Perrigo Company plc (PRGO) Earnings Call Transcript & Summary

Good afternoon, everybody. I'm Chris Schott at JPMorgan. And it's my pleasure to be introducing Perrigo today at the 40th Annual JPMorgan Healthcare Conference. From the company, we have Murray Kessler, President and CEO. And before I turn it over to Murray [Operator Instructions]. With that Murray, Happy New Year. Thanks for joining us and look forward to the comments here.

Thank you, Chris. Happy New Year to you and everybody else as well. On the next slide, please, I encourage you to read our forward-looking statements. I won't cover it off now, and I'll get into the meat of the presentation on the next slide, which is an overview, which I do encourage you to spend some time on, of what Perrigo -- for those of you less familiar with it, it has been about over the last 3 years. I came into a company that was challenged and a big part of that challenge was uncertainty, big tax bills, a declining Rx business and a company that had lost focus. We've done 5 basically divestitures and/or exits of businesses and on 8 acquisitions, a couple of big ones, one very big one pending, in order to reconfigure us into a consumer self-care. All the while we invested in innovation and built a $500 million new product pipeline and have been launching an aggressive slate of new products. We invested over $130 million in IT and infrastructure, including capacity. We invested in our management team. We invested in our ability to do service. We invested in a strong ecom platform, and we invested in business intelligence capabilities. All the while, that drove us to -- from a business that had been flattened out to one that from -- to pre-COVID had been a compound annual growth rate that had accelerated to plus 7% year-over-year, all the while delivering $100 million in cost savings and improving our service levels. Likewise, we put a lot of focus, and in the year we just finished, dramatically reduced uncertainty, and that included settling what could have been a $3 billion lawsuit very favorably and paying for that with the case that we won, exiting our New York securities litigation within insurance coverage, favorably settling our [ APAP ] litigation, getting it dismissed and basically exiting out of the remaining class actions with 245 cases dismissed, dismissed out of 25. And on Athena, the sort of the last little bit bigger one at around $800 million, have been able to get that assigned to the competent authorities where it should either go away or be reduced to an absolute fraction of the cost. So here we are 3 years later from the start of our transformation, and we have positioned Perrigo as a very focused self-care company, eliminated the overhang and are targeting strong growth with a beautiful acquisition that we're just about ready to a few months to close on and add significant accretion. Next slide. So if you sort of look at the new bigger Perrigo, we are -- once this acquisition of HRA is completed, plus the old portfolio with Rx out of it, we are now a focused leading global consumer self-care company that is primarily a private label or store brand company in the United States with 95% of our business in store brand in the U.S. And we are primarily a branded product in Europe. And when -- once the HRA closes, we'll be about 50% branded, 50% store brand around the world. Next slide. I'll talk more about HRA in a few minutes. All the while we were doing this transformation, we were growing the business 7% on the top line a year. We're a business that has raised dividends 18 consecutive years, currently with around a 2.5% dividend yield. And for 3 years, 4 years have converted cash at over 100%. Next slide. What I think is interesting is 3 years ago, I started talking about consumer self-care and how we were going to reshape the company and focus. And at that time, a number of folks were like, "Explain to me what that is. What is self-care?" And here we are a few years later, and not only we are a top player in consumer self-care, but there is a new industry and dedicated and focused industry that is formed. You just might have read about the recent announcements that in the next 18 to 24 months, J&J is separating out from its pharma division, it's a new consumer health care company. Sanofi is on a track to be in place by the end of year a standalone consumer company. GSK, separation on track for midyear of 2022, a separate company. And in the context of that on a global basis, Perrigo is a top 7 player on a net sales basis. But this is exciting to us because with this focus of these companies will come many opportunities in new products that from our store brand business we can copy to spin-offs they might have to other investment types of opportunities. It's an exciting time in consumer self-care. Next slide. The reason I'm excited about self-care, and I said it 3 years ago when I introduced our overall vision to make lives better by bringing quality affordable self-care products that consumers trust everywhere they're sold. At the basis of that was an IRI analysis that said the addressable self-care market in the world have been identified and growing but at $450 billion. And more importantly, in the core OTC markets where we compete, product lines we compete both Europe and in the U.S., those were forecasted to continue strong growth for years and decades to come. Next slide. Again, for those of you who don't know us, Perrigo has a meaningful and sizable presence in almost every one of those growing global categories. Emergency contraception growing the fastest. We don't have a position today, but when the HRA acquisition closes with ellaOne, we'll have a very strong position in that $1 billion segment. You can just see -- you read these yourself, but each of these major subsegments that are billions and billions and billions of dollars, they are a meaningful percent of the Perrigo portfolio. Next slide. This is interesting because it really comes into play when you look into the U.S. market. Now you got to follow me here a little bit. When I said we were #7 globally on net sales, that is a true statement. But because we were a store brand and then we sell to the retailer like a Walmart or a Target, they mark it up before -- and they'd sell it at a discount to their consumer, our net sales doesn't reflect our full market position with consumers. And when you look at retail dollar sales of products that Perrigo supplies, we are actually #3 neck and neck at a retail level market share right at around 11%, 12% of the broad total OTC market right along with GSK, J&J and Perrigo. They're all about 0.5 a share point apart from each other, which I think is a staggering number, but I think it's more impressive when you look at actual volume. Volume, volume. Units that consumers take. Remember, our products sell at a value. And Perrigo in the United States is the #1 provider of doses to consumers' volume than any other player in the self-care business or the U.S. OTC market. We are the largest. Next slide. We think growth continues, has come and will continue to come from our 5 global self-care platforms. And I'm not going to go into a lot of detail here, but these represent billions of dollars of opportunity. But our growth platforms, our core OTC where we are focused on major white space gaps, big multibillion-dollar segments where we can penetrate at a higher level of market share. Oral care, which is market penetration of store brand and geographic expansion. Nutrition, grow through adjacent expansion like the growth we've experienced and are currently experienced right now through our broadening against products like Pedialyte within a line of electrolyte products this year. Our nicotine replacement, we are a fraction. It's a little lower than I would have liked, but we're on the verge of launching new technology that we think will accelerate the progress of the nicotine replacement products, big opportunity. And science-based naturals, which is basically our entire European lineup or a big portion of it is all science-based naturals and bringing a lot of that to the U.S. Big opportunity for growth. Next slide. I wanted to give some examples of what that is. People ask me all the time, because we're a private label in a big piece or store brand, what is some of the innovation that you say you've invested in. This is just to give you an idea of what we've launched or in launching right now in the last 6 months to a year. But Probify probiotic products across Europe, an entire Burt's Bees kid's line of science-based natural products in the U.S. Our hypoallergenic products has helped us gain significant market share right now in the infant formula. Our Pedialyte store brand equivalent has been -- taken off like wildfire. Our branded Firefly business and kids' toothbrushes with all new licenses, bringing sustainability and compostability and recyclability to our Plackers line. Whitening products like our Deeply White product that we're launching. New flavors of nicotine lozenges. New technology in mucus products and the launches against Mucinex with our Mucus D products. New flavors on ClearLax, an insurgent brand built for a customer on [ Injoya ]. The first capsule available in omeprazole not being brought to you by the national brand, but being brought to you by the store brand with a national [ brand ]. And new bottle shapes and new flavors within cough/cold syrups, and new weight loss line of products that just had exciting clinical results that showed the product as the leading weight loss drug in the world, having comparable weight loss with a natural-based product. So just a handful, and that doesn't include the innovation and things like e-commerce. Next slide. I don't talk about this a lot, but we at Perrigo don't view just the what we are trying to accomplish, we view it just as important as the how. And we have a major push on accessibility, affordability, reliability and sustainability and the role that we play to do things responsibly. From an accessibility standpoint, most people don't think of that on a sustainability, but we provide access to medicines around the world at a greatly discounted price. So when you look at not only the access but the affordability, and I say access because you don't have to go to a doctor, you can go right to the store, hence self-care. But for each dollar spent on OTC medicine saves more than $7 in the U.S. health care system. And likewise, each euro spent on OTC medicines saves nearly EUR 7 on the EU health care system. And quality is critical to us as is a recognition that carbon emissions and climate change continue to be one of the greatest challenges for human kind, and we have to do our part. Next slide. Diversity, equity, inclusion, community engagement and giving back to the communities where we work are a major priority. You can read the slide yourself, but we're 51% -- basically 50-50 male, female, 51% female hires, 22% people of color. We're giving millions of dollars away a year into the communities we compete. We're putting our money where our mouth is, and our actions are speaking for what we believe in as well. Next slide. If I'm really putting my money where my mouth is, I will share with you the goals we have set for ourselves, the measurable goals that we are doing well with, but we are being very aggressive. It is our goal by 2026 for all facilities all over the world to be 100% renewable electricity, a 15% reduction in CO2, a 10% reduction in energy, water and waste, and we have adopted a number of the new UN sustainable goals and are committed to those, and we'll be reporting our ESG numbers under the frameworks of CDB, DGSI, SASB and TCFD, and those are the leading ones. From a packaging standpoint, our goal is by '25, 80% to 100% recyclable, reusable or compostable. And you can read the rest of these. My point is, we are going after aggressive measurable goals. Next slide. Next slide, if you have it. If the slide is not coming up, I'm just going to go on and you guys can follow along with me. But I am now on Slide #15. We had made those investments in manufacturing and business intelligence and e-commerce, enhanced service levels, IT infrastructure...

I think Murray might have -- video might come out here. Just give him a second to rejoin here. [Technical Difficulty]

Sorry, everybody. We're back. We had some technical difficulties, but we'll pick it up on Slide 15. I think the point here is all the investments in the transformation have resulted in Perrigo growing. It has, despite through COVID, almost a nonexisting cough/cold season, we are running at a 3% compound annual growth rate through 3 quarters of 2021. 7%, excluding cough/cold and CSCA, plus 2% CSCI, and the numbers are strengthening in the fourth quarter, and you'll see continued growth. To me, that's remarkable given the devastating hit to 20% of our business. Next slide. So the question you have to ask yourself is, well, first and foremost, is cough/cold back? And the answer is, yes, and it's even back more aggressively with Omicron. But our -- we're running plus 70%, plus 80%, very strong cough/cold numbers, and Omicron shows itself with traditional cough/cold-like symptoms. Good for the cough/cold segment. That's back. Next. The next issue we had was relative to well, okay, but there's been supply chain disruption all over the world. Can Perrigo handle it? And the answer is, yes. We solved those problems at the end of the third quarter, and as we're now in -- we were able to ship everything we had orders for in the fourth quarter, albeit at a higher cost. Next slide. So you've got cough/cold coming back. The business has been growing for years. The supply chains, that's fixed, and we have a massively accretive, a 50% accretive acquisition coming with HRA, the #1 foot care and blister treatment and #2 cold sore treatment in Europe; ellaOne, the undisputed category leader in emergency contraception; and Mederma, the #1 doctor/pharmacist recommended brand, expected from our just over $2 estimate for 2021 to add $1 by 2023. So a position that is with the absence and the removal of the uncertainty and strong growth coming, the company is extremely well positioned. Next slide. So why isn't Perrigo stock running a lot harder than it is? And the answer is simple. With the supply chain challenges came a big hit, almost 500 gross margin points negatively through the last quarter as we announced, which was a surprise, to a fair amount of the market. The good news is that about 20% of that wasn't really real. It was just an accounting, a structural change, which will lap in the second half. Productivity issues that were dependent on more cough/cold volume. We didn't absorb the overheads through the plant -- the fixed overheads. The plant was such a dismal nonexistent cough/cold season. That's back, and we expect to see that productivity return in the second half. Input costs, many of which we expect to return in the second half, but about half of it, we are covering through pricing, which we're more successful than we're on in the past. And then HRA is very margin accretive with north of 60% gross margin. So again, good strong volumes. We expect cost to improve as the year progresses next year, and we believe the business then is back on track and ready to create value. Next slide. I've talked about the key drivers, no surprise there. The risks and opportunities, it's all about labor and material and freight inflation on the risk side, and it's all about how big the opportunity is on cough/cold recovery and if what we're seeing right now on Omicron sticks around for a while or is short-lived as well as our success on passing through pricing. But we think those risks and opportunities are well balanced. Next slide. So in summary, the message I'm giving you, the transformation is done. We're now a pure-play consumer self-care company. The COVID and supply chain-related impacts we believe are temporary. We expect margins to improve in the second half. We're on track to add $1 of EPS or a 50% accretion, which is not reflected in our value at the moment. And we expect that over the next couple of years, to deliver some very strong results, but the focus of the company and the management team right now is on the gross margin line and cost as we've reshaped the company. That was speedy at the end, Chris, but I wanted to give you a chance to ask a couple of questions.

I appreciate that, Murray. Just to maybe dig into, I think, that point on supply chain and margin. Can you just talk through -- I know you had some freight issues in 3Q, and I know it was a big focus of yours. So entering 2022, can you just update us in terms of where we are in terms of getting additional truck drivers in place, warehouse employees? Is that largely complete at this point? I know one of the slides you talked about, I think it was the shipment volumes, up 12%, but just give us a little more color of the progress you've made of addressing, I think that issue that popped up at the end of 3Q of basically showing up at your plans.

Yes. I mean part of it, we covered the way everybody covered. Part of it we made differently ourselves. About 20% of what was on a truck was poor timing, but we had integrated our Dr. Fresh and a lot of the oral care businesses were under Perrigo temperature-controlled trucks. They didn't need that. So the first way to relieve stress on the system was to move them back to the third-party supplier that had them before. We got that done by the middle of the quarter, freed up a lot of space for higher-margin OTC products on the trucks. We signed up regional carriers, and we over-ordered on truck drivers at a cost. Some days, that was a good thing, some days it was bad. But bottom line is we were able to get out everything we had ordered at a cost, right? So -- but we have solved it, and we've extended our lead times and our order lead times, so a bit more inventory. The challenge now is that added to the gross margin erosion is over the next year, 1.5 years, to get it back.

Okay. And do you expect in terms of getting -- I know there's a number of different facets of getting the gross margin back, but specifically on that freight cost component, is that a longer-term process? Or is that something we can start even thinking about in 1Q and 2Q that those costs can -- or the efficiency of that can start to improve a bit.

Yes. The big cost -- the big freight cost is inbound freight. To put in perspective, we had a container, it would cost us about $6,000 coming from China, which is a big amount of volume on oral care, the dental floss and flossers and toothbrushes. That number went up to, post-COVID, $26,000 a container has dropped most recently in the last month or so to about $20,000, but it's holding there right now. I don't have a clear answer of when -- we think by midyear, that will break and start to come down again. And some of the other material costs, we have no estimate of them coming back yet, but we've been able to pass through in cooperation with our customers on real price increases. They'll work with us on material price increases, not inefficiency. They say that's our problem and I get it. Productivity will come back. And I guess the big unknown and which has cost us a lot of money as the employees, the absenteeism, and we have at any given time right now, 150, 200 people out on -- that are with COVID or they've come into contact with somebody in COVID. And following the public health standards, you have to send them home for what was 10 days, now 5 days. And that means everybody else is working over time. So you're paying the people that are off and you're paying everybody else over time. And over a sustained period of time, that's a lot of money. Those absentee numbers, when we get this under control, and I guess the shining hope is that Omicron is like what finally gets us to herd immunity, and we get past this, that we'll recover those costs, too.

Okay. I think you mentioned a couple of times in the 3Q and in this presentation that you've taken some price increases in the portfolio as a way to help offset these input costs. What's the reception been to those moves? And is there any pushback from customers? And again the second piece of same question I get is, when can we think about those price increases starting to impact your P&L? So is that something you see in 4Q? Or is that more a 2022 event that, that starts to help the margins in the top up line?

Well, Chris, both. You're not going to see on average on our businesses high single-digit pricing go through in a day like a national brand that -- in my old business, I could take a price increase on Friday for Monday. In the store brand business, we're a supplier. We have contracts. We have to go in and negotiate. We -- generally speaking, they have a team of people that analyze, is it true? Are the costs really up? And then they start to work through. But put it in perspective, at the end of the third quarter, after years of 2% to 3% price erosion, our price -- average pricing was up in the third quarter. So it's already started to show itself. And from the minus 1% to 2% in the last few years, I'm hoping to get plus 1% to 2% in 2022.

Okay. Okay. And then on the -- I think one of the slides -- I'm trying to remember the slide number here. I think it was slide maybe 19 again. I think you said you were looking for flat gross margins in 2022 relative to '21 with second half greater than first half. Just a little bit more color on, I guess, how extreme the difference will be as we think about the first half results versus the second half results. Any perspective you can provide on that? Is that a couple of hundred basis points? Is it something larger there? Is it...

I don't have the numbers in front of me, but just think of it as this year, right, in reverse. So we were sort of at a gross margin level. We got hit with these numbers in the second half by our costing system, which has about a 7-month lag on it. They're spread out. It's going to carry through a better part of the first half. So the first half will look like the second half of last year in gross margin and the second half will look like the first half as it covered gross margin.

Okay. Yes, that makes sense.

So it will get better as the year goes along, but the -- I'm saying the average of it will be pretty flat.

Okay. Okay. That's helpful. And then as I think about the volume side, I know it's early in this dynamic, but just talk a little bit about what you're seeing with this cough/cold season, Omicron, whatever dynamics playing out here. How substantial of an increase is this relative to what normal life's flu season might look like? And how are you thinking about the volume piece of this wave that we're seeing, I guess?

Prior to Christmas, we were thinking we were going to get about 80% back to 2019. And we had seen -- that was being confirmed by the CDC and flu-like levels equal to the 3-year average. 2019 was a strong year. 2019 was a very strong cough/cold year down. And by the way, that translates to what was 70%, 80% growth rates at consumer takeaway. Whilst a little bit behind that, but as a category. Then you come to Christmas, Omicron comes and stores were wiped out. And we are now -- you wouldn't have seen that in the fourth quarter, but all of our big customers are now calling, upping their orders based on what's happened at retail. So we'll see how long it plays out. But I mean, literally, everybody was calling me saying, there's no cough/cold products in my stores, anybody who knows us, works with us, et cetera, and our Head of Sales, who I know is listening to this, and I'm calling him every night, can't get it out there. I think our orders have been probably increased 30% for the month of January at the majors. But I don't know whether that's going to last a week, 2 weeks or 3 months.

Okay. Okay. And are you seeing -- is the same dynamic in your European business as well? Or is this more of a U.S. phenomenon in terms of the type of products in the portfolio and any differences...

We have a big cough/cold business, and likewise, it has been a strong resurgence in the cough/cold business. So they have similar big increases in cough/cold. They have different dynamics in gross margin that they can price, right? They're national or regional brands.

Okay. On the third quarter call, I think you talked about some of the impacts in 2021, about $0.80 of recoverable EPS headwinds that were cold/cough supply chain, higher input costs. I guess now we're a few months further along this process. I guess, one, your confidence that you can get all that back, that $0.80 back over the next few years. And how much of that should we think about playing out in 2022 versus how much of that's going to be longer term in nature?

Well, for 2022, I don't think that -- I think the Street is thinking about it the right way. I think most of the recovery happened. I mean you still are carrying through 6 months of the negative. So I think we offset the bulk of that in order to hold gross margins, but most of the recovery is the year after. But to me, I'm still trying to target that mid-$3 of EPS versus was going to be $2.50 to mid-$3, now it's got to be low $2 there. I'm not going to nail it down, whether it's $3.60, $3.50, $3.30. There's a lot of time to go by, but that's what we're going after, right? We want -- our focus is now integrate HRA well. We're going to finish this year. We know we're going to recover in cough/cold this first quarter and throughout the year. That's going to add a level so that should get us above our normal growth rates and above our 5% operating income. We know we're going to close on HRA, and by 2023, we're going to add -- with $30 million of synergies, we're going to add $1 of EPS. So now you're into the low $3 range. That's a 50-plus percent of EPS growth from where we are now. Now the next part is, how much can you really recover? That's where we, as a management team, are focused now. The M&A part after integrating HRA for the most part is done. We are a reconfigured company. We now have to take advantage of bringing HRA in, which is a big player, and relook at our entire supply chain as we go to recover and say, is this the optimal system? Do we have the right number of facilities? Do we have the right organizational structure now that we're 50% branded and 50% store brand? How much do we recover from productivity? Where is pricing going forward? And my commitment to you and everybody else is 3 years ago, I gave you the plan to transform. I owe you the next 3 years forward, which I'll do this summer, but I want to get the HRA deal closed first and outline how we get there. But bottom line, there's -- you have to -- there's no way not to have some very big, strong growth. And let's not forget, the major overhang issues are behind us with Ireland.

Perfect. We're about on time. Just one last question just on HRA. Any remaining hurdles or roadblocks that you think about to get that deal closed? Or at this point, you have a pretty good line of sight on that pathway?

It's not a roadblock, it's just time. We have all the approvals outside of the U.S. We're just working through the FTC because we had a small scar away brand, which has to be divested. And they have to approve that and they're working through that, but every other country in the world has approved the deal. And so then we will divest -- once they give us the approval on it and those have to be concurrent, and it just takes a few months. So it's no different than any other ones I've done. It's productive, good conversation. FTC asking lots of questions as they always do, but crossing their t's and dotting their i's. But I believe by midyear, we'll have this done. No surprises, though.

Perfect. Well, I think we're just out of time, Murray. Thanks for joining us today. I know here's a lot of moving pieces in the company. You've made a lot of progress on transforming the business, and obviously, we look forward to 2022 and addressing some of these supply chain issues. But again, I appreciate the time today.

Yes. Well, I appreciate the time. And I'm sorry, we had a little bit of an issue there, but we appreciate everybody's interest in Perrigo, and we think we're right -- I've said this, we're focused on cost, but a big opportunity for value creation, we believe. So...

Thanks.