Logo of jester cap with thought bubble.

Image source: The Motley Fool.

ELANCO ANIMAL HEALTH INC (NYSE:ELAN)
Q3 2020 Earnings Call
Nov 6, 2020, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen, thank you for standing by, and welcome to today's Elanco Animal Health Q3 Earnings Call. [Operator Instructions] I would now like to turn the call over to your speaker today, Tiffany Kanaga, Head of Investor Relations. Please go ahead.

Tiffany Kanaga -- Head of Investor relations

Good morning. Thank you for joining us for Elanco Animal Health's third quarter 2020 earnings call. I am Tiffany Kanaga, 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. As always, during this conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors. Including those listed on Slide 2 and those 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 is 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 in the Investor Section of elanco.com. The slides in the press release also contains further information about the non-GAAP financial measures that we will discuss today during this call. After our prepared remarks, we will be happy to take your questions. I will now turn the call over to Jeff to provide the highlights.

Jeffrey Simmons -- President and Chief Executive Officer

Thanks, Tiffany. Good morning, everyone. In the third quarter Elanco continued executing with discipline to deliver on our stated expectations for the quarter, all while closing the industry's largest acquisition to-date with Bayer Animal Health and announcing our initial restructuring. Our underlying business continues to perform and is bolstered by our distribution strategy, which is generating important positive progress. Finally, our independent stand-up and integration are on track. Specifically, in the quarter, we achieved Legacy Elanco revenue at the high end of our guidance.

We completed the Bayer acquisition and move with speed and decisiveness to announce the initial $100 million of value capture actions. We posted our first term loan repayment and ended the quarter with $660 million in cash on the balance sheet. We drove commercial competitiveness through our distribution strategy with improved receivables, cash conversion, pricing, margin and market share gains for Credelio and Galliprant in the U.S.

We became the retail channel leader in U.S. flea, tick and heartworm and outgrew the market in the quarter. We expanded gross margins including ongoing benefits from our productivity agenda and we received two new product approvals and I'll stand with four approvals out of at least five planned launches expected by the end of 2021, and we're on track to finalize the separation from Lilly with the ERP's stand-up transition expected by the end of Q1.

Ultimately, our IPP Innovation Portfolio and Productivity strategy is working and Elanco is competitively positioned to provide shareholder value. On Slide 3, let me summarize our execution in the quarter. On the top line Legacy Elanco delivered $694 million at the high end of our guidance. As anticipated pressure from COVID lessened sequentially and was contained through our Farm Animal business. Overall, revenue increased 16% driven by the addition of Bayer, which contributed a $196 million or 25% growth from the seven weeks of invoicing reflected in the quarter.

Revenue and growth by category and legacy business are detailed on Slide 4. Gross margin improved by 90 basis points underpinned by ongoing productivity improvements, price discipline and the addition of the higher margin Bayer business. Continued mix headwinds represented a partial offset. We're rigorously managing cost across the organization.

In the third quarter it is important to note that the inclusion on Bayer Animal Health costs began on day one while cutovers and reregistrations impacted sales. Rounding out the P&L, our adjusted EBITDA of a $148 million was down 13% versus a year ago period and our adjusted EPS was $0.13. And finally on the balance sheet and working capital, in the third quarter, we began the debt deleveraging process we achieved further sequential improvement in days of sales outstanding. All of these highlights underscores our focus and progress and I'm pleased with the execution of our global organization during this significant time in our history.

Moving to Slide 5, let's discuss the commercial environment and our performance. Beginning with U.S. Pet Health, we maintained overall dispensing share for Legacy Elanco on year-to-date basis versus last year and build share in key products. This performance comes on top of a favorable industry-backed up as vet clinic traffic continued its V-shaped global recovery. The business outperformed our expectations in the third quarter and vaccines were particularly strong.

Our flea and tick product Credelio led our growth up 85% in the third quarter with Kynetec's dispensing data showing continued market share gains at the vet clinic. We're seeing further traction in the pairing opportunity with Interceptor Plus. Kynetec data shows that for the third quarter when Interceptor Plus is sold with a flea and tick solution, it's paired with Credelio 49% of the time. Improving 6 percentage points from June and up more than 50% year-over-year. Our offering of the broadest overall parasite coverage is resonating with vets and pet owners.

Meanwhile, we're actively managing our core loyal customer base for our legacy product Trifexis where share shifts are in line with expectations that is older but profitable part of our portfolio. In Therapeutics Galliprant is performing well, continuing to outpace the branded market in dollar growth compared to last year, according to the Kynetec data.

Overall, U.S. Pet Health BDI, which represents sales from distributors in the vet clinics and alternative channels was up mid single-digits in the third quarter, in line with our reported U.S. Pet Health revenue trends after adjusting for last year's benefit from the initial stocking at a large retailer and this year's divestitures. We continue to closely manage inventory in the distribution channel to stay at target levels, and we exited the third quarter with inventory levels consistent with the second quarter

Moving to our Farm Animal business, COVID-19 pressures are lessening in the U.S. while the pandemic was a greater factor in certain international animal health sub sectors in the quarter. Globally, we estimate that COVID represented a $35 million headwind to Legacy Elanco revenue in the quarter, in line with our guidance.

About a quarter of that impact was felt domestically, primarily in swine. These challenges on the U.S. protein supply chain and on our business eased sequentially through the period. We've been encouraged by the higher cattle on feed numbers and the diminishing poor processing backlog allowing for improved producer margins in both, cattle and swine since the summer slows.

While the momentum is promising, we do expect the timeline for industry normalization to still extend into 2021. For Rumensin, we see a sustaining commercial strength, despite generic disruption. Our market share assumptions are tracking better than originally planned after 12 months of competitive entry, as our team is successfully demonstrating the products meaningful, therapeutic and quality differences to customers.

In our international business, let me start with Pet Health where markets around the world appear to have broadly stabilized in the quarter, with some variances by country. Credelio was a growth driver in the quarter outside of the U.S. driven by market expansion and uptake of Credelio for cats in Europe.

On the farm side, our international Future Protein & Health portfolio was negatively affected by unfavorable macroeconomic conditions and reduced consumption trends. As a result, the industry has seen pressured prices and producer profitability across species, most notably poultry and aqua markets. In the global poultry market, we've seen acute production declined and reduced export opportunity in certain regions particularly Central America, the Middle East and India, which more than offset growth in markets like China and Vietnam. Poultry prices have dropped to an outsized degree due to relatively high dependence on food service sales including restaurants and wholesale markets. Balancing local supply with volatile demand has proven challenging for global producers. Production growth estimates this year very widely from up 15% in China compared to declines of 8% and 10% in Thailand and India respectively. We believe, these near-term industry headwinds have impacted Elanco more acutely, as a result of our unique portfolio composition, which is weighted toward premium price feed additives.

As poultry producers experienced greater economic pressure, we see trade out of performance from safety and premium products while biologics and disease treatment products tend to remain more stable. Transitioning to aqua, we've seen severe macro-related shocks to the industry with salmon prices down 40% since the start of the year. These adverse economic conditions had impacted producers to use the premium solutions like Clynav. However, we expect our product still provide growth for 2020 in total and we see the potential for a return to robust sales growth and market share gains next year.

This volatile international backdrop in Future Protein & Health is likely to persist in 2021, but we continue to view both species as important growth drivers for Elanco over time. Although, our international ruminant and swine portfolio was pressured by macroeconomic conditions and decreased producer profitability, our Asia swine business provided a partial offset. This business experienced healthy growth in the quarter as a recovery continues compared to last year's African Swine Fever headwinds. Both Legacy Elanco and Legacy Bayer China swine sales were up robustly year-over-year and both also saw a more than 30% improvement compared to the third quarter of 2018.

Finally, let's discuss on Bayer Animal Health side of our newly combined organization. For July, Bayer reported Animal Health revenues of a EUR166 million or approximately $191 million. As I mentioned earlier, Legacy Bayer contributed a $196 million in the remainder of the quarter for Elanco totaling about $387 million combined for Q3. This represents approximately 20% growth for the quarter, excluding the impact of divestitures. The Bayer business experienced robust growth in the first seven months of the year, driven by retailer stock and to support higher demand as a result of COVID and the blackout period ahead of the deal close.

In the third quarter, we observed some unwind of this inventory pull from retailers. But overall, we believe the Bayer business remains in line with the 4% to 5% underlying growth that we estimated in the first half. The strength reflects Seresto, now our largest single product on a pro forma basis, which added nearly $20 million to Elanco's revenues for the quarter. Advantage family revenue was $55 million and performance for both in the quarter was impacted by seasonality the unwind of retailer stocking and system cutovers. In just our first few short months together, I'm encouraged by how well the integration is progressing. Our team is managing the complexities of an acquisition of this size, while still completing our stand-up to be fully independent from Lilly.

As I mentioned earlier, we are moving with speed, as evidenced by our initial restructuring announcement. We remain on track for $275 million to $300 million in total synergies, including the first two-thirds and the first three months. Our combined team is focused on commercial competitiveness, delivering innovation and realizing synergies, especially as we continue to navigate a challenging macro environment. We have the right plans in place, right people to execute them with strong momentum into the balance of the year and beyond.

Moving to Slide 6, we continue to see strong progress against our IPP strategy. Let's look at a few of the key milestones and achievements on the strategy during the quarter. Starting with innovation, we received two new approvals since our last earnings call. The first is the European Commission Approval for Increxxa, a product for bovine and swine respiratory disease, which will be a valuable complement to our Farm Animal portfolio. In October, we also received U.S. FDA approval Elura, a weight loss management treatment for cats with chronic kidney disease. With these two products alongside Experior and Cosabody remain on track toward at least five launches by the end of 2021 and 25 by the end of 2024.

Bigger picture, we're taking a holistic approach to innovation. Many short-term goals including differentiated efforts in large addressable markets. I'm excited about our pipeline potential, which will fuel a part of our growth algorithm over the long term. We look forward to sharing more at our Investor Day on December 15.

On the portfolio front, we have a solid group of focused brands to drive our growth. The 14 Legacy Elanco products launched or acquired since 2015 grew 18% in the quarter excluding divestitures and adjusting for last year's initial stock-in at a new retailer is shown on slide 17. Through Bayer, we have an enhanced portfolio and capabilities to serve customers across all channels globally. Bayer tripled the size of our international pet health business where Seresto and Advantage still have a long runway ahead, especially in markets like China. On the U.S. side, the combined Elanco is now a leader in the flea, tick and heartworm retail market and outgrew the industry and these alternative channels in the quarter.

Finally on productivity, we remain relentless on our operating expense and cash management in the quarter and layered on incremental savings from reduced travel and related expenses. We also continue to drive manufacturing efficiencies and on track to realize the $215 million in savings and cost avoidance, as planned from 2018 through the end of the year. We expect to share more on our next phase during our December investor meeting. Additionally, we maintained price discipline in the quarter, up over 2% for Legacy Elanco. Price and productivity contributed to our 54.2% gross margin performance which Todd will detail in a moment.

As I look to next year and beyond our IPP strategy has uniquely positioned Elanco within the animal health sector. Our strategic actions since the IPO have set the stage for meaningful value creation for all of our stakeholders moving forward. With that, I'll turn the call over to Todd, to provide more color on our results and outlook.

Todd Young -- Executive Vice President & Chief Financial Officer

Thanks, Jeff. Slide 7, summarizes our presentation of GAAP results while Slide 8 describes the items considered in the adjusted financials. Slide 18 to 21 in the appendix, provides 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 in order to provide insights on the underlying trends in our business so please refer to today's earnings press release for a detailed description of the year-over-year changes in our third quarter GAAP results. I'll also remind you that our third quarter 2020 results include two months with Bayer Animal Health.

Looking at the adjusted measures on slide 9, you will see the total ankle revenue increased 15% in the quarter on a reported basis, foreign exchange had a 1% negative impact. I'll breakdown the effect of Bayer on a revenue growth and further detail in a moment. Gross margin, as a percent of revenue was 54.2%, an increase of 90 basis points for the third quarter of last year. The improvement was driven by the inclusion of Bayer's higher margin business, positive price on Elanco's legacy portfolio, continued productivity gains and an absorption in advance of our Go Live on our new independent the Elanco ERP system in the first quarter of 2021, partly offset by legacy Elanco mix headwinds, as well as the cost of our fixed manufacturing footprint spread over low -- lower total sales at our legacy business.

Total operating expense increased 40% in the third quarter, including the addition of the Bayer Animal Health business in August and September. As a percent of sales, operating expense increased from 34% in the year ago period to 41% in this period, reflecting the impact of cutovers in August, as Bayer's costs at our P&L on day one, while sales experienced the blackout period of about two weeks. At Legacy Elanco operating expense continue to reflect cost management, as many parts of our business are still operating virtually. Operating income decreased 22%. At the bottom line Q3, adjusted net income decreased 46% to $60.3 million. The Q3 effective tax rate was 9.7% reflecting the decrease in international income that was subject to the GILTI tax, which was introduced to the U.S. tax reform in 2017.

Our adjusted EBITDA margin was 16.6%. On Slide 10, you can see the effect of price, rate and volume on our revenue performance. The benefit of the Bayer acquisition is reflected in volume. As is typical with acquisitions, we will continue to report the addition of the Bayer business in volume for the next four quarters. For the Legacy Elanco business, prices up 2% of the quarter demonstrating the value of our innovation and the ongoing discipline we are applying despite competitive pressures. Slide 11, provides more detail on our overall performance in the U.S. and internationally both of which were impacted by COVID, but also benefited from the addition of Bayer.

In the U.S., total revenue increased 9% and international revenues grew 23%. We expect to file our 10-Q shortly, but moving to slide 12, let me now provide an update on working capital, cash and our debt to leverage including our recent term loan paid off.

As we have discussed, working capital is an area of focus for us. In the U.S. consistent with Q2, we hold distributors on 60 day payment terms. In the third quarter, day sales outstanding continue to improve sequentially standing at 67 days versus the peak of a 103 days in the first quarter of 2020. We ended the third quarter with $660 million in cash and equivalents on our balance sheet. As announced in the quarter, we repaid a $100 million on our term loan that funded the Bayer Animal Health acquisition. We will continue to repay debt from our operating cash flow 2021 with a focus on our $500 million note, which is due in August of 2021. Our net debt leverage ratio stood at 6.4 times at the end of Q3.

During October, we borrowed $250 million on our revolver to fund local country asset purchases as part of the Bayer acquisition. Once the purchases are complete, Bayer AG will pay Elanco the $250 million purchase price back, which we will use to repay the revolver. The circular transaction should be completed this year. 2020 remains uniquely cash at the year given the stand-up and the independent Elanco ERP system and IT infrastructure the execution of the acquisition and the build of the requisite ERP infrastructure for the Bayer business. We now estimate total cash costs for the independent company stand-up to be in the range of $280 million to $320 million net a certain offsets. The increase versus the prior range of $240 million to $290 million primarily reflects higher cost to execute local country IT infrastructure deployment and transitions as a result of the COVID-19 pandemic-related travel restrictions and protocols, as well as increased site cutover and additional scope costs.

The vast majority of our global team are now operating in the Elanco IT infrastructure environment and we remain confident in completing the stand-up of the independent Elanco with be Elanco ERP cutover in Q1 of 2021. The completion of the ERP transition will drive the culmination of the remaining world transitional services agreements. Additionally, as we shared in the pro forma financials in the October 15, 8-K filing, I want to note that the Elanco capitalized approximately $72 million for the ERP infrastructure supporting the Bayer business.

Now I will transition to our outlook on Slide 13. For the fourth quarter of 2020, we expect the Elanco's total revenue to be between $1.02 billion and $1.06 billion. Our fourth quarter guidance includes an estimate of approximately $20 million to $30 million of COVID-related headwinds primarily, our Farm Animal business. We are also monitoring the potential impact of another phase of broad shutdowns including actions currently being taken in Europe. However, our guidance does not reflect a broad U.S. or international shutdown as we saw earlier this year. On the Bayer side of our global animal health business the fourth quarter will reflect an estimated $10 million of continued reversal of revenue pull forward due to COVID and IT cutovers.

For the full year, we believe that retailers are holding an additional $25 million of inventory, compared to 2019 and that the incremental balance is appropriate to match Bayer's larger sales base and strong underlying trends in recent periods, as well as the larger trend across consumer packaged goods with retailers reacting to the ongoing COVID backdrop and rising case counts.

Additionally, fourth quarter revenue guidance incorporates a number of other discrete headwinds to growth including divestitures, as part of executing the Bayer term acquisition, lapping sales of Posilac inventory awaiting regulatory clearance in India and the impact to deferring the typical January 1st price increases at Bayer to our February timeframe.

The treatment of certain trade funds is SG&A under IFRS versus the sales reduction under our U.S. GAAP accounting also reduces Legacy Bayer sales compared to all prior periods. Importantly, however, our outlook is grounded in underlying growth trends on both sides of the business that are in line with our fundamentals year-to-date, including continued 4% to 5% underlying growth for Bayer's global portfolio. We are not introducing EPS guidance at this time, given the volatile macro economic backdrop and the unpredictability of potential future effects from COVID-19. We expect to provide more details on the fourth quarter at our Investor Day in addition to 2021 guidance.

In the meanwhile, let me offer some commentary on operating metrics. We anticipate a sequential deceleration in gross margin from the third quarter's results reflecting our normal seasonality step down, as a result of plant maintenance and shutdowns sales seasonality for Seresto and the Advantage family and the reversal of the absorption benefit in advance of Elanco ERP cutovers in January, as well as ongoing mix headwinds in fixed cost deleverage.

We expect to continue to capture productivity efficiencies and remain disciplined on price. Furthermore, the quarter will include three months of Bayer's is higher margin business. With respect to operating expenses, we anticipate year-over-year declines for both Legacy Elanco and Legacy Bayer relative to the pro forma expenses provided in our October 15th, 8-K filing. Our outlook reflects benefit from the continued cost management initiatives and ongoing reductions in travel expenses. Value capture actions are on track. We remain very early on the curve to realizing benefits. Now, I'll hand it back to Jeff for closing comments.

Jeffrey Simmons -- President and Chief Executive Officer

Thanks, Todd. Let me summarize, we closed the third quarter, as a stronger enterprise, seen positive progress from key strategic decisions with the inclusion of Bayer and the distribution model shift. We're executing with discipline and urgency to deliver on our stated expectations for the quarter, achieving results at the high end of our guidance. We're gaining share with key Pet Health products and entering the balance of the year with momentum. We are moving quickly, on the integration and making the tough decisions necessary to capture value. The final phase of our independent stand-up is under way and on track for completion in early 2021.

Our IPP strategy is working with a combined stronger portfolio, greater access to the world's animals and through a pipeline that is progressing and with a productivity agenda that continues to enhance margin growth. I want to today -- on slide 14, highlighting the 2030 Elanco healthy purpose sustainability commitments we unveiled last week. These decade long commitments supports the United Nations Sustainable Development Goals and are a first of its kind in the animal health industry. Our Protein, Planning and Pet Pledges aimed to provide improved access to nutritious protein, reduce the company's and our customers' footprint on the planet, and increase the health of the pet to support people's well-being.

We outlined these pledges in detail on our website at elanco.com. It all starts with a healthy and strong enterprise driven by the growth, innovation and margin expansion agenda against which we are executing. Through these efforts, Elanco is focused on creating value for our customers, employees, shareholders and society as a whole. With that, I'll turn it over to Tiffany to moderate the Q&A.

Tiffany Kanaga -- Head of Investor relations

Thanks, Jeff. We'd like to take questions from as many callers as possible, so we ask that you limit yourself to one question and one follow-up. Michelle, please provide the instructions for the Q&A session and then we'll take the first caller.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Michael Ryskin from Bank of America. Your line is open.

Michael Ryskin -- Bank of America

Thanks. I'll just ask one to Michel without wasting our time. I want to focus on the lifestyle business in the quarter. I mean, I mean you have already answered in your comments in the prepared remarks, Jeff. But if we just look at look some of the peers we're able to accomplish then market animal health livestock was up 8%, livestock is at 9%, fiber livestock was at 5%. And then also the Legacy Elanco business declined pretty meaningfully in the quarter. If we kind of back out Bayer's contribution i mean, something I think double-digit decline. So can you go into that in a little more detail. What's the discrepancy here? Is there anything by species by geography sort of what picks out? And then how do we think about that in 4Q despite COVID headwind it seems like other businesses that are very well works through them and benefit comes from COVID impact and cattle when can we expect that to say churn up for Elanco?

.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah. Thanks, Michael. I think first of all, the differences in portfolio in places where the business is. I think first of all, we feel very good about the fundamentals and the improvement as I've said in cattle and swine in the markets and the markets are improving post COVID. Planning capacity, the diminishing backlog as I mentioned in pigs and I see that being a positive. I think, overall, I would stay on some of the positives. Again strong swine recovery from African Swine Fever. So either just some of the key I would say pushes, and then I'll share some of the differences that you outlined.

I think on the positive side, we see strong swine growth even relative to 2018, as I said, both on the Bayer side and the Elanco side in the Asian area and that is a positive. We continue to see what we would say is strong, positive fundamentals in our overall business when you look at the U.S. What I think are some of the differences is one, we've got finishing one year in relative to generic Rumensin and that is a -- we're doing well relative to our expectations, but there is a decline there.

And then the highlight to me is really poultry and aqua. We continue, they've been major growth drivers for us is Future Protein & Health. They will continue to be, but what we've seen is one, salmon industry, which is a big part of our growth and big part of our plans this year that has been impacted by industry dynamics, not by market share, not by where our products sit, but just actually by the economics of the industry and its impact on pulling away from use of animal health products. Second is international poultry, again a pretty significant 75% to 80% of our Future Protein & Health is poultry and a big international poultry business and that's been impacted as well by again, the impact of kind of the lingering effects of COVID and the pulling back of usage on certain animal health products.

Again, as we look going into '21, and there is no question, some of these trends will persist a little bit in the COVID impact, but as I look even into '21. One introduction of new products to the fundamentals of where share our and poultry and aqua recovery we continue to see them as key growth drivers in the Future Protein & Health being a key growth contributor, starting in 2021. So I would say, as a whole, we feel very good relative to our expectations. There's just been a set back a little bit relative to international poultry and aqua.

Tiffany Kanaga -- Head of Investor relations

And we'll take the next caller please.

Operator

And your next question will come from Nathan Rich from Goldman Sachs. Your line is open.

Nathan Rich -- Goldman Sachs -- Analyst

Good morning. Thanks for the questions. Jeff, I wanted to ask on the pipeline. Obviously, bringing new drugs in market and having that flow of innovation is kind of a key piece of the revenue outlook. I mean this is an industry obviously where visibility on the pipeline has been pretty limited. You talked about sharing more details at the Analyst Day. But can you talk about the type of disclosures were may be likely to get there. And what you kind of see at a high level, as the most attractive market opportunities? And as a -- just a quick follow-up, you talked about the four recent approvals, any details you can provide on the timing of those launches as well as the potential market opportunity would also be helpful. Thank you.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah. Thank you, Nathan. And so real quick. I would just say at a very high level we feel very good about where our pipeline is. As I've shared a high level and we'll get into some of the detail, we have 25 new products, five from Bayer, 20 from Elanco. We see that is the -- our starting point that's what we'll highlight and talk about at the investor conference. At least as I mentioned five between now and the end of 2021 with four approvals I'll look for pet health to contribute beyond and the remainder of the approvals here for this next year.

And I think what we're seeing this year you're going to see going forward. One, a mix of bigger, more significant products and bigger more material markets, as well as strong innovations that can play a added contribution in our overall portfolio. So a constant flow of innovation. We see this constant over this next five-year period, a contributing factor. What we're going to do at the investor conference is to highlight the markets, the market spaces we're going into parasiticides, pain, therapy, aging dog and cats therapy on the pet side, antibiotic replacements and continued therapy on the livestock side, we're going to talk about what we see in those markets and how our innovations will contribute into those.

All while balancing the competitive exposure to this. But I -- what I would say to you is, I feel very good about the portfolio we have. I feel very good about Bayer's contribution that they bring relative to pipeline and capability and size and scale and a constant flow of innovation that will be the lead growth driver in our algorithm of growth that we'll talk about at the investor conference. Next question please?

Operator

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

Erin Wright -- Credit Suisse -- Analyst

Great, thanks. I wanted to clarify, what is the fourth quarter guidance is seen in terms of the underlying growth for Bayer and Elanco separately excluding divestitures? And if there is any, what sort of major destocking stocking dynamics, we should be aware of In the fourth quarter and even into 2021 a bit of moving pieces we should be aware of there? I think you mentioned the $25 million in inventory in the channel is that companion animal or production animal? And then a follow-up question on the Advantage business. Can you give us an update on the long-term assumptions for that business, at least how it's shaping up from a competitive standpoint? How it's playing into that alternative channel as well that that would be helpful. Thanks.

Todd Young -- Executive Vice President & Chief Financial Officer

Erin, it's Todd. Thank you for the question. Overall, for Q4, we've not separated out Bayer versus Elanco as part of the guidance. We had pointed out a number of the one -- year-over-year items that are in play including registration in India hasn't happened yet, so we get the economic benefits, but we don't get the sales. We do think retailers are still holding a little more Bayer product in the U.S. Pet Health retail chain and then -- that's about a $10 million unwind in Q4. With respect to the $25 million you mentioned we -- that's also U.S. pet retail. We think that's just growth that happened this year because of the underlying growth in the Bayer business in those channels as the demand for the Seresto collar for A family all have gone very well. That's contributing to what we think is a strong underlying 4% to 5% growth for the total Bayer business, but the double-digit growth they experienced in the first half of the year definitely had those effects.

So we're expecting again, to get there. We think inventory in the channels will be appropriate across our entire portfolio Farm Animal and Pet Health by the end of this year and that's all playing out well for us as we're excited to have this higher growth Bayer business. With respect to the A family, again, it's been very good this year. They've had a very nice run especially in China. And we're pleased, as people continue to use those products and they do well in the retail and online channels with it. Originally, when we did the deal, we were expecting a low single-digit decline on A family going forward and we'll be talking more about at investor conference as we refresh our total growth portfolio at that point.

Tiffany Kanaga -- Head of Investor relations

Next question please?

Operator

Your next question will come from Chris Schott from J.P. Morgan. Your line is open.

Chris Schott -- J.P. Morgan -- Analyst

Great. Thanks so much for the questions. Just two from me. I guess, first, I want to talk about 4Q sales levels. I think it is about a $100 million below consensus. So I guess, ex the COVID headwinds, ex that Bayer inventory you laid out do you consider 4Q kind of a normalized sales number? And I know you're going have some first half seasonality of the new mix, but I'm trying to sense, as you're trying to kind of build a baseline sales level. How normalized we should think about 4Q being? And then my second question was just an update on the longer term margin targets you laid out with the deal. I guess what's your confidence in hitting those estimates? And attributable to time timelines how should -- how quickly can we think about this being achieved? Thanks so much.

Todd Young -- Executive Vice President & Chief Financial Officer

Chris. Thanks for the question. With respect to the second question, we're still confident in our ability to get to 60% plus gross margin and over 30% EBITDA margins. As we've spoken before on calls, those have been pushed out we are seeing more competitive pressure than we were in August of 2019 on the Legacy Elanco portfolio and we've been seeing that in some of our fundamental organic growth. At the same time, COVID is having these different impacts that are affecting us. That being said, we're confident in the overall portfolio for the long term and our ability to deliver on 60% gross margin and a 30-plus percent EBITDA margin.

With respect to Q4, there are a number of discrete items that we have tried to call out here today on the call. The price increase on Bayer products being pushed out to February versus happening in January does impact sales in the quarter on a year-over-year comp basis. This adjustment for accounting where trade funds previously had been down in SG&A those are moving up under GAAP reporting and those were in our numbers in Q3 and will be in Q4 and going forward, that is a decline in sales relative to the historic times for Bayer but no change at the EBITDA. It's just a movement among the P&L.

The other dimension is, we think divestiture impact is about $20 million on the Legacy Elanco portfolio and just around $10 million on the Legacy Bayer portfolio. So those are all items that are affecting the absolute quantity of sales in Q4, relative to what our pro forma without those items would have been a year ago.

Jeffrey Simmons -- President and Chief Executive Officer

I would emphasize, too, Chris. I think the underlying demand again for the Bayer business and the Elanco, especially U.S. Pet Health business we continue to grow share. We continue to see as I highlighted the 14 focused products of Elanco up 18%. We'll be adding five more to that going forward. But I would emphasize again, we feel very good about -- no change in the underlying demand sequentially coming from Q3 into Q4. A lot of this is the adjustments that Todd highlighted.

Chris Schott -- J.P. Morgan -- Analyst

Thank you.

Tiffany Kanaga -- Head of Investor relations

We'll take the next question, please.

Operator

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

David Risinger -- Morgan Stanley

Yes. Thanks very much and congrats on the corporate progress. So I have, I guess, a couple of questions here. First, clearly, various moving parts are precluding Elanco from providing earnings guidance for the fourth quarter. But given that uncertainty, how is the company going to be able to provide earnings guidance for the full year of 2021 on December 15th?

Second, with respect to the launches so five launches by the end of 2021 and 25 by 2024. Could you just please quantify how many of those I'm assuming, none of the five would have blockbuster or greater than $100 million revenue potential in terms of the five that are launching by the end of 2021. But for the 25 that are launching by the 2024 period, how many of those would have blockbuster or greater than $100 million revenue potential? Thanks very much.

Todd Young -- Executive Vice President & Chief Financial Officer

Let me take the first question, David. I'll let Jeff answer the second one. With respect to the earnings, it's a great question a very fair one. We do expect to provide greater detail in the Investor Day on December 15th with respect to how we project Q4 to come out. Clearly, with two weeks beyond the quarter you'd expect us to be able to do that and we'll do that to help provide that baseline than to give a 2021 guidance. Jeff?

Jeffrey Simmons -- President and Chief Executive Officer

Yeah, real quick. David, on the pipeline. First of all, I think I want to reiterate -- nice mix between Pet Health and Farm Animal. A constant flow of approvals throughout that entire five-year period. We will get into more of the specifics in terms of spaces and what areas that we will be launching in. We've been very clear. Areas like broad spectrum parasiticide will be in their derm -- will be in their more pet therapy antibiotic replacement in Farm Animal and some additional kind of first-in-class, best-in-class like products like Experior for instance.

So what I would say when you ask about numbers, we're looking through a different lens with a higher bar -- where they've been a larger company wining larger faster kind of adoption rates on new products. So I would say that these products are looking through that lens of an Elanco plus Bayer, needing more materiality and we've got a significant number of those that we believe with the right market creation launch and competitive commercialness -- commercial ability that they'll be blockbusters.

So I would say that there will be a series of them in there. And again, at linear line and a nice blend between Pet Health and Farm Animal. So feeling very good about our pipeline, feeling very good about the ability with Bayer plus Elanco capability, size and Bayer's contributions where we're stronger with innovation than we were before the Bayer transaction. And looking forward to starting that with these launches.

And I keep reiterating too, a lot of runway, with the 14 products that we have they're focus products, we're going to add into that Seresto and Claro, as other products with a lot more growth potential. And then you add on five this year and then these series of launches beyond. So we like our algorithm of growth, we like our pipeline and there will be some nice blockbusters within that.

David Risinger -- Morgan Stanley

Thank you.

Tiffany Kanaga -- Head of Investor relations

Next question, please.

Operator

Your next question will come from John Kreger from William Blair. Your line is open.

John Kreger -- William Blair and Company

Hi, thanks. Just wanted to clarify your comments about stocking unwinding for Bayer in the fourth quarter that $10 million. Do you think that finishes the necessary unwind or should we expect more needed in '21? And then the follow-up, Todd, I think you rattled off a number of puts and takes on gross margin, can you just kind of expand on that a little bit more? Can we think about gross margin, as having kind of a normalized improvement trajectory in '21 or will that take a little bit longer given those items? Thanks.

Todd Young -- Executive Vice President & Chief Financial Officer

Sure, John. Yes, we think that the retailer inventory levels for U.S. side on the historic Bayer business will be at the appropriate level, given the growth we've seen on dispensing data for those products in 2020 and that -- we won't have that. To the extent there was an inventory growth in 2020, that's something that will be a headwind to growth in 2021 for us, but fundamental underlying growth of U.S. pet products in Bayer -- we're really pleased with the dispensing growth continues to track very nicely on those products for the last 15 months.

On the margin side, that's something just -- as a reminder, we have a step-down on Legacy Elanco business, it was stepped down more than 500 basis points in Q4 of 2019 versus Q3 of 2019. So that's a part of how our mix plays out and something we wanted to highlight. The higher margin Bayer business certainly helps our overall gross margin, but as you know the seasonality of the U.S. parasiticide business makes Q4 a lower level than what it looks like in Q1 and Q2.

So overall, we're very pleased with our initiatives on the gross margin side, from a productivity. The team continues to take cost out and take cost out on absolute basis, with respect to reducing compensation and benefit costs, reducing the cost of API through our initiatives on sourcing, and those are on track. The mix headwinds we've seen, as called out earlier with the Legacy Elanco business in ruminants and swine, does impact that gross margin. So we'll continue to provide greater guidance on it, but we wanted to clarify that we do expect the margin step down in Q4 versus the one we just had here in Q3.

John Kreger -- William Blair and Company

Great, thank you.

Tiffany Kanaga -- Head of Investor relations

Next question.

Operator

Your next question will come from Balaji Prasad from Barclays. Your line is open.

Balaji V. Prasad -- Barclays -- Analyst

Hi, thanks for taking the question. So I just wanted to call and comment on the sustainability goals introduced. Post that I would like to get your thoughts on the parasiticide market. Your peers spoke of a 6% gain in parasiticide you're commenting on price growth and volume growth in the market too. So are there some dynamics, which are happening, which we are not probably figuring out? Is the market growing faster than what -- we are anticipating? And so if so, what are the factors? Secondly, is it fair to assume that your share of this market will stay intact or it will increase with the new launches, which are expected to come out over the next one to two years? Thanks.

Jeffrey Simmons -- President and Chief Executive Officer

Yes, so let me start first on the first question and that is we -- yes, we feel very good about the overall I think pet health market. I'll start there. I think, we know that COVID has increased the attention to the pet, the compliance we've seen a V-shape recovery. We've seen both growth nicely in the vet clinic market and we also are seeing very strong growth, as you know, in the retail market as well. Yes, on parasiticide. As you see, we've seen nice growth across all sectors price growth in parasiticides. We also -- we believe, that there is continued offering and when we look at marketing, all the way to the pet owner understanding things more clearly by reaching that direct pet owner and pulling them into the vet clinic. And I would note are pairing of Credelio plus, Interceptor Plus is an example of that. Pairing is increasing, growth is significant and a lot of that can be attributed by a marketing approach that reaches pet owners, taking them into the vet clinic and there is a knowledge and an awareness about message that is a big driver in this. And then, yeah, we believe attention and compliance helps drive volume, but it also helps drive price as well.

Todd Young -- Executive Vice President & Chief Financial Officer

But one thing to note there Balaji. We are seeing a decline in Trifexis, our historic product and so I think as Jeff mentioned your main reason that within our expectations, but that is a decline in the parasiticide market.

Balaji V. Prasad -- Barclays -- Analyst

Thanks, Tom. We think that. Thanks. Just a follow-up on lifestyle side with Rumensin. So you said that it's fairing better than what you're anticipated. So what is the current market share or what is the impact of the generic version? And you called out poultry under pressure. Could you identify the factors what's driving this in LATAM and India? Thanks.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah. There is no question that there is a lot of moving parts from the earlier question on ruminants with. We feel good about the increased number of days cattle on feed, there's been a talk about, yes, there was a cattle on in Q3 a little premature, a little sooner than normal that puts more cattle on feed as you go into Q4 that's positive. When you look at actually the generic, we see our ability to differentiate and hold, although, there was a market size change from COVID from earlier this year. So when we back up and look at our assumptions of holding in year one, 20% total value loss or less, we are feeling good relative to that and in relative terms to a market that is actually changed in size. So again, doing very well competitively. And I attribute a lot of this to portfolio and product differentiation and then.

Tiffany Kanaga -- Head of Investor relations

Balaji, on your second part of the question about the international market, poultry.

Balaji V. Prasad -- Barclays -- Analyst

The factors driving lower market growth in poultry in Latin America and in India.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah. I mean it's very clear that the COVID impact is going a little bit linger -- a little bit later and has lingered a little bit longer relative to this and a lot of this distributed -- attributed international poultry markets are more dependent on food service and restaurants and we know the impact of that. And now we're starting to see that impact. We see it returning quickly and -- but this will persist as we go into 2021.

Balaji V. Prasad -- Barclays -- Analyst

Thank you.

Tiffany Kanaga -- Head of Investor relations

Thanks. We'll take the next question.

Operator

And your next question will come from Kathy Miner from Cowen. Your line is open.

Kathleen Miner -- Cowen -- Analyst

Thank you. Good morning. Just first one quick follow-up. On your guidance or your expectation for $20 million to $30 million COVID headwind in Q4, is that mostly on the U.S. or is that outside of the U.S. expectation? Second of all, could you comment on your swine business in China? And if that's returning to growth and how you see that developing going forward? And if you could just at least a brief comment on the channel trends in the third quarter, that's certainly a big part of the Bayer transition and just curious how -- whether that was continuing to grow through Q3? thank you.

Todd Young -- Executive Vice President & Chief Financial Officer

Sure. So with respect to the swine business in China.

Jeffrey Simmons -- President and Chief Executive Officer

I will take your first question.

Tiffany Kanaga -- Head of Investor relations

Todd will take the headwind.

Todd Young -- Executive Vice President & Chief Financial Officer

COVID headwind. I'm sorry. The COVID headwind is primarily continuing international Farm Animal markets. The poultry impact, Middle East, Latin America, India, we do see those continuing and it will be some impact in the U.S., but that's not a bigger quantity. That's why we're seeing it come down quarter-over-quarter. We'll let Jeff jump in on this swine side.

Jeffrey Simmons -- President and Chief Executive Officer

Yes. So Kathy, we've seen very good growth both, in the Elanco and Bayer. And I'll even go back to using a comparison of 2018. So before the African Swine Fever effect so we're seeing stronger prices. We're seeing more industrial farms, those are two really positive trends and then I think multinational product use. So when you put those things together, we're seeing over a 30% growth in both the Elanco business back to pre-COVID comparisons in 2018, both on the Elanco and Bayer side. And again, I would put those three factors as the big drivers, strong economics. We see that, that tailwind benefiting as we go into 2021 and we'll talk some about that at the investor conference.

Let me just highlight our distribution be very clearly. Just to make sure it's real clear that on our Legacy Elanco business, the overall business, our inventory levels are the same in Q3 as there in Q2 they're at the right levels we're 60 day terms that strategy is working. Our relationships are very strong, with the four remaining distributors that we have and it's paid off, as I've shared. Relative to demand creation, we're growing market share, we've got better improved receivables and cash conversion and pricing within that and the distribution strategy, we think is working extremely well. And I would highlight that is a heavy focus.

In addition there is the retail business that Todd has talked about and we would really highlight what drove that retail Bayer business was much more retailers, distributors are not involved in that. So there is no inventory issues there at all, and that by ahead a little bit was driven by both the cutover and the COVID concerns. But again, underlying business remains very strong on both, retail and the vet clinic business for our pet business.

Tiffany Kanaga -- Head of Investor relations

Next question please.

Operator

Your next question comes from David Westenberg from Guggenheim. Your line is open.

David Westenberg -- Guggenheim -- Analyst

Hi, thanks for taking my questions. So can you talk about cap around in cats. We've seen a lot of off-label usage of entice for a number of years now. Do you see the cat market is larger than the dog market, just given the health consequences for weight in cats is much worse? And this is a small market, but it's opportunity to pioneer into maybe a $50 million product, is that fair to say? And then secondly, and can you talk about retail channel mix? We've seen just an OTC pet on dramatic acceleration in the shift to online from pet specialty in box retailers. Do you think that's to your advantage there in terms of, particularly around the Bayer Animal Health products? Thank you.

Jeffrey Simmons -- President and Chief Executive Officer

I mean, yes, let me just highlight again Elura. We believe, first, in best-in-class relative to what we have here relative to an orals treatment. And again, the mode of action would you're exactly right. We believe this is a market creation architect for us, it's an opportunity, as you know, chronic kidney disease may affect right now. The numbers are 1% to 3%. We think that can be higher, but a much higher incidence in older cats intensified where we're seeing a cat that can be in 12-15 years old, that can be estimated at 30% to 50% of the cats that are affected. So we like this segment, we like the market creation opportunity which gets back to a big part of our innovation strategy bringing first best-in-class unique mode of action here with a liquid oral solution. And so we see this being an opportunity to create a really nice product. Won't get into exactly how much, but we will say that our intention is to lean in heavily here and again, we continue to increase our portfolio. And we'll talk some about that in the fee line market, which is a really strong market highlighted even by our success with Credelio in cats in Europe.

So we feel very good. And yes, there is some pairing and some opportunity with Entyce and that is a similar product in dogs. And then yes on retail look, I would highlight, we are a retail leader -- or we are the retail leader right now with the combination of Bayer plus Elanco and flea tick heartworm. There is no question, you need that capability and the portfolio both are scripted and an unscripted OTC portfolio likes Seresto and Advantage to win and we feel very good about the Bayer capabilities in this space. Our leadership position and our innovation and our ability to grow in this space. So, yes we see these trends persisting that came through COVID.

Tiffany Kanaga -- Head of Investor relations

Next question please.

Operator

The next question comes from Elliot Wilbur from Raymond James, your line is open.

Elliot Wilbur -- Raymond James -- Analyst

Thanks. Maybe just real quickly for Jeff. Give us some perspective or color on sort of the emerging ASF cases that we're seeing in Europe, obviously negative for all markets and positive for others. But maybe just how that impacts Elanco's business, if at all? And for Todd, with respect to, Obviously to get lot of focus on cash flow, and leverage position, anything you could say at this point that could help us in terms of thinking about a longer term framework with respect to cash conversion metrics?

Jeffrey Simmons -- President and Chief Executive Officer

Yes, so let me start with ASF. We -- again, there still is -- spotted cases that have popped up in industrialize operations in Asia. For instance to some noted here in South Korea, but again, I want to emphasize, no material effect on ASFs that we see really anywhere in the world, but especially in Asia, and you're seeing again the positive fundamentals of the recovery in China that again will be a tailwind for us as we go into 2021. The cases in Europe again mostly in Germany and Eastern Europe, we do not see at this point in time a risk to any commercial productions mostly been in the LIBOR market and so we've not seen anything, and no material effect that we're assuming at this point in time for our European pet business.

Todd Young -- Executive Vice President & Chief Financial Officer

Okay. With respect to cash conversion, we feel good about the working capital discipline we've instilled over the last few months bringing DSOs down considerably since the Q1 timeframe. We are continuing to look at working capital needs across the industry -- our business. I would say one of the things about operating two different systems, as we need multiple bank accounts in countries in order to officially process the payment on both sides of the business that does chew up a little bit more of cash on the balance sheet, but something that we're working through and trying to manage. We're also focused on inventory levels -- we did grow inventory on our own balance sheet here in Q3 as a result of the IT cutover we will have to go onto our separate ERP system in Q1. So do expect that better inventory numbers in 2021, as we get past a lot of these IT-related items. So again, we will get into more on EBITDA growth expectations on the Investor Day in December.

Tiffany Kanaga -- Head of Investor relations

Next question please.

Operator

Your next question will come from Umer Raffat from Evercore. Your line is open.

Umer Raffat -- Evercore ISI -- Analyst

Hi guys, thanks for squeezing me in. I wanted to focus on the distribution strategy ex-U.S. And could you remind us, what exactly is the distribution strategy for our International livestock? And, how many months of product that these international distributors have as of end of June versus end of September? And I'm trying to understand if that had anything to do with the tightening of days sales outstanding, which drove the livestock issues at U.S.? Thank you.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah, most of that is directly with the large protein producers are mostly our customers internationally -- no factor at all. Again, as I've shared international and the U.S. and globally Elanco inventory and distribution was at the levels we wanted coming out of Q2 remain the same in Q3, and was not a factor at all in our results.

Umer Raffat -- Evercore ISI -- Analyst

Jeff, do they buy additional ahead of quarter close at their incentives that exist these large protein makers?

Jeffrey Simmons -- President and Chief Executive Officer

Very little to none. Once you allow when a price increase program is in place, sometimes there is an allowance of some buy ahead, but again that is -- we move those out mostly across the globe from Q4 into Q1 to prevent any of that, any change. But no, that is not the case. And again, I want to reemphasize inventory levels is same in Q3, as they were in Q2. We're at the right levels and feel very good about those changes. Not a factor.

Umer Raffat -- Evercore ISI -- Analyst

Thanks very much.

Jeffrey Simmons -- President and Chief Executive Officer

Yeah.

Umer Raffat -- Evercore ISI -- Analyst

Thank you very much.

Tiffany Kanaga -- Head of Investor relations

Next question?

Operator

Your next question will come from Navin Jacob from UBS. Your line is open.

Navin Jacob -- UBS

Yes, thanks Navin Jacob UBS. Appreciate you -- putting me in. So I just want to expand on Umer's questions around inventory. If you could provide very simply, how many days on hand or weeks on hand or months on hand you have for Companion Animal in the U.S. and for livestock as well as -- for not just your portfolio, but from Bayer portfolio because it seems you have called out the reduction in Bayer inventory.

I just want to trying to understand, so we don't have any more surprises quote-unquote around inventory. In quarters forward where exactly do your inventory level stand? Both on the companion side of things livestock side of things Elanco stand-alone Bayer stand-alone please. Thank you very much.

Todd Young -- Executive Vice President & Chief Financial Officer

Navin, as we said, the inventory issue we put behind us at the end of Q2. Inventories are consistent in Q3 versus Q2. If there is a material change in the inventories that drives an impact on revenue we will disclose that and we'll be upfront about it. With respect to the Bayer side, as we've talked, and tried to be very clear on the retailer side, which is not distribution, right. We're not talking about that co-veterers and MWIs and those that are our side, but rather the Amazons and Walmarts that given COVID, as well as continued uptake in the Seresto and Advantage products they did hold more inventory.

As we said, we think that's about a $25 million increase in 2020 compared to 2019 that's after another $10 million comes out of that here in Q4. And so going into 2021, we feel very good about inventory levels across our business, across the Bayer business and that they're set up to grow as we keep it. We've changed the strategy in the earlier part of this year and talked about it extensively on the Q2 call and feel very good about both our relationships with our distributors in the U.S., the international business and now it's operating as well as the retail relationships they've got. We had before, but now enhanced with the broader OTC product portfolio that Bayer brings.

Navin Jacob -- UBS

That's very clear. Thank you very much.

Tiffany Kanaga -- Head of Investor relations

With that, we'll wrap it up today. Thank you for joining us for Elanco Animal Health third quarter conference call.

Operator

[Operator Closing Remarks]

Duration: 67 minutes

Call participants:

Tiffany Kanaga -- Head of Investor relations

Jeffrey Simmons -- President and Chief Executive Officer

Todd Young -- Executive Vice President & Chief Financial Officer

Michael Ryskin -- Bank of America

Nathan Rich -- Goldman Sachs -- Analyst

Erin Wright -- Credit Suisse -- Analyst

Chris Schott -- J.P. Morgan -- Analyst

David Risinger -- Morgan Stanley

John Kreger -- William Blair and Company

Balaji V. Prasad -- Barclays -- Analyst

Kathleen Miner -- Cowen -- Analyst

David Westenberg -- Guggenheim -- Analyst

Elliot Wilbur -- Raymond James -- Analyst

Umer Raffat -- Evercore ISI -- Analyst

Navin Jacob -- UBS

More ELAN analysis

All earnings call transcripts

AlphaStreet Logo

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.