Elanco Animal Health Inc. reported May 7 its financial results for the first quarter of 2020, noting that its results reflect the impact of the COVID-19 pandemic on the business, particularly actions the pandemic has prompted the company to take with its commercial distribution partners.

Despite the unique factors that contributed to the first-quarter performance, Elanco said its "innovation, portfolio and productivity strategy" continues to be its focus and the long-term industry fundamentals and durability remain intact.

"In the first quarter, the COVID-19 pandemic created working capital pressures across our commercial value chain and dampened assumptions about near-term demand from end users of our products. These factors, coupled with our recent evaluation of distributor performance, has prompted us to tighten our approach across many facets of our distributor relationships," Elanco president and chief executive officer Jeff Simmons said. "Our relationship with our commercial partners has evolved significantly over the last 13 years, and while distribution will continue to play a role in the future, our analysis shows our internal demand generation efforts are superior to distributors, and higher inventory levels are not driving demand as it had in the past.

"In the first quarter, we made initial progress to meaningfully reduce channel inventory, primarily in our U.S. companion animal business, and we expect to further tighten channel inventory across all business areas, primarily in the second quarter," he added. "The decrease in channel inventory is a structural change that will improve our working capital and maximize our operational flexibility in the current environment and beyond. While the actions we are taking with our commercial partners negatively impact our reported sales performance in the near term, these changes will strengthen our position, optimize our promotional approach and enable us to direct investment to the internal commercial activities that drive demand for our products over the long term."

Simmons emphasized, "Importantly, these changes are independent of the underlying fundamentals that give me confidence: strong leading indicators in clinic performance driven by our internal teams, the accelerating importance of alternative channels, strong demand for our solutions in poultry and [aquaculture] and even encouraging recovery signs from China's swine industry. We do expect demand-related pressure on our business as a result of the COVID-19 pandemic in the coming quarters; however, these fundamentals -- along with a productivity agenda that continues to deliver price and cost improvement, a strong pipeline with potential for five new products contributing revenue by the end of 2021 and a continued focus on the well-being of our employees, customers, animals as well as broader communities -- are representative of the company we are building for long-term success."

Elanco said underlying fundamentals of its business in the first quarter remained strong despite the actions taken related to channel inventory:

• U.S. Companion Animal. Outbound sales from distribution to vet clinics and alternative channel customers have grown in the mid-single digits over the past year and in the first quarter. In alternative channels, Elanco said it outgrew the overall market and gained share in the quarter.

• U.S. Food Animal. The portfolio experienced flat to slightly negative outbound sales from distribution despite the trade challenges with Paylean (ractopamine), the inconsistency of supply from the company's sterile injectable manufacturing partner and the launch of a generic competitor. It said it is pleased with the execution of the strategy to maximize Rumensin (monensin) sales in the U.S.

• International. Demand for poultry, aquaculture and swine products in China drove growth in the quarter, in addition to anticipatory purchases by direct export customers ahead of potential pandemic-related supply disruptions. China's swine industry, which was a significant drag on the industry in 2019, is showing positive signs of recovery in herd repopulation efforts in large, corporate operations.

• Productivity. Manufacturing cost reduction efforts and price improvement -- elements of gross margin that will persist -- continued to improve in the quarter. All elements of the manufacturing cost reduction plans are on track.

Bayer update

Elanco reported that the Bayer Animal Health transaction continues to advance and includes the following progress since its last earnings call:

• Form CO was submitted to the European Commission as a standard part of the antitrust regulatory process, with a response expected by June 8.

• U.K.'s Competition & Markets Authority opened its formal phase 1 review of the previously announced sale of Osurnia to satisfy antitrust considerations in the canine otitis market.

• Antitrust clearance for the transaction was received in Colombia, South Africa and Vietnam, in addition to approvals in China, Ukraine and Turkey.

• The leadership team was expanded, adding a chief marketing officer and three commercial leaders to the current executive committee to lead the combined company -- two external hires who began immediately, and two from Bayer Animal Health who will join upon closing.

"I am excited about the future leadership team, whose expertise, experience and energy will drive the success of the combined company," Simmons said. "We remain encouraged by the regulatory and integration planning progress despite COVID-19 challenges, as well as Bayer's strong financial performance in the first quarter. We continue to look toward a mid-2020 close."

First-quarter reported results

Elanco said in the first quarter of 2020, total revenue was $657.7 million, a decrease of 10%, or down 9% without the impact of foreign exchange rates, compared with the first quarter of 2019. Revenue, excluding strategic exits, was $638.7 million, a decrease of 9% without the impact of foreign exchange rates. Gross margin as a percentage of revenue was 49.4%, down 360 basis points from the first quarter of 2019. The total operating expense was $248.8 million, an increase of 1% from the first quarter of 2019.

Food Animal Future Protein & Health revenue increased 8% for the quarter, driven by increased volume and price, partially offset by an unfavorable impact from foreign exchange rates. Elanco said growth was driven by continued strong demand in the international poultry and aquaculture portfolios, in addition to anticipatory buying in the quarter by direct customers in international export markets to ensure the continuity of supply ahead of potential COVID-19 pandemic disruptions.

Food Animal Ruminants & Swine revenue decreased 8% for the quarter, driven by deceased volume and price and unfavorable impact from foreign exchange rates. The decrease was driven by expected impacts from headwinds for Rumensin and Paylean, the continued replenishment of sterile injectable products from a contract manufacturing partner and actions to reduce inventory levels. These headwinds were partially offset by increased demand in China's swine market as a result of favorable producer economics and positive efforts to repopulate herds affected by African swine fever in 2019, in addition to anticipatory buying in the quarter by direct customers in international export markets to ensure the continuity of supply ahead of potential COVID-19 pandemic disruptions.

Elanco reported that gross profit was $325.0 million, or 49.4% of revenue, in the first quarter of 2020, compared with $387.3 million, or 53.0%, for the first quarter of 2019.

Financial guidance

In March, Elanco withdrew guidance for full-year 2020. While the long-term industry fundamentals remain intact, the company said it is not providing an updated 2020 guidance due to the uncertainty of the impact of COVID-19 on its business and environments in which it operate.

Although the pandemic prompted actions taken with respect to commercial distribution partners, Elanco said it did not experience a meaningful impact on underlying demand from the COVID-19 pandemic on its business in the first quarter. While it said leading indicators for its products remain encouraging, the business experienced pressure in April, given the significant impacts the pandemic is having on its customers.

Elanco said it is closely monitoring leading indicators across all parts of its business. From a macro perspective, Elanco is tracking the overall spread and containment of COVID-19, changes in government-mandated protocols, lifting of social distancing restrictions and overall economic impacts and recovery timelines. On the food animal side, Elanco is tracking production capacity constraints, primarily in the U.S., weakening producer economics and shifting consumer demand globally.

Elanco is a global animal health company that develops products and knowledge services to prevent and treat disease in food animals and pets in more than 90 countries.