Perrigo Company - Earnings Call - Q4 2019

Transcript

Speaker 0

day

Speaker 1

and welcome to Perrigo's Fourth Quarter and Full Year twenty nineteen Financial Results Conference Call. All participants will be in listen only mode. Please note that this event is being recorded. I would now like to turn the conference over to Brad Joseph, Vice President, Investor Relations. Please go ahead.

Speaker 2

Thank you, and good morning, everyone, and welcome to Perrigo's fourth quarter and year end twenty nineteen earnings conference call. Hope you all had a chance to review the press release we issued earlier this morning. A copy of the release is available on our 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 press release issued earlier this morning. When discussing our business, Murray will reference only non GAAP adjusted numbers unless otherwise stated. All comparisons to prior periods will also exclude currency changes. Ray's discussion of financial results during this call will address both GAAP and non GAAP results. In the appendix for today's call, we provided reconciliations for all non GAAP financial measures presented.

A couple of other quick items to note before we get started. One, exited businesses means the exited Animal Health and Infant Foods business. Two, non GAAP net sales excludes the exited businesses from both 2018 and 2019, and for the full year comparison also excludes the voluntary global market withdrawal of ranitidine in the third quarter twenty nineteen and three, organic growth excludes Ranir, the exited businesses and currency changes. We'd also note that the company realigned its consumer product categories to standardize reporting and evaluation across its worldwide consumer businesses, which you can see in the appendix attached in the morning's in this morning's press release. These updates have no impact on the company's net sales and are provided by quarter for fiscal twenty nineteen.

And with that, I'd like to turn the call over to Marty.

Speaker 0

Good morning, everyone. I'm pleased to share that following a good third quarter, Perrigo's business sequentially strengthened in the 2019 of the year. We believe multiple quarters of improving fundamentals demonstrates that Perrigo is executing well against our new consumer self care strategy and that our transformation initiatives are working. Of course, we're only nine months into a two to three year transformation, and there's still much work to be done. But the drivers of growth, the quality of growth and the breadth of growth across businesses in Q4 provide strong evidence that we are on the right track to deliver our stated 3.7% long term growth goals.

Starting with revenues, as compared to year ago, the company hit on all cylinders in Q4. Total Perrigo consolidated net sales grew 13.4%. All segments contributed to this growth, including a 19.4 increase in Consumer Self Care Americas, CSCA, an 11% increase in Consumer Self Care International, CSCI, and a 2.2% increase in Generic Rx. Total worldwide consumer revenues grew 16.4%, including the additional revenues from the Ranir Oral Care acquisition. Excluding Ranir, organic growth in the fourth quarter was very strong with CSCA up 10.6% versus a year ago and CSCI up 4.3%.

This brought total consumer organic growth to 4.7% in the second half of fiscal 'nineteen and 02/2002 percent for the full year. This gives us even more confidence that we can deliver on our stated 3% organic growth objective. A closer look at the drivers within our business segments should help you understand why we say the quality and breadth of the fourth quarter results I just referred to were so strong. Starting with Consumer Self Care Americas. CSCA adjusted Q4 net sales growth of a very strong 19.4% was driven by: first, 52,000,000 in incremental domestic Ranir sales, representing 45% of Q4 total CSCA year over year growth $2.42000000 in OTC sales growth, representing 37% of Q4 total CSCA year over year growth.

All CSCA OTC subsegments enjoyed strong q four growth, including coughcold plus 5%, allergy plus 19%, digestive health plus 5%, pain plus 9%, and healthy lifestyle plus 10%. When I refer to healthy lifestyle, think nicotine cessation in The US. Four factors contributed to this broad strength, and importantly, one potential factor didn't. First, the product categories we compete in grew at a faster pace in Q4 twenty nineteen versus Q3, three point three percent growth versus 1.8% or almost double in the fourth quarter, benefiting from strong cold cough and allergy seasons as well as developments in the tobacco industry that we believed encouraged increased attempted quitting by smokers and vapers. Second, total Q4 store brand penetration versus national brands increased 70 basis points and concurrently Perrigo gained share from other store brand competitors as a result of new product launches and distribution gains on existing products.

That is to say Perrigo got a larger share of a bigger slice of a bigger pie. Third, it is noteworthy that Perrigo's e commerce business has gained sufficient scale so as to become a meaningful growth contributor. E commerce represented a quarter of the $42,000,000 in ODAL OTC organic sales growth for the quarter and has generated an incremental $30,000,000 in sales for the year. We believe Perrigo's rapidly developing expertise in e commerce is quickly becoming another competitive advantage. The fourth driver of total CSCA's strong quarter was our Nutrition business unit, which returned to growth as predicted on our last call.

Perrigo Nutrition was up 21% versus a year ago and represented about 17% of total CSCA growth. The business enjoyed robust growth behind the launch of a new product to a large customer and a return to strong contract pack sales as we work through the previously discussed inventory issue. Some of the strength in Q4 Nutrition contract sales was timing related to production planning in advance of a new retail product launch in Q1, meaning we expect to give a bit of the contract pack sales back in Q1. But even adjusting for this, Nutrition still grew double digits in the quarter. And fifth, the one factor that importantly did not impact sales for the quarter was increases in trade inventory.

To be clear, trade inventory positions at the 2019 were at a lower level than the prior year, which bodes well for the first quarter of twenty twenty. Strong revenue growth and increased adjusted gross and operating margins resulted in a 20% increase in adjusted operating profits for total CSCA. We enjoyed solid adjusted operating income increases despite significant transformation investments in the quarter. Turning to Consumer Self Care International. Q4 net sales increased 11% versus year ago.

CSCI's results benefited from twenty two million dollars in incremental sales from Ranir, combined with solid organic growth of 4.3%. Organic growth in CSCI was driven by $23,000,000 in new product launches, including the XLS Fortive and Phytosun launches and good selling activities for the coughcold season in Europe. EU markets category consumption for OTC remains solid, growing at an attractive 3% to 4% rate, with Perrigo's portfolio of regional brands maintaining their collective market share. Finally, our U. K.

Store brand business realized strong growth. This, combined with the addition of Ranir, means our store brand business now represents a larger percentage of our total CSCI portfolio. As store brands carry lower gross margins, our gross margin for CSCI was negatively impacted. However, this reversed itself at the operating margin line as store brands carry almost no A and P. Bottom line, CSCI adjusted operating margin increased 100 basis points year over and the business delivered 16.4% adjusted operating income growth for the quarter.

Finally, our Generic Rx segment continued to outperform most other generic Rx companies posting 2.2% net sales growth despite comparison to last year's launch of testosterone 1.62%. Rx growth came from higher volumes of existing products and $19,000,000 in new product sales, partially offset by pricing pressure and discontinued products of $6,000,000 Total adjusted operating income for Rx was down 26.3% for the quarter due primarily to the testosterone 1.62% comparison. On a consolidated basis, Q4 adjusted EPS increased 9.3% versus a year ago. Adjusted EPS for the year 2019 finished at $4.3 which was above our original May 9 guidance, and it included $25,000,000 in transformation investments. So in summary, I am very pleased with the quarter.

It's what I like to see. The team is executing well, which is translating to solid fundamentals on our business. I'm proud of the Perrigo teams all across the world. They are energized and winning again. All of us believe that we are recapturing the Perrigo advantage and are confident that we will make lives better by bringing quality affordable self care products that consumers trust everywhere they are sold.

I'll now turn the call over to Ray Silcock, our Chief Financial Officer, to cover the financials in more detail, and then I'll return to make a few go forward comments regarding guidance. Ray?

Speaker 3

Thank you, Murray, and good morning, everyone. Now that Murray has gone through the highlights for the quarter, I'd like to walk you through the rest of Q4 P and L with a brief look at the full year 2019. Consolidated reported GAAP net income for Q4 was a loss of $19,000,000 and reported diluted loss per share was $0.14 Consolidated adjusted net income for the quarter was $145,000,000 and adjusted earnings per share were 1.06 marking our fifth consecutive quarter of meeting or exceeding market expectations. Adjusted net income includes $164,000,000 of non GAAP adjustments that we added back, including non cash impairment charges of 142,000,000 primarily driven by a lower valuation of the Rx business due principally to market and industry factors. Amortization of $80,000,000 which we always add back, all partially offset by a $50,000,000 tax adjustment.

The GAAP reported consolidated effective tax rate for the fourth quarter was 44.5%. This was generated from a tax benefit of $15,000,000 and a loss before taxes of $34,000,000 The income tax benefit was due primarily to a valuation allowance release in The U. S. The loss before taxes was principally due to the $142,000,000 of impairment charges recorded in the quarter, which were non deductible for tax purposes. After adjusting for these and other non GAAP adjustments, our effective tax rate for the quarter was 19.5%.

Full details of all these adjustments can be found in the non GAAP reconciliation table attached to this morning's press release. From this point forward, all My Dollar numbers are on a non GAAP basis, while growth percentages will be in constant currency and exclude exited businesses. First, I'm going to review the results of our worldwide consumer business, which is comprised of the Consumer Care International segment and corporate unallocated expenses. Afterwards, I'll discuss the Rx segment. Worldwide consumer sales growth in the fourth quarter was up 16.4% from prior year.

Gross profit increased $51,000,000 to $419,000,000 or 18% increase excluding the impact of currency and exited businesses. The acquisition of Ranir accounted for half of the gross profit increase, while strong performances by The U. S. OTC and Nutrition businesses as well as successful new product launches in both The Americas and International segments were responsible for the rest. Gross margin was up 40 basis points from 38.9% to 39.3%.

CSCA's gross margin was up 190 basis points from the impact of the sales flow through, including growth in the allergy and smoking cessation categories, gross margin leverage and operational efficiencies, which more than offset a 180 basis point decline in CSCI, primarily due to the addition of Ranir, whose store branded business has a lower gross margin, but a stronger operating margin due to there being almost no advertising and promotion in store brands, as well as adverse product mix. While gross profit was up $51,000,000 operating income improved by $41,000,000 primarily due to the impact of a $12,000,000 expense to restore employee bonuses and reflect twenty nineteen performance. Total operating income was $153,000,000 up 36.5% on a non GAAP basis. Turning now to the Rx segment, net sales growth in Q4 was 2.2%, but gross profit decreased by $11,000,000 in Q4 to $111,000,000 and gross margin of 43.2% was down from 49% last year, due primarily to adverse pricing, specifically of testosterone one point six two. Operating income was lower by $22,000,000 to $62,000,000 since operating expenses were up $11,000,000 primarily for pre commercialization R and D costs of generic These were principally units of generic ProAir that were made during 2019.

Since we now have approval from the FDA, these units will be sold and will have a lower cost of goal of goods providing us a benefit in 2020. Now a few quick remarks about our full year results. Worldwide consumer net sales were up 6.3% and gross profit increased versus 2018 by 4.1%. This improvement was driven by the addition of Ranir from July 2019 on, albeit at a lower gross margin profile and by strong performance of The U. S.

OTC business. Operating income decreased $47,000,000 to $545,000,000 Excluding the impact of currency and exited businesses, operating income was down three percent. Despite gross margin flow through, the year over year decline was driven firstly by $25,000,000 of investments to support innovation and future sales. Secondly, by the $37,000,000 cost of restoring employee bonus programs, which were at a low level in 2018. And thirdly, by a $17,000,000 insurance recovery in 2018 that did not recur in 2019.

For the full year, the Rx segment net sales were up 5%, but gross margin declined by 600 basis points driven by downward pricing pressure from competitor approvals. Operating income was lower by $41,000,000 due to pricing and the pre commercialization expense related to ProAir. In summary, our consolidated earnings per share for 2019 were $4.3 in line with Wall Street expectations. With respect to our balance sheet, as of December 3139, total cash on the balance sheet was $354,000,000 and total outstanding debt was $3,400,000,000 2019 cash flow from operations was $388,000,000 a 71% cash conversion on adjusted net income. This lower than anticipated ratio was driven by a higher trade accounts receivable primarily in the Rx business, which we expect to return to normal in the first half as well as by Israeli withholding tax payments of $32,000,000 made in Q4.

Before I turn the call back to Murray for him to talk about our 2020 guidance, a brief word on the potential impact of the coronavirus. Obviously, the situation continues to evolve, but currently we don't anticipate it having more than a modest impact on our results. Most of our manufacturing facilities are in The U. S. And Europe, although some of our products are manufactured and we source raw and other materials from around the world, including in China.

All of the plants in which we manufacture and from which we source our products are currently running. While we have incurred small incremental airfreight costs to date this year, we don't expect these to have a material impact on our results in Q1. And based on what we know today, we don't expect more than a modest impact on our fiscal year. With that, I'd like to turn the call back to Murray.

Speaker 0

Thanks, Ray. Looking forward, the company has momentum as we enter 2020, and we are encouraged by the transformation results so far. The fundamentals on our worldwide consumer business are solid. We have a strong lineup of new products across the portfolio. Our e commerce business is becoming an increasingly important source of growth, and we expect our revenue accretive bolt on acquisition, including this week's acquisition of Doctor.

Fresh, to further accelerate future organic growth. We also have finally received approval on generic ProAir. We expect these actions to deliver approximately 6% to 7% reported revenue growth for total Perrigo in 2020 with organic growth right around the 3% target. You might expect this strong revenue growth to translate into higher adjusted EPS than the $3.95 to $4.15 guidance range provided in this morning's release, which is only slightly higher than a year ago. Our guidance includes exited businesses and several structural cost increases.

And remember, we are only just completing the first year of our transformation, and there is still much to do to recapture the Perrigo advantage. As planned from the beginning, our transformation plan invests $50,000,000 in 2020, dollars 30,000,000 incremental, split pretty evenly across building out new channel infrastructure like e commerce, innovation like Nasonex, technology business intelligence systems and project momentum enabling technologies. Absent this investment spending, we believe our adjusted operating income growth would be close to the plus five percent we are working towards for 2021 and beyond. Worldwide consumer net sales are projected to follow their historic pattern that is spread pretty evenly across quarters with some seasonality increase in Q4 for the beginning of coughcold and allergy seasons. It should look pretty much like this year.

I would note that we do expect meaningful decline in Q1 Rx adjusted operating income much versus 2019, similar to what we saw in Q4, and for the same reason. The expiration of the one hundred and eighty day exclusivity period for testosterone, 1.62%. But with the launch of generic ProAir, total generic Rx operating profit and revenue is expected to be up for 2020 despite the decline in Q1. Perrigo capital spending for 2020 is estimated in the range of $175,000,000 to February also reflecting investments for increased capacity and project momentum enabling technologies as well as normal maintenance projects. Importantly, we expect to complete several key transformation projects this year that are necessary for us to sustainably win in the marketplace and deliver long term profitable growth.

On a final note, I'd like to thank Jeff Needham, President of our Consumer Americas business, who announced he will be retiring later this year after thirty six years of leadership at Perrigo. Jeff is an icon in the store brand industry and is loved by his colleagues at Perrigo and across the industry. He leads CSCA in strong shape with a great team, and he will be transitioning the business to Rich Soroto, CEO of Ranir, who will become President of CSCA in March to enable enough transition time prior to Jeff's departure. Rich is experienced and fully aligned with our consumer self care strategy. CSCA is in good hands.

Operator, we will now take questions.

Speaker 1

We will now begin the question and answer session. And our first question comes from Greg Gilbert with SunTrust.

Speaker 4

Hi, good morning.

Speaker 0

Have a few Hey, Gregg. I'll ask

Speaker 4

him right up front for you. Hey, Murray. First, just a follow-up for Ray on the cash flow from ops. Think that number came in over $100,000,000 below your guidance from August. You detailed a couple items that seemed like they were one time in nature.

But can you talk about anything that changes your view on sort of cash flow conversion on a more sustainable basis? Secondly, I was hoping you could provide a little color on the latest acquisition in terms of the existing growth rates margin structure of that business? And lastly, Murray, I'm curious about the Voltaren Gel opportunity. It's a product you sell in Rx today, but Glaxo or GSK is taking it over the counter. I think that's an interesting opportunity longer term for Perrigo.

So maybe you can talk about how an example like that that moves from Rx to OTC for you can help or hurt. Thanks.

Speaker 0

I like how you positioned the last question. But go ahead, we'll come back to that one. Ray, you want to do the first part on that?

Speaker 3

Sure. Yes. No, we were well below. That's why I called it out, Greg. And, the big thing was that our, on our Rx business, our trade receivables jumped.

And it's a structural thing, timing and we will get it back at the beginning of this year. We're getting it back already. In fact, it will mainly be back in the first quarter, some in the second. The other thing was Israeli withholding taxes, that was a onetime payment. We had some cash trapped in Israel, and we de dividended it out and paid the $32,000,000 of withholding taxes related to that.

Speaker 0

Okay. Doctor Fresh, and just so you know, this this guidance this this all happened this week. So we have very conservative numbers in for, Doctor Fresh. We have to extract the business out. There's TSA services we're gonna need to pay.

I haven't put in a lot into the projection. There's a little bit there, but we did I think the important part for people that are looking at this transaction, and if you look at the total transaction cost, the bulk of which was paid by us, is because Doctor Fresh was the healthiest and strongest and best performing piece of that portfolio. And frankly, the rest of it would have been non strategic for us. So we found a partner who's very interested in cleaning up and dealing with the issues on the balance of the business. But for us, Doctor Fresh has been a relatively stable business that Ranir tried to buy for significantly more money a couple years, back.

When you put the two businesses together, we believe that, there are significant, not just cost synergies, but given, the capabilities of Ranir versus Doctor Fresh to broaden that product line relatively quickly. So it's a great business that's at important customers, that is completely incremental. A big portion of that business is in the kids segment, and they're the leader in that segment. But we have the capability of bringing, a number of technologies, power and things like that at a much more advanced level, to that business. So we there's not much in there right now.

Maybe there's some upside on it. We'll see as the year progresses. But, but I we like the business very much, and we got it at a a great price. On the Voltaren gel, there's nothing in our our guidance on that right now. You know, I heard your loaded part of that question about, the benefit of having Rx, and it was.

Yeah. I mean, I'm not gonna deny that. That gives us a huge leg up, and I'm not sure today. We're waiting to hear, and we'll hear shortly, hopefully over the next couple months. That could be a 2020 opportunity.

It depends on sort of what the rulings are on exclusivity, etcetera. But, we make it today. We we could be out very, very quickly. So we'll we'll watch that one. But it it's a big switch.

And I don't wanna derail from your question. But a year ago when when I was talking about RxOTC switches, I kinda didn't even plan on any of those in our three, four year horizon. And that whole area, you know, Voltaren, some of the things talked about by our competitors and some very big categories, gives me some excitement that there's another avenue for growth that I wasn't planning on. So we'll keep you posted on Voltaren, but it's a big product. We can do it right away, depending on how the FDA rules on it.

And we'll let you know in an upcoming quarter like all.

Speaker 2

Thank you. Next question.

Speaker 1

Our next question comes from Louise Chen with Cantor.

Speaker 0

Good morning, Louise.

Speaker 5

Hi, good morning. Thanks for taking my questions here. So you highlighted the importance of e commerce a few times in the call this morning. So just curious, where is that business for you today? And where do you want it to be over the next few years?

Second question here is, in addition to ProAir, what are some other notable launches that you've included in your guidance for 2020? And then the last thing here is just on M and A. How important is it for you this year? How much capital do you have to deploy towards m and a? And and any particular areas you're interested in?

Thank you.

Speaker 0

Let me let me start the the answer by saying, you know, as I've been here a year and I honed down on our strategy, I've kind of come to the conclusion that we're gonna put the pedal down on five product growth priorities. Core OTC, nicotine, naturals, oral health, and nutrition. So that's where I look at we need to build out. In order to do that and where our investments have been coming on kind of seven growth enablers, building out our e commerce and digital capability, accelerating innovation, adding bolt ons back into the mix, as you saw, strengthening our consumer skills and analytics, more aggressively going after white space opportunities around the world, and then minimizing the negative of price erosion. And then the final one being making investments in capacity, etcetera, project momentum type initiatives to help drive cost down.

So that's kind of the big picture of cost. It changes depending on each of those different product segments, the role of bolt ons. We probably evaluated in my first year here 50 bolt on acquisitions that ultimately got down to seven or eight that we showed some initial interest in to to do due diligence in that culminated in four transactions so far. All in the, you know, the definitions that we talked about in through the course of the year at various presentations and our our priorities, and bolt ons will continue. The impact of bolt ons this year versus last year is significant.

You had basically $150,000,000 half of Ranir, you get that half added to this year, the Doctor Fresh, which again, I'm conservative by nature. So I haven't put a lot in, but that gets added in the Prevacid that is launching and off to a good start is, gets added into that as well. And Steripod that we also just bought will go in and contribute. So I can't give you a a direct answer because I don't buy it to fill a a gap. Our innovation programs have ramped up significantly in each of those areas, and ecommerce represented it's getting to be real now.

It it represented 40% of our OT growth in The U. S. Last year, and it added $30,000,000 So now and when I add Europe, it's well over $100,000,000 business that's growing close to 100%. So it's a real driver, but it goes against each of those various product categories, some more than others. And what I'm pleasantly surprised with is we're not seeing if I told you e commerce growth, you might sit there on the other end of the line and say, oh, you're talking Amazon.

But Amazon was a quarter of that growth. It was really spread out among traditional customers, some direct to consumer customers, and it is an area we put a lot of emphasis on. I believe it's a competitive advantage, and it's an area, we'll continue to press and make, and it's a meaningful part of that $50,000,000 in in investments that I talked about. I get all your questions? You asked a lot.

Speaker 2

Yes. I I think the other one was new products. How much the new products was included in the guidance for this year? Was it

Speaker 0

total new products? Or restate can you give me the question again on new products, Louise?

Speaker 5

Yeah. Sure. So in addition to ProAir, what are some of the notable new launches that you have incorporated into your 2020 guidance?

Speaker 0

Well, for competitive reasons, I'm not gonna tell

Speaker 3

you the

Speaker 0

ones that haven't launched. It's a secret. But, we we have talked pretty aggressively about that a big driver of our nutrition business was to a infant formula new product launch that, went to a specific customer, so I won't say that for competitive reasons as well. But it's that's a big new item launch, and that is baked in. It was in the fourth quarter, drove a lot of the growth that you saw in the fourth quarter.

So you should have nine months of incrementality of that for the for 2020. We have a second infant formula launch, which is the hypoallergenic, and that one's already been sold into customers. And that is what I was referring to in my comments that we had to make some of our co pack inventory in the end of the fourth quarter because when you run the hypoallergenic product, else can run the you literally have to stop, shut down, clean the whole facility, to keep that product hypoallergenic, and, that's just our normal scheduling types of things. And but, you know, our program We have a more robust new product innovation program in 2020 than we did in 2019, which was a major, increase versus 2018.

So it's a robust plan. In the consumer business, it's different than the Rx type of business, depending on what you're used to, analyzing because it all gets down to the incrementality and the cannibalization. But we think we, properly estimated that, and it'll play a big role. So, you know, I'll I'll show you those as we launch them. But they they tend to be, you know, lots of them in different markets through Europe and different categories, and they're not like a pro air.

They're, you know, they're, you know, like this year when we went into fluticasone or we, got back into some Mucinex like products with Guavacin. So it's it's a very, very, very robust new product plan. You know, I'm I'm coming off as, sounding like there's these tons of growth opportunities, and, and I'm I'm holding back. But I think six to 7% revenue growth from where this company was. And if I look back early in most of my investor meetings, everybody was disbelieving how we were going to get to 3% organic growth.

And now the questions are coming on the other side of why can't it be higher. So I guess that's a good place to be. But for those of you who know me, I'm conservative by nature.

Speaker 2

Thank you. Thanks, Louise. Next question, please.

Speaker 1

Our next question comes from Chris Schott with JPMorgan.

Speaker 6

Good morning, Good morning. Just two questions here. I guess first on product innovation in consumer. I think you've talked about some of these national brand better or brand different opportunities. I was wondering if could give little more color in terms of how long you think it's going to take to build out a broad portfolio of those assets?

And then once they've been developed, do we need to think about incremental marketing spend to build awareness around those? Or do you think just more shelf placement, etcetera, allows consumers to see some of the advantages of those opportunities? Second Sorry. Question was then

Speaker 0

No, no. It's all right. I got it. I was going say

Speaker 6

the second one was just on you I think you highlighted in CSCA the acceleration of growth in the broader OTC market. I'm just looking for a little bit more color about how sustainable you think that uptake is. So is this a pivot we're seeing to the market growing faster? Or is this just that it was a strong quarter and we see kind of some normal quarter to quarter variability of growth of that kind of broader market you're competing in? Thanks very much.

Speaker 0

Okay. Let's start with innovation. We're already starting to see NBB products hitting the market. There were NBB products that hit in nicotine. There was, an NBB product that, in in our, GI category that that was a good contributor this year.

So they're they're starting. In the world of where I truly wanna get to, we still have a fair amount of work, to go. And I you know, I'm kind of I'm gonna miss Jeff Needham tremendously. But I will also say that coming in, Ranir has been very focused on NBB, and and Rich and I are aligned with what could be an evolution of the, sort of almost a hybrid model between a traditional branded company and a store brand company. We like to you'll start hearing us use the term Consumer two point zero, where we start customizing brands, not just necessarily store brands.

And so I think we're in the infancy of what it can be. But those tend to still be brands developed for customers, so they don't add a lot of incremental, spending. However, and we buy a brand like Prevacid, part of our our spending this year is that brand needs to be advertised, and that is incremental. So there are television commercials that are airing as we speak for Prevacid and being shot for the year, and that's part of the investment as well. We you know?

But as we work towards the the 5%, you know, I've told this organization pretty clearly and the street pretty clearly that there were certain things I didn't wanna just invest, you know, very quickly and then, get a one year wonder of getting operating profit growth and all that. The the goal here was to make the real changes and investment levels. But then so if last year, we kind of reset things and or initially and, got the volume growing by the end of the year and this year deliver the three on the three, five, seven. I know I'm we're going six, seven, but I'm talking more toward the organic side. And then from 2021 on, 5%.

So when we think of those investments, and there will be some meaningful ones, we're gonna have to do that within the growth of the the rest of the the business. So I wouldn't look at it and say those will be inhibitors to our ability to grow. Everything in this company is being geared to getting the things completed, project minimum actions, the technologies, the analytics, all in place, the e commerce capabilities, the direct to consumer capabilities, all in place so that in 2021 and and on, we're delivering, you know, the rest of our our business model. And that that means on a switch product like Nasonex, that, you know, you you know, from the branded side or from, the national companies, those take significant dollars. But we're gonna have to figure out a way to do that within and still deliver on our our goals.

Speaker 2

And I think you answered the second part of

Speaker 0

the question. I know. I just spent so much time answering the first part. I forget the second part. But the second part was the total OTC growth.

I get carried away sometimes. The second part was the total OTC. We refer to the core OTC versus total OTC, and I'm going to be talking more and more about that. If you're talking $6,000,000,000 of total OTC, our core categories that we compete in are around $3,800,000,000 of that. The penetration levels are higher.

We gained 70 basis points. So we were able to drive up to almost 38% penetration, which means that's real. There are certain things that could have driven a bit of growth that are seasonal, like it was a good coughcold season in The US this fall. We'll see how that seasonality But in general, those weren't the big drivers. The big drivers on nicotine were, besides getting new products, placing and filling real consumer needs, is that it's a tiny category relative to where I came from.

And with the vaping problems that were out there and, the minimum age of tobacco being raised from 18 to 21, I would expect that category to stay at an accelerated rate. And a lot of the other categories, new products that are coming in represent growth opportunities. So the areas that we're pushing e commerce is not even included in that 3%, or some of it. When something is selling through Amazon or direct to consumer, that's not even being captured in the traditional MULO number. So it's probably a little bit more accelerated than that.

But I would think that most of them, the new products that drove on infant formula, that didn't drive the category, that drove our brands, but they'll be there all year long. The new products that we gained and the penetration that we gained, that should be there for the long term. But categories go up and down over time. But it's a long term trend that this category has been growing 2% to 3%. And I don't see health care costs getting any cheaper.

Speaker 1

Our next question comes from Randall Stanicky with RBC Capital Markets.

Speaker 7

Great. Thanks. Murray, you talked about structural cost increases in your prepared remarks. So question is how much of the $50,000,000 in transformational investment is structural? Or in other words, how much of that recurs going forward?

And does that fall all into CSCA? And then the bigger picture question is there's a lot of focus or I think there's going to be focus around the margins going forward. If we look at the CSCA margins historically, they've been in the 36% to 37% range. This year, close to 33, perhaps a bit lower with some of the spend. How do we think about the normalized margins for that CSCA business over the next couple of years?

Thanks.

Speaker 0

Let me do the first part, then Ray will talk to you about margins. The structural cost that I was talking about has nothing to do with the investment. So the transformational investments were $2,025,000,000 last year, and they're roughly 50,000,000 this year, 30,000,000 incremental. And those are those are investments that you know, if you look at it, it's 50% against innovation activities ramping up, 25% against momentum enabling technologies, and 25% against, ecommerce. That's kinda how we spend the the the 50.

The structural ones, you're you're you're talking about things like, our d and o in insurance up $15,000,000, affecting zero eight dollars of EPS, exited businesses of roughly $15,000,000 somewhere around that area, around $09 a share and some normal wage and merit increases. But so those are just sort of incremental things that are part of the business that have a negative impact, if that makes sense. But those are two different thoughts. Ray, you want to talk about margins?

Speaker 3

Yes. So our margins in The Americas business, are you talking gross margin or operating margin?

Speaker 7

Yes. No, gross margins. I'm just looking they've come down several 100 basis points in recent years. And I'm just wanting to better understand where you think they're going over the next couple of years. Can they get back to where they were?

Can you stabilize? Can you what can you do to drive margins back up?

Speaker 3

Yes. If we looked at our gross margin, it's it's definitely, you know, hurt a little by the the Ranir acquisition, and that that's probably, you know, not gonna come come back immediately. Overall, I think if we looked at, let's say, our gross margins with Ranir were down about sixty, seventy, almost 70 basis points in 2019 versus 2018. And we do have the continual drumbeat of pricing pressure. But as we as Murray has talked about, the fact that we move our portfolio from national brand equivalent to national brand better and meet the changes the structural changes we're making, I think we would hope to arrest that decline and hopefully reverse it as we go forward.

Speaker 2

Thanks, Randall.

Speaker 1

Our next question comes from David Risinger with Morgan Stanley.

Speaker 0

Good morning, David.

Speaker 8

Good morning, Murray. Sorry, I am in transit here. I just need to flip my headset. Okay. Sorry about that.

So congrats on turnaround progress.

Speaker 0

Thank you. I'm sorry. I can't hear you.

Speaker 2

Gabe, we can't hear you. Operator, maybe we can move on to the next question, and Dave, you can come back.

Speaker 1

Sure. Our next question will come from Amy Sedia with Silicon Valley Bank.

Speaker 9

Hi, good morning. Thanks for taking my question. I have three questions. Firstly, with regards to the ProAir, the genetic ProAir market potential, can you talk about the opportunity there and the ability to penetrate some of the volumes of other albuterol products? Secondly, just with regards to coronavirus, is there are you seeing any impact on demand for some of your products?

And do you think, you know, we could see some benefit on that front unfortunately as we see more and more of such events? And just thirdly, can you talk about what your expectation is for the evolution of operating margins for the CSDI business, over the next two, three years? Thank you.

Speaker 0

Okay. I'll do the first two. Ray, you do the the third one. The ProAir, again, I I don't mean to keep beating a conservative drum, but but ProAir, we found out about, like, two days ago. It was, you know, I think last May when I talked about it, I thought it, you know, it would be roughly 10¢ a quarter.

And since then, there's been three authorized generics that have have come to the market. So I I I went pretty conservative in what we put in here because we are as we speak, you know, we're outselling that product right now. When and in about two days, we'll know pricing. We'll know sort of acceptance, and we'll know demand. But I, you know, I hope I've put it in a position that it that it represents any upside to the guidance we're giving, not downside.

And, you know, from what I hear so far, so good. It was good to see the product on the Today Show yesterday. Corona is, I mean, I I I wanna make sure I under there's different levels of demand. Some cons you know, I there's some kind of levels of demand that I worry about, and there's some that I don't. So far, not on a broad level, I worry if certain customers start, building inventories because they're, you know, runs on shelves and things like that.

We haven't seen a a lot of it. We've seen a little. But, from a consumer standpoint, I think you're asking me is is that potentially an increase in demand from you know, as people get the flu and, you know, do they buy more cough and cold treatments and and things like that. I, we're not forecasting any, significant change for that. I haven't seen any uplift for that.

And it's a hard question to to answer. I I I know where you're coming from with it, but, so far, I would say I haven't seen any big spikes or anything. It was already a high illness season. You know?

Speaker 3

Right. You know, on the margin on CSCI, the margin on CSCI, the certainly, the gross margin impacted by, we saw great strength in our UK store brand business in 2019. And also for half a year, the Ranir, which is also acquisition, the European portion is included in CSCI and that's also store brand at a relatively lower margin. Although on an operating margin, some of that comes back because we don't spend advertising and promotion dollars on those products. There's also in the year, we had some of that 20,000,000 I think $20,000,000 or so that we spent $25,000,000 that we spent on investments and that found its way into CSCI margin.

And going forward though, we're focused on a couple of key initiatives. We're putting in centralized finance, will help us reduce costs, especially our administration costs in Europe, which are high at the moment because we the Omega acquisition wasn't well integrated until recently. And so as we focus on that, we would expect to see that drive our operating income in Europe, in the international.

Speaker 0

Yes. Our plans call for margin expansion over the next few years in CSCI. It's a good portion of the Project Momentum savings, as Ray just highlighted, are coming from there. I mean, do have a negative mix impact, but that's not a bad thing. It's all incremental.

Totally incremental volume. Yeah. Mean, you put in Ranir, and that that was mostly a branded business with 50% gross margins. You put in you know, a $100,000,000 of net sales and a growing, great you know, a growing UK store brand business. And, again, that's entirely incremental to our product line.

It's you know, it it has some mix effect, but not, any kind of cannibalistic mix effect. But we expect margin expansion in CSCI. Next question, Our

Speaker 1

next question will come from David Risinger with Morgan Stanley.

Speaker 8

Welcome back. Thanks very much. Thank you. Sorry about that earlier. So I have two questions, Murray, please.

First, Perrigo discussed incremental cost reduction opportunities on January 14. And today, you're talking about additional investment spending. And so could you just juxtapose the two and help us better understand the net cost trend outlook? And then second, with respect to operating cash flow, what we should expect in 2020 for operating cash flow relative to 2019? Thanks very much.

Speaker 0

You have the third one? Yeah. You know, the well, the first two were kind of a combination question. But none of that's changed. It's it is we have a $100,000,000 cost savings target on Project Momentum.

We it was you know, if you look at the guidance we gave back in in May, and despite a number of negative things that hit us, we, raised guidance, you know, several times through the the year and came in at a meaningfully higher number than we went out with in May. Project Momentum had a had a good portion of that. And I and I think that's the best example. Right? We were investing along the way, but we're saving.

So, you know, you've ramped up here to what cumulatively is now around $50,000,000 of investment, you know, a good portion of that in r and d. But that's those are designed to generate revenues and and profits on their own right. So I I can't just take one and, against the other. It's if, you know, if they need to add sales, some of them are if it takes me two years and it's new for us to develop a and switch a product, like Nasonex ourselves, yeah, you got a couple years before you get that benefit, but you're talking about roughly $50,000,000 of investment and $100,000,000 over, of cost savings. I think we said roughly, a little bit last year and then split like a third, a third, a third over the next few years.

Some of them are longer term, not because they're they just require things like the central finance that Ray talked about and the systems that go in place to help make that accomplish. There's equipment and and manufacturing, etcetera. But it it it's all part of that plan that feeds into the the model of the three five seven, and it's it it it it's on track. But, you know, most investors that I talked to, David, over the course of the last year, they wanna know I'm building a great company for, for the future that has sustainable growth, not doing quick fixes. And, and that's exactly what we're doing, and we have made major progress around here in our capabilities.

So, you'll see those benefits over time start to have major paybacks, Just like I went through the example on m and a and the criteria for that, we do the same thing on these investments. So the investments in in ecommerce are already projecting to be a hundred to two hundred million dollar business for us next year at only a year out. The project know, the investments in Nasonex should turn into a a very big piece of business for us a couple years from now. Our innovation pipeline, you know, I went from we put $500,000,000 of new products into the pipeline. I think that's now with some of the more recent things that have come up into the over $600,000,000 of new products.

You'll see that those all affect the overall margins, if that makes sense.

Speaker 8

Helpful. Thank you.

Speaker 3

So the cash flow question, I think we were clear in the prepared remarks that we had some onetime negatives to our cash flow. And therefore, we would expect in 2020 that our cash flow conversion rate would exceed 100% because we're going to we're seeing specifically, those accounts receivable, that went the wrong way in 2019 are going to come back to us in 2020, and we don't expect to have to pay withholding taxes. Great.

Speaker 7

Thank you.

Speaker 2

Thank you. Last question please.

Speaker 1

Our last question will come from Elliot Wilby with Raymond James.

Speaker 10

Hey thanks. Good morning. Not surprisingly another line of questioning around margins. If you look at the reported number in the quarter, I think it's basically the lowest level we've seen from the company in six or seven years. And I understand, obviously, there's a lot of investment and a lot of change taking place.

Maury, you've talked about a growth framework comparable to consumer companies, but is there anything you could offer up in terms of benchmark or bogey with respect to overall operating margins for the company as a whole. Obviously, we expect them to improve, but at 16.2% in the quarter, I don't know if a good long term target is 17.5%, 18% or if you think you could actually drive that a little bit higher. And within the context of that question, want to ask specifically about CSCI margins, obviously, much higher gross margin business, but operating margins still fall four to 500 basis points below The U. S. Business.

I'm just wondering if you think that that business could eventually evolve to a point where you have a comparable operating margin profile versus The U. S. Or if the level of investment spend is simply too high and that's not likely to happen. And just last question, infant formula strong quarter benefited from a couple of one time items, but you also have relatively easy comps now going forward. Just wondering if you think that business is back to the point now where we're going to see positive top line comps going forward.

Well,

Speaker 0

let me do the second part first. I mean, there weren't a couple of onetime items. Well, I guess if you look at a year ago, there was a couple of onetime items. Right? So you had a onetime a little bit of extra of contract back inventory because we needed to get ready for making hypoallergenic.

And then the year ago, you had a plan interruption in the fourth quarter. So you're right on that couple of items. But bottom line, when you you can adjust for all that, it was still a good strong 10% to 12% growth driven by new products that we expect to continue going forward. So I think the comps should be good on new nutrition. It's an area we haven't, pushed as hard as I think we can push.

So as as much as I think it's it's good and it'll continue to to grow and be a a great contributor for us, I think there's a world of opportunity, in the nutrition business, and we thought too small, in the way we invest in that business. And my comparison would be, you know, sort of oral health here where, Ranir, we've already added a couple acquisitions that'll, you know, grow that business 25%, pretty quickly. So I I expect nutrition to be an important segment and one of the five pillars for us or one of the five growth priorities for the company, and I think the comp should be good from this point going forward. As it relates to the second part, Ray?

Speaker 3

I think as it relates to the operating margins, clearly, we've got a big focus on cost control as well as on growth. But we are spending, as we've already talked about, an extra $50,000,000 in costs next year to help to drive the business forward. We wouldn't expect that margin increase to come in 2020. But going forward, we've got 100 we talked on Investor Day last year, dollars 100,000,000 in anticipated, say, cost savings from Momentum, the Project Momentum, which is completely focused on operating expenses. We've also got another part of that project where we're looking at cost of goods sold, which we're driving margins that way.

So it's definitely a focus for us, is to drive our margins up. And and we would anticipate that would be part of our 5% earnings growth target as we come into 2021.

Speaker 0

Yeah. I mean, I listen. It'll depending on the the timing of it, etcetera. But, you know, I I do I talk about the three five seven to consumer. That means, you know, on consumers, you gotta get into the 18% range of of of operating margins over time, and that's, you know, what we'll be targeting.

And you wanna bring your leverage down to below three turns too. So I mean, those are all the targets that we're working against over time.

Speaker 2

Thank you.

Speaker 1

Concludes our question and answer session. I would like to turn the conference back over to Murray Kessler for any closing remarks.

Speaker 0

Yes, let me just close that. I was optimistic when I joined the company. Time is flying by, but it's not that long. We spent six months getting a strategy. We launched it in May.

And to see the kind of response from the businesses with real fundamentals changing and great execution and the energy level in this company, I don't know how many what the multiple is, but it's exponential of how, I feel about the future. I'm very excited about Perrigo. We're making the right decisions to make this a great company so we sustain profitable growth over the long term. I'll always be conservative in nature. It's just who I am when I give guidance and as I am sure, but I don't like the erratic kind of forecasts that were before I got here.

And we've had five quarters now of meeting or beating, and, we look forward to to doing the same going forward. So thank you for your interest in Perrigo.

Speaker 1

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