Perrigo Company plc

Good evening and welcome to Perigo's third quarter 2020 financial results conference call. All participants will be in a listen-only mode. Should you require assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press the star, then the one on your telephone keypad. To withdraw your question, please press stars and two. 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 Perigo'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 perigo.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 of renitidine, as well as operating results attributable to the 2019 held-for-sale animal health business previously included in the Consumer Self-Care America segment. Comparisons to prior periods also exclude, one, divested businesses, which includes contributions from the divested animal health business and the divested Rosemont business and Canaderm 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 Parago 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 Perigo'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 argue the merits, we strongly believe Parago will ultimately prevail. I also remind you there was only upside to Parago 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 Parago 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 tax uncertainty this quarter. We did make progress on the $843 million U.S. Athena Tax Assessment, which was accepted by the Mutual Agreement Program under the Irish-U.S. Income Tax Treaty. The Irish and U.S. 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 U.S. and Ireland. But ultimately, the value of Perigo will be determined by the success of our consumer self-care transformation, not lawsuits. 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 are we progressing against our transformation plans. Let's start on slide six 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 Parago advantage. Our commercial teams are working round 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 intelligent 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 from 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 am proud of the entire Parago team and what they have 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 is authorized to purchase $150 million in Parago stock between now and the end of the calendar year. Turning to slide seven. 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 via 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 traded 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 plus 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 93 cents 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 plus 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 Perigo'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 nine, 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 plus 1.6% organically. Year to date, worldwide consumer revenues are up 11% versus year ago plus 4.6% organically, which is well above our plus 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 America's 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 of 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. Payne also benefited from continued COVID-related demand and the Voltaren store brand equivalent launch. Digestive Health benefited from the market relaunch 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 have 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 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 consumer survey noted that they have tried a store brand for the very first time. with 80% of those reporting they intend to continue buying store brands. That's big. The other big behavior switch 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's MULO, or multi-outlet data. While insightful, MULO underestimates club stores 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 omni-channel data for the first time we can now measure analyze and benchmark omni-channel performance for the entire OTC category for total store brand within the OTC category and we can also now measure Parago's share of total store brand and Parago's 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 Parago'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 perigo fairing 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 brands still declined, but to a lesser extent at 2.8%. And notably, Perigo grew 3.5%, which is fully aligned with total Perigo OTC factory shipments for the quarter, which were up 3.4%. What this clearly demonstrates is that Perigo 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 sulpidine, in the VMS category driven by new products within the Davidamon 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 U.S. as well as lice treatments due to school closings. Importantly, as you see on slide 14, CSCI's branded business in total has outperformed other self-care peers in Europe. Consumption for both Perigo 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're closely monitoring the recent lockdowns, albeit somewhat less restrictive, that were put into effect in countries including France, Germany, Spain, Italy, Belgium, UK, and Ireland. We will adjust our plans as need be 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, recovered 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 a year ago in Q3, which is a big improvement from Q2's 14% decline when doctors' offices were closed due to lockdowns and Derm Topical 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 RRX business, we did the right thing for patient safety. We will relaunch 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 on this important cash generating business. So to summarize, consolidated net sales are 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 on 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 and 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-based businesses are sustained. Four, Perrigo's Albuterol remains off the market. And five, there's no accretion impact in Q4 from the share repurchases between now and the end of the year. So bottom line, it's been a heck of a 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 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 NOAA. And with that, I will turn the call to Ray to discuss the financial details, Ray. 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 93 cents 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 as 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 Thank you for joining us. which we recorded as a result of the strong performance by Biogen's Disabri 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 deductions 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 impairment, the tax impact of all our non-GAAP adjustments, and the BEAT tax. We removed the BEAT tax since it was as a 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. From this point forward, unless otherwise noted, all dollar amounts, including year-over-year changes, basis point and 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 of divested businesses. Before moving to the business segment results, I would like first to review gross profit and margin performance at the Perigo 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 prior year. The principal drivers of these declines were the $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 as a result of strong store brand sales in the quarter with weaker performance from our branded businesses. Q3 consolidated operating income was $184 million and a number of other members of the company. 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. Years to date, our consolidated operating income was $609 million, $15 million higher than prior year, driven by the strong performance of our consumer businesses, especially USOTC. 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 mixed within our consumer portfolio. Strong growth in our lower margin CSCA store brand business, especially USOTC, 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% and many more. This was primarily as a result of gross margin flow through and that 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 USOTC performance as well as the impact of the oral care acquisitions of the last 15 months and the growth of store brand 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 America's 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 USOTC 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 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 by promotion. Year to date, CSC America's operating income was $395 million An improvement of $52 million compared to prior year, up 16%, while our operating margin improved 30 basis points to 19.8%, strongly driven by USOTC and by our acquisitions, as I said earlier. Moving on to slide 23, Consumer Self-Care International Q3's gross profit was $171 million. and a number of other companies. CSTI 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 CSC international operating income was $165 million, down $3 million compared to 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 followed a strong conversion rate last quarter of 206%. The timing of sales within the second quarter as a result of the COVID-19 distortions was responsible in the changing Q3 versus 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 at 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 are 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 12 to 15 cents per share in incremental COVID-19 costs, 14 cents per share for the cost of the albuterol recall, and a loss of 6 cents 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. 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. To ask a question, you may press the star, then the number one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Your first question comes from Greg 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 in 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 activities. So hoping you can comment on that as well as your view beyond the 150. 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.

Well, great. You know, the first question is, you know, they'll decide to appeal the law. It just came in today, Greg. The lawyers are reviewing all the information, and if they see flaws that we believe we could overturn it with, then we would appeal it. We believe our case is even stronger on the merits of the case from the very beginning. We had a very strong process argument, but our goal isn't to try to stall it. Our goal is to resolve it, win it, and do what's in the best interest of shareholders. If that ultimately was a settlement that we thought was in the best interest, then we would consider that. and yes, there's precedent for doing that. As it relates to the share buyback, it was surgical in nature. I wouldn't say it was done to be symbolic because we give out management shares over the past couple of years and we were experiencing some dilution and shareholders shouldn't pay for that. So we went ahead and are sort of leveling that back and resetting that. but I will tell you when we were talking about it at this value which we believe is that the shares are very inexpensive, it was a good time to do it.

Thanks.

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

Thank you.

Thank you. Your next question comes from Chris Shout from JP Morgan. Please go ahead.

Great. Thanks so much for the questions. Just two for 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 just 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? It sounds like some of those benefits you think are going to be sustainable, but I'm trying to get color on just pushes and pulls as we think about how to look forward to 2021 and what's a reasonable baseline.

My second question... Yeah, I think that, you know, Chris, if you look at the businesses in totality coming out of going into the fourth quarter on any kind of movement or surge-related demand or pantry loading, I think that's kind of all washed out. Now, it hasn't washed out by division, But I think that, you know, sort of the pluses you got from CSCA early on in the year or have been offset by CSCI and the RX-based business, especially early on when doctor's offices were closed. And, you know, there was some albuterol early orders that were during the height of COVID, but those have been kind of offset or have been entirely offset by the The recall. So I don't think there are any lasting effects of one time. I mean, we set up this year with plus 3% organic growth target, and I think it's going to come in a little bit better than that. We're at around four on the consumer businesses, a little north of four now. So maybe we beat our 3% number by a bit, but not a lot. Where I do think there was a meaningful change is the behavior and shift in channel shifting from e-commerce to, or excuse me, from brick and mortar to e-commerce was a very big one. And based on the McKinsey study, I think what's helping our businesses around the world in store brand is a meaningful and accelerated shift of branded to store brand. And those are fundamental and should be sticky going forward. You know, listen, whether we're lucky or not lucky, we made big investments a few years ago before I even got here in e-commerce and our market shares are much higher. And I hope you could, you know, I did a good job of illustrating that in that slide of the difference in Omnichannel versus just pure IRI Moolah, which is your traditional brick and mortar. And you can see how the trends change, not only from negative to positive, but a big shift to Parago. I don't see that going away.

Perfect. Very helpful. And maybe just on just the topic of investments, I know you've made a lot of investments since you joined the company kind of getting it ready for the growth targets you're looking at. Are there any more major investments we need to think that Parago has to make at this point or do you think you've got the kind of infrastructure where it needs to be and now it's just kind of execution as you mentioned kind of Loading in the bolt-ons, et cetera. I'm sure in a sense of like is there another like big push on expenses we need to think about at any time in the near future? Thanks so much.

The answer to that, if you sat in all the budgeting sessions that we're going through right now, I've drawn a – I basically have said to the organization, I gave you two years, gave you the investments, that added $50 or $60 million in total to our P&L and that's the cap. Now I'm not saying we won't continue to invest but those should generate either into brands that generate sales and move out of that area but that that pool there is not going to be a negative P&L hit going forward as a result of further investment on top of that. That's kind of our renovation budget that we will stick with and at some point hopefully that goes down. Now I'm not saying, and I don't see any big one next year, but I'm not saying a couple of years from now when we launch an As and X or something like that that comes with revenue and profit, you could invest in advertising and promotion because it's a branded launch, but I don't think that's what you're asking. I think you're thinking of it the same way that I am, that these investments that you were adding without being tied to revenues or operating profit and So no, those need to, as part of my chart there, and I'm not sure we left it on that algorithm chart I showed as a slide, but part of getting margin expansion is holding the line on operating expenses. Great, thanks so much.

Thank you. Your next question comes from Amy Fadia from SBP Lorin. Please go ahead.

Great, thanks for the question. Marie, can you talk about your confidence level in driving 3% top line and 5% off in growth next year? And especially on the top line with the 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. 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. 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, etc. But on the core premise for the long term, it's still intact and and I'm quite confident on the consumer businesses. But I can't even tell you if Albuterol is back yet in the first quarter, 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 Herago 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?

I've seen enough of the plans for next year that it is a significant driver. I can't give you the specific numbers. That's more of an investor day type of discussion, but we probably pushed up our plans for a year. We don't see that pulling back. There's been a lot of discussion internally and externally of the surges all and shift. Will that return to normal levels? and I think given the investments you're seeing with our top customers and I've been in top to tops they are all you know whether it's the Walmarts of the world or Targets they are making big bets on on e-commerce and and believe that shopping behavior will continue and not only is our investment and it's significant in the amount of people you know that it takes to run a digital e-commerce group we don't just ship product you've heard me say this before we're doing The analytics, the marketing of it, the comments, the promotions, it's a very big effort and Perigo has a unique capability and competitive advantage of that. And we're continuing to do the things to keep us ahead. But besides all that, we have a product line that also lends itself well to it because it is the regimented categories that really seem to be the ones benefiting. So it's less if somebody is If they get sick at the moment, they want to run to the store and get something right now. But when you're buying allergy medicines consistently over time, nicotine replacement consistently over time, it's those kind of regimented digestive health products over time. And those are where we have our highest shares. So that's sort of the double benefit for us. We are counting on e-commerce with the way we're doing it today, further growth all the way to one day looking at even more advanced opportunities. I always describe e-commerce separately than digital because they're not the same thing. E-commerce is just what most people think of today, but digital goes all the way to digital to consumer and a much broader use of technology. That is, it will be a driver for sure. But again, I'm not going to break out components of 2021 yet. I want to finish 2020 strong first.

Got it. Thank you.

Thank you. Your next question comes from Randall Stanicki from RBC Capital Markets. Please go ahead.

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

Well, you know, the organic growth has been ahead of schedule and stronger than I thought. So, you know, what boosts organic growth? I think, you know, I'm trying to remember the organic number from last year to the year before, but it was CSEA was up something like, I want to say something like 7%. It was up a relatively big number. But, you know, the premise on getting into oral care was to buy brands that were accretive to revenue growth, and that's just what they were, and that we could build onto. And Dr. Fresh, we think with the investments we'll make there, that'll be accretive. The entire wave of OTC to RX to OTC switches, which like a Voltaren was not contemplated back a year ago when I was standing out, or a year and a half ago in May, I think I had a zero in there for RxOTC switches. Now there's a whole host of them in the Advil dual combination products and at least in process a few years out with Cialis and Tamiflu and others. That's a big number that can accelerate organic growth. In nutrition, we needed to get quality and service fixed. We've made big investments and That'll take a couple years to implement, but just getting capacity expanded with a reliable product that we can service all the time and begin to promote again, as well as new product launches we have next year is another area for growth. Another area for growth is something I've talked about before, and Rich Sirota, who I'm going to get on one of these future calls soon because he's passionate about this, and I think you'd enjoy hearing from him, has had a lot of success in his history and we're seeing other success from others in the whole customized brand solutions for major customers. So it's a trend that's starting to emerge that's almost an evolution of store brands. So if you think in the world of private label, it was just sort of black and white to own brand to store brand where they're really marketed and brands like Equate are some of the biggest brands, if not the biggest brands United States. Now you see a trend on customers like Target where they're developing exclusive brands that are that are branded products not the store brand but only available to them and other major consumer packaged goods manufacturers are looking at that and we are we think we're uniquely capable to to satisfy that given our ability to handle complexity and unique products all the time and and again that would be an opportunity for for higher margins. So, you know, growth isn't the problem here. You know, growth isn't the challenge. I got to get rid of, over time, I got to get rid of the overhang. And by the way, I'm not even, you know, I can't comment on your first question. But growth isn't my concern on the businesses. Growing, growing profitably. We had some margin erosion. Some of it No big deal. Some of it was self-inflicted because we put society ahead of ourselves, and CSCA is just growing so fast that it diluted a little bit of margins. But there's still a gross margin opportunity. And on Project Momentum, we started with operating expenses. We're benefiting from that now. We'll benefit more from it next year. But we can do a better job of gross margins, and we're deep into it right now. And the street was right to point it out. and that's an opportunity as well so you know we've had two solid years of growth between that and the bolt-ons and there are plenty of bolt-ons out there as well between the bolt-ons and the new initiatives and OTC switches we there's just nothing but upside we just have to go after it profitably get our margins up and get rid of this darn overhang and and do it responsibly

All right, thanks, Murray.

Thank you. Your next question comes from David Rising from Morgan Stanley. Please go ahead.

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'll have an easy comp next year, but any more color on how we should think about Rx prospects? Thanks so much.

Yeah, on the Rx prospects, what I'm referring to is Something we talked a lot about is that the new product pipeline had kind of dwindled as so much energy in RX was focused on albuterol. So that was kind of the big push for a number of years when the history of RX had been that it was many singles and doubles. and what I'm excited about when I see my Rx team present their plans is the number of approvals that they've been getting and the number in the pipeline and expected approvals which is at a step change from where it's been over the past few years. And I think you'll see it start to play out next year and really even more in the year after that. And next year I do think you're correct absent what happens with Albuterol I think you have some easy comps in the earlier part of the year, and they've got some other areas of opportunity they're working on as well. We're not pulling back on RX. I mean, it's an important business. It generates a lot of cash, and we have not pulled back investment, and we have given them the resources to grow the business. And it's unfortunate what happened this albuterol because it colored some really great success they were. This was going to be a hero year for them, but they'll bounce back. First part of your question again? Oh, yeah, the US tax. The Athena tax of 800 and however much million dollars it is, we've talked about before that that is basically taxing, it's a different kind of tax, but it's addressing the same income that Ireland is. And there is an agreement between Ireland and the US that you wouldn't do that, that you wouldn't double tax. And if there is a dispute between the two, there is this authority that you go to, and Ray mentioned the specific name of it. What's the name of it, Ray?

M-A-P, it's called M-A-P. Just blanking on what it stands for, but it's a special commission that adjudicates disputes of this nature, and they've agreed to take it and review Which country would be the one to tax the income?

Right. So I think the important part of it is we submitted it. We believe there was a conflict, but they have to review the criteria. And this commission that stands between the U.S. and Ireland that would then negotiate it and debate it out, they accepted it in August. So that's the news there. And from our perspective, it could make it go away or it could make it, the overall combined one might be a deduction against the other, but it should bring the total down significantly. So it's hard for me to quantify, but my belief then, I think our lawyer's belief is that just took out a chunk of the overhang. I just can't tell you from where. from which authority. That's a battle between the US and Ireland now.

Understood. Thank you very much.

Thank you. Your next question comes from Elliott Wilder from Raymond James. Please go ahead.

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 Perigo. and whether or not there are categories there that are still significantly underrepresented relative to Perigo's existing base that might provide for you know significant immediate growth opportunities outside of just sort of increased usage by consumers of e-commerce means of purchase. And then question for Ray, I won't profess to have the strongest working capital projection skills on 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 Will 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.

Do you want to do the second one and then I'll come back to the comments?

Yeah, I mean, on the cash conversion, we did have a lower cash conversion rate in the third quarter. and we said that was really due to the timing of the sales, the way they were spreading in the second quarter and the impact of the COVID-19 surge and what that did to our receivables. I think we do generally achieve a little over 100% cash conversion and I think that's where we'd like to target and I think that that's where we would I think we're going on a go-forward basis, but we're not doing a precise kind of guidance for cash conversion quarter by quarter.

Yeah, and I think going back to on a worldwide consumer basis, I think e-commerce is about 8% of our total sales and growing, I think it was, I said in my comments, 142%. in the US and the Americas business and it was up in the high 40s in the European business and CSCI International. I think the growth opportunities are different. Internationally, when I talk about e-commerce and it's already a meaningful part of our CSCI brand, we think of e-commerce as a very, if you're, I don't know how familiar you are with our portfolio, but we tend to be a string of pearls, a lot of regional brands and to go and try to make those big mega pan-European brands is unlikely but it it gives us an opportunity to to address the entire European market as we broaden our e-commerce business and through like the Amazons or the Amazon of Europe is a significant opportunity and potential growth accelerator for that business and even though it's a pretty meaningful number now it's actually only in It's limited in the number of countries. So we're probably still only in a handful of countries with meaningful e-commerce business in CSCI. So that is, when we look at the strategic plans for CSCI, that's a big growth driver. When you go to the US, we've had tremendous success. And I guess there's two ways to look at it. You're looking at what other product categories, and there are plenty of them. I look at it in the penetration of e-commerce versus branded or store brand versus branded in e-commerce versus what it is in traditional brick and mortar and it's well below so I think there's a very significant penetration opportunity and if you can bear with me for a second imagine yourself walking into a traditional brick and mortar store you know you go to buy your OTC product you're faced with a side-by-side comparison right so you can see um and you that there is a 30 40 50 60 sometimes 70 percent discount versus the national brand when i'm sitting at home and i go online and i do a you know either a click and pick or i um i do an instacart order or whatever that might be if i type in the brand in the beginning you would only get the brand if i typed in ibuprofen i'd see all the options and that's an example of when I say we've invested in e-commerce so that we can work with our customers to show that when somebody clicks on that and to present the alternative with the price comparison, what the savings could be so that you build that penetration up over time. So we're attacking it from all angles, but I would say as big as it's been right now, it's still relatively underdeveloped and it's certainly underdeveloped versus store brands. I would say the national brands today have a bigger share than we do of their portfolios. Does that answer your question? Are you still there?

We lost the line.

Thank you. Your last question comes from David Steinberg from Jefferies. Please go ahead.

I thought we lost the line there for a second. Okay. Hi, David.

Hey. Hey, thanks. Thanks. I have two questions. The first one is on acquisitions. Mario, in your last quarterly call, you implied that Perigo is taking a near-term pause from bolt-ons. You just completed Dr. Fresh and Stereopod and called out the fact that People in the company hadn't been able to travel to complete due diligence and consumer multiples were high. Has that changed? Are you still in sort of pause mode because you can't travel to complete due diligence and multiples are higher? Are you starting to go back on offense? And my second question perhaps is for Ray. Coming back to the RX business, gross margins have declined. I think they were 42% in Q1, 39%. Last quarter, 37% this quarter. And you called out the fact that the decline, the 39% to 37% decline was solely due to the recall of ProAir. So I was wondering, is the baseline gross margin really 39% or should we expect continued softness until ProAir resolves itself? Thanks.

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, 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, the skincare products. and now we are evaluating many. I would say it's loosened up dramatically. There's a number of opportunities. I can't predict when we find one that's the right value and the right price, but we are clearly digging in again.

On the RX gross margin, the decline in the third quarter, as I think I said, is pretty much all attributable to the albuterol recall. It's kind of a complicated, because we share the profitability with Catalan, so it had a real adverse impact on our COGS. It came into our COGS costs and hurt our margin. I'm not really the guy to the specifics of the Q4, but I think we don't expect that that particular Mata would have any impact on Q4. In other words, the butyryl recall costs would all 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.

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. What they've accomplished in 18 months has been remarkable. Perigo is a very different company with a very different growth profile. We've had a couple bumps. We'll work our way through those. 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 and delivering on our promises, which we hope we are building credibility because of, will ultimately generate the appropriate rewards. And with that, I thank you for your interest in Parago.

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