U.S. Markets open in 5 hrs 23 mins

Edited Transcript of ELAN.N earnings conference call or presentation 6-Nov-19 1:00pm GMT

Q3 2019 Elanco Animal Health Inc Earnings Call

Nov 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Elanco Animal Health Inc earnings conference call or presentation Wednesday, November 6, 2019 at 1:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Jeffrey N. Simmons

Elanco Animal Health Incorporated - President, CEO & Director

* Jim Greffet

Elanco Animal Health Incorporated - Head of IR

* Todd S. Young

Elanco Animal Health Incorporated - Executive VP & CFO

================================================================================

Conference Call Participants

================================================================================

* Balaji V. Prasad

Barclays Bank PLC, Research Division - Director

* Christopher Thomas Schott

JP Morgan Chase & Co, Research Division - Senior Analyst

* David Michael Westenberg

Guggenheim Securities, LLC, Research Division - Analyst

* David Reed Risinger

Morgan Stanley, Research Division - MD in Equity Research and United States Pharmaceuticals Analyst

* Jonathan Marley Kaufman

William Blair & Company L.L.C., Research Division - Associate

* Kathleen Marie Miner

Cowen and Company, LLC, Research Division - VP

* Kevin Kedra

Morgan Group Holding Co. - Research Analyst

* Kevin Kim Ellich

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Michael Leonidovich Ryskin

BofA Merrill Lynch, Research Division - Associate

* Nathan Allen Rich

Goldman Sachs Group Inc., Research Division - Research Analyst

* Prakhar Agrawal

UBS Investment Bank, Research Division - Equity Research Analyst of Biotech and Pharma

* Umer Raffat

Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Analyst of Equity Research

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for standing by, and welcome to the Elanco Animal Health Q3 Earnings Conference call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker, Jim Greffet, Head of Investor Relations. Thank you. Please go ahead, sir.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [2]

--------------------------------------------------------------------------------

Good morning. Thank you for joining us for Elanco Animal Health's Q3 2019 Earnings Call. I'm Jim Greffet, Head of Investor Relations. Joining me on today's call are Jeff Simmons, our President and Chief Executive Officer; Todd Young, our Chief Financial Officer; and Katy Grissom from Investor Relations.

During this call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on Slide 2 and those outlined in our latest Forms 10-K and 10-Q filed with the Securities and Exchange Commission.

The information we provide about our products and pipeline is for the benefit of the investment community. It's not intended to be promotional and is not sufficient for prescribing decisions. You can find our press release, the slides referenced on this call and an investor workbook on elanco.com.

The slides in the press release also contain further information about the non-GAAP financial measures that we discuss during today's call. After our prepared remarks, we'll be happy to take your questions.

I'll turn the call over to Jeff to provide the highlights. Jeff?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Jim. Good morning, everyone. This quarter marks Elanco's fifth quarter as a public company. We are delivering to our expectations, and we're pleased to show continued execution on all elements of our innovation, portfolio and productivity strategy. Let's begin with the highlights on Slide 3.

We have outlined the importance of our 3-stream governance structure in this pivotal time in Elanco's history. We have dedicated teams focused on running Elanco, executing on our strategy and delivering results now and into the future, which is where the vast majority of Elanco employees are focused; secondly, standing up our independent operations. And lastly, closing and integrating the Bayer acquisition. We are moving with purpose and urgency in each stream.

First, our top line results showed a solid underlying demand for our products and the strength of our fundamentals, highlighted by the double-digit growth in our 3 targeted categories. Our portfolio approach enabled us to deliver 4% core revenue growth at constant currency.

Our productivity efforts also continue to deliver with a 210 basis point increase in our adjusted gross margin to 53.3%. Second, we're building a fit-for-purpose company and establishing a stand-alone capabilities we need. In Q3, we took another action on this front, announcing a restructuring and reduction in headcount. We also continue to exit transition service agreements with Lilly including the go-live of our HR system, Workday this month. Third, after announcing our planned acquisition of Bayer Animal Health, on August 20, we have moved quickly to establish an experienced integration team to define monthly and quarterly integration activities with Bayer's senior management and to launch the process with the regulatory bodies. We have had initial face-to-face meetings with the FTC and the European Commission, and we're engaged with regulators in all the jurisdictions where we're required to obtain competition clearance. Our teams, along with external advisers, are working collaboratively and expeditiously with the regulators. Later in the call, I'll reiterate a few key points on the Bayer acquisition.

Importantly, the vast majority of Elanco employees are focused on running our business and delivering on our commitments. And you can see the results of this focus in our third quarter results. Meanwhile, we have the right teams established in executing on our stand-up and integration priorities. For our stand-up efforts, we've established a fit-for-purpose organization design, and we are building an efficient infrastructure appropriate for our industry. For the Bayer integration, we have a well-developed capabilities having integrated 12 acquisitions over the past decade.

Let's move to Slide 4 and share some of the key events since our last earnings call, across the 3 pillars of our strategy. First, our innovation strategy. It's built on launching with excellence, progressing our internal pipeline and complementing our internal pipeline with external opportunities. Our new products and launch mode continue to fuel our growth, increasing 75% year-over-year. The group represented 15% of our total sales. This quarter, we've added the sales of Entyce and Nocita from the Aratana acquisition and Tanovea from our commercial agreement with VetDC. You can see the growth trajectory of these products in constant currency on Slide 15. Our internal pipeline is robust, and projects are advancing, including a late-stage first-in-class innovation for poultry producers.

In January 2018, we announced a development collaboration with Ab E Discovery, to advance the development of a safe and novel approach for protecting chickens from coccidiosis and necrotic enteritis. Since this product is not an antibiotic, we expect it will be an attractive option for producers that have implemented a no-antibiotics-ever or NAE approach. Recall that 50% of the U.S. chicken production uses an NAE approach, where there is not a sustainable solution today for coccidiosis or necrotic enteritis. We are happy to share that we have received and achieved GRAS, Generally Regarded As Safe, approval in all the key relevant states in the U.S. and are now highlighting this solution as part of an NAE program with a U.S. major poultry producer. We are working on a form for pelleted feed, while the liquid formulation will be available to customers in early 2020. This program is an example of our focus on producers most significant problems and our pursuit of alternatives to antibiotics. This will be a key Elanco innovation launch in 2020. Beyond this specific program, we recently completed our semiannual portfolio review, and I'm pleased with the state of our pipeline. We're excited about both the advancement and the flow of innovation with a goal to continue to deliver, on average, 3 innovative product launches per year over the next 5 years. We continue to invest in life cycle opportunities to expand the global availability of recently launched products as well as focus on brand building and brand protection initiatives. We've also fully integrated R&D programs from Aratana and Prevtec, and we're operating on our own platform with no dependencies on Lilly for R&D capabilities. In short, we've increased the speed and the value of the Elanco pipeline, while maintaining R&D investment levels and establishing stand-alone execution.

Now on the portfolio. Our targeted growth categories delivered double-digit growth and now represent about 63% of our total sales. Our portfolio approach is working, and I'll provide more commentary about the performance momentarily.

Turning to our third pillar, productivity. The continued improvement in our gross margin is a reflection of the comprehensive productivity agenda throughout our company, and we made further progress in Q3. Our board and management team are continually assessing our organization to identify and execute opportunities to advance our fit-for-purpose animal health structure across our value chain. As part of the restructuring, we announced at the end of September, we expect to reduce approximately 250 positions to enhance productivity and drive efficiency.

Specifically, we're exiting and streamlining certain manufacturing and R&D sites. We are consolidating and centralizing marketing and risk management functions. And we're adjusting the structure of regulatory functions to better align with the agencies they serve. This announcement is aligned with our previously communicated margin expansion goals. This action also enables us to increase investment in other areas of the business. Through efforts like this, we increase our degrees of freedom on our growth and margin expansion agenda. Even while preparing for the Bayer integration, we will continue to drive our productivity agenda and optimize our operations. We have open shared service centers in Warsaw, Poland and Kuala Lumpur and Malaysia creating a back office structure that is fit for Elanco.

Additionally, we opened our Innovation Alliance Center in Bangalore, India, providing key capabilities and capacity in support of number of our business areas. The independent company stand-up and TSA exits remain on track, with the go-live of our HR system in November, representing a significant step in our journey. We have now migrated substantially all judgment based activities to Elanco staff.

Lilly is now providing primarily data, system-related support and personnel only. Overall, our productivity agenda continues to progress and is delivering too. And in many cases, above our expectations, all while increasing our speed and lowering our overall cost as we transition out of Lilly.

Now let's take a look at our sales performance on Slide 5. I will start with Ruminants & Swine, as that category has had a number of factors at play. Overall performance in ruminant & swine category reflects the continued impact of African Swine fever. The supply disruption from our contract manufacturer for certain injectable products that we discussed in Q2, and some new external events. Let me note them. As China swine prices have soared in the wake of ASF and trade negotiations have progressed, exports have become a more significant opportunity for U.S. producers. As a result, many farmers are moving away from ractopamine products to enable access to the China market. This impacts our swine product, Paylean, which globally is less than 1% of our total sales. Within our swine portfolio, we have another product called Skycis that has been on the market since 2012. Skycis has a different mode of action, that we expect and see swine producers transitioning to this product as the lead alternative to Paylean. We believe that Skycis provides our customers with an attractive alternative to Paylean that does not have trade restrictions.

Second, a generic version of Rumensin was approved in Q3. Importantly, we see a strong brand loyalty among our customers for Rumensin, and we are very pleased with the durability and end-user demand. As we expected, in the distribution channel, we've seen some changes in purchasing as they assess the environment. Important to note, we remain very confident in the value of Rumensin, the portfolio we offer our cattle customers and the value beyond product that differentiates Elanco from other players, particularly generics. In summary, things are tracking to our expectations with Rumensin.

And third, throughout 2019, the drought in Australia has been a headwind to the industry. With the other items impacting Ruminants & Swine category, this headwind has started to show through in the results. All of these are known events that we've been planning for or are transient issues that will resolve. In the case of ASF, over the long run, this will likely improve animal husbandry practices in Asia and increase sophistication of farming practices, all of these positive for the industry and positive for Elanco. We are appropriately incorporating these environmental factors into our updated guidance for the year. Very importantly, the market shares of our key products match with our expectations. Furthermore, the fundamentals of our business, the underlying demand for our products and our execution are strong in the face of these uncontrollable market pressures.

Meanwhile, we're pleased in the results within our targeted growth categories, which all show double-digit growth in the quarter. On a constant currency basis, Companion Animal Disease Prevention grew 11%. Companion Animal Therapeutics grew 10% and Future Protein & Health grew 20%. Our Companion Animal business was bolstered in Q3 by a purchase from a new customer that we had expected to close in Q4. Todd will provide additional commentary on our sales growth in a moment.

Let me pause and discuss our industry and our approach as well as our outlook. This quarter is a perfect example of multiple variables in our industry and the importance of having a portfolio. Throughout this year, we faced multiple headwinds to our business, including the ones I just described, as well as foreign exchange. Despite these challenges, we've been able to grow sales, both organically and inorganically. This reinforces our approach to bring best-in-class solutions to our customer’s greatest needs, to diversify across species, geographies, therapeutic classes and channels and to be flexible to bring innovation wherever it may be found.

I am pleased with our results. More importantly, the resiliency and durability of our approach and the grit of our team across the world give me confidence for the future. Adding to my confidence is the temporary nature of these variables. We expect the impact of these items have on our growth to temper as we head into next year. The acute headwind of ASF in Asia will be less severe with the reductions already seen in 2019. Over time, there will be benefits from the repopulation of swine herd and advances in swine production. We're expecting China and Vietnam to return to growth next year. The supply, secondly, disruption that we have with our contract manufacturer is resolving, and the impact of Paylean is quantifiable, not material to our overall projections and will be mitigated with other products such as Skycis. This is the nature of our industry. We have the right strategy, products, people and focus to navigate such events, while continuing to deliver for the long term.

Now I'll turn the call over to Todd to provide more color on our Q3 results and financial guidance for 2019.

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, Jeff. Slide 6 summarizes our presentation of GAAP results, while Slide 7 describes the items considered in the adjusted financials. Slide 16 to 21 in the appendix provide a summary of the adjustments made to the GAAP results to arrive at our adjusted presentation. I'll focus my comments on our adjusted measures to provide insights into the underlying trends in our business, so please refer to today's earnings press release for a detailed description of the year-on-year changes in our third quarter GAAP results.

Looking at the adjusted measures on Slide 8, you'll see total Elanco revenue increased 1% in the quarter. On a constant currency basis, growth was 2%. Gross margin as a percent of revenue was 53.3%, an improvement of 210 basis points over last year, driven by our manufacturing productivity initiatives plus price, partially offset by product mix. Our year-to-date gross margin is 53.6%, and we continue to expect the adjusted gross margin to be between 52% and 53% for the full year 2019. As a reminder, Q4 is typically our lowest gross margin quarter as our product mix has a larger proportion of international poultry sales than in other quarters.

Operating expense increased 10% in the third quarter. Marketing, selling and administrative expense increased 7% to $192 million, reflecting additional costs from the acquired businesses in the current year. Increased marketing efforts for our Companion Animal portfolio and incremental expense as a result of operating as a public company, both new expenses and marginally higher expenses, specifically in information technology.

R&D expense increased 19% to $70 million or 9% of revenue, reflecting additional costs from acquired businesses in the current year, primarily Aratana, timing of spend within the year, increased costs from R&D infrastructure investments and increased project spend as a result of pipeline progression. Operating income declined 2%, reflecting the increased operating expenses I just described, more than offsetting the improvement in gross margin. This decline was expected, given the incremental expenses from acquisitions closed in the quarter. The operating margin in Q3 was 19%. As we have projected at the time we announced the Aratana acquisition, the increased operating expenses are partially offset by a benefit in other income and deductions.

At the bottom line, Q3 adjusted net income increased 4% to $111.7 million, with an effective tax rate of 9.6%. The lower tax rate is due to a discrete tax benefit in the quarter from the resolution of a Brazil tax audit. Note, that in the quarter, net income was impacted by 2 onetime items. The discrete tax benefit I just mentioned was partially offset by an expense in other income and deductions related to the release of a tax indemnity associated with the resolution of the Brazil tax audit. Combined, the 2 items provide an incremental $7.2 million of net income or $0.02 of EPS.

Moving to Slide 9. Let's take a look at the effect of price, rate and volume on revenue growth. The effect of foreign exchange rates on core revenue was a 1% headwind overall. Price grew 4%, while volume was flat. On the slide, you can see the breakdown of revenue across our 4 categories. I will focus on constant currency growth.

Starting with Companion Animal Disease Prevention, which includes parasiticides and vaccines. Revenue grew 11% in the quarter, 4% from volume and 7% from price. Growth is driven by the continued uptake of Interceptor Plus and Credelio as well as vaccines. Price growth is driven mainly by vaccines, which have a favorable comparison to the prior year.

Moving to Companion Animal Therapeutics. Revenue increased 10% in the third quarter, 9% from volume and 1% from price. The growth is driven primarily by the continued uptake for Galliprant as well as the inclusion of Entyce and Nocita from Aratana, which provided about 5 percentage points of growth in the quarter in this category. Both Companion Animal categories also benefited from initial stocking for a new customer agreement that we had expected in Q4, but that our team successfully delivered in Q3. Without this impact, in addition of Aratana, total Companion Animal sales grew 3%.

Turning to our Food Animal portfolio and Future Protein & Health, revenue grew 20% in the quarter, 16% from volume and 4% from price. Growth in this category is driven primarily by the continued uptake of our aqua portfolio as well as poultry products. The quarter also benefited from discrete items, including the sale of the remaining inventory of our product that will be phased out in China and a favorable comparison for the prior year for poultry products.

Ruminants & Swine revenue declined 11% in the quarter, driven by a 14% decline in volume, partially offset by a 3% increase in price. There are several environmental factors at play, as Jeff described. These headwinds were partially offset by the inclusion of Posilac sales in the current quarter. As we discussed in the Q2 call, we have revised the commercial agreement with Lilly to sell the remaining inventory of Posilac. Revenue from strategic exits decreased 33% for the quarter. Recall that the only 2 activities in this category are the contract vaccine manufacturing for BI and the production of human growth hormone for Lilly.

On Slide 10, we provide details on the overall performance in the U.S. and international. Both the U.S. and international businesses are contributing to overall growth.

Now turning to our finance guidance for the full year 2019 on Slide 11. We are updating our full year guidance for revenue and EPS. For total revenue, we now expect a range of $3.07 billion to $3.085 billion, a narrowing of the range, and a $10 million reduction in the low end of the range. We continue to expect strategic exits to be approximately $80 million. We now project core revenue to grow 3% at constant currency and finish the year between $2.99 billion and $3.005 billion. We are also updating the range for expected earnings per share. We now expect EPS on a GAAP basis to be between $0.10 and $0.18. On an adjusted basis, we are narrowing the range to be between $1.04 and $1.08.

In summary, we are pleased with the progress of our margin expansion goals and confident in the underlying growth of our core business.

Before we take questions, Jeff will provide an update on the Bayer acquisition.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Todd. Bayer reported their third quarter results on October 30, and we are pleased to see the 10% constant currency growth in the Animal Health business, particularly the 22% growth in Seresto, 19% growth in the Advantage family and the calculated growth of the rest of the Bayer Animal Health business in the portfolio is more than 4%.

Beyond a favorable comparison quarter, the drivers of growth were aligned with our due diligence findings. The key growth drivers were the continued growth of alternative channels, the continued global brand expansion of Seresto, launches of both the Advantage family and Seresto in China and the overall emerging market growth. These results reinforce the positive views developed during our thorough diligence. We're looking forward to completing the regulatory process and continue to target our close in mid-2020. We think it's key to remember that this transaction aligns with our IPP strategy and it positions Elanco to move from a position of strength to a position of leadership in a number of areas.

First, we achieved improved -- will improve scale as the #2 Animal Health company. We balance our sales nearly evenly across food and companion animals and nearly triple our international companion animal business. We gained leading brands and capabilities and the increasingly important alternative companion animal channels. We expand our cattle portfolio and our emerging markets presence in both food and companion animals space, and we expect to achieve our current profitability targets more quickly and have greater headroom to expand profitability margins higher. And we believe we can garner these benefits without taking a step backwards on our current growth and margin expansion path. We are even more excited for the opportunities before us as a combined company. And we're preparing to integrate Bayer quickly and efficiently. In the meantime, we are laser-focused on continuing to execute and deliver.

This concludes our prepared remarks. I'll now turn the call back over to Jim to moderate the Q&A.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [6]

--------------------------------------------------------------------------------

Thanks, Jeff. We'd like to take questions from many callers as we can. So we ask that you limit your questions to 2 or a single question with 2 parts.

Tina, if you could moderate, please, we're ready for the first question.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions)

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

--------------------------------------------------------------------------------

Michael Leonidovich Ryskin, BofA Merrill Lynch, Research Division - Associate [2]

--------------------------------------------------------------------------------

First, I want to start off on the moving pieces within the fiscal year revenue bridge. I appreciate the color you provided on the ractopamine and the Rumensin. But could you give us a little more clarity on just how much of the impact you saw in third quarter? And sort of what's built in your expectations for Ruminants & Swine for the year? Is ASF still $45 million headwind? Is the injectable supply disruption still $15 million? And if you could provide a little color on ractopamine or Rumensin as well, that would be helpful.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [3]

--------------------------------------------------------------------------------

Well, Mike, it's Jim. Why don't I -- I'll give you some of the statistics, and then maybe, Jeff, you can talk about -- there's lots of pushes and pulls as you appropriately noted, Mike. So on African Swine fever, our expectations are the same as we delivered last quarter, so we expect a $40 million to $50 million headwind for the entire year, and we're at roughly $30 million year-to-date from what's happened.

On the supply disruption, we think that is resolving. So we're cautiously optimistic for the fourth quarter. So we're sticking with the $15 million to $25 million expectation for that headwind for the full year. And then, Jeff, maybe the -- all of the different pushes and pulls and where the growth is and then where it would be.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [4]

--------------------------------------------------------------------------------

Yes, Michael, if you step back and just look at the pushes and pulls of the environmental factors that were noted, specifically ASF, our third-party manufacturer and this ractopamine, and then you lay it against some of the inorganic plays such as Aratana and Posilac, as well as our onetime customer purchase, they offset one another -- generally offset one another, leading to the 4% growth. Noting on Paylean, let me just mention, as I've said, this is something that has been progressing over the years. It's not -- it may be new in the news, but it hasn't been new in the industry and in the field. We have been building an alternative, as I've mentioned, with Skycis, in our portfolio. And as we mentioned, Paylean is less than 1% globally. It's less than half of that here in the U.S. So again, nonmaterial of any real significance, and we're working with that transition to another program and an alternative product.

--------------------------------------------------------------------------------

Operator [5]

--------------------------------------------------------------------------------

Yes. Our next question comes from Chris Schott with JP Morgan.

--------------------------------------------------------------------------------

Christopher Thomas Schott, JP Morgan Chase & Co, Research Division - Senior Analyst [6]

--------------------------------------------------------------------------------

First one was just on Rumensin. Can you just remind us or just walk through some of the assumptions that you have going forward, as we think about the impact from generic competition in terms of both the magnitude of impact and how quickly you expect that erosion to occur, just so that everyone's on the same page of how you're thinking about that?

My second question was just on the earnings progression this year. I think that the 4Q earnings imply a step down from what we've been seeing in the last few quarters. I think it's $0.23 at the midpoint versus $0.30 this quarter. Can you just help me understand a little bit of the dynamics that are impacting that progression of earnings that we're seeing?

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [7]

--------------------------------------------------------------------------------

Sure, thanks, Chris. Jeff, you want to talk about the Rumensin?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [8]

--------------------------------------------------------------------------------

Yes, Chris. First of all, just again, strategy is working very well. I want to emphasize it's tracking to our expectations. And as we've said, we've modeled that there's an erosion in the first couple of years, a mix between price and volume. We've talked some about in the neighborhood of 30% over that first couple of years. What I really want to emphasize, though, is when we look at durability of the brand, durability of the total portfolio offer to cattle producers, the value beyond product as well as other means and measures competitively, what I would say is we're tracking at those expectations or even better and feeling very good about it. The alteration that we've mentioned is really just a supply chain assessment that typically happens when you bring a generic to the market where people's levels of inventories may change a little bit as they are assessing the marketplace.

But again, I want to emphasize we are feeling very good relative to Rumensin and tracking to our expectations.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [9]

--------------------------------------------------------------------------------

Todd, do you want to talk about Q4?

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [10]

--------------------------------------------------------------------------------

Sure. Chris, on the EPS chain, obviously, one part is the tax rate. We do expect the tax rate to be back in the low 20s in Q4, generally where we were tracking in the year before giving this benefit from the Brazilian tax audit settlement. And then the other one would be on the gross margin side. As I mentioned in the prepared remarks, we do have a different mix in Q4, you would have seen that in last year's Q4 margin. We still expect the productivity initiatives to provide margin growth year-over-year, but just a lot of international poultry, which is a lower margin product for us in Q4. The other item is utilization of our plants. We have planned shutdowns within the year, and thus, we don't have as much positive variations that we've had this year. So that's the main drivers of the progression given we still expect to have a high revenue point for the full year here in Q4.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Our next question comes from Umer Raffat with Evercore.

--------------------------------------------------------------------------------

Umer Raffat, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Analyst of Equity Research [12]

--------------------------------------------------------------------------------

Jeff, I wanted to focus on 2 main things into 2020. First, just the impact of Credelio, Interceptor, as well as any flea, tick or worm portfolio out of Bayer. How does that get impacted from [sheer] launch into 2020 and 2021? And secondly, you mentioned Rumensin is tracking in line with expectations. I know you said that several times today, is it reasonable for us to assume a $50 million drop in Rumensin in 2020? And is that consistent with the early feedback from distributors?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [13]

--------------------------------------------------------------------------------

Thanks, Umer, for your questions. Look, I'll start by -- good question. We, on the parasiticide market again, continue to like the fundamentals. If you step back and look at the market, again, over a $5 billion market, compliance, channel, many other mechanisms, innovation, all driving really strong growth of the market. So let's start there, and we study that very closely. And I think we're working very closely also with the channel and with our customers and our sales team to continue to drive compliance, ease of use for vets as well as pet owners. I will also emphasize that we like our portfolio. Our portfolio offers competitive advantage. We're seeing that. You're seeing that in the results this quarter. We see that going into 2020. So what I'll say is we're going to continue to see growth in this category for us, Companion Animal Prevention. You're going to see continued leadership positions and share growth. We believe in our portfolio, Credelio, Interceptor Plus noted, and so I'll emphasize that you'll hear and see the progress of that as we go into 2020. I can't really note anything specifically on Bayer other than the fundamentals of the deal. And what we've said relative to what this does, is it allows us to create leadership positions in the omnichannel, be able to access, not only that vet clinic, which is always the start, the priority, and I kind of say the start and the end of any pet relationship begins and ends in that clinic, but it also allows us to continue to really grow and meet the large segment that is not going into the clinic or wanting a more convenient experience once they do have a product. So we see this increasing the strength of our total offer, both with Bayer's portfolio, but also our own as well. So those are the comments. On Rumensin, we're not going to give a specific guidance on a product. What we'll say is we've given you some of the specifics in the modeling that we had. That comes from a lot of proxying over the years and a lot of markets, very similar, feel very good about that. What I will say is, as we look at our strategy, this ultimately -- and I think this is where our focus always has to be in these conversations is value proposition. This is not a pharmaceutical market, driven by government pay. This is a cash market and cattle owners want value, they want total value. Rumensin is one element of that value proposition from Elanco, and we'll continue to expand that. But again, I'll stick with some of the modeling assumptions that I just shared with Chris, and we'll leave it at that.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

Our next question comes from the line of David Risinger with Morgan Stanley.

--------------------------------------------------------------------------------

David Reed Risinger, Morgan Stanley, Research Division - MD in Equity Research and United States Pharmaceuticals Analyst [15]

--------------------------------------------------------------------------------

I have 2 questions. First, so could you quantify the 3 segment benefits to revenue in the third quarter? You mentioned 2 stocking benefits in the 2 Companion Animal segments. And then you mentioned a sale of remaining China product inventory as well, so I just wanted to understand what those revenue items amounted to. And then second, with respect to the Bayer acquisition timing, I believe that the documents filed with the SEC state that the closing will be no earlier than July 1 next year. Could you explain that? And also discuss the 2 potential deal closing extensions that are mentioned as well.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [16]

--------------------------------------------------------------------------------

Todd, do you want me to -- you want to address the...

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [17]

--------------------------------------------------------------------------------

Sure. On the -- first on the customer stockings, Dave, that was about $17 million in the quarter, something we planned on for the full year, and the team did a great job of delivering that early, and that's obviously part of the timing of the results and then the full year guidance. And then with respect to the China bid, that was single-digit millions. The Future Protein & Health category has really led this quarter by our aqua franchise. Clynav in Norway continues to really deliver as well as Imvixa in Chile. And so we would have had double-digit revenue growth in Future Protein & Health even without this China item.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [18]

--------------------------------------------------------------------------------

David, relative to the comments on closing the deal, I will start by saying great progress on the interactions with the antitrust activities and the regulatory bodies, good engagement. Our experts are working, and our team is working very closely, and things are tracking very nicely, so I'll say that. And then I would say on the agreement that you mentioned about mid 2020. Yes, that's an agreement, but there is an aspect of this that, we have the liberty to close sooner if both parties agree. Of course, we will pursue as soon as possible. There's many dimensions to lining that up from having our TSAs and our structure in place and financing. But what I'll say is we do have a stipulation to where both parties if they do agree, we can close sooner.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

Your next question comes from Kathy Miner with Cowen & Company.

--------------------------------------------------------------------------------

Kathleen Marie Miner, Cowen and Company, LLC, Research Division - VP [20]

--------------------------------------------------------------------------------

2 questions. First, on the aqua and poultry market. Could you talk about your expectations for the market going forward? Will it be helped by the African Swine fever, and do you expect Elanco to beat those market growth expectations? And the second question, just to go back to the fourth quarter EPS and sort of the $0.02 that you took off the guidance for the full year. What were the specific things that really changed? Because my understanding is that Rumensin was on track. The sterile injectables hasn't changed, swine fever hasn't changed. What were the particular items that caused you to lower the top end of the range?

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [21]

--------------------------------------------------------------------------------

Sure, Kathleen. Jeff, do you want to talk about that?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [22]

--------------------------------------------------------------------------------

Yes, Kathy, as you can see, the poultry market is doing very, very well for Elanco. We've got our leadership position here with many portfolios against some of the most significant problems that they have. And as I just mentioned, we'll be introducing another technology in one of the larger markets with coccidiosis and necrotic enteritis with our new technology that's coming. So we feel very good about our position in this market and its position -- if you look at the U.S. poultry production, it's expected this year to grow between 1% and 2%. What I would say is there's no one segment that's probably going to benefit more from African Swine fever than poultry. As you've seen, the trade market has -- and trade has opened up for U.S. producers as well as other producers, and this will be the lead protein alternative to this. But I think also it can respond more quickly given breeding supply chain to this as well. So again, we see a strong market for poultry going forward into 2020. We see a strong portfolio by us and our capabilities. We have made adjustments, as an example, inside of China to have a larger poultry field force to be able to respond to this and got us very strong portfolio, and this will be part of the return to growth in China by our poultry growth. And then, of course, an introduction of innovation in 2020 as well, in one of the larger unmet need markets with the NAE market here in the U.S.

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [23]

--------------------------------------------------------------------------------

And then, Kathy, with respect to the EPS drop, couple of things. They did mention our tracking. Unfortunately, they're tracking close to the high end of our range versus the low end. We thought we'd get a little relief on the drought item. Obviously, the Paylean thing is new this quarter. And then there are some other upsides. We thought we had a chance of bringing in this year that we don't think now we are materializing as we get closer to the full year. And so we thought it made sense to reduce the guidance and give everyone a clear view of where we expect to finish 2019.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [24]

--------------------------------------------------------------------------------

And Kathy, I would just emphasize, I mean, we put our focus heavy on underlying demand for product. The value of our business and to our customers, and we feel very good about market shares, underlying fundamentals of the market and growth. These are environmental factors. And again, as we see them lessening or actually being out of the picture as we go into 2020.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

Your next question comes from Kevin Ellich with Craig-Hallum.

--------------------------------------------------------------------------------

Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [26]

--------------------------------------------------------------------------------

So Jeff, just a couple of things. First cattle market in the U.S. Clearly, we know you're deemphasizing Food Animal Ruminants & Swine, but just wanted to see what you guys are hearing about the dairy market. Is it stabilizing? And then what did you see with U.S. beef cattle this quarter as well. And then, Todd, with the Paylean and future Ractopamine sales, we understand that you guys are going to switch people over to Skycis, but wondering if you could give us any sense to have direction on the gross margin impact for the last Paylean sales?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [27]

--------------------------------------------------------------------------------

Yes. Thank you, Kevin. Let me start by saying, we actually see ruminant and swine as we go into 2020 as a important market for us. Yes, it wasn't part of the growth categories initially. But when you look at our portfolio, when you look at actually some of these environmental factors becoming less as we go in, our contract manufacturing issue being resolved, a flattening out here in the China, Vietnam markets, we still got to watch the other Asian markets. We see ruminant and swine continuing to be a very important part of our business going forward. If I look at the cattle market overall, I think the U.S. beef market has stabilized, as we talked about the fire in one of the major processing plants, about 15% of the production that has been picked up on Saturday and Sunday shifts, that's absorbed that. I think we're seeing overall slaughter capacity now is tracking nearly even with last year despite even this processing plant loss. I think in terms of placements, cattle placements, it appears the expansion period is kind of plateauing now, as we go forward into the rest of the year. I think another positive is the pasture, probably the best pasture conditions we've seen in many, many years. They're staying on grass longer, especially here in North America, and that's coming into the feedlot later. That bodes well with heavier weights coming in, resulting overall in good business, but resulting in a few less days on feed in that feed yard. So as a whole, I think, a stabilizing market. They've weathered the processing plant change. And I think a pretty stable market going forward. There'll be some advantage, I think, with this protein shortage as more protein is going to be moving to Asia, but also just the underlying demand of protein growing and this shortage with African Swine fever, beef will benefit some, not as much as poultry, and probably pigs, but it will benefit some.

--------------------------------------------------------------------------------

Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

--------------------------------------------------------------------------------

Jeff, any color on dairy, it was the other element.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [29]

--------------------------------------------------------------------------------

Yes. Dairy is improving overall. It's come from a very tough 3- to 4-year period. But most -- it's again regional milk prices, but they've been breaking over breakeven. People are returning to profit. And again, we feel very good about our current portfolio, and also the introduction of a broader portfolio in both beef and dairy, with the Bayer acquisition.

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [30]

--------------------------------------------------------------------------------

And then, Kevin, with respect to the Paylean, Skycis margin, they're pretty similar in their gross margin -- pretty similar in their profile. So all -- not a big difference there.

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

Your next question comes from Nathan Rich with Goldman Sachs.

--------------------------------------------------------------------------------

Nathan Allen Rich, Goldman Sachs Group Inc., Research Division - Research Analyst [32]

--------------------------------------------------------------------------------

So just 2 here. Jeff, firstly, on the new customer agreement in the companion business. Can you talk about the type of growth that you expect from this customer? And maybe kind of any unique aspects with respect to either volume commitments or pricing that you'd call out? And any sense of profitability that you can give us for that contract? And then, Todd, I also wanted to ask on operating expenses, it looks like they were up 10% year-over-year in the quarter. I think this is off pretty good performance last year. So some of this just might be the comparison, but it's a little bit higher than what I think the run rate would be. So can you just give us any color there on terms of what drove the SG&A in the quarter?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [33]

--------------------------------------------------------------------------------

Yes. Thank you, Nathan, for the question. We don't talk specifically about customers. But I will say it really now brings a demographic of accretive growth in an attractive channel. As we look at an omnichannel approach, this will be important. It will drive a broad base of a couple of our key brands in the Companion Animal space. And again, on profitability, we look at all of these deals from the standpoint of with the margin agenda that we have. We have to be extra scrutinizing on the total P&L on any customer contracts. So we look at it in a fully allocated P&L kind of a way. And what I would tell you is accretive to growth and not dilutive to margin. Those would be my high-level comments.

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [34]

--------------------------------------------------------------------------------

Yes. And Nathan, with respect to OpEx, you're right. Q3 of last year was sort of still on a carve-out basis, full team wasn't in place. And so it was a tough comp on an SG&A basis. We're actually down sequentially from Q2 of 2019. A lot of focus on the other big item in this quarter was the Aratana and Prevtec acquisitions. Those both came in, in the quarter with additional OpEx. Those will be reduced going forward. So overall, we're very focused on our spend and staying in line with the future expectations.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

Our next question comes from the line of John Kreger with William Blair.

--------------------------------------------------------------------------------

Jonathan Marley Kaufman, William Blair & Company L.L.C., Research Division - Associate [36]

--------------------------------------------------------------------------------

This is John Kaufman on for Kreger. First, can you talk about the new products that you added via acquisition recently? What's been the initial response from your sales force and from veterinarians, who weren't previously aware of offerings like Entyce and Nocita? And then on African Swine fever, I think you said you expect China and Vietnam to grow next year. Are you seeing the producers in Asia successfully repopulate the swine herds that they lost?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [37]

--------------------------------------------------------------------------------

Yes, John. So real quick like. First question was...

--------------------------------------------------------------------------------

Jonathan Marley Kaufman, William Blair & Company L.L.C., Research Division - Associate [38]

--------------------------------------------------------------------------------

Nocita.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [39]

--------------------------------------------------------------------------------

Yes. So we've just done a full review on this. And what I would say is, again, there's 2 dimensions to this demand creation. First is, we've set up a specialty sales force, primarily the Aratana sales force. We've ensured that they're in the right geographies. We put some of the Elanco brands into that portfolio as well. But what I would say is with some increase to support systems, technical people, resources, as Todd mentioned, we're feeling very good, but it's very early, but we feel very good about that specialty sales force and what it's going to do, and it will be a key part of our growth going forward. As you go and look at our sales force that's much larger in a broader U.S., what we had with Entyce and Nocita was good placement in the clinics. We've now trained our sales force on these products, and now we're driving the demand in the clinics. That was what Aratana was unable to do. But I think the proof of the significance of these products is the actual number of clinics that were actually placed shows that there was interest, need, first-in-class product with Entyce, a very unique product, and Nocita on pain. Now we are in the mode now that our sales force is trained and it is part of the call plan, is to drive now the demand, but it isn't as much about getting placements because they're there, it's about driving the demand through the clinic. So we feel very good about this. And again, these will be key parts of our growth as we go into 2020.

--------------------------------------------------------------------------------

Jonathan Marley Kaufman, William Blair & Company L.L.C., Research Division - Associate [40]

--------------------------------------------------------------------------------

Then swine repopulation?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [41]

--------------------------------------------------------------------------------

Yes. So let me be clear on my comments. First of all, let me say that African Swine fever, we've not turned the corner relative to -- we've seen cases during this quarter arise in the Philippines and in other markets. So across the Asian area, it continues to be a problem. I want to emphasize that. And we don't know, and we got to keep our eyes out for other geographies, other continents that this could show up on. So there's no question this African Swine fever is an endemic like we've not seen in decades, it's serious. There's not an easy solution. But I think the moves that are being taken in the first 2 markets that it hit the worst, China and Vietnam, the biosecurity, especially on those corporate operations are beginning a repopulation. What I want to emphasize is the Elanco business overall. So we've taken a hit, as you see, pretty materially to our overall affiliates in China and Vietnam. What we see going forward with my comments, is the mix of the total portfolio with poultry growth and with a new base actually, that we're starting from in pigs, and moving again back into that B2B industrial relationship with those companies that are repopulating. And of course, biosecurity will be important, but also multinational key brands will also be important.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

Your next question is from Navin Jacob with UBS.

--------------------------------------------------------------------------------

Prakhar Agrawal, UBS Investment Bank, Research Division - Equity Research Analyst of Biotech and Pharma [43]

--------------------------------------------------------------------------------

This is Prakhar Agrawal on behalf of Navin. I just had a question on Galliprant. Could you comment on the performance this quarter in U.S. and ex-U. S.? And longer term, how are you thinking about the competitive landscape for Galliprant given potential launch of pain products from your competitors such as the NGF drugs?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [44]

--------------------------------------------------------------------------------

Yes, Galliprant continues to perform well, and we continue to -- as we've talked about, not only expand the number of clinics that are placing this compound, but also I think the biggest focus we've had is on actually awareness, awareness of osteoarthritis, and we've launched a campaign to be able to create earlier understanding and diagnosis of arthritis. We think this is important for the well-being of pets, and so this will continue to drive and expand the market size. This is no question a best-in-class product. We'll continue to expand that. We're continuing to innovate behind it. We're continuing, I think, very important, I mentioned Nocita, our pain portfolio continues to expand this quarter by bringing Nocita in. So I think that helps as we continue to be leaders in pain, bring key opinion leaders to the table for pain. But again, Galliprant performed very well, met expectations. And we continue to see it going forward. Competitive entries will continue to enter the marketplace, we're aware. We are going to continue to do what we do best, which is expand markets, deliver broad portfolios against the big problems like pain and arthritis, and then, of course, innovate behind it ourselves.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

Yes. Our next question comes from Balaji Prasad with Barclays.

--------------------------------------------------------------------------------

Balaji V. Prasad, Barclays Bank PLC, Research Division - Director [46]

--------------------------------------------------------------------------------

So I had 2 questions. Firstly, on -- I mean, we have discussed ASF broadly. I want to understand the pace of replacement that poultry can provide with regard to the proteins loss globally? I mean, the latest USDA report shows around 30% shortage in global proteins, how much of this 30% can poultry replace and on what time lines? And naturally, I think the -- we can extrapolate this to your growth in the poultry segment, too?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [47]

--------------------------------------------------------------------------------

Yes, it's a great question. I don't think there's an easy answer there by any means. I think that there's a few factors, and we're involved in a lot of these is, first of all, the placements of birds is directly related to trade as well. So for anyone that's not in China in the poultry business, adding additional breeding stock and placement that takes time. And that's also dependent on and is risk-based decisions by our poultry customers relative to trade. And you've seen some of that in some of the poultry reports and earning reports that have come out since the trade agreements. It's good news, not just U.S., but I think globally, Brazil and others, that we'll be able to take advantage of the shortage. So I think that's positive. I think, though, it will be done in a staged way. And I don't think we're going to really be able to have an answer to your question to probably the second half of 2020 when we start to understand trade, restocking of pigs in China and then, of course, the economic state of the industries as well. So I'll hold on that because I think the new projections on growth for the poultry industry have not -- have not come out, and I would hold. But again, positive trends this quarter, trade is more open than it was a quarter ago, and poultry placements and economics are strong. So I do see them being the lead protein to replace the missing pork.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [48]

--------------------------------------------------------------------------------

Balaji, did you say, you had a second question? I don't know if you're line is still accessible.

--------------------------------------------------------------------------------

Operator [49]

--------------------------------------------------------------------------------

Your next question is from Kevin Kedra with G. Research.

--------------------------------------------------------------------------------

Kevin Kedra, Morgan Group Holding Co. - Research Analyst [50]

--------------------------------------------------------------------------------

First, on the price benefit in companion disease prevention, 7% pricing. You mentioned that was coming from the vaccines portfolio. I was hoping you might be able to give a little more detail on that? And then secondly, any change in the way that you're thinking about the divestitures as you start working through the FTC process on Bayer?

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [51]

--------------------------------------------------------------------------------

Kevin, it's Jim. So if you look back at Q3 of last year, we had actually talked about a benefit in disease prevention from some new customer agreements on our vaccine portfolio. And that, is all of these negotiations do they involve an element of price as well? So that actually gave us a bit of a favorable comparison to the price from last year, that amplifies the price benefit this year. So we wanted to call that out since the 7% this quarter is higher than typical. And then I'd emphasize, look at the year-to-date, we're at 2%, both in disease prevention and 2% overall, which is the more steady state where we think the portfolio can track in and where we'll be able to hopefully maintain that pricing over time. Jeff, do you want to talk about?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [52]

--------------------------------------------------------------------------------

Yes, I can't note any specifics on the divestitures other than I would just make a comment that, again, working very well with the jurisdictions; and two, we are preparing and will be prepared on any divestitures, if needed, and will be done in a very timely way, and of course, in a very positive economical way as appropriate, but again, no comments on any specific products other than to say, we are preparing and will be prepared.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

Yes. Our next question is from David Westenberg with Guggenheim Securities.

--------------------------------------------------------------------------------

David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [54]

--------------------------------------------------------------------------------

So just on the Bayer acquisition, can you talk about maybe conversations that you've had with retailers that might have opened up because of the Bayer acquisition? And then with focus on Europe, where flea and tick medications are largely OTC, what's the kind of the difference in terms of new market dynamics in terms of getting into access to markets? And how does that differ from the U.S.? And then for my second question, the step down in the Companion Animal Prevention category from Q3 -- Q2 to Q3 was kind of lower than I expected. And frankly, I think you called out a stocking order. Typically, with flea and T season -- flea and tick season being kind of the back end in July, what does that large order or just Q3 revenue in general mean for maybe yearlong compliance. Is that kind of picking up? Is that an opportunity to grow for Elanco?

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [55]

--------------------------------------------------------------------------------

Bayer, any conversations with retailers or the over-the-counter market, specifically in Europe?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [56]

--------------------------------------------------------------------------------

Yes. So just at a limited level, we don't get into any specifics, of course. We're competitors in the marketplace. And so we're careful, but we do have the rationale for the deal. So we've been very clear with the customer base to understand it. I would even start with the veterinarians. We are very much, and I think been accepted well by the veterinarians overall, that we are a vet-driven and vet-centered company to start with, and we're going to utilize these additional channels as a way to support, supplement things like compliance and further adoption, but again starts and ends in the vet clinic. And then I think on these alternative channels, retail channels, I think, again, we are more than 2 years in with a retail business. So we've been pretty open about. So those teams are, of course, selling and representing our portfolio now. And this does open the opportunity to just talk briefly about what can be relative to a broader portfolio that will come from Bayer. But -- and we're seeing nice growth in that alternative channel side. And no real specific difference relative to Europe that we see, again, a lot of the same dynamics that we see in the U.S.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [57]

--------------------------------------------------------------------------------

On the sequential, Todd, I can offer some color too, I'll let you go.

--------------------------------------------------------------------------------

Todd S. Young, Elanco Animal Health Incorporated - Executive VP & CFO [58]

--------------------------------------------------------------------------------

Sure. We -- obviously, we did have the stocking order. That was both in parasiticides as well as in our Companion Animal Therapeutics category with Galliprant. Overall, Q2 is typically the highest year for sales given the parasiticide season, no different for us. This year with that category doing very well in Q2 and continuing on its trajectory in Q3, bolstered by us expanding the number of customers we're serving with our products, with your question regarding are we expanding compliance in parasiticide, certainly an area we're focused on and working with customers and vets, as clearly, we think protection for animals all year-round makes more sense than picking and choosing what months you want them protected from parasiticides. But we know that is still an opportunity for greater growth across all the categories going forward.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [59]

--------------------------------------------------------------------------------

If you look at the bar charts in the back of the slide deck as well, you can see we have the breakdown of quarterly sale year-by-year for each category. So you can see this typical step down in Q3 in the disease prevention. We're almost at the hour. Maybe we have a couple more questions. Let's go quickly. If you ask your question quickly, we're are trying to get through. Tina, can we take another one?

--------------------------------------------------------------------------------

Operator [60]

--------------------------------------------------------------------------------

Your next question is from Michael Ryskin with Bank of America.

--------------------------------------------------------------------------------

Michael Leonidovich Ryskin, BofA Merrill Lynch, Research Division - Associate [61]

--------------------------------------------------------------------------------

Thanks for letting me squeeze in a follow-up. I got cut off there earlier, really quick. If you exclude that stocking order that you called out for the Companion Animal business that was expected in 4Q and some of the M&A contribution from Aratana, I think you mentioned that Companion Animal business was only 3%, up 3% on a constant currency basis. And it's -- that's a little bit below our expectations. I mean, you highlighted the continued strength in Galliprant and Credelio and Interceptor. So is it true that if you look through the rest of the Companion Animal portfolio, some of the older products, are you seeing any incremental weakness there? Did something new happen where -- tied to timing or was there maybe just some distraction with the sales force, given a lot of the turnover? Could you just talk about sort of the rest of that business, excluding the seasonality?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [62]

--------------------------------------------------------------------------------

Yes, Michael, there is some seasonality effects, as Todd just mentioned, Q3 is a little bit of a different dynamic. The channel is a little dynamic. What I would say is, we feel very good about our year-to-date. We feel good about the quarter overall. Yes, there's some pushes and pulls in there, but it is tracking very much to where we see the overall category.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [63]

--------------------------------------------------------------------------------

I can add, and Mike, it starts to get into a bit of watch-building marginal things. Remember, last year, there are some other issues with comparisons. We relaunched the high dose of Galliprant in Q3 of last year, so some of that is also influenced by just inflated comparison periods as well.

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [64]

--------------------------------------------------------------------------------

But again, I would say, everything is in that category. And all 3 of our growth categories is tracking to our expectations. Underlying demand coming out of the clinics, and the fundamentals in the market, it's tracking to our expectations.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [65]

--------------------------------------------------------------------------------

We're a minute past the hour. Jeff, do you want to do a quick close?

--------------------------------------------------------------------------------

Jeffrey N. Simmons, Elanco Animal Health Incorporated - President, CEO & Director [66]

--------------------------------------------------------------------------------

No, thank you for the interest. Again, 5 quarters as an independent company and delivering to our expectations through all 5 of those. I want to just emphasize, our energy and focus is on execution, growth, innovation, nice progress with the innovation to pipeline and really good progress on margin expansion. Know that our focus is on that as well as we're feeling very good due to the progress and the tracking on standing up our company and the Bayer acquisition. So thank you for your interest, and we look forward to continued dialogue going forward.

--------------------------------------------------------------------------------

Jim Greffet, Elanco Animal Health Incorporated - Head of IR [67]

--------------------------------------------------------------------------------

Tina, we can close.

--------------------------------------------------------------------------------

Operator [68]

--------------------------------------------------------------------------------

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.