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

Good morning, everyone. Welcome to the Elanco presentation. We're very pleased to have Jeff Simmons, CEO of Elanco, joining us today. And as you know from the past couple of days, the animal health is a very exciting space. And so we think Elanco is one of the very exciting ways to participate in, in this segment. So with that, this is going to be -- we'll do our Q&A, and the company has a breakout session to follow. But please raise your hand for any questions along the way.

So Jeff, just to start out, just you've now been public for almost 1.5 years. I think the final spinout was, what, it was March of last year, and fully out of Lilly for a year. Relative to your expectations at this time, what's been the most positive benefit of being a stand-alone company? And what's been the most challenging?

Yes. Thank you. Thanks for the opportunity, firstly, Steve and Kathy. Yes. So I think without question, I had the opportunity and the luxury of being 10 years as an officer of Lilly, setting it as 1 of the 5 business units. And Lilly, as you know, had animal health kind of separate in some regards. But I will say there's been some profound differences in the 18 months as an independent company, and it really comes down to fit-for-purpose driven around Animal Health needs, so faster decision-making. And I believe that the governance of that, the ability to deal with the risks relative to Animal Health, which is a cash business, not a payer business, so the ability to make decisions, and that translates then quickly to trade-offs along the way. And I think we've represented that with getting out of countries where you're not making money, but you used to stay in them because that's where Lilly had offices. So trimming SKUs, trimming countries that -- where you weren't making money. But then I think reallocating and adjusting through the year to say, "Hey, let's move some of those dollars to a Companion Animal launch." And I think the best representation is we delivered our EPS in the middle of the range, in the midst of African swine fever, contract manufacturer. I think an independent animal health company is more agile, quicker, risk adverse, and it's allowed us to deliver more quickly. On the other side, the challenge, I think, is, obviously, governance standing up, but we put together a Board. We really like our Board. It's a very growth-oriented Board. It's very much centered on this industry. But I would say that its -- there's without a question standing up ERP systems, creating independence takes time and takes cash as well. So those would be the differences.

On a related note, were you surprised when Merck announced that it would be keeping its animal health internally and spinning out some other parts of its pharma business?

Upset on both sides of that. I think -- I guess, I would convey that I like our position now and the timing of the marketplace. I'm extremely excited about bringing Bayer in. So what you're doing is, you're taking 2 spins work, spins and pharma really work, and taking 2 animal health companies, Bayer Animal Health, now 2% of Bayer Corporate, a division of a division under the plant science Monsanto acquisition, I think uncoupling that and uncoupling us, we believe -- we like this business model of independent, and we also like the standing up of an infrastructure that's fit for animal health from 2 divisions inside a corporate pharma.

Okay. Well, why don't we shift right to Bayer now?

Yes.

Once Bayer does close, and it looks like we're getting closer on that, what are -- as investors, what are the -- some of the things that we should watch most closely over the short-term to get a sense of how the integration is happening?

Yes. So I think, first of all, I want to convey, holistically, when you look at this relative to August, when we announced it, I've shared on the earnings call, we feel more positive now than then. And then we felt very good about it. But as I look just real quickly across the line, antitrust is coming together very nicely. We've announced the transactions that we believe are necessary. So when you put both entities together, last year's revenue is about $4.7 billion combined. We will exit about $125 million to $130 million of revenue from the combined company. We've picked up around $425 million of revenue, and we feel like we're in the final discussions with the European and U.S. authorities. So there was a lot of discussion that, that was a significant risk. We believe we're going to convey and move forward on that. As you look at the metrics, Kathy, what we would say is, one, this is an expansion and an acceleration of our strategy, not a change to the strategy. So look for continuation, look for mid-single-digit top line, double-digit bottom line, look for the margin expansion. If you look at the EBITDA, we've gone up 700 basis points and -- from 14% to 21%, and we've said we're looking to be another 1,000 basis points of EBITDA by 2022. So that's 31% by 2022. I think the cash flow is also a key one that we've talked about is by the end of 2022, putting together more than $1 billion of free cash flow, and that relates also to synergies in the neighborhood of $275 million to $300 million. I think what's exciting also and why we say we really like this is a couple of things that are additional excitements that we see is, one, is just the changing of the alternative channel outside of the vet clinic. What we see in trends in e-commerce, what we see outside the U.S., in international Companion Animals, is an exciting part. And then lastly is, I think, we've said 25 new products launch between now and 2024, 20 coming from Elanco, 5 from Bayer, so a real stream of innovation that will come from the company. So a lot of metrics there, but I think everything we said in August and a little bit more.

Which when you talk about the new products and the innovation, a lot of the questions we get is trying to get a comfort level with what some of these new products and what the pipeline might look like. And I understand that you can't talk about the specific products. But can you give us a little color on how you're going to coordinate 2 fairly large R&D efforts? This isn't like bringing in Aratana. This is a significantly larger effort. How do you go about prioritizing? How do you try to give folks confidence that this is going to be 2 plus 2 may equal 5 here, and there's some opportunity?

Right. Right. So I think our history as a company is proof. I would say the best answer is always, so what's happened in the past to start with, let's pick Novartis as an example. I think we've proven as a company that we can be agnostic to where things come from and trade-offs. So if you look at -- we delivered 5 products out of Novartis that were in late-stage development. But by being kind of independent Elanco leaning in, we drove 2 products in salmon across the line, Clynav, Imvixa. We brought in Osurnia. We brought in Credelio and Interceptor Plus. They all came out of late-stage development of Novartis. They're now part of the basket of 14 products that we're launching. So is it Elanco's? Is it Bayer's? We'll be able to do that. Now I think from an antitrust perspective, seeing how low the overlap was, there's really nothing in the pipeline. What that means is there's a lot of complement, not a lot of overlap. And the other thing is in Elanco, that spending a little over $225 million on R&D, will now go over $400 million in R&D dollars. We have scale. We're going to have fluid cash, and we're going to be able to make the trade-offs. So I think that's important. But on innovation, I cannot emphasize enough that, one, we are a company in launch mode. We've been launching 3 products a year since 2015. We will add 2 more products to that dozen products plus, and we got the 2, what I would call, new products in Nocita and Entyce from Aratana. So Elanco has got 14 products in launch mode. We'll add a Seresto. We'll add a Claro and a few more. That will be a heavy-launch focus, combined with the 25 products by 2024. That's the -- Elanco will have a constant stream of innovation in spaces that are big, mix between Pet and Food Animal. And yes, we have differentiated products in the area of derm, parasiticides, renal failure, diabetes and then, of course, on the Food Animal side, antibiotic replacement, therapy, microbiome.

Jeff, how is R&D productivity measured in animal health. There seems to be no good answer to the question in human health. Is it different in animal health?

We have some of the people that have moved actually from Lilly over that have joined us as a company then, and we've looked at a lot of similar metrics. Aaron Schacht, our Head of R&D, actually ran R&D operations for Lilly for John Lechleiter's era. So what I would say is, we are looking at some of those metrics. It's a little more difficult when you say multiple species, multiple therapeutic classes and a lot of market creation. We thought 5 years ago that food safety was the big market and obesity in dogs. No one was projecting the parasiticide market to be what it is, also derm to be what it is, as an example. So I think it's a little challenging because of market creation. But I think you got to look at, one, you've got to be bringing differentiated products, like you can't bring a me-too product. Two is, they've got to be going into marketplaces that are existing quite large and big, and then you got to look at the end-user. I mean, to approach a new company or to a pet owner, does this add some element of value? This is a cash market. I cannot emphasize enough after 20 years inside of Lilly, this is not a payer market depending upon 3 governments that creates a majority of the revenue line. So it does come back to a value proposition. So look for, I think, new products, but NPV and contribution to growth rate going forward is metrics that we're looking at on the R&D side.

A couple more questions just on Bayer. One, you've said on the call recently that the transaction will not close until middle of this year, even if you get antitrust prior to that. One, can you tell us, is the system integration moving online for a mid-2020?

Yes. We feel very good about mid-2020 for close. Antitrust is moving maybe at a little faster pace. But let me be clear, and if that does happen little sooner, that gives us the opportunity to go deeper in the integration planning and to be able to prepare ourselves even more so for the first 100 days. But remember that we're doing 2 things in a Elanco right now. We kind of call it the 3 streams. One is run the company. That's more than 90% of the organization firewalled off, running, staying competitive in the marketplace. Two is, we're standing up from Lilly. Today, we've got over 65% of the TSAs behind us with Lilly. We've got our own Workday system, HR system standing up and starting cutovers, but the big remaining item with Lilly is the ERP system. So we'll be going to SAP HANA and moving over, and that will be the rest of this year, early into next year. And then we will -- what we've agreed with Bayer is, we will be setting up an independent system with Tata Solutions. They've done this before with BASF and other companies. And so we're working on the third stream being integrating, and what will take until July 1 or midyear will be the standing up of this independent system. But everything is tracking. We're resourcing. I always pause and say, "But it's complicated." We know it's complex and complicated, but we've got the muscle of doing 12 other companies, not of this scale and also Bayer's had 4 significant separations. So we feel we've got the right teams in the right -- with the right plans in place.

I saw that when Bayer reported -- the numbers that we could see at least, since it's a discontinued op, they looked pretty good. Could you provide us with any other color at all on a product like a Seresto or how that did at the year-end?

Yes. I can't, just given some of the limitations. What I would say is a few things. First of all, when we came out, we made some very clear -- there were months and months of diligence done and observations made as we got into the diligence, and what we saw is truly what's playing out in the diligence in a positive way. So what we're seeing is significant growth in the alternative channels. We're seeing significant growth in emerging markets. The launches of Seresto and Advantage in China are also doing extremely well. And their Food Animal business is going to be very complementary and doing well relative to the market, maintaining and growing appropriate share and I think a lot of margin opportunity. So that's what we've seen. And I think that's played out. What you saw in the decline in the past with Bayer, what we've shown is that came from Advantage inside the clinic, and that's changing.

Does this -- and you talk about the opportunities in some cases with the livestock side in production animal because Bayer is bringing in some of that. How does that mesh with your 3 targeted areas? And then there's ruminants & swine. Does this put a different light on that?

Yes. So let me be clear. When we launched, we had pet therapy, pet prevention and the future protein, poultry, aqua and antibiotic replacement. Look, that was -- that's over 60% of Elanco today. That's what we needed to lean in on with this IPO to create growth. And you saw that in the 2019 results, where we grew those targeted growth categories by 7%. What I want to be very clear, though, is ruminants & swine is still the largest segment in total Animal Health. It is still our largest segment as a company. And what we've done is we've innovated. We've created some alliances. We've been opportunistic and very targeted, so cattle in the U.S. and Brazil as an example, swine in the U.S. and Asia, Europe. We're being very targeted and very opportunistic. Bayer will catalyze. They bring more dairy. They bring a bigger portfolio for Asia. They bring a bigger beef portfolio. So yes, look for significance and materiality to go forward, and they bring a pipeline in this area as well. So we see that folding in as a key category going forward.

But it may not grow at the same rate as the other 3?

Well, we aren't going forward yet until we get the company together and have completed our pro forma and our full assessment. But it will catalyze and create more significance for us in ruminants & swine.

Any questions from the audience at this point? All right. So Jeff, maybe let's go to Europe. What you mentioned before, I guess, it's your favorite 4-letter word right now is Trio. Is that correct? Now we're going to start on that?

Sure.

It's gotten approved, not surprisingly, and you've seen the label. How do you -- what is your strategy, your positioning now that it's actually out there?

Yes. It probably -- it goes without saying, I'm going to focus on what I believe is the company that's going to have the most exciting activity in 2020 in parasiticides and companimal prevention is going to be Elanco. And let me just share a little bit and unfold this. Today, first of all, we've got the broadest offering to a pet owner when you put Interceptor Plus and Credelio together. And we can get into this, but I believe that, first of all, intestinal worms in 1 out of 5 dogs in the study that we shared with IDEXX, it's important, those 2 products have that broadest coverage. They are growing significantly. They grew significantly in 2019. That momentum is continuing in 2020. We're working with partners in distribution and diagnostics, and we like our strategy that we were executing against and will continue to execute against as we go forward. I think that's important. When you add on what comes with Bayer, middle of the year, this is what brings a lot of excitement because we spent an awful lot of time comparing one product to another product in a $5.5 billion market that's growing 6%. I look at this as global, and I look at it from the standpoint of what we're going to be doing in Asia with a Seresto and Advantage, what we're going to be doing with all channels, what we're going to be doing with the vet clinic. We believe strongly that what we can do with the Elanco plus Bayer is enable us to access more pet owners to shop where they want to shop but to redirect them and bridge them back into the clinic. There's 1/3 of the pet owners in the United States, as an example, that are not going into that vet clinic, and we have the opportunity to reach them and be able to say, "Hey, your dogs at this age, maybe you have a pain problem. Hey, you haven't had your annual vaccines." And we see this as a very positive thing overall. So when I look at -- I like our portfolio. I like our pipeline. I like what Bayer brings from a channel perspective, and I like what happens globally. Any time a new innovation comes into the marketplace, and we've seen it, I've seen it in my 30 years, we've seen the Advantage frontline come in as topical, we've seen Elanco bringing Trifexis and Comfortis as the first orals, and we've seen the isoxazolines. You're seeing now that start into the fourth generation of innovation. What happens? The markets get bigger. Pet owners get more options. Segments become more clear, and innovation crosses borders. And I believe that the exciting thing is we're entering a new -- the next-generation of innovation, and these things are going to happen. And price usually also follows with that as well. So I didn't get into the specifics there, but I think what I just shared shows the context of the opportunity we see and why the durability of this business is so strong because of a cash business across lots of species that rewards innovation.

What is Credelio's and Interceptor Plus' share in the U.S. right now in their individual markets?

Yes. I'm not -- we haven't specifically talked about that. And what I will say is, we've seen significant growth that has been increasing at an increasing rate the last couple of years. Interceptor Plus is one of the faster-growing products. Its international brand is Novamox as well. And when you look at our worm coverage, again, we are the one product out there that gets all 5 worms, the intestinal worms as well as heartworm and the tape and the whip. That, I think, is continuing to be key. The study we did this summer was the first-ever study that we did in collaboration with IDEXX, 30 metro areas. I think this is important. The demographic of that dog owner is changing, more urban, more mobile, more out, more in parks. And what we saw was 1 out of 5 dogs in this study had intestinal worms, which says, "Hey, this, to me, the narrative and the understanding of this is going to increase as we see new innovation coming in the market."

Will you be doing some additional advertising or promotion to make vets and owners like, "Will I start seeing some ads, telling me to make sure that I'm aware of this for my dog?"

Yes, where all aspects of the share of voice to the pet owner, I mean definitely direct-to-consumer, depending on the marketplace, but no, we've not, right.

Okay. But we could expect it. Okay. And what can you -- are you able to tell us what percent of your parasite was -- specifically Credelio and Interceptor Plus or your parasites, are currently purchased at an alternate site setting now?

No. It's -- they're targeted for inside the clinic. So the majority of them, the vast majority are in the clinic, and that is our intention. And this is not an or game, this is an and. And we believe, without question, in all aspects of Animal Health, Companion Animal and Food Animal, it starts and ends with a veterinarian. It's absolutely critical, and we're a big believer in that. And what -- our response to the Bayer has been very clearly, "Hey, help us, enable us to reach pet owners that are either are not coming in or we don't have the traffic," is going to be key. So again, a Credelio, an Interceptor Plus, if that scripted product is in the clinic, we've got a dedicated sales force to that. We now have a dedicated sales force to the specialty clinics with Aratana and then, of course, the corporate clinics as well.

Okay. Some industry experts believe that the high expectations for Trio ultimately will not be met because of brand loyalty and familiarity with existing products. And it seems to be what you're saying. Would you agree that maybe some of the very high expectations for triples will not be achieved?

I think that -- I'll take your first point. I do think there's tremendous brand loyalty. What this industry has, Steve, you know this is a little bit of a consumer product good parallel here, where there is a lot of loyalty. If I always had my dog on, I had analysts that met with me yesterday that said, "Hey, we -- my dog's on Advantage. I like Advantage. I continue to use it." Globally, orals and -- topicals and collars still are larger than orals. You can say, "Why?" Well, my dog's used to it. I'm loyal to a brand. I think that's key. So -- and I think that good marketing, good segmentation with different mediums to reach pet owners, which we're doing much better as an industry than we were 5 years ago, is going to continue to build that. So -- and I do think subtle differences matter. I think side effects and palatability matters, and ease of use matters.

So do you think in 3 to 5 years, topicals and collars will still be the dominant product OUS?

You say OUS, I think globally, there's going to be a place. I think ease of use and the ability also to do other things with administration, there is a segment that also wants repellency to say, "I don't want the tick or the flea to have to bite the dog." So a little bit of a -- whether it's a clean dog, and the ability to also turn that collar into more value to a pet owner is another opportunity. Life cycle management, as we all know, is absolutely critical. We shared Bayer has 30 life cycle management projects that are kind of in that late stage. That's good, accretive, high probable growth also as we look at it going forward. So I think it's a market expansion. And I think it's more pet owners that are not using. There's still, I think, compliance, and reaching pet owners that are not in the clinic is going to be key, in conjunction and partnership with the veterinarian.

Question?

Yes. I was wondering why have your stocks underperformed here so much compared to Zoetis since you've gone public? What was going down?

What's the U.S….

The question was why has your stock underperformed since you've gone public.

Yes. So we opened at $24, I'll start there, in terms of -- and there's been a lot of volatility in the market sense. But I would be very clear to say, we've -- we are focused on a few things very clearly. One is -- and I'm not going to comment on, hey, stock performance, as much, is one. We've delivered 6 quarters relative to our earnings, our expectations and our consensus. That's been very important. Two is that we've, no question, come out, as we've stood up this company, Bayer was something that we didn't anticipate. But as we did the diligence, and as you can see, we believe it absolutely expands and accelerates the value proposition. There was early questions about that. I think those questions now as we talk to our shareholders and prospective shareholders understand and see the significant value of what Bayer can do to Elanco. Those are the factors. My focus right now is to make sure to say, "Hey, the opportunity with 700 basis points of margin expansion behind, 1,000 in front of us by 2022, the ability to keep a mid-single-digit, launch 14 products and bring another 20, we're making the #2 Animal Health company, the only major independent beyond the other one that was here, with the #1 value proposition." We believe, clearly, we've got the #1 value proposition from our current existing pace. I think African swine fever also created some noise into our first year coming out as an independent company. But if I -- I like where we stand. We've delivered what we've said, and we've set ourselves up to expand and accelerate with the Bayer move.

I think there's another question in the back.

So you just mentioned 1,000 basis points in the margin potentially by 2022. So over 5 years ago, I think in conjunction with the Novartis Animal Health sale, you mentioned $200 million of cost savings and nearly 20% EBIT margins by 2018. You obviously gave the components of that on an EBITDA margin basis. So why is there a big difference this time around?

Yes. So we need to uncouple that. First of all, we announced $200 million of synergy with Novartis. We achieved -- and we've been public over $300 million of synergy. Novartis, if you look at it through the lens of Eli Lilly as an acquisition, was a solid green light and positive to business case. We delivered the 5 products that I mentioned, the synergies we mentioned and the growth rates. Two things happened from that December 2015 Boston Investor Conference. They were independent and were on the core Elanco business. One is we had bST, which was a significant product that actually is something we divested before the IPO, that the dairy market went down, and there was a banning of that. And that created a significant decline. That was more -- that was the major decline relative to the growth rate. The second was Nexgard and Bravecto, a couple of products came in ahead of Credelio, a little over a year against those assumptions. Those were the 2 events. What I would say is relative to the metrics of the Novartis deal, and we were mid-20s margin at the time, so in the mid-50s and mid-20s. We actually knew about Novartis that they were breakeven or worse and that we were going into the teens. We were very transparent about it. But those 2 events I mentioned slowed the recovery. To me, it gives me confidence to say we delivered $100 million more against the $200 million synergies. We delivered $300 million, and we delivered 5 products to the pipeline. So Novartis was an extremely -- we wouldn't be here today without the Novartis acquisition. It was absolutely instrumental, and it exceeded our expectations.

[indiscernible]

It was -- there's 2 events that happened, and it was mostly the bST dairy, which, again, we made a decision to divest before we started the IPO. Okay. Thank you for that question.

Other questions? We've just got just a couple of more minutes left here. A couple of quick things. One, is -- was Galliprant in -- a blockbuster last year?

In my mind, it's growing at blockbuster rates. It's close to that blockbuster number, and we'll continue to exceed. It's glowing -- it's growing globally. We're continuing a nice life cycle management plan. And we're continuing to move it from, in some places where it's second-line treatment to first-line, as it's the safest osteoarthritis product. And I think the other is, we say 1 out of 6 dogs have this. Getting more dog owners to realize, "Hey, there is a solution if I have an aging dog that is not as mobile." There's a lot of people who just assume that needs to be a given, that there is a safe solution for that dog. So expanding the market with awareness is key.

And is this an area that we -- you would also take the portfolio approach, and we might be safe to assume that there will be some broader line of pain products in the future?

Absolutely. We've been very clear to say today we've got the most comprehensive portfolio, especially as we bring in Nocita, Onsior, Deramaxx. We have a very large portfolio of pain products, and our pipeline will complement and continue to expand that and bring the next-generation of innovation as well.

There seems to be some difference of opinion whether the pain opportunity is bigger in dogs or cats. Do you have an opinion on that?

I think there's opportunity in both. I think as we know cats as a market, I believe, I think there's 2 areas in pets that we don't talk enough about, as I shared at the conference in January, is, one is -- really 3. One is outside the U.S. and especially emerging market. I mean, China has 8% pets in the home. We have 68% here, but the trends are coming quickly. Two is alternative channels, complementing the clinic. And then I think 3 is feline, Steve. I do think that there's a lot of opportunity here in the cat market as well.

And maybe just in the last moment, can you touch upon latest on any COVID impact either in China or if you are seeing any change in visits or production over the U.S.?

We're monitoring, as everybody else. Our focus is, of course, our employees are safe. We have a supply chain that we feel is very secure, only a few CMOs through China. And of course, we're monitoring and managing by market, by country, virtual selling if necessary and doing the appropriate things and again, monitoring this -- that situation...

In the demand side, are you seeing a decrease in either visits...

No. Yes, it's too early to say. And I would say there's -- we don't want to make a direct correlation at this stage. I think it's too early.

All right. With that, we are out of time. There's a breakout, which is in Salon K, which is right behind here, down the hall. So thank you very much.

Thank you very much, Kathy and Steve. Thank you.

Thank you very much.