Elanco Animal Health Incorporated (ELAN) Q1 2019 Earnings Report, Transcript and Summary

Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Elanco Animal Health 2019 Guidance Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Jim Greffet, Director of Investor Relations. You may begin your conference.

Thanks, Chris. Good morning. Thanks for joining us for Elanco Animal Health’s conference call to discuss our 2018 and 2019 financial guidance. As Chris mentioned, I’m Jim Greffet, the Head of Investor Relations. Joining me today are Jeff Simmons, our President and Chief Executive Officer; and Todd Young, our Chief Financial Officer. During this conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on Slide 2 and those listed in our IPO prospectus filed with the SEC. The information we provide about our products and pipeline is for the benefit of the investment community, it’s not intended to be promotional and is not sufficient for prescribing decisions. You can find our press release and the slides referenced on this call on elanco.com. We’ll continue to use our site to distribute important and time critical company information. The slides and the press release also contain further information about the non-GAAP financial measures that we discuss during this call. I’ll now turn the call over to Jeff.

Thanks, Jim. I will provide an update on our trajectory for 2018, as well as some important assumptions we are making for 2019. Then we’ll have Todd discuss our overall financial expectations for next year. As a reminder, we are executing on our three pillar targeted value-generating strategy: portfolio, innovation and productivity as shown on Slide 4. Elanco is driving the growth of our marketed portfolio of products, where we can lead and can grow. We’re delivering a sustainable flow of innovation, launching multiple new innovations again in 2018. Finally, we’re executing on our productivity agenda to drive significant margin expansion and unlock value, as evidenced by our restructuring actions this quarter. Our strategy is sound. We have the foundation we need and we’re in execution mode to deliver. Slide 5 provides an update of our outlook for 2018 with a number of recent actions on the productivity front. First, we have made the decision to exit our physical presence in 16 countries and transition these markets to distribution arrangements. We described our intent to make such a change in our IPO filings and we’re moving forward on schedule. Second, we continue to reduce investment and headcount in certain areas of the business in order to invest more aggressively in our targeted growth categories. We’re also streamlining and delayering our international operations to enable faster decision-making and bring our leaders closer to the customer. We have also written-off some idle and impaired assets as part of this restructuring and separation from Lilly. As we disclosed in our 8-K filings last week, we expect a charge in the fourth quarter of approximately $37 million from these actions, composed of $19 million in severance cost and $18 million in asset write-offs. We expect these actions to provide an incremental $0.04 per share in 2019, and payback of the restructuring costs in five to six quarters. We estimate that approximately 200 employees will be impacted. In addition to the restructuring, we’ve made an adjustment to the liability for contingent consideration and our collaboration with Aratana to reflect an increase in the probability of achieving certain sales milestones and royalties. As you may recall, our accounting approach for this collaboration uses this contingent consideration liability to reflect the estimated milestones and royalties to the partner. As we make cash payments, there applied against this liability. We review the liability each quarter and adjust up or down as necessary. The adjustments to the liability are excluded from our non-GAAP results. As a result of these actions, we are reducing our 2018 GAAP earnings per share guidance to $0.15 to $0.17. We are reconfirming our adjusted EPS of $1.14 to $1.16. Likewise, we continue to expect full-year 2018 sales in the range of $3.05 billion to $3.08 billion. Slide 6 provides a reconciliation of 2018 GAAP to adjusted EPS. Overall, we’re pleased with the progress we made in 2018. We’re meeting our expectations, achieving sales growth, delivering innovation, executing our margin expansion priorities and carrying momentum into 2019. As we turn our attention to 2019, Slide 7 shows important assumptions we are making in our financial projections. First, we have updated our prior thinking about the potential launch of a broad spectrum parasiticide in the U.S.. While competitive intelligence is not perfect in the animal health industry, we are not aware that a new entrant is eminent. Consequently, we have modeled the sales of our Companion Animal parasiticides assuming the current competitive landscape. Second, based on our interactions with the regulators in Norway, we do not expect to launch Imvixa in Norway in 2019. We continue to work with the regulators to bring this important innovation to that market as quickly as possible. As we learn more about the path forward, we’ll provide updates. We are also planning on initiating our dividend after Lilly exits their remaining ownership in 2019. Slide 7 also shows the 2019 exchange rates we are using for the five main foreign currencies that impact our sales. Before Todd provides the details, let me share some thoughts about our expectations for next year shown on Slide 8. On the sales line, we will track core Elanco sales separately from strategic exits, as those businesses we’re exiting continue to wind down. When we hold currency exchange rates consistent year-over-year, our projected 2019 core Elanco growth is 4% to 6%, continuing our solid growth trajectory. On the bottom line, there are some unique elements to consider in 2019 as an independent company, which Todd will discuss in a moment. On a like-for-like comparison across the years, we expect to grow 2019 earnings at a double-digit pace. Finally, in keeping with our goal to deliver on our promises, we have used a balanced approach in our planning, and we’ve incorporated our current understanding of the market into our projections. The assumptions I mentioned earlier reflect this balanced approach. With that background, I’ll ask Todd to walk us through the financial details for 2019.

Thanks, Jeff. Before we detail 2019 guidance, let’s turn to Slide 9, which provides greater insight into a number of underlying factors behind our EPS projection. Slide 9 shows the expected progression of adjusted EPS using the midpoint of our guidance ranges for 2018 and 2019. In order to show a comparable view across years, we start with the midpoint of our adjusted 2018 EPS. Because we have interest expense for only a portion of 2018, but all of 2019, we show a pro forma adjustment as we incurred interest expense for the entirety of 2018. Likewise, our tax rate as a segment of Lilly in the first-half of 2018 was more favorable than our standalone tax rate going forward. Thus, we have made a second pro forma adjustment to show a consistent tax rate across the time horizon. The resulting comparable 2018 adjusted EPS is expected to be $0.98. In the shaded box, you can see that the underlying operational growth and the benefits of the restructuring actions provide an expected 15% increase in adjusted EPS for 2019, well above the expected constant currency for revenue growth rate of 4% to 6%. Finally, we are projecting a foreign currency headwind of $0.06 per share in 2019, due to the strengthening of the U.S. dollar, compared to the prevailing exchange rates during 2018. With that background, let’s turn to Slide 10, which shows our guidance elements for 2018 and 2019. Notice on the revenue line that we have broken out our expectations for core revenue separately from strategic exits, we believe this will be helpful in understanding the dynamics of our business. For 2019, we expect total revenue between $3.10 billion and $3.16 billion. Excluding strategic exits, we expect core revenue of $3.04 billion to $3.10 billion. As Jeff indicated, from holding foreign exchange rates constant, this would represent core revenue growth of 4% to 6%. You can see that we expect strategic exit revenue to continue to decline year-over-year. GAAP EPS are projected to be $0.36 to $0.48, while adjusted EPS are expected to be $1.02 to $1.12. The project – the projected growth of adjusted EPS well above core revenue growth reflects the continued execution of our productivity and margin improvement strategy throughout our operations. Slide 11 shows the items removed from GAAP EPS to arrive at our adjusted EPS guidance. Our practice will be to exclude the amortization expense on intangible assets, as well as the stand-up expenses we incur as we build our capabilities as an independent company. We believe this approach provides a better view of our underlying performance. In summary, we are on track for a solid performance in 2018 and expect to carry this momentum into next year. We are executing on our targeted value-generating strategy and our productivity agenda is on track. Finally, we are building the capabilities and infrastructure we need as an independent company. This concludes our prepared remarks. Now, I’ll turn the call over to Jim to moderate our Q&A session.

Thanks, Todd. We’d like to take questions from as many callers as possible. So we ask that you limit your questions to two if possible or a single question with two parts. Chris, if you could provide the instructions for the Q&A session, we’re then ready to start taking questions.

[Operator Instructions] Your first question comes from Chris Schott of JPMorgan. Your line is open.

Great. Thanks very much for the questions. Just two here. Maybe the first one, you’re targeting, I believe 4% to 6% constant currency growth for the core business. Is there any additional color you could provide as we think about the growth across the four segments either specific numbers, it was rank order how you’re thinking about growth across those four divisions? And my second question was just walking through the P&L. How are you thinking about gross margins and year-over-year OpEx trends as we think about 2019? Thank you.

Thanks, Chris. I’ll be the bad guy for your first question on the greater detail of revenue growth, and then maybe, Todd, you can talk about the – some of the, at least, conceptual profile across the P&L. I guess, Chris, so we’ve been somewhat deliberate in providing the total revenue and the core revenue. You know that we have the four pieces of our business that we track: the companion animal disease prevention; companion animal therapeutics; future protein and health, which is poultry salmon and nutritional health products; and then finally, Ruminants & Swine. I think, I would characterize it this way. Our overall projections have been, as you know, that nosis [ph] is projecting Companion Animal growth entirely about 5%. When we look at that nosis across that salmon, nutritional and poultry, when we add those numbers together, it’s somewhere around 6%, and then a lower growth for Ruminants & Swine at about 4%. I’d say, our view of our portfolio, our pipeline and how we’re looking at the business overall, those growth rates still feel representative [Technical Difficulty] our business is operating. So I think, that’s a macro way of thinking about our growth. Quarter-by-quarter, year-by-year, there will be some variability, but we’re looking at this on a long-term time horizon. So we think that’s a reasonable profile of the underlying performance. We are reticent. Over time, we may become more disclosive. But as we work our way through the growing pains of being a public company, we’ll start with the core revenue, which we think is indicative overall. And if we’re able to provide more color over time, we’ll try to do that. Todd, do you want to talk a little bit about the P&L?

Sure. Well, we’re not providing specific guidance for the individual lines of the income statement beyond sales and earnings per share. We are focused on our productivity agenda and delivering on continued expansion of gross margin. And then on the OpEx side, as you’ve seen, we are leveraging 4% to 6% sales growth into bottom line, EPS growth that significantly faster than that. So we can assure you the we are focused on keeping OpEx low, while we do have some new public company expenses. For the full-year of 2019, we’re generally focused on capital allocation to invest in higher growth areas, while reducing capital areas with slower growth.

Chris, can we take the next question?

Our next question comes from David Risinger of Morgan Stanley. Your line is open.

Great. Thanks very much, and thanks for hosting this call. So I have two questions, and then I’ll get back in the queue. So with respect to the FX rates on Slide 7, could you let us know which date you calculated those on? And then second, with respect to Imvixa, obviously, it’s a very compelling product as a treatment for sea lice in salmon and trout. Could you just remind us, which countries you’ve already launched it in? And what other countries we should be watching that are pending approval besides Norway? Thanks very much.

Todd?

Dave, on the OpEx question, as we know, we’re trying to put forth numbers for 2019 that we believe are reasonable, obviously a year of $1.17 stronger than that now trading at about $1.14 the same on the pound, while the reals are little less than the four. And so, as you know, it’s a portfolio approach and these were rates we’ve assumed here. And obviously, we’ll be trying to manage the business with those assumptions going forward.

Jeff?

Yes. David, on Imvixa, you’re right, we feel very good about this product and sea lice continues to be a major issue in the salmon industry, as you know, costing them a lot of money. And this is one of the premier products in this space. It’s performing extremely well in Chile. We have an approval there in one of the larger salmon markets. We have submissions in both the U.S. and Canada, and they’re progressing nicely. And we won’t project on a specific approval, but those are in our plans. We do have a conditional license and do sell some in Canada, given the severity and importance of a solution to salmon farmers there. And then again, we’ve had good dialogue in a recent meeting with the Norway regulators and feel extremely good about one, the product and the dialogue and again, we’ll update you as we develop plans with them moving forward.

Chris, next question.

Great. Thank you.

Thanks, Dave.

Your next question comes from Umer Raffat of Evercore ISI. Your line is open.

Hi, guys. This is [Mike Fury] [ph] in for Umer. Thanks so much for hosting this call. Two questions, if I may. Number one, back in December, you had mentioned at the sell-side analyst day roughly – that there was roughly $215 million of additional manufacturing productivity gains to be captured through, I think, it was 2020. Just wondering how much of that $215 million has already been captured in 2018? And the second one is regarding generic Rumensin. It’s still coming in 2020, and by whom? Thank you.

Thanks, Mike. Todd, I’ll start on the savings question, and then we can move on. You’re right. So as we look going forward, a lot of the productivity and margin improvement strategy that we have, we feel good and optimistic about it, because we’ve identified the majority of actions that we think will produce the margin expansion, especially at the gross margin line. The $215 that you cited, I think is a fair representation of what we expect more longer-term. Importantly, about 85% of the things of the actions that are necessary to produce that savings have already either been identified or in execution mode now, things like the lean manufacturing strategy, consolidating CMOs, in-sourcing some work that had previously been done on the outside, a pretty rigorous procurement agenda and so on. We haven’t quantified the specific amount year-by-year. I can say that we’re on track. So we’ve yielded the savings that we had anticipated. I’d say, if anything, we’re maybe a little bit ahead of schedule from the internal goals that we had. And we would expect that with the continued progress of the things that are underway that $215 should still be unachievable endpoint. Jeff, do you want to talk about the…

Yes, Mike, your question on Rumensin. So what we would say to start is no change in our assumptions that at this point in time in our model, no change at all. And I would also say that, we’re not going to project or point to one specific company. What I would say is, our lifecycle management plans and the continued focus on this franchise and the portfolio that surrounds Rumensin continue to be a focus by our team. And we feel very good about the performance in 2018 in that portfolio area and have some very nice plans for 2019.

Great. Thank you.

You’re welcome. Chris, next question?

Your next question comes from Erin Wright of Credit Suisse. Your line is open.

Hi, thanks. I have a couple of questions here. How would you characterize the underlying fundamentals across the live stock market right now? And what’s embedded in your expectations? And could you give us an update on like African swine fever, as well as some of the dynamics in the U.S. dairy market? And then the second part of my question is, how should we be thinking about the quarterly progression in terms of the top line growth, as the comps get a little bit tough – tougher here in the second-half. Are there any major quarter-to-quarter anomalies such as whether seasonal aspects in the flu and tick season have normal stocking from distributors here in the first quarter or product launch timing? Thanks.

Great, Erin. Jeff, do you want to talk about the overall food animal landscape and some of the things that we’re seeing?

Yes. Thanks, Erin. So, a lot of factors at play here. But what I would say is and again, we’ve got a global business. So, probably a lot of my comments will be noted to livestock in the U.S. But I start with a reminder that, our food animal business is very diversified. It’s larger as a percentage internationally as it is in the U.S. So, that’s a good factor. I think the other thing Erin that I would say and our team’s done a nice job. As we’ve changed our portfolio, we have a higher percentage of our food animal portfolio focused on therapy and treatment of disease and typically, productivity products get hurt more by the economics. So I start with the most important comment, I’d say, we don’t see a material impact overall globally on our business. We think the ups and downs are definitely there as they always are, but we also think we’ve got a portfolio that’s more resilient to some of these economic swings. Now specifically, I think, as you look at the livestock market here in the U.S., I think all of them are starting to face a little bit of challenge. There is also a little bit of the speculation on trade. So I think we’ve got to keep our eyes as we go into 2019 on trade. We feel good about the dialogue with Mexico and Canada and even some of the noted potential with China. But again, I think, we have to watch that closely overall. We have not noted in our assumptions from an environmental perspective that the dairy industry situation changes. They’re challenged right now. There are a lot of projections it gets better in 2019, but we’ve not projected that and again, dairy is a smaller part of our livestock business as we go forward. Specifically to African swine fever, it is something we’re all monitoring and watching. It is a serious situation. It is going to have an impact on the numbers of animals without question. Our focus right now is to assist as an industry player on the whole biosecurity area. We are working on and assuming that there will be less pigs and that market will be impacted. And our focus right now is on looking at other interventions across Asia, as well as our global pig business to counter that. So no material impact on Elanco we see in 2019, but something we’re going to monitor closely as we go into the beginning of the year. That’s probably the number one livestock issue from a disease perspective that we all need to keep our eyes on. And we’ll know a lot more, I think, as we get into that February time period.

On the seasonality, it’s a good question, Erin. And one of the things that I think you saw us do in the third quarter call, in an animal health business like ours where we have so many products across so many species and so many countries, there tends to be some lumpiness quarter-by-quarter that we should think about. Starting in just the overall seasonality, especially in the Companion Animal area because of the North American flea and tick season, those products tend to be more heavily weighted to the first-half of the year, maybe even in the second quarter less so in the second-half of the year. In our livestock, in the food animal portfolio, I’d say, as Jeff had mentioned, a lot of those are fundamental therapies and treatment of disease that tend to be more level throughout the year. There’s perhaps less lumpiness. We do maybe see a bit of cyclicality into the second-half of the year in the poultry area just because of the way producers rotate through products and the enclosed housing that we have during the cold winter months and the burden of disease that creates. So I’d say, those are probably some macro trends that are fair to think about in general in looking at our business quarter-by-quarter. Then relative to maybe specific comparisons, maybe something to consider doing in the Q3 earnings deck, the last few slides, we show bar charts of current year, prior year quarter-by-quarter. And those do highlight some of the oddities that we’ve seen in individual quarters within 2018, which is the fair comparison going into next year. And recall in the third quarter call, we had some discussion of movement across quarters this year because of some license renewals or overall stocking or purchase patterns. So I think, those – when you see dramatic changes in those bar charts, those highlights some of those anomalies that we’ll have to consider our commitment. Well, two things. One, our commitment is that in the quarterly call, we’ll do our best to highlight things that are exceptional circumstances to help characterize the results for that quarter. And then the second one, we look at our business on a long-term horizon, so it’s important to think about a quarter in a larger context. We think about growth over time understanding that there could be a lumpiness in a quarter-by-quarter. So putting that into the larger perspective will important – be important for investors to understand the real trends in the business. Chris, next question?

Your next question comes from Michael Ryskin of Bank of America Merrill. Your line is open.

Hey, guys. Thanks for taking the call. A couple of quick questions on the top line, and I want to switch to the balance sheet. One, on the triple combo that you guys – that you’re not expecting in 2019, you mentioned that the competitive intelligence isn’t always perfect. But I was wondering if your assumption that you had walked us through in the August/September timeframe for 2020, 2021, if that just all got pushed back one year or if there is any change to your longer-term thinking for what triple combo will do to your portfolio going forward? And then I have a follow-up question on the balance sheet.

Okay. Jeff, do you want to talk about…

Yes, Michael, there’s no – to us, there’s no change relative to what we see, feel very good about our parasiticide portfolio, again, Credelio, Interceptor Plus, Trifexis and offering that going forward. And again, this is just simply, as I stated, given the competitive intelligence, this is the assumption we believe is the best one to go. And if something changes, we’ll let you know. I also think, I would just remind that, even when a product does come to the market, as we’ve mentioned on the road show and Aaron did at the last call. He got to look at that product, look at a few things, coverage, safety, overall label and efficacy. So even a new product that does come, those factors will come into play. And that’s why we believe we’re well-positioned competitively, but again, this is a delay in that assumption.

All right. Thanks. And then the follow-on is, since the IPO process in August/September, interest rates have ticked up pretty dramatically higher now. Consensus is going to move even further in 2019. You’d emphasized that you’re going to delever pretty aggressively in the first couple of years and sort of bulk of your capital deployment is going to go. Is there any opportunity to take that to accelerate that even further, particularly given some of the restructuring that you’ve put in place in the fourth quarter?

Michael, thanks for the question. Generally, most of our – that’s fixed rate, so moving interest rates doesn’t have as big an impact as it would be if we were in a lot of floating right debt. The term loan we have said, we’re going to try to get that repaid as quickly as we can with free cash flow. Generally speaking, the restructuring will take about $20 million of cash, which will have more impact in the first-half of 2019 with the severance, but then has a pretty quick payback over the course of about five quarters. And so it won’t affect kind of that intent on the debt repayment. But it also won’t provide a lot of cash on an immediate basis to do it faster. And then just as a reminder, we do have the stand-up expenses to get all of our independent company back-office work established, including the implementation of an ERP system. And that will take more capital here in year one that’s just part of something we have planned for as part of that overall balance sheet work. But we are very focused on a cash flow going forward, as well as our CapEx spend.

Great. Thanks.

Chris, next question?

Your next question comes from Liav Abraham of Citi. Your line is open.

Good morning. Two quick questions. Firstly, can you confirm that your expectations for the tax rate in 2019 are around 22% within that range? And then secondly, I noticed on Slide 5, the – you detail the Q4 contingent consideration adjustments. Can you just remind us of your expectations for Galliprant growth going forward? And any comments that you can make on the trajectory of this growth? Any thoughts on – your updated thoughts on peak sales for this product to the extent that you can provide? Thank you very much.

Todd, do you want to talk about tax rate?

Sure. As we show on Slide 9, the – doing the comparable 2018, we showed the expected tax rate of 22.4%. That’s generally our expectation in 2019 for full-year as well.

Incidentally, you can also see that in the waterfall, where we make those pro forma adjustments to 2018 for the like-to-like comparison. You can see that we – there’s sort of an implicit admission of a 22.4% tax rate being a better comparison. On the contingent consideration adjustment, Liav, Jim, I’ll start with some thoughts and then maybe Jeff can talk about overall thoughts on the product and the innovation that that’s brought to the market. As we discussed in the prepared remarks, with the accounting, we’re required to look at the overall trajectory of the product each quarter and understand what that would mean for future royalties and milestone payments. I think in the Q3 call, Aratana talked about the total of the additional two milestones that are pending. We haven’t quantified the amount of each individual one or the underlying trigger. I think in general, when you have the expectation of the liability going up, that bodes well for the underlying performance of the product. So we see that it’s continuing to do well with the relaunch of the 100 milligrams that we talked about in the third quarter call, that’s adding another presentation that we think is advantageous to the market. So we’re pleased with things. So that’s probably the level of detail where we’ll stop. We haven’t talked about peak sales expectations for the product. But all else equal, they’re probably a little bit better now than they were before with what we know today. And as Jeff had mentioned, we increase or decrease the liability with the way we see the product performing. In this case, it’s looking positive. Jeff?

Yes, I think you’ve captured it, Jim. I mean, we feel very good about, I think, I would broaden it out even to the overall pain and osteoarthritis franchise. I mean, as we’ve said, we continue to be a leader in this space. We’ve got one of the largest portfolios. We’re globalizing that portfolio. Galliprant is one of the, of course, lead products in here, with Galliprant specifically as part of this lifecycle management, as Jim mentioned, launching in Europe in January. We’ve got the law – larger dog SKU that we’re bringing in the U.S. So we talked about on our last call, and then we just got the continuation of adoption in the U.S. and other countries outside of even Europe and the U.S. So we feel very good, but I keep coming back to be a leader in pain and osteoarthritis that Elanco wants to be. This will be a product that will help enable that, and that’s where our focus is right now, not only are on the front lines with veterinarians, but also back in our labs and in our pipeline as well.

Thank you.

Chris, next question?

Your next question comes from Kathy Miner of Cowen & Co. Your line is open.

Thank you. Good morning. Just two questions. First, on the restructuring that you talked about, it’s on Slide 5, can you tell us if the – what the number of distribution markets versus direct market is? And is this completed, or would we expect to see more transition in 2019? And the second question, have you provided, or do you have a targeted timeframe for when you expect the stand-up expenses, including a new ERP system to be completed? Thank you.

Thanks, Kathy. Jeff, do you want to talk about the movement across markets?

Yes, Kathy. So again, we – we’ve highlighted and we did even out on the road show that we’re going to continue to focus on the – presence in the current number of markets that we’re in today is not going to change, but the people in those markets and the product and the representation is going to continue to tighten and focus. So this exiting in the 16 countries aligns with what we’ve shared and we’re just executing as planned. And again, we will use partners. We’ll use distributors that we believe can represent our product and can continue to keep our franchises very viable in those markets, but create the efficiency that really allow us to focus back on the main markets.

And Kathy, with respect to the stand-up expenses, those will be incurred over the – most of which will in 2019 and 2020, can go a little bit into 2021. But we have TSAs with Lilly and have plans to exit the TSAs every quarter going forward, as we stand up our own internal capabilities and then no longer need those resources. So that’s the general timeline is over the next two years.

And Kathy, you asked, I didn’t answer the one question on that – on these markets when that’s happening. That is in progress now. It varies a little bit across those 16 countries, but I want to answer that specifically. It’s – it started in a lot of places, and our intention is to have all that executed in 2019.

Great. Thank you.

Chris, next question?

Your next question comes from Kevin Ellich of Craig-Hallum. Your line is open.

Good morning. Thanks for taking the question. I guess, you talked a little bit about the balance sheet and uses of capital. But can you go over your capital allocation strategy again, and I guess, if anything’s embedded in 2019 for external growth assumptions such as M&A? And then a lot’s been talked about here already. But in the near-term, we’ve seen some really harsh weather come across the Carolinas, which is a big swine market, one, and we’ve had a lot of warming weather in the upper Midwest, as you guys know. Wondering what sort of impact you guys might be seeing in those markets due to the weather? Thanks.

Great. Thanks, Kevin. Do you want to talk about capital allocation overall, Todd? And then maybe, Jeff, you can talk about M&A and the thinking overall in business development.

Sure. With respect to cash deployment, we’re obviously looking to optimize OpEx investments to drive growth, especially in the Companion Animal franchise that we’ve spoken about previously. And then we’ve got a commitment to reduce our third-party debt. As you know, we are split rated with the investment agencies and want to get to investment-grade with the agencies and that’s our intent over the course of the near-term is to make sure we meet those commitments on the debt pay down.

That’s a good segue to think about how we think about external innovation as well, Jeff.

Yes. I think, our focus is, as we’ve said is, our plan – I can continue to re – want to reemphasize the plan that we’ve laid out going forward as we’ve launched this company. It’s not dependent on business development and our focus is executing the current pipeline that we have, and this large portfolio that we’re launching right now. That’s where our resources, even the resources from this restructuring are going, as Todd mentioned, and then we’ll continue to do as we have done and you’ve heard us announce like with the Novozymes deal last quarter, as we’ll continue to look at late-stage licensing is probably our priority relative to any activity in this space. On the comment on weather. So variation usually does cause stress on an animal. So I’ll kind of rise up and say, respiratory and enteric disease or ruminant – ruminants are the challenge. Respiratory probably the most. So any variation, as you mentioned, the North Carolina or the Midwest, swine respiratory, cattle respiratory continue to be areas that are definitely in our space, our portfolio. And again, we’ll take a vet-centered approach. We’ve got our teams in the play – in play right now out there with our producers watching. Right now, I wouldn’t say, we see anything material in terms of variation. I think, we got to keep our eyes on with all the the weather variation, as Jim mentioned. I think the tick and flea season in the spring is something we just want to keep our eyes on. I don’t want to project what the weather could be, but a warmer spring could or a colder start to the spring may have an effect relative to the adoption rate of parasiticides in the applications, that some we probably watch for first and foremost as we come into the New Year.

Thanks, Jeff.

Chris, any more questions?

Yes. Your next question comes from David Risinger of Morgan Stanley. Your line is open.

Yes. Just a quick follow-up please. So it wasn’t clear to me from a question that was asked earlier. Is there a certain time in 2020 that Elanco is now assuming competition from a broad spectrum parasiticide? I think somebody said, September of 2020, I wasn’t clear on that.

Yes. We – we’re going to assume that it’ll be in the beginning of the year and we’ll assume the impact of it laid against the year as a whole. And again, we’ll keep you updated as we progress forward.

Okay. But you would assume early 2020 for the flea and tick – ahead of the flea and tick season?

Yes, we would.

Make sense, okay.

Keep in mind, we’ll always reserve the right to get smarter. So our goal here is to talk about 2019, and so we’ve made the assessment that we have with imperfect information. As we learn more through 2019 and into 2020, we’ll, of course, will take a – take stock of what the competitive landscape might be then.

But again, I think I’ll come back, David, as we’ve shared that we want to take this balanced approach. And so, yes, assuming it for the full-year and ahead of the tick and flea season is the assumption that we will make. But again, this is again focused on 2019 guidance now.

Great. That’s very helpful. Thanks, again.

Thank you.

Thanks, Dave. Chris, do we have any more questions?

Your final question comes from Michael Ryskin of Bank of America Merrill Lynch. Your line is open.

Yes. Just another quick follow-up as well. On the strategic exits, the $60 million expectation for 2019 pretty big step up versus what we previously talked about. Is there anything in particular that you can call out whether it’s one of the distribution products or what’s really taking longer there to wind down? And what’s the flow through to the bottom line on that relative to the prior expectations? Is there any boost earnings from that?

Yes. So, Michael, just quick, like Jim can close the question here. But this is actually the inclusion of the human growth hormone that we actually make for Lilly in one of our sites that we mentioned out on the road that we’re totally disentangled on the manufacturing front with one exception. That exception is this product. So as we leave Lilly, we actually are the contract manufacturer of this product for them, and that will wind down as well going forward. Jim, I don’t know on specifics on that.

Yes. So consistent with – I mean, we’re trying to be philosophically consistent there. So that is another contract manufacturing arrangement that we’ll have for a transition period of time with Lilly. And recall, the strategic exits we have some other contract manufacturing arrangements, as well as some distribution agreements, largely that were a function of the acquisitions we’ve done in the past. Those types of businesses are both not part of our strategy, but also much lower margin typically than the innovative work we’re doing with our portfolio innovation and productivity strategy. So the flow through to the bottom line, you would expect that there’s much less profitability on those sorts of activities than the core work we’re doing with therapeutics and the like. So while there is an increase in strategic exits from the manufacture of human growth hormone in 2019, there’s not a corresponding big lift to the bottom line as well. That’s why we also wanted to start providing the split guidance. So you can understand core revenue versus the strategic exits. Chris, I’ll pause and confirm do we have any more questions in the queue?

There are no further questions, sir.

Great. Then Jeff, do you want to offer some closing thoughts?

Yes. Thank you for the great exchange today. We want to thank you for your time and your interest in Elanco. We are pleased with our results and momentum we’re carrying into 2019. The fundamentals of our industry are strong and our strategy sets us up to grow revenue, expand margins and bring new innovation. Our focus is on execution. We have prioritized our resources to our growth opportunities, and we’re building the capabilities we need as an independent company. If you have any questions we didn’t answer, please reach out to Jim and have a wonderful holiday season. Thank you.

This concludes today’s conference call. You may now disconnect.