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

Hello, everybody. Thanks for joining us today. Right now, I have the pleasure of introducing Jeff Simmons, CEO of Elanco Animal Health Company. Jeff, welcome. Thank you so much for being with us today. And just to kick it off, please, give us a high-level overview of what's currently going on and the fundamentals of the business and anything else you'd like to touch upon before we delve into into specifics.

So let me give you a couple of quick updates. First of all, I have a new general counsel, and she wants to make sure I highlight the important point of, I'm again, not going to be making any forward-looking statements and definitely look to our SEC filings on the 10-K and 10-Q for the details, as always, as you all know. But look, I think at the highest level, I want to touch on an announcement we've made this morning. But coming into the fourth quarter here is we're in the midst of it, Elanco, almost a year ago, we had our Investor Day conference. So within just a couple of days of the annual anniversary of that. We've delivered 4 quarters in a row, the algorithm that we highlighted for that top line revenue growth of 3% to 4% is working. All the elements of that. I think a lot of the questions Mike will get into, we'll come back to that algorithm. It's driving double-digit bottom line. We'll -- the guidance right now is 7% growth for the year. more than 20% bottom line EBITDA growth, probably the metric that we're really centered on all of us, it takes every element of the company is 300 basis points of margin expansion is expected this year, and that comes from a lot of the elements of things that we've driven. So the commitments we made a year ago are critical. They all stand in a strong place, and we're on a very strong trajectory as a company. Part of the way we got here is what we actually announced today, which is the ability to stay ahead of the environment, the business, keep the momentum in the business. So we anticipate it coming into '22 business planning that we're looking at our business. And today, we announced this morning some restructuring that continues to streamline Elanco, concentrate our investments on key growth and innovation opportunities. And actually, from this, we see our business becoming simpler, more agile and stronger overall. So the highlights of the changes are we're going to move our international and our European units together that streamlines that brings down some infrastructure. We're going to integrate marketing, which is common in some of the animal health models into the key regions, keeping all the key capabilities in place. We're going to again keep a concentrated focus on late-stage pipeline assets. So those are all kind of 3 big moves that actually move us to a streamlined organization that's going to drive growth and innovation. That takes out approximately 380 jobs, a little shy of 4% of our organization, 20% of our senior management, that's my team and their leadership team, so N minus 1,N minus 2 levels. It will attribute about $70 million of full year savings and we're going to move in an accelerated way with a lot of this happening between now and the end of the year for good clarity to start in 2022. I see this as an accelerator and an enabler of everything we're doing to keep us on the trajectories that we're on for EBITDA margin expansion and growth in the business. It was done out of a position of strength, not out of any reaction. The $70 million will actually be used in really 3 ways. One, to offset any inflationary and supply chain costs to keep us on the trajectory of gross margin 150, 200 basis points a year. 250 to 300 basis points of EBITDA expansion a year and continuing the business to grow. The second thing will be used for us to lean in on some of our key investment areas. And then third, it will be incremental to our $300 million of synergy on top of the $300 million of synergy that we announced in the Bayer deal. So all good news, a lot of good momentum. And again, 1 year here, a pretty consistent delivery, and we like the plan we laid out a year ago, and we're staying on it.

Jeff, just to I said $70 million not $300 million, right?

Yes. $70 million is from today's savings of $380 million. On top, so this will be -- the $70 million will be really split up and used in 3 ways, offsetting inflation, investment and incremental to the productivity agenda of the $300 million of savings of synergies that came with the Bayer deal.

Got it. And Jeff, if I may, it sounds like much of the savings you discussed are at the SG&A level. So as we think about gross margin expansion into next year, any sort of high-level thoughts because I know consensus was basically modeling like 250 bps in gross margin expansion into next year, which I felt like for any business, not just you guys, for any business operating any business where the cogs is up to half of the revenues it's just so hard to expect such a margin expansion when at least what I'm hearing from big Indian API producers is API prices are an all-time high.

Yes. So look, I think a proof point is what we're doing today, but also what we've done this year. So we've moved a little over 200 basis points of gross margin this year, Umer. And really as we head to that 60%, we're guiding 56.75% to 57% this year. We're looking at that 150 to 200 basis points a year for the next 2 years to get to 60%. And we're confident in that and even the actions we're taking today will continue to help enable mostly EBITDA, as you mentioned, expansion. But let me tell you what the key drivers are to get that gross margin. One is the site consolidation. So the ones we announced with TriRx this year, we've sold Shawnnee. We will exit in February, our big U.K. facility in Speke. Second is CMO. So we went from, as you know, Umer, 140 down to 80 CMO since our IPO. When we acquired Bayer, we went back up to 130. So CMO consolidation is the next thing that will be driving it. Working on active ingredients. We have a couple of key active ingredients this year that we've moved to different suppliers and brought down active ingredient costs in a big way, strain development on our fermentation, procurement and price. Maybe one comment on price. I'll just mention is we have a company-wide initiative looking at -- historically, as you know, the industry has been at 2% price. And that's what we'll get this year. We're looking at, given the inflationary given we've got pet retail and other things, of ways to incrementally grow on top of that historical level and price in a value-based way as we go into 2022. That will be another lever. So we're in the road to 60% gross margin in the next 2 years.

Right. So that should offset like API and those types of cost pressures, correct?

Some of them, it will be partial offset. I mean these inflationary costs are material. They're significant, but it's a combination of some of those moves that I just mentioned as well as some things like we're doing today and announcing today.

Confident in 60%. Sorry. Go ahead, Mike.

I was going to say it was inflation that the primary driver of these cost cuts, Jeff, it sounds like it was.

No, I would say making the organization, we've transition Bayer in, we've integrated. We're now standing up. This is now about operationalizing, competing, streamlining. And so when you look at a stronger international unit by bringing in Europe, a concentrated focus on this late-stage pipeline. It's really more of streamlining. Sure, it will be nice with offsetting some inflation, but it was not reactionary to inflation. It was part of the process of building this company and setting it up to be more competitive as we go forward. I think that's a very important point. So it was not a reaction to inflation. It will assist with inflation, but it's more about making the company stronger and more operational.

Go ahead, I'm sorry.

Got it. No, no, no, that's excellent. Sorry. So -- So that makes sense. And I know, Jeff, one of the big sort of themes that stood up on the third quarter earnings was really just around some of the comments you guys were making on margin expansion commentary into next year in light of inflation. I guess where do we stand now then? A, it sounds like 2 things are changing. One, the $70 million that you might realize next year. And B, the potential for a little bit of price tailwind as well. Does that mean margin expansion should continue into next year?

Yes. So let me anchor back on a couple of things. I think $70 million is the savings that we will see from the changes today. And again, that will be split out with some reinvestment, some hit by inflationary costs, and then some will be incremental. We've committed to the $60 million will be the piece of the $300 million as we go forward next year. But yes, let me come back, Umer, very importantly, I think that I want to highlight is, we've achieved 300 basis points in our guidance this year in EBITDA expansion. As we look at next year, we're going to have to continue on a very similar trajectory over the next 3 years to get to 31% by 2024. We believe that we've got a plan in place to do that. That's going to come from everything from mix from the efficiencies and the synergies that we've had from Bayer, that will be critical, as well as some of these other moves, both on gross margin and making a more streamlined organization. And converting our 3% to 4% top line growth in the algorithm over time and keeping COGS flat, that will also drive EBITDA expansion. So again, I want to emphasize proof point of another action today by Elanco to continue to deliver in any environment and to this year's delivery, we've got a plan to do the same thing as we go forward and stay on that trajectory of 150 to 300 basis points of EBITDA expansion.

That's very important. And Jeff, would you agree or not that as of 3Q earnings call, it didn't sound like there was like there were more questions on whether there was something stuff needed to happen to solidify that 250 to 300 bps.

There's a lot that does need to happen, right? I mean, we're living in a very kind of changing environment, some competitiveness in certain spaces that we're in, in the marketplace. But I believe we've got a more durable, diverse company with Bayer. The Bayer plus Elanco is working very well. We're taking all the necessary actions that we need to, to make the company stronger to deliver against these. And I still think the backdrop of the industry continues to be positive as we go into go into 2022. So these are the things that I think are critical to make sure that they have.

Got it. Got it. Got it. Okay. Excellent. Very cool, very, very cool. This is super helpful because I feel like there's a lot of confusion on it. And I think this is much more clear even to me now than I was in the past. Mike, do you want to jump over to launches or pipeline and maybe touch up on Seresto briefly because I feel like we're past that topic for the most part at this point?

Yes. No. Thanks, Umer. So yes, Seresto, obviously, it just seems to me that it's becoming less and less of a concern, Jeff. But just looking at the numbers, during the first 9 months of this year, Seresto is down 3.5% year-over-year. And just by rough math, you'd have to do like $76 million in Q4, just to get even year-over-year. Like I've said, I mean, despite the whole surge in pet dynamics this year, what has kept Seresto down seemingly? Or am I totally up based?

Yes. I think I look at the overall fundamentals of Seresto, they will meet our expectations this year. So Mike, we assumed a very tough compare to 2020 when we came in, right? I mean you saw during a pandemic. I mean, probably one of the top products used, people win for the Seresto collar in a big way, and so there was a tough compare in 2020. So we're looking at year-to-date, we're 9% over 2020. Yes, there will be a step down, as you know, in the comparison, but there was a pretty big buy-in Q4. That was one of the factors Todd outlined in the Q4 factor. But the number I'm looking at is the 28% on the 2-year run to 2019. The amount of return users, the loyalty to this product, the 2-year trajectory we're seeing, we continue to see a lot of growth in Seresto over the upcoming years. Part of the reinvestment coming out of today's restructuring is to lean more into Seresto that we see. And here's 3 areas that the growth is going to come from, One is geographic expansion. We're doing more than Bayer was doing and they were part of Bayer in the markets like China, Asia, Latin America; Two is channel expansion in the U.S. and Southern Europe, we're putting it into more channels that allow more pet owners to have more access to Seresto; and Three, we are driving awareness of the product with more digital and DTC spend as still, there's markets where this product is 25% awareness. So we're doing these 3 things to drive a very high-margin Seresto, and we continue to see this being a key growth driver for us next year and going forward. And then look for us to do some life cycle management here over the next couple of years on Seresto as well. So it is where we needed to be. And Mike, we're not really looking at it on the '20 compare as much as the '19-'20 trajectory.

I see, I see. each build going on to pipeline, obviously...

No, sorry, Mike. Jeff, when you said -- yes, when you said Seresto is tracking at expectations. -- year-over-year, you guys aren't necessarily thinking about it as dropping going forward, right?

No, we are not. We see this as a key growth driver. This product is near $400 million, as we've said overall. And we see this brand with a lot more runway of potential and growth in it with those 3 or 4 things that I mentioned, absolutely. And again, this is continuing to do work at our key manufacturing site there as well to continue to keep the high margin profile that the product has.

Got it. Got it. Go ahead, Mike.

Yes. So obviously, pipeline, we're constantly getting questions, investor questions about pipeline as to when it could really start to kick in. I know next year, Jeff, you're planning to launch a canine Parvovirus product from Kindred. Just given the whole underserved market there, perhaps talk about how much that will contribute to the, I guess, total innovation dollars of like, I believe, $600 to $700 of total. And then I have some more questions after that.

Yes. So maybe, Mike, I'll jump to Parvo. But I think the more material thing that I want to really anchor on in the pipeline because I know it is a question, it's a key driver to our future multiple of value going forward. You guys have been very clear on that with me. Let me just emphasize a little bit of how we got to think about this is, this is year 1 out through 2024, 2025. So that's $600 million to $700 million. A year ago, we said $500 million to $600 million. We bought Kindred. We moved that to $600 million to $700 million 1 year ago, where I stand today. A year later, we're in a much stronger position because of Kindred, pipeline progression and products that we've put in the market. That's really important. So year 1, yes, we've had a start that was good, maybe not as good as we wanted, but watch Experior, that will be a driver to building that base towards $600 million to $700 million. We'll talk some about Credelio Plus, and that's doing very well in the international markets. Why Credelio is a franchise is the second fastest-growing oral in the market is a lot because of Credelio Plus. And then look at ZoaShield and Increxxa. Those are going to be drivers that will help that base of the 8 products we launched this year. Next year, yes, we'll launch Parvo and a few other products. We'll talk about that in our February guidance. So look at these being additive on top of the 8 that we have all headed to that $600 million to $700 million, okay? And I think no question, '23 and after with some of the new products that are more material coming. So on Parvo, what I would tell you is still some work to do. We do plan to have it in the market. We need registration. We need to work through manufacturing, again, a monoclonal antibody and the manufacturing from Kindred. Very happy with the Kindred assets, especially this one, and we're looking forward to bringing this product to market. It is an underserved market, as you said. We've shared some of the data Kindred has had where the Mars, Banfield, they're seeing 250,000 puppies a year. The real challenge is, hey, can we get over the price point that we want for this product in a market where there's a demographic with puppies that have Parvo. We've got to look at that and a supply chain. So these are all dynamics that we know we can execute and solve. We do see this as a very strong product in a market that's underserved and saving puppies lives, and there's a material number of them every year as a way also to bring a connection to the veterinarian at another level. So more to come on this launch, but there's a few dynamics we're working through and preparing for the launch and the registration before I want to give any more detail, more to come in February.

Got it. Fair enough. Just maybe one more. I mean given the underserved nature of the market, is competition very far behind or very limited, would you say, in Parvo?

Well, there's vaccines and there's other ways if you look at the attempt to prevent and other things. But no, right now, there's -- to me, there's good IP here. And this is a market that we believe we can create and we can have a very meaningful impact to vet clinics into pet owners on something that's a real tragic severe virus and disease to the docs.

Got it. All right. Excellent. Since maybe pivoting to Credelio Plus and in terms of the brand itself. Like Credelio Plus seems to be like a very nice surprise. It seems to be doing better than expected as launch, perhaps talk about the dynamics there? And maybe if you can, how much of total brand sales is Credelio Plus responsible for? And could Credelio plus itself become a blockbuster, do you think?

Yes. I'm not sure I'm ready to state that yet. As we've shared, we think it does have a lot of material opportunity to drive growth for us. We -- there's a very big international parasiticide market, but there's a long tail of countries and low-margin generics that are in a parasiticide market. We've gone to the -- or in the 3 big markets that matter to start with. So Europe, Japan and Australia. We're right in the middle of year 1 launch in Australia in the parasiticide season as we speak. What I would share with you, Mike, is this product is as competitive as anything in the marketplace. So any broad spectrum parasiticide right now, Credelio Plus can compete head-to-head with those products. So -- and then we are using our omnichannel, our Bayer portfolio and the Elanco broad presence in the marketplace to leverage that as well. So what I would tell you is we're going to need, what's going to be critical as we come around a year or 2 in Europe and other markets is more clinic adoption. So more pet owners see and being able to have access to Credelio Plus. And then 2 is just to continue to position deeper penetration with the vets that are using it now. So I think being able to answer your question a year from now. There is no question, it is our intent to make Credelio Plus everything it can be because right now, off U.S. shores, we're as competitive as anybody in the parasiticide market, and this brand will lead us that way. More to come. We're off to a great start.

Excellent. Excellent. Jumping also...

Maybe just on that topic then, I don't want to necessarily venture all the way into pipeline then, Jeff, but Jeff, would it be an accurate high-level question to just think about. Would it be inaccurate to say that when the dual market started presenting itself, Elanco was perhaps a few years behind the first few guys that launched? And for that reason, Credelio you track that sort of sub-$200 million, the guys that came out first tracked at, I don't know, somewhere between $500 million to $1 billion. However, on the Trio market, it does look like Elanco is not the first market, but in that first batch, if I may, assuming the filing is going in next year. So wouldn't that mean that your Credelio franchise would likely expand from sub-$200 million to north of $700 million, $800 million like rough ballpark?

I think it's a portfolio game, Umer. I don't know if I would point to 1 product necessarily. I think your conclusions are right. We're seeing Credelio, even though in some markets, it was third or fourth to market. Now second fastest growing. I think the power in this is channel and portfolio. Being able to reach more people and being able to put it in a portfolio. So Credelio right now with Interceptor Plus in the U.S. is as competitive as 2 products in any dog owner that wants full coverage needs 2 products. And so we've got the winning 2 products as a portfolio going forward. So I think it's portfolio and channel. I don't want to give a number of what the Credelio franchise can become. But we've got over 10 parasiticide assets in our pipeline. We've said that on average, we'll be launching 1 a year. And globally, we've got as broad of a portfolio and as many channels as anybody now with Bayer, we're well positioned to be competitive in the marketplace. At the same time, new innovation is impacting legacy products like Trifexis, which we've said, and it has had an impact on some of our legacy brands, primarily Trifexis and Comfortis. And a little bit more of a significant way here in year 1 with the success of some of the innovation coming in the marketplace.

Got it. Okay. Sorry, Mike.

No, I just bought to kind of pivot to Rumensin seems to be holding very well and kind of well within the line of your, I guess, expected erosion of around 30%, 40% typical of erosion. Is it doing above expectations -- it seems to be also doing above expectations this year? And is that just attributable to the I guess, bundling of services that are around Rumensin? And is there any difference between U.S. -- ex-U.S. and U.S. generic erosion so far?

Yes. Rumensin, to answer your question directly, Mike, yes, it is doing a little better than expectations. So we're into that time period where we thought we would lose 30% or so of the total value between volume and price. It is better than that and more favorable to us than that 30%. We're retaining over 80% market share, and we've retained a lot of the price. And back when we talked about our strategy, that strategy is exactly what is playing out. One, it's offering a portfolio. So when we're offering and adding a couple of cattle products from Bayer, we're adding Increxxa, Experior is going to help Rumensin as well. The portfolio is playing. Elanco knowledge solutions. Today, in beef, we have 1 of the most effective databases of performance data and health data. And those that are used in that database, we have a higher share of wallet, and that helps Rumensin. Third is we're doing a lot of work with the strain itself. This is a fermentation product. So all products are not bioequivalent necessarily, and we are continuing to show the science and differentiate the product in the field. These are all things that I think -- and then a lot of share of voice and a lot of closeness to especially a beef industry that really values that. We've got the largest environmental team working on the environmental challenges of beef industry. So we like our position with Rumensin at this stage, and it is doing well. And candidly, our cattle business is doing well given all those things that I mentioned. It's had a good year, and it's taken some market share.

Got it. Got it. Increxxa, I know it's obviously -- it's a generic to leading a better product out there. But more, I guess, competitors -- more generic competitors are expected to come online next year, how short-lived or how much momentum can Increxxa strength continue into next year before you see these generic competitors?

Yes. As I've said, Mike, it's unprecedented, right, to see the number of generics that have come in so fast on a multinational product. Over 10 in Europe, there's 2 in the U.S. counting hours and 1 other. So a very different U.S. market from European, but you can't assume that will stay there too long. What I would say is this, I think Increxxa, it's a great product, for us. But more importantly, as you've got over $1 billion bovine respiratory disease market, Mike, which you know really well, we are taking a very comprehensive approach with 2 products from Bayer with [ new floor ] and Baytril, and then you add our Micotil and Increxxa, and continued innovation in this space with our data and our vet team. The whole idea is this is one of the most unmet needs continued struggles with the cattle industry is respiratory disease challenge. And it has a big impact on health and it's $6, $7 corn, that is a real big factor in the feed yards. So I see the portfolio approach and what Increxxa can do when we offer that with our data and our services as really the long-term trajectory. We're not betting just on Increxxa alone. It's BRD, and what can we do with BRD over the next 5 years.

Maybe in the last 5 minutes or so, Jeff, if we could -- Mike, unless you wanted to touch up on another topic, I felt like we should go a little more to a couple of high-level big picture stuff that people are years about. Jeff, one thing I think about, as I sort of discussed Elanco a lot of investors is, in some ways, I don't want to call it a low, but I feel like in some ways, on various parameters from an investment perspective, things are only about to like turn to sort of the optimal investment case. For example, my sense is over the next 2 to 3 years, at some point, dividend probably gets put back on -- over the next 2 to 3 years, leverage is probably at a more manageable sub 3.5x or so I don't think you guys have added to that as well. And then also in the next 2 to 3 years, growth is probably going to accelerate with a couple of these filings. Would you -- sitting here today based on everything you have a sense for, would you disagree with that broad construct?

No, I think at the highest level, I think you're directionally right. I think that I would say, and you and I have had these conversations before, Umer, I think that in fairness to investors, it is, hey, prove it to us Elanco, and that's why it was such a crucial moment a year ago with this Investor Day is to lay out with the highest level of transparency ever done in this industry, what are we going to do over the next 3 to 4 years. And we are very committed and today is a proof point of our resolve to meet these commitments of 31% of EBITDA, that's $250 million to $300 million a year. 60% by 2024, 60% gross margin and delevering under 3x by Q1 of 2024. All of these things Todd Young, myself, our executive team is very committed to. And I sit here at year end to the Investor Day saying we've got a very good start after year 1, and we need for investors to show the consistency. When we do that, you're exactly right. We start delevering this company. We start increasing cash flows and with the delevering, then that gives us an opportunity with capital allocation to do other things. But right now, it is about delevering and it's about investing in growth and innovation because the pipeline delivery, as you know, is also going to be a crucial moment to really drive the value of this company as well. So we are on a very good trajectory to do that.

Got it. And Jeff, so perhaps not perhaps not like committing to it or anything, but as a general framework, it is Elanco's intention to whenever the cash flows are at the right place and leverage at the right place to have a dividend back on as well.

Well, that's not something that is on our agenda right now. Our agenda is very clear over the next couple of years of what we've got to do. So I'm not ready to make a commitment to a dividend at this stage. But my job is to put us in a position to have those options as we go forward.

Got it. And Jeff, remind us when the Bayer deal was announced, the dividend, was it canceled? Or was it suspended because of the leverage?

We've never had a dividend and we came, which is why we're early.

I'm mistaken there. I'm mistaken.

We never had a dividend at this stage, so.

I'm mistaken here. I'm mistaken. Okay. Got it. Okay. Got it. And then one last thing, as we think about capital allocation also share repurchase. Where do we stand on that? Is that -- is there interest on the Board to accelerating that in any shape or form any time soon?

Yes. I think these are all things that are definitely on the agenda as we look out. But I want to be very clear with all of your investors and our investors to be very clear to say that, hey, our job is to do just what I said. And today's again, announcement is just another signal of how committed we are to do that in any environment. We want to put our balance sheet and our income statement in a position to have that chance to do that. But we're not discussing share repurchase at this point. The next 24 months, we've got a clear agenda what we're going to do. And we will do it.

Anything we should have brought up, Jeff, I want to be very respectful of the time. I know we're approaching time, but anything we didn't bring up that you thought which is important discussing?

No, I would say a lot of times, I think, Mike, you hit on something earlier that I think clarity is very important even with today's announcement. This was made on today's decisions and everything over the last year, if you think about TriRx and reducing our footprint bringing Kindred into our pipeline, this restructuring, the moves we made are all decisions we have made from a position of strength and with our eye on the trajectory that we've said what we want to do with this company. And I think one of the things, Umer, this wasn't done because of inflation. No question it will be a good offensive move against inflation, but it's really to make Elanco stronger, more agile, streamlined and more competitive in the marketplace. And that's definitely what we're doing.

Excellent. Thank you, Jeff, so much. Thank you, guys.