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

Hello, everyone. Thank you for joining us today. My name is Erin Wright. I am Morgan Stanley's Healthcare Services and distribution analyst. I'm pleased to have Elanco CEO, Jeff Simmons with us here today. Elanco is one of those largest animal health pharmaceutical companies globally, and we're looking forward to their comments. For important disclosures, please see the Morgan Stanley research disclosure website at [ morganstanley.com/researchdisclosures ]. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, thanks again, Jeff, for coming. And I will turn it over to you for some introductory remarks.

Yes. Okay. Thanks, Erin. Thanks for all you do, and I think you've been probably the leading analyst study in this Animal Health business for a lot of years. So thank you and to Morgan Stanley as well. And I would say the same, look to our Investor Relations, most recent materials on forward-looking and investor statements. Maybe just an opening a couple of comments relative to Elanco, and I start a little bit. We know we're an exciting environment right now overall in the marketplace and especially in animal health, we've seen similar challenges in animal health. So I start with really just a little bit of the case for Elanco right now as a company, given that we've got about a $7 billion equity value, and we would see this right now as a time where the value overall, our Board, our activist investor that is on our Board, myself, other management, board members are leaning into the stock right now is the time window was opened up for that. And a little bit of just some of the rationale at the highest level, some people here may be new to the company. I think the first is margins. I mean we're looking at our current guide. We've done an awful lot on margin expansion. We can talk about this, Erin. But our current guide is about $4.6 billion. So just thinking about multiples here, a $7 billion equity value, $4.6 billion revenue, nearly, in our guide, $1.1 billion of EBITDA and that's coming from cost cuts, restructuring, better margins, pricing and even an [indiscernible] like incentive inside where our employees are now saying, "Hey, not be planned, beat last year and beat the cost of capital." And then synergies with the Bayer deal, which were $300 million of the $400 million has been captured. And the next $100 million is going to come with our IT systems that are going to integrate. I think the second one is innovation, and that's the big driver of growth. And I would say with Ellen coming on, we've put an awful lot of energy on a heavy focus on pet blockbusters that's truly -- if you really study this industry, there's kind of 2 industries, pet blockbusters and the other. And so just at a very high level, we've put a lot of energy on concentrating focus, concentrating resources, moving the microbiome out, combining really Kindred, Bayer and Elanco capabilities. And by doing that, we've seen a tremendous amount of progress. We're now moving into that submission regulatory stage on a couple of big assets, one, a broad spectrum parasiticide that we see positively differentiated from the best on the market today. as well as derm, where we are not in a 1.2 to 1.5 derm market. Then the last is just growth overall, and we can talk about drivers to growth. But we see the business overall set up in much more of a diversified durable portfolio. We see that our U.S. farm animal business is growing, is taking market share, has for 6 quarters consistently. Our international Farm Animal business is growing and doing well, and our international pet business. U.S. pet health outside of [ Para ] in the vet clinic is doing well and very competitive. And we expect that U.S. pet health business to return to growth next year. So again, innovation, durability to drive the growth overall. I think just last is we're looking at a company that's outside of an IT system that's just about finished as we get into next year, an independent global animal health company that can reach the world's animals set up independently, we think very undervalued. But probably more importantly, we're stronger today as a company than we've ever been, capabilities, pipeline and more streamlined, fit to purpose than ever before. So that just -- that's a little bit of a backdrop as we come into kind of 4 years as we been on the market as an independent company from Lilly.

Great. Great. Thanks, Jeff. And I want to dig into a little bit more around kind of 2022 and some of your near-term expectations as well. And as you think about top line growth expectations for the next couple of quarters, third quarter implied growth is about negative 3% on an organic or core growth basis, but then there's somewhat of a ramp-up into the fourth quarter. Can you talk about that quarterly cadence a little bit, the key drivers of that? And what's also impacting you from an inflation supply chain standpoint as well [indiscernible]?

We look at the second half. I think a couple of the positives. We do see pet health and poultry as the 2 segments that I think as you look at comparisons, especially as you start to push towards the fourth quarter as growth drivers offset by swine. And I think the biggest -- we took guide down a lot relative to China. China is a part of our business, which we can talk about, which is a big part of our growth index, and that had an impact, especially the lockdowns on our pet business. We'll have a positive, it will no longer be a headwind on the CMO business. That will be also a factor. I think that will be a driver as well. And then we're starting to bring in the innovation. I mean Experior continues to ramp up. We can talk about that, Credelio Plus, the Credelio franchise. And if you think about even the first half, Seresto, Rumensin, poultry, aqua, and the Credelio franchise are all brands that grew in the first half and will be contributors in the second half as well.

Okay. And then thinking about innovation here is a key component, and you mentioned a few things there. So I want you to sort of break that down for what you did retract some of your longer-term margin targets or are at least, they're still there. We just don't know exactly the time line, but can you talk about the $600 million, $700 million in innovation? Is that still targeted for the same time line? And help us understand sort of the cadence of some of those drivers.

Yes. So innovation, we've really anchored 2021 as we started the launches to 2025 and that was coming out of our Investor Day that we had in December 2020, said $600 million to $700 million of innovation. So -- we -- I would say, the first biggest drivers to 4 products that came out of 2021, led by Experior. Experior, we see is the next blockbuster for Elanco. We have -- and will be a major driver to that $600 million to $700 million. We have doubled the number of head of cattle on this, first environmental claim product from the FDA, doubled the number of cattle from Q2 compared to Q1, and then we added that many cattle in July, and we've seen continued nice uptake in August as well. So we -- and high loyalty to that brand. That will be a $100 million plus product, and that will be a driver to growth next year and will be a big part of the $600 million to $700 million. The Credelio Plus franchise outside the U.S. Credelio Plus is equivalent to the best broad spectrum parasiticide. So we see the Credelio franchise, Credelio Cats, now Credelio in China and the Credelio Plus being another driver. We have, Erin, kind of what I would say, an inset of some key products over the next -- rest of this year, next year, 6% to 7%, mostly pet products that will drive growth at Bobby Modi and our U.S. will be launching. So parvovirus, we expect a clearance sometime here in the next 6 months. The new fee line diabetes oral product will be another product that will be launched and be driving. Zorbium, which we've got into a lot of clinics, our feline pain. Advantage XD will also be a product that will be differentiated and really leveraging the Advantage brand in retail. And then we've got a few things like canine influenza vaccine, et cetera. These will be drivers to growth. And then we begin. We begin the pet blockbusters where submissions going in, in the next 1 to 3 months for both a derm asset and a para asset, which will really drive the '24, '25 growth as we go forward. So again, $600 million to $700 million, there's no question, there's pushes and pulls to that. But as a whole, we've got a very robust pipeline to achieve that, we believe.

Okay. Great. And I do want to get into the blockbusters in a second. But on Experior in particular, how -- has your expectations changed at all in terms of based on the traction that you're seeing from some of your core customers? And I think you were pretty bullish about it and kind of earlier before the call. You kind of walked back some of the expectations there. I just want to make sure we kind of understand what's really going on in terms of underlying utilization trends? And is it -- you said $100 million in sales over what sort of time frame can you get there?

Yes. So that's saying blockbuster potential, and I'm not defining that, that's it either. I mean, I think as we look at -- it is a product that is uniquely positioned. It's kind of -- creating kind of a late-stage feeding program. So I think that: one, it's exceeded our expectations relative to efficacy, the people that research it go on it, people that go on it, stay on it. I think the complexity to go on it is a good thing because once you get on it, you stay on it. But I think getting [ packer ] acceptance, getting it in the feed program and then being able to transition from research to full-time use has been a little more complex. That's not a challenge to the long-term potential of the product. It probably shifted our ramp rate about 3 months longer. But from what we're seeing in August with the product, we continue to see this being a great product. I think more importantly, just take a minute, Erin, I do believe Elanco, again, doing a really nice job, I think, in Farm Animal and taking market share. It's -- Farm Animal gets talked a lot about, but it's a durable business. It's an efficient business, an efficient industry to reach, and we do see livestock sustainability as an area where there's a lot of opportunity, which is lowering methane and dairy and beef cattle and ammonia, greenhouse gases, and then also sustainable proteins where we lead right now in aqua and in poultry. So we see more protein using less environment, mostly with methane reduction is a $1 billion to $2 billion market. Bovaer, that was just licensed by us with DSM, not part of our $600 million to $700 million, something we've said is middle of the decade, we see is in the U.S. cattle business, a $200 million product that we're working right now with the FDA on.

Okay. Great. And then the 2 blockbuster submissions in pet health, one in dermatology, one in parasiticides, do you still anticipate submitting those within the next few months? And can you talk about differentiation of those products?

Yes. We do plan to -- and we'll have Ellen on the earnings call in November, our Head of Research, and we'll talk through the details as we continue to share more disclosures on our pipeline as we go forward. But the intention is to said back in our August call, 2 to 4 months, nothing's changed there. I do think what we've done here is concentrated a lot of resource people focused moving the microbiome out, which took a lot of time and energy, was great science, but not a lot of products in the short term. All of that and integrating Kindred and Bayer into Elanco has created increased acceleration probabilities on these assets. On the derm asset, what I would say is we know we haven't disclosed what it is, but we've got a JAK product. We've got an IL, interleukin IL-31 short-acting, which will be similar kind of class that's in the marketplace today, have been a long-acting and then some other assets that came with Kindred. What I would emphasize here is this is a $1.2 billion to $1.5 billion market, 2 assets. Our data shows there's some dissatisfaction or a desire to have other assets. Our differentiation we're not specifically defining, but look at efficacy, look at convenience and administration and look at safety, and these would be the things that we think. In addition to differentiation is we're building launch capability to take share as well with our size, scale, digital. On para, again, it's same thing, same criteria relative to differentiation. We believe we have something that is positively differentiated from the best on the market today. And we've crossed the heartworm threshold, and we have a -- again, a very large portfolio of parasiticides today, and we see this coming in to complement, strengthen and really drive a lot of growth for us as we go forward.

Okay. And then whether or not you launch the JAK first or the IL-31 product first in dermatology? Does that matter to you? Could you take share quicker with the JAK leveraging distribution? And how are you ramping up in terms of manufacturing? And can we actually think about those products being pretty closely aligned from a timing perspective? Could they be back-to-back offering you a differentiated kind of portfolio as well?

Yes. More to come on that. I think Ellen will be sharing more. What I would say is they're all progressing nicely. We've been very happy with the Kindred acquisition. It was just a couple weeks ago out in our monoclonal antibody manufacturing plant that will actually bring the parvovirus to the market here in the next 6 months. So we -- not only -- we've said all along, monoclonal antibodies takes capability in manufacturing, R&D and, of course, in marketing. We're building all of those. So to answer your question specifically, I think that, yes, they'll be close. I think most importantly to us is you've got portfolio, you got to have differentiation, and this market rewards that. And what we've seen in pain and parasiticides and derm as markets grow. And derm is not -- definitely -- you don't see the shares and the usage in derm internationally that you do in the U.S. So you've got global expansion as well. So Erin, I think we -- I'm as focused on the differentiation and value add and how we launch the product to take share. And then, yes, we do see us having a very robust term portfolio that will come quite closely together.

And sorry, I have to ask this question because we get it from investors. But from a competitive standpoint, do you expect to be second or third to market with your JAK inhibitor?

I'm -- can't comment other than to say that we'll be continuing to disclose as we go forward, and we like not only the profile of the products, but our capabilities to take share too as an independent company.

Okay. That's fair. And then on differentiation with the parasiticide product, presumably, this would be a broader indication in terms of the types of parasites it prevents. And do you think that as we think about weighing cannibalization of your own products and the competitive positioning of this product, a, how do we -- do you expect to be, for instance, third or fourth to market in that category as well? But how can you -- how do you think about marketing that product to differentiate yourself from what's out there today?

Yes. I think Elanco, with Bayer and our history, is well positioned kind of globally. So I just always start, Erin, internationally, outside of the U.S., we've got as broad of a portfolio. We've got Credelio Plus, which would be an equivalent to a broad spectrum getting tick, [ flea ], heartworm. So I would say, first of all, we've got that. In the U.S., we've got an omnichannel approach, where we've got about 45% of our businesses outside the vet clinic, 55% is in the vet clinic. So -- and having the ability to move scripted product into that omnichannel both ways is really important. That will be a differentiation for us, and then continuing to utilize distribution going forward. Again, the differentiation is going to be in the area of efficacy and coverage, as you say, in parasiticides. It also could be other things like efficacy, safety, administration.

Okay. And so Ellen will be joining you, as you mentioned on the call. So is that the kind of conversation she's going to have around differentiation? What can you disclose that early on in sort of the life cycle of development there?

Well, we want to give our investors' confidence in the progress of things we're doing, and the merit of what we see is we're now reaching a stage of FDA products 12 to 18 months with a ADUFA, the animal drug user fee act. USDA, that's -- that would be the IL-31, that would be shorter. And Europe would be a little shorter than that 12 to 18 months. We want to show the progress and the confidence that, "Hey, Elanco is move into submissions and regulatory on pet blockbusters." But I will say we'll be a little cautious given that launching really matters on appropriately, we'll be exposing that differentiation as we get closer to market.

Okay. Great. And then also in atopic dermatitis -- and sorry, I forgot to ask this earlier, but on -- you have 8 dermatology, I think [indiscernible], including what you got with Kindred. How do you expect -- are all of those going to come to market? Is it just several shots on goal? How should we think about your overall atopic dermatitis strategy with that in mind?

Yes. And I think we bring a history also with Lilly. So we bring, I think, a nice portfolio of capabilities, people, expertise and assets. But my answer to that is, at this point in time, Kindred, everything that we were seeing and expect starting with the parvovirus antibody through, we continue to see all those assets progressing nicely at this stage.

Okay. And then sticking with pet health, Seresto. Could you give us an update on Seresto, the time line? When do you think investors will have greater visibility there? And I think we know your thoughts on the safety of the product, but if you could reconfirm those for us?

Yes. So I think probably one of the bigger maybe I hate to predict but maybe disconnects a little bit is Seresto. And I start with, overall, the product globally is meeting our expectations. It's growing nicely in international. It's growing nicely in fee line in the U.S. and international. It's about a 50-50 U.S. international product. It is one of the larger animal health brands. It's durable. The return usage, Erin, hasn't really changed. There's tremendous loyalty to this product. It serves a segment that's primarily dog and cat owners that don't go to the veterinarian on a regular basis, feline, that's a big segment. It's in 80 countries, and it's been a very resilient brand and it continues. We continue to see a nice pathway to growth. What we're highlighting here is the EPA is the regulatory body in the U.S. The EPA has a reregistration process that isn't product-driven, but active ingredient driven. So [indiscernible] is one of the active ingredients and that is up for reregistration. That has been updated on the EPA site where that will be actually reviewed and the time lines have been pushed out to 2024. So I think that signals a little bit of the urgency as they moved it out, and they're really looking at a lot of the environmental factors, the impact on pollinators and things that are much more on the plant side than on a low-dose, long-duration collar. So again, we work closely with the EPA. We've been working with them, very data-driven, science-driven stand by the safety of this product. And I think the big thing here is the retailers, the key people to the marketplace have not only all supported it, but they've actually been a lot of activation, shelf space, a lot of activations in e-commerce, all the major retailers, this is a big brand and a big income driver to them.

And did you mention it also on the retail strategy side. You recently made some changes to your retail strategy. Can you talk a little bit about the financial implications of those? How that impacts kind of price realization for the year? Because I think that was a little confusing for folks kind of how that plays out? And is that playing out according to plan? How is this impacting Advantage [indiscernible] sales, for instance, in the U.S. I think the U.S. program, right?

Yes. I would look at it as more of a onetime, not really a big change. I mean we're enhancing the strategy. Bobby Modi has come on with a CPG retail background, had some background in the pet side, doing a tremendous job, off to a very fast start, having a big impact on a -- he's kind of an omnichannel leader coming into pet health that corporates and retail. So I would say that, overall, we're doing a lot there to build capability and growth. What you're highlighting, Erin, is really what we did during the second quarter is actually take a little bit of a gross to net off from a price increase, move it actually to promotional dollars to try to drive some more demand. We'll see that more visibly on the effectiveness of that probably through the rest of the third quarter and maybe the second half of the year. Again, that brought price down because we use that price to drive EBITDA and actually drive promotional dollars. But it really wasn't a change in strategy. Our strategy is really clear, which is, continue to grow the portfolio, add products like Advantage XD, leverage Advantage, Seresto name, do a much more sophisticated job and elasticity in what we can do in that retail segment on price. We've got some lower price points. People that don't go to the vet, coming into a recessionary time, is there opportunity? These are the things we're looking at. And then how do we take retail and expand to more channels. So that, overall, I think we're in a really good place from a retail perspective. Again, about 45% of our U.S. pet business.

Okay. And then as you think about the retail channel and OTC, and then you also have prescription products going through the retail channel, and you're thinking about your competitive positioning, how is it holding up in OTC versus prescription products in terms of the competition in parasiticides in particular? How is U.S. performance been? If you could talk a little bit about that.

I think it is -- it has to be -- if you're going to be one of the 2 global independent companies, it has to be an and, okay? So I think it's that and retail. It is parasiticide and derm and pain and other therapy vaccines. You have to have the portfolio and we believe -- and the channel. And then ultimately the winner is the pet owner. And the veterinarian, no matter if you're retail or not, is in the center. So what I would say at this point in time is Bayer has -- we just did a business case review and a strategic review, short -- it's been a couple of years now since we've done that, and it's positive relative to the business case, not just in the financials, but in actually the assets we got and the capabilities. So for us, it's taking Elanco's legacy focused on the vet in our portfolio, adding the retail capabilities to drive the vet business, help the veterinarian and then now expand the portfolio, para, derm, pain and therapy. And that, to me, is -- those are the 2 kind of dimensions we've got to beat to win long term, and we see that being critical to our growth through '25.

I want to make sure we touch on fundamentals as well across both pet health and livestock here. So how would you characterize the current fundamental demand trends across companion animal? And how do you view the durability of growth in varying economic backdrops?

Yes. So look, pet health, I think overall and -- is coming through COVID has been resilient. There's been different news when you look at pet retailers on, hard goods versus animal health, animal health has been more resilient than maybe the pet toys and other categories even. So I would say why? I think a few things. First of all is, during COVID, we made the pet owner experience more convenient, whether that was curbside, whether that was drop shipping whether that was -- so the ability to keep your pet, keep it more compliant instead of using 4 pills a year when you should use 12, those numbers are going up because it's just been made easier. COVID made us make the pet owner experience easier. Visits are up because wellness programs are up and expectation of care in all surveys is up. So that's allowed in the veterinarian has been a lot more adaptive. I think also the veterinarians come through a spike and workforce challenges to where you're seeing that stabilize a little bit more. So I actually think in pet, overall, we're in the segment that's probably been the most resilient. I think as I look at the backdrop of the watch out globally, there's a couple of watchouts going forward is I think the economic slowdown and the energy cost in Europe impact in discretionary could be something to watch for and not an overreaction, but that was something that we guided for, that Todd guided for in the guidance. And I think the COVID lockdowns in China. We've got a really strong China pet business, but, again, lockdowns have had an impact. We guided that we don't see that fully out of the woods, and I don't think we are. So...

Okay. I definitely want you to talk about China in livestock as well. So livestock fundamentals currently, how you're thinking about higher input costs at the producer level? How that impacts your business? And how we should be thinking about even going into 2023, like what are going to be those key species groups that we should be paying attention to as key growth drivers, and how you're thinking about the China recovery?

Yes. Beef, durable, profitable, for us, even with high corn cost. Health matters to fee conversion, weight gain, mortality, these things. So actually, beef, probably the biggest driver is during African swine fever when pork was threatened, the Asian market got to experience beef and beef exports are at record highs. So I think it's durability. Yes, the droughts had an impact. Other environmental factors had an impact, but we see this as a pretty strong beef market through the rest of '22 and '23 overall. I think poultry is the big winner here in terms of they can convert this higher cost grain even with [ Ukrainian ] wheat, they can convert better than any other species. So we see that being stronger. The one with the most volatility is swine and where the pig market in China goes really impacts the global pig market. And so we're seeing some volatility. Rabobank just came out with a report saying really, the only remaining major market in protein that you still see cyclical events is Asia pigs, China pigs. And really what's happened through this African swine fever is a lot more stability. And hopefully, we see the other side of that. But I think the volatile one will be swine, poultry will be the winner and beef is stable. And then I think the backdrop in the boardrooms, it's exports, managing fee cost and using less environment. The ESG demands on the protein business is big. And I think for animal health, we see a $1 billion to $2 billion market in this footprint reduction through animal health.

Okay. Great. And then as we think about the time line to margin targets here in the prior guidance was to reach 60% gross margin in 2023, 31% adjusted EBITDA margin in 2024. So what sort of time line should we think about now? Is this pushed out one year, 2 years or more? And then -- and when do you think we'll have some visibility on that front?

We'll continue to assess, I think, the environment. Most importantly, what you can be assured of, and even with Scott Ferguson, with [indiscernible] that's come off the board. I think his statement last week. In that, he's got a lot of other actions and activities in other areas. But I think as this quote says, everything that can be done should be done. Even his experience with other animal health companies is being done very proactively on productivity. I think that's important. The $400 million of synergies with Bayer, we've got $300 million. The next $100 million, the big driver of that will be our systems. We put Bayer over on a [ Tata ] IT system starting early next year, mid next year, that will integrate in. Our standup costs will go down. We'll get that other $100 million of synergy as we get into -- starting into next year in 2024. And I think that will be another driver. I think the other one is don't underestimate the significance of our new product margins. That will be another driver is, "Hey, what we see on the ramp rate and launch." And then lastly is just I could say, over 30 years in this industry, I haven't seen a cultural mindset transformation like we've seen in Elanco this last year with an EVA metric, call it Elanco Cash earnings, everyone is focused on, "Hey, how do you beat last year, not beat plan? And how do you beat the cost of capital." So the use of cash has become something key, and that will be another driver for these margin targets. We'll come back on margin targets as we start looking at the guidance next year and what we think. But be assured, margin continues to expand even in the face of inflation, even in the face of FX and a $50 million less top line, we continue to expand margins.

And last 30 seconds here, just really quickly, if you could comment on -- and we were talking about this previously, but since you've been public, what are some of those key areas of achievement in your view versus disappointment, if you could kind of point to what those are in your view?

I think Bayer has given us scale, size, 50% pets. It's transformed the company and made us a global leader. I think all the actions we've taken very aggressively, and were very quickly, 3 restructurings, spinning out 2 manufacturing plants. And getting the cost out and making us a more agile, streamlined, faster competitive company. I think we've seen that from our Board and outsiders. There's nothing that should be done that we're all over it every day, we're looking. I think on the other side, I think legacy Elanco, legacy products, Medicated Feed ads, for instance. They eroded a little bit more than 4 years ago when we did the IPO than we assumed. I think the second is innovation. In 5 years, pet health has become a durable, strong industry, and you need pet health blockbusters. And I think what we've done with Ellen, with the rechanneling, with Kindred, pet health blockbusters, moving the microbiome out, some of the fun areas of science and putting a heavy focus, those would be the 2 areas I would say we were doing much better and leaning in on that will be the big value drivers.

Great. Excellent. Thank you so much. I appreciate the time.

Thanks, Karen. Thanks, everybody.