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

And we're thrilled to have Elanco at the Cowen Conference again this year. Representing the company, Jeff Simmons, who, of course, is President and Executive Officer. So Jeff, thank you for making it.

Great to be here, Steve.

Maybe we could start out conversation kind of in a broad-brush way. So maybe you could talk about the recent guidance and how that sets up the year of 2023 and some of the opportunities?

Sure. Thanks, Steve. Yes, I think at a high level, just everybody, Elanco had an investor conference in December of 2020. We set the stage of Elanco plus Bayer from the acquisition and really went forward in 2021, had about 5% constant currency growth, pretty consistent quarter-to-quarter, good integration of the company. 2022 came and we got to May-June time period, and many environmental factors that impact a lot of companies here at the conference hit us and some in a more over-indexed way. So the economic pullback impacted us on pet retail in a pretty significant way. China lockdowns, we were expecting a full percentage point of growth in China that had a pretty significant impact in 2021. Europe with Novartis and Bayer were pretty heavy in Europe, and the economic slowdown, sell-out data across the board in all animal health companies. And other factors, supply and other challenges. And then competitive innovation, I think from a market standpoint, we had a couple of challenges, mostly in U.S. Pet-Vet Clinic segment on parasiticides. So we ended with -- and of course, the Ukraine war and a few other factors, FX was about $200 million of step-down for us. So all of that combined, we were down about 3% in constant currency in 2022. As we come into 2023, we set a guide a few weeks ago that really takes a lot of these factors into consideration and what we would say, is an improvement, but we would say more of a U-shape than a V-shaped improvement coming into the year in our guide. We think that China will be -- we're seeing, we saw a return to growth in Q4 of 9% after many quarters of decline. We've seen OTC -- sequential improvement in the OTC business in January, February. We've seen sellout data in Europe get better and improving, and I can go down the line, I think some other things as well. But I would say that we expect that over the year, we guided midpoint of guide down 1.5%, and we would return to growth more in the second half. In the first half, again, some of these things that would actually impact us would continue. Very importantly, we sell in pet retail, the Bayer portfolio, the Advantage brands and Seresto. It's about 70% of our sales are in the first half, high-margin products. And we do see recovery, but we see it against a notional, much bigger business than with that seasonal business. So that's been factored into our guide as well. I think overall though, what are the things that are going to really drive, we see 2 to 3 percentage points of total growth coming from innovation. We see more than 2 coming from price. We see supply being favorable. We see China being favorable. And we think that the majority -- outside of U.S. vet clinic pet, the majority of our portfolio is holding share and some places like U.S. farm is actually growing share. Pain, we've grown share, et cetera. In there, we've got a competitive -- I guess the last thing, Steve, we've got a competitive innovation and generic between pain, otitis and para at about $80 million to $100 million, we have calculated in or competitive challenges. So again, a year of growth. And then, we can talk about it, but Elanco entering the next era of probably the biggest growth in innovation that we've seen in a long time, we've said that we are going to get $600 million to $700 million of innovation. We're at about $250 million coming into this year from '21 to 2025. So a pretty big step up. Six blockbusters, more than $100 million in animal health. We have a path for 6 blockbusters between Experior on the market that we've just put on the market now to 5 more coming between now and the first half of path to the first half of '24. That opens up growth, that opens up margin, and we will finish our standup on our IT systems on April 1, and that will decrease complexity and stand-up cost and increase free cash flow conversion as we go into '24 with these new products. So that's a lot, but that kind of sets things up.

That's great. So obviously, these fixed blockbusters are critically important to the company, and we have good knowledge of it. But tell us what we need to know about the other 5 and how we think about them as related to their potential, their launch curves?

Yes. So I think the first -- kind of going in order, we expect parvovirus, an antibody, our first monoclonal antibody, which we got from the Kindred acquisition. That has been announced that, that will be approved by the USDA under a conditional approval. We see about 500,000 puppies a year with parvovirus. There's a high interest in this product. We're hoping for a plant inspection in the next weeks, not months. After that plan inspection and approval, and an approval would lead then to state approvals, and we'd be bringing the product on in 2023. We see that as blockbuster potential globally overall. And again, lots of interest. And that's a big milestone for us. We have a plant in Kansas -- Atwood, Kansas. This will be our monoclonal antibody, we will get it approved on small scale, and then we will scale that quite significantly here, and that product will scale more in '24 as we scale the manufacturing. Next is derm. We've got a series of derm products, one coming from our Lilly history, JAK-1 inhibitor. That would go against -- again, the derm market in pets right now is about $1.3 billion. It's really 2 products, Apoquel and Cytopoint. We see a dissatisfaction and also people wanting alternatives in that market. We're coming with a JAK-1 first that's differentiated. We don't get into a lot of differentiation. But that's efficacy, safety, convenience. That product is moving nicely and, again, will be made in manufacturing facilities that we have today, and pretty predictable regulatory path being that it's already there. That's an opportunity that we see given the size of that market. We'll follow that. We're hoping to make a submission. We've already made a submission on the JAK and that's, again, a path for a first half '24 approval, and then following that will be an IL-31 short-acting monoclonal antibody made in the same facility as the parvovirus antibody. And that, we're hoping for a submission on that in the first half of this year. The next one is the big one, which is the broad spectrum parasiticide. We say it's differentiated to what's on the market today. That is the path. We've made a submission on that, and that's also another key. Why there's not been a lot of broad spectrum products is the heartworm threshold for the FDA is 100%, we have passed that heartworm threshold. This product -- this product, again, is progressing nicely in the pipeline and we have a path for a first half approval for that as well. And then a new one that we've highlighted that is new is Bovaer. Bovaer is a product we have licensed from DSM. It's a feed additive that actually inhibits methane growth and production in the ruminant of a cow. It reduces methane by 30% in dairy and 50% in beef. And we see this product -- the actual space of methane production in global cattle, we see it being over $1 billion and we see Bovaer's potential in the U.S. We have rights just for the U.S. right now for $200 million. That was expected to be after the middle of the decade. And the FDA has communicated with us somewhat of an approval acceleration to a path for our first half '24 approval. So that's the 6 products that we see that have more than $100 million of potential. Almost all of them have accretive margins, accretive growth. And of course, we'll drive our greatest margin expansion, and free cash flow conversion will come from these products.

If anyone has a question in the audience, anywhere along the line, just raise your hand, we'll call upon you. When you're talking about Bovaer having U.S. rights right now, does that mean you were seeking global rights? Or did I misinterpret you?

No. We've got a great collaboration with DSM. We're working together on manufacturing. The other factor is we were considering that this had to be contingent upon building a manufacturing plant. We have found a contract manufacturer. So we are working on and believe we have a path to product supply in early '24 as well if the approval comes. And so that would be initial, but we're working with DSM also on building manufacturing capabilities together on that as well.

And on parvoviruses, is that the kind of thing that should ramp quickly because it's established and well-recognized unmet need? Or is this the kind of thing that awareness will need to be build over time?

Yes. I think less on awareness, more on logistics. I think that, first of all, supply will be key in any first monoclonal antibody you get approval on the small scale, as I said. And then you literally move to that upscale 20x size. We're confident. But it is, again, new space. It is our first monoclonal antibody, but I think '23 sales will be more limited by supply. Then after that, Steve, I think it's much more about this is a broad -- every clinic having 2, 4, 5 cases a year, deadly virus, they're going to want to have product availability. So we've worked on a supply chain. It's a refrigerated frozen product. So we've worked through all those logistics. It's more of the breadth, not the depth, being able to be in the 25,000-plus clinics, and then, of course, globalizing it after that. To get the blockbuster status, we'll be globalizing as well.

One of your animal health competitors was here just a few hours ago. And of course, they are in a lot of these sectors already. And we're aware, obviously, it's some competition coming. But it was, I think, their view with that competitive intelligence is telling us that there's no major quantum leap coming, that there may be some incremental event. But would you say that, that is perhaps underestimating strength that Elanco poses? Or what do you think of that calibration?

Well, I think that the great thing about animal health and I've seen this parasiticides, this generation of innovation is the fourth or fifth generation. So we started with topicals, then we went to collars, we went to orals, we went to the first broad spectrum, now even more broad spectrum, there's injectable, long-acting. Every time a new generation comes, Steve, the market expands. Why price elasticity on a monthly basis is not anything that will change the behavior. So the good news is this is a durable, expanding profitable market. We've seen it in para, we've seen it in pain, and we're seeing it in derm, and I believe that will continue. So our goal is and belief is this is going to expand market, not contract market. We believe, yes, differentiation matters. We also think that the launch capabilities today compared to the past, we will launch better than we've ever launched anything before in this next year of innovation. And that's going to encompass segmentation, it's going to encompass distribution, targeting. Look at Zorbium. We launched the pain product last year. And with digital targeting and segmentation, we went to 12,000 clinics in a little over 3 to 4 months. That came from segmentation like we've never had before. We've recently hired somebody that's come on to the executive team that I'll just note that I think is a proof point of our belief in the size and his belief. Tim Bennington was the -- or the President of Zoetis U.S. during the Simparica Trio launch. And then he was part of BI during the next card rollout, and he's come on to join our team. And his sole focus right now is launch readiness and looking at every one of these levers. So quantum leap or not, we will be very competitive, and we'll have a portfolio. And the other is these are customers we're already calling on with one of the leading portfolio. And the other thing we have that no one else has is an omnichannel approach with Bayer. As more and more companies now, Chewy has more and more script sales.

So it sounds like 2024, '25 are going to be very kind of rich years for new product activity, lots of new products coming, likely a lot in terms of incremental sales. What comes after that? Is that likely to be followed by kind of a load before we see another wave? Or is this just any kind of a constant drumbeat of new product activity that we expect to be?

Yes. I think absolutely as the latter. Ellen de Brabander that's had 3 decades of leading R&D organizations from DSM to BI and Merial to over at PepsiCo and now Elanco has come in. And her #1 charge was not only drive this late stage, but create a pipeline, internal and external in spaces we know we can win. And I'll call out a few of them to where we know that we can be best-in-class in R&D to where she said very consistently, hey, we need a blockbuster a year. Now we've got a bunch of those coming up here at once. But how do we create a sustainable flow of big innovation in big spaces where we have competitive advantage to win? So here's an example. We've got the first -- she's brought to the market here this year, the first SGLT2 inhibitor for feline diabetes, a pill. Take -- cat owners now can take injectable 2 shots of insulin a day out and have a pill. Our plan is to build an entire platform around diabetes. On dermatology, we, as an industry, have focused a lot on the actual problem, the itch, not the actual cost. So we're going to that. This whole area of methane and sustainable, hey, climate-neutral farming on livestock is going to happen this decade. Elanco can be the biggest contributor to that. With 60 years of feed additive, how do we actually health inside the room in it and enteric of pigs, that's going to be a big focus. So she's bringing a sustainable capability and filling the pipeline. And our Board is -- we've got an innovation committee very focused on that charge.

So those are 2 great examples. There are examples, of course, that we're already aware of. But what light can you shed about the pipeline relative to at least the areas for Elanco?

Well, I think I'll start in livestock. I mean, we've taken, I think, more market share than any company I know in the U.S. I think globally, it depends on the data. But I mean, we're leaders in farm animal. You continue to see protein demand grow. You continue to see trade and profitability. You continue to see the need of less environment, more animal protein, give consumers what they want. So just a few on the livestock side and taking antibiotics out of animals and replacing that with feed additive and biological in proteins, Elanco has got leadership there. Second is the environmental footprint. You're seeing an industry move from fee conversion to footprint. Productivity is becoming much more of an environmental focus. And you say, is that economically sustainable? Well yes, it is. I mean, there's putting energy into a cow and sustaining more of it in the cow and creating less waste is a big part of this. So that's the second one that builds on 6 decades. We're the longest standing brand in front of veterinarians and farmers globally. On the pet side, I think we come from a history of JAKs and autoimmune and diabetes. I think you'll see us continue to expand our capabilities and knowledge and awareness there. And I think parasiticides with Bayer, Elanco and Novartis will continue to see ways to do that. I think last, Steve, is we've spent a lot of time on omnichannel being able to say it's not just the product themselves, but meeting more pet owners where they want to shop, how they want to shop and at price points. And so we will continue to look at OTC. We're bringing 3 outside the vet scripted products today this year to the marketplace all the way to the vet and more physical availability. Those would be spaces.

SGLT2 is a brilliant idea. Kind of hard to [Technical Difficulty] of it. Are there competitors [Technical Difficulty] that you were aware of that other competitor doesn't have?

We do. I think you can argue that in a lot of spaces. I think as the industry is consolidated, there's definitely some areas of consolidation. That's why I think the broader aspects of, hey, reaching the world's animals, being able to go inside and outside the vet, being able to -- right now, through COVID, being able -- autoship has gone up significantly. With autoship comes compliance. The third trend behind that is Rx as a percentage. You put those 3 trends together, I think it's the ability to not only bring the innovation, but then when you have 1/3 of the U.S., and it's even worse than that outside of the U.S., people that are not going to the vet or now not want to go to the vet, being able to reach them where they want to shop is really important. So our goal is to build out platforms like diabetes, and then build out the ways to approach more and to globalize innovation faster. That will be something that Tim coming on to our team will focus on.

Right. Like [Technical Difficulty] inside, as an investor like [Technical Difficulty].

So we -- this is -- number one, it's our capital allocation priority. I mean, I would say to you that we're focused heavily on this. We reduced debt, $500 million this past year, as you know. The biggest driver will be as we look even at this year is net working capital, being able to manage the inventory down on our balance sheet, as we've had a cutover we're going to have in April on our system which I mentioned. That's going to take inventory up temporarily. Our goal and our finance team is focused, and manufacturing team on how to bring that down. That will be important. Driving sales, especially on the pet side with high margins is going to get that EBITDA over $1 billion and go. So we were very safe from a covenant perspective. We have had more debt come floating and will come this fall, as you know. But you can be assured that I believe we've got durable business with durable cash flow. We've taken our operating expense down over 10% again this past year. Even with inflation, we grew margin, we grew the EBITDA, and we've held our gross margin pretty well flat. So -- and we changed our incentive plans, just so you know that every employee starts every day having to beat the EBITDA. So I would argue to say, environmental conditions in the second half of the year have devalued. We think we're way undervalued, but we've got a very durable business that didn't change with the valuation. We've got steady cash flows, we've got lots of levers, and we're set up well as we end this year and going to next year.

Obviously, you have a lot going on, on the product area, a lot of launches upcoming. Maybe you can mention this triple dynamic. So how should we think about for all of this? How do you -- the next time spending license for our going trend?

Well, the most important line is the top line and that's the energy right now. And what I would say is even after, what I would call, a 6-month perfect storm of 7 or 8 things happening to us, we were down 3% constant currency after a year of up 5%. So I think it shows there's a lot of durable portfolio that is sustained. We continue to see, and I think animal health is seeing coming through the economic times, price at historical levels. And I think that we're going to be able to see -- we've said more than 2% price. That's going to drop to the bottom line, as you know. Innovation is going to be more accretive. So that's 2 to 3 percentage point as well, and I think less disruptions in our supply chain and supply. All of these things that I think are favorable and in China that is quite profitable as an affiliate as well. So I would start with the basics to say the top line. And then as innovation feeds it, one of the big criteria where the majority of our innovation is, it's got to outgrow our company and it's got to be more profitable to drive the margins up. So I start there by saying that is our energy as win share and focus on places where we can gain share and continue to take price in every market possible. We've increased pricing capabilities, supply chain capabilities. On operating expenses, we brought Bayer and Elanco together. We quickly consolidated 3 manufacturing sites. We've consolidated any SKUs. Our Finance and Oversight Committee looked at that. We've taken out again over $200 million of operating expenses, and we'll exceed our $400 million of synergy with Bayer. So what I would say is as we get the system, the final last piece of the system stand up in place, I would say that we will continue to find ways to drive OpEx, but the big step-downs have occurred. I would say, though, a question we get commonly asked, well, you're going to need a lot more operating expense to launch. We're getting the efficiencies and crossing money over to do that. There may be some on a quarter-to-quarter basis, but we don't see a major step-up needed in sales force marketing expense overall. There may be some nominal quarter-to-quarter, but nothing significantly to change our operating expense line. Gross margin is going to be driven a lot by bringing down net working capital and working hard to create more of an efficient supply chain. And I think the second is just the continued better margins on products that really aren't going to need a new manufacturing footprint. Okay?

Earlier, we're chatting about some of the macro factor of what you touched upon, but I'd like to elaborate on [Technical Difficulty] vet visit. So what does Elanco see kind of light...

Well, I think we saw that COVID increased in dogs in vet visits and I would say that what we're going to talk about even 3, 4 years from now, and I really believe this and we're seeing it in the data, is that COVID made the pet owners experience globally more convenient, and that convenience has improved. So why has visits stabilized or has come down some, but spend gone up, it's because auto ship is better, compliance is better. People are now what we're using 4 times a year, they're now 6, 7, 8 times a year. We were in the Chewy headquarters being a major retail customer to them and you see auto ship go up, you see compliance go up, and you see spend go up. I think that metric matters. And then I think behind that is also the ability to price behind that. So Steve, I think those are the things we're seeing. I think the thing to watch here in the short term is the capacity inside the clinics. The labor situation is getting better. We're hearing leading indicators of that, but we've got to watch that. That's one indicator. The other is the economic confidence in Europe. We've seen sell-out data continue to go down, and it got a little better in the last few months. But the Northern European market as we've seen consumers back down and back away, and we're hoping to seeing some early green shoots this year, hopefully that, that improves. At China pets, I would just highlight China pets, we've seen -- I was on the phone this morning with China. I mean, the actual major retailers, there's less vets in China. So retailers mattered. Vet dispensing shops, there's a lot of them that shut down, and they're kind of almost rebuilding the physical infrastructure after the COVID lockdowns. So those are the things to watch. But autoship compliance and spend are the things that I think we're seeing still remain resilient in this industry.

Now down to just a few minutes. And we kind of touched upon a lot of this already, but I think investors are most battling in operational capability is pipeline. What is it that investors -- they had to make better handle on it, will they have a different view on volume?

Well, I think that we -- let's get to the obvious first, which is, look, we've had a lot of change with Bayer coming in. There's been a continuous amount of change. And then the second half of 2022, it was an unstable year for a lot of markets, but it was for us, is I think the most important thing, Steve, is we've got a guide we're confident in and creating the stability and confidence quarter-to-quarter that I think is going to be the base, I think the first thing. And I think when we went through 2021 and we were delivering quarter after quarter, and that was most important, I think seeing the return to growth is going to be important. It is in the second half of the year. And I think this -- the belief in the pipeline actually seeing it come to the marketplace is important. What I would say is from last quarter to this quarter, our confidence remains even stronger. We brought a new blockbuster into the pipeline, into 2024 with Bovaer. These are, I think, rich big markets that are high-margin markets, that are high-growth markets. And Elanco's position and ready to actually go in and take share, I think that's probably not understood. There's been a lot of incremental innovation in animal health. Elanco's 6 blockbusters are big markets where we're positioned to be very competitive, a lot of them U.S. markets to take a lot of share. That's probably the ultimate probably, I wouldn't say, misunderstanding, but the biggest thing that's going to change the trajectory of the value of the company.

Prior to the pandemic, there was kind of a urging about the replacement by other protein sources, and there's been less talk about that. Where does that stand? And what is the trend of that?

Yes. We've seen consistent delivery -- consistent growth of protein, low single-digit growth, but it's been very persistent. GNP growth is the driver internationally. But actually on the western side, you continue to see we consumed more meat in the U.S. last year than ever, and you continue to see this western diet of less carbs and more protein. I think the biggest thing that's most important, Steve, here is the #1 reason the next generation is not consuming at the same levels is the impact on the environment more than on nutrition. And so for the beef industry, dairy and others, the importance of being able to say, hey, climate-neutral farming is a reality. We can actually have no impact on the footprint if we can handle enteric methane and do the right thing with waste. That will change, I think, and sustain the trajectory of animal protein. No one is predicting Rabobank or anyone that this is going to slow. We can't change the world's diet. We got to change some of the perceptions about what's happened on the footprint environment.

In our last few seconds, what do you -- what would be the biggest surprise to investors at Elanco 10 years from now? So what do you know about the company that you don't think investors are savvy to that 10 years from now we will realize that we missed that very important venue?

I think standing up a company to reach the world's animals is very difficult. We've spent about $1 billion for the last 4 years to go independent, stand up, integrate Bayer. But today, we can be over in over 100 countries, and we've reached 19 species of animals with SAP regulatory. So an SGLT2 inventor can't reach the world's cats, he comes to us. DSM last year. We got something that reduced methane. We need data. We need to reach farmers and veterinarians in an incredible way. No one can do it. DSM picks Elanco. They talked to all the major animal health companies. I believe that it's going to be very difficult for many more companies to say I'm going to build an independent company to reach the world's animals. And I believe that 10 years from now, we've got a company and a brand -- longest-standing brand in front of farmers, veterinarians and pet owners that can reach the world's animals. I think that is what is sustainable, different. That is our hedgehog that we can do best that I believe will be remembered 10 years from now.

That was exciting. So we look forward to monitoring your progress, and thank you for the discussion.

Thank you.