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

Well, good afternoon, and welcome to the Elanco session at Cowen's 42nd Annual Healthcare Conference. We're very, very pleased to have back with us again this year, Jeff Simmons, who is President and CEO of Elanco. Elanco is a leading company with a strong position in a vibrant market. So it's a very interesting and attractive idea, in our opinion. Lots to talk about in the next hour or half hour. So we'll get started.

Jeff, thank you for spending the time with us. I'd like to start out with a thing that's kind of top of mind, and that is the situation -- unfortunate situation in Russia and Ukraine, just to deal with the issue at the start. So what is Elanco's position in these markets? What is your exposure both from the operational standpoint, but also what is your exposure from the supply chain pressures -- potential pressures?

Yes. Thank you, Steve. Thank you to you and Kathy and Cowen. Excited to be part of the program. I'm traveling and actually in Europe right now, and I just would start by saying just stopping and pausing on an absolute trying and challenging time for our colleagues and our customers in Ukraine and in Russia and East Europe. We've got our presence in those markets and spent a lot of time over the last week just reaching out to all of them, and their safety is our #1 priority right now. And what I would say is it's -- we're 12 days in, Steve. As you know, it's pretty dynamic. I can say that, yes, we do have operations in both Russia and Ukraine. It's approximately 2% of our revenue kind of coming into this year. So not real material. And as you know, it's pretty dynamic and challenging right now in those markets, and it's changing, and we're assessing that day-to-day as we go forward. And again, another reason why you mentioned it, we're in a very durable industry. We're in a very -- Elanco today with our Bayer acquisition and our business and how we positioned it over the last 3 years, we have really set ourselves up into a much more of a diverse, durable portfolio, durable and diverse geography and species mix, which allows these kind of things to be looked at as very important and critical to our overall business and our employees. But not something that we see as a material at least at this stage. And again, it's dynamic, and we'll continue to assess it, Steve.

Okay. And is supply chain also a relatively small sourcing part of the overall system within Elanco?

It is. We don't see anything that is of any materiality relative to sourcing out of those countries or supply chain dynamics that come from those countries at this time.

Great. Okay. So let's drill into the future of Elanco, which is, of course, in its current products and in its pipeline. So as part of your refocused R&D efforts, what are the key benefits that investors will see? So what will we monitor and measure? Would it be shorter time to market? Would it be reduced costs on the P&L? Would it be greater new product flow? What would it be that we would see from your refocused R&D efforts?

Yes. And I would say it's a continuation in a doubling down that we've seen. As Ellen has come in, as you know, she participated in our earnings call and really highlighted a few key points that I would reiterate. First of all, we brought together Elanco, Bayer and Kindred. We've integrated and concentrated that organization. And what Ellen has done is taken everything that Aaron and the organization had and really continued to streamline and tighten really around doing a couple of things, building deeper expertise and project management. In the expertise area, she made some reorganization, some expansion in the organization all around more CM&C, more regulatory, more clinical and deeper expertise. The second is project management to make it go. So if you turn and say, what are the outcomes we should look for, it really should be 2. One is all around progress and probability. As you saw, 8 approvals last year, expecting 7 this year, 5 to 7 submissions. We noted progress in all of that, the reiteration of $600 million to $700 million. Last year, at this conference, it was $500 million to $600 million. So look at progress and increased probability, and our intention is to increase speed over time with that. That's number one. Number 2 is actually a tightening of the R&D expenses. As we've highlighted what she has done is actually concentrated our spend and really scaled and concentrated spend on our late-stage pet blockbusters in the pipeline and really that clinical development to drive a very robust pet blockbuster pipeline and also on some of the key refilling of the pipeline. So you'll actually see some tightening of the expenses, as you saw in Q4, as we come into 2022 as she's brought these 3 organizations into one. So probability, progress, moving to the pipeline, which you've seen; and 2 is a tightening of the overall R&D organization and spend and then concentrating on that.

Great. As you noted, Elanco has greatly benefited and become more diverse via M&A. So when we think about the current environment, whether it be the inflationary pressures, maybe rising interest rates, is this driving more potential M&A opportunities for Elanco or fewer? And what areas at this point in time would be of greatest interest?

Yes, I'll be real clear. We got a very solid plan. Our IPP strategy, the innovation and the pipeline we just talked about, a very diverse durable portfolio given us growth that you saw that exceeded expectations last year, where we delivered 7% pro forma, 10% in PAT, 6% in farm animal, that's the portfolio, and a productivity that's driving double-digit EBITDA and EPS, and we continue to see that. We stand by our commitments of 60% gross margin next year, 31% EBITDA in 2024. So Steve, to come back to say, our focus is on debt paydown, not on M&A, and that will just continue to leverage and create more value in the flywheel that we've talked about. We hit our 5.5x leverage, EBITDA-to-debt target even with the acquisition of Kindred. As Todd shared on the earnings call, we're targeting somewhere in the neighborhood of $450 million to $500 million of additional debt paydown this year, taking us to 4.75% or so in our ratios, and that will be our focus. And then it all channels back, Steve, to an execution of keep that top line growing, deliver this pipeline and double-digit EBITDA and EPS growth continuing.

Great. And that's a great segue into another question, and then I'll turn it to Kathy for some embellishment on specifics. But what is the company's latest thinking on potentially paying a dividend now that Bayer has been integrated and the company is on much firmer footing going forward?

We are on firmer footing, and we're creating cash. And as I said, the dividend right now is not part of our agenda. It is debt pay down. It is continuing to invest to drive growth and drive the pipeline. That's our current agenda.

Okay. Great. With that, I'll turn it to Kathy.

Jeff, we're going to talk a little bit maybe about some of the specific products and areas, and I thought we'd start with the pet side, since that's the rapidly growing one. So first, if we could go to the parasiticides, the big piece that's out there for you guys. Can you talk a little bit about how Elanco views the U.S. parasiticides, specifically the canine side of the market? And how you see it growing? Or is it changing this year? You've talked about the headwind, $60 million headwind this year. What are you seeing in terms of owners' preferences? Are there any pricing issues? And how does the Elanco product portfolio fit into all of this?

Yes. Great question, Kathy. It is a market we are well-positioned in. Parasiticides is the largest pet markets, $5 billion and growing significantly. I will take your question, Kathy, and just broaden it because I'm traveling here in Europe to say parasiticide starts for us globally. And I just want to start there by saying, first of all, that when we think about our overall portfolio, we launched Credelio Plus last year. Credelio Plus can compete with any [indiscernible] broad spectrum parasiticide outside of the U.S. today. So all of those other innovations, we today are doing very well with that product. It's launching our Credelio franchise internationally, it's doing extremely well. Also as we look at Advantage, as you've seen the Advantage in A family has done better than we expected since the Bayer portfolio or since the Bayer acquisition, driven a lot by our A family in China. And we have invested and leaned in a little more aggressively maybe than Bayer would have as part of corporate on launches and leveraging our omnichannel strategy in China. So look at our overall parasiticide portfolio, the international markets, our retail in Asia and then the Seresto global campaign that we're focused on. As you come into the U.S., I would say we still continue to see pet retail and our leadership in pet retail continuing to be critical. So we're, one, Seresto, we see continuing growth with Seresto. We can talk more about this. We saw fourth quarter growing 19% compared to 2019. That's the better compare. It met our expectations last year, and we'll have one of the most extensive investments behind Seresto coming into 2022, and we expect to see it return to some nice growth in 2022 overall. Now when you get into the $60 million in the specifics, yes, the competitive intensity is in the U.S., is in the vet clinic. Today, we see Credelio and Interceptor Plus still being the 2 product broadest spectrum portfolio today that can give you the broadest coverage needed, and that is with our work with the tapeworms and our focus even with our collaboration with IDEXX working extremely well. That's one. So that $60 million. Last year, we said it was around $75 million in terms of competitive intensity, and that's about what we hit. The $60 million this year is around our legacy brands, primarily Comfortis and Trifexis. We also highlighted for the first time that Trifexis sales last year were at about $137 million. So what that does is that starts to show you sizing the risk and containing that risk around the legacy brands. We believe the $60 million gives you better perspective and better balance relative to our global parasiticide franchise. It's very competitive. And then we're going to continue to launch a product every year, Credelio Plus last year and then Advantage XD this year, and continue to bring a parasiticide every year on average going forward in the innovation.

Do you see the push to orals? How much higher does that have to go in the U.S.?

How much higher does that have to go...

It seems like the orals have been taking larger, even away from the topicals. Do you see that continuing? Or do you think it's sort of leveled off, if you will, that there's always going to be a place certainly for topicals?

Yes. I believe that topicals, as well as collars, and OTC. Remember, Kathy, as we continue to see a large percentage, still up to 1/3 of pet owners are not going and don't normally go to the veterinarian. So that continues to reinstill the importance of OTC and brands. We also see e-commerce segment continuing to grow and some of these categories continue to grow within it, around topicals and collars. I think the biggest thing around COVID, I'll just note, that 2 years from now, when we look back at the pandemic, it will be the pet owner experience improved. I was in vet clinics here in Europe, and what the vet clinics are even doing Europe, U.S. is doing a better job of serving customers in their home, where they want to shop, whether it's telemedicine, curbside check-in or actually drop shipping to improve that. That continues to allow even some of these OTC products to continue. But again, the overall segment is growing nicely, innovation drives it and also compliance is going up because these vet clinic experience has improved.

Great. Great. Let's move now to and just talk on the derm side a little bit. One of the other large areas on the pet side. And just to confirm, you're going to -- you intend to file this year for one of your derm products in the pipeline. And will that be a global? Will that be both U.S. and Europe?

Yes. The submission is focused on the U.S. market. I would highlight what Ellen wanted to really focus and highlight on again, progress, probability, not just portfolio-enhancing products, but also the blockbuster products. And again, we are going to be submitting up to 2 of these pet blockbusters, 1 in [ para ], 1 in derm. And we also highlighted the importance of the differentiation of these products. Differentiation, Kathy, would come whether it's efficacy, whether it's label or convenience for the pet owner. So we're excited about this next era of innovation for Elanco as it is differentiated in some of these categories going into some very large markets. And again, I would take away from the message on the earnings call and this is that we are making progress, the probability of our pipeline is going up and again, these late-stage blockbusters will be differentiated and progressing to the market.

One of the products that's been -- a couple of products that have been very successful in the pet area have been the monoclonals. Can you give us a sense in your pipeline and talking about the progress on blockbusters? Are you working on monoclonals? Can you just give us any, at least broad picture of some of the segments you're interested in?

Yes. So yes, I remember, Kathy, you asked me the same question last year, and what I'll say is, 1 year later, just an idea of a little bit of how Elanco operates is, as Aaron highlighted in our December 2020 Investor Day, we've had a couple of very, very good assets in the monoclonal antibody in our existing pipeline. Since last year, as you know, we've acquired KindredBio that has brought in 4 additional assets into the marketplace or into our pipeline. So we've got a robust pipeline. We brought in expertise from the Kindred organization. And we've also brought in a manufacturing plant in Elwood, Kansas. So if I look at where we were in monoclonal antibodies a year ago and where we are today, we're well positioned as one of the industry leaders. We've got the parvovirus progressing nicely, as we have mentioned. And of course, the derm products as well. So more to come. I would highlight, there's complexity in this space. There's not a lot of products that have come in to animal health and monoclonal antibody space yet. And the complexity comes everything from regulatory, supply chain, manufacturing and making sure cost of production is also competitive as we're a cash market, not a payer market. So more to come, but very, very excited about this space in animal health.

Okay. Is there -- is gene therapy also, which I think we also asked you about a year or 2 years ago, is that something there's also been some development on? Or is that just still kind of in the watching phase?

Yes. We're doing some assessing. We've looked at this space and looked at assets in the space and leaned in. But I would say that this would not be in the top tier of our priority space. We've got, again, very robust pipeline. Ellen is bringing tremendous amount of expertise and discipline. She has a long history in animal health and bringing pet blockbusters to the market and other assets. And again, that would not be in our top-tier priorities. But just like monoclonal antibodies a few years ago, we'll stay opportunistic and continue to assess.

Okay. Bigger picture question on the pet side. Would you consider expanding into some very different markets, such as diagnostics, pet foods, some of the OTC products, whether they're topicals or grooming products or nutritionals?

We wouldn't, Kathy, at this time. Our strategy is extremely tight right now around a $600 million to $700 million pipeline, refilling that pipeline, building that expertise. Again, the strategy is working. I believe that 2021 results showed that this strategy is working. We're building a global diverse company, creating durable, diverse growth, one of the most robust pipelines relative to our size in the industry. We've created an independent company with IT systems coming off from Lilly and standing up. And the Bayer acquisition is meeting and exceeding our expectations in a lot of areas. So it's about products, delivering innovation, staying extremely focused on driving value and driving growth.

Great. Just 1 last question on the pet side. As we look outside of the United States, what's your biggest opportunity in 2022?

Yes. On the pet side, there's no question. China continues, as we've noted, it grew more than 1% growth for total Elanco last year. We expect it again this year. On China, we've got one of the leading pet organizations. We've got a Chinese leadership team. We've got Advantage, Seresto. We're bringing the Credelio franchise into China. And again, continued growth there. And that follows then with all of that international capability. As we move marketing into the commercial organizations look for us to continue to expand into the [ Asian ] area, see some really nice growth in Southern Europe as well as LatAm. All led with also some strong pricing as well that we believe will be important as we go forward in those markets.

Okay. Great. Let's switch gears a little bit and go to the farm animal side, because certainly, it's still is a very important part of your business. One question, if we could start with, is the U.S. beef cycle. We've talked a lot about the other bigger picture things. But can you take a step back and just let us know where you think we're at, where Elanco thinks we're at in the beef cycle? And how has the pandemic impacted the traditional trend of this cycle?

Yes. I think, without question, and maybe I'll just say -- I'm going to start, maybe, Kathy, at the highest level, farm animal for Elanco had a very robust year. It did have some COVID compared versus 2020. But we look at market share overall, it grew nicely at 6%. It took market share in key markets, like U.S. cattle and in China and other key markets that we wanted to grow in, even U.S. swine, it did extremely well. And I've always said, the U.S. farm animal business or the global farm animal business, it takes a broad portfolio. The Bayer additions to the farm animal portfolio paid off, takes global presence, takes value beyond product. The Elanco Knowledge Solutions is adding significant value. And those customers using it, we've expanded and then bringing innovation. We brought 5 new products into farm animals. So it's a profitable, durable business that we believe we have in the right areas, competitive advantage. Now on beef, what I would say is that the U.S. beef market is tight. It's tightening. The biggest driver here is exports. Exports have kept prices higher. And exports, I believe, are driven a lot by the changing diets slightly as African Swine Fever hit Asia, an alternative protein was beef, and that has definitely spiked increased demand without question. And we see at least over the next 6 to 8 months, a more cattle on feed, numbers not necessarily climbing, but values remaining. And beef prices through retail and through export markets have sustained, which has allowed it. Elanco is well positioned as feed costs continue to climb. Elanco has a performance portfolio that converts that higher cost feed into right now protein values that are being recognized out into the marketplace into the retail markets. So we're -- we see a pretty strong year in beef for us, especially in the U.S. in 2022.

And to lead into that, Experior, which you've talked about as being a blockbuster. How does that fit into driving the value add for the farmer? And why is that now all of a sudden becomes such a dynamic product for you?

Well, without question, when you talk about livestock sustainability, we believe that this is one of the big areas of opportunity going forward. But Experior has a compelling proposition to the farmer, reduces ammonia, it creates value for that producer and for the packer. We've seen this product do extremely well in the field. As I mentioned on the earnings call, increased packer access, and producer demand continues to grow every week. The number of cattle have doubled every month since November, and we see that even ramping up even more significantly with more cattle going on for the first time and 100% reuse going into the second quarter. This will be one of the biggest drivers of our doubling of innovation from 2021 to 2022. So that $120 million to $160 million of total innovation, we see Experior being a big driver here. I think, Kathy, we see then this helping our overall when you bring innovation, it helps our overall cattle portfolio, and it opens the door to livestock sustainability, which we think is the next era of innovation and opportunity.

Are there any similar products or are you aware of any other similar type of agents coming out with the same environmental type of claim of reducing emissions of some sort?

Not in this class or this specific area that Experior is in at this time. There's definitely products and innovation. We as well have a pipeline and are focusing together ourselves and others on methane reduction and ammonia reduction. And then I think very important to note, over the last 4 months, we've launched 2 new tools that I think are really important. UpLook takes our data, company that we have, Benchmark, that links data together. We've got the top really key opinion leader in Dr. Sara Place, our Sustainability Officer, and now we can benchmark. I was on with a very large cattle producer, on a call last week, where now he knows what his footprint is. And then we've seeded money in another company called Athian that will actually aggregate, certify and monetize that carbon reduction so that the cattle producer can actually retain economic value as well. So this is something that's not conceptual anymore. It's not just long-term targets, but it's turning into economic value at the feed yard and dairy.

And you're seeing this outside of the U.S., too?

The demand is actually as high or higher where I am right now in Europe. We're having some meetings actually this week while I'm here. And the carbon market is very strong here, more than even in the U.S. in some places. The challenge now is making sure we've got a portfolio in some of these tools that are being piloted in the U.S. Our intent is to globalize them, to be able to globalize the value.

Great. Okay. Maybe we can spend just a few minutes on the swine market. And Jeff, if you would lump them both together, just how you see both the U.S. swine turning around, if it will. And second of all, just on China, when you think about the largest producer of pork, a couple of years ago, the production was cut 30%, 40%. And now 2 years later, we're in a position where the prices are dropping and it's a difficult business over there. Can you just sort of give us a synopsis of both those areas?

Yes. I would just say, overall, I think we've got to look at the China, African Swine Fever first because I think this is important. It's less now about the virus. It's more now about supply and demand. And the second emergence of African Swine Fever last year in the second half caused prices to sink, and there was an oversupply. So right now, there's -- we see the first half of this year being really a rebalancing of the supply/demand and the stabilizing of the prices. It's not as much -- the headwind we have in the first half of this year in China was swine, it's more about the economics of the marketplace. Now underneath that, the second real positive, though, through this is that the industrialized companies that have better biosecurity are also more apt to outsize the growth and be better positioned in a higher percentage of that market, which is better for Elanco long term. That, to me, is the most significant trend that we'll look back on 2 to 3 years ago -- 2 to 3 years from now that I think Elanco is better positioned. Multinational portfolios, performance and disease prevention are going to win with industrialized swine companies, and Elanco is going to be 1 of those top companies to do that. I think the U.S. market, again, is a lot -- very much around a couple of things. I think continues to be a lot of disease burden, probably a better supply/demand management system, so there's less volatility, but a very, very important export-dependent market. I think you're seeing now swine and beef starting to head to where U.S. poultry is, where exports matter in a more material way than they ever have. And that probably was accelerated by African Swine Fever. But a pretty stable -- we're well positioned in the U.S. market. It's not a big material business for us, but it's something that we see going forward is a more stable market in 2022.

Okay. And last question on the farm animal. Just a bigger picture if we take a step back. When I think about -- we've talked about all the innovation on the pet side, and that's where your efforts are certainly focused and that makes all the sense. But as you look at farm animal, is that somewhere down the road we're going to start seeing some really different innovation? And is that environmental like Experior? Or could it actually be in a therapeutic or parasiticide area?

I think 2 areas, Kathy, and I'll say, no question, disease prevention. And whether it's biologicals, whether it's proteins, whether it is targeted therapy, even working with genetics in that space, I think, is very important as consumers want great animal well-being, safe food and less use of antibiotics going forward. I think that's definitely going to continue to be a trend. You've seen us with Clinacox, ZoaShield, and others continuing to focus in those markets. They got to be economic, though, because I think the economic value of protein still matters. The second is sustainability. I am very much of a believer, and Elanco is extremely well positioned with some of these tools, our data as well as our portfolio that you're going to start to see portfolios that are going to be measured more by footprint reduction and linkage to ESG metrics than maybe the traditional approach. And then, yes, even economic value coming from carbon markets or biodigesters and playing into the energy market. So we do see that ammonia reduction, methane reduction, overall footprint measurement is going to be essential, and I believe it's the next big area of market opportunity for farm animal. And it's going to start with us this year with maybe the most innovation growth coming from one product in that space. More to come in that space as well for Elanco.

Great. I'll turn it back to Steve now for the last few minutes.

So Jeff, we're actually concluding all sessions at the conference with the same question. So if you'll allow us to ask. Within Elanco, what do you think will be the biggest change or surprise over the next decade? So what isn't visible now, but you believe will be and will be important in a decade?

Very simply, very clearly, we've built this independent company. We're standing it up. It's been a challenge to do so in the middle of a couple of pandemics with African Swine Fever and COVID. But Steve, the Elanco will be one of the few and only companies that can reach the world's animals. We're in 19 species, we're in 150 countries, we're going to have SAP systems, regulatory, frontline value-added services to serve veterinarians, pet owners and farmers, and we're going to be able to not only bring our innovation, but we're going to be able to bring partner's innovation, like we have with Kindred and Aratana and maybe small inventors. There's capital coming into this space. There's a lot of innovation coming into this space, and we're going to be one of the few companies that can reach the world's animals, and we can bring innovation through products primarily to them. And I believe in not even a decade, but in 5 years from now, we'll be one of the only companies that are going to be able to do that, do it well. And I think a partner with innovators as well as our own innovation will be the difference. And I think we've seen the importance of animals to society and the value that people will pay, whether that's nutritional protein with less footprint and healthier animals or more pets and more homes with more of a convenient pet owner experience, Elanco will be in the center of that in a big way.

It sounds like an exciting 5 to 10 years on tap, and it's one we think investors should want to embrace and be part of. So Jeff, thank you for taking your time out of your busy day, and especially since it's late at night in Europe. So all the best and thanks again.

Thank you. Thanks, Steve. Thank you, Kathy.

Thank you, Jeff.