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Elanco Animal Health Incorporated (NYSE:ELAN)
Q2 2019 Earnings Call
Aug. 13, 2019, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome. My name is Adrienne, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Elanco Animal Health Q2 2019 earnings 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. If you would like to ask a question during this time, simply press *1 on your telephone keypad. If you would like to withdraw your question please press #. Thank you. I would now like to turn the call over to your host Jim Greffet, Head of Investor Relations. Please go ahead.

Jim Greffet -- Head of Investor Relations

Thanks, Adrienne. Good morning. Thank you for joining us for Elanco Animal Health's Q2 2019 earnings call. I'm Jim Greffet, the 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 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 and 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.

As a reminder, our financial statements for the second quarter of 2018 have been derived from the consolidated financial statements and accounting records of Eli Lilly & Company. 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 and 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 Simmons -- President and Chief Executive Officer

Thanks, Jim. Good morning, everyone. This quarter marks Elanco's fourth quarter as a public company, and we're pleased to be delivering on the vision we set forth last fall. Our second-quarter results are in line with our expectations and reflect the disciplined execution of our global team across our innovation, portfolio, and productivity strategy. You will see that we're taking a nimble approach to executing our strategy in the face of some external events impacting our business.

Let's begin with the highlights since our last call on slide 3. Our Q2 results demonstrate execution and focus. Our targeted growth categories are growing above the market on a constant currency basis. Fueled by new products and geographic expansion, our productivity agenda is delivering and driving improved profitability, and we continue to demonstrate our position as a partner of choice with additional strategic relationships, all while building a fit-for-purpose independent company.

Our top-line results represent the solid underlying demand for our products and the strength of our fundamentals. The 9% growth of our targeted growth categories is in line with our expectations. Next, our margin expansion continues to unlock value. We're pleased with the improvement in adjusted gross margin, which continues to drive accelerated growth and profitability and cash flow, as shown by the 29% growth in our adjusted EBITDA.

We also continue to make important investments that strengthen our portfolio and pipeline. The acquisition of Prevtec Microbia and the R&D collaboration with AgBiome advance Elanco's commitment to deliver a suite of alternatives to antibiotics, such as vaccines and nutritional health products like enzymes and probiotics. Finally, we're delivering on our IPP strategy, while in parallel, executing on our goals to stand up the independent Elanco. With half of the year complete, we're narrowing the range for both sales and EPS, which Todd will discuss later in the call.

Slide 4 summarizes some of the key events since our last earnings call across the three pillars of our strategy. First, our innovation strategy is built on launching with excellence, progressing our internal pipeline, and complementing with external opportunities. Our new products and launch mode continue to fuel our growth, increasing 45% year over year. The group now represents 14% of our total sales, and you can see the growth trajectory of these products in constant currency on slide 15.

We continue to expand our reach by launching these products in new geographies. For example, Galliprant continues to launch in additional European countries, and both Credelio and Galliprant were approved in Brazil since our last call. As you'll remember, 60% of the innovation growth we expect between now and 2023 will come from these products already on the market. The near-term focus is on ensuring launches are flawlessly executed.

Importantly, our internal pipeline continues to deliver as expected across every stage of development. We're meeting milestones and progressing development programs. We're pursuing best-in-class and first-in-class innovations with concentrated investments in large opportunity targets. We have a prioritized and focus internal investment approach and intend to fund acceleration where the science and risk allow.

Complementary external opportunities round out our innovation strategy. The R&D collaboration with AgBiome and our acquisition of Prevtec, which includes their R&D pipeline, are examples since our last call. With the Aratana acquisition, which closed in July, the VetDC collaboration, and now the Prevtec acquisition, we have added seven development programs to our pipeline. We're launching well, we're progressing the internal pipeline, and we're complementing with external opportunities. Our strategy is on track to deliver a sustainable flow of innovation over the long term.

Now, on the second pillar, "Portfolio." Our targeted growth categories delivered above-market growth of 9%, and now represent about 62% of our total sales, an increase of 5 percentage points since our IPO. With the acquisition of Aratana now closed, we have completed the first phase of cross-training on the products and have begun offering our integrated portfolio to our customers, both in the general practice vet clinics as well as the specialty clinics with Aratana's specialty field force.

Finally, the Prevtec acquisition gives Elanco full ownership of Coliprotec, a vaccine for swine which Elanco currently markets in Europe and Canada. This agreement provides Elanco with a portfolio of solutions against E. coli, one of the greatest challenges for swine producers, and offers options as the market for antibiotic alternatives continues to expand. Similar to our Aratana relationship, we have a progressive history with Prevtec, beginning with a licensing agreement showcasing our partnering approach. By having full ownership, Elanco will be better positioned to grow Coliprotec, expand in more geographies, and capture the full margin benefit.

Now, turning to our third pillar, "Productivity." The efforts in our manufacturing organization continue in support of our long-term margin expansion goals. We're pleased to report that now, 100% of the productivity initiatives are under way that are needed to deliver our expected cost savings through 2020. The team is now turning their focus to the next phase in the journey from 2021 to 2023 and beyond. On the SG&A side, we have shifted our go-to-market model in 13 of the 16 international markets we announced last December and expect to complete the remaining three by the end of this year.

Additionally, the independent company stand-up efforts are progressing well, aligned with our timeline and cost expectations. While there are essential TSAs still active with Lilly, we've exited many ahead of schedule and continue to receive the support we need to ensure business continuity. Finally, in the second quarter, we paid down $50 million on our term loan. This is coupled with our growth in adjusted EBITDA. It demonstrates progress toward our deleveraging goals. Overall, our productivity agenda continues to progress, and is delivering meaningful financial benefit.

Now, let's take a look at our sales performance on slide 5. We are pleased with the results, especially in our targeted growth categories, which show solid growth in the quarter. Performance in the ruminant and swine category reflects two main external pressures. First, the impact of African swine fever on Asian markets continues to be the most significant headwind for sales.

Since our last call, the situation has continued to worsen, with herd losses increasing in China and the disease spreading further throughout Asia. While we still believe there's opportunity for increased swine production from other markets and increased poultry and beef production to mitigate the swine loss in Asia, we do not believe there is a full offset in the near term for our business. Clearly, the underlying demand for protein persists, and we believe this bodes well for our longer-term recovery in China and across Asia, as well as the prospects for swine, poultry, and to a lesser extent, beef production globally. While the situation is fluid, we continue to focus on supporting our customers around the world as they navigate these dynamic changes in the global protein markets.

Additionally, there's a second external pressure in ruminant and swine that comes with production issues that a contract manufacturer had disrupted supply of certain injectable cattle products in the second quarter. While we are working closely with this supplier to mitigate downsides, we expect a continued disruption in supply in the second half of the year as these issues are resolved. Very importantly, without these headwinds, our core revenue growth is 5% on a constant currency basis, demonstrating that our fundamentals remain strong and our IPP strategy is delivering. Now, I'll turn the call over to Todd to provide more color on our Q2 results and financial guidance for 2019.

Todd Young -- Chief Financial Officer

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

Elanco delivered another strong quarter. 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 4%. Gross margin as a percent of revenue was 54.6%, an improvement of 540 basis points over the last year, driven by our manufacturing productivity initiatives, and to a lesser extent, price improvement and the favorable impact of foreign exchange rates on international inventories.

Our gross margin improvement is tracking to our plans for the first half of 2019. In the second half, due to the typical seasonality of our product mix and lower plant utilization, we expect a lower gross margin than in the first half. Thus, we continue to expect adjusted gross margin for the full year to be between 52-53%.

Operating expense increased 7% in the second quarter. Marketing, selling, and administrative expense increased 5% to $201 million, reflecting increased direct-to-consumer marketing efforts for our companion animal portfolio, and to a lesser extent, incremental expenses as a result of operating as a public company, partially offset by the benefit from foreign exchange rates.

R&D expense increased 12% to $69 million, or 8.8% of revenue, due to the timing of spend within the year, increased project spend as a result of pipeline progression, and increased costs as a result of operating as a stand-alone company. The combination of sales growth and gross margin improvement, partially offset by increased investments in our brand and R&D, produced an operating income increase of $30.7 million or 24% compared to the second quarter of 2018. The resulting operating margin is roughly 20% of sales in the second quarter of 2019. At the bottom line, Q2 adjusted net income increased 3% to $101.6 million, with an effective tax rate of 23.4%. Normalizing for the $20.7 million of interest expense we had in the quarter, which we did not have in 2018, adjusted net income increased 24%.

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 3% headwind overall. Price grew 2%, while volume growth was 1%. On the slide, you can see the breakdown of revenue across our four categories. I will focus on constant currency growth. We are pleased that our business grew in the U.S. and internationally in each category except international ruminants and swine.

Starting with companion animal disease prevention, which includes parasiticides and vaccines, revenue grew 6% in the quarter -- 3% from volume and 3% from price. Growth was driven by the continued uptake of Interceptor Plus and Credelio, partially offset by declines in certain older-generation parasiticides. Moving to companion animal therapeutics, revenue increased 26% in the quarter -- 21% from volume and 5% from price. The growth is driven by demand for products across the therapeutics portfolio, primarily the continued uptake for Galliprant in the U.S., and now, a strong launch in Europe as well.

Turning to future protein and health in our food animal portfolio, revenue grew 7% in the quarter -- 4% from volume and 3% from price. Growth in this category is driven primarily by the continued uptake of our aqua portfolio as well as poultry and nutritional health products. Ruminants and swine revenue declined 6%, with flat price and a 6% volume decline. Growth in our U.S. business was more than offset by external factors impacting our international business.

Our swine business in Asia continues to face headwinds due to the spread of ASF in the region. We estimate the impact in the second quarter was about $8 million. However, the increasing herd losses are expected to have a more significant downside in the second half of 2019. Our international business was also impacted by the continued implementation of antimicrobial policies in Asia and product rationalizations aligned with our productivity agenda.

The U.S. cattle business was negatively impacted by purchasing patterns for Rumensin, offset by favorable purchasing patterns in other cattle products, primarily Optaflexx. Finally, we estimate the disruption in the global supply of certain injectable cattle products reduced sales by $8 million in the quarter. ASF and the supply disruption provided a 500-basis-point drag on our ruminants and swine performance.

Revenue from strategic exits increased 51% in the quarter, driven by higher demand from our contract manufacturing arrangement with BI and from the production of human growth hormone for Lilly, a contract that was not put into place until the fourth quarter of 2018. These were partially offset by the continued year-over-year reduction in other strategic exit items. Aside from these two contract manufacturing agreements, all other strategic exits have been reduced to zero as of this quarter.

Slide 10 provides our overall performance in the U.S. and internationally. The U.S. business continues to drive overall growth. Our international business returned to growth in the second quarter, with growth in all three targeted growth categories offset by the headwinds I just described in ruminants and swine.

Before discussing the financial guidance, I would like to provide an update on our dividend plans. With the significant cash flow we project over time, we expect a dividend will be an element of our value proposition to equity holders. However, we are postponing the initiation of our dividend, as our management team and board of directors wants to maximize flexibility to use our cash in the most productive ways possible.

Now, turning to our financial guidance for the full year 2019 on slide 11. For revenue, we remain confident in the growth prospects of our targeted growth categories and our underlying ruminants and swine business. We expect a downside of $40-50 million from the impact of African swine fever across Asia and $15-25 million from the disruption in global supply for certain injectable cattle products for the full year 2019. Our targeted growth categories, especially companion animal therapeutics, aqua, and poultry, paired with our business development efforts, will partially offset these temporal headwinds.

In the second half of the year, we will benefit from the inclusion of sales from Entyce, Nocita, and Tanovea. Additionally, we have revised our commercial agreement with Lilly for Posilac, which Elanco has continued to distribute since the separation. Moving forward, Elanco will record the full income statement benefit from the sale of the remaining inventory of Posilac.

Based on these dynamics, we are updating full-year guidance for revenue and EPS. For total revenue, we now expect a range of $3.08-3.12 billion, a reduction of $20 million from the top end of our previous range. We now project core revenue to be between $3-3.04 billion, reflecting up to 4% core revenue growth excluding the impact of foreign exchange rates. The updated revenue expectations also include a $20 million increase in strategic exit revenue due to the increased contract manufacturing demand from BI.

Finally, we are narrowing our range for expected earnings per share. We now expect EPS on a GAAP basis to be between $0.36-0.44, and on an adjusted basis, between $1.04-1.10. Keep in mind the year-over-year EPS growth is impacted by the full year of interest expense that Elanco has in 2019.

In summary, our year-to-date results are in line with our expectations and illuminate the value of being a portfolio innovator. We are pleased with the trajectory of our margin expansion goals and confident in the underlying growth of our core business. This concludes our prepared remarks. Now, I'll turn the call back over to Jim to moderate the Q&A session.

Questions and Answers:

Jim Greffet -- Head of Investor Relations

Thanks, Todd. We want to take questions from as many callers as possible, so we ask you to limit your questions to two or a single question with two parts. Adrienne, we're ready for the questions. Can you take the first one, please?

Operator

At this time, if you would like to ask a question, press *1 for questions. We'll pause for just a moment to compile the Q&A roster. Again, that is *1 for questions.

Jim Greffet -- Head of Investor Relations

Adrienne, do you see questions in the queue? We're ready, Adrienne, whenever you are.

Operator

Your first question comes from the line of Erin Wright with Credit Suisse.

Erin Wright -- Credit Suisse -- Analyst

Great, thanks so much. On the gross margin, it was seemly better than your internal expectations or what you articulated last quarter. What were some of those factors that contributed to the better growth margin trend, how much of it was attributable to mix versus FX, and can you speak to how we should be thinking about the quarterly progression on gross margin? Thanks.

Todd Young -- Chief Financial Officer

Sure, Erin. Thanks for the question. Overall, we had utilization of our plants that was slightly higher than we expected that drove a portion of that margin expansion, and as I mentioned, we don't expect that to happen in the back half of the year. FX was a slight positive overall due to the FX impact on international inventories. The biggest driver was the productivity initiatives that we've been executing against over the last few years, and those continue to drive value, and finally, with slightly higher growth in the U.S., which is typically a higher-margin geography for us, as well as in the companion animal business, those were all contributors to first-half margin expansion slightly ahead of our expectations.

In the back half, we don't have that planned utilization. There was also a seasonality of mix. If you look back at Q4 of 2018, it's a big quarter for us on our poultry business, which is primarily international, and thus comes with a slightly lower margin than overall. So, that's sort of the expectation of why we still believe for the full year, we'll be in the 52-53% range.

Jim Greffet -- Head of Investor Relations

Great. Adrienne, next caller.

Operator

The next question comes from the line of Michael Riskin with Bank of America Merrill Lynch.

Michael Ryskin -- Bank of America Merrill Lynch -- Vice President

Hey, guys. Thanks for taking. I'll squeeze in two quick ones. 1). There was a generic Rumensin approval in the U.S. in the quarter. Could you comment on how that leads in relative to your expectations, and any update on timing of generic Rumensin competition in the U.S.? And also, your comments in the prepared remarks of flexible use of cash when you talk about spending the dividend -- obviously, you've seen a lot of press reports in recent weeks about a potential large M&A transaction. Could you remind us your outlook on leverage, cash utilization, opportunities of a larger size, and, for example, the acquisition of Aratana?

Jim Greffet -- Head of Investor Relations

Thanks, Mike. Jeff?

Jeff Simmons -- President and Chief Executive Officer

Thank you, Michael. On the generic monensin that is coming into the marketplace, real quick -- again, I'll reiterate -- we're prepared, it aligns with what our expectations were, and we'll continue to pursue combination clearances in beef and able to be in the dairy market. I want to emphasize that again, this is a competitor that we know with Huvepharma. Our full-year guidance incorporates all of the known dynamics right now that are impacting us in the industry, including this, so it aligns very much with our assumptions that we've had, both this year as well as next year, and we'll keep you updated as we go forward.

I'll make one comment briefly on capital allocation. As mentioned by Todd, our allocation decisions are made with the intent of using cash in the most productive ways possible, and that's absolutely critical and clear in our strategy, and hopefully just by the showing of our delivering of our results, and 29% improvement in adjusted EBITDA shows the strength of the business, and that will continue to be important as we go forward, that we'll invest cash appropriately for the most productive ways possible.

Todd Young -- Chief Financial Officer

Michael, as you notice, we did pay down $50 million of debt on our term loan during the quarter as well as utilized about $60 million of cash on the Prevtec acquisition, all in line with our IPP strategy.

Jim Greffet -- Head of Investor Relations

Adrienne, can we go to the next question?

Operator

The next question comes from the line of Umer Raffat with Evercore.

Umer Raffat -- Evercore ISI -- Managing Director

Hi, guys. Thanks for taking my question. Jeff, I know -- I realize what you guys can and can't say, but it's one of those periods where the stock was reacting very aggressively to the repeated press reports, the number of outlets they were in, as well as the sheer specificity in those articles. So, my question is as investors look for clarity -- and, I know you just mentioned IPP strategy stays on execution -- is it fair to say that the core strategy remains smaller tuck-ins and not large deals, and are we at the stage where we're past any specific deals mentioned in the press? And, I had a quick one for Todd as well. Todd, on gross margins, I think it would be really helpful given how strong it's been coming in if you could lay out a bridge from when you guys went public, when the gross margin was at 50%, to the 54.6% reported today. So, for example, it's 100 bps from one-timers, but if you could just lay out that for us, that'd be really helpful. Thank you very much.

Jeff Simmons -- President and Chief Executive Officer

Thanks, Umer. At a high level, I'm going to make sure that the energy of our organization is focused on executing our strategy, which I think you can see is working very well. It's the right strategy, a lot of proof points, and our stock price at any given time can be subject to many factors, so I'm not going to comment on market rumors. As I've said very clearly in the past, we're a company in execution mode, and I think this is our fourth quarter as an independent company, and it shows that.

Our focus is on standing up as an independent company and delivering against this strategy. It also upset in the past. We're always assessing this industry and its dynamic, and this quarter represents that, whether it's African swine fever, a contract manufacturer, or a meat processing plant that had a fire this weekend. It's a dynamic industry, and we're always evaluating these vectors of risk and opportunity that are present in the industry, and we'll be looking at those as we keep our focus on long-term sustainable value and growth for our investors.

Todd Young -- Chief Financial Officer

Umer, on the margin bridge, as we've communicated previously, we do expect to be able to add 1,000 basis points of gross margin from the 50% you referenced up to approximately 60% by 2023. We've said that generally, we'll be on a linear basis, and so, as we project the 52-53% gross margin here for 2019, it's generally in line with that. I will say that our swine business in Asia is typically a little bit of a lower-margin business than our U.S. business, and thus, as you see some of that mix playing through, that is a factor in the gross margin in 2019, as well as the higher utilization of certain plants this year that just helped drive.

Our fundamentals with respect to our gross margin productivity efforts are fully under way. We're now -- 100% of the initiatives that we had planned to deliver the 2018-2020 gross margin story are all under way and are delivering, and we've now turned to look to those next level of efforts to get us to '21-'23. So, overall, the manufacturing team across the Elanco footprint is really delivering on results and owning this effort to drive productivity forward.

Jim Greffet -- Head of Investor Relations

Great, Todd. Adrienne, do we have another question?

Operator

The next question comes from the line of David Westenberg with Guggenheim Securities.

David Westenberg -- Guggenheim Securities -- Vice President

Hi. Thanks for taking my question. Great work on Galliprant internationally. When we talk to vets in the U.S., they love the label -- the "no lab work." Is that "no lab work" dynamic similarly popular in Europe, and do you see international as a more exciting opportunity than the U.S.? And then, my second question is on Rumensin or generic Rumensin. Some of the smaller competitors I talk to talk about how Rumensin is a great product for cross-selling, not even in the sense that it's usually sold in combination, but in the fact that you're the only one that has it, and it really helps you sell other kinds of products, not necessarily just in combination. Thank you.

Jeff Simmons -- President and Chief Executive Officer

Great questions, David. We're really excited about Galliprant. What it does ultimately -- you start with a pet owner and with a dog that is now living a longer life because of the advancements of the animal health industry in bringing in what we believe is the leading product for osteoarthritis. It all comes down to the pet owner wanting something that is easy to administer, that works, and is safe. So, it starts there, and our entire focus through the veterinarians is thinking about that pet owner. So, we're seeing great interest and uptake in the international markets, we continue to globalize the product, as we've shared, and we see the same interest as we globalize this product and see tremendous growth remaining in Galliprant, and that marked a little bit of the rationale for the Aratana acquisition.

As you move to Rumensin, I say the second pillar of our strategy is portfolio, and we are looking, as we've shared out on the road, the biggest problems for our customers and how we offer a portfolio of solutions against those, whether it's salmonella in poultry or arthritis and pain in dogs to the cattle. It's really everything from the ruminant to the respiratory and being able to offer a package of products. Rumensin is one of those, but we are looking at, again, the suite of products that we have as well as bringing new products on, as we've talked about with a new product that is coming, like Experior, that has an environmental claim. So, we feel very good about this, and again, we're a portfolio company, not just a product company, and Rumensin represents that.

Jim Greffet -- Head of Investor Relations

Adrienne, next question.

Operator

Next question comes from the line of David Risinger from Morgan Stanley.

David Risinger -- Morgan Stanley -- Managing Director

Thanks very much. So, I have two questions, please. First is strategic and second is on the exits. So, on the first question, how would you assess a large transaction which enhances scale but has uninspiring revenue growth prospects? Second, with respect to your strategic exit revenue, it was $20 million in the quarter. That was more than double what we expected, and I think there was a comment about an additional $20 million in exit revenue. I'm not sure. I guess if you could help us understand how to model the strategic exit revenue line over the next few quarters. Thank you.

Jim Greffet -- Head of Investor Relations

Jeff, do you want to talk a little bit about beating?

Jeff Simmons -- President and Chief Executive Officer

Dave, I appreciate the question, and as I said, I'm not going to comment specifically on any of the market rumors or assets, and again, we're in execution mode. I think I would highlight a lot of what we're doing and what we have done in the first year. We're assessing opportunities and optimizing our strategy through that, and I think examples of Prevtec and Aratana are examples, but I want to emphasize this is the one thing that is not changing, and the lens that we look through is this IPP strategy -- innovation, portfolio, and productivity -- and those key pillars around each one of those and the critical aspects of it. That's the lens we look through: A heavy focus on execution, a heavy focus on standing up this independent company, and delivering on this strategy. That's the lens that we'll look through as we look into the marketplace.

Jim Greffet -- Head of Investor Relations

Todd, do you want to talk about strategic actions? I can.

Todd Young -- Chief Financial Officer

Jim, why don't you go ahead and handle it? David, we've got two things going on still with strategic exits -- the BI contract manufacturing revenue that we're doing for them on vaccines and human growth hormone for Lilly -- but I'll leave it to Jim on the timelines.

Jim Greffet -- Head of Investor Relations

You can probably solve for it, Dave. In our updated guidance, we do give a separate number for strategic exits. We've raised it to $80 million for the full year; it was $60 million, and I think that's roughly split between Q3 and Q4. Q2 was a pop because of increased production, especially for the Boehringer Ingelheim vaccines and the volume that they require. We think that comes back down to the run rate that was closer to what we saw in Q1, and those two -- HGH for Lilly and the BI vaccines -- those will continue to dissipate as we complete those contracts. Adrienne, can we take the next question?

Operator

The next question comes from the line of Chris Schott with J.P. Morgan.

Chris Schott -- J.P. Morgan Chase -- Managing Director

Great. Thanks very much for the questions. The first one here -- I'd just be interested in your views on the parasiticide market in light of the pending Simparica Trio launch. I think there's been quite a bit of debate of what that means for your flea and tick business, so I'd just be interested in any comments you might have about how you see the market evolving and how Elanco plays in that evolution. Second question, which is coming back to the comments on business development and its focus on execution: Regardless of size, can you just talk a little bit about the capacity the organization has at this point from a bandwidth perspective? Do you have bandwidth at this point to consider further transactions? Did we think about standing up the company, the Aratana deal, et cetera, and the work that's going on there? Maybe just for some context of how stretched is the organization right now. Thank you.

Jeff Simmons -- President and Chief Executive Officer

Thanks, Chris. We feel -- and, very clearly, nothing new since the news on additional innovation coming in. As we shared very openly in the IPO, this was expected. We shared that we would likely not be first-in-class; we're working on elements of best-in-class in our pipeline. I don't talk as openly about this given that our pipelines are not quite as transparent as the pharmaceutical industry, but I'll emphasize we're tracking very nicely internally on our prospects in this area. We most importantly -- and, as you saw with the new products, Chris, we're tracking very well relative to our portfolio of parasiticide products that we're offering to the market today. We offer the broadest solution to the seven main parasites today between the two products of Credelio and Interceptor Plus. We also have different niches in segments, both in vet market as well as the retail market, that we offer, so we like our current portfolio, assumptions are not new, and our pipeline is progressing, so we overall feel very good about it.

I come back -- on capacity of the organization, we look at execution and engagement scores quarterly. I will tell you that they've grown significantly since the start of the IPO, making our employees owners. The engagement is high. We look at execution scores quarterly as well, and what I would tell you is we've narrowed the focus as a company. As we've moved from being a division to an independent company, the clarity is high, and I believe that the supervisors we have around the world are crystal clear on this IPP strategy. So, to me, I start there, and I don't say it lightly when I say we're a company in execution mode, we're serious in what we're doing, we know the job we have to do, and Chris, I would say that's my answer to you. It's something that is front and center in the way I lead and it is something that I monitor on a quarterly basis, and I feel very good about the state of Elanco right now.

Jim Greffet -- Head of Investor Relations

Adrienne do we have another question?

Operator

Kevin Ellich with Craig-Hallum.

Kevin Ellich -- Craig-Hallum Capital Group -- Analyst

Good morning. Thanks for taking the questions. I wanted to start off with the underlying organic growth for the business. You have a lot of moving pieces with the Aratana acquisition, Prevtec, generic meds coming into play here. Could you walk us through what are the true underlying organic growths for the businesses? Then, Jeff, just wanted your thoughts on the use of different distribution channels for companion animal products -- online versus distributors. It seems like more people are opening up to Chewy and 1-800-PET-MEDS.

Jeff Simmons -- President and Chief Executive Officer

I just think the underlying growth -- I want to emphasize one key number that's important. When you take out the events, which is African swine fever and the contract manufacturing impact in the ruminant and swine segment, we're growing. The underlying demand for core revenue on constant currency is at 5%. I think the other point that was stated by Todd is seven of the eight categories -- when you look at our four market categories and U.S. and international, seven of the eight are growing.

So, when I look at this -- and, we look at things such as the placements and the demand pull-through in vet clinics when we look at market share in these key segments. We feel very good about the fundamentals, and again, you understand when we talk about the fundamentals with animal health continue, and I think the diversity of our industry and the global aspects of it, and many therapeutic classes -- this year is an example. That diversity creates sustainability of growth. So, that's important.

Second question was distribution channels. Great question. So, just since the launch of our IPO, continued dynamic of change, both in distribution, and retail, and corporate vet clinics, and specialty clinics. To me, the multichannel approach to reach a pet owner globally continues to be more and more dynamic. It's something that we've got our eyes on, it's something we've got to be very conscious of, and what I would say is I feel very good today about where we stand, but it's something that we need to continue to monitor and assess. As I talk about looking of vectors of risk and opportunity, this is one that we'll continue to look at.

Probably a good example since the start of this year with Aratana -- and, I'll reiterate a comment I've made -- we've cross-trained our sales force. We've got Aratana sales force as part of the Elanco team. They've been trained. They're focused on those specialty clinics in the U.S., while our core team is selling Aratana products back to the general vet clinic, and we've got a retail group and a corporate vet clinic group, so those are examples of where we have teams in place and we'll continue to monitor some of these other changes that are occurring. But, it is something I think we need to keep our eyes on as we move forward in the global pet market.

Jim Greffet -- Head of Investor Relations

Adrienne, next question.

Operator

The next question comes from the line of Steve Scala with Cowen.

Steve Scala -- Cowen & Company -- Analyst

Thank you. A couple questions. Regarding the postponing the initiation of the dividend, is there any clarity on when it might be initiated? Apologies if I missed it, but can you speculate on what cash -- or, can you be specific on what cash needs are taking priority over initiating the dividend? Secondly, the Novartis acquisition several years ago was a greater challenge and more disruptive to integrate than many had expected, so just philosophically, what factors would the company consider before going down that road again? Thank you.

Jim Greffet -- Head of Investor Relations

Todd?

Todd Young -- Chief Financial Officer

Steve, thanks for the question on the dividend. We have not stated when we expect to initiate a dividend. We do think over time that our business is going to generate a significant amount of cash, and that we'll be able to pay a substantial dividend in the future. In the near term, obviously, we've paid down the term loan as we had planned. What was unplanned was this nice opportunity with Prevtec, and with that, the $60 million of cash utilization that we think really drives value in antibiotic alternatives as we get a vaccine for swine producers, proposed weaning diarrhea on E. coli, and that's the sort of opportunity we're excited to invest in for the long-term value proposition that Elanco brings.

Jeff Simmons -- President and Chief Executive Officer

Let me share, Steve, just at a very high level. I think it's important to note on Novartis -- and, we did this when we were out on the roadshow when we launched the company -- that the challenges faced between 2015 and 2017 were heavily dependent on two events that occurred more to our organic Elanco business, and I think that impacted the external results between 2015-17. One was the emergence of some new companion animal innovations. Since then, we've launched Interceptor Plus and Credelio. And, the second was the whole clean food movement, where it impacted both our antibiotic franchise and some of our productivity products. Again, those were on the actual business. I think when we look at Novartis -- synergies, new products, the capabilities it brought, the global nature of the business -- we felt good. It was not really as much of a distraction as the two external events impacting our results, but we learned a lot of things that were helpful for us as we go forward in running our existing business.

Jim Greffet -- Head of Investor Relations

Adrienne, can we have the next question about our results?

Operator

John Kreger with William Blair.

John Kreger -- William Blair & Company -- Analyst

Hi. Thanks very much. Jeff, what's your latest view on how the ASF issue in Asia will play out for the business? Sounds like the impact is getting a little bit worse, but do you have a view about whether or not that will likely become a bigger headwind in '20, or perhaps, could it flip to be more neutral or positive as other producers and other regions start to increase capacity? Just curious what your views are. And also, kind of a similar question -- the global supply disruptions that you mentioned -- from your perspective, when might those be resolved? Thanks.

Jeff Simmons -- President and Chief Executive Officer

Let me take your second question first, which is -- this is related, let me be clear, to this contract manufacturing issue, where we're working very closely with this company. This is directly related to the Micotil outage that we had in the past, so it's the same contract manufacturer. The problems are contained, they're known, it's really more of the resupply and the pathway back to resupply. It is our intention that these are issues that should be resolved by the end of the year and not be issues going into 2020. I will keep you updated on that, but I feel good about that.

I think relative to African swine fever, there's a lot that we've learned, but there's a lot we still don't know. It's significant. It's like nothing I've seen in my 30 years. These are large numbers. It's moved from China to the Asian countries. There's early emerging cases still unknown relative to what they are in some of the emerging eastern European countries, but I would say we need to keep our eye on it. There's no question the dynamics we need to look for is 1). I think you'll see poultry within Asia benefit the most initially, and then, I think trade will be the second factor -- the ability to move pork into diets that will not and won't want to change as fast, and that pork demand will be there -- is the ability to supply from other areas.

I do think that on the ground, the biosecurity measures that are being taken are the right thing, but it could just take time, so I think the leveling off will be poultry locally, maybe poultry globally, and then, I do think -- keep our eyes on trade as we start to look at other parts of the world that want to feed this demand. It's important. As you look at swine economics here in the U.S., we went from last quarter them making money to them moving closer to break-even, and a lot of that is simply because of the inability to trade pork, and that's something to watch. I think it's something we need to continue to monitor as we go through 2020. I do think some of these upsides will balance out some of the local downside, and I think innovation is still quite a ways off. So, those are my thoughts at this stage. More to come -- I think this is one of these quarter by quarter, we'll learn and put more of this puzzle together.

Jim Greffet -- Head of Investor Relations

Adrienne, I think we still have a few more people in the queue.

Operator

The next question comes from the line of Liv Abraham with Citi.

Liav Abraham -- Citigroup Research -- Analyst

Good morning. A follow-up question on generic Rumensin. What do you consider a fully generic market in terms of number of generic players, and how many generic players do you ultimately assume will play in this market? And then, secondly, perhaps a couple of comments on pricing from your end. Pricing across your portfolio remained quite strong in the second quarter and in the first half, so can you just comment on the sustainability of the pricing trends that we've seen across your portfolio? Thank you.

Jeff Simmons -- President and Chief Executive Officer

Great questions. I always come back on the generic -- this industry has had a high percentage of generics. Monensin is an example that's been generic for more than 20 years in many other markets that are similar to the U.S., like Canada. Again, it comes back to a few key fundamentals that are important: The total portfolio, the continued innovation that comes with lifecycle management, I think the pure economics -- I think this is a cash market, and Rumensin, like many other products, is a small cost. It's pennies per pound in terms of the cost.

So, that comes into play where you add share voice, value beyond product, and a portfolio of products. That is -- really, it's not about the number of generics as much as the total value proposition, and we really like where we are relative to our total portfolio in cattle, and examples of that is an Experior that is coming as a product, as well as even as we look at a deal that we've done earlier with Novozymes as we continue to build out and give that B producer more value in total offering.

And, I think pricing -- when you look at the underlying fundamentals of demand, we feel good about pricing. We've said our industry in the past has averaged about 2% in terms of price. We've predicted that or a little less going forward, and we continue to monitor carefully, but we see nothing that would change that going forward.

Jim Greffet -- Head of Investor Relations

Adrienne, next question.

Operator

The next question comes from the line of Navin Jacob with UBS.

Navin Jacob -- UBS -- Analyst

Hi. Thanks for taking the question. Just a couple on gross margins, if I can. Very nice progression here, but if you could help us understand how much of a benefit -- sorry if I missed this in the prepared remarks or during the questions, but how much of a benefit FX had this quarter. And then, just broadly speaking, on that same point, could you help us understand how it flows through going forward, just so we know how to model it? So, if it's a negative impact on revenues, if it's a positive impact on gross margins, is that always the case? Any color there would be helpful. And then, if I didn't mention this, Posilac -- if you could help us explain that impact, please, that would be very helpful. Thank you.

Jim Greffet -- Head of Investor Relations

Hey, Navin. It's Jim. I've spent a lot of quality time with our accountants on gross margin. So, for Q2, as Todd mentioned, overall, foreign exchange was a benefit to our gross margin, about 80 basis points. That's the combination of two things: Operational FX -- so, just as we had the three-percentage-point headwind to sales, we have residual headwind on our gross margin from just the operational change in foreign currency. I think that was roughly 50 basis points of headwind. Then, we have this other issue that, if anybody follows Lilly, it's similar to the FX impact on foreign international inventories. That can be somewhat counterintuitive depending on when rates move, where they move, and the inventory turns.

For this quarter, that was actually a tailwind of 130 basis points or so, and that's why Todd phrased his language as he did. I'd say if you parse those two things apart, generally, as we see rates move and create a headwind or tailwind to sales, you would see a similar level -- a reduction, of course, because of the marginal impact, but you'd see a resulting impact on gross margin. Then, we'll do our best period to period to talk about this other FX on international inventories because it can be discrete, and at times, counterintuitive, as it is this quarter, so we'll do our best to be clear on that. Jeff, do you want to talk about Posilac?

Jeff Simmons -- President and Chief Executive Officer

Posilac real quick -- again, we've been representing this product in the U.S. and international markets for the remaining inventory owned by Lilly, as Todd stated. This was just really a transactional decision. It made more sense for us to have the inventory on our books, and it links a little bit to my portfolio approach. As we work through the inventory, we'll be selling this through the portfolios that we have in the dairy industry.

Jim Greffet -- Head of Investor Relations

Adrienne, do we have any more questions?

Operator

If you would like to ask a question, press *1. The next question comes from the line of Kevin Ellich with Craig-Hallum.

Kevin Ellich -- Craig-Hallum Capital Group -- Analyst

Hey, Jeff. Just had a quick follow-up. So, the U.S. cattle market -- it seems like with the wet summer we've had, cattle are staying on pasture longer; they're heavier when they go to feed lots. You guys called out Optaflexx as a driver this quarter. Was wondering what's really driving that, and are you still seeing competition from generic ractopamines? Also, I want your view on the meat alternative plant-based market and the longer-term implication on your food animal business. Thanks.

Jeff Simmons -- President and Chief Executive Officer

Great questions. I'll say this: If you just look at the basic fundamentals of each one of the segments of protein, cattle on feed in most major U.S. feedlots continue to run about 2% ahead of last year's pace. The demand continues to be quite strong there. They've got their pressures, but I think as a whole, there's nothing that -- U.S. pasture and range conditions overall are in good condition, allowing cattle to be on grass longer, and so, as a whole, beef is in a good place. Dairy continues to struggle, as we've shared. The combination of Optaflexx, as we've talked, Rumensin, and some of our other -- even respiratory, therapeutic products, soon, nutritional health products -- it does allow us to have a portfolio approach that offers value, and I think it's a representative example of the earlier question relative to the importance of portfolio overall.

On protein alternatives, something I speak on and talk about quite often and our team looks at -- no question we're monitoring right now the alternative meat, but I will say this: We have a bigger challenge internally. If you just put the numbers to this, they're predicted that the alternative meat industry will be about $6.5 billion by 2023. When you have a trillion-dollar industry growing 1-2%, we're growing $10-20 billion a year, so we're growing on an annual basis what the alternative market will be totally in 2023.

With that said, we've got our own challenges, and this is where animal health -- I believe it's so critical right now, whether it's environmental and the challenges there, to trade, to African swine fever. The importance of, I believe, mortality, morbidity, the health and wellbeing of animals -- animal health is in the center of this, which is what we call "One Health," sustaining supply, sustaining economics, the health of the animal, the quality of the food -- it really gets back to the impact, not just on the animal, but on the environment and the person. So, a lot of interest in alternative proteins. It's something we've got our eyes on, but the bigger is really the shifting diet -- more protein, as well as, of course, increased population and more GNP. So, those are some of my thoughts on why the importance and the priority of animal health in the center of this animal protein dynamic has never been as critical as it is today, I believe.

Jim Greffet -- Head of Investor Relations

Adrienne, we're almost at the top of the hour. I think we have time for one more question.

Operator

The final question comes from the line of Gregg Gilbert with SunTrust.

Gregg Gilbert -- SunTrust Robinson Humphrey -- Managing Director

Thanks for the question. Jeff, can you comment on your geographic mix, and are you content with where it exists now? Are there any markets you're looking to add to or enhance via organic efforts? And then, secondly, curious on your longer-term view on cats, and the opportunity to increase medicalization rates for cats, and how your pipeline is aligned for that. Thanks.

Jeff Simmons -- President and Chief Executive Officer

Great questions, Gregg. No question we're much more global than we've ever been. We're as diversified as we've ever been, but we're not enough. As I look at a few spots, no question a more global companion animal market is going to be critical for us. We've got a good, strong U.S. business, as you know, and a pretty good European and Japanese business, but as you can see the emerging market companion animal market is critical. We've got a nice global poultry market overall, but as we look at being opportunistic, as we build a swine portfolio with Coliprotec and Prevacent and our cattle portfolio, we're going to want to continue to be opportunistic, and where our productivity agenda allows, to continue to expand overall.

The feline market, Gregg, as you know, continues to be very attractive. It's probably not talked about enough. An example of that is our Credelio cat launch in Europe, and the success of that is showing the importance of this segment. Innovating there, the administration to a cat becomes even new innovation in itself, and as you know, there's a couple big areas of opportunity there, like renal failure, et cetera, so we're excited about that. Our pipeline is lined up and going after those targets as well, so as a whole, we're in a good place.

Jim Greffet -- Head of Investor Relations

Jeff, we have just a couple seconds left. Do you want to offer closing comments?

Jeff Simmons -- President and Chief Executive Officer

I want to thank you for joining us today. I hope the second quarter represents clearly our IPP strategy -- innovation, portfolio, and productivity -- is working as you look at the growth of the business, the impact of innovation on our business, and the progress in our pipeline, and one of the biggest quarters here -- our fourth quarter as an independent company -- in the area of productivity, and our ability with the guidance that we've given to continue to deliver in that range. Thank you for your interest in Elanco, and I want to assure you that Elanco employees around the world -- we're invested, we're engaged, we're acting like owners, and we're delivering on this strategy. Thank you for your time, and have a great day.

Operator

You may now disconnect.

Duration: 59 minutes

Call participants:

Jim Greffet -- Head of Investor Relations

Jeff Simmons -- President and Chief Executive Officer

Todd Young -- Chief Financial Officer

Katy Grissom -- Director, Investor Relations

Erin Wright -- Credit Suisse -- Analyst

Michael Ryskin -- Bank of America Merrill Lynch -- Vice President

Umer Raffat -- Evercore ISI -- Managing Director

David Westenberg -- Guggenheim Securities -- Vice President

David Risinger -- Morgan Stanley -- Managing Director

Chris Schott -- J.P. Morgan Chase -- Managing Director

Kevin Ellich -- Craig-Hallum Capital Group -- Analyst

Steve Scala -- Cowen & Company -- Analyst

John Kreger -- William Blair & Company -- Analyst

Liav Abraham -- Citigroup Research -- Analyst

Navin Jacob -- UBS -- Analyst

Gregg Gilbert -- SunTrust Robinson Humphrey -- Managing Director

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