HRA Pharma, SAS (PRGO) Earnings Call Transcript & Summary

Good day, and welcome to the Perrigo conference call. [Operator Instructions] Please note today's event is being recorded. I'd now like to turn the conference over to Brad Joseph, Vice President of Investor Relations. Please go ahead, sir.

Thanks, Rocco. Good morning, everyone, and welcome to Perrigo's conference call to announce its binding offer to acquire HRA Pharma, a leading global consumer self-care company. I hope you all had a chance to review the press release we issued this morning. A copy of the release and presentation for today's discussion are available within the Investors section of the perrigo.com website. Leading today's call is President and CEO, Murray Kessler. CFO, Ray Silcock, will join Murray for the Q&A portion. I'd like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information regarding these forward-looking statements in our press release issued earlier this morning for more detail about the risks that could cause actual results to differ materially from these expectations. And with that, I'm pleased to turn the call over to Murray.

Thanks, Brad. Good morning, everyone. We have some exciting news to share about an acquisition in progress that Brad just referred to. But before we get through the details of that, I wanted to take a minute to ground those of you who are less familiar with our story or remind some of you who are more familiar with it, the journey that we've been on over the last 2 years. It was May 2019, we unveiled our transformation plan to go from being a health care company to a consumer self-care company. We set forth a vision that said our goal is and vision was to make lives better by bringing quality affordable self-care products that consumers trust everywhere they are sold, and that our goal was to achieve a repeatable [ 3 57 ] growth by capitalizing on self-care trends through our focus on our core OTC businesses; two, to exit Rx and nonstrategic businesses to reduce volatility and simplify our business model and I remind you that was about 1/3 of our company; to expand into adjacent self-care segments and technologies via bolt-on M&A. To invest in new product pipeline, talent, systems, capabilities and capacity; and to trim costs by reducing overheads. So here we are, a little over 2 years later, and I'd like to believe that we have completely overhauled the company to set us up for a very, very bright future. You can read through this, but to hit a couple of highlights. You see a dozen transactions selling that generic Rx division, selling our Latin American operations, selling our Rosemont Rx business. Selling animal health, closing our R&D facilities in India and then buying and building out the adjacency in oral care with Ranir, Dr. Fresh and Steripod. Buying Prevacid, buying an Eastern European skincare, buying the Dexcel brand in the EU and investing in CBD. But none of those compare to what I'm about to share with you on the acquisition that we're announcing this morning. We also spent a lot of time and effort rebuilding our new product pipeline, investing in people, investing in IT and infrastructure, delivering $100 million in cost savings, improving service levels, building out our e-com and that resulted in over the past couple of years before some of the recent interruption from COVID in a very strong and accelerated net sales CAGR. We also have been working hard at reducing uncertainty, and we have significantly reduced the Irish NoA, and I think more progress is to be made on that in the near future. On the Athena case, we strengthened our cybersecurity. We've strengthened ESG, D&I, divested our most volatile businesses. And just last week, we won $400 million in cash from the original Omega Pharma purchase. So again, uncertainty clearly being reduced. And then ultimately, all of that has generated a more focused CPG companies and a company that was committed to growing in line with top-tier CPG companies that we are optimistic about as we get through the sort of the worst of the logistics and supply chain issues with COVID that is poised to have accelerated base business growth against our original 3 57 commitment, but that also had a significant war chest, a couple of billion dollars that it had available to be able to invest for growth, which was always part of that original May '19 plan. So I talked a lot about in the beginning of positioning Perrigo for base growth and divesting Rx was the Perrigo 2.0. And the next 2 moves, I think, evolve us to Perrigo 3.0. The first is today, which is acquiring HRA and it's leading high-growth brands, and I'll go through that in detail, but that's a step change. I really -- I can't emphasize enough how significant move this is for Perrigo and building scale in Europe, augmenting our CSCI and CICS businesses, with high-growth leading brands with significant and achievable synergies, high margins, clean brands. It's just an awesome opportunity for us. And then the final piece of that is to get rid of that big piece of uncertainty, which we hope to be back to you within the next few months. We've already made significant progress, and that puts us in a position where we will be the company that has come through transformation and is poised to deliver significant and superior results over the next few years and beyond. So let's turn to HRA. The acquisition of HRA is strategically compelling. I got to tell you, we went through a process over the last year or so well in advance of even selling Rx where we had gone through and screened dozens and dozens of opportunities and ultimately came to the one that by far, was the most strategically compelling. It's aligned with our vision and our capabilities to fall squarely within our 5 pillars and that we've gone to the street with on our acquisition focus. The HRA brands are all #1. There's kind of 3 major brands, and we'll go through that. They're all category leaders globally. They are -- they will put us in a position to deliver top line growth in excess of CPG averages, the HRA itself is a double-digit grower, but it will help drive Perrigo up to higher levels. The brands themselves are not played out, not even close. They're leading brands, but importantly, they have huge potential to expand through numerous types of adjacencies -- adjacent categories into adjacent geographies, and I'll go through a little bit more of that in a couple of minutes. There's upside potential that we won't be talking about today. It's not built into any of our financial projections. But there are 2 significant Rx to OTC switch projects, which are part of this to bring the first-to-market regular contraception product to the U.S. and select European markets. And there is an experienced internal switch team that has a heck of a track record at HRA that has been proving their ability to get that done. Because the overlap with Perrigo is so significant, there's actionable synergies that, again, I will talk about. But these are synergies that aren't maybes. These are synergies that we're going to get. And it's a -- it's primarily through third-party distributors and external sales forces, again, where there's opportunities. But of course, we'll do all of that in a disciplined and careful way. And then most importantly, I think when you look at the size of what this does in transforming Perrigo, this is not just another acquisition. This is a scale acquisition that meaningfully offsets literally about 75% of the earnings from the Rx diverse -- divestiture, but it's a trade for what was volatile and declining earnings to growing extremely high quality earnings and adds critical scale to our European business and in numerous markets raises the size and also, again, deploys the Rx proceeds effectively. Like I said, HRA is a store asset. By 2023, with the growth plans in place, we estimate about EUR 400 million in net sales in 4 segments. The biggest is the Compeed brand in Blister Care, which is about a little under 1/2 of the business, women's health with ellaOne and NorLevo brand, is about 25% of the business. Mederma is a scar care business, primarily in the U.S., about 15% of the business. And there is a -- unlike our previous Rx business, there's a small rare disease business. That's about 15% of the sales, but growing. The business is 60% Europe, 20% U.S. and 20% in the rest of the world. Again, if I go through them, Compeed, fantastic brand, market leader with a 70% market share in the EU. Today is primarily blister care treating blisters, bunions, callus, corns, cold sores, #1 foot care treatments, #2 in cold sores in Europe. And with the potential and is already on the path towards expanding through new adjacencies, either geographically into the U.S. where it's starting to make some inroads or through adjacent categories like cuts and burns and spots and broader wound care. Women's health, ellaOne. It is -- has a point of difference. It's the most effective morning after pill available without a prescription, and it is -- has more than a 50% market share in the EU, again growing. HRA is the undisputed category leader in emergency contraception in Europe. Has the potential to -- for further switches around the world, and progress is being made on those. And then there are also the opportunity for switches in everyday contraception. In fact, just within the last few weeks, they received MHRA approval in the U.K. for a product called Hana, which will be the first over-the-counter everyday contraception pill and it's in process -- in the switch process with a product called [ Frieda ] in the United States right now. Again, not in our model yet, but huge upside. Third one is Mederma. We know a lot about this store care business. This is the category leader in U.S. scar care. And again, the opportunity to expand into others. And the smaller rare disease business is, for the most part, focused on Cushing's syndrome and adrenocortical carcinoma. Next. The team that has been leading HRA, I have gotten to know David Wright, the CEO extremely well over the past months that we've been working on this transaction. And by the way, this was not a process. This was a relationship and a negotiation between David and I and the respective private equity partners on their side. But I got to know the management team extremely well, which was an important part of this transaction for me. These are pros. They know what they're doing. They'll be -- they've all agreed to stay on with Perrigo. And I think that is important for you to know that I don't believe there will be any disruption on this. I did the same thing with Ranir when we purchased it. It worked beautifully and I'm looking forward to these group of folks joining us and keeping that continuity and growth engine going. The other thing, I think this sort of really has a significant impact on our European business. People have asked about it, are you half in or half out to Europe. You layer Compeed and ellaOne, it becomes our #1 and #3 brands in our total portfolio, more products that are actually legitimate OTC products that aren't just science-based, nutritionals, et cetera, gives us way more credibility with customers, significant opportunities for our revenue synergies on both sides, our sales force is multiple -- much, much larger than theirs, which again can become an accelerator. And this is just pointing at [ LOC ], but it shows that it puts Perrigo as a major player in Europe, not to mention dramatically improves the margins in Europe. An important part of this transaction and that helps to make the returns on it so strong is that with the overlap, there is operating synergies of greater than $30 million by 2023, that there is a clear path to and we have a high degree of certainty on. Frankly, I think they could be bigger, but these are the ones that I'm willing to say today for sure. And this, again, does not exclude -- it does not include revenue synergies. And I think it's important to understand, these are more fixed cost infrastructure and backroom kinds of sharing. It's less of a people story with synergies. It's much more of an infrastructure and leveraging the facilities that -- and systems and processes and procedures and everything else we have in place at Perrigo because today's HRA is mostly outsourced and paying a premium to be outsourced. This transaction will substantially improve our financial growth profile. Like I said, projected to add approximately EUR 400 million in net sales in fiscal '23, growing at an expected mid-teen percentage level. It expands CS -- because it's both U.S. and Europe, 2/3 Europe, let's call it a little less than 1/3 that will affect the U.S. and overall Perrigo, but it will expand their margins, their sales, the operating margins. And for perspective, these operating margins that we'll be bringing in with HRA approach 30%, which means if we back into sort of the numbers you're approaching, 70% gross margins, which will have a nice accretive impact. We expect to operate cash flow conversion of 100% in line with Perrigo. And -- and this is -- it's immediately accretive. But within the first -- that first 2023 year when we have that full year, we expect it to add around approximately $1 to adjusted EPS. So like I said, this is a scale, not just a quality acquisition, it's a scale acquisition for Perrigo. The details of the transaction EUR 1.8 billion is the purchase price. So that's $2.1 billion in today's conversion rate in U.S. dollars. It values HRA at an enterprise value to expected 2022 adjusted EBITDA of 18x. And if you add the synergies to it expected by 2023, it drops it to less than 14x. We anticipate that it will be funded in cash. As of the second quarter, we had $336 million in cash on the balance sheet. We received $1.5 billion from the Rx divestiture. We are -- we will be receiving $400 million for the Omega lawsuit, of which half is in escrow right now. And the court day or the binding arbitration gave them 30 days to come up with that cash plus our additional operating cash flow all year long. And we also have a $1 billion current credit facility. Now having said that, I'm not ruling out the fact that we might refinance opportunistically some of the debt, but I'll leave that in Ray's hands because we have some debt coming due next year. But we don't need to do it for this deal. The cash is sitting there. I think that we anticipate through there is normal processes. And when you do a deal in France, and we think this is a great deal and a win-win, but we need to get work council approval in France. And so we'll go through that process. And likewise, we'll have some regulatory approvals around the world. I'd say short -- should get done in the first half of 2022, maybe we'll beat it a little bit, but we're saying the end of the first half of 2022. Okay. So if I go back to May 2019, again. What I'm most excited about besides just the high quality of this particular acquisition is also that we are fulfilling our May 19 2019 Investor Day promise. So when I look back on it, we were at -- if I take a slide on the top half of the slide on the screen, we were at $3.60 to $3.95 in the 2019 guidance, and we said we would do 3 things. We would -- business growth that we would have M&A and cost savings that would get us to -- back to the $3.65. And that was after we had sold off the Rx division, which represented about 1/3 of the EPS at the time. So on the bottom, walking us through where we are, we are exactly on that commitment. It took a little longer than I might have liked. We were originally trying to get Rx sold right out of the chute. But in order to get a good price for order at a good value, it took us about a year longer than I thought, but we got a better multiple. We made cash along the way. And when you do that, some other divestitures that we made, like the divestiture of our Rx business in the U.K. That was sort of our starting point. Then we added back some acquisitions. Some base business growth, got hit a little bit by cough and cold. That got us to where at the end of the second quarter, we provided guidance to the low end of our original range of $2.50 to $2.70. So if that's the starting point, with the normal growth from the base business that we've been talking about and the addition of approximately $1 by 2023, which includes the synergies that puts us right back at that original commitment. So I think it's worth a moment to sort of step back and say that this company has completely reconfigured itself, has sold off 1/3 of its earnings, replaced it with higher quality earnings, and we'll sit today with a business that is -- and you can see from the numbers that I'm putting on here, some very strong double-digit growth in both top and bottom line over the next couple of years getting back to where it was before with a high-quality focused consumer portfolio that has benefited now with stronger brands, higher scale -- and again, higher margins than just a beautiful and bright outlook. We compare this acquisition to investing in alternative uses of our capital, we looked at acquisitions. And like I said, dozens of them to get to this one. We looked at share repurchases. We looked at special dividends, and I'm saying special dividends because dividend -- regular dividends are always a priority for Perrigo. And over the 3-year horizon on every analytic whether it was IRR, ROI, accretion, everything, correlation to value, the HRA acquisition, won on all metrics. Now having said that, this is a big acquisition for us and a big use of cash. And I will tell you that our focus now will be to close this transaction, work with the regulatory authorities, work councils, get the deal done, integrate it and put a lot of energy against integrating it well. And there'll be a lot less M&A. I mean I won't say there won't be anything if something opportunistically, but it will not be our capital allocation priority in the near time. Going forward, incremental capital allocation will be directed towards reducing uncertainty. First and foremost, reducing leverage and then opportunistically some share repurchases if it makes sense. So here we are, 2 years, 4 months later, and I truly believe that Perrigo is a transformed company. That is not to say that Perrigo isn't a company that needs to -- now that it's a consumer company needs to get better and better and better every year and continuously improve, but the major overhaul is behind us. We are now a focused global consumer self-care company positioned to deliver top-tier revenue growth and double-digit EPS growth over the next few years that has meaningful scale in both the United States and Europe that is an equally divided company, both with national brands and store and value brands with significant value creation potential through profitable growth and multiple expansion with a team that is working hard and I believe will accomplish restoring certainty through the reduction over the overhang. And I think we have a completely uncomplicated clean story going forward for our investor base and we're excited about making it all happen. And with that, we'll open the line up to Q&A.

[Operator Instructions] Today's first question comes from Chris Schott at JPMorgan.

Congrats on the deal. Just my first question was just a little bit more color on the growth in the portfolio you're acquiring. I think you talked about mid-teens growth. I'm just trying to get a sense of how that compares to historically how we thought about organic growth for this business. And when we think about that growth, is it kind of one of these assets driving most of that growth? Or is it the whole portfolio? I'm just trying to get my hands around basically the drivers here. And is there any -- sort of thinking about risk to the growth profile, like how should we be thinking about that? And a couple of follow-ups after that.

Well, the -- I'll give you a much more detailed answer in the future as we get closer to the transaction closing. But I will say that the HR team are pros. And each has -- each of these segments has strong growth plans that are consistent with their historical growth with the exception of that they, too, like us, like many companies had an interruption from COVID, right? So people aren't out -- were not traveling and hiking as much in 2020. So it was affected on their business as well on that particular brand. So you have probably a stronger growth rate initially on Compeed because you got rebound on that, which is not something that we're hoping to see has already clearly begun in the run rate so far there. In any acquisition, the management team puts together their projections, we risk adjust those. So -- and we've done that. But there are strong growth plans with Mederma. Mederma just went through a major restage in the U.S. It is positioning itself beyond just the scar care and the fever blisters and all kinds of different medicated skin care, and it has the ability to do that. In the women's health business, there is the daily contraception, there is -- Europe, I would say, isn't the primary -- the existing business isn't the primary driver of the growth. There's tons of growth from more new markets. I think they've already switched 35 countries with ellaOne, which has a significant competitive advantage versus Plan B. And then there's the upside that we don't have in our models yet on the daily oral contraception, which just got approved in the U.K. and is in the process in the United States. So yes, Compeed, the same thing. They are broadening their strategy to not just blisters, but into burns and into cold sores, into wounds. And I mean this -- it's a beautiful -- you get a chance to see Compeed. It's a superior product and there's a reason it sells so well, and taking that technology and taking it into other areas has been working for them, and that's a big driver of future growth as is geography right now. I mean they've just started coming into the -- to the U.S. And that will be some work to do. It's a big market. But again, lots of running room. I don't have the numbers in front of me right now on the percentages, but all 3 brands will contribute, and we believe that based on the history are realistic growth rates.

Great. And just as a follow-up to that, it seems like you mentioned a strong team you're bringing on board here. Is -- I guess as you think about running this portfolio, is this largely kind of running it, as the prior management team had been thinking about in terms of strategy? Or is key to the growth kind of leveraging Perrigo's footprint and driving further sales in that direction. I'm just trying to get a sense of, again, is this a business that could have generated mid-teens growth on its own? Or are you stepping up the kind of forward growth rate because of the benefits of the broader scale you're bringing to the entity?

I have not factored -- this is based on their track record and their plans that are the drivers of growth right now. I believe there is upside to that. We have not built revenue synergies into this. But the fact that we have a -- they have no sales force really of scale in the United States, we do. They don't have -- we have doubled the size of the sales force in Europe. It can only bring higher sales to them and the credibility that we get from there -- the size of their brands, it represents opportunities for us, and I'm not talking cost synergies, I'm talking about revenue synergies. There are products that are in our portfolio. I mean we have lines like ACO and all that, that are medicated skin products. And how you leverage the 2 technologies across it. I think this is our best shot that we've ever had at making the sense of having a European branded business and a U.S. private label business to bring things across the ocean each way is another significant opportunity for us. So I feel good about -- the growth rates, Chris. But they're -- and they're in line with their historic numbers. No. This isn't like we put in some wild numbers in order to make this deal work. This is what they were doing and performing it.

Perfect. And then just a final quick one for me, just trying to make sure I'm getting the leverage post this deal, right. I mean is something in the 4x range of EBITDA for -- by '23, a reasonable way to think about things? I'm just trying to refactor in the Omega cash flow, et cetera, or payment. Just help me a bit on leverage for the company.

Yes. Without taking into account the potential Irish NoA payment, which would change the numbers slightly. We'd expect our leverage in '22 to be about around 4 and then coming down into the 3 -- 3.5, 3 range and even down to better than 3 by 2024 Now obviously, the payment of the Irish NoA would potentially change that slightly.

[Operator Instructions] Our next question comes from Elliot Wilbur, Raymond James.

Maybe just a few financial questions real quickly for Ray upfront, specifically on synergy realization targets, $30 million assuming that is largely the permanent level of synergies you anticipate achieving from this transaction? And are there any cash costs associated with achieving that level? I want to try and get a little bit better sense of what the operating leverage is on the double-digit expected growth from the business. What's the level of operating income growth when you -- if in fact, you are able to achieve double-digit top line growth?

So I'll try and answer that one a little bit, but then Murray can talk about the synergies. The operating margin on this business stand-alone is in the mid- to high 20s, 27%, 28%. And their gross margin is in the high 60s, almost 70%. So that gives you an idea what we do have operating leverage. The synergies come from the fact that we have, especially in Europe, an almost perfect overlap in geography with our existing CSCI business in Europe. And as a -- this company HRA is really low, it's a lean asset, low asset base, they outsource both manufacturing and selling and distribution. We have no plans to bring the manufacturing in-house but we do plan to bring sales and distribution into our existing sales force and distribution capabilities. And that's where the big synergies are. And because it's basically -- it is bringing -- is getting rid of distributors and bringing it sort of in-person sales force, we think these synergies are really -- an in-house sales force, I mean to say, and we think these synergies are really achievable.

Having said that, we'll do it carefully, and it will take us over. We won't do that initially because we don't want to disrupt the business. Your operating leverage, you can do the math as well as I can do the math. What I'm telling you is in 2023, you're at $1 of EPS, right? So if you're at -- and whether it's exactly 3 57 or not, that's what I put today, but we'll build our plans like we always do, maybe it will be a little higher because this year wasn't good. Maybe it will be a little less. But if you just assume 3 57 right now, and then you layer in $1 of EPS, you're adding 50% EPS in 2 years. right? So you can do your compound annual growth rate on that, but those are clearly dramatically higher than the 3 57, and that's why I made the point that you're adding a lot of scale here.

Okay. And Murray, in respect to your commentary earlier about getting more detail in terms of top line growth drivers going forward. But I mean anything you can share at this point, at least in terms of what's been driving those numbers historically? Is it geographic expansion, just additional penetration within core targeted markets? Are there -- is it new products? Obviously, very strong numbers there and just trying to get a sense of the sustainability of double-digit growth, what the key drivers have been. And I know that the HRA recently did a -- or executed a partnership for the Chinese market. Maybe just a little bit of insight into how important that segment is currently and what potentially the longer-term growth opportunity there may be?

Sure. Again, we'll go into more details of it. But when I look at what's written their business over the past, and they have been one of the fastest-growing consumer companies in the world, they've done it systematically from geographic expansion has played a big role for Compeed so has channel expansion. So has price and channel management. So has been rebuilding the brand's positioning. I mean it's been growing at 6x a faster rate under their ownership. And the prior ownership. They believe and I believe, based on the data that they've shown me, there's a potential to double the size of the blister category. They believe that by expanding to being a wound care leader, that puts them into significant segments. And I'm sorry, I don't have it at my fingertips the size of those, but they are big categories that we're talking about. Same thing with Mederma going into additional areas, but Compeed is clearly a big driver as is women's health. You mentioned that, for example, there are numerous switches in Asian markets underway and partnerships that are being done. And again, you mentioned a key one that has been a driver for ellaOne. And ellaOne has a competitive advantage, right? The leading brand in the U.S., I think, is -- sort of has an efficacy rate with 3 days of emergency contraception and ellaOne has 5 days which gives it competitive advantage. I don't -- I'm not going to promise a OTC switch in the U.S. because that's a difficult and challenging one. I'm actually more optimistic about the daily contraception and that one seems to be proceeding really well. But if it was to break through in Perrigo as good as HRA as we bring a lot of cloud in the FDA as well, that could be even a significant and bigger opportunity. But I would say the driving will come from continued geographic expansion and switching in women's health business. So those are kind of the big drivers. And again, we can go through it as we get into more detail, but a lot of new product activity, a lot of e-commerce. Again, Mederma is now -- I think it's got -- almost 30%, 40% of its business is e-commerce. They've done a beautiful job building that out. And again, those are synergies that will work together on both companies. I hope I've given you enough color here. As it gets closer to us, when we know when we're closing and we get through all the councils and regulatory authorities, et cetera, we'll probably do some short introduction and let you meet the management team and hear about their plans themselves. But I get it. These are big numbers, but they've been delivering them year after year and their confidence in their ability to continue to do so.

Last question, Rx business. Can you just talk a little bit about the operating margin or EBITDA margin structure there? How important is that segment to the profitability of the overall business. And given that these are Rx assets, just maybe a little bit of commentary on the sustainability of the revenue streams associated with the various products there?

Well, listen, they have been growing. There is significant opportunity without much investment for, again, geographic expansion. They are confident in their ability and it's good margin business. We'll see what role it plays in our portfolio. I obviously bought the business for the 3 global leading consumer brands. I don't -- we've assessed it. We did a good job in assessing it. It's a stand-alone business. They've set it up as a stand-alone business within their own portfolio. So -- and I don't think there's any -- we have to worry about any volatility within it. And we'll see how it plays out, and we'll give you a point of view on that later. But the good point now is right now, it is a good quality business that is not like subject to pricing erosion and things like that. They're -- it's solid.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

Well, we just want to thank everybody for their interest in Perrigo. We know we've gone through a lot of change over the past couple of years, but I'm really excited about the future of the portfolio. Again, I think we have a more financially compelling simpler story than we've had the whole time I've been here. We've got just a little bit more to go to get all the certainty done. And of course, we'll continue to keep getting better, but I really believe the next couple of years, you're going to see some big growth out of Perrigo, and the stage is set. So thank you very much.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.