Elanco Animal Health Incorporated (ELAN) Earnings Call Transcript & Summary

Overall, our messaging on ASF has been headwind in the first half of the year because the impact really started to hit us in the back half of the year. Overall, for the year, we're generally expecting it to be neutral based off continued repopulation of sows across the industry in China and the fact that as it consolidates with more corporate players, that gives us a better opportunity than sow repopulation on backyard farms. That being said, that's in the context of coronavirus not negatively impacting that sow repopulation. And obviously, the still -- uncertain there on how this plays out and the impacts on the farm. And so that's something that could in fact make that less than neutral, with -- the coronavirus has an impact, it's too early to say on that end. With respect to the broader bit of ASF, clearly, there's a impact on imports. We've seen that jump up. Beef imports into China have grown. Pork imports, we've seen greater increase in production to help offset that. We keep thinking poultry will be bigger. Our poultry business is growing. There is some shift, but there's been less poultry demand than I think we would have thought early on. And I think that's just the consumer desires, right, is shifting that and just saying, okay, you can eat chicken, not pork. Well, if you want pork, you want pork. So that's a factor involved. We continue to have good growth in our poultry portfolio in China but frankly, it was off a very low base. So that plays out. But over the course of this year, we definitely think there will be opportunities. In the Phase 1 trade agreement with China, there is a risk assessment being done with respect to [ direct ] opening. We've talked about the Paylean coming out as the producers just don't want to deal with segregating pork that can go to China versus that, that can't. That's been a headwind for us here in Q1 as we were selling Paylean last year and cannot this year. But that being said, we're feeling like this is an opportunity. The ractopamine products are very clean. They're accepted in Japan. They're accepted in, under the Kodak Standards. It's a nontariff trade barrier. We hope that goes away as part of better trade relations with China and we're looking for that. That being said, we haven't factored it into the guidance for 2020 either.

Okay. Just for a second, you touched on the coronavirus potential impact. And I want to make sure we touched on that before we move on. Could you remind us, we sort of have a good sense of your overall exposure to China revenues after all the discussion on ASF. But what about as part of the supply chain, whether it's API, local manufacturing, sort of if this extends for many, many months, sort of what's the potential downstream impact? And how much do you have in terms of contingency, inventory stocks, that type of thing?

Yes. I mean, one of the things, we carry a lot of inventory, I think as folks know, if you just look at our balance sheet. Part of that's because we have this broad contract manufacturing bid because of the size of products in animal health, the different formulations and the like. And so with that, we have no issues with respect to supply chain or API in 2020. Obviously, if it became a much longer [ term ], then we'd have to think about what that means. We've got, I think somewhere in the 8 to 9 contract manufacturers in China. So of the 90 contract manufacturers we have, a small part's in China and they don't dedicate themselves 100% to us by any stretch. It may be that we're set up to have our run of product in August. Okay, well, if that gets pushed to December, it's probably not going to be the end of the world. It gets pushed to August of 2021, all right, then we have to think about it. But overall, we don't think there's an impact on us from a supply chain perspective. Clearly, the total China business now is about 2% of our total revenues, so that would be a factor. We learned a lot from how to interact with our customers from ASF. We weren't able to go on the farms, in many cases. So we improved our digital touch points and have continued to do that here during the shutdowns that have happened across China over the last month. So all of that's to say, we feel okay with respect to our supply chain and our business, but it's obviously early days on things. As we mentioned on the earnings call last week, you have the strong dollar, and to the extent that's coronavirus-driven, and it seems to have had a little bit of tendency here, we are along those currencies globally. We are in a position where we hedge any of the currencies. So to the extent the dollar continues to strengthen, the headwind we've called out in '19, the headwind we've called out for '20 as well as the rates we've provided for our 5 biggest currencies, we said we did our plan, the [ $1.11, euro ], right? Well, it's a [ $1.08 ]. So those things could be a factor on a broader scale just because of the global business we operate. But overall, we're monitoring it. We're staying on top of our employee health. They're healthy, they're accounted for. They're anxious to get back to work in a more normal environment.

Okay. And then sort of just taking a step back then and going through all those moving pieces, ASF, Trio, Rumensin. One of probably the most common questions we've dealt with over the last couple of days and the last couple of months has sort of been, it seems like there's a lot of one-timers. There's a lot of moving pieces. If you adjust them out, what's the underlying growth rate? I mean, that question of underlying growth has probably been the most common question I've dealt with in Elanco for about 6 months now. So I think if you look at -- the way I think about it is, you called out the sterile injectable issue in 2019. You quantified the ASF impact. You quantified the $60 million to $90 million of headwinds in 2020. You sort of back that out and you do get to a 4- to 5-ish percent growth rate, whether or not people could debate whether that's fair or not to do to remove headwinds, but still, that's one way of looking at it. And the way I've thought about it is, sort of ASF is a once-a-generation type of outbreak, right, hopefully. Simparica Trio is a, probably going to be one of the biggest, if not the biggest animal health drug all the time. So again, you're not going to -- I didn't say that. You're not going to get that type of a launch as a headwind to sales every single year, right? So if these are truly sort of onetime events or relatively rare events, the underlying growth rate should be the underlying growth rate. So is that still -- is that model still in play? Is that sort of the right way to think about it as, market as mid-single-digit, Elanco is mid-single-digit. It's just that 2019 and 2020, you've got a number of sort of major headwinds that happened to all line up?

Yes, I think we view that as a fair characterization. We've continued to say mid-single-digit with the Bayer acquisition coming in. Clearly, these headwinds are ones we identified at the time of the IPO. They actually got pushed back a little bit from that time frame and we didn't deliver on Imvixa in Norway, which would have been a counter one that we thought we would have in 2020, that unfortunately we didn't get approval on. So overall, we do feel like we've got good underlying strength with the new innovative products we've been coming out as well as being a key driver in our big base of products that have provided real efficacy for farmers and pet owners for generations. That being said, obviously, FX has been a big headwind for us, both in '19 as well as in '20 relative to the timing of when we launched. That's something that may flip. Obviously, we get less exposure net on the euro from doing the Bayer deal just because they do a lot of manufacturing in Germany that gets sold in the U.S. We do a lot of manufacturing in the U.S. that gets sold across the EU. But overall, we feel very good about the pipeline. Clearly, our pipeline will need to deliver as part of continuing to get to that mid-single-digit growth. As we've talked now, we've switched to 25 launch equivalents coming out of the pipeline between '20 and 2024, the combination of the products we've been talking about since our IPO. In the Elanco portfolio, the addition of the 8 products, we talked about in the Bayer acquisition as well as the products we've gotten from Aratana. Those are continuing to progress well. We feel good about the innovation we're bringing there, the extent of meeting unmet medical needs, being big enough to move the needle, and we look forward to proving that to the marketplace. As we've talked this year, the Experior combo. We're just waiting on approval of the residual from 1 big export market, and we're excited to bring a product that's got an environmental claim to our cattle producers because they've obviously been getting beaten up over their impact on the environment, and this is a way to help offset that. We have seen chicken mortality increase for the first time in 20 years in 2019 as the no-antibiotic-ever chickens became more than 50% of the market. We're just going to have more sick chickens with that. This IL-10 product we've been talking about, we have to get it to where it can go through heat encapsulation, so it can go in feed. And once we do that, we think we're going to provide a really good product to help deal with intestinal issues that chicken producers have while maintaining that no-antibiotic-ever standard for them. So those innovations are definitely ones we're counting on to help augment the growth going forward. And again, as we get in more with Bayer, we think we'll have more opportunities to help do that and get to that industry level, mid-single-digit growth range.

So on the Bayer transaction, you've got a lot of updates over the last couple of weeks and months obviously with the divestments and the equity raise. Could you remind us what the key events are between now and deal close and why is deal close still in the summer? I mean, sort of what are the regulatory steps still required? What are the internal executions that's still required? And what are the catalysts we're going to see?

So we've gotten approval in Turkey, China and Ukraine on the antitrust side, but there's 7 other jurisdictions that still have to approve as conditions to close, the big 3 being the U.K., the EU and the U.S. With the dispositions we'd announced, we feel like we're addressing the concerns they have posed to us. But it's not over until it's over but we feel very good that we are, in fact, addressing those concerns with the divestitures. We've got 5 announced divestitures and then we did finish up our sixth one last week for StandGuard which gets after horn flies. Not exactly a huge issue but one that we need to deal with as part of feedback from the regulators. So overall, that's going really well. But they're not done, we have to get those signed off on. We've obviously completed the financing, so pleased to have that in the books and pleased with the capital raise we did there. The big item, as antitrust is going, I guess, faster than maybe we thought it might when we signed the deal in August, becomes the stand-up with Tata. As we have disclosed from the start, Bayer has not been doing TSAs on their recent dispositions. They've been using what they call a carve-out factory with Tata Business Consulting, where they shift the ERPs, they operate their business on over to Tata and then that runs the stand-alone business. So we are working with Bayer, with Tata to build out that infrastructure. That does take time. It also requires us to build out infrastructure we don't have because we're still working off the Lilly systems. So an example just because it's close to my world. We weren't needing to do VAT collection and compliance until we got on our own ERP in Q1 of 2021. Well now under the Bayer deal, we're going to need to do that after the deal closes. So we're having to accelerate building out our systems, our people to be able to do VAT compliance. All of that's progressing well. We're working closely across the 3 organizations to do it, but it does take some time.

Okay. And then about the divestments you highlighted, Osurnia, Capstar, defender, could you give us an idea. I mean, you've indicated you're well within that $120 million to $140 million in 2018 sales range you talked about, but what's the impact to the combined company in terms of growth rate or margins? Are these products -- are the divestments going to be growth dilutive where you're divesting faster growth assets or slower growth assets and what's the margin profile?

Yes. So generally speaking, we did less than what the original model was, so that's been a positive. It's not necessarily like we beat it by 6x or anything like that, as you can imagine. Certain of these products were actually declining in sales in '19 so that would help growth. Overall, the margin side of this becomes a question of we divested Osurnia, but we kept Claro and we're excited to have Claro. If you looked at their absolute sales of those 2 products in '18, and say, well, you'd want Osurnia, because Claro had just been launched. We like Claro because it's 1 treatment versus Osurnia, another Piedmont product, it's 2 treatments and needed refrigeration. So we feel very good about the products that came out in Capstar. We hate to lose, it's been a product for Elanco. And it had a feline indication. Well, the Advantage family is what has the canine implication -- indication. We need to extend that to now get feline so we can compete against Capstar. Again, choices where they don't like you to split brands. And so we'd much rather keep all of the A family than just keep a small indication for felines with Capstar. So overall, we feel very good about the products we kept, that it was better than what the model assumptions we've gone in with, and that it is right in line with the future growth we can do as a combined company.

Okay. Are there any questions from the audience? No. All right. I'll keep going. I mean, the other thing that's come up a lot in sort of our conversations and all of the focus that you've sort of emphasized since the deal has been your desire to have a bigger presence in some of these retail alternate channels. Talking about the majority of Bayer's portfolio moves through that. Whereas the majority of the orders was actually through the vets. And now you've got this approach of wherever the pet owner is, that's where you want to be. At the same time, there's a little bit of pushback there because when Bayer first went with this alternate channel strategy, the vets pushed back against that. So do you think there's any risk of now that you're sort of tying up together, that some of that animosity that vets have towards Bayer's going to extend towards your Elanco portfolio?

Again, we look at the Claro launch they had within the U.S. vet channel in 2019 and it went very well. That's an indicative nature that vets want to do what's best for pet owners and their pets versus just views of it. I think the market's obviously changed a lot. I mean, when Bayer did this a decade ago, the Chewy.com wasn't there. Covetrus and the Vets First Choice model wasn't in play. So we're very cognizant of it. We've got great relationships with the vets and we're continuing to work. We think that with data and our insights as well as bringing products that the pet owners need, we'll be able to continue to help pet owners go back to the vets. We obviously view vets as a very important part of overall animal health and want to be supportive of them, continuing to treat animals across all of the continuum. But certainly, there's an aspect here that the world keeps changing, and we want to stay in front of it. We don't feel like we can just ignore a channel or ignore an aspect of where pet owners want to be, because at the end of the day, they are the ones that are consuming the products. We like having the ability to be in the OTC side of things because we didn't have a play there. We learned from the products we did have that the brand name recognition was such a value driver that we were struggling to compete OTC because we didn't have the advantage name. We didn't have Seresto, Seresto, Seresto, right? Those things that have really resonated with consumers and continue to have growth. So overall, we understand that there's an aspect here of over-the-counter versus vets. At the same time, we'll continue to be very good partners with our vets and continue to work that and help them provide great health to pet owners across the globe.

And I would say the other angle that you continue to emphasize as far as things to be excited for in the future, things that are going to drive the company going forward, and you touched on this earlier, is the innovation pipeline and the opportunity for future new product launches. At the same time, it's something that we also get a lot of pushback from investors is that, well, there's not a lot of visibility into the pipeline. And a lot of clients that look at animal health also, are you still looking at human health, where you have clinical trial data, lead off well ahead of time to build the market. Here, I appreciate your color on Experior and on the IL-10 product. But for the majority of those other products you talked about with, with a future pipeline in terms of the 25 products, the 8 from Bayer, we don't know how big they are. So it's hard to sort of factor that into the long-term growth model. It's one thing if it's a bunch of derm products that are going to really challenge the established play there or if it's a triple combo. It's another thing if it's a small product for aquaculture, for example, right? So how do you -- how do we, as -- in the investment community, sort of assign value to a pipeline that's mostly unknown or uncertain?

Again, we're within a competitive landscape, right? I mean, I don't think we're doing anything that's radically different than most of the competitors in the space. We've heard the feedback, we continue to think about how do we provide that clarity. We've tried to do that with the IL-10 product that we announced back in November on our Q3 earnings call. We've talked about it with Experior as we continue to move through that. And so it's something we're always evaluating. At the same time, the IL-10 product, it went from an idea to getting to market in less than 2 years. Well, do we want to do that, and provide that information when there's a competitive aspect to it? That becomes part of how we've talked about it. Obviously, we've said we're working on a broad spectrum parasiticide that will be better. I mean, we're very focused on Interceptor Plus. And when we talked about the IDEXX collaborative study of 30 dog parks with client-owned dogs, right, these are pets that are loved by their pet parents and finding that 1 in 5 of those parks have parasiticides that, everything but Interceptor Plus won't cover, right? And so is convenience more important than efficacy in protecting your pet? We're very much wanting to focus on, as we bring out innovation, that we've got that broad coverage that comes with it, just like the current protection we provide pets on Interceptor Plus. So we are cognizant of the feedback. We continue to evaluate how can we do this in a way that's helpful to the investment community but also not a disadvantage to the organization over the long term. But again, we've talked to -- yes, we understand derm's a big space, and we're looking to bring a product out that's better than what's currently on the marketplace. Again, we look at -- there aren't -- people aren't producing blockbusters in animal health every 2 months. But certainly, when they're out there and competitors have done -- created some big markets like in derm, we are also looking at that. We understand that we are going to be a $4.7 billion, $4.8 billion organization. So bringing out things that add $2 million in sales probably are not going to excite you. And so that's certainly something that we are cognizant of and we're looking to play in big spaces like no-antibiotic-ever chickens, where there's 4.5 billion chickens in the U.S. that could be available to use our product.

So in those 25 products you highlighted or you talked about, sort of what are your criteria for sort of seeing what goes into that bucket? Is there a minimum peak sales number of -- we think that they'll all be $50 million or over -- or $20 million or over? Or is there a certain target sort of -- how do you think about that? How do you think about that future opportunity contributing to revenues? Are these products that are going to be 5% of sales, 10% of sales down the road, sort of in aggregate?

I mean, that's exactly what we're doing. We're looking at them in total. We want to go into markets where it's big enough to move the needle or fits really well within our portfolio. There's obviously a cost of getting them over the line, how do those incrementally. But we don't want to be just doing something that we think is nice and it's going to be $5 million of revenue. We need to have them be meaningful. Are all 25 of those going to be a $100 million-plus products? No, I'm not believing that. But do all of them have the potential to be north of $50 million? Yes, we feel very much like these are products that have that ability to be noticeable in terms of our revenue contribution over time.

Any other questions from the audience? Okay. I think in the interest of time, I think we're going to call it there. Thank you so much, Todd.

Thank you.

And thank you, everyone. It's been a pleasure having you here. If there's any other questions or if you want to follow up, we'll be around for a while and you know where to find us. Thanks for joining us.