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

Thank you for joining us. My name is Mike Ryskin. I'm on the Bank of America Life Science Tools and Diagnostics team and also cover the animal health space here for BofA. For our next session, we have Elanco and joining us is CEO, Jeff Simmons. So Jeff, thank you very much for being here. Thanks for taking the time.

Great. Great to be here, Mike. Thank you.

So the format of the session is actually going to be a fireside chat. And then if there's questions, feel free to submit them through the portal or via e-mail directly. I think, Jeff, maybe just to get the ball rolling, maybe you can open with some prepared remarks.

Yes. Real quick. Just a couple of comments. First of all, thank you to you and Bank of America. Great conference, you're having some great meetings. A couple of quick comments. First, I would just say, as I think it's probably been noted, 2020 -- in my 31 years, I've never seen anything like 2020 as an industry perspective, a lot of other aspects, too. But pets and proteins, the importance of them to society, the connection of them to society, the durability of our industry was underpinned like never before. It also accelerated a lot of trends that we'll talk about, retail, omnichannel, the way the vet clinic transformed itself. So at the same time, August 1, we landed and closed and started with Bayer. And the Bayer acquisition, Mike, as you know, and we did that virtually. And on December 15, we really launched a new company in our investor conference. So maybe just a couple of comments on that. We are a more diverse, durable company. 50% pets, 50% livestock, 50% U.S., 50% international, an omnichannel leader, a larger pipeline, the size and the scale that we wanted. But our strategy stays the same. It's expanded. It's strengthened. And we'll talk some about that, I think, Mike, in the questions. We introduced on December 15, in addition to our strategy, how we're going to get growth. So let me just touch on this algorithm, which is really key, and especially the growth side of the algorithm. So we're looking at 2 to 3 percentage coming from new products starting this year where we're going to have 8 launches. We've got good momentum already with 9 out of the 13 regional approvals to get those 8 launches already set and in place. And then some focus brands that are going to drive growth. 5 key growth enablers, we'll talk about digital, omnichannel, geographic focus like in China, while we have the defend brands. All of this growth, leading 3 to 4 percentage points of consistent growth that will drive double-digit EBITDA and EPS. I think the earnings yesterday, we can talk some but they've demonstrated that, that algorithm is alive. The company is moving. We have delivered our expectations internally every month since day 1 of August. And the company's engagement is high. And we're in a good place as we enter 2021, demonstrated by the momentum coming out of Q4 and the raising of our guidance yesterday.

Okay. Great. That's a really helpful overview. And I think there are some points there that we want to jump off of. But first, as you said, 4Q results yesterday, the 2021 guide update, could you give us a brief recap of some of what you thought were the more important points and some of the takeaway messages that we should focus on?

Yes. So top line in the fourth quarter was driven by 3 factors that have continued into Q1: U.S. Pet Health growth and increasing and growing share, two is U.S. Farm Animal growth and China swine. Those were the key drivers. We've also seen the continued movement in the productivity agenda, especially for manufacturing, continuing to drive leverage on the gross margin line and the COPS line and that's been beneficial. And then of course, the progress in getting products approved. As I said, 9 out of these 13 launches -- or approvals for the 8 launches is really on track, maybe a little ahead of track, which gives us the confidence in that momentum and those key drivers looking at Q1 now to raise the guidance for the year.

Right. And so following up on that, I guess, maybe let's start on the new launches because you just wrapped up there and sort of the 1Q guide for the 2021 full year. The way I look at it is -- you've guided to -- you got into a pretty strong first quarter right out of the gate. And then -- and yet the new product contribution is going to come, I mean, as you go through the course of the year. So if we take that and we sort of run rate it forward -- I'm just looking at the seasonality you typically see in Elanco products, the seasonality you typically see in Bayer products. They kind of go opposite ways where Elanco tends to be back end of the year heavy. Bayer tends to be front end of the year heavy. It kind of balances out. And then you've got the incremental contribution in the fourth quarter -- in the second half from the new products. So if I sort of put all that together, it feels like there's something missing, right? Because if I look at your guide for 1Q and I run rate it for all 4 quarters, you should be coming in sort of above that full year guide. So what are we not thinking of? What are we missing that's offsetting the new product contribution? Is it some uncertainty on the market? Is it some specific purchasing pattern dynamics that we may be seeing in the first quarter? Could you walk me through the bridge there?

Yes. Well, we raised the guidance $30 million on both ends to start. We believe it is a balanced plan, a lot of dynamics, as you know. Yes, the new products will play a role much more in the second half of the year. So our confidence and where we see the pillars that will continue to drive growth throughout the year, U.S. Pet Health, U.S. Farm Animal and China. We continue to see that contributing a full percentage point of growth led by pigs. But poultry and pets will also play a role in China. Look, the factors that are still unknown are COVID, the seasonality in pets. You talk about Bayer in the first half. You have to -- especially topicals and collars, very important to have the right season. So getting the dogs and the cats outside the warmer weather that drives that. So we've got to watch that factor in here as well, Mike. And then of course, you know competitive exposure to pipelines, innovation and changes. So those are factors we took into play as we looked at the guidance. I believe we've made a nice adjustment to the guidance with what we know and it's balanced and believe strongly in what we conveyed yesterday. The company has great momentum and it's more diverse and durable than ever before, which also gives confidence in the guidance.

Okay. Talking about competitive pressures and exposure to sort of other products. Something that didn't get touch on a lot yesterday was Rumensin. It was a big focus in 2020. And I think sort of by the end of the year, the net view was that it held in better than we thought it would given the generic pressure. So any changes in that market landscape this coming year? I mean with Huvepharma's generic or potentially any other generics in the market?

Yes. We've guided and we shared at the investor conference, we anticipate and have modeled in a $50 million additional erosion. It did have a strong fourth quarter. Mike, as you look at $5 corn, you look at performance products. I really bridge to our Farm Animal business overall. We have a performance portfolio that does well with value customers that we target with a portfolio, especially as corn prices go up. So we're in a very good position, I think, given that. And Rumensin, look, we continue to innovate around the product. We add to the portfolio with an Increxxa, with an Experior, with a Baytril and a Cydectin. Now the largest cattle portfolio we've ever had, largest in the industry, so a portfolio approach. And then a value beyond product, our Elanco Knowledge Solutions, Benchmark database and the additional performance-driven services, not animal ID or -- but its performance-driven systems continue to expand our value proposition. And we'll continue to innovate around Rumensin. Rumensin, a fermented feed additive product, is a very different kind of a product. It may be an injectable that could be copied a little differently. So given those factors, yes, we really are doing well with this defend brand. It still is a defend brand. It's still modeled to decline. But this is another fundamental competitiveness that we see in the marketplace. It's very strong.

Okay. Okay. And then switching to some of the more -- some things from the Companion Animal side from 4Q. One area where we've got a lot of questions was some sort of your comments on the call regarding the retailer purchasing patterns, especially for Bayer products in the fourth quarter. So many pieces between 4Q and 1Q. I know that led to some confusion or some misunderstanding. So maybe you could clarify that a little bit. Sort of what are these purchasing patterns? What is the retail channel holding? Sort of how do we think about that buffer going forward?

Let me be very clear because this is a good problem. As you know, Mike, we were guiding that the Bayer portfolio in Pet Health, the underlying demand we were predicting to be 4% to 5%. And COVID, we thought the impact would lessen in the last 5 months of the year when we took the business over. It did not lessen. The demand continued. The demand -- underlying demand was 8%. And by brands and by customers, it was even significantly more than that. So this is a good problem. We don't have distributors between us and the major retailers, the Amazons, the Chewys, the -- we're selling them directly. They determine how much they keep. So they're taking on some additional inventory because they see significantly increased demand. Secondly, they're seeing a COVID marketplace where they want to keep a little more demand because it isn't lessening and they want to have assurance of that supply. So this is a really positive thing that is demand driven. It is not like a distributor that holds product that goes to a vet clinic. So it is a direct relationship. And we continue to share transparently what we're doing relative to this, but this is a really good thing. Bayer's underlying growth was 8% on their pet health products. We were anticipating 4% to 5%.

And what's built into your assumptions for Bayer underlying growth for 2021 then? I mean you commented on sort of on the overall portfolio. But is that 8% would have been sustainable, maybe not exactly at those levels but sort of that elevated level of demand?

Yes. Mike, I think we've got some compares here that we've got to be careful too as we think about COVID hit in late March so that will impact Q1. It was a strong Q1. So a hard compare in Q1, a little less of a compare in Q2. But you take an Advantage that grew double-digit in the U.S. It grew 5% overall. It hadn't grown in, I think, 4 or 5 years. A lot of this comes back to that omnichannel. So we continue to see in the Seresto and Advantage family, tremendous opportunities given this retail trend. It has changed. But again, we will continue to model long term the Advantage family to decline, Seresto to continue to grow. We haven't gotten into the details on overall growth rates. But again, I would emphasize the compare factor. I would take just a moment though to say, and I said it at the end of my earnings comments, there's a few trends as we enter this new decade after COVID that are significant. And one of them is the pet owner. Just think about this. Everyone's talking about dog adoptions and all this. I really think it's not about dog adoption. It's not about dog numbers. It's about -- or pet numbers. It's not adoption, it's access. 3 statistics to remember. One of them, we started with the Bayer acquisition. 1/3 of pet owners do not go to the veterinarian here in the U.S., more so internationally. Two, since COVID, 1/3 have started buying at their door, auto shipped and they don't plan to change. But those 2 numbers together, it's significant. 500 million pets in the U.S. or globally, half of them are medicalized. With this omnichannel capability that we have to reach pet owners with the veterinarian where they want to shop, we believe globally, access to pets is something that COVID accelerated and made significant. That will be, I believe, one of the most significant trends in pet health in the first half of this decade. And we're well positioned with the Bayer acquisition to take advantage.

That's a really, really good point. And then actually, it very closely mirrors something that came up in an earlier session today where the adoption sort of may have had an impact on the margins. But it was really that people have more flexibility and more and more options for getting their drugs, for getting the products they need. That's what's really driven the strong companion animal trends in 2020. That's a really good point. I guess one last point sort of backwards looking on the quarter that I want to circle back on where we had a lot of questions in the last 24 hours was on the price benefit you saw, the price versus volume relationship you saw in the fourth quarter. It was a pretty big move, especially in some of the companion animal segments. Could you walk us through again what are the dynamics there in terms of being a little bit more -- exercising a little bit more control on the price? And why isn't that more sustainable going forward? Shouldn't that repeat at least in the first half of next year?

So there's a little nuance in the compare. The message I want everyone to hear, we continue to believe with our portfolio and our value offering that we see Elanco over the long term continuing to obtain about 2% on price. It's been our history. We see that going forward. The nuance in the fourth quarter, Mike, was primarily in pet vaccines in the U.S. It compared to the fourth quarter before. Wellness visits were up, as you know. Vaccine sales, we were robust. And then our change in distribution, which was significant this year and very positive and has worked well, we've seen gross-to-net tighten up. So -- where less product was given away. That was a factor as well as just overall, the strength and the compliance of the usage. So that was primarily a U.S. vaccine compare that drove some of that. When you look at the net price going forward, we continue to see the 2%. But it's an attribute, I think, when you look at our DSOs have gone from like 103 days to 66 days. When you look at our price that we're able to obtain and our gross-to-net, that's actually bringing more to the bottom line, we believe strongly that this distribution change of fewer distributors, U.S. pet vet clinics, paying them for what they do best and a buy/sell relationship has paid off very well. And this is an attribute of price.

Got it. Appreciate that. I guess I want to pivot a little bit to sort of the broader market. And you touched on it a little bit just now when we were talking about access to health care and sort of the changes. We saw a lot of dynamics changed in 2020 because of COVID. A lot of it was some sort of a shock to the system, especially some of the things we saw on the livestock side. Whereas you look at the companion animal, a lot of it was a continuation of trends we have seen before, where the strength of the retail and the alternate channel, the shift away from the vet into the online purchasing. If we sort of look forward, I mean, I realize that 2021 is going to be a very volatile and uncertain year in terms of the timing of vaccine rollout. But at some point, whether it's spring or summer or fall, most of the developed world is going to get vaccinated by end of this year, maybe early next year. Things are going to go back to normal, whatever that is. What do you see as the lingering impact on the animal health industry from COVID, both on the companion animal side and on the livestock side? What's going to be different? What's going to revert back to the way things were before? Sort of how do you envision the landscape a year or 2 from now?

Yes. I think first of all, let's not lose what's most important out of 2020 and that is people's reliance on pets. And looking at 500 million pets, that will probably grow in number globally. Half of them are medicalized. That's our first opportunity as an industry. Pets' importance, taking care of pets is important, well, more access. So in our Healthy Purpose pledge, our ESG for the decade, we're going after 100 million more pets to be medicalized as an example. That's good for a healthy enterprise. It's good for a healthier society as we've seen. So I want to emphasize that. The same with animal protein. People are looking at a 1.5% to 2% growth in animal protein. That is not decelerating during COVID. It emphasized the importance of it. So with that said, I think, remember the industry. Second, Mike, I think on the pet health side, a few trends that I do believe will stick. I do think that our care and our attention for pets and adoptions, it will lessen. It won't stay at COVID levels. But I do believe that being able to transform the channel and the clinic -- let's start at the clinic. Clinics have learned telemedicine, curbside service, "I'll be going to Starbucks while you're taking care of my dog," or, "Hey, I will jump into this retail and auto ship to your door. And I'll partner with one of those retailers." I think what may have taken 5 years to transform a vet clinic happened in these 9, 10 months. I believe that is here to stay and that's a good transformation. It's allowing us with Bayer to be able to do omnichannel capability and bring the vet much faster than we normally would have done. And then I think, again, on the omnichannel, it's here. Pet owners want to be taken care of. If they don't like a vet clinic experience, they want auto ship. They want easier compliance. We have become lazier people that want more of this service during COVID. And the animal health -- pet animal health market will change. Over on the farm animal side, I believe that there's 2 trends. One is the supply chain matters. So trade matters. But also we saw with the processing plants, you see now human medical directors in processing plants to make sure the employees are taken care of. Taking care of the vulnerability of that supply chain to ensure consistent supply. A lot of intervention there. We have a stronger supply chain in all major geographies, nonprotein. And then secondly is this trend everyone's talking about in farm animals. You got to give consumers what they want, I call it the kind of the golden triangle here, give animals what they need and use less environment. You heard my comments. I'll talk but I really think the first half of this decade, helping cattle operations and pig operations heading on a path of net 0 is really in the hands of the animal health industry. And there's economic opportunity in that for our customers and for ourselves. So those are some of the trends that I believe are ahead of us here in the first half of this decade.