is well above our 3% goal. This compares to a Worldwide Consumer business that was growing less than 1% for several years prior to the start of the transformation. It is especially worth noting that Worldwide Consumer operating profit year-to-date is up 12%, essentially we are achieving our 3.5% consumer growth goals one year early just as we achieved our 3% revenue growth goal a year early in 2019. As shown on Slide 10, Consumer Self-Care Americas performance has remained robust through this pandemic and was once again in the third quarter the company's primary growth engine. Third quarter net sales increased 8% versus a year ago, led by OTC with organic net sales up 4%. Oral care, allergy, digestive health, and pain were the growth leaders benefiting from consumers switching to e-commerce in these highly regimented product categories. For perspective, CSCA, e-commerce revenues grew more than 140% year-over-year in the quarter, a testament to the investments I discussed earlier. Pain also benefited from continued COVID-related demand, and the Voltaren store brand equivalent launch. Digestive health benefited from the market re-launch of branded Prevacid. Nutrition benefited from the launch of a new product late last year to a major customer, and oral care benefited from the Dr. Fresh acquisition and continued organic growth. Similar to what you've heard from others, our cough/cold products were down in the quarter, which we attribute to lower year-over-year illnesses that we believe are due to social distancing and mask measures designed to prevent the spread of COVID, as well as our belief that consumer pantries for cold/cough products are still above year-ago levels from the March-April consumer demand surge. Importantly, our projections for the balance of the year assume an overall weaker cough/cold season. This assumption is also built into our guidance. All in all, it was another very strong quarter for CSCA within a very strong year. There are two other notable trends in the US that are benefiting CSCA, I think, that are worth mentioning. The first is shown on Slide 11, which is important data from a recently released McKinsey survey. It shows that there is a consumer shift in shopping behavior to store brand occurring through the pandemic. According to this study, 75% of consumers have tried a new shopping behavior since COVID began. 25% of consumers surveyed noted that they have tried a store brand for the very first time, with 80% of those reporting they intend to continue buying store brand, that's significant. The other big behavior highlighted in the survey was a huge shift in shopping behavior to digital and e-commerce. We've seen that ourselves in our omnichannel data as shown in Slide 12. Let me take a minute to explain what I mean by our omnichannel data. This refers to a broader way of measuring consumer takeaway than we've done in the past. Historically, CSCA measured and reported sell-out data from IRI MULO or multi-outlet data. While insightful, MULO underestimates club store significantly, and more importantly, it does not capture sell-out through the e-commerce channel. As consumer buying habits continue to shift from brick and mortar to online, which was turbocharged by COVID, e-commerce has become a much larger component of our overall sales, and as such it is critical to include e-commerce in our market share data to more accurately reflect consumer behavior. We refer to this as omnichannel data. For the first time, we can now measure, analyze, and benchmark omnichannel performance for the entire OTC category, for total store brand within the OTC category, and we can also now measure Perrigo share of total store brand and Perrigo share of the overall OTC category. The omnichannel data on this slide is compiled from IRI MULO point of sale data plus IRI panel data and e-commerce point of sale data provided by Perrigo's top customers. The difference in results between MULO and omnichannel data is quite dramatic. MULO shows OTC total category revenues down 4.8% in the third quarter, with total store brand down 6.3%, and total Perrigo faring better down 2.5%. But now compare this to the omnichannel data, which includes MULO plus the whole wholesale club channel and e-commerce sales. In this broader data set, the OTC market was actually up 1.2% in the third quarter, total store brand still declined but to a lesser extent at 2.8%, and notably, Perrigo grew 3.5% which is fully aligned with total Perrigo OTC factory shipments for the quarter, which were up 3.4%. What this clearly demonstrates is that Perrigo has a very high share of store brand omnichannel sales, which is the result of its investments in this area over the past few years and is clearly a major driver of the CSCA business. Turning to Consumer Self-Care International. Net sales were down 2% versus a year ago. CSCI is a bit of a mixed bag when looking at the impact on our business from COVID-related consumer behavior. Certain categories benefited from increased usage, while others were negatively impacted by lockdowns across Europe. On the positive side, sales grew in the pain category, driven by the fever reducer Solpadeine, in the BMS category driven by new products within the Davitamon supplement brand, new innovations to the XLS weight management brand and finally strong e-commerce growth across most of the businesses. These were more than offset by lower selling of cough/cold products for the same reason as the US, as well as life treatments due to school closings. Importantly, as you see on Slide 14, CSCI branded business in total has outperformed other Self-Care peers in Europe. Consumption for both Perrigo and the total market is recovering to near pre-COVID levels, which explains why the business performed a little better than we anticipated in this third quarter. However, we are closely monitoring the recent lockdowns albeit somewhat less restrictive that were put into effect in countries including France, Germany, Spain, Italy, Belgium, the UK and Ireland. We will adjust our plans as needed in the fourth quarter based on consumer behavior changes resulting from these lockdowns. Turning to Rx. Net sales in the third quarter were $20 million lower than the prior year as $23 million in albuterol net sales during the first half of the quarter were more than offset by a $31 million reserve established for the early September albuterol recall and discontinuance of $9 million in lower margin products. The underlying Rx business, or what I'll refer to as the base Rx business which completely excludes albuterol and discontinued products, are recovering faster than expected during the quarter, albeit it's still below pre-COVID levels. As you can see, base Rx sales were down 1.2% versus year ago in Q3, which is a big improvement from Q2's 14% decline when doctors' offices were closed due to lockdowns and derm topicals prescriptions as reported by IQVIA reported similar declines. Notably, our most profitable derm topicals business returned to above pre-COVID and year-ago levels in the quarter, which is good news. So while halting albuterol sales is clearly a hit to our Rx business, we did the right thing for patient safety, we will re-launch when the problem is solved, and in the meantime, our base business is stabilizing and we have a full pipeline of new products to restart growth in this important cash-generating business. So to summarize, consolidated net sales were up 10% year-to-date, highlighted by greater than 4% organic revenue growth. And our worldwide consumer business is meeting or exceeding our plus 3% organic revenue and plus 5% adjusted operating income growth targets, a full year earlier than expected, and plans are in place to restart growth in Rx. So looking to the rest of 2020, we remain focused on ending the year strong, by getting our US supply chain fully replenished, keeping up with consumer demand in certain categories and continuing our transformation activities. Within our reaffirmed adjusted EPS guidance range, we assume the following: one, continued strength for CSCA in Q4, driven by e-commerce and new products even with a double-digit decline in cough/cold built in; two, no new major surge in consumer demand for our essential products between now and the end of the year; three, the Q3 recoveries in CSCI and the Rx base businesses are sustained; four, Perrigo's albuterol remains off the market; and five, there is no accretion impact in Q4 from the share repurchases between now and the end of the year. So bottom line, it's been a remarkable year. Perrigo is growing again. Our Consumer Self-Care transformation is working and we remain confident that Perrigo is well positioned to continue to grow by capitalizing on a new normal world where self-care, value, and e-commerce are more important than ever before. And again, we believe we will ultimately prevail on the Irish tax issue. And with that, I will turn the call to Ray to discuss the financial details.

Thank you, Murray, and good afternoon everyone. Now that Murray has gone through the sales and business drivers for the quarter and year-to-date, I would like to walk you through the rest of the P&L starting with Slide 19. On a consolidated basis, the company reported a GAAP net loss of $155 million in the quarter, a loss of $1.13 per diluted share. On an adjusted basis, consolidated net income for the quarter was $128 million, and adjusted diluted EPS was $0.93 a share. Adjusted net income for the quarter included $283 million of non-GAAP adjustments, the largest of which was the $202 million impairment of goodwill in our prescription Rx business. This was primarily a consequence of our voluntary recall of albuterol and the fact that the timing of this product returning to market is unclear at this time. In addition, as always, our non-GAAP adjustments included the removal of amortization which this quarter amounted to $75 million and we also removed $20 million from the early debt extinguishment of our 2021 bonds. These bonds were repaid as a result of having issued $750 million of new 10-year bonds at the end of Q2. Additionally, we removed a $22 million increase in the valuation of Tysabri contingent milestone, which we recorded as a result of the strong performance by Biogen Tysabri business in the third quarter. Full details of these and other smaller adjustments can be found in the non-GAAP reconciliation table attached to this afternoon's press release. Moving on to taxes. In our Q3 GAAP results, we reported tax expense for the quarter despite having a pre-tax book loss. This was primarily because the Rx goodwill impairment taken this quarter is non-deductible for tax purposes. We also recorded a non-cash base erosion and anti-abuse or BEAT tax in Q3. The BEAT tax arose from the impact of the additional interest expense reductions, provided by the CARES Act, as well as from our early adoption of other new tax regulations. The non-GAAP adjusted tax rate in the quarter was 15.8%. Tax rate adjustments included the non-deductible Rx goodwill impairments, the tax impact of all our non-GAAP adjustments, and the BEAT tax. We removed the BEAT tax since it was the result of regulatory changes, and we believe that leaving it in our results will inhibit the comparability of our tax rate to both prior and future periods. On this point forward, unless otherwise noted, all dollar amounts including year-over-year changes, basis points to margin percentage changes, as well as year-over-year margin changes will be on a non-GAAP adjusted basis. Growth percentages are also based on our non-GAAP adjusted numbers, and in addition, exclude the impact of currency and the divested businesses. Before moving to the business segment results, I would like to review gross profit and margin performance at the Perrigo consolidated level. This is moving on to Slide 20. Q3 consolidated gross profit for the third quarter was $471 million, $14 million lower than the prior year. Consolidated gross margin for the quarter was 38.8%, down 170 basis points compared to the prior year. The principal drivers of these declines were a $22 million albuterol recall charges, the divestiture on June 19, 2020 of our higher margin Rosemont business, as well as unfavorable portfolio mix. The unfavorable mix was due to strong store brand sales in the quarter, with weaker performance from our branded businesses. Q3 consolidated operating income was $184 million, $24 million lower than the prior year, primarily due to the Rx albuterol recall which also resulted in a 150 basis point reduction in operating margin for the quarter. Consolidated operating margin was 15.2%, 220 basis points lower than the prior year. In addition to the impact from the albuterol recall, operating margin was adversely impacted by higher variable compensation costs, the result of strong worldwide consumer business performance so far this year. Year-to-date, our consolidated operating income was $609 million, $15 million higher than the prior year, driven by the strong performance of our consumer businesses, especially US OTC. Moving on to Slide 21. I'd like to continue with the Worldwide Consumer business where third quarter gross profit of $393 million was 1.3% higher than previous year, but gross margin was down 120 basis points to 39.2%. The major cause of this margin reduction in Q3 was a mix within our consumer portfolio, strong growth in our lower margin CSCA store brand business, especially US OTC, and the addition of the newly acquired Dr. Fresh business, contrasted with lower sales in our higher margin CSCI business. Third quarter Worldwide Consumer operating income was $141 million, $13 million lower than the prior year, while our operating margin was 14%, 180 basis points down from the prior year. This was primarily due to gross margin flow-through and the year-over-year increase in variable compensation costs. Year-to-date, Worldwide Consumer operating income was $423 million, $31 million or 12.5% higher than in the prior year. Growth of our CSCA business, much of which came from strong US OTC performance, as well as the impact of the oral care acquisitions over the last 15 months and the growth of store brands in the UK were partially offset by increased COVID-related expenses and several divestitures. Now let's look at the individual consumer segments in more detail moving on to Slide 22. Consumer Self-Care Americas gross profit increased $12 million versus last year's Q3, up 6% to $222 million. While gross margin of 33.5% declined 50 basis points. Successful new product launches, the continued strength of the US OTC business, and the acquisition of Dr. Fresh were largely offset by our normal pricing pressure, despite operating efficiencies in the quarter. While the gross margin declined 50 basis points this quarter versus the prior year, we are making considerable progress improving our gross margin each quarter this year on a sequential basis. We have increased gross margin 210 basis points from the first quarter, 150 basis points from Q1 to Q2 and 60 more from Q2 to Q3. Operating income grew $11 million or 9% in the third quarter to $134 million, and operating margin was 20.1%, up 30 basis points, as operating leverage on gross margin flow-through was partially offset by increased brand investments and promotions. Year-to-date CSCA operating income was $395 million, an improvement of $52 million compared to the prior year, up 16%, while our operating margin improved 30 basis points to 19.8%, strongly driven by US OTC and by our acquisitions as I said earlier. Moving on to Slide 23. Consumer Self-Care International Q3's gross profit was $171 million, 4.3% lower than the prior year, while gross margin declined 150 basis points to 50.4% primarily from adverse product mix and also from increased commodity costs for a specific brand. CSCI operating income in Q3 was $51 million, $12 million lower than the prior year, while the operating margin was down 310 basis points to 15.1%, due primarily to gross margin flow-through as operating expenses remained flat compared to the prior year. Year-to-date CSCI operating income was $165 million, down $3 million compared to the prior year, despite strong store brand growth in the UK, but up 7.4% when divested businesses and currency are excluded. Operating margin year-to-date is 15.9%, down 40 basis points from prior year, principally due to the divestment of higher margin businesses this year. Turning now to the Rx segment on Slide 24. Q3 gross profit decreased by $16 million to $78 million, primarily due to $22 million of albuterol recall costs, in line with our expectations. Gross margin of 37.1% was down 380 basis points entirely due to the recall. Rx operating income was $44 million, $12 million lower than the prior year, principally due to the gross profit shortfall, but partially offset by reduced operating expenses, including lower R&D and lower administrative expenses. Year-to-date operating income was $168 million, down $17 million or 8% compared to prior year, as the positive impact of albuterol sales in the first half was more than offset by the sharp reduction in the number of scripts written by doctors during the pandemic lockdown. The cost of the subsequent recall of albuterol this quarter had a further adverse impact on Rx year-to-date operating income. Moving now to the balance sheet on Slide 25. Operating cash flow in the quarter was $63 million, a conversion ratio of 49%, which was in line with our expectations. This follows a strong conversion rate last quarter at 206%. The timing of sales within the second quarter as a result of the COVID-19 distortions was responsible for the change in Q3 versus the prior quarter. Year-to-date operating cash flow and cash conversion remains strong with a cash conversion ratio year-to-date of 124%. And our elevated cash position, we have $849 million on the balance sheet as of the end of Q3 provides optionality for additional bolt-on acquisition opportunities to further propel our self-care transformation. This cash position will also allow us to go into the market at what we believe is a great discount to repurchase $150 million in shares that will help offset those used in our management compensation programs. Finally, we are reaffirming our original guidance for this year of 6% to 7% net sales growth, better than 3% organic net sales growth, and adjusted diluted EPS in the range of $3.95 to $4.15 per share. Strong business fundamentals and a lower than expected tax rate for the year have enabled us to absorb $0.12 to $0.15 per share, an incremental COVID-19 costs, $0.14 per share for the cost of the albuterol recall and the loss of $0.06 per share from divesting the Rosemont Rx business. In summary, year-to-date business results are very strong and our outlook for the remainder of the year remains positive as the investments we are making in the business continue to take hold. With that, I would now like to turn the call back to Murray.

Thank you, Ray. Operator, we'll go ahead and open it up to questions.

Thank you. We will now begin the question-and-answer session. Your first question comes from Gregg Gilbert from Truist. Please go ahead.

Thank you. Hey, how are you? I'm going to first get the one out of the way that you probably don't want to discuss but it's inevitable to come up. So about the Irish issue, is there any precedent for Ireland settling with companies? And then, what scenario would you not appeal the first step that didn't go your way, I'm just trying to understand why you wouldn't want to drag it out as long as possible unless a settlement is at least theoretically possible. And then question number two is about your share buyback decision. It seems on the surface to be a bit more symbolic than a major decision on capital allocation vis-a-vis sort of additional bolt-on activity. So hoping you can comment on that as well as your view beyond the $150 million and the relative attractiveness of shares versus more bolt-on activity? And I have more, but I'll respect the queue and get back in line. Thanks.

The first question is regarding the potential appeal of the law we just received today. Our lawyers are currently reviewing all the information, and if they identify any laws that we believe we can challenge effectively, we will pursue an appeal. Otherwise, we think our case is strong based on the merits from the outset. We felt we presented a compelling argument, and our focus is not on delaying the process. Instead, we aim to resolve the matter, achieve a favorable outcome, and act in the best interests of our shareholders. If we believe that a settlement is the best course of action, we would consider that, and there is precedent for such action. Regarding the share buyback, it was targeted in nature. It was not merely symbolic; we have had management shares for the last few years and have faced dilution that shareholders shouldn’t bear the cost of. Therefore, we initiated this buyback to restore balance, and we believe the shares are currently undervalued, making this an opportune time to act.

Thanks.

I don't know if I answered the last part, but I'll just add to it. My number one priority and capital allocation is both getting the infrastructure right, which the investments we've made and capital to make this a world-class company and bolt-ons that help become accretive to growth. I'm delighted with what we have been able to do with Oral Care, but with Ranir, Dr. Fresh, Steripod creating up and opening a whole platform of growth for us. So that's still the priority things that will generate long-term returns for the investors.

Thank you.

Great. Thank you so much for the questions. Just two from me. I guess, first, just taking a step back and thinking about the top line impact from COVID across your business this year. Can you help us think a little bit about what the net impact we should be thinking of there when we look at maybe some of the earlier year benefits you saw in the Americas business versus the headwinds in the international and Rx franchise? And some of those benefits you think you're going to be sustainable, but I just want to get color on just pushes and pulls as we think about how to look forward to 2021 as a reasonable baseline? My second question on the status of the markets and pricing environment in the U.S., just anything you can provide on that would be helpful as well. Thanks.

Yes, Chris, if we consider the overall business, as we enter the fourth quarter, the impact of demand surges or pantry loading seems to have settled down. While this has not completely evened out across divisions, the initial gains from CSCA at the beginning of the year have been offset by CSCI and the Rx base business, particularly during the early days when doctors' offices were shut down. There were some early orders for albuterol during the peak of COVID, but these have been balanced out or completely negated by the recall. I don't believe there are any lasting effects from one-time events. We started this year with a target of 3% organic growth, which I think will exceed slightly, as we are currently around 4% for the consumer businesses, possibly slightly above that. So, we may surpass our 3% goal by a small margin, but not significantly. A notable change has been the shift in consumer behavior from brick-and-mortar shopping to e-commerce. According to a McKinsey study, our global store brand businesses are benefiting from a significant and accelerated move from branded products to store brands, which should be a stable trend moving forward. Fortunately, we made substantial investments in e-commerce a few years ago, and our market shares have improved significantly. I hope my earlier slide effectively showed the differences between omnichannel performance and traditional brick-and-mortar metrics such as IRI MULO, highlighting a shift from negative to positive trends for Perrigo. I don't anticipate that trend reversing.

Perfect. Very helpful. Regarding investments, I know you've made numerous investments since joining the company to prepare for your growth targets. Are there any major investments that Perrigo still needs to make at this point, or do you believe the infrastructure is where it needs to be, and it's now simply about execution, as you mentioned with the bolt-ons? I'm trying to understand if there's another significant push in expenses we should anticipate in the near future. Thanks so much.

The answer to that is based on the budgeting sessions we are currently going through. I have communicated to the organization that over the past three years, we made investments totaling $50 million to $60 million, and that will be the limit for now. I'm not suggesting we won't continue investing, but those investments should support brands that generate sales. The funds we have allocated will not negatively impact our profit and loss going forward. This is essentially our renovation budget, which we plan to maintain, and ideally, that will decrease over time. While I don't anticipate any major investments next year, I cannot rule out the possibility in a couple of years, especially with a new launch like Nasonex that could bring in revenue and profit. You could justify spending on advertising and promotion for such a branded launch, but I believe your concern is that these investments should not be made without a direct connection to revenue or operating profit. Therefore, they need to align with our financial strategy, and part of achieving margin expansion is managing our operating expenses effectively.

Great. Thanks for the question. Murray, can you talk about your confidence level in driving 3% top line and 5% op in growth next year. And especially on the top line would be albuterol headwinds, how should we think about some of the contributors to growth on a year-over-year basis? And then just separately, with regards to e-commerce, how much of growth is it contributing this year and how should we think about e-commerce related growth for your entire business as we think about next year? Thanks.

Yes, I'm not ready nor do I want to start providing goals for next year or guidelines. We're in the budgeting season. I'm very confident, you know the whole premise a year ago was to get 357 on the consumer businesses and then exit Rx. We still have Rx. I wasn't able to get value because at the time based on the multiples in the industry and it throws off cash. So I'm very focused on still delivering the 357, and I'm optimistic on growth of the base business. I have an anomaly, I have to deal with albuterol and I'm not in a position yet to say whether, you know how much we deal with that, it depends on what bolt-ons, et cetera. But on the core premise for the long-term, it's still intact, and I'm quite confident on the consumer businesses. But I can't even tell you with albuterol is back yet in the first quarter or midway through or not at all. They are closing in on the issues and there are shorter term solutions and longer-term solutions, and as all that budget comes back, you guys will be the first to know when I come and present and share the plans for next year.

Thanks. Can you also elaborate on the e-commerce trends that we're seeing here. It looks like Perrigo is taking share from other store brands, because the overall store brand omnichannel declined about 2.8%. How much of this is sustainable and could this be a driver for growth for your overall consumer business?

Yes, I've seen enough of the plans for next year to recognize that it is a significant driver. While I can't provide specific numbers, that's more of a discussion for Investor Day. We've likely advanced our plans by a year, and we don't anticipate reverting back. There has been considerable discussion, both internally and externally, regarding whether the surges and shifts will return to normal levels.However, given the investments being made by our top customers, like Walmart and Target, they are making substantial bets on e-commerce and believe that shopping behaviors will persist. Our investment in this area is significant, including the staffing required to manage a digital e-commerce group. We don’t just ship products; we also handle analytics, marketing, and promotions, which is a major undertaking. Perrigo has unique capabilities and competitive advantages in this regard, and we are continually working to stay ahead. Additionally, our product line is well suited to this model, focusing on regimented categories that tend to thrive. It's less about immediate needs when someone is sick; instead, it's about consistent purchases of products like allergy medicines, nicotine replacements, and digestive health that drive our highest shares. This gives us a dual benefit. We are confident in our e-commerce strategy and are looking towards further growth, potentially exploring more advanced opportunities in the future. It's important to differentiate e-commerce from digital; e-commerce is what people typically think of, while digital encompasses a broader range of technology and direct-to-consumer initiatives. E-commerce will certainly be a key driver, but I won't be breaking out specifics for 2021 yet; my priority is to finish 2020 strong first.

Great. Hey, how you doing? Has Perrigo been involved in any preliminary settlement discussions thus far regarding the Irish tax liabilities? That's the first question. Second question, Voltaren Gel has been a nice new launch opportunity for you in CSCA. As you look at the next call it, three, four years, are there other specific product opportunities or categories that you're watching that could help boost the organic growth in CSCA? Thanks.

Organic growth has exceeded expectations and is stronger than anticipated. The growth in organic numbers was significant last year compared to the year before, largely driven by acquiring brands in Oral Care that contribute positively to revenue and can be expanded with Dr. Fresh. The investments made in that area are expected to yield additional growth. The shift from OTC to Rx, including products like Voltaren, was not predicted a year ago, but now there are numerous opportunities for Rx to OTC switches, including Advil dual combination products and future prospects with Cialis and Tamiflu, which can significantly enhance organic growth. In nutrition, we focused on improving quality and service, which we've addressed with substantial investments. While it will take time to implement these changes, enhancing our capacity with reliable products will enable us to promote effectively and launch new products next year, providing more growth avenues. Another key opportunity lies in customized brand solutions for major customers. This emerging trend is similar to the evolution from private labels to branded store products exclusive to retailers like Target. Other major consumer goods manufacturers are exploring this avenue as well, and we believe we have the unique capability to meet these complex needs, which could lead to higher margins. Growth itself is not the issue; the challenge is managing overhangs in the business. While there has been some margin erosion, some of it self-inflicted due to prioritizing community needs, overall gross margins still have potential for improvement. We started making progress on operating expenses, which is benefiting us now and will continue to do so next year. The opportunity to enhance gross margins has been recognized, and we are actively addressing it. We have seen two solid years of growth, supported by acquisitions and new initiatives, particularly in OTC switches, which present significant upside potential. Our focus is on achieving this growth profitably while improving our margins and responsibly addressing existing challenges.

Yes, thanks very much. Hi, Murray. So some of my questions have been answered. I just have two please. First, you had briefly touched on the US tax litigation. Could you just provide some more detail on that please? And then second, you also touched on the opportunity to restart growth in Rx. Obviously, the second quarter of this year was impacted by the pandemic, you have an easy comp next year, but any more color on how we should think about Rx prospects? Thanks so much.

Yes, regarding the Rx prospects, I’m referring to something we’ve discussed extensively. The new product pipeline has diminished as much of the focus in Rx was directed towards albuterol. This has been the main priority for several years, while historically, Rx has been about small, consistent achievements. I’m encouraged when I see my Rx team present their plans because the number of approvals they’re achieving and the volume in the pipeline, along with expected approvals, represents a significant improvement compared to recent years. I believe you will start to see this unfold next year and even more in the following year. I agree that, regardless of what happens with albuterol, next year offers some favorable comparisons early on, and there are additional areas of opportunity they are exploring. We are not reducing our commitment to Rx, as it’s a vital business that generates substantial cash flow. We haven’t cut back on investments and have provided the necessary resources for growth. It’s unfortunate what occurred with albuterol, as it overshadowed some significant successes they’ve had. This was intended to be a standout year for them, but I am confident they will recover. The first part of your question again. Yes, the US tax. The Athena tax of $800 million and however many millions of dollars it is, we've discussed before that it essentially taxes the same income as Ireland does, and there is an agreement between Ireland and the US to avoid double taxation. If there is a dispute between the two, there is an authority to address it, and Ray mentioned the specific name of that authority. What's the name of it Ray?

MIP. It is called MIP. Just blanking on it.

Right. The important part is that we submitted it. We believe there was a conflict, but they have to review the criteria and the commission that stands between the US and Ireland will then negotiate and debate it. They accepted it in August, which is the latest update. From our perspective, this could either resolve the issue or it could result in a combined overall deduction against the other, but it should significantly reduce the total. It's difficult for me to quantify, but my belief, along with our lawyers', is that it has removed a portion of the overhang. I just can't specify where it's coming from, as that's a dispute between the US and Ireland now.

Understood. Thank you very much.

Thank you. Your next question comes from Elliot Wilbur from Raymond James. Please go ahead.

Yes, thanks, good afternoon. I wanted to go back to some of your commentary around the growth differential in omnichannel versus brick and mortar and just wondering if you could help us with some specifics on the e-commerce and club market relative to the size of the brick and mortar channel? Just trying to get a sense of how big that market is, how important it is currently for Perrigo and whether or not there are categories there that are still significantly underrepresented relative to Perrigo's existing base that might provide for significant immediate growth opportunities outside of just sort of increased usage by consumers of e-commerce means of purchase? And then a question for Ray. I won't profess to have the strongest working capital projection skills on the street, but still struggle with sort of trying to predict your relative cash flow from operations versus adjusted net income and cash conversion metrics. Just wondering if you could provide some help there with respect to fourth quarter? And then how do we think about that longer-term, most CFO always be somewhat higher than adjusted net income or roughly equivalent, just trying to get a little bit better handle on that metric? Thanks.

Moving to the second one and I'll come back to e-commerce.

Yes, we experienced lower cash conversion rates in the third quarter, primarily due to the timing of sales from the second quarter and the effects of the COVID-19 surge on our receivables. Typically, we achieve just over 100% cash conversion, which is our target moving forward. However, we aren't providing precise guidance for cash conversion on a quarterly basis.

Yes, when looking at our global consumer sales, e-commerce represents about 8% of our total sales and is on the rise. In the US and Americas, it has grown by 142%, while in Europe and CSCI, the growth has been in the high 40s. The growth potential varies by region. In CSCI, e-commerce already plays a significant role, and our strategy involves expanding this through regional brands rather than attempting to create large pan-European brands. This approach allows us to tap into the entire European market. The Amazon-like platform in Europe presents a substantial growth opportunity, even though our current e-commerce presence is still limited to a few countries. In the US, we've seen remarkable success. There are many product categories that can be explored. I focus on e-commerce penetration in comparison to traditional retail, and it remains significantly lower. For instance, in a physical store, when you compare products side-by-side, discounts of 30% to 70% can be evident against national brands. However, online, if you search for a specific brand like Ibuprofen, you primarily find that brand. We aim to enhance e-commerce by collaborating with customers to present options and pricing, which helps increase penetration over time. We're addressing this through various strategies, but even with our current growth, e-commerce remains underdeveloped compared to store brands. National brands currently hold a greater share of their categories than we do. Did that answer your question? Are you still there?

We lost the line.

Thank you. I have two questions. The first is about acquisitions. Murray, during your last quarterly call, you suggested that Perrigo was pausing on bolt-on acquisitions. You recently completed Dr. Fresh and Steripod, which seems to indicate that the company's ability to travel for due diligence may have been a factor, along with higher consumer multiples. Has that situation changed? Are you still in pause mode due to travel difficulties and high multiples, or are you starting to pursue new opportunities? My second question, possibly for Ray, concerns the Rx business. I've noticed that gross margins have fallen from 42% in Q1 to 39% last quarter, and now 37% this quarter. You mentioned that the drop from 39% to 37% was entirely due to the ProAir recall. Could you clarify if the baseline gross margin is really 39%, or should we expect ongoing softness until the ProAir issue is resolved? Thank you.

Well, the answer to the first question is back on offense. I mean, you said it well, but it wasn't just us that couldn't travel and do due diligence. But given the state of affairs, there just weren't deals kind of froze up and we were fortunate that we had completed due diligence on a number of deals. We've closed on another one since then, with some assets we bought from Sanofi, right, the skincare products. And now we are evaluating many. I would say, it's loosened up dramatically. There is a number of opportunities. I can't predict when we find one, that's the right value in the right price, but we are clearly digging in again.

Yes, on the Rx gross margin, the decline in the third quarter, do I think I said is pretty much all attributable to the albuterol recall. It is kind of a complicating because we shared a profitability with Buys. So it didn't have a real adverse impact on our COGS. It came into our COGS costs and hit our margin. I'm not ready to guide to the specifics for Q4, but I think we will expect that particular matter will have any impact on Q4. In other words, the key albuterol recall costs that will be contained into the third quarter.

Great. Thanks.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Murray for closing remarks.

Yes, as I sit here, I'll just leave you on. I've been doing this for a long time. I am proud of the team, and what they've accomplished in 18 months has been remarkable. Perrigo is a very different company with a very different growth profile. We've had a couple of bumps. We'll work our way through those, but yes, we think the stock is a great value. We appreciate those of you who are working with us and sticking with us through it, and we think ultimately that our consistency in delivering on our promises, which we hope we are building credibility because it will ultimately generate the appropriate rewards. And with that, I thank you for your interest in Perrigo.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.